-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, U6NbDOvEMhK1yHu77o6gXTqBnfc39DHJx7z/TkbLOl4E6Z3eg5La/UeeLgelAZOy PSXT6tuWlXlbbc8pgjnUpw== 0000930661-99-000838.txt : 19990416 0000930661-99-000838.hdr.sgml : 19990416 ACCESSION NUMBER: 0000930661-99-000838 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990415 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SURETY CAPITAL CORP /DE/ CENTRAL INDEX KEY: 0000784932 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 752065607 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-12818 FILM NUMBER: 99594645 BUSINESS ADDRESS: STREET 1: 1845 PRECINCT LINE RD STE 100 CITY: HURST STATE: TX ZIP: 76054 BUSINESS PHONE: 8174982749 MAIL ADDRESS: STREET 1: 1845 PRECINCT LINE RD STE 100 CITY: HURST STATE: TX ZIP: 76054 FORMER COMPANY: FORMER CONFORMED NAME: K CAPITAL INC DATE OF NAME CHANGE: 19870407 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ________________ FORM 10-K Mark One [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 1998 --- Commission File Number 33-1983; OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period From ___________ to ___________. ____________________ SURETY CAPITAL CORPORATION (Exact name of Registrant as specified in its charter) Delaware 75-2065607 - -------------------------------------------------------------------------------- (State of Incorporation) (IRS Employer Identification No.) 1845 Precinct Line Road, Suite 100, Hurst, Texas 76054 - -------------------------------------------------------------------------------- (Address of Principal Executive Offices) (817) 498-2749 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered ------------------- --------------------- Common Stock, $0.01 par value American Stock Exchange - -------------------------------------------------------------------------------- Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 par value Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. --- The aggregate market value of Common Stock held by nonaffiliates of the Registrant, based on the quoted price of the Common Stock as reported on the American Stock Exchange on March 31, 1999, was $4,438,186. For purposes of this computation, all officers, directors and 5% beneficial owners of the Registrant are deemed to be affiliates. Such determination should not be deemed an admission that such officers, directors or 5% beneficial owners are, in fact, affiliates of the Registrant. As of March 31, 1999, 5,760,235 shares of Common Stock were outstanding. Documents Incorporated by Reference: Portions of the Company's Proxy ----------------------------------- Statement dated not later than 120 days after the end of the Company's most recent fiscal year, filed pursuant to Regulation 14A of the Securities Exchange Act of 1934 for the 1999 Annual Meeting of Stockholders of Surety Capital Corporation, are incorporated by reference into Part III. PART I ITEM 1. BUSINESS. General Surety Capital Corporation (the "Company"), a corporation incorporated under the laws of the state of Delaware in 1985, is a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the "BHC Act"). The Company owns all of the issued and outstanding shares of capital stock of Surety Bank, National Association, Hurst, Texas, formerly Texas Bank, National Association and formerly Texas National Bank (the "Bank"), with full service offices in Converse, Hurst, Midlothian, New Braunfels, San Antonio, Schertz, Universal City, Waxahachie, and Whitesboro, Texas. The Company's principal executive offices are located at 1845 Precinct Line Road, Suite 100, Hurst, Texas 76054, and its telephone number is 817-498-2749. The Bank's principal offices are located at 1845 Precinct Line Road, Suite 100, Hurst, Texas 76054, and its telephone number is 817-498-2749. The Company Surety Finance Company, the predecessor to the Company, commenced business in 1985 as a sole proprietorship owned by C. Jack Bean and Lorene Sims Bean. On December 30, 1989 the Company acquired approximately 98% of the common stock of the Bank and subsequently increased its ownership to 100%. Prior to acquisition of the Bank, the Company operated as a casualty insurance premium finance ("IPF") company licensed by the State of Texas. Upon its acquisition by the Company, the Bank began making IPF loans, and the Company ceased writing new IPF business to allow the Bank to succeed to the existing business of the Company at that time. The Company conducts all its operations through the Bank. Recent Developments The Company's net loss was $1.9 million for the year ended December 31, 1998, compared to a net loss of $3.5 million for the year December 31, 1997. The major factors contributing to the loss for 1998 were higher loan losses and charge-offs in the Bank's loan and medical claims receivable portfolios. See "Item 1. Business - Commercial and Consumer Banking," "Item 1. Business - Insurance Premium Financing," and "Item 1. Business - Medical Claims Factoring." On November 19, 1998, the Bank entered into a formal written agreement (the "Formal Agreement") with the Office of the Comptroller of the Currency (the "OCC") pursuant to which the Bank was required to achieve certain capital levels and adopt and implement certain plans, policies and strategies by March 31, 1999 and is required to achieve certain additional capital levels by December 31, 1999. Under the Formal Agreement, the Bank was required to achieve by March 31, 1999 total risk-based capital at least equal to 12% of risk-weighted assets and Tier I leverage capital at least equal to 7.5% of adjusted total assets, and is required to achieve by December 31, 1999 total risk-based capital at least equal to 14% of risk-weighted assets. At December 31, 1998 the Bank had total risk- based capital of 10.24% of risk weighted assets and Tier I leverage capital of 5.64% of adjusted total assets. The Bank failed to achieve the capital requirements of the Formal Agreement to be met by March 31, 1999. The Bank submitted a request to the OCC for an extension from March 31, 1999 to September 30, 1999 to meet the capital requirements of the Formal Agreement. The OCC granted the extension, subject to revocation based on the results of examinations by the OCC to be conducted in April and June of 1999 or if the OCC finds the Bank to not be in substantial compliance with the other articles of the Formal Agreement. See "Formal Agreement with the OCC" under "Item 1. Business - Supervision and Regulation: Regulation of the Bank." -2- In order to attain the capital levels and the leverage ratio required by the Formal Agreement, the Bank has decided to sell its Midlothian and Waxahachie branches (the "Branches"). See "Item 1. Business - Disposition of Assets." The Bank has entered into a definitive purchase and assumption agreement with respect to the sale of the Branches. If the sale is consummated, management of the Company believes the Bank will attain both the total risk-based capital levels and the leverage ratio required by the Formal Agreement. The consummation of the sale is subject to a number of contingencies, including due diligence review of the Branches by the prospective purchaser and receipt of all regulatory approvals. The prospective purchaser of the Branches is in the process of conducting a due diligence review of the Branches. If all contingencies are satisfied, the sale is expected to close between June 30, 1999 and September 30, 1999; however, no assurance can be given that the sale will close, or if the sale closes, that it will close by September 30, 1999. See "Formal Agreement with the OCC" under "Item 1. Business - Supervision and Regulation: Regulation of the Bank." Additionally, the Company, as a holding company without significant assets other than its ownership of all the common stock of the Bank, is dependent upon dividends received from the Bank in order to meet its cash obligations, including debt service on the $4,350,000 aggregate principal amount of 9% Convertible Subordinated Notes due 2008 (the "Notes"), issued under an indenture dated as of March 31, 1998 between the Company and Harris Trust and Savings Bank, Chicago, Illinois, as trustee (the "Indenture"). The Bank is currently precluded from declaring and paying any dividends under the Formal Agreement. The Company will attempt to secure a loan to meet its cash flow needs for the twelve months ended March 31, 2000, which includes servicing the interest payment on the Notes. After March 31, 2000, the Company will attempt to pay dividends from the Bank to the Company in an amount necessary to service the interest payments on the Notes and for general corporate purposes. No assurance can be given that the Company will be successful in such efforts in which event the Company may be required to restrict operations. See "Restrictions on Distribution of Subsidiary Bank Dividends and Assets" under "Item 1. Business - Supervision and Regulation: Regulation of the Bank." Acquisitions In April 1998 the Company acquired TexStar National Bank, Universal City, Texas ("TexStar"), with four branch locations in the greater San Antonio, Texas metropolitan area. At April 1, 1998, TexStar had $70.3 million in total assets, $64.8 million in deposits and $5.0 million in shareholders' equity. The purchase price for TexStar was approximately $19.36 per share of TexStar common stock outstanding (total cash consideration: $9,772,000), which was paid to the shareholders of TexStar in connection with the merger. The acquisition of TexStar was financed, in part, through a private placement by the Company of the Convertible Notes. In February 1996 the Company acquired First National Bank, Midlothian, Texas, with $53.8 million in assets, for $6,595,707. The Company financed the Midlothian acquisition through a $7,394,293 underwritten public offering of its Common Stock. Dispositions During 1998 the Company sold the Bank's four Lufkin-area branches located in Chester, Kennard, Lufkin, and Wells, Texas (the "Lufkin Branches") to Commercial Bank of Texas, National Association ("Commercial Bank"), Nacogdoches, Texas. The sale of the Lufkin Branches was consummated on October 16, 1998. As a result of the sale, a pretax gain of $1.1 million was recognized. The Bank sold loans totaling -3- approximately $10,912,000, real property, furniture and equipment totaling approximately $610,000, and cash and other assets totaling approximately $1,067,000, relieved goodwill and other assets associated with the Lufkin Branches by approximately $677,000, and Commercial Bank assumed deposits and other liabilities totaling approximately $56,936,000. After giving effect to a deposit premium of 3% on the deposits assumed totaling approximately $1,703,000, in addition to the cash at the Lufkin Branches, the Bank paid approximately $43,632,000 in cash to Commercial Bank as consideration for the net deposit liabilities assumed by Commercial Bank. On April 13, 1999 the Bank entered into a definitive Purchase and Assumption Agreement with The Citizens National Bank in Waxahachie, Waxahachie, Texas ("Citizens"), to sell to Citizens certain assets and assumption of certain liabilities of the Bank associated with the Bank's branches located in Midlothian and Waxahachie, Texas. Consummation of the transaction is subject to numerous contingencies, including a due diligence review of the Midlothian and Waxahachie branches by Citizens, and receipt of all necessary regulatory approvals. If all contingencies to closing are satisfied, the transaction is expected to close between June 30, 1999 and September 30, 1999. No assurance can be given, however, that the foregoing transaction will be consummated, and if consummated, that it will be consummated by September 30, 1999. The Bank The Bank was chartered as a national banking association in 1963. The Bank's principal offices are located at 1845 Precinct Line Road, Suite 100, Hurst, Texas 76054, and its telephone number is 817-498-2749. The Bank operates full service branches in Converse, Midlothian, New Braunfels, San Antonio, Schertz, Universal City, Waxahachie, and Whitesboro, Texas. The Bank's activities include both traditional community banking loans, such as commercial, real estate and consumer loans, and the niche lending product of insurance premium financing ("IPF"). At December 31, 1998 approximately 29.1%, 4.2%, 41.8% and 24.9% of the Company's total loan portfolio represented commercial loans, consumer banking loans, real estate loans, and IPF loans, respectively. Commercial and Consumer Banking The Company provides general commercial banking services for corporate and other business clients as a part of the Company's efforts to serve the local communities in which it operates. The Company's commercial loans are generally made to provide working capital, to finance the purchase of equipment, and for the expansion of existing businesses. These loans typically are secured by the assets of the businesses, including real estate, inventories, receivables, equipment and cash. The Bank usually requires that these loans also be guaranteed by the owners of the businesses. The average yield during the twelve months ended December 31, 1998 for the Company's consumer, commercial and real estate lending activities was 10.1%. The Company's commercial loans generally have maturities of twelve months or less. During 1998, the Bank had net charge- offs of $722,844 on its commercial and consumer loans. The losses were concentrated within used car floor plan lending losses of $399,000. Management has discontinued these type of lending activities. The Company provides a full range of consumer banking services, including checking accounts, "NOW" and "money market" accounts, savings programs, installment and real estate loans, money transfers and safe deposit facilities. -4- Insurance Premium Financing The Company distinguishes itself from other community banking organizations by supplementing its traditional community bank lending with its specialized niche lending product of insurance premium financing. The Company funds this specialized lending activity by using relatively low cost core retail deposits from its network of community banking offices which gives the Company a pricing advantage over non-bank competitors for its loan products. Insurance premium finance ("IPF") lending involves the lending of funds to companies and individuals for the purpose of financing their purchase of property and casualty insurance. The Company markets this product through over 1,100 independent insurance agents and maintains a loan portfolio consisting of insurance policies underwritten by nearly 1,850 insurance companies. At December 31, 1998 the Company reported total gross IPF loans of $24.9 million (approximately 25% of gross loans), as compared to the December 31, 1997 total balance of $40.3 million in IPF loans (40% of gross loans). The loans are relatively short term, generally with initial maturities of eight to ten months. The down payment and monthly installments on each loan are calculated so that in most cases the equity or value of the unearned premium in the policy exceeds the net balance due on the loan. If the borrower does not make the loan payments on time, the Company has the right, after notice to the borrower, to cancel the insurance policy and to receive the entire amount of the unearned premium from the insurance company writing the insurance. The unearned premium is then applied to the net loan balance. The Company charged off IPF loans net of recoveries in the amount of $1.8 million for the twelve months ended December 31, 1998, primarily related to IPF loans generated by the Bank's southeastern United States insurance premium financing operation headquartered in Atlanta, Georgia. As a result of the charge-offs, there was a substantial increase in the provision for credit losses on IPF loans and IPF loan charge-offs for the twelve months ended December 31, 1998. The Atlanta office has been closed and, with the exception of a few relationships, loan production from that market has been terminated. Management will continue to actively and aggressively attempt to collect the charged-off IPF loans. Management believes that all known losses in the IPF portfolio have been recognized. Medical Claims Factoring From 1990 through 1998 the Company was engaged in medical claims factoring, purchasing primarily insurance company claims from a variety of health care providers. Management has planned to discontinue the operations of the medical claims factoring division by June 1999. At December 31, 1998, the Company reported $646,000 in gross medical claims receivables, representing 0.44% of interest-bearing assets of the Company, after net charge-offs of $3.5 million against the allowance for medical claims receivable losses and a credit of $0.7 million to the allowance. The credit is attributed to the recovery of unearned revenue as a result of charge-offs accompanied by an overall reduction of the required reserve due to recoveries during 1998 of $956,024. The interest income from medical claims receivables accounted for 6.32% of the total gross interest income of the Company for 1998. The medical claims factoring receivables charged-off during the twelve month period ended December 31, 1998 were originated prior to December 31, 1997. The balance of medical claims factoring receivables net of unearned interest and allowance at December 31, 1998 was approximately $505,000 and is not expected to increase. Due to the existence of contractual commitments to nine customers of the Company and in order to enhance the collectibility of previously charged-off medical claims, the Company is continuing to factor new medical claims receivables on behalf of these nine customers. However, as such contractual commitments expire, they will not be renewed. Management expects that the Company will have totally discontinued factoring medical claims operations by June 30, 1999, except to actively pursue the collection of the charged-off -5- receivables. At this time, however, the Company cannot predict the likely amount of any such recoveries. Management believes that all known significant losses in the portfolio have been recognized. Competition There is significant competition among banks and bank holding companies in the market served by the Company, and the Company believes that such competition among such banks and bank holding companies, many of which have far greater assets and financial resources than the Company, will continue to increase in the future. The Company also encounters intense competition in its commercial and consumer banking business from savings and loan associations, credit unions, factors, insurance companies, commercial and captive finance companies, and certain other types of financial institutions, many of which are larger in terms of capital, resources and personnel. The casualty IPF business of the Company is also very competitive. Large insurance companies offer their own financing plans, and other independent premium finance companies and other financial institutions offer IPF loans. The Company believes that such competition will continue and increase in the future. In addition, the manner in which and the means by which financial services are delivered to customers have changed significantly in the past and can be expected to continue to change in the future. It is not possible to predict the manner in which existing technology, and changes in existing technology, will affect the Company. Changes in technology are likely to require additional capital investments to remain competitive. Although the Company has invested in new technology in the past, there can be no assurance that the Company will have sufficient financial resources or access to the proprietary technology which might be necessary to remain competitive in the future. Employees As of December 31, 1998 the Company had 132 full-time employees and 2 part- time employees. None of the Company's employees are subject to a collective bargaining agreement, and the Company believes that its employee relations are good. As of March 31, 1999 the Company has reduced its number of full-time employees to 119 in connection with its efforts to reduce non interest expense and correspondingly improve its efficiency ratio. SUPERVISION AND REGULATION General The Company and the Bank are subject to the generally applicable state and federal laws governing businesses and employers. The Company and the Bank are further regulated by special state and federal laws and regulations applicable only to financial institutions and their parent companies. Virtually all aspects of the Company's and the Bank's operations are subject to specific requirements or restrictions and general regulatory oversight, including laws regulating consumer finance transactions, such as the Truth in Lending Act, the Home Mortgage Disclosure Act and the Equal Credit Opportunity Act and laws regulating collections and confidentiality, such as the Fair Debt Collection Practices Act, the Fair Credit Reporting Act and the Right to Financial Privacy Act. The supervision and regulation of bank holding companies and their subsidiaries is intended primarily for the protection of depositors, the deposit insurance funds of the Federal Deposit Insurance Corporation ("FDIC") and the banking system as a whole, and not for the protection of bank holding company stockholders or creditors. To the extent that the following discussion describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statute or regulation. Any change in applicable laws, -6- regulations or policies of various regulatory authorities may have a material effect on the business, operations and prospects of the Company and the Bank. The Company is unable to predict the nature or the extent of the effects on its business or earnings that fiscal or monetary policies, economic control or new federal or state legislation may have in the future. Regulation of the Company The Company is a bank holding company registered under the BHC Act, and therefore is subject to regulation and supervision by the Board of Governors of the Federal Reserve System ("FRB"). The Company is required to file reports with, and to furnish such other information as, the FRB may require pursuant to the BHC Act, and to subject itself to examination by the FRB. The BHC Act and other federal laws subject bank holding companies to particular restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations. Certain violations may also result in criminal penalties. Regulatory Restrictions on Dividends; Source of Strength. It is the policy of the FRB that bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization's expected future needs and financial condition. This supports the FRB's position that, in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the FRB to be an unsafe and unsound banking practice or a violation of the FRB regulations or both. This doctrine has become known as the "source of strength" doctrine. As discussed below, a bank holding company in certain circumstances could be required to guarantee the capital plan of an undercapitalized banking subsidiary. Under the prompt corrective action provisions of the Federal Deposit Insurance Act, as amended ("FDIA"), any company which controls an undercapitalized bank can be required to guarantee compliance by the bank with a capital restoration plan. The aggregate liability of the holding company of an undercapitalized bank is limited to the lesser of 5% of the institution's assets at the time it became undercapitalized or the amount necessary to cause the institution to become "adequately capitalized." The bank regulators have greater power in situations where an institution becomes "significantly" or "critically" undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution can be required to obtain prior FRB approval of proposed dividends, or might be required to consent to a consolidation or to divest the troubled institution or other affiliates. In the event of a bank holding company's bankruptcy under Chapter 11 of the United States Bankruptcy Code, the trustee will be deemed to have assumed and is required to cure immediately any deficit under any commitment by the debtor holding company to any of the federal banking agencies to maintain the capital of an insured depository institution, and any claim for breach of such obligation will generally have priority over most unsecured claims. As of the date of this report the Company has neither the cash flow nor the financial flexibility to act as a source of strength for the Bank. Acquisitions of Control. The BHC Act and the Change in Bank Control Act, together with regulations promulgated by the FRB, require that, depending on the particular circumstances, either FRB approval must be obtained or notice must be furnished to the FRB and not disapproved prior to any person -7- or company acquiring "control" of a bank holding company, such as the Company, subject to certain exemptions for certain transactions. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person acquires 10% or more but less than 25% of any class of voting securities and either the company has registered securities under Section 12 of the Securities Exchange Act of 1934, as amended, or no other person will own a greater percentage of that class of voting securities immediately after the transaction. The regulations provide a procedure for challenge of the rebuttable control presumption. Control is rebuttably presumed not to exist if a company acquires less than 5% of any class of voting securities of a bank or a bank holding company. As a bank holding company, the Company is required to obtain approval from the FRB prior to merging or consolidating with any other bank holding company, acquiring all or substantially all of the assets of any bank or acquiring ownership or control of shares of a bank or bank holding company if, after the acquisition, the Company would directly or indirectly own or control 5% or more of the voting shares of such bank or bank holding company. In approving bank acquisitions by bank holding companies, the FRB is required to consider the financial and managerial resources and future prospects of the bank holding company and the banks concerned, the convenience and needs of the communities to be served and various competitive factors. Activities Closely Related to Banking. The BHC Act prohibits a bank holding company, with certain limited exceptions, from acquiring a direct or indirect interest in or control of more than 5% of the voting shares of any company which is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiary banks, except that it may engage in and may own shares of companies engaged in certain activities found by the FRB to be so closely related to banking or managing and controlling banks as to be a proper incident thereto. Some of the activities that have been determined by regulation to be closely related to banking include operating a mortgage, finance, credit card, or factoring company; performing certain data processing operations; providing investment and financial advice; acting as an insurance agent for certain types of credit-related insurance; leasing personal property on a full-payout, non-operating basis; and providing certain stock brokerage and investment advisory services. In approving acquisitions by bank holding companies of companies engaged in banking related activities or the addition of activities, the FRB considers whether the acquisition or the additional activities can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh such possible adverse effects as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. The FRB is also empowered to differentiate between activities commenced de novo and activities commenced through acquisition of a going concern. The BHC Act generally imposes certain limitations on transactions by and between banks that are members of the Federal Reserve System and other banks and non-bank companies in the same holding company structure, including limitations on extensions of credit (including guarantees of loans) by a bank to affiliates, investments in the stock or other securities of a bank holding company by its subsidiary bank, and the nature and amount of collateral that a bank may accept from any affiliate to secure loans extended to the affiliate. A bank holding company, as an affiliate of a bank, is also subject to these restrictions. Anti-Tying Restrictions. Under the BHC Act and FRB regulations, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. Securities Activities. The FRB has approved applications by bank holding companies to engage, through nonbank subsidiaries, in certain securities-related activities (underwriting of municipal revenue -8- bonds, commercial paper, consumer receivable-related activities and one-to-four family mortgage-backed securities), provided that the affiliates would not be "principally engaged" in such activities for purposes of Section 20 of the Glass-Steagall Act. In limited situations, holding companies may be able to use such subsidiaries to underwrite and deal in corporate debt and equity securities. Safe and Sound Banking Practices. Bank holding companies are not permitted to engage in unsafe or unsound banking practices. The FRB's Regulation Y, for example, generally requires a bank holding company to give the FRB prior notice of any redemption or repurchase of its own securities, if the consideration to be paid, together with the consideration paid for any repurchases or redemptions in the preceding year, is equal to 10% or more of the company's consolidated net worth. The FRB may oppose the transaction if it believes that the transaction would constitute an unsafe or unsound practice or would violate any law or regulation. Depending on the circumstances, the FRB could take the position that paying a dividend would constitute an unsafe or unsound banking practice. The FRB has broad authority to prohibit activities of bank holding companies and their nonbanking subsidiaries which represent unsafe and unsound banking practices or which constitute violations of laws or regulations, and can assess civil money penalties for certain activities conducted on a knowing and reckless basis, if those activities caused a substantial loss to a depository institution. The penalties can be as high as $1,000,000 for each day the activity continues. Regulation of the Bank The Bank is a national banking association and therefore is subject to regulation, supervision and examination by the Office of the Comptroller of the Currency ("OCC"). The Bank is also a member of the FRB and the FDIC. Requirements and restrictions under the laws of the United States include a reserves requirement, restrictions on the nature and the amount of loans which can be made, restrictions on the business activities in which a bank may engage, restrictions on the payment of dividends to shareholders, and minimum capital requirements. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital Resources." Because the FRB regulates the bank holding company parent of the Bank, the FRB also has supervisory authority which directly affects the Bank. In addition, upon making certain determinations with respect to the condition of any insured national bank, such as the Bank, the FDIC may begin proceedings to terminate a bank's federal deposit insurance. Formal Agreement with the OCC. On November 19, 1998 the Board of Directors of the Bank entered into a formal written agreement with the OCC (the "Formal Agreement") pursuant to which the Bank was required to achieve certain capital levels and adopt and implement certain plans, policies and strategies by March 31, 1999 and is required to achieve certain additional capital levels by December 31, 1999. Under the Formal Agreement, the Bank was required to achieve by March 31, 1999 total risk-based capital at least equal to 12% of risk- weighted assets and Tier I leverage capital at least equal to 7.5% of adjusted total assets, and is required to achieve by December 31, 1999 total risk-based capital at least equal to 14% of risk-weighted assets. At December 31, 1998 the Bank had total risk-based capital of 10.24% of risk weighted assets and Tier I leverage capital of 5.64% of adjusted total assets. The Bank failed to achieve the requirements of the Formal Agreement to be met by March 31, 1999. The Bank submitted a request to the OCC for an extension from March 31, 1999 to September 30, 1999 to meet the capital requirements of the Formal Agreement. The OCC granted the extension, subject to revocation based on the results of examinations by the OCC to be conducted in April and June of 1999 or if the OCC finds the Bank to not be in substantial compliance with the other articles of the Formal Agreement. Management expects to achieve the December 31, 1999 Formal Agreement capital requirements of total risk-based capital ratio at least equal to 14% of risk-weighted assets and Tier I leverage capital at least equal to 7.5% upon completion of the sale of the branches located in Midlothian and Waxahachie, Texas. -9- Additionally, pursuant to the Formal Agreement the Board of Directors is required to develop a three year capital plan program, a plan to enhance its management information systems, a three year strategic plan establishing objectives for the Bank's earnings performance, growth, balance sheet mix, off- balance sheet activities, liability structure, capital adequacy, reduction in the volume of non-performing assets, product line development and market segments which the Bank intends to promote or develop, together with strategies to achieve those objectives, a revised loan policy, and a loan classification policy, each for submission to, and approval by, the OCC. Management has implemented each of the OCC recommended enhancements, and the three year capital plan, the plan to enhance Bank's management information systems and the three year strategic plan have been adopted by the Bank's Board of Directors and have been submitted to the OCC for their approval. The Bank is in the process of selling its Midlothian and Waxahachie branches (the "Branches") in order to attain the capital levels and leverage ratio required by the Formal Agreement. See "Item 1. Business - Disposition of Assets." The Bank has entered into a definitive purchase and assumption agreement with respect to the sale of the Branches. If the sale is consummated, management of the Company believes that the Bank will attain both the total risk-based capital levels and the leverage ratio required by the Formal Agreement. The consummation of the sale is subject to a number of contingencies, including receipt of all regulatory approvals. If all contingencies are satisfied, the sale is expected to close between June 30, 1999 and September 30, 1999; however, no assurance can be given that the sale will close, or if the sale closes, that it will close by September 30, 1999. The OCC has extensive enforcement authority over the operations of all national banks, including the Bank. In the event the Company fails to comply with the Formal Agreement, the OCC may under certain circumstances assess civil monetary damages against the Bank and the Directors of the Bank, issue cease- and-desist or removal orders and initiate injunctive actions. Additionally, the OCC may impose a number of corrective measures on the Bank, including (1) the imposition of restrictions on certain activities involving asset growth, acquisitions, branch establishment, expansion into new lines of business, declaration and payment of dividends, and transactions with affiliates, (2) the imposition of certain additional mandated capital raising activities, and (3) merger or sale of the Bank. The Formal Agreement also prohibits the Board of Directors from declaring or paying any dividends unless the Bank (1) is in compliance with 12 U.S.C. (S)(S) 56 and 60 (see "Restrictions on Distribution of Subsidiary Bank Dividends and Assets" under "Item 1. Business - Supervision and Regulation: Regulation of Bank"), its approved capital program provided for in the Formal Agreement, and the capital levels set forth in the Formal Agreement, as more fully described above, and (2) has obtained the prior written approval of the OCC. Restrictions on Distribution of Subsidiary Bank Dividends and Assets. The Company owns all the outstanding common stock of the Bank. As a holding company without significant assets other than its ownership of all the common stock of the Bank, the Company's ability to meet its cash obligations, including debt service on the $4,350,000 aggregate principal amount of the Notes is almost entirely dependent upon the payment of dividends by the Bank on its common stock. The declaration and payment of dividends by the Bank is subject to the discretion of the Board of Directors of the Bank and is restricted by the national banking laws and the regulations of the OCC, as well as by the Formal Agreement. Pursuant to 12 U.S.C. (S) 56, a national bank may not pay dividends from its capital. All dividends must be paid out of undivided profits, subject to other applicable provisions of law. As of December 31, 1998, the Bank has undivided profits of $1,249,490. Payment of dividends out of undivided profits is -10- further limited by 12 U.S.C. (S) 60(a), which prohibits a national bank from declaring a dividend on its shares of common stock until its surplus equals its common capital, unless there has been transferred to surplus not less than 1/10th of the national bank's net income of the preceding half year in the case of quarterly or semi-annual dividends or not less than 1/10th of the national bank's net income of the preceding two consecutive half year periods in the case of annual dividends. The payment of dividends by the Bank is also subject to the provisions of 12 U.S.C. (S) 60(b), which provides that no dividend may be declared or paid without the prior approval of the OCC if the total of all dividends, including the proposed dividend, in any calendar year exceeds the total of the Bank's net income for that year combined with its retained net income (or loss) of the preceding two years. The Bank incurred an aggregated loss for fiscal years 1997 and 1998 in the amount of ($4,707,359). Furthermore, under federal law, a bank cannot pay a dividend if after paying the dividend, the bank will be "undercapitalized." Moreover, the OCC may find a dividend payment that meets all of the foregoing statutory requirements to be an unsafe and unsound practice and on those grounds prohibit the dividend. Additionally, the Formal Agreement prohibits the Board of Directors of the Bank from declaring or paying any dividends unless the Bank (1) is in compliance with 12 U.S.C. (S)(S) 56 and 60, its approved capital program provided for in the Formal Agreement, and the Tier I capital levels set forth in the Formal Agreement, and (2) has obtained the prior written approval of the OCC. See "Formal Agreement with the OCC" under "Item 1. Business - Supervision and Regulation: Regulation of the Bank." The Company as a stand alone entity had sufficient cash on hand at March 31, 1999 to pay interest accrued under the Notes as of March 31, 1999. After the payment of the March 31, 1999 interest payment on the Notes the Company had $61,000 in cash remaining for future operating expenses. Therefore, the Company does not have sufficient cash to pay the next installment of interest under the Notes due on September 30, 1999. Until the restrictions under the Formal Agreement are lifted and the Bank satisfies the other statutory and regulatory requirements with respect to the payment of dividends, the Bank is precluded from paying a dividend to the Company. In order to meet its future operating expenses, including its interest obligations under the Notes, the Company will have to raise capital through borrowings from financial institutions or issuances of equity securities and subordinated debt instruments. The Company will attempt to secure a loan to meet its cash flow needs for the twelve months ended March 31, 2000, which includes servicing the interest payment on the Notes. After March 31, 2000, the Company expects to be permitted to pay dividends from the Bank to the Company in an amount necessary to service the interest payments on the Notes and for general corporate purposes. There can be no assurance that the financing can be obtained on satisfactory terms or that the Bank will be permitted to pay dividends to the Company by March 31, 2000. In this event, the Company could be required to restrict its operations. In the event the Company is unable to receive dividends from the Bank or to borrow funds or raise additional capital from outside sources, the Company will not be able to pay accrued interest under the Notes and will be in default under the Notes. The Indenture pursuant to which the Notes are issued does not provide for any right of acceleration of the payment of the Notes as a result of any failure of the Company timely to pay principal of and interest on the Notes, or to comply with the covenants contained in the Indenture. The Notes may only be accelerated in the event of the bankruptcy, insolvency or reorganization of the Company. In the event of a default in the payment of interest, principal or premium, if any, by the Company, or the failure of the Company to perform any covenants or agreements contained in the Indenture, the holder of the Note (or the Trustee on behalf of the holders of all the Notes affected) may, in lieu of accelerating the maturity of the Notes, seek to enforce payment of such interest, principal or premium, if any, and the performance of such covenants or agreements. The initiation of such a course of action by the holders of the Notes in the event of the failure of the Company to meet its debt servicing -11- obligations under the Notes could have a significant adverse impact on the future operations of the Company. Because the Company is a legal entity separate and distinct from its subsidiaries, its right to participate in the distribution of assets of any subsidiary upon the subsidiary's liquidation or reorganization will be subject to the prior claims of the subsidiary's creditors. In the event of a liquidation or other resolution of an insured depository institution, the claims of depositors and other general or subordinated creditors are entitled to a priority of payment over the claims of holders of any obligation of the institution to its stockholders, including any depository institution holding company (such as the Company) or any stockholder or creditor thereof. Limitations on Interest Charges. Federal and Texas state laws generally limit the amount of interest and fees which lenders, including the Bank, may charge regarding loans. The applicable law, and the applicable limits, may vary depending upon, among other things, the identity, nature and location of the lender, and the type of loan or collateral. In Texas, the maximum interest rate applicable to most loans changes with changes in the average auction rate for United States Treasury Bills, but does not decline below 18% or rise above 24% (except for certain loans in excess of $250,000 for which the maximum annual rate may not rise above 28%). However, the interest which may be charged on an insurance premium financing loan is regulated by the Texas Department of Insurance and is governed by the Texas Consumer Loan Law. The Texas Consumer Loan Law provides that for regular transactions (loans payable in consecutive monthly installments of substantially equal amounts with the first installment due within one month and 15 days after the date of the loan), the maximum interest rate may not exceed the amount of add-on rate equal to $18 per $100 per year on the first $1,380 and $8 per $100 on amounts of $1,380 up to $11,500. These amounts are subject to adjustments as of July 1 of each year under the Texas adjustment of dollar amounts provisions. Branching. National banks may establish a branch anywhere in Texas provided that the branch is approved in advance by the OCC, which considers a number of factors, including financial history, capital adequacy, earnings prospects, character of management, needs of the community and consistency with corporate powers. The Interstate Banking Act, which expanded the authority of bank holding companies and banks to engage in interstate bank acquisitions and interstate banking, allows each state the option of "opting out" of the interstate branching (but not banking) provisions. The Texas Legislature opted out of the interstate branching provisions in 1995. Interstate banking was effective on September 25, 1995, and interstate branching would have become effective in Texas in June 1997 if Texas had not elected to opt out. The Texas legislation prohibiting interstate branching is effective until September 1999. Corrective Measures for Capital Deficiencies. FDIA requires the OCC to take "prompt corrective action" with respect to any national bank which does not meet specified minimum capital requirements. The applicable regulations establish five capital levels, ranging from "well-capitalized" to "critically undercapitalized," and require or permit the OCC to take supervisory action regarding any national bank that is not at least "adequately capitalized." Under these regulations, a national bank is considered "well capitalized" if it has a total risk-based capital ratio of 10% or greater, a Tier I risk-based capital ratio of 6% or greater, a leverage ratio of 5% or greater, and it is not subject to any order, written agreement or directive to meet and maintain a specific capital level for any capital measure. A national bank is considered "adequately capitalized" if it has a total risk-based capital ratio of 8% or greater, a Tier I risk-based capital ratio of 4% or greater, and a leverage capital ratio of 4% or greater (3% or greater if the institution was rated a CAMEL 1 in its most recent report of examination and is not experiencing significant growth), and the institution does not meet the definition of an undercapitalized institution. A national bank is considered "undercapitalized" if it has a total risk-based capital ratio that is less than 8%, a Tier I risk- based capital ratio that is less than 4%, or a leverage ratio that is less than 4% (or a leverage -12- ratio that is less than 3% if the institution was rated CAMEL 1 in its most recent report of examination, subject to appropriate federal banking agency guidelines). A "significantly undercapitalized" institution is one which has a total risk-based capital ratio that is less than 6%, a Tier I risk-based capital ratio that is less than 3%, or a leverage ratio that is less than 3%. A "critically undercapitalized" institution is one which has a ratio of tangible equity to total assets that is equal to or less than 2%. With certain exceptions, national banks will be prohibited from making capital distributions or paying management fees if the payment of such distributions or fees will cause them to become undercapitalized. Furthermore, undercapitalized national banks will be required to file capital restoration plans with the OCC. Undercapitalized national banks also will be subject to restrictions on growth, acquisitions, branching and engaging in new lines of business unless they have an approved capital plan that permits otherwise. The OCC also may, among other things, require an undercapitalized national bank to issue shares or obligations, which could be voting stock, to recapitalize the institution or, under certain circumstances, to divest itself of any subsidiary. The OCC is authorized to take various enforcement actions against any significantly undercapitalized national bank and any undercapitalized national bank that fails to submit an acceptable capital restoration plan or fails to implement a plan accepted by the OCC. The powers include, among other things, requiring the institution to be recapitalized, prohibiting asset growth, restricting interest rates paid, requiring prior approval of capital distributions by any bank holding company which controls the institution, requiring divestiture by the institution of its subsidiaries or by the holding company of the institution itself, requiring a new election of directors and requiring the dismissal of directors and officers. As an institution's capital decreases, the OCC's enforcement powers become more severe. A significantly undercapitalized institution is subject to mandated capital raising activities, restrictions on interest rates paid and transactions with affiliates, removal of management and other restrictions. The OCC has only very limited discretion in dealing with a critically undercapitalized institution and is virtually required to appoint a receiver or conservator. Based on its capital ratios as of December 31, 1998 and exclusive of the Formal Agreement, the Bank was "adequately capitalized" under the applicable regulations. However, if the Bank were to become undercapitalized and these restrictions were to be imposed, the restrictions, either individually or in the aggregate, could have a significant adverse effect on the operations of the Bank. Additionally, the Bank is not in compliance with certain capital level and leverage ratio requirements set forth in the Formal Agreement, which may result in the imposition of certain regulatory sanctions by the OCC. See "Formal Agreement with the OCC" under "Item 1. Business - Supervision and Regulation: Regulation of the Bank." Capital Adequacy Guidelines. Capital management consists of providing equity to support both current and future operations. The Company is subject to capital adequacy requirements issued by the FRB and the Bank is subject to similar requirements imposed by the OCC. The various federal bank regulatory agencies, including the FRB and the OCC, have adopted risk-based capital requirements for assessing bank holding company and bank capital adequacy. These standards define capital and establish minimum capital requirements in relation to assets and off-balance sheet exposure, adjusted for credit risk. The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profile among bank holding companies and banks, to account for off- balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate relative risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. -13- The minimum standard for the ratio of Tier I capital to total risk-weighted assets is 4% and the ratio of total capital to risk-weighted assets (including certain off-balance sheet obligations, such as standby letters of credit) is 8%. At least half of the risk-based capital must consist of common equity, retained earnings, and qualifying perpetual preferred stock, less deductions for goodwill and various other intangibles ("Tier I capital"). The remainder may consist of a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, preferred stock, and a limited amount of the general valuation allowance for loan losses ("Tier II capital"). The sum of Tier I capital and Tier II capital is "total risk-based capital." See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." The FRB (for the Company) and the OCC (for the Bank) have also adopted guidelines which supplement the risk-based capital guidelines with a minimum leverage ratio of Tier I capital to average total consolidated assets ("leverage ratio") of 3% for institutions with well diversified risk (including no undue interest rate exposure; excellent asset quality; high liquidity; good earnings); that are generally considered to be strong banking organizations (rated a CAMEL 1 under applicable federal guidelines); and that are not experiencing or anticipating significant growth. Other banking organizations are required to maintain a leverage ratio of at least 4% to 5%. These rules further provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain capital positions substantially above the minimum supervisory levels and comparable to peer group averages, without significant reliance on intangible assets. The FRB continues to consider a "tangible Tier I leverage ratio" in evaluating proposals for expanding activities by bank holding companies. The tangible Tier I leverage ratio is the ratio of a banking organization's Tier I capital (less deductions for intangibles otherwise includable in Tier I capital) to total tangible assets. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital Resources" for a discussion of the Company's and the Bank's Tier I and Tier II capital ratios. Bank regulators may raise capital requirements applicable to banking organizations beyond current levels, as is the case with the Bank. Due to recent significant increases in the provision for credit losses and charge-offs on IPF and medical claims factoring receivables, the Board of Directors of the Bank on November 19, 1998 entered into the Formal Agreement pursuant to which the Bank is required to achieve certain capital levels and adopt and implement certain plans, policies and strategies. Under the Formal Agreement, the Bank was required to achieve by March 31, 1999 total risk-based capital at least equal to 12% of risk-weighted assets and Tier I leverage capital at least equal to 7.5% of adjusted total assets, and is required to achieve by December 31, 1999 total risk-based capital at least equal to 14% of risk-weighted assets. The table below sets forth the capital requirements for the Bank under the Capital Adequacy Guidelines of the OCC and the Formal Agreement:
Actual Formal Agreement OCC Regulations ------------------------------------------ --------------------------------- ---------------------------- Capital Ratios Capital Ratios September 30, December 31, Adequately Well December 31, 1998 December 31, 1997 1999(2) 1999 Capitalized Capitalized ------------------- ------------------ --------------------------------- -------------- ----------- Leverage(1) 5.64% 6.24% 7.50% 7.50% 4.00% 5.00% Risk-Based Capital: Tier I 8.98% 9.92% 6.00% 6.00% 4.00% 6.00% Tier I & II 10.24% 11.28% 12.00% 14.00% 8.00% 10.00%
-14- (1) Calculated as adjusted assets divided by adjusted equity at December 31, 1998 and 1997. (2) As extended from March 31, 1999. See "Item 1. Business - Insurance Premium Financing," "Item 1. Business - Medical Claims Factoring," "Formal Agreement with the OCC" under "Item 1. Business - Supervision and Regulation: Regulation of the Bank" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital Resources." Restrictions of Transactions with Affiliates and Insiders. Transactions between the Bank and its nonbanking affiliates, including the Company, are subject to Section 23A of the Federal Reserve Act. In general, Section 23A imposes limits on the amount of such transactions and also requires certain levels of collateral for loans to affiliates parties. It also limits the amount of advances to third parties which are collateralized by the securities or obligations of the Company or its subsidiaries. Affiliate transactions are also subject to Section 23B of the Federal Reserve Act which generally requires that certain transactions between the Bank and its affiliates be on terms substantially the same, or at least as favorable to the Bank, as those prevailing at the time for comparable transactions with or involving nonaffiliated persons. The restrictions on loans to directors, executive officers, principal stockholders and their related interests (collectively referred to herein as "insiders") contained in the Federal Reserve Act and Regulation O apply to all insured institutions and their subsidiaries and holding companies. These restrictions include limits on loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate limitation on all loans to insiders and their related interests. These loans cannot exceed the institution's total unimpaired capital and surplus, and the OCC may determine that a lesser amount is appropriate. Insiders are subject to enforcement actions for knowingly accepting loans in violation of applicable restrictions. Examinations. The OCC periodically examines and evaluates national banks. Based upon such an evaluation, the OCC may revalue the assets of the institution and require that it establish specific reserves to compensate for the difference between the OCC-determined value and the book value of such assets. Audit Reports. Insured institutions with total assets of $500 million or more must submit annual audit reports prepared by independent auditors to federal and state regulators. In some instances, the audit report of the institution's holding company can be used to satisfy this requirement. Auditors must receive examination reports, supervisory agreements and reports of enforcement actions. In addition, financial statements prepared in accordance with generally accepted accounting principles, management's certifications concerning responsibility for the financial statements, internal controls and compliance with legal requirements designated by the FDIC, and an attestation by the auditor regarding the statements of management relating to the internal controls must be submitted. For institutions with total assets of more than $3 billion, independent auditors may be required to review quarterly financial statements. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") requires that independent audit committees be formed, consisting of outside directors only. The committees of such institutions must include members with experience in banking or financial management, must have access to outside counsel and must not include representatives of large customers. At present, these requirements do not apply to the Bank, since total assets are substantially below $500 million. -15- Brokered Deposit Restrictions. Adequately capitalized institutions cannot accept, renew or roll over brokered deposits except with a waiver from the OCC, and are subject to restrictions on the interest rates that can be paid on such deposits. Undercapitalized institutions may not accept, renew or roll over brokered deposits. Cross-Guarantee Provisions. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") contains a "cross-guarantee" provision which generally makes commonly controlled insured depository institutions liable to the FDIC for any losses incurred in connection with the failure of a commonly controlled depository institution. Deposit Insurance Assessments. Deposits held by the Bank are insured by the Bank Insurance Fund ("BIF") of the FDIC. The FDIC assessment is calculated on the level of deposits held by the Bank. The BIF assessment rate is determined by the FDIC for categories of banks based upon the risk to the insurance fund. An institution's risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to the regulators. In addition, the FDIC can impose special assessments in certain instances. The current range of BIF assessments is between zero and 27 cents per $100 in assessable deposits. The FDIC has also established a process for raising or lowering all rates for insured institutions semi-annually if conditions warrant a change. Under this system, the FDIC has the flexibility to adjust the assessment rate schedule twice a year without seeking prior public comment, but only within a range of five cents per $100 above or below the premium schedule adopted. Changes in the rate schedule outside the five cent range above or below the current schedule can be made by the FDIC only after a full rulemaking with opportunity for public comment. The FDIC assessment for the twelve months ended December 31, 1998 was $69,976. The FDIC assessment for the first quarter of 1999 was $146,792. The increased FDIC assessment is attributed to a higher risk assessment by the FDIC. In November 1996 the FDIC's Board of Directors approved an assessment against BIF-assessable deposits to be paid to the Financing Corporation ("FICO") to assist in paying interest on FICO bonds, which financed the resolution of the thrift industry crisis. The FICO assessment is approximately 1.22 basis points, on an annual basis, on BIF-insured deposits. Community Reinvestment Act of 1977 ("CRA"). Under the CRA, a bank's applicable regulatory authority (which is the OCC for the Bank) is required to assess the record of each financial institution which it regulates to determine if the institution meets the credit needs of its entire community, including low- and moderate-income neighborhoods served by the institution, and to take that record into account in its evaluation of any application made by such institution for, among other things, approval of the acquisition or establishment of a branch or other deposit facility, an office relocation, a merger, or the acquisition of shares of capital stock of another financial institution. The regulatory authority prepares a written evaluation of an institution's record of meeting the credit needs of its entire community and assigns a rating. The Bank has undertaken significant actions to comply with the CRA, and received a "satisfactory" rating in its most recent review by federal regulators with respect to its compliance with the CRA. Both the United States Congress and the banking regulatory authorities have proposed substantial changes to the CRA and fair lending laws, rules and regulations, and there can be no certainty as to the effect, if any, that any such changes would have on the Bank. Instability of Regulatory Structure. Various legislation, including proposals to overhaul the bank regulatory system, expand the powers of banking institutions and bank holding companies and limit investments that a depository institution may make with insured funds, is from time to time introduced in Congress. Such legislation may change banking statutes and the operating environment of the Company and the Bank in substantial and unpredictable ways. The Company cannot determine the ultimate effect -16- that potential legislation, if enacted, or implementing regulations with respect thereto, would have upon the financial condition or results of operations of the Company or the Bank. Expanding Enforcement Authority. One of the major additional burdens imposed on the banking industry by FDICIA is the increased ability of banking regulators to monitor the activities of banks and their holding companies. In addition, the FRB, OCC and FDIC possess extensive authority to police unsafe or unsound practices and violations of applicable laws and regulations by depository institutions and their holding companies. For example, the FDIC may terminate the deposit insurance of any institution which it determines has engaged in an unsafe or unsound practice. The agencies can also assess civil money penalties, issue cease and desist or removal orders, seek injunctions, and publicly disclose such actions. FDICIA, FIRREA and other laws have expanded the agencies' authority in recent years, and the agencies have not yet fully tested the limits of their powers. Effect on Economic Environment. The policies of regulatory authorities, including the monetary policy of the FRB, have a significant effect on the operating results of bank holding companies and their subsidiaries. Among the means available to the FRB to affect the money supply are open market operations in United States government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits and their use may affect interest rates charged on loan or paid for deposits. FRB monetary policies have materially affected the operating results of commercial banks in the past and are expected to continue to do so in the future. The nature of future monetary policies and the effect of such policies on the business and earnings of the Company and its subsidiaries cannot be predicted. ITEM 2. PROPERTIES. The Company has nine full-service banking facilities, located in Converse, Hurst, Midlothian, New Braunfels, San Antonio, Schertz, Universal City, Waxahachie, and Whitesboro, Texas. The Company believes the existing facilities are adequate for its present needs. The following chart provides information about the Company's existing facilities. -17-
Deposits at Branch/Office Sq. Ft. Location/Ownership December 31, 1998 Converse 3,750 9154 FM 78 $ 13,641,657 Converse, Texas 78109 Owned Hurst 14,810 1845 Precinct Line Road $ 6,448,770 Suite 100 Hurst, Texas 76054 Leased Midlothian(1) 17,116 910 North 9th Street $ 44,872,361 Midlothian, Texas 76065 Owned New Braunfels 1,250 1012 IH 35 South $ 1,262,313 New Braunfels, Texas 78130 Leased San Antonio 2,800 426 Wolfe $ 1,266,428 San Antonio, Texas 78216 Owned Schertz 1,000 420 Schertz Parkway $ 9,113,606 Schertz, Texas 78154 Leased Universal City 12,000 600 Pat Booker Road $ 31,399,201 Universal City, Texas 78148 Owned Waxahachie(1) 19,186 104 Elm Street $ 13,101,066 Waxahachie, Texas 75165 Owned Whitesboro 6,365 2500 Highway 82 East $ 34,057,999 Whitesboro, Texas 76263 Owned Total $155,163,401 ============
(1) Planned to be sold during 1999. See "Item 1. Business - Recent Developments" for a discussion of the pending sales. ITEM 3. LEGAL PROCEEDINGS. Surety Bank, National Association (the "Bank") is a defendant in two related cases: Tennessee, ex.rel., Douglas Sizemore, Commissioner of Commerce and Insurance for the State of Tennessee, et al. vs. Surety Bank, N.A., filed in June 1995 in the Federal District Court for the Northern District of Texas, Dallas, Division (the "Anchorage Case"), and United Shortline, Inc. Assurance Services, N.A. et al. vs. MacGregor General Insurance Company, Ltd., et al., now pending in the 141st Judicial District Court of Tarrant County, Texas (the "MacGregor Case"). The plaintiff in the Anchorage case is the Tennessee Commissioner of Commerce and Insurance ("Tennessee"), appointed by the Chancery Court for the State of Tennessee, Twentieth Judicial District, Davidson County, to liquidate Anchorage Fire and Casualty Insurance Company ("Anchorage"), including Anchorage deposits at the Bank. Tennessee sought to recover compensatory and punitive damages on various alleged causes of action, including violation of orders issued by a Tennessee court, fraudulent and preferential transfers, common law conversion, fraud, negligence, and bad faith, all of which are based on the same underlying facts and alleged course of conduct. Both the Anchorage case as well as the MacGregor case arise out of the Bank's alleged exercise of control over funds, representing the Bank's collateral, held in accounts at the Bank under agreements with Anchorage and MacGregor. The Bank asserts that it had a right to exercise control over its collateral under contractual agreements between the Bank and the respective insurance companies or the Bank and the policy holders. The Bank also contends that it had a right to exercise control over its collateral to protect itself against the possibility of inconsistent orders regarding the same funds. Tennessee seeks to recover funds allegedly transferred in and out of Anchorage/MacGregor accounts at the Bank during an approximate four month period in 1993. Tennessee also claims that the Bank allegedly transferred funds in and out of Anchorage accounts after receiving notice of a court order prohibiting such transfer. Tennessee is claiming damages in excess of $2,000,000. The Anchorage case was called to trial in July 1998, where, immediately before trial was to begin, the court granted summary judgment in favor of the Bank and entered a take nothing judgment against the Plaintiff. Tennessee has since appealed the trial court's summary judgment to the Fifth Circuit Court of Appeals, where that appeal is pending. The Plaintiff in the MacGregor case, United Shortline, Inc. Assurance Services, N.A. ("Shortline"), purports to be the holder of a Florida judgment against MacGregor General Insurance Company, Ltd. ("MacGregor"), who seeks to recover funds allegedly belonging to MacGregor which were held by the Bank. When the MacGregor case was initially filed, Shortline sought a restraining order against the Bank concerning the MacGregor funds. When the Bank received notice of competing claims to some or all of those funds by Tennessee, the Bank intervened and interpled approximately $600,000 into the court's registry. Shortline now seeks, inter alia, damages against the Bank from an alleged wrongful offset wherein the Bank allegedly exercised control over the MacGregor funds at the Bank pursuant to agreements with MacGregor. The Bank moved for and obtained a summary judgment that its intervention and interpleader of funds was proper. Shortline also sought and obtained a summary judgment from the trial court that the funds interpled by the Bank into the court's registry belonged to Shortline. Tennessee appealed the summary judgment to the Fort Worth Court of Appeals. The Fort Worth Court of Appeals affirmed the trial court's ruling that the Bank's intervention and interpleader was proper but reversed the trial court's ruling that the funds in the court belonged to Shortline. Tennessee then appealed that ruling to the Texas -18- Supreme Court which affirmed the judgment of the Court of Appeals. This case has recently been remanded to the trial court for disposition of the remaining issues. The Bank believes both of these cases lack merit and will continue to defend them vigorously. The final outcome of both of these cases is uncertain at this time. The Bank is also a Defendant in Dr. Christian J. Renna, et al. vs. Barry Carroll, et al., filed in April 1997 in the 348th Judicial District Court of Tarrant County, Texas (the "Renna Case"). Christian J. Renna, D.O. ("Renna") claims that his contract billing and collection manager, James Sharbrough, signed Renna's name to an agreement with the Bank and begin submitting medical claims belonging to Renna and his medical practice to the Bank for factoring. Renna claims that these alleged activities by his billing/collection manager, who was also Renna's brother-in-law at the time, were without his authority. The plaintiffs in the Renna case alleged that damages were suffered as a result of failing to receive advances for collections on the accounts allegedly factored by the Bank. The plaintiffs also contend that they have been further damaged as a result of factoring fees paid to factor the accounts. The plaintiffs assert that they have suffered actual damages of approximately $1,500,000, consisting of the face amount of the receivables, lost profits/income and other consequential damages. Exemplary damages and attorneys fees in an unspecified amount are also sought. The Bank has recently filed a motion for summary judgment. The case is currently set for trial to begin on May 10, 1999. The Bank will continue to defend this case vigorously. The Company is a defendant in various other legal proceedings arising in connection with its ordinary course of business. In the opinion of management, the financial position of the Company will not be materially affected by the final outcome of these legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matter was submitted to a vote of the stockholders of the Company during the fourth quarter of 1998. ITEM 4A. EXECUTIVE OFFICERS OF THE CORPORATION. The executive officers of the Corporation, each elected to serve at the pleasure of the Board of Directors until the next annual meeting of the Board of Directors to be held on May 21, 1999, their respective ages, and their present position with the Corporation are as follows:
Position With Position Name Age Corporation Held Since - ------------------------------------------------------------------------------------- C. Jack Bean 71 Chairman of the Board, Chief Executive February 1999 Officer and Director - ------------------------------------------------------------------------------------- G. M. Heinzelmann, III 36 President and Director July 1992 - ------------------------------------------------------------------------------------- B. J. Curley 35 Vice President, Secretary and Chief June 1996 Financial Officer - -------------------------------------------------------------------------------------
The business experience of each of these executive officers during the past five (5) years is set forth below: -19- C. Jack Bean has served as Chairman of the Board and Chief Executive Officer of the Company since he returned from retirement in February 1999, and has served as a director of the Company since March 1987. Mr. Bean previously served as Chairman of the Board and Chief Executive Officer of the Company from March 1987 until his retirement in August 1998, and as President of the Company from March 1987 to July 1992. Mr. Bean was the owner and founder of Surety Finance Company, the predecessor company to the Company's business, from 1985 until March 1987. Mr. Bean has served as Chairman of the Board, Chief Executive Officer and President of the Bank since he returned from retirement in February 1999, and has served as a director of the Bank since December 1989. He previously served as Chairman of the Board of the Bank from December 1989 until his retirement in August 1998. Mr. Bean has served as a director of Dallas Fire Insurance Company, a licensed Texas stock insurance company, since November 1996. The president of Dallas Fire Insurance Company is also a director of the Company. G. M. Heinzelmann, III has served as President of the Company since July 1992 and a director since July 1993. He previously served as Vice President of the Company from May 1987 to July 1992. Mr. Heinzelmann has served as Executive Vice President and a director of the Bank since December 1989 and as Manager of the insurance premium finance division of the Company, and subsequently the Bank, since May 1987. B. J. Curley has served as Secretary of the Company since June 1996, Vice President and Chief Financial Officer since October 1995, Controller since May 1993 and a director since August 1998. He has also served as Executive Vice President of the Bank since April 1998, Chief Financial Officer since December 1994, Secretary since June 1996, Controller since May 1993, and as a director since August 1998. He previously served as Vice President of the Bank from May 1993 to December 1994 and as Senior Vice President from December 1994 to April 1998. No family relationships exist among the executive officers and directors of the Corporation except as follows: G. M. Heinzelmann, III, President and a director of the Company, is the son-in-law of C. Jack Bean, Chairman of the Board of the Company. Otherwise, there is no family relationship between any of the directors and any executive officer of the Company. ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. Market Information Since January 10, 1995 the Company's Common Stock has been traded on the American Stock Exchange, Inc.'s ("AMEX") primary list under the symbol "SRY." The following table sets forth, for the periods indicated, the high and low sale price per share of the Company's Common Stock as reported on the AMEX Primary List for the fiscal years ended 1998 and 1997. -20-
High Low - -------------------------------------------------------------------------------- 1998 Fiscal Year - ---------------- First Quarter $7.06 $4.38 Second Quarter $6.00 $3.88 Third Quarter $4.88 $2.00 Fourth Quarter $2.75 $1.94 1997 Fiscal Year - ---------------- First Quarter $5.75 $4.13 Second Quarter $5.63 $5.00 Third Quarter $6.50 $5.13 Fourth Quarter $7.25 $5.69
Stockholders As of March 31, 1999 there were 398 record holders of the Company's Common Stock. Quarterly Data (Unaudited)
- -------------------------------------------------------------------------------------------------------- (dollars in thousands, First Third Total Year except per share data) Quarter Second Quarter Quarter Fourth Quarter to Date - -------------------------------------------------------------------------------------------------------- 1998 Fiscal Year Interest income $ 3,811 $ 4,799 $ 4,601 $ 3,407 $ 16,518 Net interest income 2,358 983 2,605 1,466 7,412 Income (loss) before income taxes 525 (1,233) 197 (784) (1,295) Net (loss) income 332 (785) 151 (1,561) (1,863) Basic earnings per share .06 (.14) .03 (.27) (.32) Weighted average shares 5,756,838 5,760,502 5,759,338 5,760,235 5,759,579 Diluted (loss) earnings .06 (.14) .03 (.27) (.32) per share Weighted average shares outstanding and common stock equivalents 5,991,740 6,007,112 5,759,338 5,760,235 5,759,979 1997 Fiscal Year Interest income $ 4,020 $ 4,161 $ 3,828 $ 3,424 $ 15,433 Net interest income 2,544 2,635 2,242 (4,124) 3,298 Income (loss) before income taxes 795 813 798 (7,682) (5,276) Net (loss) income 500 511 520 (5,007) (3,476) Basic earnings per share .09 .09 .09 (.87) (.60) Weighted average shares 5,749,858 5,751,882 5,751,882 5,753,793 5,751,847 Diluted (loss) earnings per share .09 .09 .09 (.87) (.60) Weighted average shares outstanding and common stock equivalents 5,873,717 5,875,741 5,875,741 5,991,473 5,990,815
-21- Dividend Policy The Company. The Company has not previously paid any cash dividends. The Company currently intends to retain earnings to make the interest payment on the Notes and to pay its other operating expenses, rather than using earnings to pay dividends. The payment of any cash dividends by the Company in the future will depend to a large extent on the receipt of dividends from the Bank. The ability of the Bank to pay dividends is dependent upon the Bank's earnings and financial condition, the Bank's compliance with 12 U.S.C. (S)(S) 56 and 60, and the Bank's fulfillment of certain requirements set forth in the Formal Agreement. See "Formal Agreement with the OCC" and "Restrictions on Distribution of Subsidiary Bank Dividends and Assets" under "Item 1. Business - Supervision and Regulation: Regulation of the Bank" for a discussion of regulatory constraints on the payment of dividends by national banks and bank holding companies generally. ITEM 6. SELECTED FINANCIAL DATA. The following summary consolidated financial data of the Company is derived from the financial statements of the Company as of and for the five years ended December 31, 1998. The following summary consolidated financial data of the Company should be read in connection with the consolidated financial statements of the Company and the notes thereto and the information in Management's Discussion and Analysis of Financial Condition and Results of Operations. -22-
Years Ended December 31, ----------------------------------------------------------------- 1998(1) 1997 1996(2) 1995(3) 1994(4) ----------------------------------------------------------------- Income Statement Data: ($ in 000's) Interest income $ 16,518 $ 15,433 $ 14,390 $ 9,535 $ 5,387 Interest expense 7,101 5,750 5,362 3,678 1,488 ----------------------------------------------------------------- Net interest income before 9,417 9,683 9,029 5,857 3,899 provision for credit losses Provision for credit losses and for Medical claims factoring losses 2,005 6,385 135 60 107 ----------------------------------------------------------------- Net interest income after provision for credit losses on 7,412 3,298 8,894 5,797 3,792 loans and medical claims factoring losses Noninterest income 3,425 2,539 1,877 1,419 1,160 Noninterest expense 12,132 11,113 8,135 5,879 4,462 ----------------------------------------------------------------- (Loss) earnings before income taxes (1,295) (5,276) 2,636 1,338 490 Income taxes 568 (1,800) 938 451 18 ----------------------------------------------------------------- Net (loss) earnings (1,863) (3,476) 1,698 887 472 Common Share Data: Basic (loss) earnings $ (0.32) $ (0.60) $ 0.32 $ 0.27 $ 0.20 ================================================================= Diluted (loss) earnings $ (0.32) $ (0.60) $ 0.31 $ 0.25 $ 0.20 Book value $ 2.43 $ 2.74 $ 3.34 $ 2.94 $ 2.65 Weighted average common shares 5,759 5,752 5,389 3,279 2,394 outstanding (in 000's) Weighted average shares outstanding and common stock 5,759 5,991 5,438 3,614 2,425 Equivalents (in 000's) Period end shares outstanding (in 5,760 5,756 5,748 3,506 3,041 000's) Balance Sheet Data: ($ in 000's) Total assets $175,062 $171,652 $176,439 $121,339 $102,294 Insurance premium finance loans, net 24,146 38,350 38,224 21,905 20,497 Other loans, net 73,323 59,333 58,819 42,211 41,597 Allowance for credit losses on loans 1,962 951 1,067 535 563 Medical claims factoring, net 505 3,073 6,116 3,217 2,693 Total deposits 155,163 154,541 155,690 109,599 92,027 Long term debt 4,350 Shareholders' equity 13,994 15,877 19,231 10,294 8,066 Performance Data Return (loss) on average total assets (.9)% (2.0)% 1.0% .8% .8% Return (loss) on average shareholders' equity (13.2)% (18.7) 9.8 9.5 7.4 Net interest margin 5.2 6.2 6.2 6.1 7.1 Loans to deposits 62.8 63.2 61.5 57.7 66.6 Asset Quality Ratios Nonperforming assets to total assets 1.2% 2.6% 1.2% 1.0% .6% Nonperforming loans to total loans(5) 1.8 0.2 0.3 0.1 0.2 Net loan charge-offs to average loans(5) 2.2 0.3 0.2 0.1 0.4 Allowance for credit losses to total loans(5) 2.0 1.0 1.1 0.8 0.9 Allowance for credit losses to nonperforming loans(5) 108.2 502.0 417.4 758.5 463.4 Capital Ratios for the Bank Tier I risk-based capital 8.98% 9.92% 11.10% 10.76% 10.13% Total risk-based capital 10.24 11.28 12.29 11.72 11.17 Leverage(6) 5.6 6.2 7.0 6.9 5.6
-23- (1) On April 1, 1998 the Company acquired 100% of the outstanding common stock of TexStar National Bank, Universal City, Texas. (2) On February 29, 1996 the Company acquired 100% of the outstanding common stock of First Midlothian Corporation, Midlothian, Texas, and on March 15, 1996 the Bank completed the acquisition of certain assets and the assumption of certain liabilities relating to Providers Funding Corporation located in Dallas, Texas. (3) On September 28, 1995 the Company completed the acquisition of certain assets and the assumption of certain liabilities relating to the branch of Bank One, Texas, National Association located in Waxahachie, Texas. (4) On May 31, 1994 the Company acquired 100% of the outstanding common stock of The Farmers Guaranty State Bank of Kennard, Kennard, Texas, and on December 8, 1994 the Company acquired 100% of the outstanding common stock of First National Bank, Whitesboro, Texas. (5) Exclusive of medical claims factoring. (6) Calculated as adjusted assets divided by adjusted equity at December 31, 1998 and 1997 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. GENERAL Management's Discussion and Analysis of Financial Condition and Results of Operations of the Company analyzes the major elements of the Corporation's consolidated balance sheets and statements of income. This discussion should be read in conjunction with the consolidated financial statements, accompanying notes, and selected financial data appearing elsewhere in this report. Performance Summary Net loss for 1998 was $1,863,113, a decrease of $1,613,191, or 46%, from the $3,476,304 recorded for 1997. On a weighted average share basis, net loss for 1998 was $.32 per diluted share as compared to $.60 per share for 1997, a decrease of 47%. The major contribution to the reduced loss during 1998 was a 125% increase in net interest income and a decrease in the provision for credit losses of $4,380,009 or 68.6%. Further explanation of these results of operations and changes are set forth below. The net loss for 1997 was $3,476,304 compared to net income of $1,697,987 for 1996. The loss for 1997 was also attributable to significant credit losses and recorded impairments of long-lived assets. During 1998 management discontinued the Company's lending activities in three areas which gave rise to the majority of losses described above. These include medical claims factoring, the southeastern United States division of insurance premium financing and used car floor planning and purchase financing. -24- The information presented below reflects the lending and related funding business of the Company.
Year Year Year Ended Ended Ended December 31, 1998 December 31, 1997 December 31, 1996 ----------------- ----------------- ----------------- INSURANCE PREMIUM FINANCING: Average Balance Outstanding $ 36,784,786 $ 44,188,830 $ 29,210,848 Average Yield 10.2% 11.2% 12.2% Interest Income $ 3,745,792 $ 4,935,716 $ 3,563,467 CONSUMER, COMMERCIAL AND REAL ESTATE FINANCING: Average Balance Outstanding $ 79,264,565 $ 59,132,390 $ 52,047,775 Average Yield 10.1% 10.5% 11.5% Interest Income $ 8,013,705 $ 6,183,824 $ 5,983,791 MEDICAL CLAIMS FACTORING: Average Balance Outstanding $ 3,582,939 $ 9,044,262 $ 3,660,432 Average Yield 29.1% 16.3% 33.7% Interest Income $ 1,044,069 $ 1,477,510 $ 1,232,463 COST OF FUNDS: Average Balance of Deposits $188,242,954 $154,531,929 $145,572,001 Average Interest Rate 3.6% 3.7% 3.7% Interest Expense $ 6,782,611 $ 5,749,798 $ 5,361,689 COST OF DEBT: Average Balance of Debt $ 3,262,500 $ 60,108 Average Interest Rate 9.7% 11.0% Interest Expense $ 318,082 $ 6,612
Note: Average balances are computed using daily balances throughout each period. The following table shows selected key performance ratios over the last three years:
For the Year Ended December 31, --------------------------------------- 1998 1997 1996 ---- ---- ---- Return (loss) on average assets (.9)% (2.0)% 1.0% Return (loss) on average equity (13.2)% (18.7)% 9.8% Average equity to average assets 6.8% 10.6% 10.5%
The Company has entered into a Purchase and Assumption Agreement regarding the sale of the branches of the Bank located in Waxahachie and Midlothian, Texas. The sale of these branches is expected to bring the Bank into full compliance with the Formal Agreement capital requirements. The Bank failed to achieve the capital requirements of the Formal Agreement to be met by March 31, 1999. The Bank submitted a request to the OCC for an extension from March 31, 1999 to September 30, 1999 to meet the capital requirements of the Formal Agreement, which was granted by the OCC, subject to revocation based on the results of examinations by the OCC to be conducted in April and June of 1999 or if the OCC finds the Bank to not be in substantial compliance with the other articles of the Formal Agreement. Upon full compliance with the Formal Agreement, the Bank will seek to have the Formal Agreement lifted. There can be no assurance that, upon meeting the requirements of the Formal Agreement, the OCC will lift the -25- Formal Agreement. See "Formal Agreement with the OCC" under "Item 1. Business - Supervision and Regulation: Regulation of the Bank." The Company's strategy is to comply with the OCC's Formal Agreement and then return to its basic business plan of acquiring community banks with low loan-to-deposit ratios and to use excess deposits to fund insurance premium financing and other lending products. See "Item 1. Business - Acquisitions." (Loss) Earnings Before Income Taxes The loss before income taxes was $(1,295,356) for the year ended December 31, 1998, compared with a loss before income taxes of $(5,276,374) for the year ended December 31, 1997, a change of $3,981,018 or 75.5%. Even though the Bank had a loss before income taxes, an income tax expense was incurred during 1998 as a result of valuation allowance for deferred tax assets in the amount of $868,784. The valuation allowance for the deferred tax assets was needed upon a determination that the realizability of the deferred tax asset could not be assured within a reasonable period of time based upon continuing operations. The loss before income taxes was $(5,276,374) for the year ended December 31, 1997, compared with earnings before income taxes of $2,636,115 for the year ended December 31, 1996, a change of $7,912,489 or 300.2%. The substantial increase in the loss before income taxes for the year ended December 31, 1997 versus the year ended December 31, 1996 was a result of a decision by management to charge-off certain medical claims receivables, to make provisions for other medical claims receivables outstanding over 120 days and to recognize an impairment to the unamortized goodwill and other assets of $1,198,288 relating to the medical claims factoring division. Net Interest Income Net interest income is the difference between interest earned on earning assets and interest paid for the funds supporting those assets. The largest category of earning assets consists of loans to businesses and individuals. The second largest is investment securities. Net interest income is the principal source of the Company's earnings. Interest rate fluctuations, as well as changes in the amount and type of earning assets and liabilities supporting those assets, affect net interest income. Interest rates primarily are determined by national and international market trends, as well as competitive pressures in the Company's operating markets. Net interest income before credit losses for 1998 was $9,417,099, a decrease of $265,787 or 2.7% compared to the prior year. The net decrease reflected a $1,085,108 increase in interest income which was offset by a $1,350,895 increase in interest expense. The Company's yield on earning assets declined to 9.2% in 1998, from 9.9% for 1997. Rates paid on the Company's interest-bearing liabilities remained unchanged at 4.4% in 1997 and 1998. These adverse shifts in yield on earning assets resulted in the net interest margin declining from 6.2% in 1997 to 5.2% for 1998. Meanwhile, an interest income effect of a 14.6% increase in average earning assets was more than offset by the interest expense effect of a 21.2% increase in interest-liabilities. These asset and liability increases arose primarily from the TexStar acquisition. From 1997 to 1998, the average balance of non-interest bearing demand deposits increased $9,029,939 or 40.3%. Average demand deposits as a percent of average total deposits increased to 45.5% in 1998 from 44.2% in 1997. -26- Summary of Earning Assets and Interest Bearing Liabilities Although the year-end detail provides satisfactory indicators of general trends, the daily average balance sheets are more meaningful for analysis purposes than year-end data because averages reflect the day-to-day fluctuations that are common to bank balance sheets. Also, average balances for earning assets and interest-bearing liabilities can be related directly to the components of interest income and interest expense on the statements of income. This provides the basis for analysis of rates earned and paid, and sources of increases and decreases in net interest income as derived from changes in volumes and rates. Net interest income is the difference between income earned on interest- earning assets and the interest expense incurred on interest-bearing liabilities before provisions for credit losses and provisions for medical claims receivables. The net yield on total interest-earning assets, also referred to as interest rate margin or net interest margin, represents net interest income divided by average interest-earning assets. The Company's principal interest- earning assets are loans, investment securities, medical claims receivables and federal funds sold. The following table sets forth for each category of interest-earning assets and interest-bearing liabilities the average amounts outstanding, the interest earned or paid on such amounts and the average rate paid for the three years ended December 31, 1998. The table also sets forth the average rate earned on all interest-earning assets, the average rate paid on all interest-bearing liabilities, and the net yield on average interest-earning assets for the same periods. -27- AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST INCOME
Year ended December 31, 1998 Year ended December 31, 1997 --------------------------------------------------------------------------- Interest Interest Average Income/ Average Average Income/ Average Balance Expense Rate Balance Expense Rate ------------- ----------- -------- ------------- ----------- -------- ASSETS(1) Interest-earning assets: Interest-bearing deposits $ 94,939 $ 5,844 6.2% $ 186,945 $ 18,768 10.0% U.S. Treasury and agency securities(2) 32,200,324 1,989,418 6.2 35,693,396 2,300,527 6.4 Federal funds sold 31,027,035 1,718,964 5.5 9,999,199 516,340 5.2 Loans(3) (4) 116,049,351 11,759,497 10.1 103,321,220 11,119,540 10.8 Medical claims receivables 3,582,939 1,044,069 29.1 9,044,262 1,477,510 16.3 Allowance for credit losses and Factoring (3,501,675) - (1,655,993) - - ------------ ----------- ---- ------------ ----------- ----- Total interest-earning assets 179,452,913 16,517,792 9.2% 156,589,029 15,432,685 9.9% ------------ ----------- ---- ------------ ----------- ----- Cash and due from banks 9,098,676 5,943,102 Premises and equipment 6,191,020 3,865,966 Accrued interest receivable 991,940 951,155 Other real estate owned 505,629 259,828 ------------ ------------ Other assets 12,775,599 7,296,715 ------------ ------------ Total assets $209,015,777 $174,905,795 ============ ============ LIABILITIES(1) Interest-bearing liabilities: Interest-bearing demand deposits $ 44,741,576 1,151,356 2.6% $ 38,109,284 1,046,696 2.8% Savings deposits 9,499,843 232,491 2.4 7,846,458 189,443 2.4 Time deposits 102,551,436 5,398,764 5.3 86,156,027 4,513,659 5.2 Notes payable 3,262,500 318,082 9.7 - - - ------------ ----------- ---- ------------ ----------- ----- Total interest-bearing liabilities 160,055,355 7,100,693 4.4% 132,111,769 5,749,798 4.4% ------------ ----------- ---- ------------ ----------- ----- Noninterest-bearing deposits 31,450,099 22,420,160 Other liabilities 3,382,877 1,759,679 ------------ ------------ Total liabilities 194,888,331 156,291,608 Shareholders' equity 14,127,446 18,614,187 ------------ ------------ Total liabilities and equity $209,015,777 $174,905,795 ============ ============ Net interest income $ 9,417,099 $ 9,682,887 =========== =========== Net interest spread 4.8% 5.5% ==== ==== Net interest margin 5.2% 6.2% ==== ====
-28- AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST INCOME, continued
Year ended December 31, 1996 ---------------------------------------------- Interest Average Income/ Average Balance Expense Rate ------------- ----------- ------- ASSETS(1) Interest-earning assets: Interest-bearing deposits $ 531,688 $ 42,117 7.9% U.S. Treasury and agency securities(2) 38,229,219 2,489,906 6.5 Federal funds sold 19,291,373 1,078,618 5.6 Loans(3) (4) 85,325,222 9,547,258 11.2 Medical claims receivables 3,660,432 1,232,463 33.7 Allowance for credit losses and Factoring (1,162,713) - - ------------ ----------- ---- Total interest-earning assets 145,875,221 14,390,362 9.9% ------------ ----------- ---- Cash and due from banks 6,231,693 Premises and equipment 3,806,385 Accrued interest receivable 1,010,323 Other real estate owned 585,587 Other assets 6,965,368 ------------ Total assets $164,474,577 ============ LIABILITIES(1) Interest-bearing liabilities: Interest-bearing demand deposits $ 36,910,314 $ 880,776 2.4% Savings deposits 8,174,212 176,108 2.1 Time deposits 80,397,763 4,298,193 5.3 Notes payable 60,108 6,612 11.0 ------------ ----------- ---- Total interest-bearing liabilities 125,542,397 5,361,689 4.3% ------------ ----------- ---- Noninterest-bearing deposits 20,089,712 Other liabilities 1,564,827 ------------ Total liabilities 147,196,936 Shareholders' equity 17,277,641 ------------ Total liabilities and equity $164,474,577 ============ ----------- Net interest income $ 9,028,673 =========== Net interest spread 5.6% ==== Net interest margin 6.2% ====
(1) The average balance sheet and interest income/expense column include the balance sheet and income statement accounts of First National Bank, Midlothian, Texas; Providers Funding Corporation; TexStar National Bank, Universal City, Texas; and the Lufkin area branches from February 29, 1996, March 15, 1996, April 1, 1998 and October 16, 1998 (the respective dates of acquisition or disposition of such bank branches or divisions) through December 31, 1998. (2) Interest income on tax exempt securities does not reflect the tax equivalent yield and the yield information does not give effect to changes in fair value that are reflected as a component of stockholders' equity. (3) Loans on nonaccrual status have been included in the computation of average balances. (4) The interest income on loans does not include loan fees. Loan fees are immaterial and are included in noninterest income. -29- Net interest margin, the net return on earning assets which is computed by dividing net interest income by average total earning assets, was 5.2% for 1998, a one hundred basis point decline from the previous year. This decline in the margin reflected a lower yield on earning assets contributed to by a declining interest rate market in the fourth quarter of 1998 and a more competitive economic market that resulted in somewhat lower pricing of some loans. Also, competitive market conditions resulted in higher rates being paid on deposit products, along with issuance of subordinated debt in mid-1998. The following table reflects the changes in net interest income resulting from changes in interest rates and from asset and liability volume, including mix. The change in interest attributable to both rate and volume has been allocated to the changes in rate and volume on a pro rata basis. RATE/VOLUME ANALYSIS OF NET INTEREST INCOME
Year Ended Year Ended December 31, 1998 December 31, 1997 Compared with Compared with December 31, 1997 December 31, 1996 --------------------------------------- --------------------------------------------------- Increase/ Increase/ Increase/ Increase/ (Decrease) (Decrease) Due to (Decrease) (Decrease) Due to Volume Rate Changes Volume Rate Changes ------------ ----------- ------------ ------------ -------------- ------------- Interest Income(1): Interest-bearing deposits $ (7,236) $ (5,688) $ (12,924) $ (39,733) $ 16,384 $ (23,349) In financial institutions U.S. Treasury and agency Securities (218,586) (92,523) (311,109) (163,674) (25,705) (189,379) Federal funds sold 1,162,336 40,289 1,202,625 (485,270) (77,008) (562,278) Loans(2) 1,315,518 (675,561) 639,957 1,948,532 (376,250) 1,572,282 Medical claims receivables (1,196,476) 763,035 (433,441) 1,121,471 (876,424) 245,047 ----------- --------- ---------- ---------- ----------- ---------- Total interest income 1,055,556 29,552 1,085,108 2,381,326 (1,339,003) 1,042,323 ----------- --------- ---------- ---------- ----------- ---------- Interest Expense(1): Interest-bearing demand Deposits 164,143 (59,483) 104,660 29,375 136,545 165,920 Savings deposits 40,430 2,618 43,048 (6,637) 19,972 13,335 Time deposits 863,023 22,082 885,105 299,270 (83,804) 215,466 Federal funds purchased and other borrowed funds 318,082 0 318,082 (3,306) (3,306) (6,612) ----------- --------- ---------- ---------- ----------- ---------- Total interest expense 1,385,678 (34,783) 1,350,895 318,702 69,407 388,109 ----------- --------- ---------- ---------- ----------- ---------- Net interest margin $ (330,122) $ 64,335 $ (265,787) $2,062,624 $(1,408,410) $ 654,214 =========== ========= ========== ========== =========== ==========
(1) The average volume and average rate columns include the balance sheet and income statement accounts of the First National Bank, Midlothian, Texas; Providers Funding Corporation; TexStar National Bank, Universal City, Texas; and the Lufkin area branches from February 29, 1996, March 15, 1996, April 1, 1998 and October 16, 1998 (the respective dates of acquisition or disposition of such bank branches or divisions) through December 31, 1998. (2) Non-accrual loans are included in the average volumes used in calculating this table. -30- Noninterest Income Noninterest income is generated primarily from fees associated with noninterest and interest-bearing accounts as well as fees associated with loans (e.g., loan late fees, deposit account service charges, and exchange fees). Noninterest income for the year ended December 31, 1998 was $3,425,302, an increase of $886,384 or 35% compared with noninterest income of $2,538,918 for the year ended December 31, 1997. The increase in noninterest income is primarily attributed to the gain realized on the sale of the Chester, Kennard, Lufkin and Wells branches of the Bank. The gain realized on the sale amounted to $1.1 million. Noninterest income not including the gain on the sale of the Chester, Kennard, Lufkin and Wells branches was $2,321,819 for the twelve months ended December 31, 1998, which represents a decrease in the noninterest income of 8.5% from the noninterest income for the twelve months ended December 31, 1997 of $2,538,918. The decrease is attributed to the Company's decision to close its Atlanta IPF office. The closure of this office resulted in a decrease in IPF loans and subsequently a decrease in the noninterest income for the twelve months ended December 31, 1998. Noninterest income for the year ended December 31, 1997 was $2,538,918, an increase of $661,464 or 35.2% compared with noninterest income of $1,877,454 for the year ended December 31, 1996. The increase in noninterest income is attributed to the increase in late fee charges driven by the increase in average insurance premium finance loans outstanding during 1997 of $44,188,830 when compared to the average balance outstanding during 1996 of $29,210,848. Late fees for the year ended December 31, 1997 were $1,169,407 as compared $681,644 for the same period during 1996. Noninterest Expense Total non-interest expense increased $1,019,587 or 9.2% in 1998 over 1997 reflecting $2,217,875 of increases in salaries and benefits, occupancy expenses, amortization of intangibles and other operating expenses (largely arising from the TexStar acquisition), partially offset by a $1,198,288 decrease in recorded impairments of goodwill. The increase in noninterest expense is attributed to the acquisition of TexStar (i.e., additional occupancy expenses and salary expense), legal expenses of $683,000, settlement and accruals for legal proceedings for $337,000 and operational losses of $230,000 during 1998. The operational losses arise from expenses incurred in the acquisition of TexStar. As a percent of average assets, non-interest expenses were 5.8% in 1998, 6.3% in 1997 and 4.9% in 1996, and the "efficiency ratio" (non-interest expenses divided by total non-interest income plus net interest income) was 112.0% in 1998, 190.4% in 1997 and 75.5% in 1996. The efficiency ratio measures what percentage of total revenues are absorbed by non-interest expense. These measures of operating efficiency compare unfavorably to other financial institutions in the Company's peer groups. Noninterest expense was $11,113,183 for the year ended December 31, 1997, an increase of $2,978,171 or 36.6% compared with noninterest expense of $8,135,012 for the year ended December 31, 1996. This increase resulted principally from the decision by the Company's management to recognize an impairment for goodwill relating to the factoring division during 1997 in the amount of $1,151,111, and certain fixed assets within the factoring division in the amount of $46,112. Additionally, the Company's management decided that it was necessary to accrue approximately $370,000 for the preparation of the planned registration statement during the fourth quarter of 1997 and this amount was treated as professional fees. The remaining balance of the increase related to professional fees associated with the proposed acquisition of TexStar as well as additional staffing associated with the acquisition of First National Bank, Midlothian, Texas, and the increase in staffing required by the medical claims receivables division. -31- NONINTEREST EXPENSE
Years ended December 31, ------------------------------------------------- 1998 1997 1996 -------------- ------------- ---------------- Salaries and employee benefits $ 5,620,710 $ 4,748,097 $4,244,874 Occupancy and equipment 2,004,070 1,517,662 1,244,551 General and administrative expense: Professional fees 1,020,970 1,126,351 467,662 Settlements and accruals for legal 336,698 - - proceedings Office supplies 341,028 290,533 386,114 Travel and entertainment 128,961 132,476 96,577 Telephone 363,023 342,161 283,564 Advertising 164,163 189,510 174,335 Postage 447,312 374,233 299,388 Amortization of intangibles 634,821 506,172 359,717 Dues and subscriptions 120,130 72,847 70,559 Insurance 153,260 95,957 167,245 Bank service charge 183,086 116,631 110,881 FDIC assessment 69,976 15,626 3,553 Credit reports 32,796 46,314 22,850 Operational losses 229,761 13,987 23,075 Other 282,005 326,338 180,067 ----------- ----------- ---------- Total general and administrative 4,507,990 3,649,136 2,645,587 Impairment of long lived assets - 1,198,288 - ----------- ----------- ---------- Total noninterest expense $12,132,770 $11,113,183 $8,135,012 =========== =========== ==========
