-----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, VdGj7hqVpQDHNSojHYZ/DI6AoBEZcfyQaIFpN7ebuKskW4ZHQeC4fEAsJ5Qeykzk ibF1aTbLV2tFJ+B7sSwsPQ== 0000928385-98-002714.txt : 19981230 0000928385-98-002714.hdr.sgml : 19981230 ACCESSION NUMBER: 0000928385-98-002714 CONFORMED SUBMISSION TYPE: 10KSB40 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981229 FILER: COMPANY DATA: COMPANY CONFORMED NAME: UNION FINANCIAL BANCSHARES INC CENTRAL INDEX KEY: 0000926164 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 570264560 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10KSB40 SEC ACT: SEC FILE NUMBER: 033-80808 FILM NUMBER: 98776924 BUSINESS ADDRESS: STREET 1: 203 WEST MAIN ST STREET 2: C/O PROVIDENT COMMUNITY BANK CITY: UNION STATE: SC ZIP: 29379 BUSINESS PHONE: 8644279000 MAIL ADDRESS: STREET 1: 203 WEST MAIN STREET STREET 2: C/O PROVIDENT COMMUNITY BANK CITY: UNION STATE: SC ZIP: 29379 10KSB40 1 FORM 10-KSB SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended September 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 1-5735 ------ Union Financial Bancshares, Inc. ---------------------------------------------- (Name of small business issuer in its charter)
Delaware 57-1001177 - --------------------------------------------- -------------- (State or other jurisdiction of incorporation (I.R.S. Employer or organization) Identification No.) 203 West Main Street, Union, South Carolina 29379 - --------------------------------------------- -------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (864) 427-9000 --------------
Securities registered pursuant to Section 12(b) of the Act: None ----------------- Securities registered pursuant to Section 12(g) of the Act: Common Stock, par ----------------- value $.01 per ----------------- share ----------------- (Title of Class) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, during the past 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 ------- ------- Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of the registrant's knowledge, in definitive proxy or other information statements incorporated by reference in Part III of this Form 10-KSB or any amendments to this Form 10-KSB. X ----- The registrant's gross revenues for the fiscal year ended September 30, 1998 were approximately $14,443,000. As of September 30, 1998, there were issued and outstanding 1,278,250 shares of the registrant's Common Stock. The aggregate market value of the voting stock, including that held by insiders, computed by reference to the average bid and asked price on September 30, 1998, was approximately $18,215,062 (1,278,250 shares at $14.25 per share). DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the Annual Report to Shareholders for the Fiscal Year Ended September 30, 1998 (Parts I and II). 2. Portions of the Proxy Statement for the 1999 Annual Meeting of Shareholders (Part III). PART I ITEM 1. BUSINESS - ---------------- GENERAL Union Financial Bancshares, Inc. ("Union Financial") was incorporated in the State of Delaware in April 1994 for the purpose of becoming a savings and loan holding company for Provident Community Bank (formerly known as Union Federal Savings Bank, (the "Bank"). On August 24, 1994, the stockholders of the Bank approved a plan to reorganize the Bank into the holding company form of ownership. The reorganization was completed on November 9, 1994, on which date the Bank became the wholly-owned subsidiary of Union Financial, and the shareholders of the Bank became shareholders of Union Financial. Prior to completion of the reorganization, Union Financial had no material assets or liabilities and engaged in no business activities. Subsequent to the acquisition of Union Federal, Union Financial has engaged in no significant activity other than holding the stock of the Bank and certain passive investment activities. Accordingly, the information set forth in this report, including financial statements and related data, relates primarily to the Bank. Union Financial and the Bank are collectively referred to as "the Corporation" herein. The Bank is a federally-chartered, capital stock savings bank headquartered in Union, South Carolina. The Bank, which was originally chartered in 1934 as a mutual savings and loan association, converted from mutual to stock form in 1987. The Bank was known as Union Federal Savings and Loan Association until 1992, when it converted its charter to a federal savings bank charter and changed its name to Union Federal Savings Bank. In 1997, the Bank changed its name to Provident Community Bank. The Bank conducts its operations through its main office, which is located at 203 West Main Street, Union, South Carolina, and three full service banking centers located in Union, Jonesville, and Laurens, South Carolina. The Jonesville banking center was approved by the OTS in March 1994 and opened with a temporary office in July 1994. A permanent facility is being constructed on the site with a projected completion date of April, 1999. The Bank acquired its Laurens banking center in 1997 in a purchase and assumption agreement with First Union National Bank of South Carolina. For additional information, see "Properties." The Bank is a member of the Federal Home Loan Bank ("FHLB") and its deposits are insured up to applicable limits by the Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC"). The business of the Bank consists primarily of attracting deposits from the general public and originating mortgage loans on residential properties located in Laurens and Union County, South Carolina. The Bank also makes commercial real estate, construction and consumer loans and invests in obligations of the federal government and its agencies and of state and local municipalities. The Bank purchases both fixed and adjustable rate mortgage-backed securities issued by Federal Home Loan Mortgage Corporation ("FHLMC"), Federal National Mortgage Association ("FNMA") and Government National Mortgage Association ("GNMA"). The Bank has purchased fixed and variable rate mortgages originated by other organizations. Historically, the Bank's primary lending focus has been on the origination of long-term, fixed-rate mortgage loans for its portfolio. Beginning in fiscal year 1989, the Bank began originating adjustable-rate mortgage loans ("ARMs") and in 1992 began selling its fixed-rate loans in the secondary market. See "Lending Activities." The principal sources of funds for the Bank's lending activities include deposits received from the general public, interest and principal repayments on loans and, to a lesser extent, borrowings from the FHLB-Atlanta. The Bank's primary source of income is interest earned on loans and investments. The Bank's principal expense is interest paid on deposit accounts and borrowings and expenses incurred in operating the Bank. RECENT DEVELOPMENTS On October 5, 1998, the Corporation, through its subsidiary, Provident Community Bank, entered into a definitive agreement with CCB Financial's wholly- owned subsidiary, American Federal Bank, FSB to purchase the deposits of American Federal's Union, South Carolina banking center. At September 30, 1998, this branch had $14,756,000 in deposits. This transaction is expected to close in February, 1999. 2 AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS/COST The following table sets forth certain information for the periods indicated regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities and average yields and costs. Such yields and costs for the periods indicated are derived by dividing income or expense by the average monthly balance of assets or liabilities, respectively, for the periods presented. Average balances are derived from month-end balances. Management does not believe that the use of month-end balances instead of daily balances results in any material difference in the information presented. 3
Year Ended September 30, ------------------------------------------------------------------------------------------------------ 1998 1997 1996 ------------------------------------------ ------------------------------ -------------------------- Average Average Average Average Yield/ Average Yield/ Average Yield/ Balance Interest Cost Balance Interest Cost Balance Interest Cost --------------------- --------- -------- --------- --------- -------- -------- --------- ----- (Dollars in Thousands) Interest-earning assets: Loans receivable, net (1)... $146,515 $11,865 8.10% $120,542 $ 9,747 8.08% $ 73,026 $6,436 8.81% Mortgage-backed securities 8,610 599 6.96% 8,079 546 6.76 16,867 1,105 6.55 Investment securities: Taxable..................... 12,432 814 6.55% 19,691 1,462 7.42 18,891 1,249 6.61 Nontaxable.................. 449 17 3.88% 952 37 3.92 2,665 122 4.58 -------- ------- -------- ------- -------- ------ Total investment securities 12,881 831 6.45% 20,643 1,499 7.26 21,556 1,371 6.36 -------- ------- -------- ------- -------- ------ Overnight deposits.......... 3,103 110 3.54% 2,076 63 3.03 2,747 92 3.35 -------- ------- -------- ------ Total interest-earning assets................... 171,109 13,406 7.83% 151,340 11,855 7.83 114,196 9,004 7.88 Non-interest-earning assets 6,055 5,072 3,821 -------- -------- -------- Total assets.............. $177,164 :$156,412 $118,017 ======== ======== Interest-bearing liabilities: Savings accounts............ 11,527 253 2.20% 11,611 274 2.36 $ 11,641 302 2.59 Negotiable order of withdrawal ("NOW") accounts................... 24,056 411 1.71% 20,493 353 1.72 12,581 264 2.10 Certificate accounts........ 88,492 4,880 5.51% 75,008 4,038 5.38 70,069 3,913 5.58 FHLB advances and other borrowings................. 35,197 2,005 5.70% 35,237 1,982 5.62 9,499 571 6.01 -------- ------- -------- ------- -------- ------ Total interest-bearing liabilities.............. 159,272 7,549 4.74% 142,349 6,647 4.67 103,790 5,050 4.87 ------ Non-interest-bearing liabilities................ 3,494 1,180 1,936 -------- -------- -------- Total liabilities......... 162,766 143,529 105,726 -------- -------- Shareholders' equity........ 14,398 12,883 12,291 -------- -------- -------- Total liabilities and shareholders' equity..... $177,164 $156,412 $118,017 ======== ======== ======== Net interest income......... $ 5,856 $ 5,208 $3,954 ======= ======= ====== Interest rate spread (2).... 3.09% 3.16% 3.01% Net interest margin (3)..... 3.42% 3.44% 3.46% Ratio of average interest-earning assets to average interest-bearing liabilities................ 1.07x 1.06x 1.10x - ---------------------------
(1) Average loans receivable includes nonaccruing loans. Interest income does not include interest on loans 90 days or more past due. (2) Represents difference between weighted average yield on all interest- earning assets and weighted average rate on all interest-bearing liabilities. (3) Represents net interest income before provision for loan losses as a percentage of average interest-earning assets. 4 LENDING ACTIVITIES GENERAL. The principal lending activity of the Corporation has historically been the origination of conventional single family residential mortgage loans. The Corporation's net loan portfolio totaled approximately $142.2 million at September 30, 1998, representing approximately 75.0% of total assets. At September 30, 1998, approximately $65.7 million, or 46.2% of the Corporation's total loan portfolio, consisted of long-term, fixed-rate mortgage loans. As of September 30, 1998, ARMs represented approximately $48.7 million, or 34.2% of the total loan portfolio. See "Real Estate Loans." Set forth below is selected data relating to the composition of the Corporation's loan portfolio on the dates indicated (dollars in thousands):
At September 30, --------------------------------------------------------------- 1998 1997 1996 ---------------------- ------------------- ------------------ Amount Percent Amount Percent Amount Percent ----------- -------- --------- -------- -------- -------- First mortgage loans: Conventional................... $114,383 80.44% $105,242 80.98% $70,959 82.51% Construction loans............. 12,838 9.03 13,508 10.39 4,627 5.38 Participation loans purchased.. 665 0.47 1,002 .77 1,133 1.32 -------- ------ -------- ------ ------- ------ Total mortgage loans......... 127,886 89.94 119,752 92.14 76,719 89.21 -------- ------ -------- ------ ------- ------ Second mortgage loans............ 5,857 4.12 4,478 3.45 1,484 1.73 Consumer and installment loans.......................... 14,218 10.00 12,990 10.00 9,871 11.48 Savings account loans............ 1.551 1.09 183 .14 414 0.48 -------- ------ -------- ------ ------- ------ Total loans.................. 149,512 105.15 137,403 105.73 88,488 102.90 ------ ------- ------ Less: Undisbursed loans in process... (6,625) (4.66) (6,598) (5.08) (1,644) (1.91) Allowance for loan losses...... (827) (.59) (928) (.71) (799) (0.93) Deferred loan fees............. 142 .10 80 .06 (48) (0.06) -------- ------ -------- ------ ------- ------ Net loans receivable......... $142,202 100.00% $129,957 100.00% $85,997 100.00% ======== ====== ======== ====== ======= ======
5 The following table sets forth, at September 30, 1998, certain information regarding the dollar amount of principal repayments for loans becoming due during the periods indicated (in thousands). Demand loans (loans having no stated schedule of repayments and no stated maturity) and overdrafts are reported as due in one year or less.
Due After Due After Due After Due 1 Year 3 Years 5 Years Within Through Through Through Due After One Year 3 Years 5 Years 10 Years 10 Years Total -------- ------- ------- -------- -------- --------- First mortgage loans: Conventional loans............ $15,206 $16,270 $17,537 $45,053 $20,317 $114,383 Construction loans (a)........ 12,838 12,838 Participation loans purchased..................... 665 665 Second mortgage loans........... 5,857 5,857 Consumer and installment loans.. 4,965 3,782 2,333 2,031 1,107 14,218 Savings account loans........... 1,551 ----- 1,551 -------- ------- ------- -------- -------- --------- Total......................... $34,560 $20,052 $19,870 $47,084 $27,946 $149,512 ======= ======= ======= ======== ======== =========
- ------------------------ (a) These construction loans include construction/permanent loans. The actual average life of mortgage loans is substantially less than their contractual term because of loan repayments and because of enforcement of due- on-sale clauses which give the Corporation the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase, however, when current mortgage loan rates substantially exceed rates on existing mortgage loans. The following table sets forth the dollar amount of loans due after September 30, 1999 which have fixed rates of interest and which have adjustable rates of interest (in thousands).
Fixed Rate Adjustable Rate Total ---------- --------------- -------- Real estate mortgage loans.. $50,506 $48,671 $ 99,177 Consumer and other loans.... 9,918 5,857 15,775 ------- ------- -------- Total $60,424 $54,528 $114,952 ======= ======= ========
6 REAL ESTATE LOANS. The primary lending activity of the Corporation has been the origination of conventional mortgage loans to enable borrowers to purchase existing single family homes or to construct new homes. The Corporation's residential real estate loan portfolio also includes loans on multi-family dwellings (more than five units). At September 30, 1998, approximately 85.9% of the Corporation's total loan portfolio consisted of loans secured by residential real estate (net of undisbursed principal). OTS regulations limit the amount which federally chartered savings institutions may lend in relationship to the appraised value of the real estate securing the loan, as determined by an appraisal at the time of loan origination. Federal regulations permit a maximum loan-to-value ratio of 100% for one- to four-family dwellings and 80% for all other real estate loans. The Corporation's lending policies, however, limit the maximum loan-to-value ratio on one-to four-family real estate mortgage loans to 80% of the lesser of the appraised value or the purchase price. Any single-family loan made in excess of an 80% loan-to-value ratio and any commercial real estate loan in excess of a 75% loan-to-value ratio is required to have private mortgage insurance or additional collateral. In the past, the Corporation has originated some commercial real estate loans in excess of a 75% loan-to-value ratio without private mortgage insurance or additional collateral. The loan-to-value ratio, maturity and other provisions of the loans made by the Corporation have generally reflected a policy of making less than the maximum loan permissible under applicable regulations, market conditions, and underwriting standards established by the Corporation. Mortgage loans made by the Corporation are generally long-term loans (15-30 years), amortized on a monthly basis, with principal and interest due on each month. In the Corporation's experience, real estate loans remain outstanding for significantly shorter periods than their contractual terms. Borrowers may refinance or prepay loans, at their option, with no prepayment penalty. The Corporation offers a full complement of mortgage lending products with both fixed and adjustable rates. Due to the nature of the Corporation's marketplace, only a small percentage of "local" loans are adjustable-rate loans. The majority of adjustable-rate loans in the portfolio are originated outside of Union and Laurens County by third party originators. The Corporation has established a network of third party loan brokers who originate loans for the Corporation, as well as other originators, throughout the state of South Carolina. These loans are originated and underwritten using the same terms and conditions as loans originated by the Corporation. The Corporation offers ARMs tied to U.S. Treasury Bills with a maximum interest rate adjustment of 2% annually and 6% over the life of the loan. At September 30, 1998, the Corporation had approximately $48.7 million of ARMs, or 34.2% of the Corporation's total outstanding loan portfolio. At September 30, 1998, 46.2% of the Corporation's loan portfolio consisted of long-term, fixed-rate real estate loans. Because of this high concentration of fixed-rate loans, the Corporation is more vulnerable to a reduction in net interest income during periods of increasing market interest rates. Net interest income depends to a large extent on how successful the Corporation is in "matching" interest-earning assets and interest-bearing liabilities. The Corporation has taken steps to reduce its exposure to rising interest rates. For a discussion of these steps, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Annual Report. Beginning in fiscal year 1992, the Corporation began selling a portion of current year loan production to the FHLMC. The Corporation sells fixed-rate loans with maturities ranging from ten to 30 years. This activity is one method used by the Corporation to reduce its interest rate risk exposure. The loans are sold without recourse and the Corporation retains 25 basis points for servicing these loans. During the year ended September 30, 1998, the Corporation sold approximately $123.7 million of its fixed-rate mortgage loans. The Corporation purchases participation interests from other financial institutions on a selected basis. These purchased interests are adjustable-rate loans and are collaterized by either residential or commercial real estate. At September 30, 1998, these interests totaled approximately $665,000. 7 Commercial real estate loans constituted approximately $4.2 million, or 2.9% of Union Financial's loan portfolio at September 30, 1998. Commercial real estate loans consist of permanent loans secured by multi-family properties, generally apartment houses, as well as commercial and industrial properties, including office buildings, warehouses, shopping centers, hotels, motels and other special purpose properties. Commercial real estate loans have been originated and purchased for inclusion in the Corporation's portfolio. These loans generally have 20 to 30 year amortization schedules and are callable or have balloon payments of five to ten years. Typically, the loan documents provide for adjustment of the interest rate every one to three years. Fixed- rate loans secured by multi-family residential and commercial properties have terms ranging from 20 to 25 years. Loans secured by commercial properties may involve greater risk than single- family residential loans. Such loans generally are substantially larger than single-family residential loans. The payment experience on loans secured by commercial properties typically depends on the successful operation of the properties, and thus may be subject to a greater extent to adverse conditions in the real estate market or in the economy generally. CONSTRUCTION LOANS. The Corporation engages in construction lending that is primarily secured by single family residential real estate and, to a much lesser extent, commercial real estate. These loans are made for a maximum 12-month construction period and require monthly interest payments. In some cases these loans automatically convert to a permanent loan requiring monthly principal and interest payments. The Corporation also grants construction loans to individuals with a takeout for permanent financing from another financial institution, and to approved builders on both presold and unsold properties. Loan brokers are the Corporation's primary source for construction loans. The loan broker sends the Corporation both individuals seeking construction financing for their personal dwelling or builders seeking lines of credit for the construction of single family residences on both presold and unsold properties. Individuals are made construction loans that mature in one year or less or construction/permanent loans that convert to permanent loans at the end of the construction period. Builders are made construction loans for a term not to exceed 12 months. Generally, all draw inspections are handled by the appraiser who initially appraised the property; however, in some instances the draw inspections are performed by the originating brokerage firm. Construction financing overall is generally considered to involve a higher degree of credit risk than the long-term financing of residential properties. The Corporation's risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value at completion of construction or development and the estimated cost (including interest) of construction. If the estimate of construction cost or the salability of the property upon completion of the project proves to be inaccurate, the Corporation may be required to advance funds beyond the amount originally committed to permit completion of the development. If the estimate of value proves to be inaccurate, the Corporation may be confronted at or prior to the maturity of the loan with a projection of a value which is insufficient to assure full repayment. Although these loans afford the Corporation the opportunity to achieve higher interest rates and fees with shorter terms to maturity than do single-family permanent mortgage loans, construction loans are generally considered to involve a higher degree of risk than single-family permanent mortgage lending due to (i) the concentration of principal among relatively few borrowers and development projects, (ii) the increased difficulty at the time the loan is made of estimating the building costs and selling price of the residence to be built, (iii) the increased difficulty and costs of monitoring the loan, (iv) the higher degree of sensitivity to increases in market rates of interest and (v) the increased difficulty of working out loan problems. Speculative construction loans have the added risk associated with identifying an end-purchaser for the finished home. At September 30, 1998, the Corporation had approximately $12.8 million outstanding in construction loans, including approximately $6.6 million in undisbursed proceeds. Of the $12.8 million in construction loans at September 30, 1998, approximately $2.1 million were "speculative," meaning that, at the time the loan was made, there was no sales contract or permanent loan in place for the finished home. Substantially all of these loans were secured by one- to four-family residences. 