Income Taxes The Company and the Bank will file a consolidated tax return for 1998. The Company's effective tax rate for 1998 is 43.8% due to income tax expense of $567,757 on a loss before taxes of $(1,295,356) for the year ended December 31, 1998 as compared with income tax benefit of $(1,800,070), or an effective tax rate of 34.1% on a loss before taxes of $(5,276,374) for the year ended December 31, 1997. The tax expense for 1998 is a result of management's decision to provide a 100% valuation allowance for deferred tax asset in the amount of $868,784. Interest Rate Sensitivity Management The operating income and net income of the Bank depend, to a substantial extent, on "rate differentials," i.e., the differences between the income the Bank receives from loans, securities and other earning assets, and the interest expense it pays to obtain deposits and other liabilities. These rates are highly sensitive to many factors which are beyond the control of the Bank, including general economic conditions and the policies of various governmental and regulatory authorities. The objective of monitoring and managing the interest rate risk position of the balance sheet is to contribute to earnings and to minimize the adverse changes in net interest income. The potential for earnings to be affected by changes in interest rates is inherent in a financial institution. Interest rate -32- sensitivity is the relationship between changes in market interest rates and changes in net interest income due to the repricing characteristics of assets and liabilities. An asset sensitive position in a given period will result in more assets being subject to repricing; therefore, as interest rates rise, such a position will have a positive effect on net interest income. Conversely, in a liability sensitive position, where liabilities reprice more quickly than assets in a given period, a rise in interest rates will have an adverse effect on net interest income. One way to analyze interest rate risk is to evaluate the balance of the interest rate sensitivity position. A mix of assets and liabilities that are roughly equal in volume and term and repricing represents a matched interest rate sensitivity position. Any excess of assets or liabilities in a particular period results in an interest rate sensitivity gap. The following table presents the interest rate sensitivity for the Bank's interest-earning assets and interest-bearing liabilities at December 31, 1998: -33- INTEREST RATE SENSITIVE ASSETS AND LIABILITIES
3 months 6 months 1 year 3 months to to to Over or less 6 months 1 year 5 years 5 years Total ------------ ------------ ------------- ------------ ------------ ------------- Interest-earning assets: Interest-earning deposits in $ 94,939 $ 94,939 financial institutions Investment securities $ 9,564,813 $ 570,000 $ 500,000 3,373,816 $10,358,237 24,366,866 Federal funds sold 24,761,752 24,761,752 Loans, net of unearned Interest 39,971,141 15,775,603 13,072,722 24,421,050 6,190,245 99,430,761 Medical claims receivable 646,378 - - - - 646,378 ----------- ----------- ------------ ----------- ----------- ------------ Interest-earning assets 74,944,084 16,345,603 13,572,722 27,889,805 16,548,482 149,300,696 ----------- ----------- ------------ ----------- ----------- ------------ Interest-bearing liabilities: Interest-bearing demand Deposits 35,235,325 35,235,325 Savings deposits 8,313,889 8,313,889 Time deposits 24,080,103 14,735,581 29,471,162 11,860,792 - 80,147,638 ----------- ----------- ------------ ----------- ----------- ------------ Interest-bearing Liabilities 67,629,317 14,735,581 29,471,162 11,860,792 - 123,696,852 Period interest sensitivity Gap 7,314,767 1,610,022 (15,898,440) 16,029,013 16,548,482 25,603,844 ----------- ----------- ------------ ----------- ----------- ------------ Cumulative interest sensitivity gap $ 7,314,767 $ 8,924,789 $ (6,973,651) $ 9,055,361 $25,603,844 $ 25,603,844 ----------- ----------- ------------ ----------- ----------- ------------ Cumulative gap as a Percent of total assets 4.19% 5.11% (3.99)% 5.18% 14.65% 14.65% Cumulative interest- sensitive assets as percent of cumulative interest-sensitive liabilities 110.8% 110.8% 93.8% 107.3% 120.7% 120.7%
The cumulative rate-sensitive gap position at one year was a liabilitiy- sensitive position of $7.0 million, or a negative 4.0%. Accordingly, the Company believes it will not experience a significant impact from changes in interest rates. The Company undertakes this interest rate-sensitivity analysis to monitor the potential risk to future earnings from the impact of possible future changes in interest rates on currently existing net assets or net liability positions. However, this type of analysis is as of a point-in-time, when in fact the Company's interest rate sensitivity can quickly change as market conditions, customer needs, and management strategy change. Thus, interest rate changes do not affect all categories of assets and liabilities equally or at the same time. The Company's investment policy does not permit the purchase of derivative financial instruments or structured notes. The preceding table does not necessarily indicate the impact of general interest rate movements on the Company's net interest income because the repricing of certain assets and liabilities is discretionary and is subject to competitive and other pressures. At December 31, 1998 the Bank held $3,179,716 in -34- mortgage-backed securities. Although the mortgage-backed securities have a stated maturity greater than five years, it is not uncommon for mortgage-backed securities to fully pay down well ahead of stated maturities. As a result, assets and liabilities indicated as repricing within the same period may, in fact, reprice at different times and at different rate levels. ANALYSIS OF FINANCIAL CONDITION Loans and Asset Quality The Company's loans are diversified by borrower and industry group. There was a slight decrease in loans from December 31, 1997 to December 31, 1998 by approximately $500,000 along with a significant change in the composition of the loan portfolio, primarily a decrease in the amount of insurance premium finance loans by approximately 38% and an increase in the amount of real estate loans of approximately 57%. The decrease in insurance premium finance loans is attributed to the Company's decision to close its southeast office in Atlanta, Georgia and the increase in real estate loans is attributed to the acquisition of TexStar. Loan growth has occurred during 1997, 1996, 1995 and 1994 and can be attributed to acquisitions, increased loan demand and the addition of new lending products. The following table describes the composition of loans by major categories outstanding at December 31, 1998, 1997, 1996, 1995 and 1994: -35- LOAN PORTFOLIO AND MEDICAL CLAIMS RECEIVABLES NALYSIS
December 31, ---------------------------------------------------------------------- 1998 1997 1996 1995 1994 ---------------------------------------------------------------------- Aggregate Principal Amount -------------------------- Loans Insurance premium financing $ 24,887,202 $ 40,373,695 $39,168,604 $22,409,356 $20,931,642 Commercial loans 29,270,444 23,171,566 22,745,139 16,301,840 13,205,698 Installment loans 4,250,159 10,632,451 12,631,520 10,645,406 12,029,243 Real estate loans 41,939,108 26,668,598 24,774,167 16,281,558 17,297,636 ------------ ------------ ----------- ----------- ----------- Total loans 100,346,913 100,846,310 99,319,430 65,638,160 63,464,219 Less: Unearned interest (916,152) (2,212,391) (2,501,747) (1,869,751) (1,506,843) Allowance for credit losses (1,961,840) (950,809) (1,067,041) (535,250) (562,649) ------------ ------------ ----------- ----------- ----------- Total loans, net $ 97,468,921 $ 97,683,110 $95,750,642 $63,233,159 $61,394,727 ============ ============ =========== =========== =========== Medical claims receivables Medical claims receivables, net of unearned interest $ 646,378 $ 7,381,040 $ 6,334,005 $ 3,333,830 $ 2,705,974 Allowance for medical claims Receivables losses (141,184) (4,307,885) (217,733) (167,677) (135,299) ------------ ------------ ----------- ----------- ----------- Total medical claims receivables, net $ 505,194 $ 3,073,155 $ 6,116,272 $ 3,166,153 $ 2,570,675 ============ ============ =========== =========== =========== Percentage of Loan Portfolio ---------------------------- Loans: Insurance premium financing 24.9% 40.0% 39.4% 34.1% 33.0% Commercial loans 29.1 23.0 22.9 24.8 20.8 Installment loans 4.2 10.5 12.7 16.2 19.0 Real estate loans 41.8 26.5 25.0 24.9 27.2 ------------ ------------ ----------- ----------- ----------- Total 100.0% 100.0% 100.0% 100.0% 100.0% ============ ============ =========== =========== ===========
The concentration of insurance premium financing loans may expose the Bank to greater risk of loss than would a more diversified loan portfolio. As of December 31, 1998 and 1997 commitments of the Bank under standby letters of credit and unused lines of credit totaled approximately $6,891,000 and $5,048,000, respectively. Stated loan maturities (including floating rate loans reset to market interest rates) of the total loan portfolio, net of unearned income, as of December 31, 1998 were: -36- STATED LOAN MATURITIES
One Within Year to After One Five Five Year Years Years Total -------------- ------------- ------------- ------------- Stated Loan Maturities/Floating Rates $23,341,200 $23,341,200 Reset: 45,478,266 $24,421,050 $6,190,245 76,089,561 Insurance premium financing ----------- ----------- ---------- ----------- $68,819,466 $24,421,050 $6,190,245 $99,430,761 Commercial and real estate loans ----------- ----------- ---------- ----------- Total $ 646,378 $ 646,378 Medical claims receivable =========== ===========
Rate sensitivities of the total loan portfolio before unearned income as of December 31, 1998 were as follows: LOAN REPRICING
One Year After Within To Five Five One Year Years Years Total -------- ----- ----- ----- Fixed Rate $44,890,299 $15,609,127 $6,190,245 $66,689,671 Variable Rate 22,530,367 8,811,923 31,342,290 Non Accrual 1,398,800 1,398,800 ----------- ----------- ---------- ----------- Total $68,819,466 $24,421,050 $6,190,245 $99,430,761 =========== =========== ========== ===========
The maturities presented above are based upon contractual maturities. Many of these loans are made on a short-term basis with the possibility of renewal at time of maturity. All loans, however, are reviewed on a continuous basis for creditworthiness. Nonperforming Assets The Company's financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on its loan portfolio, unless a loan is placed on a nonaccrual basis. Loans are placed on a nonaccrual basis when there are serious doubts regarding the complete collectibility of principal and interest. Amounts received on nonaccrual loans generally are applied first to principal and then to interest after all principal has been collected. Troubled debt restructurings are those for which concessions, including reduction of interest rates or deferral of interest or principal, have been granted, due to a borrower's weakened financial condition. Interest on restructured loans is accrued at the restructured rates when it is anticipated that no loss of original principal will occur. It is the policy of the Bank not to renegotiate the terms of a loan simply because of a delinquent status. Rather, a loan is generally transferred to a nonaccrual status if it is not in the process of collection and is delinquent in payment of either principal or interest beyond 90 days. Loans which are 90 days delinquent but are well secured and in the process of collection are not included in nonperforming assets. Management has established a schedule to be used as a guideline for insurance premium finance loans in determining what level of reserve is appropriate and if charge-off of the loan is needed. All insurance premium finance loans from 120 days to 149 days past the cancellation date are classified as -37- substandard and require a 25% allowance reserve. All insurance premium finance loans 150 days to 179 days past cancellation date are classified as doubtful and require a 50% allowance reserve. All loans which are greater than 179 days are classified as a loss and are charged-off. Any insurance premium finance loan which is guaranteed 100% by a state or exchange guarantee fund require a 50% allowance reserve. Beginning in 1998, insurance premium finance loans which continue to be outstanding are put on non-accrual status after 120 days past the cancellation date. A similar set of guidelines have been established for the medical claims factoring. All medical claims receivables are considered current if their aging is between zero days and 60 days from funding. Receivables 61 days to 90 days are classified as special mention and require a 10% allowance reserve. Receivables 91 days to 120 days are classified as substandard and require a 33% allowance reserve. Receivables 121 days to 180 days are classified as doubtful and require a 66% allowance reserve. Any receivable which continues to be outstanding and aged beyond 180 days is classified as a loss and is charged-off. Receivables are put on non-accrual after 90 days from funding. Other nonperforming assets consist of real estate acquired through loan foreclosures, other workout situations and other assets acquired through repossessions or medical factoring receivables aged beyond 120 days since the initial funding. It is estimated that the nonaccrual loans for 1998 and 1997 would have earned interest income of approximately $141,279 and $9,922 on an annualized basis. The following table summarizes nonperforming assets by category as of December 31, 1998 and 1997: NONPERFORMING ASSETS
1998 1997 ---------- ---------- Nonaccrual loans $1,398,800 $ 91,868 Loans 90 days past due and still accruing interest 414,969 97,537 ---------- ---------- Total nonperforming loans 1,813,769 189,405 Medical claims receivable aged beyond 120 days - 4,183,064 Other real estate owned and other assets 205,877 158,271 ---------- ---------- Total nonperforming assets $2,019,646 $4,530,740 ---------- ---------- Nonperforming assets to total assets 1.2% 2.6% Nonperforming loans to total loans 1.8% 0.2%
The classification of a loan on nonaccrual status does not necessarily indicate that the principal is uncollectible, in whole or in part. A determination as to collectibility is made by the Bank on a case-by-case basis. The Bank considers both the adequacy of the collateral and the other resources of the borrower in determining the steps to be taken to collect nonaccrual loans. Alternatives that are considered are foreclosure, collecting on guarantees, restructuring the loan or collection lawsuits. The following table sets forth a summary of other real estate owned and other collateral acquired as of December 31, 1998: -38- OTHER REAL ESTATE OWNED AND OTHER COLLATERAL ACQUIRED
Number of Net Book Carrying Description Parcels/Autos Value - -------------------------- ------------- ----------------- Vacant land or unsold lots 4 $158,545 Repossessed automobiles 14 47,332 -- -------- Total 18 $205,877
Allowance for Credit Losses on Loans In originating loans, the Company recognizes that credit losses will be experienced and the risk of loss will vary with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the quality of the collateral for such loan. The allowance for credit losses represents the Company's estimate of the allowance necessary to provide for losses incurred in the loan portfolio. In making this determination, the Company analyzes the ultimate collectibility of the Company's loan portfolio, incorporating feedback provided by the internal loan review staff and provided by examinations performed by regulatory agencies. The Company makes an ongoing evaluation as to the adequacy of the allowance for credit losses. To establish the appropriate level of the allowance, all loans (including nonperforming loans), commitments to extend credit and standby letters of credit are reviewed and classified as to potential loss exposure. Specific allowances are then established for those loans, commitments to extend credit or standby letters of credit with identified loss exposure and an additional allowance is maintained based upon the size, quality, and concentration characteristics of the remaining loan portfolio using both historical quantitative trends and the Company's evaluation of qualitative factors, including future economic and industry outlooks. The determination by the Company of the appropriate level of allowance amount, excluding medical receivables factoring, was $1,961,840 at December 31, 1998. The Company recorded a $2.7 million provision for credit losses during the twelve months ended December 31, 1998, and charged off IPF loans net of recoveries in the amount of $1.8 million and charged off the Bank's traditional loan products net of recoveries $722,844, for the twelve months ended December 31, 1998. The substantial increase in the provision for credit losses on IPF loans and IPF loan charge-offs for the twelve months ended December 31, 1998 were primarily related to IPF loans generated by the Bank's southeastern United States insurance premium financing operation, headquartered in Atlanta, Georgia. The Atlanta office has been closed and, with the exception of a few relationships, loan production from that market has been terminated. Management will continue to actively and aggressively attempt to collect the charged-off IPF loans. Management believes that all known losses in the IPF portfolio have been recognized. The additional provision in the Bank's traditional loan portfolio is also attributed to net loan charge-offs of $722,844. The Bank had charge-offs of $555,230 on commercial loans. This charge-off was related primarily to the Bank's used car floor plan lending program. The Bank has discontinued its used car floor plan lending program. The Bank had a charge-off in its installment loan program of $305,333. This charge-off is primarily attributed to consumer auto installment loans made in connection with the Bank's used car floor plan lending program. After the Bank had determined to discontinue the used car floor plan lending program, the Bank saw an increase in the amount of defaults on its consumer auto installment loan program. The Bank made the necessary charge-offs and has discontinued its consumer auto installment loan program as it relates to the floor plan lending. The allowance for credit losses is based on estimates, and ultimate results could vary from current estimates. These estimates are reviewed monthly and as adjustments, either positive or negative, become necessary they are reported in earnings in the periods in which they become known. The following table -39- presents a detailed analysis of the Company's allowance for credit losses for the five years ended December 31, 1998: ALLOWANCE FOR CREDIT LOSSES ON LOANS
December 31, ----------------------------------------------------------------------- 1998 1997 1996 1995 1994 ------------- ------------- ------------ ------------ ----------- Beginning balance $ 950,809 $ 1,067,041 $ 535,250 $ 562,649 $ 282,253 ------------ ------------ ----------- ----------- ----------- Charge-offs: Commercial loans (555,230)) (32,519) (6,245) (13,151) (41,537) Installment loans (305,333) (367,493) (188,419) (104,295) (163,669) Real estate loans (10,058) (38,046) (21,185) (5,350) Insurance premium finance (2,287,015) - (939) - (1,710) ------------ ------------ ----------- ----------- ----------- Total charge-offs (3,157,636) ( 438,058) ( 216,788) ( 117,446) ( 212,266) ------------ ------------ ----------- ----------- ----------- Recoveries: Commercial loans 83,515 6,258 5,067 1,012 15,698 Installment loans 49,071 92,511 43,538 37,366 43,070 Real estate loans 15,191 40,455 10,240 13,288 Insurance premium finance 501,084 42,602 2,720 - 2,488 ------------ ------------ ----------- ----------- ----------- Total recoveries 648,861 181,826 61,565 51,666 61,256 ------------ ------------ ----------- ----------- ----------- Net charge-offs (2,508,775) (256,232) (155,223) (65,780) (151,010) Bank acquisition 820,625 - 614,700 10,759 340,832 Provision for credit losses on 2,699,181 140,000 72,314 27,622 90,574 loans ------------ ------------ ----------- ----------- ----------- Ending balance $ 1,961,840 $ 950,809 $ 1,067,041 $ 535,250 $ 562,649 ============ ============ =========== =========== =========== Period end total loans, net of Unearned interest $ 99,430,761 $ 98,633,919 $96,817,683 $63,768,409 $61,957,376 ============ ============ =========== =========== =========== Average loans $116,049,351 $103,321,220 $85,325,222 $64,644,273 $38,127,350 Ratio of net charge-offs to average loans 2.2% 0.3% 0.2% 0.1% 0.4% ============ ============ =========== =========== =========== Ratio of provision for credit losses on Loans to average loans 2.3% 0.1% 0.1% 0.0% 0.2% ============ ============ =========== =========== =========== Ratio of allowance for credit losses on Loans to ending total loans 2.0% 1.0% 1.1% 0.8% 0.9% ============ ============ =========== =========== =========== Ratio of allowance for credit losses on Loans to total nonperforming loans 108.2% 502.0% 417.4% 758.5% 463.4% ============ ============ =========== =========== =========== Ratio of allowance for credit losses on Loans to total nonperforming assets 97.1% 21.0% 51.5% 44.1% 144.8% ============ ============ =========== =========== ===========
The following table sets forth an allocation of the allowance for credit losses among categories as of December 31, 1998 and 1997. The Company believes that any allocation of the allowance for credit losses into categories lends an appearance of precision which does not exist. The allowance is utilized as a single unallocated allowance available for all loans. The following allocation table should not be interpreted as an indication of the specific amounts or the relative proportion of future charges to the allowance. Such a table is merely a convenient device for assessing the adequacy of the allowance as a whole. The following allocation table has been derived by applying a general allowance to the portfolio as a whole, in addition to specific allowance amounts for internally classified loans. In retrospect, the specific allocation in any particular category may prove excessive or inadequate and consequently may be reallocated in the future to reflect the then current condition. Accordingly, the entire allowance is available to absorb losses in any category. The following allocation table has been derived by applying a general allowance to the portfolio as a whole, in addition to specific allowance amounts for internally classified loans. In retrospect, the specific allocation in any particular category may prove excessive or inadequate and consequently may be reallocated in the future to reflect the then current condition. Accordingly, the entire allowance is available to absorb losses in any category.
December 31, 1998 December 31, 1997 ------------------------------------------- --------------------------------------- Percent of Percent of Allowance Allowance Amount by Category Amount by Category ------------------ -------------------- --------------- ------------------- Insurance premium Financing loans $ 644,456 32.9% $353,765 37.2% Commercial loans 450,724 23.0% 152,117 16.0% Installment loans 351,246 17.9% 234,798 24.7% Real estate loans 515,414 26.2% 210,129 22.1% ------------------ -------------------- --------------- ------------------- Total $1,961,840 100% $950,809 100.0% ================== ==================== =============== ===================
ALLOWANCE FOR MEDICAL CLAIMS RECEIVABLE LOSSES The Company has substantially reduced its medical claims factoring operations. The allowance for medical claims receivables losses was based on estimates, and ultimate results could vary from estimates. These estimates were reviewed monthly and as adjustments, either positive or negative, became necessary they were reported in earnings in the periods in which they became known. The following table presents a detailed analysis of the Company's allowance for medical claims receivables losses for the five years ended December 31, 1998:
December 31, ------------------------------------------------------------------- 1998 1997 1996 1995 1994 ------------- ------------ ------------ ----------- ----------- Beginning balance $ 4,307,885 $ 217,734 $ 167,677 $ 135,299 $ 118,974 ----------- ----------- ---------- ---------- ---------- Charge-offs (4,428,530) (2,156,355) (12,629) Recoveries 956,023 1,510 ----------- ----------- ---------- ---------- ---------- Net charge-offs (3,472,506) (2,154,845) (12,629) (Credit) provision for medical claims receivable losses (694,194) 6,244,996 62,686 32,378 16,325 ----------- ----------- ---------- ---------- ---------- Ending balance $ 141,184 $ 4,307,885 $ 217,734 $ 167,677 $ 135,299 =========== =========== ========== ========== ========== Period end medical claims receivables, net of unearned interest $ 646,378 $ 7,381,040 $6,334,005 $3,333,830 $2,705,974 =========== =========== ========== ========== ========== Average medical claims receivables $ 3,582,939 $ 9,044,262 $3,660,432 $3,239,985 $2,009,576 =========== =========== ========== ========== ==========
-40- The Company recorded a $694,194 credit for medical claims receivables losses during the twelve months ended December 31, 1998. The credit can be attributed to the recovery of unearned revenue as a result of charge-offs accompanied by an overall reduction of the required allowance due to recoveries. The medical claims receivables portfolio had a gross balance of $8,079,524 at December 31, 1997. This balance had been reduced to a gross balance of $646,378 by December 31, 1998 through collections, recoveries and charge-offs. Recoveries for the twelve months ended December 31, 1998 were $956,023 as compared to $1,510 for the same period during 1997. Charge-offs were $4,428,530 and $2,156,355 for the twelve months ended December 31, 1998 and 1997, respectively. Investment Activities As of December 31, 1998, $24,366,866 in investment securities were classified as available-for-sale. The investment portfolio, which was 16.6% of the Company's earning asset base as of December 31, 1998, is being managed to minimize interest rate risk, maintain sufficient liquidity and maximize return. The Company's financial planning anticipates income streams based on normal maturity and reinvestment. The short duration of the portfolio provides adequate liquidity through normal maturities. Investment securities classified as available-for-sale are purchased with the intent to provide liquidity and to increase returns. The securities classified as available-for-sale are carried at fair value. The Company does not have any securities classified as trading or held-to-maturity at December 31, 1998 and December 31, 1997. On April 1, 1998 the Bank's investment portfolio increased by $19.3 million as a result of the acquisition of TexStar. In anticipation of the acquisition, management determined that it was necessary to restructure the investment portfolio beginning in the fourth quarter of 1997. In order to complete the restructure, management transferred all securities classified as held-to- maturity to the available-for-sale classification. The amount transferred from the held-to-maturity classification to the available-for-sale classification was $17,370,604 with a net unrealized gain of $142,212. The reclassification from the held-to-maturity classification to the available-for-sale classification will prohibit the Bank from utilizing the held-to-maturity classification for a period of time. The securities added to the investment portfolio through the acquisition increased the size of the investment portfolio by approximately 44.1%, and closely matched the restructured investment objectives of the Bank. The efforts to restructure the investment portfolio were completed before the acquisition. As of December 31, 1998 proceeds from the maturity of available- for-sale securities were $44,130,203 and sales of available-for-sale securities during 1998 were $5,807,634, with a gross realized gain on the sale of these securities in the amount of $120,353. As of December 31, 1997 proceeds from the maturity of held-to-maturity securities were $5.2 million and the maturity of available-for-sale securities were $6.2 million. The securities within the available-for-sale classification had an amortized cost of $24.3 million and an estimated market value of $24.4 million on December 31, 1998. The unrealized gain in the available-for-sale securities was $73,649 as of December 31, 1998. These unrealized gains are the result of interest rate movements during 1998 and other market factors, and would be realized in part or in whole if some or all of the available-for-sale securities were sold and no changes in the respective market values occurred. -41- The securities within the available-for-sale classification had an amortized cost of $28.6 million and an estimated market value of $28.8 million on December 31, 1997. The unrealized gain in the available-for-sale securities was $142,212 as of December 31, 1997. These unrealized gains are the result of interest rate movements during 1997 and other market factors, and would be realized in part or in whole if some or all of the available-for-sale securities were sold and no changes in the respective market values occurred. As of December 31, 1998 the mortgage-backed securities held by the Bank were classified as available-for-sale, and all were fixed rate securities. The available-for-sale securities are carried at fair value. The following tables describe the composition of investment securities portfolio by major category and maturity at December 31, 1998: INVESTMENT PORTFOLIO
December 31, 1998 December 31, 1997 Available-for-Sale Available-for-Sale ------------------ ------------------- U.S. Treasury notes $ 5,512,050 $ 4,993,751 U.S. government agencies 11,710,341 18,494,687 State and county municipal securities 2,514,782 3,806,271 Mortgage backed securities 3,179,716 442,699 Other investments 1,449,977 1,047,754 ----------- ----------- Total $24,366,866 $28,785,162 =========== ===========
INVESTMENT PORTFOLIO MATURITY/REPRICING SCHEDULE
Maturing or Repricing After After 5 Within 1 1 Year Years Other Year but but Securities Within Within 5 Years 10 Years Amount Yield Amount Yield Amount Yield Amount Yield ----------- ----- ---------- ------ ---------- ------ --------- ----- U.S. Treasury notes $ 5,512,050 5.3% U.S. government agencies 5,504,665 5.3% $1,480,975 6.2% $4,724,701 6.4% Municipals 296,374 4.9% 1,363,383 4.9% 855,025 4.9% Mortgage-backed 3,179,716 6.7% securities Other investments - - - 1,449,977 N/A ----------- ---------- ---------- ---------- Total $11,313,089 $2,844,358 $5,579,726 $4,629,693 =========== ========== ========== ==========
-42- INVESTMENT PORTFOLIO MATURITY SCHEDULE
U.S. Mortgage- U.S. Treasury Government Backed Notes Agencies Municipals Securities Other Total ------------- ---------- ---------- ----------- ---------- Within one year $5,512,050 $ 5,504,665 $ 296,374 $11,313,089 One year to two years 252,284 252,284 Two years to three 1,003,150 280,453 1,283,603 years Three years to four 645,197 645,197 years Four years to five 477,825 185,449 663,274 years After five years 4,724,701 855,025 5,579,726 Other securities $3,179,716 $1,449,977 4,629,693 ---------- ----------- ---------- ---------- ---------- ----------- Total $5,512,050 $11,710,341 $2,514,782 $3,179,716 $1,449,977 $24,366,866 ========== =========== ========== ========== ========== ===========
Deposit Activities Deposits are attracted through the offering of a broad variety of deposit instruments, including checking accounts, money market accounts, regular savings accounts, term certificate accounts (including "jumbo" certificates in denominations of $100,000 or more), and retirement savings plans. The Company's average balance of total deposits was $188,242,954 for the year ended December 31, 1998, representing an increase of $33,711,025 or 21.8% compared with the average balance of total deposits for the year ended December 31, 1997. The Company's average balance of total deposits was $154,531,929 for the year ended December 31, 1997, representing an increase of $8,959,928 or 6.2% compared with the average balance of total deposits for the year ended December 31, 1996. The net increase in deposits during 1998 is primarily due to the acquisition of TexStar and the increases in deposits during 1997 are due to internally generated growth. The following table sets forth certain information regarding the Bank's average deposits as of December 31, 1998 and 1997: AVERAGE DEPOSITS
December 31, 1998 December 31, 1997 ---------------------------------- ----------------------------------- Average Percent Average Average Percent Average Amount of Total Rate Paid Amount of Total Rate Paid ------------ -------- --------- ------------ -------- --------- Noninterest-bearing demand deposits $ 31,450,099 16.7% - $ 22,420,160 14.5% - Interest-bearing demand deposits 44,741,576 23.8% 2.6% 38,109,284 24.7% 2.8% Savings deposits 9,499,843 5.0% 2.4% 7,846,458 5.1% 2.4% Time deposits 102,551,436 54.5% 5.3% 86,156,027 55.7% 5.2% ------------ ----- --- ------------ ----- --- Total average deposits $188,242,954 100.0% 4.4% $154,531,929 100.0% 4.4% ============ ===== === ============ ===== ===
As of December 31, 1998 non-brokered time deposits over $100,000 represented 15.6% of total deposits, compared with 15.2% of total deposits as of December 31, 1997. As of December 31, 1998 -43- jumbo certificates of deposits in excess of $100,000 accounted for $24,224,817 of the Bank's deposits. Of this amount, $22,436,964 had a maturity of one year or less. The Bank does not have and does not solicit brokered deposits. The following table sets forth the remaining maturities for time deposits of $100,000 or more at December 31, 1998 and 1997: TIME DEPOSITS OF $100,000 OR MORE
December 31, December 31, Maturity Range 1998 1997 -------------- ----------- ----------- Three months or less $ 9,236,000 $ 9,924,000 Three through six months 4,400,000 3,932,000 Six through twelve months 8,801,000 7,863,000 Over one year and less than two years 1,788,000 1,773,000 Over five years - - ----------- ----------- Total $24,225,000 $23,492,000 =========== ===========
Liquidity The Bank's investment securities portfolio, including federal funds sold, and its cash and due from bank deposit balances serve as the primary sources of liquidity. At December 31, 1998, 15.2% of the Bank's interest-bearing liabilities were in the form of time deposits of $100,000 and over. Substantially all of such large deposits were obtained from the Bank's market area, and none were obtained through brokers. Management believes these deposits to be a stable source of funds. However, if a large number of these time deposits matured at approximately the same time and were not renewed, the Bank's liquidity could be adversely affected. Currently, the maturities of the Bank's large time deposits are spread throughout the year, with approximately 38% maturing in the first quarter of 1998, 18% maturing in the second quarter of 1998, and the remaining 36% maturing in the second half of 1998 and the remaining 8% maturing thereafter. The Bank monitors those maturities in an effort to minimize any adverse effect on liquidity. The Bank is limited through regulatory commitments from using brokered funds without prior approval. The Company raised approximately $4,350,000 during 1998 in a private subordinated debt offering and $116,000 during 1997, $7.4 million during 1996, $1.2 million during 1995 and $2.3 million during 1994 through the sale of the Company's common stock in registered stock offerings, private stock offerings or incentive stock option exercises. Management anticipates that future registered and private offerings of the Company's common stock may be used to raise additional capital, in connection with acquisitions or if the regulatory capital requirements with which the Bank must comply necessitate the injection of additional capital by the Company into the Bank. Failure to raise such additional capital could adversely impact the growth of the Bank or result in its failure to comply with applicable regulatory capital requirements, which could necessitate a reduction in the volume of assets and deposits of the Bank. Such reductions could adversely affect the Bank's earnings and liquidity. See "Capital Adequacy Guidelines" under "Item 1. Business - Supervision and Regulation: Regulation of the Bank." On April 1, 1998 the Company completed the acquisition of TexStar through the merger of TexStar into Surety Bank. As of April 1, 1998 TexStar had total assets of $70,335,000, and Surety Bank's total -44- assets as of the same date were $177,871,000. The assets and liabilities of TexStar have been recorded at their fair values as of April 1, 1998. In September 1997 the Bank made application to become a member of the Federal Home Loan Bank. Upon acceptance on October 9, 1997 the Bank purchased 5,247 shares of Federal Home Loan Bank of Dallas capital stock for $524,700. As a member, the Bank has the option of borrowing up to $10,700,000 from the Federal Home Loan Bank, subject to a borrowing base that is determined from the Bank's first mortgage loans and Federal Home Loan Bank stock. The payment of dividends by the Bank is subject to the provisions of 12 U.S.C. (S) 60 which provides that no dividend may be declared or paid without the prior approval of the OCC if the total of all dividends, including the proposed dividend, in any calendar year exceeds the total of the Bank's net profits for that year combined with its retained net profits of the preceding two years. The Bank incurred an accumulated loss for fiscal years 1998 and 1997 in the amount of $4,707,359. Under 12 U.S.C. (S) 60 the Bank will not be able to declare a dividend, without the prior approval of the OCC, until it has profits in excess of $4,707,359. No assurance can be given if and when the Bank will attain such level of profitability. On November 19, 1998 the Board of Directors of the Bank entered into the Formal Agreement with the OCC pursuant to which the Bank was required to achieve certain capital levels and adopt and implement certain plans, policies and strategies by March 31, 1999 and is required to achieve certain additional capital levels by December 31, 1999. Under the Formal Agreement, the Bank was required to achieve by March 31, 1999 total risk-based capital at least equal to 12% of risk-weighted assets and Tier I leverage capital at least equal to 7.5% of adjusted total assets, and is required to achieve by December 31, 1999 total risk-based capital at least equal to 14% of risk-weighted assets. At December 31, 1998 the Bank had total risk-based capital of 10.24% of risk weighted assets and Tier I leverage capital of 5.64% of adjusted total assets. The Bank failed to achieve the capital levels and the leverage ratio required by the Formal Agreement to be met by March 31, 1999. The Bank submitted a request to the OCC for an extension from March 31, 1999 to September 30, 1999 to meet the capital requirements of the Formal Agreement. The OCC granted the extension, subject to revocation based on the results of examinations by the OCC to be conducted in April and June of 1999. See Management's plans to address this compliance issue in "Item 1. Business - Recent Developments." See also "Formal Agreement with the OCC" under "Item 1. Business - Supervision and Regulation: Regulation of the Bank." In the longer term, the liquidity of the Company and its ability to meet its cash obligations will depend substantially on its receipt of dividends from the Bank, which are limited by banking statutes and regulations. See "Item 1. Business - Supervision and Regulation." Capital Resources The Company's shareholders' equity at December 31, 1998 was $14.0 million, compared with $15.9 million at December 31, 1997. The decrease in equity was primarily the result the 1998 net loss. The Company repurchased 45,547 and 18,671 shares as treasury stock during 1998 and 1997, respectively, at a total cost of $202,615 and $98,289 for 1998 and 1997, respectively. The shares repurchased as treasury stock were repurchased in connection with an exercise of stock options. Exclusive of the Formal Agreement, the Bank is expected to meet a minimum risk-based capital ratio to risk-weighted assets ratio of 8%, of which at least one-half (or 4%) must be in the form of Tier 1 (core) capital, and a leverage ratio of 3%. The remaining one-half (or 4%) may be either in the form of Tier 1 (core) or Tier 2 (supplementary) capital. The amount of loan loss allowance that may be included -45- in capital is limited to 1.25% of risk-weighted assets. The ratio of Tier 1 (core) and the combined amount of Tier 1 (core), Tier 2 (supplementary) capital to risk-weighted assets, and leverage ratio for the Bank were 8.98%, 10.24%, and 5.64%, respectively, at December 31, 1998, and 9.92%, 11.28%, and 6.24%, respectively, at December 31, 1997. The Bank is currently in compliance with these standard guidelines; however, the Bank is not in compliance with the guidelines of the Formal Agreement at March 31, 1999. The Bank submitted a request to the OCC for an extension from March 31, 1999 to September 30, 1999 to meet the capital requirements of the Formal Agreement. The OCC granted the extension, subject to revocation based on the results of examinations by the OCC to be conducted in April and June of 1999 or if the OCC finds the Bank to not be in substantial compliance with the other articles of the Formal Agreement. Management expects to achieve the Formal Agreement capital requirements of total risk-based capital at least equal to 14% of risk-weighted assets and Tier I leverage capital at least equal to 7.5% upon completion of the sale of the branches located in Midlothian and Waxahachie, Texas. See "Capital Adequacy Guidelines" under "Item 1. Business -Supervision and Regulation: Regulation of the Bank." The Board of Governors of the Federal Reserve System ("FRB") has announced a policy sometimes known as the "source of strength doctrine" which requires a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. The FRB has interpreted this requirement to require that a bank holding company, such as the Company, stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity. The FRB has stated that it would generally view a failure to assist a troubled or failing subsidiary bank in these circumstances as an unsound or unsafe banking practice or a violation of Regulation Y or both, justifying a cease and desist order or other enforcement action, particularly if appropriate resources are available to the bank holding company on a reasonable basis. The requirement that a bank holding company, such as the Company, make its assets and resources available to a failing subsidiary bank could have an adverse effect upon the Company and its stockholders. The following table sets forth an analysis of the Bank's capital ratios as required at December 31, 1998. The Bank will not be in compliance with these guidelines at March 31, 1999: RISK-BASED CAPITAL RATIOS
Minimum Well- September 30, 1999 September 30, 1999 Capital Capitalized Formal Agreement Formal Agreement December 31, Ratios Ratios Ratios(2) Ratios(2) ------------------------------ ---------- ----------- ------------------ ------------------ 1998 1997 ---- ---- Tier I risk-based $ 9,314,000 $ 10,277,000 capital Tier II risk-based 1,304,000 1,402,000 capital Total capital 10,618,000 11,679,000 Risk-weighted assets 103,722,000 103,559,000 Capital ratios: Tier I risk-based 8.98% 9.92% 4.00% 6.00% capital Tier II risk-based 10.24 11.28 8.00 10.00 12.00% 14.00% capital Leverage ratio(1) 5.64 6.24 4.00 5.00 7.50 7.50
(1) Calculated as adjusted assets divided by adjusted equity at December 31, 1998 and 1997. (2) As extended from March 31, 1999. -46- Stockholders' Rights Agreement Pursuant to the Rights Agreement dated June 17, 1997 between the Company and Securities Transfer Corporation, as rights agent, the Company declared a dividend of one common stock purchase right (a "Right") for each outstanding share of common stock, $0.01 par value, of the Company (the "Common Stock Purchase Plan") to stockholders of record at the close of business on June 6, 1997. Each Right initially entitles stockholders to buy one share of common stock at an exercise price of $50.00 (the "Purchase Price"). The Rights will be exercisable only if a person or group acquires 15% or more of the common stock or announces a tender offer the consummation of which would result in ownership by such person or group of 15% or more of the common stock. The Company will be entitled to redeem the Rights at $0.0001 per Right at any time prior to the tenth day after a person or group acquires 15% or more of the common stock, other than pursuant to a transaction approved by the Company's Board of Directors. The Rights are redeemable even after a 15% or more acquisition, if the Board so determines, in connection with a merger of the Company with a "white knight" and under other circumstances. In the event of a 15% or more acquisition, each Right will entitle its holder to purchase that number of shares of common stock equal to the result obtained by dividing the Purchase Price by 50% of the then current market price of the common stock. If the Company, or any subsidiary of the Company, is acquired in a merger or other business combination transaction in which the common stock is exchanged or changed, or 50% or more of the Company's assets or earning power are sold, each Right will entitle its holder to purchase that number of shares of common stock of the surviving or acquiring entity equal to the result obtained by dividing the Purchase Price by 50% of the then current market price of the common stock of the surviving or acquiring entity. Recent Accounting Pronouncements In June 1998 FASB issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"). SFAS 133 establishes accounting and reporting standards for derivative instruments and hedging activities. It requires recognition of all derivatives as either assets or liabilities in the statement of financial condition and measurement of those instruments at fair value. The accounting for gains and losses on derivatives depends on the intended use of the derivative. SFAS 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999, with earlier application encouraged. Retroactive application is not permitted. Management does not believe that the adoption of this pronouncement will have a material impact on the financial condition or results of operations of the Company since the Company currently does not enter into derivative instruments or hedging activities. Year 2000 Safety and Soundness The Bank has developed an intensive Action Plan for addressing the concerns and risks associated with the coming millennium. The Bank has reviewed the Federal Reserve's and Federal Financial Institutions Examination Council's ("FFIEC") Interagency Statement entitled "Year 2000 Project Management Awareness" and related materials. In addition, the Bank has done extensive research and documentation to develop a strategy that will facilitate compliance with federal banking agency policies which will be reviewed by regulatory agencies in their monitoring process and examinations. -47- This Action Plan includes the defined phases from the FFIEC: Awareness, Assessment, Renovation, Validation and Implementation. As part of the Awareness phase a Year 2000 Team was organized and developed an overall strategy to encompass systems, vendors, customers and correspondents. This phase has been completed. The Assessment phase identified the size and complexity of potential problems, and in all hardware, software and related systems with interdependencies affected by the Year 2000 date change. The Assessment phase is substantially completed, but the Bank considers it an ongoing process due to the need to evaluate any new relationships and information system hardware and software obtained through the Year 2000. Under the Renovation phase, code enhancements, hardware and software upgrades, and vendor certifications have been pursued and are substantially complete. Testing under the Validation phase is being tracked and results recorded. Testing of in-house mission critical systems was substantially completed by December 31, 1998. Further testing with mission critical vendors was substantially completed by March 31, 1999 and is expected to be fully completed by June 30, 1999. The final phase of Implementation includes the acceptance of certified systems and the completed remediation and business resumption contingency plans for all mission critical items. The Company has completed the remediation and business resumption contingency plans. As additional agency policies and statements are made available, the Bank will modify its Action Plan as necessary to maintain compliance. Current costs and estimated future expenditures are not significant and are expected to have negligible effects on the Company's results of operations, liquidity and capital resources. Costs incurred only to upgrade equipment to Year 2000 compliance are expensed as incurred. Pursuant to the Year 2000 Information and Readiness Disclosure Act of 1998, Publication L. No. {05-27}, 112 Statute 2386 (the "Act"), the Bank hereby designates this Year 2000 Statement as a Year 2000 Readiness Disclosure. This Year 2000 Readiness Disclosure is made for the sole purpose of facilitating responses or communicating or disclosing information aimed at correcting and/or helping to correct and/or avoid Year 2000 failures. By designating the Year 2000 Statement as a Year 2000 Readiness Disclosure, the Bank intends to comply fully with, and to be afforded the protections of, the Act. Therefore, all statements made in this Year 2000 Readiness Disclosure shall be construed within the confines of the Act. This Year 2000 disclosure replaces and supercedes all prior communications related to the Year 2000. Impact of Inflation, Changing Prices and Monetary Policies The financial statements and related financial data concerning the Company in this report have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary effect of inflation on the operations of the Company is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, changes in interest rates have a more significant effect on the performance of a financial institution than do the effects of changes in the general rate of inflation and changes in prices. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. Interest rates are highly sensitive to many factors which are beyond the control of the Bank, including the influence of domestic and foreign economic conditions and the monetary and fiscal policies of the United States government and federal agencies, particularly the Federal Reserve Bank. The Federal Reserve Bank implements national monetary policy such as seeking to curb inflation and combat recession by its open market operations in United States government securities, control of the discount rate applicable to -48- borrowing by banks and establishment of reserve requirements against bank deposits. The actions of the Federal Reserve Bank in these areas influence the growth of bank loans, investments and deposits, and affect the interest rates charged on loans and paid on deposits. The nature, timing and impact of any future changes in federal monetary and fiscal policies on the Bank and its results of operations are not predictable. Related Party Transactions In the ordinary course of business, the Bank has loans, deposits and other transactions with its executive officers and directors and businesses with which such persons are associated. It is the Company's policy that all such transactions are entered into on substantially the same terms as those prevailing at the time for comparable transactions with unrelated third parties. As of December 31, 1998 and 1997, loans to director-related companies and other related parties totaled approximately $329,000 and $479,000, respectively. During 1998, 1997 and 1996, the Company paid legal fees to a director in the amount of $182,335, $110,216 and $125,145, respectively. Insurance Premium Finance Purchase Agreements On March 17, 1998 the Company announced that the Bank entered into an agreement with CAA Premium Finance Company, L.L.C. ("CAA") for the purchase of insurance premium finance ("IPF") loans. Pursuant to the five-year agreement, CAA agreed to sell all of its IPF loans to the Surety Premium Finance division of the Bank ("Surety Premium") on an exclusive basis. The agreement provides for the sale by CAA to Surety Premium of a minimum of $4,000,000 in IPF loans per year ($20,000,000 over the five-year term of the agreement). Surety Premium has agreed to purchase CAA's IPF loans which are in compliance with Surety Premium's underwriting standards. The loans which do not meet Surety Premium's underwriting standards will be held by CAA. On June 8, 1998 the Company announced that the Bank entered into an agreement with Cardinal Premium Finance, L.L.C. ("Cardinal") for the purchase of insurance premium finance ("IPF") loans. Pursuant to the five-year agreement, Cardinal agreed to sell all of its IPF loans to Surety Premium on an exclusive basis. The agreement provides for the sale by Cardinal to Surety Premium of a minimum of $8,000,000 in IPF loans per year ($40,000,000 over the five-year term of the agreement). Surety Premium has agreed to purchase Cardinal's IPF loans which are in compliance with Surety Premium's underwriting standards. The loans which do not meet Surety Premium's underwriting standards will be held by CAA. Subsequent Events On February 3, 1999 the Company announced that Bobby W. Hackler had resigned as Chairman of the Board, Chief Executive Officer and director of the Company and as Chairman of the Board, Chief Executive Officer, President and director of the Bank effective February 3, 1999. The Board of Directors of the Company and the Bank elected C. Jack Bean to fill the vacancies resulting from the resignation of Mr. Hackler. On April 13, 1999, the Company entered into a Purchase and Assumption Agreement with The Citizens National Bank in Waxahachie, Waxahachie, Texas ("CNB"), to sell to CNB the Bank's two branches located in Waxahachie and Midlothian, Texas (the "Branches"). The purchase price for the Branches will be based upon the net value of the assets less the balance of liabilities assumed plus 11% of the deposit base and 2.5% of the loan base and the value of certain premises, equipment and other assets. The transaction will be structured as a purchase of certain assets and assumption of certain liabilities of the Branches, including deposits, by CNB. As of December 31, 1998, the Branches had total deposits of approximately $58,000,000, total net loans of approximately $15,000,000 and fixed assets of approximately $1,600,000. The Bank is currently a $175,000,000 asset-based bank with nine full-service banking -49- facilities. After the sale is completed, the Bank will have approximately $120,000,000 in assets and approximately $85,000,000 in loans. The Bank will continue to operate its remaining seven banking branches, located in north- central and south-central Texas, as full service community banking facilities serving the local retail and small business markets. The Bank's operating division, Surety Premium Finance ("Surety Premium"), will continue to market its niche lending product, insurance premium financing. The Bank uses its Surety Premium division to utilize investable funds that are not used by the Bank in its traditional lending programs, rather than investing in lower yielding investment securities. The completion of the sale is subject to a number of contingencies, including regulatory approvals by applicable banking authorities. There can be no assurance that the transaction will be completed. If consummated, the transaction is expected to close no later than September 30, 1999, upon the expiration of all applicable waiting periods following receipt of all necessary regulatory approvals. Forward-Looking Statements The Company may from time to time make forward-looking statements (within the meaning of the Private Securities Litigation Reform Act of 1995) with respect to earnings per share, credit quality, expected Year 2000 compliance program, corporate objectives and other financial and business matters. The Company cautions the reader that these forward-looking statements are subject to numerous assumptions, risks and uncertainties, including economic conditions; actions taken by the Federal Reserve Board; legislative and regulatory actions and reforms; competition; as well as other reasons, all of which change over time. Actual results may differ materially from forward-looking statements. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The Company faces market risk to the extent that the fair values of its financial instruments are affected by changes in interest rates. The asset/liability management discipline as applied to the Company seeks to limit the volatility, to the extent possible, of both earnings and the fair value of equity that can result from changes in market interest rates. This is accomplished by limiting the maturities of fixed rate investments, loans and deposits; matching fixed rate assets and liabilities to the extent possible; and optimizing the mix of non-interest fee and net interest income. As can be seen from the table contained in the Interest Rate Sensitivity Management section, the Company's asset/liability mix is liability sensitive under one year with a cumulative gap of $6,973,651 or 3.99%. As such, the Company is susceptible to changes in interest rates, with a increasing net interest margin and fair value of equity experienced in periods of rising interest rates, correspondingly, a decrease in the net interest margin and fair value of equity in periods of declining interest rates. The following table presents the Company's projected change in fair value of equity for various rate shock levels as of December 31, 1998 after one year. All market risk sensitive instruments presented in this table are available-for- sale. The Company has no trading or held-to-maturity securities. -50-