8 CONSUMER LOANS. Federal regulations permit federally chartered thrift institutions to make secured and unsecured consumer loans up to 35% of the institution's assets. In addition, a federal thrift institution has lending authority above the 35% category for certain consumer loans, such as home equity loans, property improvement loans, mobile home loans and loans secured by savings accounts. The Corporation's consumer loan portfolio consists primarily of automobile loans on new and used vehicles, mobile home loans, boat loans, home equity loans, property improvement loans, loans secured by savings accounts and unsecured loans. As of September 30, 1998, consumer loans amounted to $14.2 million, or 10% of the Corporation's total loan portfolio. The Corporation makes consumer loans to serve the needs of its customers and as a way to improve the interest-rate sensitivity of the Corporation's loan portfolio. Consumer loans tend to bear higher rates of interest and have shorter terms to maturity than residential mortgage loans; however, nationally, consumer loans have historically tended to have a higher rate of default than residential mortgage loans. LOAN SOLICITATION AND PROCESSING. Loan originations come from both walk-in customers and loan brokers. The loan origination process for walk-in customers includes an initial interview with an officer of the Corporation for the purpose of obtaining a formal application. Upon receipt of a loan application from a prospective borrower, a credit report is ordered to verify specific information relating to the loan applicant's employment, income and credit standing. This information may be further verified by personal contacts with other reference sources. An appraisal of the real estate intended to secure the proposed loan is undertaken by pre-approved, independent fee appraisers. As soon as the required information has been obtained and the appraisal completed, the loan is submitted to the authorized officer, loan committees or full Board of Directors for review. The Corporation utilizes various officers and loan committees for the approval of real estate loans. The President/Chief Executive Officer has the authority to approve loan requests up to and including $500,000 in secured credit and up to and including $150,000 in unsecured credit. The Board of Directors has appointed an Executive Loan Committee comprised of seven senior executive Bank officers consisting of the President/Chief Executive Officer, the Executive Vice President/Chief Financial Officer, the Vice President/Chief Operating Officer, the Vice President/Credit Administration Manager, Assistant Vice President/Consumer Loan Manager, Vice President/Mortgage Loan Acquisitions and and Vice President/Mortgage Lending Sales Manager. This Committee has the authority to approve all loan requests up to and including $500,000 in secured credit and up to and including $150,000 in unsecured credit. A quorum of two members is required for any action. The Board of Directors has also appointed a Board Loan Committee comprised of two members elected annually from the Board of Directors and four senior executive officers of the Bank. A quorum of three members, including at least one Board member, is required for any action. This Committee has the authority to approve all secured and unsecured loan requests up to the Bank's legal lending limit with the exception of a single loan request exceeding $1,000,000 in secured credit and exceeding $300,000 in unsecured credit. Single loan requests exceeding $1,000,000 in secured credit and $300,000 in unsecured credit require approval of the entire Board of Directors. Loan applicants are promptly notified of the decision of the Corporation by telephone, setting forth the terms and conditions of the decision. If approved, these terms and conditions include the amount of the loan, interest rate, amortization term, and a brief description of the real estate to be mortgaged to the Corporation. The Corporation also issues a commitment letter to the potential borrower which typically remains in effect for 60 days. The Corporation's experience is that very few commitments go unfunded. See "Loan Commitments." The borrower is required to pay all costs of the Corporation, as well as his/her own costs, incurred in connection with the particular loan closing. The Corporation originated approximately $20.2 million in mortgage loans from walk-in customers during fiscal year 1998. The Board of Directors has appointed a second review loan committee to review all denied loan applications. This committee reviews the rationale used to deny credit and reviews denied applications for the possibility of being able to supply credit under a different loan program, or under different terms and conditions. Every attempt is made to supply credit to creditworthy applicants in a manner consistent with their needs. LOAN ORIGINATIONS, PURCHASES AND SALES. Prior to fiscal year 1992, all mortgage loans originated by the Corporation were retained in the Corporation's loan portfolio. Most of these loans were long-term, fixed-rate real estate loans. Beginning in 1992, the Corporation began selling a portion of its current long-term, fixed-rate loan production 9 to FHLMC on a servicing-retained basis. These were cash sales with no recourse provisions. The Corporation receives 25 basis points for servicing these loans. During fiscal year 1997 the Corporation established Provident Mortgage Corporation as a division of Provident Community Bank. The primary purpose of the mortgage division is to purchase residential mortgage loans that will be packaged as securities and sold in the secondary market. The mortgage division purchases the loans from mortgage brokers primarily located in South Carolina. The loan types purchased are primarily fixed rate residential along with some adjustable rate residential. In addition, construction/permanent loans will also be purchased. The mortgage division had total purchases through the broker network of $141.4 million with loan sales of $123.7 million. The mortgage division will limit the Bank's interest rate risk exposure by purchasing forward commitments whereby approximately 50% to 75% of projected closings will be presold. The mortgage division retains the servicing of the loans in order to generate additional fee income for the Bank. At September 30, 1998 the Bank was servicing $164.4 million of loans for others. The Corporation purchases participation interests in loans originated by other institutions. These participation interests are on both residential and commercial properties and carry either a fixed or adjustable interest rate. The following table sets forth the Corporation's loan origination and sale activity for the periods indicated (in thousands):
Year Ended September 30, -------------------------------- 1998 1997 1996 -------- -------- ------- Loans originated: First mortgage loans: Loans on existing property......................... $150,924 $ 83,419 $25,853 Construction loans................................. 10,728 17,649 2,516 -------- -------- ------- Total mortgage loans originated (1)................................. 161,652 101,068 28,369 Consumer and other loans............................ 23,351 15,984 8,139 -------- -------- ------- Total loans originated........................... $185,003 $117,052 $36,508 ======== ======== ======= Loans purchased....................................... -- -- $ 570 Loans sold............................................ $123,676 $ 46,763 $ 810
(1) Includes mortgage division loans purchased. LOAN COMMITMENTS. The Corporation's commitments to make conventional mortgage loans on existing residential dwellings are normally made for periods of up to 30 days from the date of loan approval. Union Financial's total loan commitments outstanding as of September 30, 1998 were approximately $2,736,000. See "Financial Condition, Liquidity and Capital Resources" in the Annual Report. LOAN ORIGINATION AND OTHER FEES. In addition to interest earned on loans and fees for making loan commitments, the Corporation charges origination fees or "points" for originating loans. Loan origination fees are usually a percentage of the principal amount of the mortgage loan, typically between .5% and 2%, depending on the terms and conditions. The Corporation does not receive origination fees on broker loans, but does receive a $150 review fee. The Corporation also offers loan products that require no origination fees to walk- in customers. Other fees collected include late charges applied to delinquent payments and fees collected in connection with loan modifications. The Corporation charges a 5% late charge fee on payments delinquent 15 days or more on new loan originations, loan modifications, loan assumptions and loans currently in the Corporation's portfolio where applicable. The 5% late charge is calculated on the delinquent monthly principal and interest payment amount. Late charges and modification 10 fees do not constitute a material source of income. Current accounting standards require fees received (net of certain loan origination costs) for originating loans to be deferred and amortized into interest income over the contractual life of the loan. As of September 30, 1998, the Corporation had net deferred loan fees of approximately $142,000. PROBLEM ASSETS AND ASSET CLASSIFICATION. When a borrower fails to make a required payment on a loan, the Corporation attempts to cure the default by contacting the borrower. In general, borrowers are contacted after a payment is more than 30 days past due. In most cases, defaults are cured promptly. If the delinquency on a mortgage loan is not cured through the Corporation's normal collection procedures, or an acceptable arrangement is not worked out with the borrower, the Corporation will institute measures to remedy the default, including commencing a foreclosure action. The Corporation generally does not accept voluntary deeds of the secured property in lieu of foreclosure. Loans are reviewed on a regular basis and an allowance for uncollectible interest is established against accrued interest receivable when, in the opinion of management, the collection of additional interest is doubtful. An allowance for uncollectible interest on real estate loans and consumer loans is established when either principal or interest is more than 90 days past due. Subsequent payments are either applied to the outstanding principal balance or recorded as interest income, depending on the assessment of the ultimate collectibility of the loan. See Note 3 of Notes to Financial Statements. The Corporation generally determines a loan to be impaired at the time management believes that it is probable that the principal and interest may be uncollectible. Management has determined that, generally, a failure to make a payment within a 90-day period constitutes a minimum delay or shortfall and does not generally constitute an impaired loan. However, management reviews each past due loan on a loan-by-loan basis and may determine a loan to be impaired prior to the loan becoming over 90 days past due, depending upon the circumstances of that particular loan. A loan is classified as a nonaccrual at the time management believes that the collection of interest is improbable, generally when a loan becomes 90 days past due. The Corporation's policy for charge-off of impaired loans is on a loan-by-loan basis. At the time management believes the collection of interest and principal is remote, the loan is charged off. The Corporation's policy is to evaluate impaired loans based on the fair value of the collateral. Interest income from impaired loans is recorded using the cash method. Real estate acquired by the Corporation as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate acquired in the settlement of loans. When such property is acquired it is recorded at the lower of the unpaid principal balance of the related loan or its fair market value. Any subsequent write-down of the property is charged to income. The following table sets forth information with respect to the Corporation's non-performing assets for the periods indicated (dollars in thousands). It is the policy of the Corporation to cease accruing interest on loans 90 days or more past due. At the dates indicated, there were no restructured loans within the meaning of Statement of Financial Accounting Standards ("SFAS") No. 15 and no impaired loans as defined by SFAS No. 114 and SFAS No. 118. Also, at the dates indicated, there were no loans which are not disclosed in the following table about which there was known information of possible credit problems of the borrowers' ability to comply with the present repayment terms:
At September 30, ---------------------- 1998 1997 1996 ------ ------ ------ Loans accounted for on a nonaccrual basis: Real estate: Residential............. $ 581 $ 751 $1,049 Commercial.............. -- -- 74 Construction............ -- -- --
11 Consumer.................. 115 27 -- ----- ----- ------ Total................. $ 696 $ 778 $1,123 ----- ----- ------ Accruing loans which are contractually past due 90 days or more............. -- -- -- Real estate owned, net....... 35 1 19 ----- ----- ------ Total non-performing assets.. $ 779 $ 1 $ 142 ===== ===== ====== Percentage of loans receivable net............ .55% .60% 1.33% ===== ===== ======
Interest income that would have been recorded for the year ended September 30, 1998 had non-accruing loans been current in accordance with their original terms amounted to approximately $20,000. The amount of interest included in interest income on such loans for the year ended September 30, 1998 amounted to approximately $0. ALLOWANCE FOR LOAN LOSSES. In originating loans, the Corporation recognizes that losses will be experienced and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the security for the loan. To cover losses inherent in the portfolio of performing loans, the Corporation maintains an allowance for loan losses. Management's periodic evaluation of the adequacy of the allowance is based on a number of factors, including management's evaluation of the collectibility of the loan portfolio, the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans and economic conditions. Specific valuation allowances are established to absorb losses on loans for which full collectibility may not be reasonably assured. The amount of the allowance is based on the estimated value of the collateral securing the loan and other analysis pertinent to each situation. The Corporation increases its allowance for loan losses by charging provisions for loan losses against income. The allowance for loan losses is maintained at an amount management considers adequate to absorb losses inherent in the portfolio. Although management believes that it uses the best information available to make such determinations, future adjustments to the allowance for loan losses may be necessary and results of operations could be significantly and adversely affected if circumstances differ substantially from the assumptions used in making the determinations. While the Bank believes it has established its existing allowance for loan losses in accordance with GAAP, there can be no assurance that regulators, in reviewing the Bank's loan portfolio, will not request the Bank to increase significantly its allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that substantial increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely affect the Corporation's financial condition and results of operations. Management periodically evaluates the adequacy of the allowance based upon historical delinquency rates, the size of the Corporation's loan portfolio and various other factors. See Notes 1 and 3 of Notes to Consolidated Financial Statements for information concerning the Corporation's provision and allowance for possible loan losses. The following table sets forth an analysis of the Corporation's allowance for loan losses for the periods indicated (dollars in thousands):
At September 30, ---------------------- 1998 1997 1996 ------ ------ ------ Balance at beginning of period: $ 928 $ 799 $ 878 ----- ----- ----- Loans charged-off:
12 Real estate: Residential...................... -- -- (6) Commercial....................... -- -- -- Consumer........................... (127) (165) (88) ----- ----- ----- Total charge-offs.............. (127) (165) (94) ----- ----- ----- Recoveries: Real estate: Residential...................... -- -- -- Commercial....................... -- -- -- Consumer........................... 26 51 15 ----- ----- ----- Total recoveries............... 26 51 15 ----- ----- ----- Net (charge-offs) recoveries......... (101) (114) (79) ----- ----- ----- Provision for loan losses(1)......... -- 243 -- ----- ----- ----- Balance at end of period............. $ 827 $ 928 $ 799 ===== ===== ===== Ratio of net charge-offs to average gross loans outstanding during the period......................... .07% .09% .11% ===== ===== =====
- --------------------------- (1) See "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Annual Report for a discussion of the factors responsible for changes in the provision for loan losses between the periods. 13 The following table sets forth the breakdown of the allowance for loan losses by loan category and the percentage of loans in each category to total loans for the periods indicated. Management believes that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance to each category is not necessarily indicative of further losses and does not restrict the use of the allowance to absorb losses in any category (dollars in thousands):
At September 30, ------------------------------------------------------------------------- 1998 1997 1996 ----------------------- ----------------------- ----------------------- % of Loans in % of Loans in % of Loans in Each Category Each Category Each Category Amount to Total Loans Amount to Total Loans Amount to Total Loans ------ --------------- ------ --------------- ------ --------------- Real estate: Residential.............. $ 400 85.90% $ 400 83.49% $400 82.81% Commercial............... 100 2.90 162 4.88 125 3.50 Consumer................. 277 11.20 266 11.63 174 13.69 Unallocated............... 50 N/A 100 N/A 100 N/A ----- ------ ----- ------ ---- ------ Total allowance for loan losses.................. $ 827 100.00% $ 928 100.00% $799 100.00% ===== ====== ===== ====== ==== ======
The Corporation maintains an allowance for losses on real estate acquired in settlement of loans when needed. At September 30, 1998, Union Financial had an allowance for losses on real estate acquired in settlement of loans of approximately $0. These values reflect current market conditions and sales experience. See Notes 1 and 3 of Notes to Consolidated Financial Statements. The OTS requires savings institutions to classify problem assets. Under this classification system, problem assets of insured institutions are classified as "substandard," "doubtful" or "loss," depending on the presence of certain characteristics discussed below. ASSET CLASSIFICATION. An asset is considered "substandard" if inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the institution will sustain some loss if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses inherent in those classified as "substandard" with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. When an institution classifies problem assets as either substandard or doubtful, it is required to establish general allowances for loan losses in an amount deemed prudent by management. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an institution classifies problem assets or a portion of assets as loss, it is required either to establish a specific allowance for losses equal to 100% of the amount of the asset or a portion thereof so classified or to charge-off such amount. An institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OTS which can order the establishment of additional general or specific loss allowances. As of September 30, 1998, the Corporation had approximately $1,446,000 of loans classified as substandard assets, which included real estate loans totaling $1,195,000 and consumer loans totaling $251,000. The Corporation had loans totaling approximately $182,000 classified as doubtful and approximately $1,979,000 designated as special mention at September 30, 1998, which included real estate loans totaling $1,491,000 and consumer loans totaling 14 $488,000. The Corporation carefully monitors its delinquent loans and real estate owned account as to changes in collectibility and other characteristics of asset and borrower quality. INVESTMENT ACTIVITIES The Corporation is required under OTS regulations to maintain a minimum amount of liquid assets which may be invested in specified short-term securities and is also permitted to make certain other investments. The Corporation's liquidity requirement at September 30, 1998 was $5.2 million. At that date the Corporation held approximately $19.1 million in liquid funds, well in excess of regulatory requirements. Such funds consisted of United States Treasury and Agency obligations, certificates of deposits, overnight deposits, mortgage- backed securities and municipal bonds. SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," requires that investments be categorized as "held to maturity," "trading securities" or "available for sale," based on management's intent as to the ultimate disposition of each security. SFAS No. 115 allows debt securities to be classified as "held to maturity" and reported in financial statements at amortized cost only if the reporting entity has the positive intent and ability to hold those securities to maturity. Securities that might be sold in response to changes in market interest rates, changes in the security's prepayment risk, increases in loan demand, or other similar factors cannot be classified as "held to maturity." Debt and equity securities held for current resale are classified as "trading securities." Such securities are reported at fair value, and unrealized gains and losses on such securities would be included in earnings. Debt and equity securities not classified as either "held to maturity" or "trading securities" are classified as "available for sale." Such securities are reported at fair value, and unrealized gains and losses on such securities are excluded from earnings and reported as a net amount in a separate component of equity. 15 The following table sets forth the Corporation's investment and mortgage- backed securities portfolio at the dates indicated (dollars in thousands):