Change in Basis Points Fair Value % Change -300 $14,213,508 1.6% -200 $14,140,422 1.0% -100 $14,067,336 0.5% -50 $14,030,793 0.3% 0 $13,994,250 0.0% +50 $13,957,707 (0.3)% +100 $13,921,164 (0.5)% +200 $13,848,078 (1.0)% +300 $13,774,992 (1.6)%
The preceding table indicates that at December 31, 1998, in the event of a sudden and sustained decrease in prevailing market interest rates, the Company's fair value of equity would be expected to decline. In the event of a sudden and sustained increase in prevailing market interest rates, the Company's fair value of equity would be expected to increase. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates and repricing opportunities of loans which are adjustable and should not be relied upon as indicative of actual expected results. Furthermore, the computations do not contemplate any actions management could undertake in response to such changes in interest rates. Certain shortcomings are inherent in the method of analysis presented in the computation of fair value of equity. Actual values may differ from the projections presented, should market conditions vary from the assumptions used in the calculation of fair value of equity. Emphasis will continue to be placed on granting loans with short maturities and floating rates where possible. This strategy increases liquidity and is necessitated by the continued shortening and more frequent repricing opportunities of the Company's funding sources. Management will continue to monitor the Company's interest rate risk position to minimize adverse impact of earnings caused by changes in interest rates. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The financial statements and supplementary data required to be included in this Item 8 are set forth in Item 14 of this Report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. The Company has had no changes in accountants or disagreements with its accountants on accounting and disclosure to report under this Item 9. -51- PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. This information is incorporated by reference from the Company's definitive Proxy Statement for the Company's 1999 annual meeting for the fiscal year ended December 31, 1998, to be filed no later than April 30, 1999. ITEM 11. EXECUTIVE COMPENSATION. This information is incorporated by reference from the Company's definitive Proxy Statement for the Company's 1999 annual meeting for the fiscal year ended December 31, 1998, to be filed no later than April 30, 1999. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. This information is incorporated by reference from the Company's definitive Proxy Statement for the Company's 1999 annual meeting for the fiscal year ended December 31, 1998, to be filed no later than April 30, 1999. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. This information is incorporated by reference from the Company's definitive Proxy Statement for the Company's 1999 annual meeting for the fiscal year ended December 31, 1998, to be filed no later than April 30, 1999. -52- PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) Documents filed as part of Report. 1. Financial Statements Page The following financial statements of the Company required to be included in Item 8 are filed under Item 14 at the page indicated: Report of Independent Accountants F-1 Consolidated Balance Sheets at December 31, F-2 1998 and 1997 Consolidated Statements of Operations for F-3 the years ended December 31, 1998, 1997 and 1996 Statement of Comprehensive Income for the years ended December 31, 1998, 1997 and 1996 F-4 Consolidated Statements of Shareholders' F-5 Equity for the years ended December 31, 1998, 1997 and 1996 Consolidated Statements of Cash Flows for F-6 the years ended December 31, 1998, 1997 and 1996 Notes to Consolidated Financial Statements F-8 2. Financial Statement Schedules No schedules are required because they are inapplicable or the information is otherwise shown in the financial statements or notes thereto. 3. Exhibits 2.01 Reorganization Agreement by and between Bancwell Financial Corp.; Dan W. Brent, Jody Pearson and Joe M. Pearson; Texas Bank, N.A.; and Surety Capital Corporation dated July 23, 1992; and Agreement to Merge Bank of East Texas with and into Texas Bank, N.A. under the Charter of Texas Bank, N.A. and under the Title of Texas Bank, N.A., dated July 23, 1992. (4) 2.02 Reorganization Agreement by and between Newell Bancshares, Inc.; Dan W. Brent, Jody Pearson and Joe M. Pearson; Texas Bank, N.A.; and Surety Capital Corporation dated July 23, 1992; and Agreement to Merge First State Bank with and into Texas Bank, N.A. under the Charter of Texas Bank, N.A. and under the Title of Texas Bank, N.A., dated July 23, 1992. (4) 2.03 Reorganization Agreement by and between The Farmers Guaranty State Bank of Kennard; Dr. Frank A. Smith, III; Surety Bank, National Association; and Surety Capital Corporation, dated February 4, 1994; and Agreement to Merge The Farmers Guaranty State Bank of Kennard with and into Surety Bank, National Association under the Charter of Surety Bank, National Association and under the title of Surety Bank, National Association, dated February 4, 1994. (6) -53- 2.04 Reorganization Agreement by and between First National Bank; Lloyd W. Butts, D. C. Degan, Norman Denton, Murriel Gilbreath, Robert S. Light, and Joe B. Turner, Jr. (the "Shareholders"); Surety Bank, National Association; and Surety Capital Corporation, dated May 24, 1994; and Agreement to Merge between Surety Bank, National Association, First National Bank and joined in by the Shareholders and Surety Capital Corporation, dated May 24, 1994. (7) 2.05 Reorganization Agreement by and between First Midlothian Corporation; First National Bank; certain individual shareholders and directors of First Midlothian Corporation and First National Bank; Surety Bank, National Association; and Surety Capital Corporation, dated October 17, 1995. (10) 2.06 Amendment Number One to Reorganization Agreement, dated January 16, 1996. (11) 2.07 Amendment Number Two to Reorganization Agreement, dated February 29, 1996. (11) 2.08 Agreement to Merge SCC Acquisition, Inc. with and into First Midlothian Corporation Under the Charter of First Midlothian Corporation and Under the Title of First Midlothian Corporation between First Midlothian Corporation and SCC Acquisition, Inc., and joined in by Surety Bank, National Association and the directors of First Midlothian Corporation and First National Bank, dated October 17, 1995. (10) 2.09 Amendment Number One to Agreement to Merge SCC Acquisition, Inc. with and into First Midlothian Corporation Under the Charter of First Midlothian Corporation and Under the Title of First Midlothian Corporation, dated February 29, 1996. (11) 2.10 Agreement to Consolidate First National Bank and Surety Bank, National Association under the Charter of Surety Bank, National Association and Under the Title of Surety Bank, National Association between Surety Bank, National Association and First National Bank, and joined in by SCC Acquisition, Inc. and Surety Capital Corporation, dated January 16, 1996. (10) 2.11 Agreement and Plan of Reorganization by and among Surety Bank, National Association, TexStar National Bank, Surety Capital Corporation, and certain shareholders of TexStar National Bank, dated as of October 10, 1997; and Agreement to Merge TexStar National Bank with and into Surety Bank, National Association Under the Charter of Surety Bank, National Association and Under the Title of Surety Bank, National Association, between Surety Bank, National Association and TexStar National Bank and joined in by Surety Capital Corporation and certain shareholders of TexStar National Bank, dated as of October 10, 1997. (15) 2.12 Indenture between Surety Capital Corporation and Harris Trust and Savings Bank, as Trustee, dated March 31, 1998. (16) 2.13 Branch Purchase and Assumption Agreement by and between Surety Bank, National Association and Commercial Bank of Texas, National Association, dated July 13, 1998. (19) 2.14 Purchase and Assumption Agreement by and between The Citizens National Bank in Waxahachie and Surety Bank, N. A., dated April 13, 1999. * 3.01 Certificate of Incorporation. (1) -54- 3.02 Certificate of Amendment of Certificate of Incorporation, as filed with the Delaware Secretary of State on April 8, 1987. (2) 3.03 Certificate of Amendment to the Certificate of Incorporation, as filed with the Delaware Secretary of State on April 4, 1988. (3) 3.04 Certificate of Designations Establishing Series of Shares of Preferred Stock, as filed with the Delaware Secretary of State on April 4, 1988. (3) 3.05 Certification of Elimination of Series of Shares of Preferred Stock, as filed with the Delaware Secretary of State on January 31, 1992. (5) 3.06 Certificate of Amendment to the Certificate of Incorporation, as filed with Delaware Secretary of State on June 14, 1993. (6) 3.07 Form of Common Stock certificate (specimen). (6) 3.08 Restated Bylaws of the Company. (8) 4.01 Rights Agreement between Surety Capital Corporation and Securities Transfer Corporation as Rights Agent, dated as of June 17, 1997 (14); as amended by Amendment No. 1 to Rights Agreement of Surety Capital Corporation, dated as of March 10, 1998. (15) 4.02 Indenture dated as of March 31, 1998 between the Company and Harris Trust and Savings Bank, Chicago, Illinois, as trustee. (16) 4.03 Form of Notes (included in Exhibit 4.02). (16) 4.04 Form of Note Purchase Agreements dated March 31, 1998. (17) 10.01 Surety Capital Corporation 1988 Incentive Stock Option Plan. (5) 10.02 Form of Change in Control Agreement entered into between Surety Capital Corporation and C. Jack Bean, Bobby W. Hackler and G. M. Heinzelmann, III, dated August 16, 1994. (8) 10.03 Lease agreement between Precinct Campus, Inc., as landlord, and Surety Capital Corporation, as tenant, regarding offices located in Hurst, Texas, dated February 14, 1994. (6) 10.04 Surety Capital Corporation 1995 Incentive Stock Option Plan. (8) 10.05 Form of Amended and Restated Executive Deferred Compensation Agreements and related Adoption Agreements with Designation of Beneficiaries entered into between Surety Capital Corporation and B. J Curley, Bobby W. Hackler and G. M. Heinzelmann, III, dated August 29, 1997. (15) 10.06 Form of Amended and Restated Letter Agreements between Surety Capital Corporation and B. J. Curley, Bobby W. Hackler and G. M. Heinzelmann, III regarding provision by Surety Capital Corporation of term life insurance coverage, dated August 29, 1997. (15) 10.07 Change in Control Agreement entered into between Surety Capital Corporation and B. J. Curley, dated February 9, 1996. (12) -55- 10.08 Asset Purchase Agreement by and among Surety Bank, National Association, Surety Capital Corporation, Providers Funding Corporation, and Lawrence C. Blanton, Barry T. Carroll and Bill M. Ward; Employment, Non-Competition and Confidentiality Agreement by and between Surety Bank, National Association, Surety Capital Corporation, and Barry T. Carroll; Non- Competition and Confidentiality Agreement by and between Surety Bank, National Association, Surety Capital Corporation, and Lawrence C. Blanton; and Non-Competition and Confidentiality Agreement by and between Surety Bank, National Association, Surety Capital Corporation, and Bill M. Ward; all dated March 15, 1996. (12) 10.09 Surety Capital Corporation Amended and Restated Stock Option Plan for Directors, and Form of Stock Option Agreement. (13) 10.10 Surety Capital Corporation 1997 Non-Qualified Stock Option Plan for Officers and Key Employees, and Form of Stock Option Agreement. (15) 10.11 Surety Capital Corporation 1997 Non-Qualified Stock Option Plan for Non- Employee Directors, and Form of Stock Option Agreement. (15) 10.12 Amended and Restated Post Retirement Services Agreement Between Surety Capital Corporation, Surety Bank, National Association and C. Jack Bean, dated November 1, 1998. * 10.13 Surety Capital Corporation Amended and Restated 1998 Incentive Stock Option Plan. (18) 21 Subsidiaries of the Registrant. * 23 Consent of PricewaterhouseCoopers LLP. * 24 Special Power of Attorney. * 27 Financial Data Schedule. * (1) Filed with Registration Statement No. 33-1983 on Form S-1 and incorporated by reference herein. (2) Filed with the Company's Form 10-K dated October 31, 1987 and incorporated by reference herein. (3) Filed with the Company's Form 10-Q for the quarter ended April 30, 1988 and incorporated by reference herein. (4) Filed with Registration Statement No. 33-44893 on Form S-3 and incorporated by reference herein. (5) Filed with the Company's Form 10-K dated December 31, 1991 and incorporated by reference herein. (6) Filed with the Company's Form 10-K dated December 31, 1993 and incorporated by reference herein. -56- (7) Filed with the Company's Form 8-K dated December 8, 1994 and incorporated by reference herein. (8) Filed with the Company's Form 10-K dated December 31, 1994 and incorporated by reference herein. (9) Filed with Registration Statement No. 33-89264 on Form S-2 and incorporated by reference herein. (10) Filed with Registration Statement No. 33-64789 on Form S-1 and incorporated by reference herein. (11) Filed with the Company's Form 8-K dated February 29, 1996 and incorporated by reference herein. (12) Filed with the Company's Form 10-K dated December 31, 1995 and incorporated by reference herein. (13) Filed with the Company's Form 10-K dated December 31, 1996 and incorporated by reference herein. (14) Filed with the Company's Form 8-K dated June 17, 1997 and incorporated by reference herein. (15) Filed with the Company's Form 10-K dated December 31, 1997 and incorporated by reference herein. (16) Filed with the Company's Form 10-Q for the quarter ended March 31, 1998 and incorporated by reference herein. (17) Filed with the Company's Registration Statement No. 333-57601 on Form S-3 and incorporated by reference herein. (18) Filed with the Company's Proxy Statement for the Annual Meeting of Stockholders held on May 21, 1998 and incorporated by reference herein. (19) Filed with the Company's Form 8-K dated July 13, 1998 and incorporated by reference herein. * Filed herewith. (b) Reports on Form 8-K. On October 6, 1998 the Company filed a Current Report on Form 8-K/A (Amendment No. 3) to amend the Form 8-K filed on April 9, 1998 to include unaudited financial statements of the acquired bank. On November 2, 1998 the Company filed a Current Report on Form 8-K to report that on October 16, 1998 the Company's subsidiary, Surety Bank, National Association ("Surety Bank"), completed the sale of its four Lufkin-area branches located in Chester, Kennard, Lufkin and Wells, Texas to Commercial Bank of Texas, National Association, Nacogdoches, Texas. The following financial statements were included: Pro Forma Balance Sheet as of September 30, 1998 and Pro Forma Income Statement for the nine months -57- ended September 30, 1998 and for the twelve months ended December 31, 1997. On November 18, 1998 the Company filed a Current Report on Form 8-K/A (Amendment No. 1) to amend the Form 8-K to amend the pro forma financial statements. On November 30, 1998 the Company filed a Current Report on Form 8-K to report that on November 19, 1998 each member of the Board of Directors of Surety Bank signed a formal written agreement with the Office of the Comptroller of the Currency pursuant to which Surety Bank is required to achieve certain capital levels and adopt and implement certain plans, policies and strategies. (c) Exhibits Required by Item 601 of Regulation S-K. The exhibits listed in Part IV, Item 14(a)(3) of this report, and not incorporated by reference to a separate file, are included after "Signatures," below. (d) Financial Statement Schedules Required by Regulation S-X. (Included under Part IV, Item 14(a)(2)). All schedules are omitted because they are not required, inapplicable or the information is otherwise shown in the financial statements or notes thereto. -58- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SURETY CAPITAL CORPORATION Date: April 14, 1999 By: /s/ C. Jack Bean ------------------------------------- C. Jack Bean, Chairman of the Board Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons in the capacities indicated on this 14th day of April, 1999. Signature Capacity --------- -------- /s/ C. Jack Bean Chairman of the Board, Chief Executive Officer - ---------------------------- and Director (Principal Executive Officer) C. Jack Bean /s/ G. M. Heinzelmann, III President and Director - ---------------------------- G. M. Heinzelmann, III s/ B. J. Curley Vice President, Chief Financial Officer, - ---------------------------- Secretary and Director (Principal Financial B. J. Curley Officer and Chief Accounting Officer) * Director - ---------------------------- William B. Byrd * Director - ---------------------------- Joseph S. Hardin * Director - ---------------------------- Margaret E. Holland * Director - ---------------------------- Michael L. Milam -59- * Director - ---------------------------- Garrett Morris * Director - ---------------------------- Cullen W. Turner * By: /s/ C. Jack Bean ---------------------- C. Jack Bean, as Attorney-in-Fact for each of the persons indicated -60- INDEX TO EXHIBITS Exhibit Exhibit Number - -------------------------------------------------------------------------------- 2.14 Purchase and Assumption Agreement by and between The Citizens National Bank in Waxahachie and Surety Bank, N. A., dated April 13, 1999. 10.12 Amended and Restated Post Retirement Services Agreement Between Surety Capital Corporation, Surety Bank, National Association and C. Jack Bean, dated November 1, 1998. 21 Subsidiaries of the Registrant. 23 Consent of PricewaterhouseCoopers LLP. 24 Special Power of Attorney. 27 Financial Data Schedule. Report of Independent Accountants --------------------------------- Board of Directors and Shareholders Surety Capital Corporation Fort Worth, Texas We have audited the accompanying consolidated balance sheets of Surety Capital Corporation as of December 31, 1998 and 1997 and the related consolidated statements of operations, comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Surety Capital Corporation as of December 31, 1998 and 1997 and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. The accompanying 1998 consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has suffered losses and is now operating under a written formal agreement with the Office of the Comptroller of the Currency, which requires it to meet, among other things, prescribed capital requirements. The ability of the Company to comply with the formal agreement and the resulting uncertainty as to regulatory actions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans concerning these matters are also described in Notes 1, 18, and 22. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Fort Worth, Texas February 18, 1999, except as to the information presented in Notes 8 and 18, for which the date is March 31, 1999 and Note 22, for which the date is April 13, 1999 SURETY CAPITAL CORPORATION CONSOLIDATED BALANCE SHEETS December 31, 1998 and 1997
1998 1997 ------------ ------------ Assets: Cash and due from banks $ 9,289,897 $ 6,204,177 Federal funds sold 24,761,752 22,257,266 Interest bearing deposits in financial institutions 94,939 94,939 Available-for-sale investment securities 24,366,866 28,785,162 Loans 100,346,913 100,846,310 Less: Unearned interest (916,152) (2,212,391) Allowance for credit losses (1,961,840) (950,809) ------------ ------------ Loans, net 97,468,921 97,683,110 Medical claims receivables, net 505,194 3,073,155 Premises and equipment, net 6,762,223 3,760,550 Accrued interest receivable 759,833 908,487 Deferred tax asset, net of valuation allowance - 1,622,394 Other real estate and repossessed assets 205,877 158,271 Other assets 2,451,172 2,381,887 Excess of cost over fair value of net assets acquired, net of accumulated amortization of $2,581,074 and $2,377,636 at December 31, 1998 and 1997, respectively 8,395,121 4,722,220 ------------ ------------ Total assets $175,061,795 $171,651,618 ============ ============ Liabilities and shareholders' equity: Demand deposits $ 31,732,996 $ 22,185,320 Savings, NOW and money markets 43,282,766 44,477,424 Time deposits, $100,000 and over 24,224,817 23,492,179 Other time deposits 55,922,822 64,386,569 ------------ ------------ Total deposits 155,163,401 154,541,492 Accrued interest payable and other liabilities 1,554,144 1,232,793 Convertible subordinated debt 4,350,000 -- ------------ ------------ Total liabilities 161,067,545 155,774,285 ------------ ------------ Commitments and contingent liabilities (Notes 12 & 17) Shareholders' equity: Preferred stock, $.01 par value, 1,000,000 shares authorized, none issued at December 31, 1998 and 1997 -- -- Common stock, $.01 par value, 20,000,000 shares authorized, 5,840,071 and 5,790,171 shares issued at December 31, 1998 and 1997, respectively, and 5,760,235 and 5,755,882 outstanding at December 31, 1998 and 1997, respectively 58,401 57,902 Additional paid-in capital 17,093,786 16,867,777 Accumulated deficit (2,887,548) (1,024,435) Stock rights issuable 57,902 57,902 Treasury stock, 79,836 and 34,289 shares carried at cost at December 31, 1998 and 1997, respectively (375,443) (172,828) Unrealized gain on available-for-sale securities, net of tax 47,152 91,015 ------------ ------------ Total shareholders' equity 13,994,250 15,877,333 ------------ ------------ Total liabilities and shareholders' equity $175,061,795 $171,651,618 ============ ============
The accompanying notes are an integral part of the consolidated financial statements F-2 SURETY CAPITAL CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS for the years ended December 31, 1998, 1997 and 1996
1998 1997 1996 ----------- ----------- ----------- Interest income: Commercial and real estate loans $ 6,460,480 $ 4,917,092 $ 4,539,602 Consumer loans 866,337 1,266,732 1,444,189 Insurance premium financing 3,745,792 4,935,716 3,563,467 SBA loans 686,888 -- -- Medical claims receivable factoring 1,044,069 1,477,510 1,232,463 Federal funds sold and interest bearing deposits 1,724,808 535,108 1,120,735 Investment securities: Taxable 1,800,078 1,984,533 2,165,301 Tax-exempt 189,340 315,994 324,605 ----------- ----------- ----------- Total interest income 16,517,792 15,432,685 14,390,362 ----------- ----------- ----------- Interest expense: Savings, NOW and money market 1,383,847 1,236,139 1,056,884 Time deposits, $100,000 and over 1,715,524 1,144,071 1,106,754 Other time deposits 3,683,240 3,369,588 3,191,439 Interest expense on notes payable 318,082 -- 6,612 ----------- ----------- ----------- Total interest expense 7,100,693 5,749,798 5,361,689 ----------- ----------- ----------- Net interest income before provision for credit losses 9,417,099 9,682,887 9,028,673 Provision for credit losses on loans 2,699,181 140,000 72,314 (Credit) provision for medical claims receivables losses (694,194) 6,244,996 62,686 ----------- ----------- ----------- Total provision for credit losses 2,004,987 6,384,996 135,000 ----------- ----------- ----------- Net interest income 7,412,112 3,297,891 8,893,673 ----------- ----------- ----------- Noninterest income 3,425,302 2,538,918 1,877,454 ----------- ----------- ----------- Noninterest expense: Salaries and employee benefits 5,620,710 4,748,097 4,244,874 Occupancy and equipment 2,004,070 1,517,662 1,244,551 General and administrative 4,507,990 3,649,136 2,645,587 Impairment of long lived assets -- 1,198,288 -- ----------- ----------- ----------- Total noninterest expense 12,132,770 11,113,183 8,135,012 ----------- ----------- ----------- (Loss) income before income taxes (1,295,356) (5,276,374) 2,636,115 Income tax expense (benefit): 567,757 (1,800,070) 938,128 ----------- ----------- ----------- Net (loss) income $(1,863,113) $(3,476,304) $ 1,697,987 =========== =========== =========== Basic (loss) earnings per share of common stock $(.32) $(.60) $.32 =========== =========== =========== Weighted average shares outstanding 5,759,579 5,751,847 5,389,366 =========== =========== =========== Diluted (loss) earnings per share of common stock $(.32) $(.60) $.31 =========== =========== =========== Weighted average shares outstanding and common stock equivalents 5,759,579 5,990,815 5,437,661 =========== =========== ===========
The accompanying notes are an integral part of the consolidated financial statements. F-3 SURETY CAPITAL CORPORATION STATEMENT OF COMPREHENSIVE INCOME for the years ended December 31, 1998, 1997, and 1996
1998 1997 1996 ----------- ----------- ---------- Net (loss) income $(1,863,113) $(3,476,304) $1,697,987 Other comprehensive (loss) income, net of income tax: Unrealized holding (losses) gains on available-for-sale Securities (43,863) 105,335 (156,203) ----------- ----------- ---------- Comprehensive (loss) income $(1,906,976) $(3,370,969) $1,541,784 =========== =========== ========== Disclosure of reclassification amount, net of income tax: Net unrealized holding gains (losses) arising during the year $ (120,889) $ (5,616) $ (156,203) Reclassification adjustment for net gains included in net (loss) income 77,026 110,951 - ----------- ----------- ---------- Net unrealized (losses) gains on available-for-sale Securities $ (43,863) $ 105,335 $ (156,203) =========== =========== ==========
The accompanying notes are an integral part of the consolidated financial statements. F-4 SURETY CAPITAL CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY for the years ended December 31, 1998, 1997 and 1996
Unrealized Gain/ Common Stock (Accumulated Loss on -------------------- Additional Deficit)/ Stock Available Par Paid-in Retained Rights Treasury for-Sale Total Shares Value Capital Earnings Issuable Stock Securities Equity --------- ------- ----------- ------------ -------- --------- ---------- ----------- Balance at December 31, 1995 3,516,595 $35,166 $ 9,356,469 $ 811,784 $(50,830) $ 141,883 $10,294,472 Sale of Common Stock 2,239,218 22,392 7,371,901 7,394,293 Purchase of Treasury Stock (23,709) (23,709) Net Income 1,697,987 1,697,987 Exercise of stock options 7,924 79 23,633 23,712 Change in unrealized gain/(loss) on available-for-sale securities, net of tax of $81,147 (156,203) (156,203) --------- ------- ----------- ----------- ------- --------- -------- ----------- Balance at December 31, 1996 5,763,737 57,637 16,752,003 2,509,771 (74,539) (14,320) 19,230,552 --------- ------- ----------- ----------- ------- --------- -------- ----------- Stock rights issuable (57,902) $57,902 Purchase of Treasury Stock (98,289) (98,289) Net loss (3,476,304) (3,476,304) Exercise of stock options 26,434 265 115,774 116,039 Change in unrealized gain/(loss) on available-for-sale securities, net of tax of $59,251 105,335 105,335 --------- ------- ----------- ----------- ------- --------- -------- ----------- Balance at December 31, 1997 5,790,171 57,902 16,867,777 (1,024,435) 57,902 (172,828) 91,015 15,877,333 --------- ------- ----------- ----------- ------- --------- -------- ----------- Purchase of Treasury Stock (202,615) (202,615) Net loss (1,863,113) (1,863,113) Exercise of stock options 49,900 499 226,009 226,508 Change in unrealized gain/(loss) On available-for-sale securities, net of tax of $18,720 (43,863) (43,863) --------- ------- ----------- ----------- ------- --------- -------- ----------- Balance at December 31, 1998 5,840,071 $58,401 $17,093,786 $(2,887,548) $57,902 $(375,443) $ 47,152 $13,994,250 ========= ======= =========== =========== ======= ========= ======== ===========
The accompanying notes are an integral part of the consolidated financial statements. F-5 SURETY CAPITAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS for the years ended December 31, 1998, 1997 and 1996
December 31, ---------------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Cash flows from operating activities: Net (loss) income $ (1,863,113) $ (3,476,304) $ 1,697,987 Adjustments to reconcile net (loss) income to net Cash provided by operating activities: Provision for credit losses 2,004,987 6,384,996 135,000 Impairment of long lived assets 1,198,288 Depreciation 753,040 673,362 573,745 Amortization of intangible assets and debt acquisition costs 634,821 506,172 359,717 Net gain on sale of available-for-sale securities (120,353) (173,361) Net loss (gain) on sale or disposal of assets 61,895 4,758 (22,879) Gain on sale of branches, net (1,103,483) Deferred income taxes 1,622,394 (1,800,070) Changes in assets and liabilities: Unearned interest on loans (777,195) (289,356) 655,342 Accrued interest receivable 540,794 174,849 (302,305) Other assets 360,175 (1,288,718) 317,230 Accrued interest payable and other liabilities (163,851) (167,199) (101,725) ------------ ------------ ------------ Net cash provided by operating activities 1,950,111 1,747,417 3,312,112 ------------ ------------ ------------ Cash flows from investing activities: Net decrease (increase) in loans 20,676,220 (2,002,404) (15,070,139) Payments received on purchased medical claims receivables 13,739,893 18,633,244 14,229,677 Purchases of medical claims receivables (10,477,738) (21,835,125) (17,480,467) Purchases of available-for-sale securities (26,197,558) (14,223,479) (7,239,958) Proceeds from sales of available-for-sale securities 5,807,634 12,680,593 Proceeds from maturities of available-for-sale securities 44,130,203 6,167,712 909,492 Purchases of held-to-maturity securities (3,081,744) Proceeds from maturities of held-to-maturity securities 5,190,666 15,515,641 Proceeds from maturities of interest bearing deposits in financial institutions 190,903 1,034,697 Purchases of bank premises and equipment (619,628) (604,999) (518,010) Proceeds from sales of bank premises and equipment 37,850 136,898 4,437 Proceeds from sale of other real estate and repossessed assets 893,937 644,659 428,217 Net cash paid in sale of branches (43,632,384) Net cash acquired in acquisitions 2,704,674 3,731,462 ------------ ------------ ------------ Net cash provided by (used in) investing activities 7,063,103 4,978,668 (7,536,695) ------------ ------------ ------------ Cash flows from financing activities: Net decrease in deposits (7,380,994) (1,148,849) (3,145,274) Principal payments on note payable (375,000) Purchase of treasury stock (202,615) (98,289) (23,709) Exercise of stock options 226,508 116,039 23,712 Proceeds from issuance of note payable, net of issuance costs 3,934,093 Proceeds from the sale of stock 7,394,293 ------------ ------------ ------------ Net cash (used in) provided by financing activities (3,423,008) (1,131,099) 3,874,022 ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents 5,590,206 5,594,986 (350,561) Beginning cash and cash equivalents 28,461,443 22,866,457 23,217,018 ------------ ------------ ------------ Ending cash and cash equivalents $ 34,051,649 $ 28,461,443 $ 22,866,457 ============ ============ ============
The accompanying notes are an integral part of the consolidated financial statements. F-6 SURETY CAPITAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS for the years ended December 31, 1998, 1997 and 1996 (continued)
December 31, ---------------------------------------------------------- 1998 1997 1996 ------------ ----------- ------------ Supplemental disclosure: Cash paid during the year for interest $ 7,268,131 $ 5,821,868 $ 5,190,521 Cash paid during the year for federal income taxes $ 50,000 $ 995,000 $ 545,000 Supplemental schedule of noncash investing and financing activities: Transfers of repossessed collateral to other real estate and repossessed assets $ 698,046 $ 576,329 $ 752,648 Additions to loans to facilitate the sale of OREO and other assets $ 155,038 $ 357,037 $ 212,715 Transfer of held-to-maturity to available-for-sale investment securities $17,370,604 Declaration of stock rights dividend $ 57,902 Supplemental schedule of investing activities: Interest bearing deposits in financial institutions Loans, net $(10,912,251) Premises and equipment, net (610,068) Other assets (201,095) Gain on sale of branches (1,103,483) Goodwill, net (476,099) Deposits 56,758,737 Other liabilities 176,643 ------------ Net cash paid in sale of branches $ 43,632,384 ============ Interest bearing deposits in financial institutions $ 274,242 Investment securities $ 19,261,707 21,214,629 Loans, net 33,839,277 18,476,948 Premises and equipment, net 3,785,737 1,270,401 Other assets 1,099,582 959,648 Excess of cost over fair value of net assets acquired 4,756,534 3,939,773 Deposits (64,761,640) (49,237,113) Other liabilities (685,871) (629,990) ------------ ------------ Net cash acquired in acquisitions $ (2,704,674) $ (3,731,462) ============ ============
The accompanying notes are an integral part of the consolidated financial statements. F-7 SURETY CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies: ------------------------------------------ Basis of Presentation --------------------- The accompanying consolidated financial statements include the accounts of Surety Capital Corporation (the "Company") and its wholly-owned subsidiary, Surety Bank, National Association (the "Bank"). All significant intercompany accounts and transactions have been eliminated in consolidation. Business -------- The Bank is principally engaged in traditional community banking activities provided through its nine branches located in north Texas and south-central Texas. Community banking activities include the Bank's commercial and retail lending, deposit gathering and investment and liquidity management activities. In addition to its community banking services, the Bank offers insurance premium financing and medical claims receivables factoring. Insurance premium finance ("IPF") lending involves the lending of funds to companies and individuals for the purpose of financing their purchase of property and casualty insurance. From 1990 through 1998, the Company was engaged in medical claims factoring, purchasing primarily insurance company claims from a variety of health care providers. Management has determined to substantially reduce the operations of the medical claims factoring business. Going Concern ------------- The accompanying consolidated financial statements have been prepared on a going-concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company incurred a net loss of $1.9 million during the year ended December 31, 1998 and a net loss of $3.5 million during the year ended December 31, 1997. These losses primarily resulted from medical claims factoring operations, insurance premium financing operations in the southeastern United States and the Bank's used car floor planning and purchase financing each of which has been substantially discontinued. The Bank is subject to compliance with capital requirements as prescribed by the Office of the Comptroller of the Currency (the "OCC") under a formal agreement signed by the Board of Directors of the Bank on November 19, 1998 (the "Formal Agreement"). The Bank was not in compliance with the Formal Agreement at March 31, 1999; however, the Bank requested and received an extension from March 31, 1999 to September 30, 1999 for meeting the regulatory capital ratios, subject to revocation based upon the results of examinations by the OCC to be conducted in April and June of 1999, or if the OCC finds the Bank to not be in substantial compliance with the other articles of the Formal Agreement. If the Bank is unable to or does not meet the minimum capital requirements or other articles of the Formal Agreement, one or more regulatory sanctions may result. These sanctions may include, among others, such operating restrictions as growth limitations, prohibitions on dividend payments, increased supervisory monitoring, limitations on executive compensation, restrictions on deposit interest rates and a merger or sale of the Bank. Management's plans concerning these matters have been submitted to the OCC and are described in Notes 18 and 22. Management believes that it will be able to meet all of the requirements of the Formal Agreement. The consolidated financial statements do not include adjustments, if any, that might have been required had the outcome of the above-mentioned uncertainties been known, or any adjustments relating to the recoverability of recorded asset amounts or the amount of liabilities that may be necessary should the Company be unable to continue as a going concern. The Company's continuation as a going concern is dependent upon its ability to comply with the terms of the Formal Agreement, maintain sufficient liquidity and ultimately, return to profitable operations. F-8 1. Summary of Significant Accounting Policies continued: ------------------------------------------ Cash and Cash Equivalents ------------------------- For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold. Generally, federal funds are sold for one day periods. Investment Securities --------------------- Management determines the appropriate classification of securities at the time of purchase. Securities to be held for indefinite periods of time are classified as available-for-sale and are carried at fair value. Unrealized gains and losses, net of taxes, related to securities available-for-sale are recorded as a separate component of shareholders' equity. The cost of securities sold is based on the specific identification method. Loans, Medical Claims, and Allowance for Credit Losses ------------------------------------------------------ Loans and medical claims are stated at the amount of unpaid principal, reduced by unearned interest and an allowance for credit losses, and deferred fees or costs on originated loans. Origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related receivable. The allowance for credit losses is established through a provision for credit losses charged against current earnings. A loan and a medical claim are considered impaired if, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal and interest or receivable balance when due, according to the contracted terms of the loan agreement or the claim receivable. The evaluations take into consideration such factors as changes in the nature and volume of the loan and medical claims portfolios, overall portfolio quality, review of specific problem loans or medical claims, and current economic conditions that may affect the borrower's ability to pay or the likelihood of collection. The Company has adopted Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan" ("SFAS 114"), as amended by Statement of Financial Accounting Standards No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosure." Under SFAS 114, the allowance for loan losses related to any loans that are identified for evaluation in accordance with SFAS 114 (impaired loans) is based on discounted cash flows using the loan's initial effective rate or the fair value of the collateral for certain collateral dependent loans. Smaller balance homogenous loans consisting of insurance premium finance loans and consumer loans are evaluated for reserves collectibility based on historical loss experience. Loans and medical claims are charged against the allowance for credit losses when management believes that the collectibility of the receivable is not probable. The accrual of interest on impaired loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received. The fees on medical claims are recorded into income as the claims are collected. F-9 1. Summary of Significant Accounting Policies continued: ------------------------------------------ During 1998 Management revised the policy that is used for insurance premium finance loans in determining what level of reserve is appropriate and if charge-off of the loan is needed. All insurance premium finance loans from 120 days to 149 days past the cancellation date are classified as substandard and require a 25% allowance reserve. All insurance premium finance loans 150 days to 179 days past cancellation date are classified as doubtful and require a 50% allowance reserve. All loans which are greater than 179 days are classified as a loss and are charged-off. Any insurance premium finance loan which is past due more than 179 days and guaranteed 100% by a state or exchange guarantee fund requires a 50% allowance reserve. Beginning in 1998, insurance premium finance loans which continue to be outstanding are put on non-accrual status after 120 days past the cancellation date. A similar set of guidelines have been established for the medical claims factoring. All medical claims receivables are considered current if their aging is between zero days and 60 days since funding. Receivables 61 days to 90 days are classified as special mention and require a 10% allowance reserve. Receivables 91 days to 120 days are classified as substandard and require a 33% allowance reserve. Receivables 121 days to 180 days are classified as doubtful and require a 66% allowance reserve. Any receivable which continues to be outstanding and aged beyond 180 days is classified as loss and is charged-off. Receivables are put on non-accrual after 90 days from funding. Interest income recognized on insurance premium financing loans and installment loans approximates the interest method. Interest income on commercial and real estate loans is accrued daily on the amount of outstanding principal. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that a borrower's financial condition is such that collection of interest and principal is doubtful. Management evaluates the book value (including accrued interest) and collateral value on loans placed on nonaccrual status and provides specific provision for credit losses as deemed appropriate. Premises and Equipment ---------------------- Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method at rates sufficient to amortize the cost over the estimated lives of the assets. Expenditures for repairs and maintenance are expensed as incurred, and renewals and betterments that extend the lives of assets are capitalized. Cost and accumulated depreciation are eliminated from the accounts when assets are sold or retired and any resulting gain or loss is reflected in operations in the year of disposition. Other Real Estate and Repossessed Assets ---------------------------------------- Other real estate is foreclosed property held pending disposition and is valued at the lower of its fair value or the recorded investment in the related loan. At foreclosure, if the fair value, less estimated costs to sell, of the real estate acquired is less than the Company's recorded investment in the related loan, a writedown is recognized through a charge to the allowance for credit losses. Any subsequent reduction in value is recognized by a charge to income. Operating expenses of such properties, net of related income, and gains and losses on disposition are included in non-interest expense. Goodwill and Identifiable Intangibles ------------------------------------- Net assets acquired in purchase transactions are recorded at their fair value at the date of acquisition. The excess of the purchase price over the fair value of net assets acquired is amortized on a straight-line basis, generally over a 15 year period. The Company continually re- evaluates the propriety of the carrying amount of such intangible assets and the remaining amortization period, to determine whether current events and circumstances warrant adjustments to the carrying value and/or revised estimates of the period of benefit. F-10 1. Summary of Significant Accounting Policies continued: ------------------------------------------ Earnings Per Share ------------------ The Company adopted the provisions of Statement of Financial Accounting Standards No. 128, "Earnings Per Share" on December 31, 1997. This Statement requires the disclosure of basic earnings per share using the weighted average number of shares outstanding during the period. It also requires disclosure of diluted earnings per share which uses the weighted average number of shares outstanding during the period plus additional shares that would be issued upon exercise of all outstanding stock options, as computed by the treasury method. As required by this Statement, all prior period earnings per share amounts have been restated to conform to the new method. Reporting Comprehensive Income ------------------------------ The company adopted the provisions of the Financial Accounting Standards Board Statement of Financial Accounting Standards No. 130 ("Statement 130"), "Reporting Comprehensive Income", which establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. Statement 130 requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of the balance sheet. Statement 130 was adopted by the Company in January of 1998, and has conformed to previously reported amounts accordingly. Disclosures about Segments of an Enterprise and Related Information ------------------------------------------------------------------- In June 1997 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131 ("Statement 131"), "Disclosures about Segments of an Enterprise and Related Information." Statement 131 establishes standards for the way that public business enterprises report information about operation segments in annual financial statements and requires that those enterprises report selected information about operation segments in interim financial reports issued to shareholders. Statement 131 also establishes standards for related disclosures about products and services, geographic areas, and major customers. Statement 131 is effective for financial statements for periods beginning after December 15, 1997, and was adopted by the Company in 1998. Income Taxes ------------ The Company's method of accounting for income taxes utilizes an asset and liability approach for financial statement purposes. The types of differences between the tax basis of assets and liabilities and their financial reporting amounts that give rise to significant portions of deferred income tax liabilities or assets include: allowances for possible credit losses, property and equipment, investment securities and net operating loss carryforwards. The necessity of a valuation allowance on the deferred tax asset is periodically reviewed and is estimated based upon the probability of realization, through the Company's ability to generate sufficient taxable income from operations. Use of Estimates ---------------- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. F-11 2. Acquisitions and Dispositions: ----------------------------- Acquisition of TexStar National Bank, Universal City, Texas On April 1, 1998 the Company completed the acquisition of TexStar National Bank, Universal City, Texas ("TexStar"), through the merger of TexStar into Surety Bank. As of April 1, 1998, TexStar had total assets of $70,335,000. The acquisition has been accounted for as a purchase with the assets and liabilities of TexStar being recorded at their fair values as of April 1, 1998. The consolidated results of operations include the operations of TexStar subsequent to April 1, 1998. The unaudited pro forma information for the twelve months ended December 31, 1998 and December 31, 1997, presented below, reflect the acquisition of TexStar as if it had been acquired as of January 1, 1997. Pro forma adjustments consisting of a provision for income taxes and interest expense have been made to reflect the unaudited pro forma information. Twelve Months Ended Twelve Months Ended December 31, 1998 December 31, 1997 ------------------- ------------------- Total interest income $17,718,774 $20,913,513 Net (loss) income (2,694,971) (3,350,957) Basic (loss) income per share of common stock ($0.47) $ (0.58) Sale of Chester, Kennard, Lufkin and Wells Branches In October 1998 the Company sold the Bank's four branches located in Chester, Kennard, Lufkin and Wells, Texas (the "Lufkin Branches") to the Commercial Bank of Texas, National Association ("Commercial Bank"), Nacogdoches, Texas. The sale of the Lufkin Branches was consummated on October 16, 1998, resulting in a pretax gain of $1.1 million. The Bank sold loans totaling approximately $10,912,000, real property, furniture and equipment totaling approximately $610,000, and cash and other assets totaling approximately $1,067,000, relieved goodwill and other assets associated with these branches by approximately $677,000, and Commercial Bank assumed deposits and other liabilities totaling approximately $56,936,000. After giving effect to a deposit premium of 3% on the deposits assumed totaling approximately $1,703,000, in addition to the cash at the Lufkin Branches, the Bank paid approximately $43,632,000 in cash to Commercial Bank as consideration for the net deposit liabilities assumed by Commercial Bank. The consolidated results of operations exclude the operations of the Lufkin Branches subsequent to October 16, 1998. The unaudited pro forma information for the twelve months ended December 31, 1998 and 1997, presented below, reflect the sale of the Lufkin Branches as if it the sale had occurred as of January 1, 1997. These pro forma adjustments do not reflect the acquisition of TexStar. Pro forma adjustments consisting of a provision for income taxes and interest expense have been made to properly reflect the unaudited pro forma information. Twelve Months Ended Twelve Months Ended December 31, 1998 December 31, 1997 -------------------- -------------------- Total interest income $13,811,988 $11,813,596 Net (loss) income (2,126,866) (3,818,037) Basic (loss) income per share of common stock ($0.37) $ (0.66) F-12 3. Investment Securities: --------------------- Investment securities, all classified as available-for-sale, consisted of the following at December 31, 1998 and 1997:
Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------- ---------- ---------- ----------- December 31, 1998: U.S. Treasury $ 5,498,506 $ 13,544 $ 5,512,050 Obligations of other U.S. government agencies 11,727,000 13,164 $29,823 11,710,341 State and county municipals 2,457,968 57,718 904 2,514,782 Mortgage-backed securities 3,159,766 21,682 1,732 3,179,716 Other securities 1,449,977 1,449,977 ----------- -------- ------- ----------- Total investment securities $24,293,217 $106,108 $32,459 $24,366,866 =========== ======== ======= =========== Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------- ---------- ---------- ----------- December 31, 1997: U.S. Treasury $ 4,994,786 $ 1,035 $ 4,993,751 Obligations of other U.S. government agencies 18,448,670 $ 56,870 10,853 18,494,687 State and county municipals 3,714,719 92,030 478 3,806,271 Mortgage-backed securities 437,021 5,678 442,699 Other securities 1,047,754 1,047,754 ----------- -------- ------- ----------- Total investment securities $28,642,950 $154,578 $12,366 $28,785,162 =========== ======== ======= ===========
The amortized cost and estimated market value of investment securities at December 31, 1998 by contractual maturity are shown below. Expected maturities differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Estimated Amortized Fair December 31, 1998: Cost Value ----------- ----------- Due within one year $11,297,594 $11,313,089 Due after one year through five years 2,812,258 2,844,359 Due after five years through ten 5,573,623 5,579,726 years Mortgage-backed securities 3,159,766 3,179,716 Other securities 1,449,976 1,449,976 ----------- ----------- Total investment securities $24,293,217 $24,366,866 =========== ===========
In anticipation of the acquisition of TexStar National Bank, management determined that it was necessary to restructure the investment portfolio beginning in the fourth quarter of 1997. In order to complete the restructure, management transferred all securities classified as held-to- maturity to the available-for-sale classification. The amount transferred from the held-to-maturity classification to the available-for-sale classification as of December 31, 1997 was $17,370,604 with a net unrealized gain of $142,212. F-13 3. Investment Securities, continued: --------------------- Proceeds from sales of available-for-sale investment securities during the year ended December 31, 1998 were $5,807,634 with gross recognized gains of $120,430 and gross recognized losses of $77. Proceeds from sales of available-for-sale investment securities during the year ended December 31, 1997 were $12,680,593 with gross recognized gains of $180,978 and gross recognized losses of $7,613. No sales of available-for- sale investment securities occurred during 1996. At December 31, 1998 and 1997 the carrying value of Federal Reserve Bank stock was $581,250 and $446,250, respectively. The Federal Reserve Bank stock's market value was estimated to be the same as its carrying value at both dates. At December 31, 1998 and 1997 the carrying value of Federal Home Loan Bank stock was $791,923 and $524,700, respectively. The Federal Home Loan Bank stock's market value was estimated to be the same as its carrying value at both dates. At December 31, 1998 and 1997 securities with a carrying amount of $17,820,000 and $12,999,000, respectively, were pledged as collateral for public deposits, as required or permitted by law. At December 31, 1998 and 1997 the investment securities had accrued interest receivable of $455,116 and $399,364, respectively. 4. Loans, net: ----------- At December 31, 1998 and 1997 the loan portfolio was composed of the following:
1998 1997 -------------- ------------- Real estate loans $ 41,939,108 $ 26,668,598 Insurance premium financing 24,887,202 40,373,695 Commercial loans 23,011,395 23,171,566 SBA loans 6,259,049 Installment loans 4,250,159 10,632,451 -------------- ------------- Total gross loans 100,346,913 100,846,310 Unearned interest (916,152) (2,212,391) Allowance for credit losses on loans (1,961,840) (950,809) -------------- ------------- Loans, net $ 97,468,921 $ 97,683,110 ============== =============
At December 31, 1998 and 1997 the loan portfolio had accrued interest receivable of $301,863 and $509,123. A summary of changes in allowance for credit losses on loans for the years ended December 31, 1998 and 1997 were as follows: F-14 4. Loans, net continued: ----------
December 31, December 31, 1998 1997 -------------- -------------- Balance at beginning of year $ 950,809 $1,067,041 Additions (deductions): Provision for credit losses on loans 2,699,181 140,000 Bank acquisition 820,625 - Loans charged off (3,157,636) (403,454) Recoveries of loans previously charged-off 648,861 147,222 -------------- -------------- Balance at end of year $ 1,961,840 $ 950,809 ============== ==============
At December 31, 1998 and December 31, 1997 the Company's recorded investment in loans for which impairment has been recognized in accordance with SFAS 114 consists primarily of commercial loans and installment loans as follows:
December 31, December 31, 1998 1997 ------------ ------------ Impaired loans with related allowance calculated under SFAS 114 $3,640,069 $2,306,501 Impaired loans with no allowance calculated under SFAS 114 1,614,945 505,443 ------------ ------------ Impaired loans $5,255,014 $2,811,944 ------------ ------------ Allowance on impaired loans calculated under SFAS 114 $ 971,456 $ 331,174 ============ ============ For the year ended December 31, ------------------------------------------------------------ 1998 1997 1996 ------------ ------------ ------------- Average impaired loans $5,494,830 $2,304,892 $1,723,362 Interest income recognized on impaired loans 554,978 253,538 189,570
Loans on which the accrual of interest has been discontinued amounted to approximately $1,398,000 and $92,000 at December 31, 1998 and 1997, respectively. As of December 31, 1998 and December 31, 1997, there were no commitments to lend additional funds to borrowers of loans which were considered impaired. 5. Medical Claims Receivables: -------------------------- At December 31, 1998 and 1997 the medical claims receivables portfolio was composed of the following:
December 31, December 31, 1998 1997 ------------- ------------- Medical claims receivables $ 646,378 $ 8,079,524 Unearned interest - (698,484) Allowance for medical claims Receivables losses (141,184) (4,307,885) ------------- ------------- Medical claims receivables, net $ 505,194 $ 3,073,155 ============= =============
F-15 5. Medical Claims Receivables continued: -------------------------- During 1998 the Company substantially reduced its medical claims factoring operations after incurring substantial losses. As a result of the deteriorated condition of the portfolio during the fourth quarter of 1997, in addition to a substantial provision for medical claims receivables losses, management recognized an impairment to the unamortized goodwill of $1,151,111, and undepreciated fixed assets of $47,177, relating to the medical claims factoring division. A summary of changes in the allowance for medical claims receivables credit losses for the years ended December 31, 1998 and 1997 were as follows:
December 31, December 31, 1998 1997 ------------- ------------- Balance at beginning of year $ 4,307,885 $ 217,734 Additions (deductions): (Credit) provision for credit losses (694,194) 6,244,996 Receivables charged off (4,428,530) (2,156,355) Recoveries of receivables previously charged-off 956,023 1,510 ------------- ------------- Balance at end of year $ 141,184 $ 4,307,885 ============= =============
6. Premises and Equipment: ----------------------- Premises and equipment at December 31, 1998 and 1997 are summarized as follows:
Estimated Useful Lives 1998 1997 ------------------------ ------------------- -------------------- Buildings 5 - 30 years $ 3,470,359 $ 2,214,170 Furniture, fixtures and computers 3 - 10 years 4,443,964 3,295,948 Automobiles 3 - 5 years 98,518 196,611 Leasehold improvements 3 - 5 years 139,504 105,222 ------------------- -------------------- 8,152,345 5,811,951 Less accumulated depreciation (2,414,535) (2,467,430) Land 1,024,413 416,029 ------------------- -------------------- Premises and equipment, net $ 6,762,223 $ 3,760,550 =================== ====================
F-16 7. Deposits: -------- At December 31, 1998 the scheduled maturities of time deposits are approximately as follows: Years Ending December 31, ------------- 1999 $68,100,000 2000 6,197,000 2001 4,665,000 2002 585,000 2003 601,000 ------------ $80,148,000 ============ As of December 31, 1998 and 1997 certificates of deposits in excess of $100,000 accounted for approximately $24,225,000 and $23,492,000 of the Bank's deposits, respectively. As of December 31, 1998, $22,437,000 of such certificates had a maturity of one year or less. 8. Convertible Subordinated Debt: ----------------------------- Effective March 31, 1998, the Company issued $4,350,000 in 9% Convertible Subordinated Notes Due 2008 (the "Notes"), pursuant to an indenture between the Company and Harris Trust and Savings Bank, Chicago, Illinois, as trustee (the "Trustee"). The Notes are general unsecured obligations of the Company. The terms of the Notes are such that they qualify as Tier II capital under the Federal Reserve Board's regulatory capital guidelines applicable to bank holding companies. The Notes bear interest at a rate of 9% per annum until maturity. Interest on the Notes is payable semi- annually on March 31 and September 30 of each year, commencing September 30, 1998. No principal payments are due until maturity on March 31, 2008. The amount of the principal and any accrued and unpaid interest on the Notes are subordinated in right of payment to the prior payment in full of all senior indebtedness of the Company, including the Bank's deposits. Upon the occurrence of certain events involving the bankruptcy, insolvency, reorganization, receivership or similar proceedings of the Company, either the Trustee or the holders of not less than 25% in aggregate principal amount of the outstanding Notes may declare the principal of the Notes, together with any accrued and unpaid interest, to be immediately due and payable. The Notes do not otherwise provide for any right of acceleration of the payment of principal thereof. Each holder of Notes has the right at any time prior to maturity of the Notes, unless previously redeemed, at the holder's option, to convert such Notes, or any portion thereof which is an integral multiple of $10,000, into shares of Common Stock of the Company, at the conversion price of $6.00 per share, subject to certain antidilutive adjustments (the "Conversion Price"). The Notes are not subject to mandatory redemption or sinking fund provision. The Notes are redeemable for cash at the option of the Company on at least 30 but not more than 60 days notice, in whole or in part, at any time after the date of issuance and on or before March 31, 2002 at the redemption prices set forth in the table below, plus accrued interest to the date of redemption, if the closing sales price of the Company's common stock shall be at least 130% of the Conversion Price then in effect for a period of 20 consecutive trading days in the principal market in which the common stock is then traded. At any time after March 31, 2002 and prior to maturity, the Notes are redeemable for cash at the option of the Company, on at least 30 but not more than 60 days notice, in whole or in part, at the redemption prices set forth in the table below, plus accrued interest to the date of redemption. F-17 8. Convertible Subordinated Debt continued: ----------------------------- F-18
If Redeemed During Percentage of If Redeemed During Percentage of 12 Months Ended Principal 12 Months Ended Principal March 31, Amount March 31, Amount - ----------------------------------- -------------------------- -------------------------- ------------------------ 1999 109% 2004 104% 2000 108% 2005 103% 2001 107% 2006 102% 2002 106% 2007 101% 2003 105% 2008 100%
The Company made the required March 31, 1999 interest payment on the Notes. After this payment interest on the Notes the Company as a stand alone entity had approximately $61,000 in cash remaining for future operating expenses (see Note 18 regarding plans to meet future cash requirements). 9. (Loss) Earnings Per Share: -------------------------- Under the provisions of SFAS 128, which became effective December 31, 1997, basic earnings per share applicable to common stock are based on the weighted average number of common shares outstanding during the year. Diluted earnings per share include the effect of potential common shares resulting from the assumed exercise of all outstanding stock options. For the twelve months ended December 31, 1997 and 1996, 238,968 and 48,295 of common stock equivalent shares were added to the weighted average shares outstanding for each year, respectively. None were added for 1998. There was no effect to the 1998 and 1997 diluted EPS since the common stock equivalents were considered anti dilutive. 10. Stock-Based Compensation Plans: ------------------------------- The Company has four stock-based compensation plans, which are described below. The Company applies Accounting Principles Board Opinion 25 ("APB 25") and related Interpretations in accounting for its stock-based compensation plans. In 1995, the FASB issued FASB Statement No. 123 "Accounting for Stock-Based Compensation" ("SFAS 123") which, if fully adopted by the Company, would have changed the method the Company applies in recognizing the cost of its stock-based compensation plans. Adoption of the cost recognition provisions of SFAS 123 is optional and the Company has decided not to elect these provisions of SFAS 123. However, pro forma disclosures as if the Company adopted the cost recognition provisions of SFAS 123 are presented herein. The Company has adopted the 1988, 1995 and 1998 Incentive Stock Option Plans of Surety Capital Corporation and the 1997 Non-Qualified Stock Option Plan for Officers and Key Employees of Surety Capital Corporation (the "Stock Option Plans") for officers and/or key employees of the Company. Options for the purchase of Common Stock under the Stock Option Plans may be granted to officers or key employees selected from time to time by the Stock Option Committee of the Board of Directors. The exercise price for any options granted pursuant to the Stock Option Plans must be at least equal to the fair market value of the Common Stock on the date the options are granted. Under the Stock Option Plans an aggregate of 1,200,000 shares of Common Stock of the Company were set aside for issuance pursuant to the exercise of options granted thereunder, of which 1,056,958 shares are subject to outstanding options or remain available for grant at December 31, 1998. To exercise the options, grantees must pay the exercise price in cash or Common Stock, or any combination of cash and Common Stock. F-19 10. Stock-Based Compensation Plans continued: ------------------------------ The Company has also adopted the 1996 Stock Option Plan for Directors (the "1996 Directors Plan") and the 1997 Non-Qualified Stock Option Plan for Non-Employee Directors (the "1997 Directors Plan") (collectively, the "Directors Plans"). Under the Directors Plans an aggregate of 250,000 shares of Common Stock of the Company were set aside for issuance pursuant to the exercise of options granted thereunder, of which 244,000 shares are subject to outstanding options or remain available for grant at December 31, 1998. The 1996 Directors Plan is a formula plan pursuant to which annual options are automatically granted to directors of the Company who are not employees of the Company or the Bank at fair market value. All options under the 1996 Directors Plan are nonstatutory stock options. On the first calendar business day of each year, each non-employee director is automatically granted an option to purchase 2,000 shares of Common Stock of the Company at the closing price of the Common Stock as reported on the American Stock Exchange on the grant date. In 1998 each of six non- employee directors of the Company received an option to purchase 2,000 shares of Common Stock of the Company at an exercise price of $6.9375 per share. In 1997 each of five non-employee directors of the Company received an option to purchase 2,000 shares of Common Stock of the Company at an exercise price of $4.1875 per share. In 1997, pursuant to a one time provision in the 1997 Directors Plan, each non-employee director of the Company received an option to purchase 25,000 shares of Common Stock of the Company at exercise prices ranging from $4.18 to $5.375 per share. A summary of the status of the Company's stock options as of December 31, 1998, 1997, and 1996 and the changes during the year ended on that date is presented below:
1998 1997 1996 - --------------------------------------------------------------------------------------------------------------- Number of Weighted Number of Weighted Number of Weighted Shares Average Shares Average Shares Average Underlying Exercise Underlying Exercise Underlying Exercise Options Prices Options Prices Options Prices - --------------------------------------------------------------------------------------------------------------- Outstanding at Beginning of the year 755,857 $4.18 87,292 $4.13 55,216 $4.36 Granted 102,000 $5.75 708,195 $4.24 40,000 $3.59 Exercised 49,900 $4.54 26,434 $4.39 7,924 $2.99 Expired or forfeited 65,000 $4.31 13,196 $6.42 -- -- Outstanding at End of year 742,957 $4.33 755,857 $4.18 87,292 $4.13 Exercisable at end of year 360,957 $4.39 75,856 $3.80 62,292 $4.28 Weighted-average fair value at grant date of options granted during the year $2.80 $1.98 $1.79
The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for grants in 1998, 1997 and 1996, respectively: dividend yield of 0% for all three years; expected volatility of 47.66% for 1998, 43.46% for 1997 and 48.85% for 1996; risk-free interest rates of 5.63% for 1998 grants, 6.28% for 1997, and 5.68% for 1996, and the expected lives of the options are 5.00 years for 1998 grants, 4.96 years for 1997 grants, and 5.00 years for 1996 grants. F-20 10. Stock-Based Compensation Plans continued: ------------------------------ The following table summarizes information about stock options outstanding at December 31, 1998:
Options Outstanding Options Exercisable ------------------------------------------ ------------------------- Weighted Average Weighted Remaining Weighted Average Range of Number Contractual Average Number Exercise Exercise Prices Outstanding Life Exercise Price Exercisable Price - ------------------------------------------------------------------------------------------------------------ $3.13 to $4.19 640,661 7.90 $4.12 290,661 $4.04 $4.44 to $6.94 102,296 8.61 $5.90 70,296 $5.87 - ------------------------------------------------------------------------------------------------------------ $3.13 to $6.94 742,957 8.00 $4.36 360,957 $4.39
Had the compensation cost for the Company's stock-based compensation plans been determined consistent with SFAS 123, the Company's net (loss) income and net (loss) income per common share for 1998, 1997 and 1996 would approximate the pro forma amounts below:
1998 1997 1996 ------------------------------------------------------------------------------------ As Reported Pro Forma As Reported Pro Forma As Reported Pro Forma ------------------------------------------------------------------------------------ SFAS 123 charge -- $ (434,391) -- $ (368,194) -- $ 59,189 APB 25 charge -- -- -- -- -- -- Net (loss) income $(1,863,113) $(2,297,504) $(3,476,304) $(3,844,498) $1,697,987 $1,642,519 Net (loss) income per basic common share $ (.32) $ (.40) $ (.60) $ (.67) $ 0.32 $ 0.30 Net (loss) income per diluted common share $ (.32) $ (.40) $ (.60) $ (.67) $ 0.31 $ 0.29
The effects of applying SFAS 123 in this pro forma disclosure are not indicative of future amounts. Under all of the plans, in the aggregate, 558,000 shares remain available for option grants. 11. Stockholder's Rights Agreement: ------------------------------ Pursuant to the Rights Agreement dated June 17, 1997 between the Company and Securities Transfer Corporation, as rights agent, the Company declared a dividend of one common stock purchase right (a "Right") for each outstanding share of common stock, $0.01 par value, of the Company (the "Common Stock Purchase Plan") to stockholders of record at the close of business on June 6, 1997. The Rights will be exercisable only if a person or group acquires 15% or more of the common stock or announces a tender offer the consummation of which would result in ownership by such person or group of 15% or more of the common stock. The Company will be entitled to redeem the Rights at $0.0001 per Right at any time prior to the tenth day after a person or group acquires 15% or more of the Common Stock, other than pursuant to a transaction approved by the Company's Board of Directors. The Rights are redeemable even after a 15% or more acquisition, if the Board so determines, in connection with a merger of the Company with a "white knight" and under other circumstances. F-21 12. Financial Instruments With Off-Balance-Sheet Risk and Concentration of ---------------------------------------------------------------------- Credit Risk: ----------- The Bank is party to financial instruments with off-balance-sheet risk, entered into in the normal course of business to meet the financing needs of its customers. These financial instruments include loan commitments and letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements. The Bank's exposure to credit loss in the event of nonperformance by counterparties to loan commitments and letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as are used in underwriting on-balance sheet instruments. The total amounts of financial instruments with off-balance sheet risk at December 31, 1998 were unfunded loan commitments of $6,653,000 and letters of credit of $238,000. Since many of the loan commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. Loans are made in accordance with formal written loan policies. The Bank evaluates each customer's creditworthiness on a case by case basis. The amount of collateral obtained, if deemed necessary by the Bank, upon extension of credit is based on management's evaluation of the counterparty. Collateral held varies, but may include cash, accounts receivable, inventory, property, equipment and real estate. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank had certificates of deposit, or other deposit accounts, in the amount of $56,000 at December 31, 1998, as collateral supporting those letter of credit commitments for which collateral is deemed necessary. The Bank sold approximately $24,762,000 and $22,257,000 in federal funds at December 31, 1998 and 1997, respectively. These funds represent uncollateralized loans made by the Bank, in varying amounts, to other commercial banks with whom the Bank has correspondent relationships. The Bank maintains deposits with other financial institutions in amounts which exceed FDIC insurance coverage. The Bank has not experienced any losses in such accounts and believes it is not exposed to any significant credit risks on cash and cash equivalents. The Bank has geographic concentrations of credit in its principal trade areas of Bexar, Comal, Ellis, Grayson, and Tarrant Counties, Texas. Additionally, the Bank has a significant concentration of credit, based upon like collateral, in its insurance premium finance portfolio. Insurance premium finance comprises approximately $24,887,000 or 25% and $40,374,000 or 40% of consolidated total loans as of December 31, 1998 and 1997, respectively. 13. Related Party Transactions: -------------------------- In the ordinary course of business, loans have been granted to directors, director related companies, executive officers and employees. Loans to these related parties are approximately $329,000, and $479,000 as of December 31, 1998 and 1997, respectively. During 1998, 1997 and 1996 the Company paid legal fees to a director in the amount of $182,335, $110,216 and $125,145, respectively. F-22 14. Employee Benefit Plan: --------------------- The Company adopted the Surety Bank 401(k) Plan (the "Plan"), in which all full-time employees are eligible for participation. Under the terms of the Plan, eligible employees are allowed to contribute up to 10% of their gross pay. The Company contributes amounts equal to a maximum of 2.5% of the employee's gross wages, subject to statutory limits. The expense and employer contribution for the Plan for the years ended December 31, 1998, 1997 and 1996 was $86,148, $93,773, and $85,886, respectively. 15. Federal Income Tax: ------------------ The components of the net deferred tax (liability) asset recognized at December 31, 1998 and 1997 are as follows:
December 31, December 31, 1998 1997 ------------- ------------- Deferred tax liabilities: Depreciation and amortization $ (749,587) $ (374,241) Deferred loan costs (215,219) (172,705) Other (105,963) (42,228) Net unrealized gain on available-for-sale investment securities (32,476) (2,686) ------------- ------------- Total gross deferred tax liabilities: (1,103,245) (591,860) ------------- ------------- Deferred tax assets: Net operating loss carryforwards 1,098,444 208,415 Alternative minimum tax loss carryforward 81,599 Depreciation - 21,254 Allowance for credit losses 205,582 1,522,354 Non compete agreement impairment 374,644 404,980 Other real estate losses 39,719 9,675 Other 139,565 47,576 ------------- ------------- Total gross deferred tax assets: 1,939,553 2,214,254 ------------- ------------- Net deferred tax assets: $ 836,308 $1,622,394 Less valuation allowance for net deferred tax assets (868,784) - ------------- ------------- Total net deferred tax (liability) asset: $ (32,476) $1,622,394 ============= =============
F-23 15. Federal Income Tax continued: ------------------ The Company's effective tax rate on (loss) income before income taxes differs from the U.S. statutory tax rate as follows:
December 31, ----------------------------------------------------------- 1998 1997 1996 ----------------- ---------------- --------------- U.S. statutory rate (34.0)% (34.0)% 34.0% Valuation allowance 67.1% Goodwill 10.3% (2.9)% 4.4% Tax-exempt interest (5.2)% 2.1% (3.7)% Other 5.6% 0.7% 0.9% ----------------- ---------------- --------------- Effective tax rate 43.8% (34.1)% 35.6% ================= ================ ===============
As of December 31, 1998 for income tax reporting purposes, the Company has a current net pretax operating loss carryforward of approximately $3,230,000, which expires, if not used, in 2013. As of December 31, 1998 the Company has an additional loss carryforward of approximately $104,000 for income tax reporting purposes which expires, if not used, in 2003. The utilization of this additional net operating loss carryforward is limited by Section 382 of the Internal Revenue Code to approximately $15,000 annually until its expiration. The Company also has an alternative minimum tax credit carryover of approximately $82,000, which can be used to offset regular tax in future periods. The comprehensive provision (benefit) for federal income taxes for the years ended December 31, 1998, 1997 and 1996 consists of the following:
December 31, ---------------------------------------------------------------- 1998 1997 1996 ---- ---- ---- Current: Federal $(1,164,482) - $916,674 State - - 33,826 --------------- -------------- ----------- (1,164,482) - 950,500 --------------- -------------- ----------- Deferred: Federal 863,455 $(1,800,070) (12,372) Valuation allowance 868,784 - - --------------- -------------- ----------- 1,732,239 (1,800,070) (12,372) --------------- -------------- ----------- Provision (benefit) for tax expense charged to results of operations 567,757 (1,800,070) 938,128 Tax on unrealized gain (loss) on available-for-sale securities (18,720) 59,251 (81,147) --------------- -------------- ----------- Comprehensive provision (benefit) for federal income taxes $ 549,037 $(1,740,819) $856,981 =============== ============== ===========
15. Federal Income Tax continued: ------------------ As of December 31, 1998 the Company had a net deferred tax asset in the amount of $868,784. The Company provided a 100% valuation allowance for its net deferred tax asset at the end of 1998 which could not be utilized by a NOL carryback and due to uncertainty of the realization of the deferred tax asset in future years. The realization of the net deferred tax asset is contingent upon the Company generating sufficient future taxable income. 16. Other Noninterest Income and Expense: ------------------------------------ Other noninterest income for the years ended December 31, 1998, 1997 and 1996 was composed of the following:
1998 1997 1996 ------------- ------------ ------------ Noninterest Income: Nonsufficient fund charges $ 672,276 $ 569,649 $ 460,156 Late fee charges 947,327 1,169,407 681,644 Service charges 383,356 305,494 372,756 Collection fees 110,168 162,297 135,533 Gain on sale of branches 1,103,483 Other 208,692 332,071 227,365 ------------- ------------ ------------ Total $3,425,302 $2,538,918 $1,877,454 ============= ============ ============
General and administrative expense for the years ended December 31, 1998, 1997 and 1996 was composed of the following:
1998 1997 1996 ------------ ----------- ------------ General and administrative expense: Professional fees 1,020,970 1,126,351 467,662 Settlements and accruals for legal proceedings 336,698 - - Office supplies 341,028 290,533 386,114 Travel and entertainment 128,961 132,476 96,577 Telephone 363,023 342,161 283,564 Advertising 164,163 189,510 174,335 Postage 447,312 374,233 299,388 Amortization of intangibles 634,821 506,172 359,717 Dues and subscriptions 120,130 72,847 70,559 Insurance 153,260 95,957 167,245 Bank service charge 183,086 116,631 110,881 FDIC assessment 69,976 15,626 3,553 Credit reports 32,796 46,314 22,850 Operational losses 229,761 13,987 23,075 Other 282,005 326,338 180,067 ------------ ----------- ------------ Total general and administrative $4,507,990 $3,649,136 $2,645,587 ============ =========== ============
F-24 17. Commitments and Contingencies: ----------------------------- As of December 31, 1998 the Company leased office space in Hurst, Texas (which expires in 2001), and Schertz, Texas (which expires in 1999), under noncancellable operating leases. The Company also leases the land for its branch located in New Braunfels, Texas (which expires in 2001). Future minimum lease payments for all noncancellable operating leases are as follows: For the years ending -------------------- 1999 $273,427 2000 89,793 2001 29,727 -------- Total $392,947 ======== Rent expense was $218,000, $184,000, and $162,000 for the years ended December 31, 1998, 1997 and 1996, respectively. The Company has entered into change in control agreements with certain of its executive officers. The change in control agreements provide for the payment under certain circumstances of benefits to these executive officers in the event of a change in control of the Company followed by the termination of employment of the officers. The Bank became a member of the Federal Home Loan Bank ("FHLB") on October 9, 1997 and subsequently purchased 5,247 shares of FHLB capital stock for $524,700. As a member, the Bank has the option of borrowing up to $10,700,000 from the FHLB, subject to a borrowing base that is determined from the Bank's first mortgage loans and FHLB stock. The Bank entered into an agreement with CAA Premium Finance ("CAA") on March 16, 1998 to purchase premium finance loans for a term of five years on an exclusive basis and at an annual minimum amount of $4,000,000. The Bank has reserved the right to accept or reject each loan offered to it for purchase. The purchased loans must meet the Bank's underwriting standards prior to purchase. Loans which do not meet the Bank's underwriting criteria are retained by CAA.+ The Bank also entered into an agreement with Cardinal Premium Finance ("Cardinal") on June 7, 1998 to purchase premium finance loans for a term of five years on an exclusive basis and at an annual minimum amount of $8,000,000. The Bank has reserved the right to accept or reject each loan offered to the Bank for purchase. The purchased loans must meet the Bank's underwriting standards prior to purchase. Loans which do not meet the Bank's underwriting criteria are retained by Cardinal. Legal Matters ------------- ("Surety Bank") is a defendant in two related cases: Tennessee, ex.rel., Douglas Sizemore, Commissioner of Commerce and Insurance for the State of Tennessee, et al. vs. Surety Bank, N.A., filed in June 1995 in the Federal District Court for the Northern District of Texas, Dallas, Division (the "Anchorage Case"), and United Shortline, Inc. Assurance Services, N.A. et al. vs. MacGregor General Insurance Company, Ltd., et al., now pending in the 141st Judicial District Court of Tarrant County, Texas (the "MacGregor Case"). F-25 17. Commitments and Contingencies continued: ----------------------------- The plaintiff in the Anchorage case is the Tennessee Commissioner of Commerce and Insurance ("Tennessee"), appointed by the Chancery Court for the State of Tennessee, Twentieth Judicial District, Davidson County, to liquidate Anchorage Fire and Casualty Insurance Company ("Anchorage"), including Anchorage deposits at the Bank. Tennessee sought to recover compensatory and punitive damages on various alleged causes of action, including violation of orders issued by a Tennessee court, fraudulent and preferential transfers, common law conversion, fraud, negligence, and bad faith, all of which are based on the same underlying facts and alleged course of conduct. Both the Anchorage case as well as the MacGregor case arise out of the Bank's alleged exercise of control over funds, representing the Bank's collateral, held in accounts at the Bank under agreements with Anchorage and MacGregor. The Bank asserts that it had a right to exercise control over its collateral under contractual agreements between the Bank and the respective insurance companies or the Bank and the policy holders. The Bank also contends that it had a right to exercise control over its collateral to protect itself against the possibility of inconsistent orders regarding the same funds. Tennessee seeks to recover funds allegedly transferred in and out of Anchorage/MacGregor accounts at the Bank during an approximate four month period in 1993. Tennessee also claims that the Bank allegedly transferred funds in and out of Anchorage accounts after receiving notice of a court order prohibiting such transfer. Tennessee is claiming damages in excess of $2,000,000. The Anchorage case was called to trial in July 1998, where, immediately before trial was to begin, the court granted summary judgment in favor of the Bank and entered a take nothing judgment against the Plaintiff. Tennessee has since appealed the trial court's summary judgment To the Fifth Circuit Court of Appeals where that appeal is pending. The Plaintiff in the MacGregor case, United Shortline, Inc. Assurance Services, N.A. ("Shortline"), purports to be the holder of a Florida judgment against MacGregor General Insurance Company, Ltd. ("MacGregor"), who seeks to recover funds allegedly belonging to MacGregor which were held by the Bank. When the MacGregor case was initially filed, Shortline sought a restraining order against the Bank concerning the MacGregor funds. When the Bank received notice of competing claims to some or all of those funds by Tennessee, the Bank intervened and interpled approximately $600,000 into the court's registry. Shortline now seeks, inter alia, damages against the Bank from an alleged wrongful offset wherein the Bank allegedly exercised control over the MacGregor funds at the Bank pursuant to agreements with MacGregor. The Bank moved for and obtained a summary judgment that its intervention and interpleader of funds was proper. Shortline also sought and obtained a summary judgment from the trial court that the funds interpled by the Bank into the court's registry belonged to Shortline. Tennessee appealed the summary judgment to the Fort Worth Court of Appeals. The Fort Worth Court of Appeals affirmed the trial court's ruling that the Bank's intervention and interpleader was proper but reversed the trial court's ruling that the funds in the court belonged to Shortline. Tennessee then appealed that ruling to the Texas Supreme Court which affirmed the judgment of the Court of Appeals. This case has recently been remanded to the trial court for disposition of the remaining issues. The Bank believes both of these cases lack merit and will continue to defend them vigorously. The final outcome of both of these cases is uncertain at this time. F-26 17. Commitments and Contingencies continued: ----------------------------- The Bank is also a Defendant in Dr. Christian J. Renna, et al. vs. Barry Carroll, et al., filed in April 1997 in the 348th Judicial District Court of Tarrant County, Texas (the "Renna Case"). Christian J. Renna, D.O. ("Renna") claims that his contract billing and collection manager, James Sharbrough, signed Renna's name to an agreement with the Bank and begin submitting medical claims belonging to Renna and his medical practice to the Bank for factoring. Renna claims that these alleged activities by his billing/collection manager, who was also Renna's brother-in-law at the time, were without his authority. The plaintiffs alleged that damages were suffered as a result of failing to receive advances for collections on the accounts allegedly factored by the Bank. The plaintiffs also contend that they have been further damaged as a result of factoring fees paid to factor the accounts. The plaintiffs assert that they have suffered actual damages of approximately $1,500,000, consisting of the face amount of the receivables, lost profits/income and other consequential damages. Exemplary damages and attorneys fees in an unspecified amount are also sought. The Bank has recently filed a motion for summary judgment. The case is currently set for trial to begin on May 10, 1999. The Bank will continue to defend this case vigorously. The Company is a defendant in various other legal proceedings arising in connection with its ordinary course of business. In the opinion of management, the financial position, results of operations and liquidity of the Company will not be materially affected by the final outcome of these legal proceedings. 18. Regulatory Matters: ------------------ The Bank is a national banking association and therefore is subject to regulation, supervision and examination by the Office of the Comptroller of the Currency ("OCC"). The Bank is also a member of the FRB and the FDIC. Requirements and restrictions under the laws of the United States include a reserves requirement, restrictions on the nature and the amount of loans which can be made, restrictions on the business activities in which a bank may engage, restrictions on the payment of dividends to shareholders, and minimum capital requirements. Because the FRB regulates the bank holding company parent of the Bank, the FRB also has supervisory authority which directly affects the Bank. In addition, upon making certain determinations with respect to the condition of any insured national bank, such as the Bank, the FDIC may begin proceedings to terminate a bank's federal deposit insurance. Formal Agreement with the OCC. On November 19, 1998 the Board of Directors of the Bank entered into the Formal Agreement with the OCC pursuant to which the Bank was required to achieve certain capital levels and adopt and implement certain plans, policies and strategies by March 31, 1999 and is required to achieve certain additional capital levels by December 31, 1999. Under the Formal Agreement, the Bank was required to achieve by March 31, 1999 total risk-based capital at least equal to 12% of risk-weighted assets and Tier I leverage capital at least equal to 7.5% of adjusted total assets, and is required to achieve by December 31, 1999 total risk-based capital at least equal to 14% of risk-weighted assets. At December 31, 1998 the Bank had total risk-based capital of 10.24% of risk weighted assets and Tier I leverage capital of 5.64% of adjusted total assets. The Bank failed to achieve the capital levels and the leverage ratio required by the FA to be met by March 31, 1999. The Bank submitted a request to the OCC for an extension from March 31, 1999 to September 30, 1999 to meet the capital requirements of the Formal Agreement. The OCC granted the extension subject to revocation based on the results of examinations by the OCC to be conducted in April and June of 1999 or if the OCC finds the Bank to not be in substantial compliance with the articles of the Formal Agreement. Management expects to achieve both the FA capital requirements for March 31, 1999 and December 31, 1999 upon completion of the branch sales of Midlothian and Waxahachie (see Note 22). The FA establishes higher capital requirements than those applicable under OCC regulations for an "adequately" and "well capitalized" bank. The table below sets forth the capital requirements for the Bank under OCC regulations, under the Formal Agreement, in addition to the Bank's actual capital ratios at December 31, 1998 and 1997. F-27 18. Regulatory Matters continued: ------------------
Actual Formal Agreement OCC Regulations --------------------------------------- --------------------------------- ------------------------------- Capital Ratios Capital Ratios December 31, December 31, September 30, December 31, Adequately Well 1998 1997 1999(1) 1999 Capitalized Capitalized ------------------- ------------------ --------------- ---------------- ---------------- ------------- Leverage 5.64% 6.24% 7.50% 7.50% 4.00% 5.00% Risk-Based Capital: Tier I 8.98% 9.92% 6.00% 6.00% 4.00% 6.00% Tier I & II 10.24% 11.28% 12.00% 14.00% 8.00% 10.00%
(1) As extended from March 31, 1999. The Bank's actual capital amounts and ratios are presented in the table for the years ended December 31, 1998 and 1997. December 31, ---------------------------------- 1998 1997 -------------- -------------- Tier I risk-based capital $ 9,314,000 $ 10,277,000 Tier II risk-based capital 1,304,000 1,402,000 -------------- -------------- Total capital $ 10,618,000 $ 11,679,000 ============== ============== Risk-weighted assets $103,722,000 $103,559,000 Additionally, pursuant to the Formal Agreement, the Board of Directors was required to develop a three year capital plan program, a plan to enhance its management information systems, a three year strategic plan establishing objectives for the Bank's earnings performance, growth, balance sheet mix, off-balance sheet activities, liability structure, capital adequacy, reduction in the volume of non-performing assets, product line development and market segments which the Bank intends to promote or develop, together with strategies to achieve those objectives, a revised loan policy, and a loan classification policy, each for submission to, and approval by, the OCC. All of these recommended enhancements have been implemented and the three year capital plan program, the plan to enhance the Bank's management information systems and the three year strategic plan have been submitted to the OCC for approval. The OCC has extensive enforcement authority over the operations of all national banks, including the Bank. The OCC may under certain circumstances assess civil monetary damages against the Bank and the Directors of the Bank, issue cease-and-desist or removal orders and initiate injunctive actions. Additionally, the OCC may impose a number of corrective measures on the Bank, including (1) the imposition of restrictions on certain activities involving asset growth, acquisitions, branch establishment, expansion into new lines of business, declaration and payment of dividends, and transactions with affiliates, (2) the imposition of certain additional mandated capital raising activities, and (3) a merger or sale of the Bank. The Formal Agreement also prohibits the Board of Directors from declaring or paying any dividends unless the Bank (1) is in compliance with 12 U.S.C. (S)(S) 56 and 60, its approved capital program provided for in the Formal Agreement, and the capital levels set forth in the Formal Agreement, as more fully described above, and (2) has obtained the prior written approval of the OCC. F-28 18. Regulatory Matters continued: ------------------ The Company, as the holding company for the Bank, does not have material working capital needs separate from those of the Bank, other than the payment of interest on its convertible subordinated debt (see Note 8). The Bank is currently precluded from declaring and paying any dividends to the Company under the Formal Agreement. The Company will attempt to secure a loan to meet its cash flow needs for the twelve months ended March 31, 2000, which includes servicing the interest payment on the Notes. The provisions of the subordinated debt do not allow holders to force an interest payment. After March 31, 2000, the Bank expects to be permitted to make dividends to the Company in an amount necessary to service the interest payments on the Notes and for general corporate purposes. There can be no assurance that the Company's present capital and financing will be sufficient to finance future operations thereafter. If the Company sells additional shares of common and/or preferred stock to raise funds, the terms and conditions of the issuances and any dilutive effect may have an adverse impact on the existing stockholders. If additional financing becomes necessary, there can be no assurance that the financing can be obtained on satisfactory terms. In this event, the Company could be required to restrict its operations. The Board of Governors of the Federal Reserve System (the "Federal Reserve") has announced a policy sometimes known as the "source of strength doctrine" that requires a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. The Federal Reserve has interpreted this requirement to require that a bank holding company, such as the Company, stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity. The Federal Reserve has stated that it would generally view a failure to assist a troubled or failing subsidiary bank in these circumstances as an unsound or unsafe banking practice, a violation of Regulation Y, or both, justifying a cease and desist order or other enforcement action, particularly if appropriate resources are available to the bank holding company on a reasonable basis. The requirement that a bank holding company, such as the Company, make its assets and resources available to a failing subsidiary bank could have an adverse effect upon the Company and its stockholders. 19. Fair Value of Financial Instruments: ----------------------------------- The following assumptions were used in estimating fair values of financial instruments: Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. For variable-rate loans that reprice frequently with no significant change in credit risk, fair values are based on carrying values. The fair values of other loans are estimated using discounted cash flow analysis, which utilize interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The fair values of noninterest and interest-bearing demand deposits are, by definition, equal to the amount payable on demand, i.e., their carrying amount. The fair values of interest-bearing time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates of similar maturities. The carrying amounts for cash and due from banks, federal funds sold, and medical claims receivables approximate the fair values of such assets and liabilities. The subordinated notes payable do not have readily determinable fair market values. The Company has valued the subordinated notes payable at the par value plus the premium the Company would be required to pay if it had retired the subordinated notes payable at December 31, 1998. F-29 19. Fair Value of Financial Instruments continued: ----------------------------------- Fair values for the Company's off-balance sheet instruments, which consist of lending commitments and standby letters of credit, are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. Management believes the value of these off-balance sheet instruments are not materially different from the commitment amount.