Year Ended September 30, --------------------------------------------------------------------- 1998 1997 1996 ----------------------- --------------------- --------------------- Carrying Percent of Carrying Percent of Carrying Percent of Value Portfolio Value Portfolio Value Portfolio ---------- ----------- -------- ----------- -------- ----------- AVAILABLE FOR SALE: Investment securities: U.S. Agency obligations...... $ 7,682 28.60% $10,341 65.22% $12,221 55.12% Municipal securities........ 451 1.68 447 2.82 1,444 6.51 ------- ------ ------- ------ ------- ------ Total investment securities.. 8,133 30.28 10,788 68.04 13,665 61.63 ------- ------ ------- ------ ------- ------ Mortgage-backed securities.... 18,723 69.72 5,067 31.96 8,509 38.37 ------- ------ ------- ------ ------- ------ Total available for sale...... $26,856 100.00% $15,855 100.00% $22,174 100.00% ======= ====== ======= ====== ======= ====== HELD TO MATURITY: Investment securities: U.S. Agency obligations...... $ 1,500 55.58 $ 5,995 76.75% $ 5,473 47.09% Mortgage-backed securities... 1,199 44.42 1,816 23.25 6,149 52.91 ------- ------ ------- ------ ------- ------ Total held to maturity........ $ 2,699 100.00% $ 7,811 100.00% $11,622 100.00% ======= ====== ======= ====== ======= ======
The Corporation purchases mortgage-backed securities, both fixed-rate and adjustable-rate, from FHLMC, FNMA and GNMA with maturities from five to 30 years. The Corporation also purchases adjustable-rate Small Business Administration ("SBA") securities that are backed by the full faith and credit of the U.S. government. The Corporation also purchases mortgage derivative securities in the form of collateralized mortgage obligations ("CMOs") and structured notes. While these securities possess minimal credit risk due to the Federal guarantee backing the U. S. government agencies, they do posses liquidity risk and interest rate risk. The amortized cost of the CMOs on the books at September 30, 1998 was approximately $7,896,000 with a fair value of $7,958,000. The Corporation has purchased structured notes for investment purposes. These include step-up bonds, single-index floaters and dual-index floaters. While all financial instruments are subject to interest rate risk and liquidity risk, structured notes are more sensitive to changes in interest rates and differing note structures (call provision, rate adjustments, etc.). The Corporation had approximately $2.1 million in structured notes as of September 30, 1998 with a fair value of approximately $2.1 million as of that date. See Note 2 of Notes to Consolidated Financial Statements for more information regarding investment and mortgage-backed securities. 16 The following table sets forth at amortized cost the maturities and weighted average yields of the Corporation's investment and mortgage-backed securities portfolio at September 30, 1998 (dollars in thousands):
Amount Due or Repricing within: ------------------------------------------------------------------------------------------------------ One Year Over One to Over Five to Over or Less Five Years Ten Years Ten Years Total -------------------- ------------------- ------------------ ------------------ ------------------- Weighted Weighted Weighted Weighted Weighted Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average Value Yield Value Yield Value Yield Value Yield Value Yield -------- ---------- --------- -------- -------- -------- -------- -------- -------- --------- AVAILABLE FOR SALE: Investment Securities: U.S. Agency Obligations.. $500 3.03% $1,546 5.05% $ 220 6.21% $ 5,416 7.50% $ 7,682 6.68% Municipal Securities(a).. 250 5.30 131 5.93 -- -- 70 8.32 451 5.95 -------- --------- --------- ------- ------ ---- ------- ---- ------- ---- Total Investment Securities............... 750 3.79 1,677 5.12 220 6.21 5,486 7.51 8,133 6.64 Mortgage-backed Securities 111 7.02 728 7.40 262 5.51 17,622 7.04 18,723 7.03 -------- --------- --------- ------- ------ ---- ------- ---- ------- ---- Total Available for Sale.. 861 4.20% 2,405 5.81 482 5.83 23,108 7.15 26,856 6.91 HELD TO MATURITY: Investment Securities U.S. Agency Obligations.. -- -- -- -- 1,500 7.58% -- -- 1,500 7.58 Mortgage-backed Securities.............. -- -- -- -- -- -- 1,199 7.87 1,199 7.87 -------- --------- --------- ------- ------ ---- ------- ---- ------- ---- Total Held to Maturity... $ -- --% $ -- --% $1,500 7.58% $ 1,199 7.87% $ 2,699 7.71%
- -------------------------- (a) Yields are presented on a fully taxable equivalent basis. 17 At September 30, 1998, approximately $1.4 million of debt securities and $751,000 of mortgage-backed securities were adjustable-rate securities. At September 30, 1998, the Corporation held obligations of Union County, South Carolina, in the amount of approximately $99,000 with a fair value of approximately $102,000 as of the same date. DEPOSITS AND BORROWINGS Deposits are the major source of the Corporation's funds for lending and other investment purposes. In addition to deposits, the Corporation derives funds from principal repayments and interest payments on loans and investment and mortgage-backed securities. Principal repayments and interest payments are a relatively stable source of funds, although principal repayments tend to slow when interest rates increase. Deposit inflows and outflows may be significantly influenced by general market interest rates and money market conditions. During fiscal year 1998, the Corporation experienced a net increases in deposits of approximately $11.9 million. The Corporation borrowed funds to support the remaining growth experienced in fiscal 1998. DEPOSITS. Local deposits are, and traditionally have been, the primary source of the Corporation's funds for use in lending and for other general business purposes. The Corporation offers a number of deposit accounts including NOW accounts, money market savings accounts, passbook and statement savings accounts, individual retirement accounts ("IRAs") and certificate of deposit accounts. Deposit accounts vary as to terms regarding withdrawal provisions, deposit provisions and interest rates. The Corporation adjusts the interest rates offered on its deposit accounts as necessary so as to remain competitive with other financial institutions in Union and Laurens County. Savings deposits in the Corporation at September 30, 1998 were represented by the various types of savings programs described below:
Weighted Average Minimum Percentage Interest Balance of Total Deposits Rate Required Balances Balances - ----------------------------------- --------- -------- -------- ----------- (in thousands) NOW accounts: Commercial non-interest-bearing.. 0.00% $ -- $ 7,119 5.48% Noncommercial.................... 1.33 250 10,925 8.41% Money market checking accounts................ 3.40 1,000 6,832 5.26 Regular savings accounts........... 1.97 100 11,849 9.12 ------- ----- Total demand and savings deposits.............. 1.60 36,725 28.28% ---- ------- ----- Certificates of deposit: 91-day........................... 4.42 500 800 .86% 6 months......................... 4.78 500 18,392 19.72 9-12 months...................... 5.50 500 22,768 24.42 15-19 months..................... 5.70 500 19,833 21.27 20-30 months..................... 5.73 500 12,460 13.36 36-40 months..................... 5.72 500 2,277 2.44
(table continued on following page) 18
Weighted Average Minimum Percentage Interest Balance of Total Deposits Rate Required Balances Balances - ----------------------- --------- -------- -------- ----------- (in thousands) 48 months............ 5.86% $500 539 .55 60 months............ 6.38 500 3,839 4.25 IRAs................... 5.58 100 12,240 10.57 Total certificates of deposits....... 5.51 93,148 71.72% Total deposits......... 4.40 $129,873 100.00%
TIME DEPOSITS BY RATES AND MATURITY. The following table sets forth the time deposits of the Corporation classified by rates as of the dates indicated (in thousands):
At September 30, --------------------------------- 1998 1997 1996 ---------- ----------- -------- Up to 4%.......................................................... $ 37 $ 22 $ 125 4.01% to 6.0%..................................................... 89,155 77,401 61,794 6.01% to 8.0%..................................................... 3,956 5,342 7,139 ------- ------- ------- Total savings certificates $93,148 $82,765 $69,058 ======= ======= ======= The following table sets forth the maturities of time deposits at September 30, 1998 (in thousands): Amount ------- Within three months.............................................. $27,611 After three months but within six months......................... 29,953 After six months but within one year............................. 17,120 After one year but within three years............................ 14,508 After three years but within five years.......................... 3,956 After five years but within ten years............................ -- ------- Total..................................................... $93,148 =======
Certificates of deposit with maturities of less than one year increased from $60.8 million at September 30, 1997 to $74.6 million at September 30, 1998. Historically, the Bank has been able to retain a significant amount of its deposits as they mature. In addition, management of the Bank believes that it can adjust the offering rates of savings certificates to retain deposits in changing interest rate environments. 19 The following table indicates the amount of the Bank's jumbo certificates of deposit by time remaining until maturity as of September 30, 1998 (in thousands). Jumbo certificates of deposit are certificates in amounts of $100,000 or more.
Maturity Period Amount - ------------------------------- ------- Three months or less........... $ 5,581 Over three through six months.. 6,055 Over six through 12 months..... 3,461 Over 12 months................. 3,732 ------- Total jumbo certificates of deposit............... $18,829 =======
See Note 5 of Notes to Consolidated Financial Statements for additional information about deposit accounts. BORROWINGS. The Corporation utilizes advances from the FHLB and other borrowings (treasury, tax and loan deposits) to supplement its supply of lendable funds for granting loans, making investments and meeting deposit withdrawal requirements. See "Regulation -- Federal Home Loan Bank System." The following tables sets forth certain information regarding borrowings by the Bank at the dates and for the periods indicated (dollars in thousands):
At September 30, ---------------------------- 1998 1997 1996 -------- -------- -------- Balance outstanding at end of period: FHLB advances and other borrowings........ $41,441 $37,979 $20,488 Weighted average rate paid on: FHLB advances and other borrowings........ 5.69% 6.00% 6.30% Year Ended September 30, --------------------------- 1998 1997 1996 ------- ------- ------- Maximum amount of borrowings outstanding at any month end: FHLB advances and other borrowings........ $41,441 $37,979 $20,488 Approximate average short-term borrowings outstanding with respect to: FHLB advances and other borrowings........ 35,197 35,237 9,499 Approximate weighted average rate paid on: FHLB advances and other borrowings........ 5.70% 5.62% 6.01%
At September 30, 1998, the Corporation had unused short-term lines of credit to purchase federal funds from unrelated banks totaling $4 million. These lines of credit are available on a one-to-ten day basis for general purposes of the Corporation. All of the lenders have reserved the right to withdraw these lines at their option. At September 30, 1998, the Corporation had unused lines of credit with the FHLB of Atlanta totaling $8 million. 20 COMPETITION The Corporation faces competition in both the attraction of deposit accounts and in the origination of mortgage and consumer loans. Its most direct competition for savings deposits has historically derived from other thrift institutions and commercial banks located in and around Union County, South Carolina. The Corporation faces additional significant competition for investor funds from money market instruments and mutual funds. It competes for savings by offering depositors a variety of savings accounts, convenient office locations and other services. The Corporation competes for loans principally through the interest rates and loan fees it charges and the efficiency and quality of the services it provides borrowers, real estate brokers and home builders. The Corporation's competition for real estate loans comes principally from other thrift institutions, commercial banks and mortgage banking companies. As of September 30, 1998, a local commercial bank, one branch office of a regional commercial bank and an office of a regional savings and loan association were located in Union County, South Carolina. The Corporation is the largest financial institution based in Union County, South Carolina. During the fiscal year 1997, the Corporation expanded to Laurens County with the purchase of a First Union banking center. The makeup of the area and the competition is similar to that of Union County. The State of South Carolina has a reciprocity law with twelve other states and the District of Columbia that allows for interstate mergers between financial institutions. As of June 30, 1997, federal law permits bank holding companies from any state to acquire banks in South Carolina. These statutes have created, and are expected to continue to create, additional competition from large, out of state, financial institutions. SUBSIDIARY ACTIVITIES Under OTS regulations, the Bank generally may invest up to 3% of its assets in service corporations, provided that at least one-half of the investment in excess of 1% is used primarily for community, inner-city and community development projects. In 1997, the Bank formed Provident Financial Services, Inc. for the purpose of engaging in securities brokerage activities for the benefit of the Bank's customers. YEAR 2000 ISSUES The approach of the year 2000 ("Year 2000") presents significant issues for many financial, information, and operational systems. Many systems in use today may not be able to interpret dates after December 31, 1999, appropriately, because such systems allow only two digits to indicate the year in a date. The Year 2000 problems may occur in computer programs, computer hardware, or electronic devices that utilize computer chips to process any information that contains dates. Therefore, the issue is not limited to dates in computer programs but is a complex combination of problems that may exist in computer programs, data files, computer hardware, and other devices essential to the operation of the business. Further, companies must consider the potential impact that Year 2000 may have on services provided by third parties. Substantially all of the Year 2000 risk is related to the Bank's activities. The Bank has a formal Year 2000 Plan which includes a Year 2000 Task Force. The Plan has been reviewed by the senior management and the Board of Directors. Included in the Plan is a listing of all systems (whether in-house or provided/supported by third parties) which may be impacted by Year 2000 and a categorization of the systems by their potential impact on Bank operations. The Task Force has received Year 2000 plans from third parties identified during 21 the assessment phase of the Year 2000 Plan. For systems that have been classified as critical to the operations of the Bank, contingency plans have been developed. Contingency plans may include utilization of alternate third party vendors, alternate processing methods and software, or manual processing. The plans have various activation dates (e.g., the date on which a third party processor fails to meet its Year 2000 compliance deadline). In addition to addressing its own Year 2000 issues, the Bank is in the process of assessing the impact of the Year 2000 on significant commercial borrowers. The Bank's Year 2000 readiness is reviewed and monitored by the Office of Thrift Supervision ("OTS"). The Bank core processing systems are outsourced through a contract with The BISYS Group, Inc. ("BISYS"). BISYS has developed a Year 2000 Plan and provides the Bank with periodic updates. BISYS also has held Year 2000 workshops, whose objectives have been to assist the Bank in the development of its Year 2000 Plan, to provide updates on the BISYS Year 2000 plan, and training on the use of the BISYS Year 2000 test facility, whose function is to allow BISYS clients to test their systems' compatibility with the BISYS system. BISYS completed all program maintenance associated with Year 2000 prior to October 31, 1998, and expects a full year of testing prior to January 1, 2000. Like the Bank, BISYS Year 2000 activities are subject to OTS oversight. The incremental cost associated with the Bank's compliance is expected to be less than $25,000 to $50,000. The majority of all hardware upgrades began in ------------------- 1995 as a result of the Bank's plan to increase efficiencies and eliminate obsolescence of some system components. Should the Bank or any of its third party service providers fail to complete Year 2000 measures in a timely manner, it would likely have a material adverse effect, which amount cannot be reasonably estimated at this time. EMPLOYEES The Corporation had 65 full-time employees as of September 30, 1998. None of the employees are represented by a collective bargaining unit. The Corporation believes that relations with its employees are excellent. REGULATION GENERAL The Bank is subject to extensive regulation, examination and supervision by the OTS as its chartering agency, and the FDIC, as the insurer of its deposits. The activities of federal savings institutions are governed by the Home Owners' Loan Act, as amended ("HOLA") and, in certain respects, the Federal Deposit Insurance Act ("FDIA") and the regulations issued by the OTS and the FDIC to implement these statutes. These laws and regulations delineate the nature and extent of the activities in which federal savings associations may engage. Lending activities and other investments must comply with various statutory and regulatory capital requirements. In addition, the Bank's relationship with its depositors and borrowers is also regulated to a great extent, especially in such matters as the ownership of deposit accounts and the form and content of the Bank's mortgage documents. The Bank must file reports with the OTS and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. There are periodic examinations by the OTS and the FDIC to review the Bank's compliance with various regulatory requirements. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such policies, whether by the OTS, the FDIC or Congress, could have a material adverse impact on the Corporation, the Bank and their operations. The Corporation, as a savings and loan holding company, is also required to file certain 22 reports with, and otherwise comply with the rules and regulations of, the OTS and the Securities and Exchange Commission ("SEC"). FEDERAL REGULATION OF SAVINGS ASSOCIATIONS OFFICE OF THRIFT SUPERVISION. The OTS is an office in the Department of the Treasury subject to the general oversight of the Secretary of the Treasury. The OTS generally possesses the supervisory and regulatory duties and responsibilities formerly vested in the Federal Home Loan Bank Board. Among other functions, the OTS issues and enforces regulations affecting federally insured savings associations and regularly examines these institutions. FEDERAL HOME LOAN BANK SYSTEM. The FHLB System, consisting of 12 FHLBs, is under the jurisdiction of the Federal Housing Finance Board ("FHFB"). The designated duties of the FHFB are to: supervise the FHLBs; ensure that the FHLBs carry out their housing finance mission; ensure that the FHLBs remain adequately capitalized and able to raise funds in the capital markets; and ensure that the FHLBs operate in a safe and sound manner. The Bank, as a member of the FHLB-Atlanta, is required to acquire and hold shares of capital stock in the FHLB-Atlanta in an amount equal to the greater of (i) 1.0% of the aggregate outstanding principal amount of residential mortgage loans, home purchase contracts and similar obligations at the beginning of each year, or (ii) 1/20 of its advances (borrowings) from the FHLB-Atlanta. The Bank is in compliance with this requirement with an investment in FHLB-Atlanta stock of $2.0 million at September 30, 1998. Among other benefits, the FHLB-Atlanta provides a central credit facility primarily for member institutions. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes advances to members in accordance with policies and procedures established by the FHFB and the Board of Directors of the FHLB-Atlanta. FEDERAL DEPOSIT INSURANCE CORPORATION. The FDIC is an independent federal agency that insures the deposits, up to prescribed statutory limits, of depository institutions. The FDIC maintains two separate insurance funds: the Bank Insurance Fund ("BIF") and the Savings Association Insurance Fund ("SAIF"). As insurer of the Bank's deposits, the FDIC has examination, supervisory and enforcement authority over the Bank. The Bank's deposit accounts are insured by the FDIC under the SAIF to the maximum extent permitted by law. The Bank pays deposit insurance premiums to the FDIC based on a risk-based assessment system established by the FDIC for all SAIF-member institutions. Under applicable regulations, institutions are assigned to one of three capital groups that are based solely on the level of an institution's capital ("well capitalized," "adequately capitalized" or "undercapitalized"), which are defined in the same manner as the regulations establishing the prompt corrective action system under the Federal Deposit Insurance Act as discussed below. The matrix so created results in nine assessment risk classifications, with rates that until September 30, 1996 ranged from 0.23% for well capitalized, financially sound institutions with only a few minor weaknesses to 0.31% for undercapitalized institutions that pose a substantial risk of loss to the SAIF unless effective corrective action is taken. Pursuant to the Deposit Insurance Fund Act ("DIF Act"), which was enacted on September 30, 1996, the FDIC imposed a special assessment on each depository institution with SAIF-assessable deposits which resulted in the SAIF achieving its designated reserve ratio. In connection therewith, the FDIC reduced the assessment schedule for SAIF members, effective January 1, 1997, to a range of 0% to 0.27%, with most institutions, including the Bank, paying 0%. This assessment schedule is the same as that for the BIF, which reached its designated reserve ratio in 1995. In addition, since January 1, 1997, SAIF members are charged an assessment of 0.065% of SAIF-assessable deposits for the purpose of paying interest on the obligations issued by the Financing Corporation ("FICO") in the 1980's to help fund the thrift industry cleanup. BIF-assessable deposits will be charged an assessment to help pay interest on the FICO bonds at a rate of approximately .013% until the earlier of December 31, 1999 or the date upon which the last savings association ceases to exist, after which time the assessment will be the same for all insured deposits. The DIF Act provides for the merger of the BIF and the SAIF into the Deposit Insurance Fund on January 1, 1999, but only if no insured depository institution is a savings association on that date. The DIF Act contemplates 23 the development of a common charter for all federally chartered depository institutions and the abolition of separate charters for national banks and federal savings associations. It is not known what form the common charter may take and what effect, if any, the adoption of a new charter would have on the operation of the Bank. The FDIC may terminate the deposit insurance of any insured depository institution if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is aware of no existing circumstances that could result in termination of the deposit insurance of the Bank. LIQUIDITY REQUIREMENTS. Under OTS regulations, each savings institution is required to maintain an average daily balance of liquid assets (cash, certain time deposits and savings accounts, bankers' acceptances, and specified U.S. Government, state or federal agency obligations and certain other investments) equal to a monthly average of not less than a specified percentage (currently 4.0%) of its net withdrawable accounts plus short-term borrowings. Monetary penalties may be imposed for failure to meet liquidity requirements. PROMPT CORRECTIVE ACTION. Under the FDIA, each federal banking agency is required to implement a system of prompt corrective action for institutions that it regulates. The federal banking agencies have promulgated substantially similar regulations to implement this system of prompt corrective action. Under the regulations, an institution shall be deemed to be (i) "well capitalized" if it has a total risk-based capital ratio of 10.0% or more, has a Tier I risk- based capital ratio of 6.0% or more, has a leverage ratio of 5.0% or more and is not subject to specified requirements to meet and maintain a specific capital level for any capital measure; (ii) "adequately capitalized" if it has a total risk-based capital ratio of 8.0% or more, has a Tier I risk-based capital ratio of 4.0% or more, has a leverage ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of "well capitalized", (iii) "undercapitalized" if it has a total risk-based capital ratio that is less than 8.0%, has a Tier I risk-based capital ratio that is less than 4.0% or a leverage ratio that is less than 4.0% (3.0% under certain circumstances); (iv) "significantly undercapitalized" if it has a total risk-based capital ratio that is less than 6.0%, has a Tier I risk-based capital ratio that is less than 3.0% or a leverage ratio that is less than 3.0%; and (v) "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. A federal banking agency may, after notice and an opportunity for a hearing, reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category if the institution is in an unsafe or unsound condition or has received in its most recent examination, and has not corrected, a less than satisfactory rating for asset quality, management, earnings or liquidity. The OTS may not, however, reclassify a significantly undercapitalized institution as critically undercapitalized. An institution generally must file a written capital restoration plan that meets specified requirements, as well as a performance guaranty by each company that controls the institution, with the appropriate federal banking agency within 45 days of the date that the institution receives notice or is deemed to have notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. Immediately upon becoming undercapitalized, an institution shall become subject to various mandatory and discretionary restrictions on its operations. At September 30, 1998, the Bank was categorized as "well capitalized" under the prompt corrective action regulations of the OTS. STANDARDS FOR SAFETY AND SOUNDNESS. The federal banking regulatory agencies have prescribed, by regulation, standards for all insured depository institutions relating to: (i) internal controls, information systems and 24 internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v) asset growth; (vi) asset quality; (vii) earnings, and (viii) compensation, fees and benefits. The regulations set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the OTS determines that the Bank fails to meet any standard prescribed by the regulations, the agency may require the Bank to submit to the agency an acceptable plan to achieve compliance with the standard. OTS regulations establish deadlines for the submission and review of such safety and soundness compliance plans. QUALIFIED THRIFT LENDER TEST. All savings associations are required to meet a qualified thrift lender ("QTL") test to avoid certain restrictions on their operations. A savings institution that fails to become or remain a QTL shall either become a national bank or be subject to the following restrictions on its operations: (i) the association may not make any new investment or engage in activities that would not be permissible for national banks; (ii) the association may not establish any new branch office where a national bank located in the savings institution's home state would not be able to establish a branch office; (iii) the association shall be ineligible to obtain new advances from any FHLB; and (iv) the payment of dividends by the association shall be subject to the statutory and regulatory dividend restrictions applicable to national banks. Also, beginning three years after the date on which the savings institution ceases to be a QTL, the savings institution would be prohibited from retaining any investment or engaging in any activity not permissible for a national bank and would be required to repay any outstanding advances to any FHLB. In addition, within one year of the date on which a savings association controlled by a company ceases to be a QTL, the company must register as a bank holding company and become subject to the rules applicable to such companies. A savings institution may requalify as a QTL if it thereafter complies with the QTL test. Currently, the QTL test requires that either an institution qualify as a domestic building and loan association under the Internal Revenue Code of 1986, as amended ("Code") or that 65% of an institution's "portfolio assets" (as defined) consist of certain housing and consumer-related assets on a monthly average basis in nine out of every 12 months. Assets that qualify without limit for inclusion as part of the 65% requirement are loans made to purchase, refinance, construct, improve or repair domestic residential housing and manufactured housing; home equity loans; mortgage-backed securities (where the mortgages are secured by domestic residential housing or manufactured housing); FHLB stock; direct or indirect obligations of the FDIC; and loans for educational purposes, loans to small businesses and loans made through credit cards. In addition, the following assets, among others, may be included in meeting the test subject to an overall limit of 20% of the savings institution's portfolio assets: 50% of residential mortgage loans originated and sold within 90 days of origination; 100% of consumer loans; and stock issued by Federal Home Loan Mortgage Corporation or FNMA. Portfolio assets consist of total assets minus the sum of (i) goodwill and other intangible assets, (ii) property used by the savings institution to conduct its business, and (iii) liquid assets up to 20% of the institution's total assets. At September 30, 1998, the Bank was in compliance with the QTL test. CAPITAL REQUIREMENTS. Under OTS regulations a savings association must satisfy three minimum capital requirements: core capital, tangible capital and risk-based capital. Savings associations must meet all of the standards in order to comply with the capital requirements. The Corporation is not subject to any minimum capital requirements. OTS capital regulations establish a 3% core capital or leverage ratio (defined as the ratio of core capital to adjusted total assets). Core capital is defined to include common stockholders' equity, noncumulative perpetual preferred stock and any related surplus, and minority interests in equity accounts of consolidated subsidiaries, less (i) any intangible assets, except for certain qualifying intangible assets; (ii) certain mortgage servicing rights; and (iii) equity and debt investments in subsidiaries that are not "includable subsidiaries," which is defined as subsidiaries engaged solely in activities not impermissible for a national bank, engaged in activities impermissible for a national bank but only as an agent for its customers, or engaged solely in mortgage-banking activities. In calculating adjusted total assets, adjustments are made to total assets to give effect to the exclusion of certain assets from capital and to account appropriately for the investments in and assets of both includable