At December 31, 1998 At December 31, 1997 --------------------------- ---------------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value ---------- ------------ ---------- ------------ (in Thousands) (in Thousands) Financial Assets: Cash and due from banks $ 9,290 $ 9,290 $ 6,204 $ 6,204 Federal funds sold 24,762 24,762 22,257 22,257 Interest bearing deposits in financial institutions 95 95 95 95 Available-for-sale securities 24,367 24,367 28,785 28,785 Loans receivable 97,469 95,999 97,683 98,044 Medical claims receivable 505 505 3,073 3,073 Financial Liabilities: Noninterest bearing deposits 31,733 31,733 22,186 22,186 Interest bearing deposits 123,430 123,570 132,356 132,380 Notes payable 4,350 4,742 - - Off-balance sheet instruments - 69 - 50
F-30 20. Business Segments: ----------------- The accounting policies of the segments are the same as those described above in Note 1. The Company evaluates segment performance based on net interest income, or profit or loss from operations, before income taxes not including nonrecurring gains and losses.
Insurance Medical Claims Community Premium Receivables Banking Financing Factoring Total ------------------- ----------------- ----------------- -------------------- 1998: Net interest income before provision for credit losses $ 7,222,819 $ 1,587,486 $ 606,794 $ 9,417,099 Provision for credit losses 435,209 2,263,972 (694,194) 2,004,987 Noninterest income 2,529,060 896,242 - 3,425,302 Noninterest expense 9,075,421 2,107,115 950,234 12,132,770 Net (loss) income (47,773) (2,205,919) 390,579 (1,863,113) Loans, gross 75,459,711 24,887,202 100,346,913 Medical claims receivables, gross 646,378 646,378 Total assets 149,739,286 24,602,796 719,713 175,061,795 1997: Net interest income before provision for credit losses 5,754,941 1,764,036 2,163,910 $ 9,682,887 Provision for credit losses 195,000 (55,000) 6,244,996 6,384,996 Noninterest income 1,492,582 1,046,336 - 2,538,918 Noninterest expense 7,434,769 1,678,874 1,999,540 11,113,183 Net (loss) income 510,957 $ 782,488 (4,769,749) (3,476,304) Loans, gross 60,472,615 40,373,695 100,846,310 Medical claims receivables, gross 8,079,524 8,079,524 Total assets 124,850,117 42,450,596 4,350,905 171,651,618 1996: Net interest income before provision for credit losses 6,502,936 1,311,676 1,214,061 9,028,673 Provision for credit losses 40,000 50,000 45,000 135,000 Noninterest income 1,242,723 634,731 - 1,877,454 Noninterest expense 6,498,397 1,251,756 384,859 8,135,012 Net income 910,092 417,172 370,723 1,697,987 Loans, gross 60,150,826 39,168,604 99,319,430 Medical claims receivables, gross 6,377,067 6,377,067 Total assets $131,947,288 $38,343,966 $ 6,148,056 $176,439,310
F-31 21. Parent Company Financial Information: ------------------------------------ Condensed Parent Company Only Balance Sheets as of December 31, 1998 and 1997
1998 1997 --------------- ---------------- Assets: Cash $ 274,233 $ 730,094 Investment in subsidiary, at equity 17,756,212 15,090,094 Other assets 411,680 57,145 --------------- ---------------- Total assets $18,442,125 $15,877,333 =============== ================ Liabilities: Convertible subordinated debt $ 4,350,000 $ - Accrued interest payable 97,875 - --------------- ---------------- Total liabilities 4,447,875 - Shareholders' equity: Common stock 58,401 57,902 Additional paid-in capital 17,093,786 16,867,777 Accumulated deficit (2,887,548) (1,024,435) Stock rights issuable 57,902 57,902 Treasury stock (375,443) (172,828) Unrealized gain on available-for-sale securities 47,152 91,015 --------------- ---------------- Total shareholders' equity 13,994,250 15,877,333 --------------- ---------------- Total liabilities and shareholders' equity $18,442,125 $15,877,333 =============== ================
F-32 21. Parent Company Financial Information, continued: ------------------------------------ Condensed Parent Company Only Statements of Operations for the years ended December 31, 1998, 1997 and 1996
December 31, ------------------------------------------------------------------ 1998 1997 1996 -------------- -------------- ------------- Interest income $ 19,806 $ 20,533 $ 40,045 Interest expense 324,818 - 6,612 -------------- -------------- ------------- Net interest (expense) income (305,012) 20,533 33,433 Noninterest expense (160,897) (244,120) (169,610) Equity in net (loss) income of subsidiary (1,374,112) (3,333,245) 1,788,489 -------------- -------------- ------------- Net (loss) income before income taxes (1,840,021) (3,556,832) 1,652,312 Income tax expense (benefit): 23,092 (80,528) (45,675) -------------- -------------- ------------- Net (loss) income $(1,863,113) $(3,476,304) $1,697,987 ============== ============== =============
F-33 21. Parent Company Financial Information, continued: ------------------------------------ Condensed Parent Company Only Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996
December 31, -------------------------------------------------------- 1998 1997 1996 ------------- -------------- ------------- Cash flows from operating activities: Net (loss) income $(1,863,113) $(3,476,304) $ 1,697,987 Adjustments to reconcile net (loss) income to net cash used in operating activities: Amortization of debt issuance costs 31,193 - - Equity in net loss (income) of subsidiary 1,374,112 3,333,245 (1,810,509) Net decrease (increase) in receivable from Subsidiary - 103,760 (35,762) Net (increase) decrease in other assets 30,179 (5,170) 55,082 Net increase (decrease) in accrued liabilities 97,875 - (58,806) ------------- -------------- ------------- Net cash used in operating activities (329,754) (44,469) (152,008) ------------- -------------- ------------- Cash flows from investing activities: Investment in subsidiary (4,084,093) - (6,170,000) ------------- -------------- ------------- Net cash used in investing activities (4,084,093) - (6,170,000) ------------- -------------- ------------- Cash flows from financing activities: Sale of common stock - - 7,394,293 Exercise of stock options 226,508 116,039 23,712 Proceeds from borrowings, net of issuance Costs 3,934,093 - - Payments on borrowings - - (375,000) Purchase of treasury stock (202,615) (98,289) (23,709) ------------- -------------- ------------- Net cash provided by financing activities 3,957,986 17,750 7,019,296 ------------- -------------- ------------- Net (decrease) increase in cash and cash equivalents (455,861) (26,719) 697,288 Beginning cash and cash equivalents 730,094 756,813 59,525 ------------- -------------- ------------- Ending cash and cash equivalents $ 274,233 $ 730,094 $ 756,813 ============= ============== =============
F-34 22. Subsequent Events: ----------------- On April 13, 1999, the Bank entered into Purchase and Assumption Agreement a with The Citizens National Bank in Waxahachie, Waxahachie, Texas ("Citizens"), to sell to Citizens the Bank's two branches located in Waxahachie and Midlothian, Texas (the "Branches"). The purchase price for the Branches will be based upon the net value of the assets less the balance of liabilities assumed plus 11% of the deposit base and 2.5% of the loan base and the value of certain premises, equipment and other assets. The transaction will be structured as a purchase of certain assets and assumption of certain liabilities of the Branches, including deposits, by Citizens. As of December 31, 1998, the Branches had total deposits of approximately $58,000,000, total net loans of approximately $15,000,000 and fixed assets of approximately $1,600,000. The completion of the sale is subject to a number of contingencies, including regulatory approvals by applicable banking authorities and a due diligence review of the Branches by Citizens. There can be no assurance that the transaction will be completed. If consummated, the transaction is expected to close no later than September 30, 1999, upon the expiration of all applicable waiting periods following receipt of all necessary regulatory approvals. F-35 EX-2.14 2 PURCHASE AND ASSUMPTION AGREEMENT EXHIBIT 2.14 PURCHASE AND ASSUMPTION AGREEMENT --------------------------------- by and between THE CITIZENS NATIONAL BANK IN WAXAHACHIE Waxahachie, Texas and SURETY BANK, N.A. Hurst, Texas Dated as of April 13, 1999 TABLE OF CONTENTS SECTION 1. SALE AND PURCHASE OF CERTAIN ASSETS AND ASSUMPTION AND TRANSFER OF CERTAIN LIABILITIES.......................................................1 1.1 Sale of Assets..................................................1 1.2 Assets to be Retained by Seller.................................2 1.3 Assumption of Liabilities of Seller.............................3 1.4 Liabilities to be Retained by Seller............................3 1.5 Purchase Premium................................................4 1.6 Valuation of Assets and Liabilities.............................4 1.7 Delivery of Schedules...........................................4 1.8 The Closing, the Closing Date and the Effective Time............4 1.9 Preliminary Balance Sheet and Final Balance Sheet...............4 1.10 Adjustments.....................................................5 1.11 Deliveries by Seller at the Closing.............................5 1.12 Deliveries by Buyer at the Closing..............................7 1.13 Closing Costs and Recording.....................................7 1.14 Further Assurances..............................................7 1.15 Personnel.......................................................7 SECTION 2. REAL ESTATE PROVISIONS..............................................9 2.1 Commitment for Title Insurance and Survey.......................9 2.2 Objections and Remedies.........................................9 2.3 Title Insurance Policy.........................................10 2.4 Environmental Investigation....................................10 2.5 Destruction or Damage Prior to Closing.........................11 SECTION 3. REPRESENTATIONS AND WARRANTIES OF SELLER...........................12 3.1 Organization and Standing......................................12 3.2 Execution and Delivery.........................................12 3.3 Compliance with Laws, Permits and Instruments..................12 3.4 Litigation.....................................................13 3.5 Consents.......................................................13 3.6 Title to Assets................................................13 3.7 Real Property..................................................13 3.8 Financial Statements...........................................13 3.9 Absence of Certain Changes or Events...........................13 3.10 Contracts......................................................14 3.11 No Adverse Change..............................................14 3.12 Evidences of Indebtedness......................................14 3.13 Books and Records..............................................14 3.14 Regulatory Compliance..........................................14 3.15 Brokerage Fees.................................................15 3.16 Employee Matters...............................................15 3.17 Representations Not Misleading.................................15 SECTION 4. REPRESENTATIONS AND WARRANTIES OF BUYER............................15 4.1 Organization and Standing......................................15 4.2 Execution and Delivery.........................................15 i 4.3 Compliance with Laws, Permits and Instruments..................15 4.4 Litigation.....................................................16 4.5 Consents.......................................................16 4.6 Brokerage Fees.................................................16 4.7 Disclosure.....................................................16 SECTION 5. COVENANTS OF SELLER................................................16 5.1 Best Efforts...................................................16 5.2 Information for Governmental Applications......................16 5.3 Required Acts of Seller........................................16 5.5 Prohibited Acts of Seller......................................17 5.6 Access; Pre-Closing Investigation..............................18 5.7 Additional Financial Statements................................18 5.8 Untrue Representations.........................................18 5.9 Notice of Adverse Changes, Litigation and Claims...............18 5.10 No Disclosure or Negotiation with Others.......................19 5.11 Notices to Customers...........................................19 SECTION 6. COVENANTS OF BUYER.................................................19 6.1 Best Efforts...................................................19 6.2 Regulatory Approvals...........................................19 6.3 Notice of Adverse Changes, Litigation and Claims...............19 6.4 Change of Name, Notice to Customers............................19 6.5 Use of Name....................................................20 SECTION 7. CONDITIONS PRECEDENT TO THE OBLIGATIONS OF BUYER...................20 7.1 Compliance with Representations, Warranties and Agreements.....20 7.2 Necessary Corporate Actions....................................20 7.3 Governmental Approvals.........................................20 7.4 No Litigation..................................................21 7.5 No Material Adverse Change.....................................21 SECTION 8. CONDITIONS PRECEDENT TO THE OBLIGATIONS OF SELLER..................21 8.1 Compliance with Representations, Warranties and Agreements.....21 8.2 Governmental and Other Approvals...............................21 8.3 No Litigation..................................................21 SECTION 9. SURVIVAL OF REPRESENTATIONS, WARRANTIES, AGREEMENT AND OBLIGATIONS; INDEMNIFICATION...............................22 9.1 Survival 22 9.2 Indemnification by Seller..... 22 9.3 Indemnification by Buyer...... 23 9.4 Limit on Indemnities.......... 23 SECTION 10. OPERATIONAL AGREEMENTS............................................23 10.1 Replacement of Customer Check Stock............................23 10.2 Payment of Checks, Drafts, and Orders..........................23 10.3 Uncollected Items..............................................24 10.4 Data Processing and Utilities..................................24 ii 10.5 Compliance with Garnishments and Similar Orders................25 10.6 Direct Deposit Arrangements....................................25 10.7 Direct Debit Arrangements......................................26 10.8 IRA Deposits...................................................26 10.9 Keogh Accounts.................................................26 10.10 Final Statements...............................................26 10.11 IRA Deposits and Keogh Accounts................................26 10.12 Interest Reporting and Withholding.............................27 10.13 Loans..........................................................27 10.14 Other Items....................................................28 10.15 Safe Deposit Box and Safekeeping Business......................28 10.16 Noncompetition Agreement.......................................28 10.17 Books and Records..............................................29 10.18 Taxes..........................................................29 10.19 Clearing Items.................................................29 SECTION 11. TERMINATION AND ABANDONMENT.......................................29 11.1 Right of Termination...........................................29 11.2 Notice of Termination..........................................30 11.3 Effect of Termination..........................................30 SECTION 12. MISCELLANEOUS.....................................................30 12.1 Entire Agreement...............................................30 12.2 Multiple Counterparts..........................................30 12.3 Amendment......................................................31 12.4 Notices........................................................31 12.5 Binding Effect.................................................31 12.6 Governing Law..................................................32 12.7 Attorneys' Fees and Costs......................................32 12.8 Severability...................................................32 12.9 Assignability..................................................32 12.10 Rules of Construction..........................................32 12.11 Expenses.......................................................32 12.12 Waiver.........................................................32 12.13 Specific Performance...........................................33 12.14 Public Disclosure..............................................33 12.15 Confidential Information.......................................33 12.16 Arbitration....................................................33 12.17 Seller's Knowledge.............................................33 iii PURCHASE AND ASSUMPTION AGREEMENT --------------------------------- THIS PURCHASE AND ASSUMPTION AGREEMENT (this "Agreement") is made and entered into as of the 13th day of April, 1999, by and between The Citizens National Bank in Waxahachie, a national banking association having its principal place of business in Waxahachie, Texas ("Buyer"), and Surety Bank, N.A., a national banking association having its principal place of business in Hurst, Texas ("Seller"). RECITALS: -------- WHEREAS, Seller desires to sell and transfer to Buyer, and Buyer desires to purchase assets from Seller associated with the branches of Seller located at 310 N. Ninth Street, Midlothian, Texas (the "Midlothian Branch"), and 104 N. Elm, Waxahachie, Texas (the "Waxahachie Branch") (collectively, the "Branches"), and to assume certain liabilities of Seller associated with the Branches as hereinafter described on the terms and subject to the conditions set forth herein; NOW, THEREFORE, for and in consideration of the foregoing and of the mutual representations, warranties, covenants and agreements contained herein, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, and subject to the conditions herein set forth, the parties hereto, intending to be legally bound hereby, do undertake, promise, covenant and agree with each other as follows: SECTION 1. SALE AND PURCHASE OF CERTAIN ASSETS ------------------------------------ AND ASSUMPTION AND TRANSFER OF CERTAIN LIABILITIES -------------------------------------------------- 1.1 Sale of Assets. On the terms and subject to the conditions contained in this Agreement, at the Closing (as defined in Section 1.8) Buyer shall purchase from Seller and Seller shall sell, convey, assign, transfer and deliver to Buyer all of the rights, title, and interests of Seller in and to the following assets of the Branches as a going concern, free and clear of all liens, security interests, pledges, encumbrances, adverse claims and demands of every kind, character and description whatsoever, except as otherwise provided in this Agreement (all of which are collectively referred to herein as the "Assets"): A. All cash and other amounts due from banks, including cash items in the process of collection (the "Cash on Hand"); B. All Loans (as defined in Section 1.1H) (except for any such loans or any portions thereof that are repaid on or prior to the Effective Time), plus accrued but unpaid interest on such loans through the Effective Time; C. All rights, title and interest in the real property on which the Branches are located, as described on Schedule 1.1(C), and all improvements to such property, purchased, installed or constructed by or on behalf of Seller and used in connection with the operation or maintenance of the Branches, including, without limitation, buildings, structures, parking facilities and drive-in teller facilities (the "Real Property"); D. All furniture, fixtures, leasehold improvements, equipment and other tangible personal property located on or affixed to the Real Property or used in connection with the operations of the Branches; 1 E. All Prepaid Expenses (as defined in Section 1.9); F. All safe deposit contracts and leases for the safe deposit boxes located at the Branches as of the Effective Time (the "Safe Deposit Contracts"); and G. All books, records (including computer records), files and documentation relating to the Assets and the Liabilities (the "Records"), including, but not limited to: (i) Signature cards, orders and contracts between Seller and its depositors, including records related to IRA Deposits, and records of similar character; (ii) Records of deposit balances carried with other financial institutions; (iii) Loan and collateral records and credit files on all Loans; (iv) Available tax records pertaining to the Real Property; (v) Deeds, mortgages, abstracts, surveys, appraisals and other instruments or records of title pertaining to real estate or real estate mortgages; and (vi) Card forms and printed copy of master applications, file layouts, documentation of the files transferred, and a description of the data in such files, as well as any other documentation to facilitate the orderly operation and conversion to Buyer's system of Seller's data processing operations. It is understood that certain of Seller's records may be available only in the form of photocopies, film copies or other non-original and non-paper media. H. "Loans" shall refer to the outstanding obligations, as of the Closing Date, associated with loans, and loan participations on the books of the Branches as of the date of this Agreement (including unfunded or partially funded loan commitments, lines of credit, and letters of credit for which Buyer shall be responsible for providing the credit thereunder from and after the Closing Date (the "Commitments"), and overdrafts less than 30 days old as of the Closing Date. "Loans" shall also include loans, Commitments, and loan participations associated with the Branches approved by Seller (with Buyer's input pursuant to Section 5.4K) after the date of this Agreement. Buyer shall succeed to all rights, title, benefits and interests in and to the Assets as of the Effective Time, and shall be entitled to receive all benefits therefrom. 1.2 Assets to be Retained by Seller. Seller shall retain all assets not expressly purchased by Buyer pursuant to Section 1.1, including, but not limited to all investment securities owned by Seller; all securities purchased by Seller subject to repurchase agreements; all other real estate owned by Seller and properties carried as in substance foreclosures that are associated with the Branches (if any); all assets and records associated with the investment or brokerage business of Seller or its affiliates, whether conducted at the Branches or any other location of Seller; all intangible assets, including goodwill and mortgage servicing rights, of Seller; all rights to the name "Surety Bank, N.A." and any of Seller's corporate logos, trademarks, trade names, signs, paper stock, monetary instruments (including, but not limited to, traveler's checks and cashier's checks), forms and other supplies containing any such logos, trademarks or tradenames; and all trust assets and trust accounts (collectively, the "Excluded Assets"). Seller shall coordinate with Buyer to remove the Excluded Assets from the Branches on or prior to the Effective Time. 2 Seller shall remove the Excluded Assets at its own cost and will be responsible for making any repairs necessitated by Seller's removal of the Excluded Assets. 1.3 Assumption of Liabilities of Seller. At the Closing, subject to the conditions contained herein, Seller shall transfer and assign to Buyer, and Buyer shall assume, pay for, perform and discharge from and after the Effective Time, as and when due and payable, the following liabilities of Seller attributable to the Branches and reflected on the general ledger of Seller (all of which are collectively referred to herein as the "Liabilities"): A. All deposits as of the Effective Time (the "Deposits"), including accrued and unpaid interest on any interest-bearing deposits through the Effective Time ( "Accrued Interest"), together with all duties and obligations of Seller associated therewith, including, but not limited to, the agreements with customers associated with such deposits (the "Deposit Agreements"; the holders of record of the Deposits are hereinafter referred to as the "Depositors"), but the Deposits shall not include the deposits of the Branches listed on Schedule 1.3A nor shall the Deposits include deposit overdrafts present on the books of the Branches 30 days or more as of the Closing Date unless Buyer agrees otherwise; furthermore, the Deposits shall not exceed $58,000,000; B. All accrued real estate taxes on the Real Property attributable to the portion of the year during which Buyer owns such banking facility; C. All liabilities, duties and obligations under the Safe Deposit Contracts; D. All duties and obligations of Seller under the loan documents related to the Loans; E. All contracts listed on Schedule 1.3E; and F. All accrued expenses associated with the Branches as contemplated by Section 1.9. Buyer shall succeed to all obligations and liabilities of Seller to the extent included in the Liabilities as of the Effective Time, and shall be liable from then and thereafter to pay, discharge and perform all of the Liabilities as if Buyer had itself incurred such obligations and liabilities, and Buyer shall succeed to all rights, offsets and defenses of Seller in connection therewith. For purposes of this Agreement, the term "deposit" shall include, but not be limited to, all uncollected items included in the depositors' balances and credited on the books of Seller, and shall have the meaning identical to that defined in section 3(1) of the Federal Deposit Insurance Act, 12 U.S.C. (S) 1813(1). 1.4 Liabilities to be Retained by Seller. Seller shall retain all liabilities or obligations not expressly assumed by Buyer pursuant to Section 1.3, including, but not limited to: A. All real estate taxes on other real estate and properties carried as in substance foreclosures of Seller, all sales and use, social security and unemployment taxes withheld or collected from employees or customers and all accounts payable and operating expenses, whether or not accrued, for products or services incurred prior to the Effective Time including, but not limited to, salaries, attorneys' fees and telephone, utility, advertising and public relations expenses; B. All liabilities for overdrafts in accounts maintained by Seller with other financial institutions, including accrued but unpaid interest thereon through the Effective Time; and 3 C. All real estate taxes on the Real Property attributable to the portion of the year Seller owns such facility. D. Liabilities or obligations with respect to any litigation, suits, claims, demands or governmental proceedings arising, commenced or resulting from the operations of the Branches prior to the Effective Time. E. Seller's cashier checks, letters of credit, money orders, interest checks and expense checks issued prior to closing, consignments of U.S. Government "E" and "EE" bonds and any and all traveler's checks. 1.5 Purchase Premium. Buyer agrees to pay to Seller a premium (the "Purchase Premium") equal to $6,000,000. Such amount shall be adjusted by mutual agreement as of the close of business as of the end of the month immediately prior to the Closing Date based upon the amount of Assets and Liabilities on the books of the Branches as of such date. At the Closing, Seller shall transfer to Buyer cash in an amount equal to the value of the Liabilities as determined pursuant to Section 1.6, and at the Closing, Buyer shall transfer to Seller cash in an amount equal to the sum of (a) the value of the Assets determined pursuant to Section 1.6, plus (b) the Purchase Premium. In lieu of a direct payment of funds from Buyer to Seller in accordance with the preceding sentence, the parties agree that such amount shall be treated as an offset to the amounts to be paid from Seller to Buyer pursuant to the preceding sentence. 1.6 Valuation of Assets and Liabilities. For purposes of calculating the value of the Assets to be purchased and the Liabilities to be assumed by Buyer from Seller, all such assets and liabilities shall be valued at their net book value as shown on the books and records of Seller as of the Closing Date (as defined in Section 1.8) (the "Net Book Value"); provided, however, that (i) book value of any asset or liability not recorded in accordance with generally accepted accounting principles shall be adjusted to conform with generally accepted accounting principles and (ii) all Loans shall be valued at principal, excluding accrued but unpaid interest. 1.7 Delivery of Schedules. Schedules provided for in this Agreement shall be delivered to Buyer and Seller respectively no later than April 21, 1999. Each party shall have two (2) business days to notify the other party whether the information contained in the Schedules is acceptable to such party or constitute a "material adverse change" as contemplated herein. 1.8 The Closing, the Closing Date and the Effective Time. The sale and purchase of the Assets and the assumption of the Liabilities pursuant to this Agreement (the "Closing") shall occur on a date mutually determined by Buyer and Seller no later than 7 days after receipt of all required regulatory approvals and expiration of all required waiting periods. The Closing shall be held at the offices of Seller at 310 N. 9th St., Midlothian, Texas, at 10:00 a.m., unless another place and time is mutually agreed upon by Buyer and Seller. The date of the Closing is referred to herein as the "Closing Date." Buyer and Seller shall use their best efforts to cause the Closing Date to occur on or before June 30, 1999. The effective time (the "Effective Time") shall be 2:00 p.m. (or such later or earlier time as which deposits are posted by Buyer as of the next business day), local time, on the Closing Date. Buyer and Seller specifically agree that time is of the essence for all purposes with respect to this Agreement and the transactions contemplated hereby. 1.9 Preliminary Balance Sheet and Final Balance Sheet. On the Closing Date, Seller shall present Buyer with a list of the balances of the Assets and the Liabilities as of a date 3 business days prior to the Closing Date, certified by the Chief Executive Officer or Chief Financial Officer of Seller to be true 4 and correct as of the date reflected thereon (the "Preliminary Balance Sheet"), and the parties will calculate all amounts pursuant to Sections 1.5 and 1.6 in accordance with the amounts reflected on the Preliminary Balance Sheet. Within 3 days following the Closing Date, and when all the data with respect to the Branches up to and including the Effective Time is available, Seller shall present Buyer with a list of the balances of the Assets and the Liabilities as of the Effective Time, certified by the Chief Executive Officer or Chief Financial Officer of Seller to be true and correct as of the date reflected thereon (the "Final Balance Sheet"). Additionally, Seller shall deliver to Buyer a list of loans purchased, individually identified by account number, which list shall be appended to the Bill of Sale. Subject to Buyer's rights of indemnification pursuant to Section 11, the Final Balance Sheet shall become final and binding on Buyer and Seller 10 business days after its delivery to Buyer, unless Buyer gives written notice to Seller of its disagreement with respect to any item included in such statement, including, without limitation, any differences in application of method for calculating accrued interest receivable. Seller and Buyer shall use reasonable efforts to resolve the disagreement during the 10 day period following receipt by Seller of the notice. If the disagreement is not resolved during such 10-day period, the parties agree to follow the procedures set forth in Section 12.16 to resolve such dispute, and such Final Balance Sheet shall be modified by any such resolution, whereupon the Final Balance Sheet shall become final and binding. When the Final Balance Sheet becomes final and binding, an appropriate adjusting settlement payment from Seller to Buyer or from Buyer to Seller, as the case may be, will be made together with accrued interest calculated at the federal funds rate in effect on the Closing Date for the number of days elapsed between the Closing Date and the date of such adjusting settlement payment. 1.10 Adjustments. All operating expenses and fees accrued or prepaid on or prior to the Effective Time, including, without limitation, wages, salaries, deposit insurance premiums, utility payments, telephone charges, prepaid rents, property taxes, other ordinary operating expenses of the Branches and other expenses related to the Assets or Liabilities, shall be prorated between the parties as of the Effective Time. All real property taxes with respect to the Real Property shall be prorated based upon the tax rate in effect as of the Closing Date of the appropriate taxing authority. All amounts prepaid on Safe Deposit Contracts shall be prorated through the Effective Time, and all deposits paid thereon shall be paid to Buyer. Notwithstanding Seller's normal practices and procedures, to the extent that Seller has paid expenses that are expenses allocable to Buyer pursuant to this Section 1.9, such expenses shall appear as "Prepaid Expenses" on the Preliminary Balance Sheet, or, if not allocable as of the date the Preliminary Balance Sheet is calculated (the "Preliminary Balance Sheet Date"), on the Final Balance Sheet. Notwithstanding Seller's normal practices and procedures, to the extent that expenses have been incurred but not paid by Seller on or prior to the Effective Time, they shall appear as an "Accrued Expense" on the Preliminary Balance Sheet or, if not incurred by the Preliminary Balance Sheet Date, on the Final Balance Sheet. 1.11 Deliveries by Seller at the Closing. At the Closing, Seller shall execute, acknowledge and deliver to Buyer in recordable form as appropriate, and with third party consents and releases of liens and security interests when required, certificates and other instruments of sale, conveyance, transfer and assignment relating to all of the Assets, and containing warranties consistent with the representations and warranties contained in this Agreement, including without limitation, the following (all of such actions constituting conditions precedent to Buyer's obligations to close hereunder): A. A general warranty bill of sale covering the Personal Property; B. A special warranty deed conveying good and indefeasible fee simple title to the Real Property, subject only to ad valorem taxes for the year in which the Closing occurs and the Permitted Exceptions; 5 C. Documents properly endorsed for transfer reflecting the assignment of all notes, guaranties, security agreements and any other agreements to inure to the benefit of Buyer with respect to the Loans, and possession of any escrow deposits relating to the Loans; D. All collateral security of any nature whatsoever held by Seller as collateral for any of the Assets; E. All of the Records; F. The Preliminary Balance Sheet. G. The Cash on Hand and such of the other Assets that are capable of physical delivery; H. A certificate duly executed by an authorized officer of Seller, dated as of the Closing Date, pursuant to which such officer shall certify that all of the representations and warranties of Seller as set forth in this Agreement are true and correct as of the Closing Date and that there have been no material adverse changes in the condition of the Assets as of the Closing Date; I. A certificate duly executed by the Cashier or Secretary of Seller pursuant to which such officer shall certify (i) the due adoption by the Board of Directors of Seller of corporate resolutions attached to such certificate authorizing the transaction and the execution and delivery of this Agreement and the other agreements and documents contemplated hereby and the taking of all actions contemplated hereby and thereby; and (ii) the incumbency and true signatures of those officers of Seller duly authorized to act on its behalf in connection with the transaction contemplated by this Agreement and to execute and deliver this Agreement and other agreements and documents contemplated hereby and the taking of all actions contemplated hereby and thereby on behalf of Seller; J. All documents, contracts, certificates, instruments, keys and records necessary or appropriate to transfer the safe deposit and safekeeping businesses, if any, of the Branches to Buyer; K. Possession of the Assets and access to and keys to the Branches and all security devices located at the Branches, together with security codes for access to the Branches and combinations to all locking devices of Seller located at the Branches; L. A list, certified by an authorized officer of Seller, setting forth all garnishments, similar court orders, tax liens and orders of any governmental entity in effect with respect to the Deposits; M. Payment to Buyer as may be required pursuant to Section 1.5 in immediately available funds (such payment to be made at a time no later than 12:00 Noon, Waxahachie, Texas time, on the Closing Date); N. A Power of Attorney in a form to be mutually agreed upon by Buyer and Seller; 6 O. Such other documents as may be reasonably required by the Title Company in connection with the issuance of the Title Policy; and P. All other documents, certificates and instruments of conveyance, transfer and assignment as are reasonably requested by Buyer or Buyer's counsel. All instruments, agreements and certificates described in this Section 1.10 shall be in form and substance reasonably satisfactory to Buyer's legal counsel. 1.12 Deliveries by Buyer at the Closing. At the Closing, Buyer shall execute, acknowledge and deliver to Seller, in recordable form as appropriate, such documents and certificates necessary to carry out the terms and provisions of this Agreement, including without limitation the following (all of such actions constituting conditions precedent to Seller's obligations to close hereunder): A. An assignment and assumption agreement by which Buyer assumes the Liabilities; B. A certificate duly executed by an authorized officer of Buyer, dated as of the Closing Date, pursuant to which such officer shall certify that all of the representations and warranties of Buyer as set forth in this Agreement are true and correct as of the Closing Date; C. A certificate duly executed by the Cashier or Assistant Cashier of Buyer pursuant to which such officer shall certify (i) the due adoption by the Board of Directors of Buyer of corporate resolutions attached to such certificate authorizing the execution and delivery of this Agreement and the other agreements and documents contemplated hereby and the taking of all actions contemplated hereby and thereby on behalf of Buyer, and (ii) the incumbency and true signatures of those officers of Buyer duly authorized to act on its behalf, in connection with the transaction and this Agreement and to execute and deliver the Agreement on behalf of Buyer; and D. Such other documents, certificates and instruments as are reasonably requested by Seller and Seller's counsel. All instruments, agreements and certificates described in this Section 1.11 shall be in form and substance reasonably satisfactory to Seller's legal counsel. 1.13 Closing Costs and Recording. Seller and Buyer shall each pay one-half of any documentary, stamp or other transfer taxes, recording fees and escrow fees relating to the sale of the Real Property. Except as otherwise specified in this Agreement, Buyer shall be responsible for filing or recording any instruments or documents evidencing, or otherwise notifying persons who are not parties to this Agreement regarding, the consummation of the transactions contemplated by this Agreement. 1.14 Further Assurances. From time to time following the Closing, at the request of any party hereto and without further consideration, the other party hereto shall execute and deliver to such requesting party such instruments and documents and take such other action (but without incurring any material financial obligation) as such requesting party may reasonably request in order to consummate more fully and effectively the transactions contemplated hereby. 1.15 Personnel. The parties shall follow the following procedure in dealing with employees of the Branches regarding employment after the Closing: A. With respect to all employees of Seller affiliated with the Branches ("Employees"), as soon as reasonably practicable, but no later than 10 days after the date hereof, Seller shall notify each Employee that Seller and Buyer have entered into an agreement with 7 respect to the Buyer's acquisition of the Branches. Seller shall also furnish to Buyer within such time period a schedule containing the name of each Employee, such Employee's salary and benefits, and a synopsis of each Employee's tenure with Seller and any other information reasonably requested by Buyer with respect to such Employee, upon receipt by Seller of each such Employee's consent to such delivery. B. Within 20 days of receipt of information referred to in Section A. above, Buyer shall (i) interview each of the Employees, (ii) deliver to Seller a confidential list (the "Employment List") setting forth the Employees to whom Buyer intends to offer employment beginning at the Closing, the position to be offered to each such Employee and such Employee's anticipated compensation and employee benefits (which Employment List may not be changed prior to the Closing except upon mutual agreement of Buyer and Seller, except that the terms of the Employment List shall not be applicable with respect to the employment of any Employee who does not accept employment with Buyer in accordance with the terms of this Section 1.14), and (iii) at a date to be mutually agreed upon by Seller and Buyer, offer to each such Employee a position with Buyer on the terms reflected in the Employment List with respect to such Employee. Each Employee will have 5 business days to accept or reject the offer made by Buyer to such Employee. Each Employee who accepts the offer of employment made by Buyer is hereinafter referred to as a "Designated Employee." If an Employee (i) is not offered employment by Buyer or (ii) rejects Buyer's offer of Employment with such five-day period, Seller may, at its option, approach such Employee to discuss opportunities for such Employee to transfer to other positions with Seller or its affiliates after the Closing. Seller shall pay any and all costs (including without limitation, severance pay and accrued vacation pay) associated with any transfer or termination of any Employee of Seller other than the Designated Employees. C. Buyer and Seller shall coordinate all communications of employment offers to, or plans to terminate, any Employee; provided, however, this paragraph shall not be construed to require Buyer and Seller to act jointly at any time. D. On the Closing Date, Buyer shall employ each of the Designated Employees at the positions and with the compensation and benefits set forth in the Employment List. Buyer shall not employ any Employees of Seller prior to the Closing Date. Buyer shall not be obligated to make any contribution to any plan or program on behalf of any of such employees, or to otherwise provide any compensation or benefits to any of such employees, with respect to any period prior to the Closing. It is further provided that in no way shall Buyer be liable for any claims of any Designated Employees or other employees of the Branches that any of them may have against Seller. E. Seller shall retain all liabilities and obligations (including, without limitation, the liability and obligation for all wages, salary, vacation pay and unemployment, medical, dental, vision, health, disability and retirement benefits), for any claims incurred by any Employee prior to the Effective Time. Buyer shall not at any time assume any liability for the benefits of any Employee under any of Seller's plans. Seller shall be responsible for providing any Employee whose "qualifying event," within the meaning of section 4980B(f) of the Internal Revenue Code of 1986, as amended (the "Code"), occurs on or prior to the Effective Time (and such Employee's "qualified beneficiaries" within the meaning of section 4980B(f) of the Code) with the continuation of group health coverage required by section 4980B(f) of the Code under the terms of the health plan maintained by Seller. 8 F. Nothing in this Section is intended, nor shall it be construed, to confer any rights or benefits upon any person other than Buyer and Seller. G. Prior to the Closing Date, Seller shall reasonably cooperate with Buyer, at Buyer's expense and at no expense to Seller, in making Employees available to Buyer, its employees and representatives at reasonable times for such training as Buyer deems advisable such times to be other than during lobby hours; provided, however, Buyer shall conduct such training program (some of which training may be conducted off-site from the Branches) in a manner that does not materially interfere with or prevent the performance of the normal duties and activities of such Employees or the operation of the Branch at which such Employees are employed. Buyer shall not be liable for the acts or omissions of Seller's agents or employees. H. Nothing in this Section is intended, nor shall it be construed, to obligate Buyer to hire any current Employees of Seller. I. Seller shall use its reasonable best efforts to maintain its Employees as employees of the Seller at the Branches until the Closing Date. SECTION 2. REAL ESTATE PROVISIONS ---------------------- 2.1 Commitment for Title Insurance and Survey. Within 30 business days from the date of this Agreement, Seller shall, at its expense, deliver to Buyer and Buyer's counsel (a) a title commitment (including all documents, instruments or agreements evidencing or creating the exceptions referenced in such commitment) (the "Commitment") issued by Ellis County Abstract & Title, Waxahachie, Texas (the "Title Company") covering the Real Property and (b) a land title survey of the Real Property, prepared and certified as to all matters shown thereon by a surveyor licensed by the State of Texas (the "Survey"), which Survey shall include a notation stating whether or not any portion of the Real Property is located in a 100-year flood plain, flood-prone area of special flood hazard and shall show the specific location of any portions of the Real Property that may be located in any such flood areas. The Commitment shall reflect that Buyer has good and indefeasible title to the Real Estate, subject only to (1) any shortages in area, (2) taxes for 1999 and subsequent years and subsequent assessments for prior years due to a change in land usage or ownership, (3) existing building and zoning ordinances, (4) utility easements, reservations or other exceptions accepted or deemed waived by Buyer. 2.2 Objections and Remedies. If the Commitment contains any exceptions other than those described in Section 2.1, Buyer may object to such exceptions by providing written notice of such objection on or before the close of business on the fifth business day after delivery of the Commitment and the Survey to Buyer. All objections raised by Buyer are referred to herein as the "Objections". Within 30 days after receipt of the Objections, Seller shall either (i) remedy or remove all Objections, or (ii) notify Buyer that Seller has elected not to remedy or remove some or all of the Objections. In the event Seller gives the notice set forth in the preceding clause (ii) of this Section 2.3, or in the event Seller fails to remedy or remove all Objections within said 30-day period, Buyer may (as its sole remedy) on or before close of business on the fifth business day after such 30-day period (or, if applicable, on or before close of business on the fifth business day after receipt of Seller's notice), terminate this Agreement in its entirety by giving Seller written notice, whereon this Agreement shall terminate and have no further force and effect except as set forth in Section 11.3 hereof. If Buyer fails to terminate within such 5-business day period, Buyer shall be deemed to have waived its Objections. 9 2.3 Title Insurance Policy. At the Closing, Seller shall, at its expense, cause the Title Company to issue a Texas Owner's Policy of Title Insurance, covering the Real Estate in the amount equal to its Net Book Value as of the Closing Date. Such policy shall guarantee Buyer's title to the Real Property to be good and indefeasible subject only to the exceptions set forth in Section 2.1 (the "Permitted Exceptions"). 2.4 Environmental Investigation A. Buyer and its consultants, agents and representatives, shall have the right to the same extent that Seller has such right, but not the obligation or responsibility, to inspect the Properties, including, without limitation, conducting asbestos surveys and sampling, environmental assessments and investigation, and other environmental surveys and analyses including soil and ground sampling ("Environmental Inspections") at any time on or prior to 20 days after the date hereof. Any Environmental Inspection conducted by Buyer shall be at the expense of Buyer. Buyer shall notify Seller prior to any physical inspections of the Properties, and Seller may place reasonable restrictions on the time of such inspections. If, as a result of any such Environmental Inspection, further investigation ("Secondary Investigation") including, without limitation, test borings, soil, water and other sampling is deemed desirable by Buyer, Buyer shall (i) notify Seller of any Property for which it intends to conduct such a Secondary Investigation and the reasons for such Secondary Investigation, and (ii) commence such Secondary Investigation, on or prior to 40 days after the date hereof. Any Secondary Investigation conducted by Buyer shall be at the expense of Buyer. Buyer shall give reasonable notice to Seller of such Secondary Investigations, and Seller may place reasonable time and place restrictions on such Secondary Investigations. B. Seller agrees to indemnify and hold harmless Buyer for any claims for damage to property, or injury or death to persons, made as a result of any Environmental Inspection or Secondary Investigation conducted by Buyer or its agents, which damage or injury is attributable to the negligent actions or negligent omissions of Seller or its agents. Buyer agrees to indemnify and hold harmless Seller for any claims for damage to property, or injury or death to persons, attributable to the negligent actions or omissions of Buyer or its agents in performing any Environmental Inspection or Secondary Investigation. Buyer shall not have any liability or responsibility of any nature whatsoever for the results, conclusions or other findings related to any Environmental Inspection, Secondary Investigation or other environmental survey. If this Agreement is terminated, then except as otherwise required by law, reports to any governmental authority of the results of any Environmental Inspection, Secondary Investigation or other environmental survey shall be made by Seller and not by Buyer. Buyer shall make no such report prior to the Closing unless required to do so by law, and in such case will give Seller reasonable notice of Buyer's intentions. C. Buyer shall have the right to terminate this Agreement if (i) the results of such Environmental Inspection, Secondary Investigation or other environmental survey are disapproved by Buyer because the environmental inspection, Secondary Investigation or other environmental survey identifies violations or potential violations of Environmental Laws; (ii) Seller has refused to allow Buyer to conduct an Environmental Inspection or Secondary Investigation in a manner that Buyer reasonably considers necessary; (iii) the Environmental Inspection, Secondary Investigation or other environmental survey identifies any past or present event, condition or circumstance that would or potentially would require remedial or cleanup action or result in a material adverse change in the Assets or the business of such Branch; (iv) the presence of any underground or above ground storage tank in, on or under any Property that is not shown to be in compliance with all Environmental Laws applicable to the tank either now or at a future time certain, or that has had 10 a release of petroleum or some other Hazardous Material that has not been cleaned up to the satisfaction of the relevant governmental authority or any other party with a legal right to compel cleanup. Promptly upon receipt of all reports associated with the Environmental Inspections and any Secondary Investigation, Buyer shall notify Seller in writing if Buyer intends to terminate this Agreement pursuant to this Section 2.5. Seller shall have the opportunity to correct any objected to violations or conditions to Buyer's reasonable satisfaction for a period of 10 days after such notice. If Seller fails to demonstrate its satisfactory correction of the violations or conditions to Buyer, Buyer may terminate this Agreement at any time after such 10-day period. D. Seller agrees to make available to Buyer and its consultants, agents and representatives all documents and other material relating to environmental conditions of the Property including, without limitation, the results of other environmental inspections and surveys. Seller also agrees that all engineers and consultants who prepared or furnished such reports may discuss such reports and information with Buyer and shall be entitled to certify the same in favor of Buyer and its consultants, agents and representatives and make all other data available to Buyer and its consultants, agents and representatives. E. The term "Environmental Laws" means the common law and all federal, state, local and foreign laws or regulations, codes, orders, decrees, judgments or injunctions issued, promulgated, approved or entered thereunder, now or hereafter in effect, relating to pollution or protection of public or employee health or safety or the environment, including, without limitation, laws relating to (i) emissions, discharges, releases or threatened releases of Hazardous Materials, into the environment (including, without limitation, ambient air, indoor air, surface water, ground water, land surface or subsurface strata), (ii) the manufacture, processing, distribution, use, generation, treatment, storage, disposal, transport or handling of Hazardous Materials, and (iii) underground and above ground storage tanks, and related piping, and emissions, discharges, releases or threatened releases therefrom. F. The term "Property" or "Properties" consists of: (i) all real property owned or leased by Seller relating to the Branches, including but not limited to the Real Property. G. The term "Hazardous Material" means any pollutant, contaminant, chemical, or toxic or hazardous substance, constituent, material or waste, or any other chemical, substances, constituent or waste including, without limitation, petroleum, including crude oil or any fraction thereof, or any petroleum product. 2.5 Destruction or Damage Prior to Closing. In the event of damage to or destruction of all or any portion of the Real Property by fire or other casualty prior to the Effective Time, Seller will promptly notify Buyer of the nature and extent of such damage or destruction, the amount estimated to be necessary to repair or restore the Real Property, the amount, if any, of Seller's insurance proceeds that are available to make such repairs or restoration and the estimated period of time it will take to make such repairs and restoration. The rights and obligations of the parties by reason of such damage or destruction shall be as follows: A. If the estimated time for completion of the repairs to the Real Property is three months or less, then Buyer, at Buyer's option, may (i) take title to the Real Property subject to such damage or destruction with Seller assigning to Buyer all Seller's rights to proceeds of insurance carried by Seller and payable as a result of such damage or destruction, or (ii) request that Seller cause the repairs to be made, in which case Seller shall cause the repairs to be made and the Closing Date shall be extended until the repairs are completed. 11 B. If the estimated time for completion of the repairs to the Real Property is more than three months, then Buyer, at Buyer's option, may (i) take title to the Real Property subject to such damage or destruction with Seller assigning to Buyer all Seller's rights to proceeds of insurance carried by Seller and payable as a result of such damage or destruction, (ii) subject to (c) below, request in writing (the "Buyer's Repair Request") that Seller cause the repairs to be made, in which case Seller shall cause the repairs to be made and the Closing Date shall be extended until the repairs are completed, or (iii) terminate this Agreement by giving written notice to such effect to Seller not later than 10 days after receipt of written notice from Seller notifying Buyer of the estimated time needed for repair, whereupon this Agreement shall terminate and have no further force or effect except as set forth in Section 11.3. C. In the event Buyer requests that Seller repair the Real Property pursuant to (b)(ii) above, Seller, shall have the option to terminate this Agreement by giving notice to such effect to Buyer not later than 10 days after receipt of Buyer's Repair Request, whereupon this Agreement shall terminate and have no further force or effect except as set forth in Section 11.3. SECTION 3. REPRESENTATIONS AND WARRANTIES OF SELLER ---------------------------------------- Seller represents and warrants to Buyer as follows: 3.1 Organization and Standing. Seller is a national banking association duly organized, validly existing and in good standing under the laws of the United States, and has full power and authority (including all licenses, franchises, permits and other governmental authorizations as are legally required) to own, operate and/or lease its properties and to carry on the business and activities now conducted by it. Seller is an insured financial institution as defined in the Federal Deposit Insurance Act, and all of the Deposits are insured by the Bank Insurance Fund. Seller has all requisite corporate power to enter into this Agreement with Buyer, to carry out its obligations under this Agreement and to consummate the transactions contemplated hereby. 3.2 Execution and Delivery. Seller has taken all corporate and shareholder action, if any, necessary to authorize the execution, delivery and (provided the required regulatory approvals are obtained) performance of this Agreement and the other agreements and documents contemplated hereby to which it is a party. This Agreement has been, and the other agreements and documents contemplated hereby have been or at Closing will be, duly executed by Seller constituting the valid and binding obligation of Seller, enforceable in accordance with their respective terms and conditions, except as enforceability may be limited by bankruptcy, insolvency, reorganization or similar laws and judicial decisions affecting the rights of creditors generally and by general principles of equity (whether applied in a proceeding at law or in equity). 3.3 Compliance with Laws, Permits and Instruments. To the knowledge of Seller, the Branches have been operated in all material respects in accordance with applicable laws, rules and regulations. The execution, delivery and (provided the required regulatory and shareholder approvals are obtained) performance of this Agreement and the consummation of the transactions contemplated hereby will not conflict with, or result, by itself or with the giving of notice or the passage of time, in any violation of or default under, any provision of the Articles of Association or Bylaws of Seller or any material mortgage, indenture, lease, agreement or other instrument or any permit, concession, grant, franchise, license, contract, authorization, judgment, order, decree, writ, injunction, statute, law, ordinance, rule or regulation applicable to Seller or its properties. 12 3.4 Litigation. There are no actions, claims, suits, investigations or proceedings pending or, to Seller's knowledge, threatened (or any basis therefor known by Seller) affecting the Assets or Liabilities at law or in equity, or by or before any governmental department, commission, board, bureau, agency or instrumentality, that involve any claim not fully covered by insurance. No legal action, suit or proceeding or judicial, administrative or governmental investigation is pending or, to the knowledge of Seller, threatened against Seller that questions or might question the validity of this Agreement or any actions taken or to be taken by Seller pursuant hereto or seeks to enjoin or otherwise restrain the transactions contemplated hereby. 3.5 Consents. Other than governmental approvals contemplated by Section 7.3, no approval, consent, authorization or action of, filing with, any governmental body or other third party is required on the part of Seller in connection with (a) the execution, delivery or performance by Seller of this Agreement and the other agreements and documents contemplated hereby or (b) the consummation by Seller of the transactions contemplated hereby. 3.6 Title to Assets. Except for Permitted Exceptions, Seller has good and marketable title, free and clear of all security interests, mortgages, encumbrances, pledges, trust agreements, liens or other adverse claims to any of the Assets. No person or entity other than Seller has any right, title or interest in and to any of the Assets. Upon payment by Buyer of the amounts contemplated by this Agreement, Buyer will acquire good and indefeasible title to the Assets, free and clear of any lien, charge, encumbrance, option or adverse claim, other than Permitted Exceptions. 3.7 Real Property. Schedule 1.1(C) contains an accurate and complete description of the Real Property. Seller has received no notice of, or is not otherwise aware of, any proposed condemnation or eminent domain proceeding with respect to the Real Property or any portion thereof. Except as specifically set forth herein or disclosed to Buyer in writing within 30 business days after the execution of this Agreement, Seller has not entered into any agreement regarding the Real Property, and the Real Property is not subject to any claim, demand, suit, proceeding or litigation of any kind, pending or outstanding, or to the knowledge of Seller, threatened or likely to be made or instituted, that would in any way be binding upon Buyer or its successors or assigns or materially affect or limit Buyer's or its successors' or assigns' use and enjoyment of the Real Property or that would materially limit or restrict Buyer's right or ability to enter into this Agreement and consummate the sale and purchase contemplated hereby. To Seller's best knowledge and belief, the Real Property and collateral underlying the Loans are free from contamination with Hazardous Materials. 3.8 Financial Statements. Seller has provided Buyer with daily statements and trial balances that fairly present, in all material aspects, the financial condition of the Branches in accordance with generally accepted accounting principles, including a list of overdrafts, past due Loans, new and renewed Loans and new and closed accounts, with respect to the Assets and Liabilities of the Branches as of March 31, 1999 (the "Financial Statements"); 3.9 Absence of Certain Changes or Events. Since March 31, 1999, with respect to its Branches, Seller has conducted its business only in the ordinary course and has not, other than in the ordinary course of business and consistent with past practices and safe and sound banking practices: A. Incurred any obligation or liability, absolute, accrued, contingent or otherwise, whether due or to become due; 13 B. Mortgaged, pledged or subjected to lien, charge, security interest or any other encumbrance or restriction any of the Assets; C. Sold, transferred, leased to others or otherwise disposed of any of the Assets; D. Terminated, canceled or surrendered, or received any notice of or threat of termination or cancellation of any contract, lease or other agreement or suffered any damage, destruction or loss (whether or not covered by insurance) which, in any case or in the aggregate, has had a materially adverse affect on the Assets; E. Suffered any change, event or condition that, in any case or in the aggregate, has had or may have a materially adverse effect on the Assets or the Liabilities; or F. Entered into any agreement or made any commitment to take any of the types of action described in subsections A. through E. above. 3.10 Contracts. There are no agreements, contracts or commitments affecting the Assets to which Seller is a party and that require consent by any other person or entity in connection with the consummation of the transactions contemplated hereby either to prevent a breach or to continue the effectiveness thereof. 3.11 No Adverse Change. To the knowledge of Seller, and except as disclosed in the representations and warranties made hereunder, there has been no material adverse change nor any event or condition that has had, nor has a reasonable possibility of having in the future, a material adverse change, financial or otherwise, in the Assets or Liabilities since March 31, 1999. No material liabilities affecting the Branches have been incurred since March 31, 1999, other than those arising from normal transactions in the ordinary course of business that have been or will be disclosed to Buyer in writing prior to the Closing Date. 3.12 Evidences of Indebtedness. To the knowledge of Seller, all evidences of indebtedness and leases reflected as Assets of Seller associated with the Branches are legal, valid and binding obligations of the respective obligors thereof enforceable in accordance with their respective terms (except as limited by applicable bankruptcy, insolvency, reorganization and similar laws affecting creditors generally and the availability of injunctive relief, specific performance, and other equitable remedies) and are not subject to any defenses, offsets or counterclaims that may be asserted against Seller or the present holder thereof. Anything herein to the contrary notwithstanding, Seller does not guarantee collectibility of any of the Loans. 3.13 Books and Records. To the knowledge of Seller, the books and records of the Branches of Seller have been kept accurately in the ordinary course of business, the transactions entered therein represent bona fide transactions and the revenues, expenses, assets and liabilities of Seller have been properly recorded in such books and records. 3.14 Regulatory Compliance. To the knowledge of Seller, and except as disclosed in writing to Buyer, all reports, records and other documents or information involving any of the Assets or the Liabilities or the operation of the Branches that are required to be filed by Seller with any regulatory authority including, without limitation, the OCC, the Federal Deposit Insurance Corporation and the Internal Revenue Service have been duly and timely filed and all information and data contained in such reports, records or other documents is true, accurate and correct. 14 3.15 Brokerage Fees. Seller has not paid or agreed to pay any fee or commission to any agent, broker, finder or other person for or as a result of services rendered as a broker or finder in connection with this Agreement or the transactions covered and contemplated hereby. All negotiations relating to this Agreement have been conducted by Seller directly and without the intervention of any person in such manner as to give rise to any valid claim against Seller for any brokerage commission or like payment. 3.16 Employee Matters. Schedule 3.16 lists the names of all Employees as of the date specified thereon and states for each such individual his or her position, dates of employment with Seller, years of service and present compensation. 3.17 Representations Not Misleading. No representation or warranty by Seller contained in this Agreement, and no statement made by Seller contained in any other agreement or document contemplated hereby, contains or will contain any untrue statement of material fact or omits or will omit to state any material fact necessary to make the statements herein or therein, in light of the circumstances under which it was or will be made, not misleading. SECTION 4. REPRESENTATIONS AND WARRANTIES OF BUYER --------------------------------------- Buyer represents and warrants to Seller as follows: 4.1 Organization and Standing. Buyer is a national banking association duly organized, validly existing and in good standing under the laws of the United States and has full power and authority (including all licenses, franchises, permits and other governmental authorizations that are legally required) to own, operate and lease its properties and to carry on the business and activities now conducted by it. Buyer has all requisite corporate power to enter into this Agreement and carry out its obligations under this Agreement and to consummate the transactions contemplated hereby. 4.2 Execution and Delivery. Buyer has taken all corporate action necessary to authorize the execution, delivery and (provided the required regulatory approvals are obtained) performance of this Agreement and the other agreements and documents contemplated hereby to which it is a party. This Agreement has been, and the other agreements and documents contemplated hereby have been or at Closing will be, duly executed by Buyer, and each constitutes the legal, valid and binding obligation of Buyer, enforceable in accordance with their respective terms and conditions, except as enforceability may be limited by bankruptcy, insolvency, reorganization or similar laws and judicial decisions affecting the rights of creditors generally and by general principles of equity (whether applied in a proceeding at law or in equity). 4.3 Compliance with Laws, Permits and Instruments. The execution, delivery and (provided the required regulatory and shareholder approvals are obtained) performance of this Agreement and the consummation of the transactions contemplated hereby will not conflict with, or result, by itself or with the giving of notice or the passage of time, in any violation of or default under, any provision of the Articles of Association or Bylaws of Buyer or any material mortgage, indenture, lease, agreement or other instrument or any permit, concession, grant, franchise, license, contract, authorization, judgment, order, decree, statute, law, ordinance, rule or regulation applicable to Buyer or its properties. No consent, approval, order or authorization of, or registration, declaration or filing with, any governmental authority or other third party is required in connection with the execution and delivery of this Agreement by Buyer or the consummation by Buyer of the transactions contemplated hereby, except for filings required in order to obtain the required regulatory approvals, as described in Section 7.3. 15 4.4 Litigation. No legal action, suit or proceeding or judicial, administrative or governmental investigation is pending or, to the knowledge of Buyer, threatened against Buyer that questions or might question the validity of this Agreement or any actions taken or to be taken by Buyer pursuant hereto or seeks to enjoin or otherwise restrain the transactions contemplated hereby. 4.5 Consents. Other than the approvals described in Section 7.3, no approval, consent, authorization or action of, filing with, any governmental body or other third party is required on the part of Buyer in connection with (a) the execution, delivery or performance by Buyer of this Agreement and the other agreements and documents contemplated hereby or (b) the consummation by Buyer of the transactions contemplated hereby. 4.6 Brokerage Fees. Buyer has not paid or agreed to pay any fee or commission to any agent, broker, finder or other person for or as a result of services rendered as a broker or finder in connection with this Agreement or the transactions covered and contemplated hereby. All negotiations relating to this Agreement have been conducted by Buyer directly and without the intervention of any person in such manner as to give rise to any valid claim against Buyer for any brokerage commission or like payment. 4.7 Disclosure. No representation or warranty by Buyer contained in this Agreement, and no statement made by Buyer contained in any other agreement or document contemplated hereby, contains or will contain any untrue statement of material fact or omits or will omit to state any material fact necessary to make the statements herein or therein, in light of the circumstances under which it was or will be made, not misleading. SECTION 5. COVENANTS OF SELLER ------------------- 5.1 Best Efforts. Seller agrees to use its best efforts to cause the consummation of the transactions contemplated hereby in accordance with the terms and conditions of this Agreement. 5.2 Information for Governmental Applications. Seller shall promptly, but in no event later than 10 business days after receipt of a request by Buyer, furnish Buyer with all information concerning Seller required for inclusion in any application or statement to be made by Buyer to or filed by Buyer with any governmental body in connection with the transactions contemplated by this Agreement, or in connection with any unrelated transactions during the pendency of this Agreement, and Seller represents and warrants that all information so furnished for such statements and applications shall be true and correct in all material respects and shall not omit any material fact required to be stated therein or necessary to make the statements made, in light of the circumstances under which they were made, not misleading. Seller shall otherwise cooperate with Buyer in obtaining all governmental and regulatory consents, approvals, licenses, waivers and the like required to be fulfilled or obtained for the completion of the transactions contemplated by this Agreement. 5.3 Required Acts of Seller. Prior to the Closing, Seller shall, unless otherwise permitted in writing by Buyer, and as such acts relate to the Branches: A. Operate the Branches in the ordinary course of business; B. Use all reasonable efforts to preserve its business organization intact and to retain its present customers, depositors, suppliers, officers and employees; 16 C. Act in a manner that will preserve or attempt to preserve its goodwill; D. Perform all of its obligations under contracts, leases and documents relating to or affecting its assets, properties and business associated with the Branches, except such obligations as Seller may in good faith reasonably dispute; E. Maintain all Real Property and Personal Property in its current operating condition and repair, ordinary wear and tear excepted; F. Maintain in full force and effect all insurance policies now in effect or renewals thereof and give all notices and present all claims under all insurance policies in due and timely fashion; G. Timely file all reports required to be filed with governmental authorities and observe and conform to all applicable laws, rules, regulations, ordinances, codes, orders, licenses and permits; H. Timely file all tax returns required to be filed by it and promptly pay all taxes, assessments, governmental charges, duties, penalties, interest and fines that become due and payable; I. Withhold from each payment made to each of its employees the amount of all taxes (including, but not limited to, Federal income taxes, FICA taxes and state and local income and wage taxes) required to be withheld therefrom and pay the same to the proper tax receiving officers; J. Continue to follow and implement policies, procedures and practices regarding the identification, monitoring, classification and treatment of all assets in substantially the same manner as it has in the past; and K. Cooperate with and assist Buyer in assuring the orderly transition of the business of the Branches to Buyer from Seller, including permission by Seller to meet regularly with Seller's Chief Lending Officer, Mr. Lloyd Butts, and to receive reports from Mr. Butts regarding any matters related to the assets or liabilities of the Branches to be acquired by Buyer. If the Acquisition is finally disapproved by any appropriate regulatory authority, the Buyer's representatives will no longer be entitled to receive such reports. 5.5 Prohibited Acts of Seller. Prior to the Closing, Seller shall not, without the prior written consent of Buyer: A. Introduce any new material method of management or operation of the Branches: B. Take any action that may result in a material adverse change in the business of the Branches or the Assets; C. Take or fail to take any action that would cause or permit the representations made in Section 3 to be inaccurate at the time of the Closing or preclude Seller from making such representations and warranties at the time of the Closing; 17 D. Default with respect to any provision of any insurance policy now or hereafter in effect relating to the Branches; E. Enter into any transaction affecting any Asset or Liability other than in the ordinary course of business; F. Make, or incur any obligation to make, any capital expenditures or enter into any contracts to make such expenditures with respect to the Branches, in either case in an aggregate amount not to exceed $10,000, provided that Seller can make any emergency repairs required to restore the Branches to a safe operating condition; G. Make any material modifications, including, but not limited to, any changes in collateral, repayment terms or interest rates, to the Assets or Liabilities as a whole; H. Sell, transfer, mortgage, encumber or otherwise dispose of any of the Assets except for the disposition of Assets (other than the Real Property) in the ordinary course of business; or I. Cause the transfer from the Branches to Seller's other operations of any deposits of the type included in the Liabilities, provided, however, that Seller may transfer deposits to Seller's other branches or offices upon the unsolicited request of the depositors; or L. Pay more than prevailing market rates on deposits. 5.6 Access; Pre-Closing Investigation. Seller shall afford the officers and authorized representatives of Buyer full access to the properties, books and records of Seller pertaining to the Assets and Liabilities and employees of the Branches in order that Buyer may have full opportunity to make such reasonable investigation as it shall desire to make of the Assets and Liabilities, including, without limitation, access sufficient to verify the value of the Assets and the Liabilities and the satisfaction of the conditions precedent to Buyer's obligations described in Section 7. Seller agrees at any time, and from time to time, to furnish to Buyer as soon as practicable, any additional information pertaining to the Assets and Liabilities that Buyer may reasonably request. 5.7 Additional Financial Statements. Seller shall furnish Buyer with Financial Statements as of each month end until the Closing Date for the Branches. 5.8 Untrue Representations. Seller shall promptly notify Buyer in writing if Seller becomes aware of any fact or condition that makes untrue, or shows to have been untrue, in any material respect, any schedule or any other information furnished to Buyer or any representation or warranty made in or pursuant to this Agreement or that results in Seller's failure to comply with any covenant, condition or agreement contained in this Agreement. 5.9 Notice of Adverse Changes, Litigation and Claims. Seller shall promptly notify Buyer in writing if Seller becomes aware of (i) any fact or condition that makes untrue, or shows to have been untrue, in any material respect, any schedule or any other information furnished to Buyer or any representation or warranty made in or pursuant to this Agreement or that results in Seller's failure to comply with any covenant, condition or agreement contained in this Agreement, (ii) any litigation, or any claim, controversy or contingent liability that might become the subject of litigation, against Seller or affecting the Branches, if such litigation or potential litigation might, in the event of an unfavorable 18 outcome, have a material adverse effect on the business, results of operations or condition, financial or otherwise, of the Branches, (iii) any change that has occurred or has been threatened (or any development has occurred or been threatened involving a prospective change) in the business, financial condition, operations or prospects of Seller that is or may reasonably be expected to have a material adverse effect on the Assets or the Liabilities. 5.10 No Disclosure or Negotiation with Others. Seller shall prevent the disclosure of any of the terms or conditions hereof to any other person except for disclosure required by appropriate regulatory authorities, and as long as this Agreement shall remain effective, Seller shall not, directly or indirectly, nor shall it authorize any of its officers, directors, employees, representatives or agents to, directly or indirectly, encourage, solicit or initiate discussions or negotiations with, or discuss or negotiate with, or provide any non-public information to, any corporation, partnership, person or other entity or group (other than Buyer or an affiliate or an associate of Buyer or an officer, partner, employee or other authorized representative of Buyer or such affiliate or associate) concerning any merger, tender offer or other takeover offer, sale of substantial assets, sale of shares of capital stock or similar transaction involving the Assets or the Liabilities. 5.11 Notices to Customers. Prior to the Closing Date, Seller agrees to mail or cause to be mailed, to each of the Depositors, each holder of a safe deposit box domiciled at the Branches and to such other customers as may be required by applicable law, such notice of contemplated transfer of the Assets, the Liabilities or the operations of the Branches as may be required of Seller as a condition of approval by any regulatory authority, or as otherwise may be required by applicable law. Each such notice shall be in a form acceptable to each party hereto, such approval not to be unreasonably withheld. Seller will cooperate with Buyer in preparation and mailing of such notices. SECTION 6. COVENANTS OF BUYER ------------------ 6.1 Best Efforts. Buyer agrees to use its best efforts to cause the consummation of the transactions contemplated hereby in accordance with the terms and conditions of this Agreement. 6.2 Regulatory Approvals. Buyer shall promptly, but in no event later than 10 days after the date of this Agreement, unless delayed by Seller, file or cause to be filed applications for all regulatory approvals required to be obtained by Buyer in connection with the transactions contemplated hereby. Buyer shall promptly respond to comments and requests for information received from regulatory authorities. Buyer shall use its best efforts to obtain such regulatory approvals at the earliest practicable time. 6.3 Notice of Adverse Changes, Litigation and Claims. Buyer shall promptly notify Seller in writing if Buyer becomes aware of (i) any fact or condition that makes untrue, or shows to have been untrue, in any material respect, any schedule or any other information furnished to Buyer or any representation or warranty made in or pursuant to this Agreement or that results in Buyer's failure to comply with any covenant, condition or agreement contained in this Agreement, or (ii) any litigation against Buyer if such litigation might prevent consummation of the transactions contemplated by this Agreement. 6.4 Change of Name, Notice to Customers. A. Prior to the Closing Date, Buyer agrees to mail or cause to be mailed, to each of the Depositors, each holder of a safe deposit box domiciled at the Branches and to such other 19 customers as may be required by applicable law, such notice of contemplated transfer of the Assets, the Liabilities or the operations of the Branches as may be required as a condition of approval by any regulatory authority, or as otherwise may be required by applicable law. Each such notice shall be in a form acceptable to each party hereto, such approval not to be unreasonably withheld. B. After the Closing Date, Buyer shall, (i) as soon as practicable, change the name on all documents and facilities relating to the Branches from Seller's name to Buyer's name, and all signs and other trademarks or logos identifying Seller as the owner and operator of the Branches shall be returned to Seller; (ii) starting promptly after the Closing Date, mail written notice by first class mail to all customers of the Branches as of the Closing Date, all Depositors and all borrowers with respect to the Loans, of the consummation of the transactions contemplated by this Agreement, the form and substance of such notice being mutually satisfactory to Buyer and Seller; and (iii) to the extent required by law, give the notices required to be given by it pursuant to section 6 of the Federal Real Estate Settlement Procedures Act, as amended. 6.5 Use of Name. It is understood that Seller is not transferring to Buyer any right, title or interest in or to, or any right of license to use, Seller's name in connection with the Branches or otherwise. No agency relationship exists between the parties hereto. At no time, whether before or after Closing Date, shall Buyer transact any business in the name of Seller or use any forms, checks or receipts with Seller's name or any trademark or service mark utilized by Seller thereon or in any way hold itself out as the actual or apparent agent of Seller. SECTION 7. CONDITIONS PRECEDENT TO THE OBLIGATIONS OF BUYER ------------------------------------------------ All obligations of Buyer under this Agreement are subject to the fulfillment, prior to or at the Closing, of each of the following conditions, any or all of which may be waived in whole or in part in writing by Buyer: 7.1 Compliance with Representations, Warranties and Agreements. The representations and warranties made by Seller in this Agreement or in any schedule delivered to Buyer pursuant hereto shall have been true and correct when made and shall be true and correct as of the Closing with the same force and effect as if such representations and warranties were made at and as of the Closing, except with respect to those representations and warranties specifically made as of an earlier date (in which case such representations and warranties shall be true as of such earlier date). Seller shall have performed or complied with all agreements, terms, covenants and conditions required by this Agreement to be performed or complied with by Seller prior to or at the Closing except as specifically provided to the contrary in this Agreement. 7.2 Necessary Corporate Actions. Seller shall have taken any and all requisite corporate actions and other steps and secured any other corporate approvals, including any requisite shareholders approval, necessary to authorize and consummate this Agreement and the transactions contemplated hereby. 7.3 Governmental Approvals. Buyer shall have received approvals, acquiescences or consents, all on terms and conditions acceptable to Buyer in its sole discretion, from all necessary governmental agencies and authorities to the transactions contemplated by this Agreement, including, but not limited to the approval of the OCC and expiration of applicable waiting periods, for Buyer to acquire the Assets and assume the Liabilities and to establish branches of Buyer at each location of the Branches. 20 Such approvals and the transactions contemplated hereby shall not have been contested or threatened to be contested by any Federal or state governmental authority or by any other third party by formal proceedings. 7.4 No Litigation. No action shall have been taken, and no statute, rule, regulation or order shall have been promulgated, enacted, entered, enforced or deemed applicable to the acquisition by any Federal, state or foreign government or governmental authority or by any court, domestic or foreign, including the entry of a preliminary or permanent injunction, that would (a) make this Agreement or the transactions contemplated hereby illegal, invalid or unenforceable (b) require the divestiture of a material portion of the Assets or the Liabilities once acquired by Buyer, (c) impose material limits in the ability of Buyer to consummate the Agreement or the transactions contemplated hereby, (d) otherwise materially and adversely affect the Assets, the Liabilities or the Branches or (e) if the Agreement or the transactions contemplated hereby are consummated, subject Buyer or any officer, director or employee of Buyer to criminal penalties or to civil liabilities. No action or proceeding before any court or governmental authority, domestic or foreign, by any government or governmental authority or by any other person, domestic or foreign, shall be threatened, instituted or pending that would reasonably be expected to result in any of the consequences referred to in clauses (a) through (e) above. 7.5 No Material Adverse Change. Buyer shall have determined in good faith that there has been no material adverse change in the business, properties, operations or financial condition of any of the Branches or any of the Assets or Liabilities in the aggregate since the date of this Agreement. SECTION 8. CONDITIONS PRECEDENT TO THE OBLIGATIONS OF SELLER ------------------------------------------------- All obligations of Seller under this Agreement are subject to the fulfillment, prior to or at the Closing, of each of the following conditions, any or all of which may be waived in whole or in part by Seller. 8.1 Compliance with Representations, Warranties and Agreements. The representations and warranties made by Buyer in this Agreement shall have been true and correct when made and shall be true and correct as of the Closing with the same force and effect as if such representations and warranties were made at and as of the Closing, except with respect to those representations and warranties specifically made as of an earlier date (in which case such representations and warranties shall be true as of such earlier date). Buyer shall have performed or complied in all material respects with all agreements, terms, covenants and conditions required by this Agreement to be performed or complied with by Buyer prior to or at the Closing. 8.2 Governmental and Other Approvals. Buyer shall have received approvals, acquiescences or consents to the transactions contemplated by this Agreement from all necessary governmental agencies and authorities for the transactions contemplated hereby, and Seller and Buyer shall have received satisfactory evidence that such approvals have been obtained and that any necessary waiting periods have passed or Buyer shall have notified Seller in writing that such approvals, acquiescences or consents are reasonably expected to be obtained in due course. 8.3 No Litigation. No action shall have been taken, and no statute, rule, regulation or order shall have been promulgated, enacted, entered, enforced or deemed applicable to the acquisition by any Federal, state or foreign government or governmental authority or by any court, domestic or foreign, including the entry of a preliminary or permanent injunction, that would (a) make the Agreement or the transactions contemplated hereby illegal, invalid or unenforceable or (b) if the Agreement or the 21 transactions contemplated hereby is consummated, subject any officer, director or employee of Seller to criminal or civil liability. No action or proceeding before any court or governmental authority, domestic or foreign, by any government or governmental authority or by any other person, domestic or foreign, shall be threatened, instituted or pending that would reasonably be expected to result in any of the consequences referred to in clauses (a) or (b) above. SECTION 9. SURVIVAL OF REPRESENTATIONS, WARRANTIES, AGREEMENT AND OBLIGATIONS; ------------------------------------------------------------------- INDEMNIFICATION. --------------- 9.1 Survival. The representations, warranties, obligations, covenants, indemnities and agreements of Seller and Buyer contained in this Agreement shall survive the Closing for nine months and shall continue thereafter. Such representations, warranties, obligations, covenants, indemnities and agreements shall not be affected by, and shall remain in full force and effect notwithstanding, any investigation at any time made by or on behalf of any party hereto or any information any party may have with respect thereto. 9.2 Indemnification by Seller. Seller agrees, effective as of the Closing, to pay, and to indemnify, save, defend and hold harmless Buyer and each of its officers, directors, shareholders and representatives (collectively, "Insiders"), from and against, and shall reimburse Buyer and its Insiders with respect to, any and all damages, liabilities, losses, obligations, actions, suits, disbursements, claims, deficiencies, penalties, interest, expenses, fines, assessments, charges and costs (including, without limitation, reasonable attorneys' and expert witness' fees, costs of investigation and court costs) of every kind (collectively, "Losses"), imposed on, incurred by or asserted against Buyer or its Insiders (or any of them) in any way relating to or arising from or out of: A. A breach, deficiency, inaccuracy or inadequacy of or in any statement, representation or warranty of Seller contained in this Agreement, or any schedule, certificate or other document delivered pursuant hereto or as part of the transactions contemplated hereby; B. Ownership or operation of each of the Branches or their respective businesses and properties prior to the Effective Time; C. Liabilities of Seller that are not expressly assumed by Buyer; D. A breach of any covenant of Seller or the failure of Seller to perform any agreement, covenant or obligation of Seller contained in this Agreement or in any other agreement or document executed pursuant to this Agreement, E. Any taxes, including interest and penalties, required to be paid by Seller or its successor, which relate to Seller's business or assets at or prior to the Effective Time; F. The termination of employment by Seller prior to the Effective Time of any individual who is an officer or employee of Seller; and G. All refunds or repayments made by Seller following the Effective Time of credit life or single interest insurance premiums on policies that were issued in connection with loans made by Seller prior to the Effective Time and purchased by Buyer. 22 Any claim for indemnification shall be applicable to each representation independently, irrespective of whether such claim is consistent with any other representation contained in this Agreement. 9.3 Indemnification by Buyer. Buyer hereby agrees, effective as of the Closing, to pay, and to indemnify, save and hold harmless Seller from and against, and shall reimburse Seller with respect to, any and all Losses imposed on, incurred by or asserted against Seller in any way relating to or arising from or out of: A. A breach, deficiency, inaccuracy or inadequacy of or in any statement, representation or warranty of Buyer contained in this Agreement, or any schedule, certificate or other document delivered pursuant hereto or as part of the transactions contemplated hereby; B. Ownership or operation of each of the Branches or their respective businesses and properties after the Effective Time; C. Liabilities of Seller that are expressly assumed by Buyer; D. A breach of any covenant of Buyer or the failure of Buyer to perform any agreement, covenant or obligation of Buyer contained in this Agreement or in any other agreement or document executed pursuant to this Agreement, Any claim for indemnification shall be applicable to each representation independently, irrespective of whether such claim is consistent with any other representation contained in this Agreement. 9.4 Limit on Indemnities. Notwithstanding any other provision hereof, the rights of any party to be indemnified shall be subject to the following limitations: A. The indemnifying party shall pay claims hereunder when a claim against the indemnified party has been established by a final judgment in litigation or by settlement consented to in writing by Seller and Buyer; and B. The indemnifying party shall not be liable for any claim covered by the indemnities under Sections 9.2 or 9.3 unless the indemnifying party has been notified of such claim prior to the third anniversary of the Closing Date. SECTION 10. OPERATIONAL AGREEMENTS ---------------------- 10.1 Replacement of Customer Check Stock. Upon customer request, Buyer shall forward to each Depositor new checks on Buyer's check stock, which checks the Depositor may draw upon Buyer for the purpose of effecting transactions with respect to such Deposits. The parties will use reasonable efforts to develop procedures (i) that will cause checks drawn on Seller's form of check stock against Deposits that are received after the Effective Time to be cleared through Buyer's then current clearing procedures and (ii) to provide for the orderly conversion of ATM and debit cards. 10.2 Payment of Checks, Drafts, and Orders. After the Effective Time, Buyer agrees (i) to pay in accordance with applicable law, the Deposit Agreements and customary banking practice all checks, drafts and withdrawal orders properly drawn by Depositors and properly presented to Buyer by mail, over its counters or through the check clearing system of the banking industry, whether drawn on the checks, withdrawal or draft forms provided by Seller or by Buyer, and (ii) in all other respects to discharge, in 23 accordance with applicable law, the Depository Agreements and customary banking practice in the usual course of its banking business, all duties and obligations of Seller with respect to the balances due and owing to the Depositors. If any of the Depositors shall demand payment from Seller for all or any part of any Deposit, Seller shall not be liable or responsible for making such payment. 10.3 Uncollected Items. If an item included in the Deposits at the Effective Time is returned to Seller after the Effective Time as uncollected (an "Uncollected Item") within the first six months after the Closing Date, then: A. Within one business day after receipt, Seller will fax to Buyer a list reflecting the amount of such Uncollected Item, the date of deposit and depositor's account number (if available) and Seller will forward a consolidated collection request with the original Uncollected Item (a "Collection Advice"), to Buyer. B. Upon receipt of a Collection Advice, Buyer may place holds on the respective customers' Deposits in an amount not less than the amount of the Uncollected Item and may take any actions appropriate to ensure that such Deposits are not withdrawn in accordance with normal procedures of Buyer. C. Within 2 business days after receipt of such Collection Advice and original Uncollected Item, Buyer will debit the available Deposits and/or overdraw the depositor's account (except in such cases when Seller's negligence is the basis of a defense by the customer to Buyer's right to debit such accounts or overdraw such account) and return the paid collection request to Seller. Uncollected Items that overdraw an account balance shall be held by Buyer unless requested by Seller during the collection process. Buyer will release Uncollected Items to depositors only upon receipt of sufficient good funds to cover any deficient balances. D. A list reflecting name, address, phone number and number of accounts overdrawn $1,500 or more, resulting from Uncollected Items forwarded by Seller being charged to the customer's account, shall be sent to Seller on the date such item is charged back. E. Unless Buyer consents otherwise, Seller will be responsible for collecting overdrawn balances of Uncollected Items for thirty days and older as of the Closing Date. Buyer will cooperate with Seller with respect to providing information or records that may be needed to pursue resolution of amounts due to Seller. Buyer will be responsible for reasonable collection efforts on overdrawn balances of Uncollected Items for less than 30 days as of the Closing Date. F. After a period of 60 days from the date an account is charged for an Uncollected Item and becomes overdrawn, Buyer will submit a collection request to Seller for any remaining balances that could not be collected. The original Uncollected Items received shall be returned with the collection letter. 10.4 Data Processing and Utilities. A. Following the receipt of all required regulatory approvals, Seller shall assist Buyer in the transfer of all utilities relating to the Branches, including the existing phone number for the Branches, into the name of Buyer. 24 B. From the date hereof through the Closing Date, Seller shall cooperate and work with Buyer to complete the tasks required to facilitate the conversion of the data processing operations of the Branches. C. Within 15 days of the date of this Agreement, and as reasonably requested by Buyer, Seller shall provide Buyer with initial computer data on media acceptable to Buyer ("test tapes") to be used by Buyer solely to assist in the conversion of the data processing operations of the Branches to the data processing system of Buyer. Seller shall use best efforts to provide any computer programming or changes in existing file layouts related to any of the Assets or Liabilities that Buyer may reasonably request. In addition, Seller shall deliver to Buyer final computer data on media acceptable to Buyer ("final tapes") and deconversion reports as of the Closing Date by not later than 10:00 a.m. local time on the day immediately following the Closing Date. Such test tapes and final tapes shall be in a format currently used by Seller, and Seller will reasonably cooperate with Buyer in Buyer's conversion of such format to one which is reasonably acceptable to Buyer. Such test tapes and final tapes shall include master applications, specifications, file layouts, documentation of the files transferred, and a description of the data in such files. Such test tapes and final tapes shall contain such data that Buyer may reasonably request, including, but not limited to, customer name, address, account number, taxpayer identification number, deposit type, account opening date, average collected balance, current balance, branch code, interest method and frequency, maturity date, last rollover date, term, and next interest payment due date. Seller warrants and represents that the information based upon which such test tapes are created, and final tapes shall be true and correct in all material respects as of the time given. D. Seller agrees to reasonably cooperate in resolving any conversion-related issues arising from the conversion of the accounts for a period of 90 days following the date that the conversion is completed. If Buyer requests, Seller shall reformat or data scrub the conversion tapes and Buyer shall reimburse Seller for any costs and expenses incurred by Seller in such reformatting or data scrubbing. E. During the period following receipt of all necessary regulatory approvals for the transaction until Closing Date, on a date and time mutually agreeable to Buyer and Seller, Seller shall cooperate with and permit Buyer, at Buyer's option and expense and at no expense to Seller, to make provision for the installation of teller equipment in the Branches; provided, however, that Buyer shall arrange for the installation of such equipment at such times and in a manner that does not significantly interfere with the normal business activities and operation of Seller or the Branches. 10.5 Compliance with Garnishments and Similar Orders. After the Effective Time, Buyer will comply in all material respects with any and all garnishments, similar court orders, tax liens and order of any governmental entity in effect with respect to the Deposits, and Buyer will not pay any Deposits in violation of such garnishments, orders or tax liens or otherwise take any actions not permitted pursuant thereto or pursuant to applicable law. 10.6 Direct Deposit Arrangements . Seller will use reasonable efforts to transfer to Buyer on the Closing Date all of those automated clearing house and Fed wire direct deposit arrangements that are tied by agreement or other standing arrangement to the Deposits. For a period of 120 days, (the "Direct Deposit Cut-off Date"), Seller will, no later than the next business day following the date of receipt thereof, remit and transfer by electronic transmission to Buyer all direct deposits intended for the Deposits. After the Direct Deposit Cut-off Date, Seller may discontinue accepting and forwarding automated-clearing- 25 house and Fed-wire entries and funds and return such direct deposits to the originators marked "Account Closed". 10.7 Direct Debit Arrangements. With respect to all Deposits that have arrangements providing for direct debit of such accounts by third parties ("Direct Debit Accounts"), for a period of 120 days after the Closing Date, Seller will forward to Buyer all direct debits on Direct Debit Accounts on the business day following the date of receipt thereof, and will give Buyer a daily accounting of such debits to Buyer's clearing account. Thereafter, Seller may discontinue forwarding such entries and return them to the originators marked "Account Closed". 10.8 IRA Deposits. With respect to Deposits that are individual retirement accounts created by a trust for the exclusive benefit of an individual or his or her beneficiaries in accordance with the provisions of section 408 of the Code ("IRA Deposits"), effective as of the Closing Date, Seller will resign as custodian and Seller will appoint Buyer as successor custodian of all such IRA Deposits, including but not limited to, sending to the depositors thereof appropriate notices, and filing any appropriate applications with applicable regulatory authorities. At the Effective Time, Buyer will accept appointment as custodian with respect to such IRA Deposits and will perform all of the duties so transferred and comply with the terms of Seller's agreement with the depositor of the IRA Deposits affected thereby. 10.9 Keogh Accounts. With respect to Deposits that are Keogh Accounts created by a trust for the benefit of employees and that comply with the provisions of section 401 of the Code ("Keogh Accounts"), Seller will use reasonable efforts and cooperate with Buyer to invite depositors thereof to direct a transfer of each such depositor's Keogh Account and the related Deposit to Buyer, as custodian thereof, and to adopt Buyer's form of Keogh master plan as a successor to Seller's Keogh master plan. Buyer will assume no Deposits that are Keogh Accounts unless Buyer has received the documents necessary for such assumption or transfer at or before the Closing. With respect to any depositors who do not transfer such Keogh Accounts to Buyer's form of Keogh master plan, Seller will use reasonable efforts in order to enable Buyer to retain such Keogh Accounts at the Branches. 10.10 Final Statements. Seller will render a final statement to each Depositor of an account assumed under this Agreement as to transactions occurring through the Effective Time and will comply with all laws, rules and regulations regarding tax reporting of transactions of such accounts through the Effective Time; provided, however, that Seller shall not be obligated to render a final statement on any account not ordinarily receiving periodic statements in the ordinary course of Seller's business. Seller will be entitled to impose normal fees and service charges on a per-item basis, but Seller will not impose periodic fees or blanket charges in connection with such final statements. Seller shall provide magnetic records of final customer statements to Buyer. 10.11 IRA Deposits and Keogh Accounts. Seller will deliver to Buyer on the Closing Date all of the documents in Seller's possession governing each IRA Deposit and Keogh Account that is included in the Deposits. Seller will prepare and file all reports to government authorities required to be filed for the period ending on the Closing Date and all prior periods (except for filing IRS Form 1099's for the calendar year in which the Closing occurs, for which filings Buyer will be responsible pursuant to Section 10.12 A. and B.). Buyer will be responsible for all such reporting for periods commencing on the day after the Closing. 26 10.12 Interest Reporting and Withholding. A. For the period from January 1 of the year in which the Closing occurs through the Closing Date, Seller will provide all information necessary for Buyer to report to applicable taxing authorities and owners of Deposits, all interest credited to, withheld from and any early withdrawal penalties imposed upon the Deposits during such period (collectively, the "Reported Amounts"). With respect to all periods beginning on or after January 1 of the year in which the Closing occurs, Buyer will report all Reported Amounts to applicable taxing authorities and owners of Deposits. B. With respect to any Accounts for which amounts are required by any governmental agency to be withheld (the "Withholding Accounts"), Seller will: (i) for the period from January 1, of the year in which the Closing occurs through the Closing Date, report all Reported Amounts incurred during such period on the Withholding Accounts to applicable taxing authorities and to the owners of the Withholding Accounts; and (ii) withhold any amounts required by any governmental agencies to be withheld from the Withholding Accounts on or before the Closing Date in accordance with applicable law or appropriate notice from any governmental agency and remit such amounts to the appropriate agency on or prior to the applicable due date; and Buyer will: (i) for the period from the day after the Closing Date to the end of the calendar year (and all periods thereafter), report all Reported Amounts incurred during such period on the Withholding Accounts to applicable taxing authorities and to the owners of the Withholding Accounts; and (ii) withhold any amounts required by any governmental agencies to be withheld from the Withholding Accounts after the Closing Date in accordance with applicable law or appropriate notice from any governmental agency and remit such amounts to the appropriate agency on or prior to the applicable due date. C. Buyer shall report to applicable authorities and the borrowers of the Loans all interest paid on such loans for the year in which such loans are acquired by Buyer. 10.13 Loans. In connection with the transfer of the Loans, Seller and Buyer agree as follows: A. The parties will cooperate and use their best efforts to cause Buyer to become the beneficiary of credit life, accident and health, vendor's single interest premium or similar insurance purchased by or on behalf of such customer on the Loans. For the duration of such insurance, Seller and Buyer agree to cooperate in good faith to develop a mutually satisfactory method by which the issuer of such insurance will make rebate payments to and satisfy claims of the holders of such certificates of insurance after the Effective Time. B. Each of Buyer and Seller will use their best efforts to comply with all notice and reporting requirements of the loan documents or of any law or regulation with respect to the transfer of such loans. C. Within 30 days after the Closing Date, Buyer may, at its expense, issue new coupon books, if applicable, or similar payment notices for payment of the Loans with instructions to use Buyer's coupons or statements and to destroy unused coupons furnished by Seller. 27 D. For a period of 60 days after the Closing Date, within 3 business days after receipt by Seller of any check or money order made payable to Seller representing payment on a Loan, Seller shall issue and forward a cashier's check made payable to Buyer or wire transfer to the benefit of Buyer in the amount of such item, and forward the item for collection. If the item is returned unpaid, however, Seller shall promptly notify Buyer of such item's return and shall forward the original of such item to Buyer. Within 3 business days after receipt of such returned item, Buyer shall issue and forward a cashier's check or wire transfer to Seller in the amount of such item, and Buyer shall be responsible for any further efforts to collect such item. E. If the balance due on any Loan has been reduced by Seller as a result of a payment by check received prior to the Closing Date, which item is returned after the Closing Date, the asset value representing the Loan transferred shall be correspondingly increased and an amount in cash equal to such increase shall be paid by Buyer to Seller promptly upon demand. F. The parties hereby agree that Seller makes no representations or warranties as to whether the Loans are collectible. 10.14 Other Items. Following the Effective Time, Seller agrees to deliver immediately, but in no event later than three (3) business days after receipt by Seller, to Buyer any collected funds accepted by Seller for credit to any account included in the Deposits, (iii) any refunds or reimbursements of prepaid expenses included in the acquired Assets which are accepted by Seller and (iv) any written notices or correspondence received by Seller relating to the Deposits or the Loans. 10.15 Safe Deposit Box and Safekeeping Business. From and after the Closing, Buyer agrees to assume and discharge, in the usual course of the banking business, the duties and obligations of Seller with respect to all safe deposit boxes located in the Branches, and to maintain all necessary facilities for the use of such boxes by the renters thereof during the period for which such persons have paid rent therefor in advance to Seller, subject to the provisions of the rental agreements between Seller and the respective renters of such boxes. From and after the Closing, Buyer shall assume, honor, and discharge the duties and obligations of Seller with respect to all safekeeping items obtained from Seller and shall be entitled to any right or benefit heretofore accrued or hereafter accruing therefrom. At the Closing, Seller shall provide Buyer with a true and correct list of all safe deposit rental agreements and contracts with respect to the Branches in effect as of the Closing Date, together with the rentals or other amounts paid on such agreements and contracts and the expiration dates of such contracts. 10.16 Noncompetition Agreement. For and in consideration of the purchase by Buyer of the Assets and the assumption of the Liabilities, the payment of the Purchase Premium and the other agreements and covenants contained in this Agreement, Seller agrees as follows: A. From the date hereof and for a period of three years following the Closing Date, Seller and the officers, directors and employees of Seller (for so long as they are employed by Seller) will not (i) establish, own or operate a branch or other office within Ellis County, Texas, (ii) other than banking services offered to the public generally via the Internet, and insurance premium finance marketing efforts in place with insurance agencies, solicit the banking business of any current customers of the Branches whose banking business or any part thereof is transferred to Buyer pursuant to the terms of this Agreement, or (iii) recruit, hire, assist others in recruiting or hiring, discuss employment with, or refer to others concerning employment, any person who is, or within the preceding 12 months was, a Designated Employee or an employee of Buyer. 28 B. If any court of competent jurisdiction should determine that any term or terms of this covenant are too broad in terms of time, geographic area, lines of commerce or otherwise, such court shall modify and revise any such term or terms so that they comply with applicable law. Seller hereby acknowledges and agrees that Buyer will be irreparably damaged if the provisions of this Section 10.16 are not specifically enforced. Accordingly, Buyer shall be entitled to an injunction restraining any violation of this Section 10.16 by Seller (without any bond or other security being required), or any other appropriate decree of specific performance. Such remedies shall not be exclusive and shall be in addition to any other remedy that Buyer may have at law or in equity. 10.17 Books and Records. Buyer shall allow Seller and its authorized agents and representatives to inspect any of the Records for any proper purpose during regular business hours after the Closing Date upon reasonable notice to Buyer (which notice shall specify the purpose of such inspection), and Seller may, at its own expense, make such copies of and excerpts from such books and records as it may deem desirable; provided, however, that all information, including copies of books and records, obtained by Seller from Buyer pursuant to this Section 10.17 shall be and remain confidential information known to Seller or otherwise contained in Seller's books and records. Buyer shall maintain all material books and records relating to the Assets, the Liabilities and the business of the Branches for a period that is not less than the greater of (i) the period required by applicable law, rule or regulation or (ii) three (3) years from the Closing Date. 10.18 Taxes. Buyer shall be responsible for the payment of all taxes arising as a result of the purchase of the Assets; except that Buyer shall not be responsible for, or have any liability with respect to, taxes on any income to Seller arising out of this transaction. Seller shall cooperate with Buyer in Buyer's efforts to minimize all taxes payable by Buyer, if any, as a result of the transactions contemplated by this Agreement. 10.19 Clearing Items. During the 120-day period following the Closing Date, if it is not possible to clear checks and other items drawn on a Deposit account through Buyer's then current clearing procedures, Seller will make provisional settlement to the presenting institution and will forward such checks and other items on such Deposit to Buyer, no later than the next business day after receipt thereof, and Buyer will reimburse Seller for such provisional settlement. Upon the expiration of such 120-day period, Seller shall cease forwarding checks and other debits against the Deposit accounts and return them to the originators marked "Account Closed". Upon timely presentation to Buyer, Buyer will assume all responsibility for such items (except for such items that have not been handled by Seller in accordance with applicable law or regulation, or with ordinary care), including but not limited to determining whether to honor or dishonor such items and giving any required notification for the return of items. SECTION 11. TERMINATION AND ABANDONMENT --------------------------- 11.1 Right of Termination. This Agreement and the transactions contemplated hereby may be terminated and abandoned at any time prior to or at the Closing as follows, and in no other manner: A. By the mutual consent of Seller and Buyer; B. By either Buyer or Seller, if the Closing has not occurred by September 30, 1999, or such other date as Seller and Buyer shall agree in writing, unless the failure to so consummate by such time is due to a breach of this Agreement by the party seeking to terminate; 29 C. By Buyer if Buyer reasonably determines that regulatory approval as set forth in Section 7.3 cannot be reasonably and economically obtained on terms and conditions satisfactory to Buyer in its sole discretion. D. By Seller or Buyer in the event regulatory approval is denied. E. By Buyer if there shall be any actual or threatened litigation to restrain or invalidate the sale of the Assets to, or the assumption of the Liabilities by, Buyer that, in the good faith judgment of Buyer makes it inadvisable to proceed with such transaction; F. By Buyer if there shall have been any material adverse change in the condition, business, operations, affairs, prospects, properties or assets of Seller that are the subject of this Agreement; G. By Buyer if any material representation or warranty made herein by Seller is untrue in any material respect, or Seller shall have defaulted in any material respect in the performance of any material obligation under this Agreement; H. By Buyer pursuant to the termination provisions provided in Section 2.3, Section 2.5 or Section 2.6. I. By Seller if any material representation or warranty made herein by Buyer is untrue in any material respect, or Buyer shall have defaulted in any material respect in the performance of any material obligation under this Agreement, including any default under Section 6.2. 11.2 Notice of Termination. The power of termination provided for by Section 11.1 may be exercised only by a notice given in writing, as provided in Section 12.4. 11.3 Effect of Termination. Without limiting any other relief to which either party hereto may be entitled, in the event of the termination and abandonment of this Agreement pursuant to the provisions of Section 11.1, no party to this Agreement shall have any further liability or obligation in respect of this Agreement, except for (a) liability of a party for expenses pursuant to Section 12.11, and (b) the provisions of Section 12.15 shall remain applicable. SECTION 12. MISCELLANEOUS ------------- 12.1 Entire Agreement. This Agreement and the other agreements, documents and instruments executed and delivered by the parties to each other at the Closing constitute the full understanding of the parties, a complete allocation of risks between them and a complete and exclusive statement of the terms and conditions of their agreement relating to the subject matter hereof and supersede any and all prior agreements, whether written or oral, that may exist between the parties with respect thereto. 12.2 Multiple Counterparts. For the convenience of the parties hereto, this Agreement may be executed in multiple counterparts, each of which shall be deemed an original, and all counterparts hereof so executed by the parties hereto, whether or not such counterpart shall bear the execution of each of the parties hereto, shall be deemed to be, and shall be construed as, one and the same Agreement. a telecopy or facsimile transmission of a signed counterpart of this Agreement shall be sufficient to bind the party or parties whose signature(s) appear thereon. 30 12.3 Amendment. This Agreement may be amended, modified or supplemented only by a written instrument signed by each party hereto. 12.4 Notices. Any and all notices and other communications required or permitted to be given under this Agreement by any party hereto to the other party may be delivered personally or by overnight courier service or sent by mail, telex or facsimile transmission, at the respective addresses or transmission numbers set forth below and shall be effective upon the earlier of actual receipt or (a) in the case of mail, upon the earlier of actual receipt or 3 business days after deposit in the United States Postal Service, first class certified or registered mail, postage prepaid, return receipt requested; and (b) in the case of overnight courier service, one business day after delivery to such courier service. The parties may change their respective addresses and transmission numbers by written notice to all other parties, sent as provided in this Section 12.4. All communications must be in writing and addressed as follows: If to Seller: Surety Bank, N.A. 1845 Precinct Line Rd., Suite 100 Hurst, Texas 76054 Attn: C. Jack Bean Chairman Telecopy: (817) 498-0647 With a Copy to: Ms. Margaret Holland Tracy & Holland, L.L.P. 306 West Seventh Street, #500 Fort Worth, Texas 76102-4982 Telecopy: (817) 332-3140 If to Buyer: The Citizens National Bank in Waxahachie 200 N. Elm St., P.O. Box 717 Waxahachie, Texas Attn: Mark Singleton President Telecopy: (972) 938-4364 With a Copy to: Carolyn V. Kelly, Esq. Jenkens & Gilchrist, a Professional Corporation 1445 Ross Avenue, Suite 3200 Dallas, Texas 75202 Telecopy: (214) 855-4300 12.5 Binding Effect. All of the terms, covenants, representations, warranties and conditions of this Agreement shall be binding upon, and inure to the benefit of and be enforceable by, the parties hereto and their respective successors, representatives and permitted assigns. Nothing expressed or referred to herein is intended or shall be construed to give any person other than the parties hereto any legal or equitable right, remedy or claim under or in respect of this Agreement, or any provision herein contained, it being the intention of the parties hereto that this Agreement, the assumption of obligations and statements of responsibilities hereunder, and all other conditions and provisions hereof are for the sole benefit of the parties to this Agreement and for the benefit of no other person. Nothing in this Agreement shall act to relieve or discharge the obligation or liability of any third party to any party to this Agreement, 31 nor shall any provision give any third party any right of subrogation or action over or against any party to this Agreement. 12.6 Governing Law. THIS AGREEMENT SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE LAWS OF THE STATE OF TEXAS. VENUE FOR ANY CAUSE OF ACTION ARISING FROM THIS AGREEMENT SHALL LIE IN ELLIS COUNTY, TEXAS. 12.7 Attorneys' Fees and Costs. In the event attorneys' fees or other costs are incurred to secure performance of any of the obligations herein provided for, or to establish damages for the breach thereof, or to obtain any other appropriate relief, whether by way of prosecution or defense, the prevailing party shall be entitled to recover reasonable attorneys' fees and costs incurred therein. 12.8 Severability. In the event that any provision of this Agreement is held to be illegal, invalid or unenforceable under present or future laws, then (a) such provision shall be fully severable and this Agreement shall be construed and enforced as if such illegal, invalid or unenforceable provision were not a part hereof; (b) the remaining provisions of this Agreement shall remain in full force and effect and shall not be affected by such illegal, invalid or unenforceable provision or by its severance from this Agreement; and (c) there shall be added automatically as a part of this Agreement a provision as similar in terms to such illegal, invalid or unenforceable provision as may be possible and still be legal, valid and enforceable. 12.9 Assignability. No party to this Agreement shall assign this Agreement, by operation of law or otherwise, in whole or in part, without the prior written consent of the other parties. Any assignment made or attempted in violation of this Section 12.9 shall be void and of no effect. 12.10 Rules of Construction. All sections referred to herein are sections of this Agreement and all exhibits and schedules referred to herein are exhibits and schedules, respectively, attached to this Agreement. Descriptive headings as to the contents of particular sections are for convenience only and shall not control or affect the meaning, construction or interpretation of any provision of this Agreement. The exhibits and schedules to this Agreement (and any appendices thereto) referred to in this Agreement and attached hereto are and shall be incorporated herein and made a part hereof for all purposes as though set forth herein verbatim. Each use herein of the masculine, neuter or feminine gender shall be deemed to include the other genders. Each use herein of the plural shall include the singular and vice versa, in each case as the context requires or as it is otherwise appropriate. The word "or" is used in the inclusive sense. 12.11 Expenses. Seller shall pay all of its expenses and costs (including, without limitation, all attorneys' fees and expenses and application fees), and Buyer shall pay all of its expenses and costs (including, without limitation, all attorneys' fees and expenses and application fees), in connection with this Agreement and the consummation of the transactions contemplated hereby. 12.12 Waiver. Any of the terms or conditions of this Agreement may be waived at any time by the party that is entitled to the benefit thereof. Such action shall be evidenced by a signed written notice given in the manner provided in Section 12.4. No party to this Agreement shall by any act (except by a written instrument given pursuant to Section 12.4) be deemed to have waived any right or remedy hereunder or to have acquiesced in any breach of any of the terms and conditions hereof. No failure to exercise, nor any delay in exercising any right, power or privilege hereunder by any party hereto shall operate as a waiver thereof. No single or partial exercise of any right, power or privilege hereunder shall preclude any other or further exercise thereof or the exercise of any other right, power or privilege. A waiver of any party of any right or remedy on any one occasion shall not be construed as a bar to any right 32 or remedy that such party would otherwise have on any future occasion or to any right or remedy that any other party may have hereunder. 12.13 Specific Performance. Each of the parties hereto acknowledges that the other parties would be irreparably damaged and would not have an adequate remedy at law for money damages in the event that any of the covenants contained in this Agreement were not performed in accordance with its terms or otherwise were materially breached. Each of the parties hereto therefore agrees that, without the necessity of proving actual damages or posting bond or other security, the other party shall be entitled to temporary and/or permanent injunction or injunctions to prevent breaches of such performance and to specific enforcement of such covenants in addition to any other remedy to which they may be entitled, at law or in equity. 12.14 Public Disclosure. Seller and Buyer will consult with each other regarding the content of any press release or other public disclosure concerning this transaction and obtain the prior written approval of the other party hereto; provided, however, that notwithstanding anything else contained in this Section 12.14, Seller and Buyer shall be permitted to make any public disclosure or governmental filings as its counsel may deem necessary to maintain compliance with or to prevent violations of applicable Federal or state laws or regulations. 12.15 Confidential Information. Except as may be required by applicable securities laws or as may be necessary to obtain the regulatory approvals as described in Section 7.3, Seller and Buyer will treat as confidential any information related to the transactions described herein obtained from any other party. Seller and Buyer will use such information, and not disclose it to others, except their employees, advisors, directors and agents, expressly for the purposes of evaluating the potential of consummating the transactions proposed herein. The term "information" does not include any information that (a) at the time of disclosure or thereafter is generally available to and known by the public, (b) was available on a nonconfidential basis from a source other than Seller or Buyer or (c) was independently acquired or developed without violating any laws or obligations under this Agreement. 12.16 Arbitration. Buyer and Seller shall agree, by amendment to this Agreement, on provisions whereby any controversy or claim between Buyer and Seller arising out of or relating to this Agreement or any agreements or instruments relating hereto or delivered in connection herewith, including, but not limited to, a claim based on or arising from an alleged tort, will, at the request of any party, shall be determined by arbitration. 12.17 Seller's Knowledge. '"Seller's Knowledge" or other similar phrases means information that is known to any Executive Officer or Loan Review Officer of the Seller, or to the Branch Manager or Branch President of the applicable Branch, without (except for Section 3.12) independent investigation. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their duly authorized officers and their corporate seals to be hereunto affixed as of the date first above written. Buyer: THE CITIZENS NATIONAL BANK IN WAXAHACHIE [S E A L] By: /s/ Mark Singleton ------------------------------------------------ Mark Singleton, President 33 ATTEST: /s/ Shirley K. Singleton - ------------------------------ Name: Shirley K. Singleton Title: Vice President Seller: SURETY BANK, N.A. [S E A L] By: /s/ C/ Jack Bean ------------------------------------------------ C. Jack Bean, Chairman ATTEST: /s/ B. J. Curley - ------------------------------ Name: B. J. Curley Title: Secretary 34 EX-10.12 3 POST RETIREMENT SERVICES AGREEMENT EXHIBIT 10.12 AMENDED AND RESTATED POST RETIREMENT SERVICES AGREEMENT BETWEEN SURETY CAPITAL CORPORATION, SURETY BANK, NATIONAL ASSOCIATION AND C. JACK BEAN This Amended and Restated Post Retirement Services Agreement ("Agreement") is entered into by and among Surety Capital Corporation, a Delaware corporation (the "Corporation"), Surety Bank, National Association, a national banking association (the "Bank"), and C. Jack Bean, an individual of Fort Worth, Texas ("Bean"). The Corporation, the Bank and Bean are collectively referred to as the "Parties." The Corporation's business operations that are conducted by the Bank are referred to as its "Banking Business." In consideration of the mutual covenants set forth below, it is agreed as follows: 1. Purposes. The purposes of this Agreement are to provide: (a) Bean with compensation and benefits for certain consulting services to be rendered by Bean for the Corporation and the Bank on a part-time basis after his retirement as a full-time employee of the Corporation; and (b) the Corporation and the Bank with the part-time consulting services of Bean after his retirement as a full-time employee of the Corporation in the activities of (1) promoting the Corporation's and the Bank's ongoing operations with businesses and business professionals in the service areas covered by the Corpora tion's Banking Business, (2) representing the Corporation and the Bank at functions and events relating to the Corporation's business activities and its Banking Business, (3) providing the Corporation with information that may come to Bean's attention as to potential business acquisitions for the Corporation or the Bank, (4) providing the Corporation with advisory services specifically related to acquisitions for the Banking Business, and (5) providing the Corporation with services in connection with the furtherance of stockholder relations (all of the foregoing being referred to in this Agreement as the "Services"). 2. Definitions. For purposes of this Agreement, certain terms are defined as follows: (a) "Accelerated Payment" means either the payment by the Corporation and the Bank pursuant to Section 6 or pursuant to Section 7. (b) "Cause" means any act that is materially adverse to the best interests of the Corporation or the Bank and constitutes, on the part of Bean, common law fraud, a felony or other gross malfeasance of duty. (c) "Change in Control of the Corporation" shall be deemed to have occurred if: (A) any "person" (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended, the "Exchange Act"), other than a trustee or other fiduciary holding securities under an employee benefit plan of the Corporation, is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Corporation representing twenty percent (20%) or more of the combined voting power of the Corporation's then outstanding voting securities; (B) during any period of two (2) consecutive years during the term of this Agreement, individuals who at the beginning of such period constitute the Corporation's Board of Directors (the "Board") cease for any reason to constitute at least a majority thereof, unless the election of each director who was not a director at the beginning of such period has been approved in advance by directors representing at least two-thirds (2/3rds) of the directors then in office who were directors at the beginning of the period; (C) the Corporation sells or otherwise transfers more than fifty percent (50%) voting control of the Bank; or (D) there is a sale of substantially all of the assets of the Bank. (d) "Disability" means the inability of Bean to perform the Services required by this Agreement by reason of illness, infirmity, insanity, mental incompetency or otherwise. This determination will be made in good faith by Board and concurred in by Bean. If there is a dispute between the Parties as to the exis tence of a Disability, Bean, the Board, and Bean's physician (defined as a person licensed to practice medicine in Texas who is regularly attending Bean) will consult and reach a determination. If Bean does not have a regularly engaged physician, the Board may engage at the Corporation's expense a physician to examine Bean, and Bean consents to such examination and to waive, if applicable, any privilege between the physician and Bean that may arise as a result of said examination. If Bean has not engaged a physician, the opinion of the physician engaged by the Board shall control. 3. Bean's Services. The Services to be provided by Bean under this Agreement will be furnished by Bean as an independent contractor and not as an employee and will commence at the time Bean retires from providing his active, full-time services to the Corporation in its day-to-day operations and will terminate on the fifteenth (15th) anniversary date of Bean's retirement date, unless terminated earlier, in accordance with the provisions of this Section 3. The nature and extent of the actual activities to be conducted by Bean will be mutually agreed to by Bean and the Corporation and the Bank from time to time during such period; however, the manner and means by which such activities are performed by Bean shall be determined by Bean. Bean will devote such time to the performance of his duties under this Agreement as is reasonably necessary for a satisfactory performance of his duties under this Agreement. (a) This Agreement may be terminated by the Corporation or the Bank under the following circumstances: (1) for Cause or (2) in the event of Bean's Disability or death. (b) This Agreement may be terminated by Bean under the following circumstances: (1) in the event of a default by the Corporation or the Bank of its obligations under this Agreement, immediately after providing the Corporation or the Bank, as the case may be, with written notice thereof, or (2) at any time for any reason, in his sole discretion, after providing the Corporation with thirty (30) days written notice of such intent. (c) This Agreement shall terminate upon the occurrence of a Change in Control of the Corporation. (d) In the event of a termination of this Agreement by the Corporation or the Bank pursuant to Section 3(a), neither the Corporation nor the Bank will have any further obligations under this Agreement, except to the extent payments and benefits are owed pursuant to Section 5 for periods prior to the termination of this Agreement. In the event of a termination of this Agreement by Bean pursuant to Section 3(b)(2), neither the Corporation nor the Bank will have any further obligations under this Agreement, except to the extent payments and benefits are owed pursuant to Section 5 for periods prior to the termination of this Agreement. If the termination of this Agreement is pursuant to Section 3(b)(1) as a result of a default by the Corporation or the Bank in the performance of their respective obligations hereunder or pursuant to Section 3(c) as a result of a Change in Control of the Corporation, the Corporation and the Bank will be obligated to pay any amounts owed under Section 5 and to also pay the Accelerated Payment due pursuant to either Section 6 or Section 7, as the case may be, which obligation shall survive the termination of this Agreement. -2- The Corporation (to the extent of 25% thereof) and the Bank (to the extent of 75% thereof) shall also pay to Bean all legal fees and expenses incurred by Bean in seeking to obtain or enforce any right or benefit provided by this Agreement. 4. Compensation for Services. During the period that Bean performs the Services for the Corporation and the Bank after he retires from providing his active, full-time services to the Corporation in its day-to-day operations, the Corporation (to the extent of 25% thereof) and the Bank (to the extent of 75% thereof) will reimburse Bean for meals and other out-of-pocket expenses that he incurs in connection with his providing the Services. Bean agrees in this regard to follow the Corporation's and the Bank's normal substantiation and reimbursement policies in connection with such expenses. 5. Payments and Benefits for Services Rendered. At the time Bean retires from providing his active, full-time services to the Corporation in its day-to- day operations, the Corporation and the Bank agree to provide to Bean the compensation and benefits listed below. (a) Annual Payment. Upon Bean's retirement from full-time employment, the Corporation and the Bank will begin payments to Bean in the amount of $53,825 per year. This amount will be pro-rated for partial years and will be paid to Bean, at his option, in annual, monthly or bi-monthly installments. (b) Insurance Coverage. The Corporation and the Bank will provide Bean, or reimburse Bean for the cost of, health, accident and medical insurance coverage that is equivalent to the coverage provided to those persons serving from time to time as the senior executive officers of the Corporation and the Bank. (c) Twenty-five percent of all payments pursuant to this Section 5 will be paid by the Corporation and seventy-five percent of all payments pursuant to this Section 5 will be paid by the Bank. 6. Default. If the Corporation or the Bank defaults in the performance of any provision under Section 5 of this Agreement, the payments, insurance coverage and reimbursements under Section 5(a) and (b) shall be accelerated and immediately due and payable to Bean. In such event, the Parties agree that it may be diffi cult, if not impossible, to accurately determine the amount of damages that Bean may incur by reason of such default; therefore, the Parties agree that the sum of the amounts calculated under the following subsections shall be used to determine the amount then owed to Bean for such default (the "Accelerated Payment"). The Accelerated Payment shall be immediately due and payable to Bean (payable by certified or cashier's check) upon the occurrence of the default. All or any portion of such total that is not paid to Bean within thirty (30) days of the default will bear interest at ten percent (10%) per annum until paid. Twenty-five percent of all payments pursuant to this Section 6 will be paid by the Corporation and seventy-five percent of all payments pursuant to this Section 6 will be paid by the Bank. (a) Annual Payment. The amount owed under Section 5(a) shall be equal to the discounted present value of $53,825 per year for the number of years equal to eighty-five (85) minus Bean's age at the time of the default. The discount interest rate for these purposes will be five percent (5%) per year. (b) Insurance Coverage. The amount owed under Section 5(b) shall be equal to the "insurance cost" (as defined below) times the number of years equal to eighty-five (85) minus Bean's age at the time of the default. The insurance cost for these purposes will be the cost of the coverage and reimbursement provided under Section 5(b) for the immediately preceding twelve (12) calendar month period. -3- 7. Change in Control of the Corporation. In the event of a Change in Control of the Corporation, the Corporation (to the extent of twenty-five percent (25%) thereof) and the Bank (to the extent of seventy-five (75%) thereof) shall pay to Bean the Accelerated Payment, calculated in accordance with Section 6 as of the effective date of the Change in Control. The Accelerated Payment shall be due and payable to Bean (payable by certified or cashier's check) immediately prior to the effectiveness of the Change in Control of the Corporation. All or any portion of such total that is not paid to Bean immediately prior to the effectiveness of the Change in Control of the Corporation will bear interest at ten percent (10%) per annum until paid. 8. Nature of Accelerated Payment as a Result of a Change in Control Payment. The benefits payable to Bean under this Agreement in the event of a Change in Control of the Corporation shall be considered severance pay in consideration of Bean's past service and Bean's continued service after the date this Agreement. Bean shall not be required to mitigate the amount of any payment provided for in Section 7 by seeking other employment or otherwise, nor shall the amount of any payment or benefit provided for in Section 7 be reduced by any compensation earned by Bean as the result of employment by another employer or by retirement benefits after the date of termination, or otherwise. 9. Restrictions. Bean's rights or benefits under this Agreement shall not be subject to anticipation, alienation, sale, assignment, pledge, encumbrance or charge and any such actions shall be void. Bean's rights or benefits under this Agreement shall not in any manner be liable for or subject to the debts, contracts, liabilities or torts of the person entitled to such benefits. 10. Taxes. As an independent contractor, Bean shall be responsible for the payment of all federal income taxes and his own self-employment and social security taxes, the liability for which arises from or relates to any and all payments made by the Corporation and the Bank to Bean under this Agreement, including payments pursuant to Sections 5, 6 and 7. Bean hereby agrees to indemnify and hold harmless the Corporation and the Bank from and for any liability or claim respecting the foregoing taxes which are the sole obligation and liability of Bean. Bean's obligation to indemnify the Corporation and the Bank as provided by this Section 10 shall survive the termination of this Agreement. 11. Notices. Any notice required or permitted by either Party must be in writing and must be delivered either personally to the other Party or by certified mail, return receipt requested, at the Party's address indicated below, and any notice will be effective upon delivery in the case of personal delivery and, in the case of delivery by certified mail, three (3) business days after the date of deposit in the United States mail, postage prepaid. The addresses of the Parties are as follows: If to Corporation: Surety Capital Corporation 1845 Precinct Line Road, Suite 100 Hurst, Texas 76054 Telephone: 817-788-7558 Telecopy: 817-428-0054 If to Bank: Surety Bank, National Association 1845 Precinct Line Road, Suite 100 Hurst, Texas 76054 Telephone: 817-788-7558 Telecopy: 817-428-0054 -4- With a copy to: Margaret E. Holland Tracy & Holland, L.L.P. 306 West Seventh Street, Suite 500 Fort Worth, Texas 76102-4982 Telephone: 817-335-1050 Telecopy: 817-332-3140 If to Bean: Mr. C. Jack Bean 2721 Heritage Hills Drive Fort Worth, Texas 76109 Telephone: 817-922-0446 The names and address of the Parties to receive notice as stated in this Section 11 may be changed at any time by notice given in accordance with this Section 11. As used in this Agreement, the term "business day" means any day of the week, Monday through Friday, that is not recognized by the United States Postal Service as a national holiday and on which national banks are open for business. 12. Independent Contractor Status. It is expressly agreed and stipulated by the Parties hereto that Bean in an independent contractor and that Bean shall not be deemed nor construed to be an employee of the Corporation or the Bank for federal income tax purposes or within the meaning of the Workers' Compensation Act of the state of Texas. 13. Invalid Provision. In the event any of the provisions, or portions thereof, of this Agreement are held to be invalid, illegal or unenforceable by any court of competent jurisdiction, the validity, legality and enforceability of the remaining provisions, or portions thereof, shall not be affected. Moreover, so far as is reasonable and possible, effect shall be given to the intent manifested by the portion held invalid, illegal or unenforceable. 14. Captions. The captions or headings in this Agreement are made for convenience and general reference only and shall not be construed to describe, define or limit the scope or intent of the provisions of this Agreement. 15. Governing Law. This Agreement has been executed in and shall be governed by the laws of the state of Texas. The Parties agree that the terms of this Agreement will be performed and all legal proceedings involving this Agreement will be conducted in Tarrant County, Texas. 16. Inurement. This Agreement shall extend to and be binding upon Bean and his heirs, legatees, legal representatives and successors, and on the Corporation and the Bank and their respective successors or assigns. The rights of the Corporation and the Bank under this Agreement may not be assigned without Bean's consent. 17. Amendment. All amendments or changes to this Agreement shall be in writing. 18. Counterparts. This Agreement may be executed in multiple counterparts, each of which shall be an original Agreement. All counterparts together shall represent but one and the same instrument. 19. Further Assurances. Each Party to this Agreement agrees to perform any further acts and to execute and deliver any documents or legal instruments which may be reasonably necessary to carry out the provisions of this Agreement. -5- 20. Entire Agreement. This Agreement contains the entire understanding between the undersigned concerning the subject matter of the Agreement. There are no other representations, agreements, arrangements or understandings, oral or written, between or among the Parties, relating to the subject matter of this Agreement, which are not fully expressed herein. The Parties agree that the Post Retirement Services Agreement dated January 20, 1998 between the Corporation and Bean is hereby terminated and of no further force and effect, such agreement being superseded in its entirety by this Agreement. 21. Authorization. The Corporation and the Bank are authorized to enter into this Agreement by virtue of resolutions duly adopted by the respective Board of Directors of the Corporation and the Bank. 22. Effective Date. The effective date of this Agreement is November 1, 1998. SURETY: SURETY CAPITAL CORPORATION By: /s/ B. J. Curley ------------------------------ Title: Vice President BANK: SURETY BANK, NATIONAL ASSOCIATION By: /s/ Bobby W. Hackler ------------------------------ Title: President BEAN: /s/ C. Jack Bean --------------------------------- C. Jack Bean -6- EX-21 4 SUBSIDIARIES EXHIBIT 21 SUBSIDIARIES OF SURETY CAPITAL CORPORATION Jurisdiction Subsidiary of Organization Surety Bank, National National Banking Association Association EX-23 5 CONSENT OF PRICEWATERHOUSECOOPERS Exhibit 23 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statements of Surety Capital Corporation on Form S-8 (File No. 33-35415), Form S-8 (File No. 33-63695), Form S-8 (File No. 333-20615), Form S-8 (File No. 333-57253), Form S-3 (File No. 33-44893); Form S-3 (File No. 33-89264) and Form S-3 (File No. 333-57601) of our report, which includes a going concern explanatory paragraph due to the ability of the Company to comply with the Formal Agreement mandated by the Office of the Comptroller of the Currency, and the resulting uncertainty as to regulatory actions, dated February 18, 1999, except as to the information presented in Notes 8 and 18, for which the date is March 31, 1999, and Note 22, for which the date is April 13, 1999, on our audits of the consolidated financial statements of Surety Capital Corporation as of December 31, 1998 and 1997, and for the years ended December 31, 1998, 1997 and 1996, which report is included in this Annual Report on Form 10-K. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Fort Worth, Texas April 15, 1999 EX-24 6 SPECIAL POWER OF ATTORNEY EXHIBIT 24 SPECIAL POWER OF ATTORNEY The undersigned hereby appoint C. Jack Bean and B. J. Curley, and each of them severally, as attorneys and agents for the undersigned, with full power of substitution, for and in the name, place and stead of the undersigned, to sign and file with the Securities and Exchange Commission the Annual Report on Form 10-K of Surety Capital Corporation (the "Form 10-K") for the fiscal year ended December 31, 1998, with said attorneys and agents to have full power and authority to do and perform in the name of and on behalf of the undersigned, every act whatsoever necessary or advisable to be done in the premises as fully and to all intents and purposes as the undersigned might or could do in person, such power to extend to the execution of any amendment to the Form 10-K. Executed this 1st day of April, 1999. /s/ C. Jack Bean ------------------------------ C. Jack Bean /s/ William B. Byrd ------------------------------ William B. Byrd /s/ B. J. Curley ------------------------------ B. J. Curley /s/ Joseph S. Hardin ------------------------------ Joseph S. Hardin /s/ G. M. Heinzelmann, III ------------------------------ G. M. Heinzelmann, III /s/ Margaret E. Holland ------------------------------ Margaret E. Holland /s/ Michael L. Milam ------------------------------ Michael L. Milam /s/ Garrett Morris ------------------------------ Garrett Morris /s/ Cullen W. Turner ------------------------------ Cullen W. Turner EX-27 7 FINANCIAL DATA SCHEDULE
9 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 9,289,897 94,939 24,761,752 0 24,366,866 0 0 99,430,761 (1,961,840) 175,061,795 155,163,401 0 1,554,144 4,350,000 0 0 58,401 13,935,849 175,061,795 11,759,497 3,714,226 1,044,069 16,517,792 6,782,611 7,100,693 9,417,099 2,004,987 0 12,132,770 (1,295,356) (1,295,356) 0 0 (1,863,113) (.32) (.32) 0 1,398,800 414,969 0 0 950,809 (3,157,636) 648,861 1,961,840 1,961,840 0 990,384
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