and nonincludable subsidiaries. An institution that fails to meet the core capital requirement would be required to file with the OTS a capital plan that details the steps they will take to reach compliance. In addition, the OTS's prompt corrective action regulation provides 25 that a savings institution that has a leverage ratio of less than 4% (3% for institutions receiving the highest CAMEL examination rating) will be deemed to be "undercapitalized" and may be subject to certain restrictions. See " Prompt Corrective Action." Savings associations also must maintain "tangible capital" not less than 1.5% of the Bank's adjusted total assets. "Tangible capital" is defined, generally, as core capital minus any "intangible assets" other than purchased mortgage servicing rights. Each savings institution must maintain total risk-based capital equal to at least 8% of risk-weighted assets. Total risk-based capital consists of the sum of core and supplementary capital, provided that supplementary capital cannot exceed core capital, as previously defined. Supplementary capital includes (i) permanent capital instruments such as cumulative perpetual preferred stock, perpetual subordinated debt and mandatory convertible subordinated debt, (ii) maturing capital instruments such as subordinated debt, intermediate-term preferred stock and mandatory convertible subordinated debt, subject to an amortization schedule, and (iii) general valuation loan and lease loss allowances up to 1.25% of risk-weighted assets. The risk-based capital regulation assigns each balance sheet asset held by a savings institution to one of four risk categories based on the amount of credit risk associated with that particular class of assets. Assets not included for purposes of calculating capital are not included in calculating risk-weighted assets. The categories range from 0% for cash and securities that are backed by the full faith and credit of the U.S. Government to 100% for repossessed assets or assets more than 90 days past due. Qualifying residential mortgage loans (including multi-family mortgage loans) are assigned a 50% risk weight. Consumer, commercial, home equity and residential construction loans are assigned a 100% risk weight, as are nonqualifying residential mortgage loans and that portion of land loans and nonresidential construction loans that do not exceed an 80% loan-to-value ratio. The book value of assets in each category is multiplied by the weighting factor (from 0% to 100%) assigned to that category. These products are then totaled to arrive at total risk-weighted assets. Off- balance sheet items are included in risk-weighted assets by converting them to an approximate balance sheet "credit equivalent amount" based on a conversion schedule. These credit equivalent amounts are then assigned to risk categories in the same manner as balance sheet assets and included risk-weighted assets. The OTS has incorporated an interest rate risk component into its regulatory capital rule. Under the rule, savings associations with "above normal" interest rate risk exposure would be subject to a deduction from total capital for purposes of calculating their risk-based capital requirements. A savings association's interest rate risk is measured by the decline in the net portfolio value of its assets (i.e., the difference between incoming and ---- outgoing discounted cash flows from assets, liabilities and off-balance sheet contracts) that would result from a hypothetical 200 basis point increase or decrease in market interest rates divided by the estimated economic value of the association's assets, as calculated in accordance with guidelines set forth by the OTS. A savings association whose measured interest rate risk exposure exceeds 2% must deduct an interest rate risk component in calculating its total capital under the risk-based capital rule. The interest rate risk component is an amount equal to one-half of the difference between the institution's measured interest rate risk and 2%, multiplied by the estimated economic value of the association's assets. That dollar amount is deducted from an association's total capital in calculating compliance with its risk-based capital requirement. Under the rule, there is a two quarter lag between the reporting date of an institution's financial data and the effective date for the new capital requirement based on that data. A savings association with assets of less than $300 million and risk-based capital ratios in excess of 12% is not subject to the interest rate risk component, unless the OTS determines otherwise. The rule also provides that the Director of the OTS may waive or defer an association's interest rate risk component on a case-by-case basis. Under certain circumstances, a savings association may request an adjustment to its interest rate risk component if it believes that the OTS-calculated interest rate risk component overstates its interest rate risk exposure. In addition, certain "well-capitalized" institutions may obtain authorization to use their own interest rate risk model to calculate their interest rate risk component in lieu of the OTS-calculated amount. The OTS has postponed the date that the component will first be deducted from an institution's total capital. 26 LIMITATIONS ON CAPITAL DISTRIBUTIONS. OTS regulations impose uniform limitations on the ability of all savings associations to engage in various distributions of capital such as dividends, stock repurchases and cash-out mergers. In addition, OTS regulations require the Bank to give the OTS 30 days advance notice of any proposed declaration of dividends, and the OTS has the authority under its supervisory powers to prohibit the payment of dividends. The regulation utilizes a three-tiered approach which permits various levels of distributions based primarily upon a savings association's capital level. A Tier 1 savings association has capital in excess of its fully phased-in capital requirement (both before and after the proposed capital distribution). A Tier 1 savings association may make (without application but upon prior notice to, and no objection made by, the OTS) capital distributions during a calendar year up to 100% of its net income to date during the calendar year plus one-half its surplus capital ratio (i.e., the amount of capital in excess of its fully ---- phased-in requirement) at the beginning of the calendar year or the amount authorized for a Tier 2 association. Capital distributions in excess of such amount require advance notice to the OTS. A Tier 2 savings association has capital equal to or in excess of its minimum capital requirement but below its fully phased-in capital requirement (both before and after the proposed capital distribution). Such an association may make (without application) capital distributions up to an amount equal to 75% of its net income during the previous four quarters depending on how close the association is to meeting its fully phased-in capital requirement. Capital distributions exceeding this amount require prior OTS approval. A Tier 3 savings association has capital below the minimum capital requirement (either before or after the proposed capital distribution). A Tier 3 savings association may not make any capital distributions without prior approval from the OTS. The Bank currently meets the criteria to be designated a Tier 1 association and, consequently, could at its option (after prior notice to, and no objection made by, the OTS) distribute up to 100% of its net income during the calendar year plus 50% of its surplus capital ratio at the beginning of the calendar year less any distributions previously paid during the year. LOANS TO ONE BORROWER. Under the HOLA, savings institutions are generally subject to the national bank limit on loans to one borrower. Generally, this limit is 15% of the Bank's unimpaired capital and surplus, plus an additional 10% of unimpaired capital and surplus, if such loan is secured by readily- marketable collateral, which is defined to include certain financial instruments and bullion. The OTS by regulation has amended the loans to one borrower rule to permit savings associations meeting certain requirements, including capital requirements, to extend loans to one borrower in additional amounts under circumstances limited essentially to loans to develop or complete residential housing units. At September 30, 1998, the Bank's limit on loans to one borrower was $1.9 million. At September 30, 1998, the Bank's largest aggregate amount of loans to one borrower was $1.4 million. ACTIVITIES OF SAVINGS ASSOCIATIONS AND THEIR SUBSIDIARIES. When a savings association establishes or acquires a subsidiary or elects to conduct any new activity through a subsidiary that the association controls, the savings association must notify the FDIC and the OTS 30 days in advance and provide the information each agency may, by regulation, require. Savings associations also must conduct the activities of subsidiaries in accordance with existing regulations and orders. The OTS may determine that the continuation by a savings association of its ownership control of, or its relationship to, the subsidiary constitutes a serious risk to the safety, soundness or stability of the association or is inconsistent with sound banking practices or with the purposes of the FDIA. Based upon that determination, the FDIC or the OTS has the authority to order the savings association to divest itself of control of the subsidiary. The FDIC also may determine by regulation or order that any specific activity poses a serious threat to the SAIF. If so, it may require that no SAIF member engage in that activity directly. TRANSACTIONS WITH AFFILIATES. Savings associations must comply with Sections 23A and 23B of the Federal Reserve Act relative to transactions with affiliates in the same manner and to the same extent as if the savings association were a Federal Reserve member bank. A savings and loan holding company, its subsidiaries and any other 27 company under common control are considered affiliates of the subsidiary savings association under the HOLA. Generally, Sections 23A and 23B: (I) limit the extent to which the insured association or its subsidiaries may engage in certain covered transactions with an affiliate to an amount equal to 10% of such institution's capital and surplus and place an aggregate limit on all such transactions with affiliates to an amount equal to 20% of such capital and surplus, and (ii) require that all such transactions be on terms substantially the same, or at least as favorable to the institution or subsidiary, as those provided to a non-affiliate. The term "covered transaction" includes the making of loans, the purchase of assets, the issuance of a guarantee and similar types of transactions. Any loan or extension of credit by the Bank to an affiliate must be secured by collateral in accordance with Section 23A. Three additional rules apply to savings associations: (i) a savings association may not make any loan or other extension of credit to an affiliate unless that affiliate is engaged only in activities permissible for bank holding companies; (ii) a savings association may not purchase or invest in securities issued by an affiliate (other than securities of a subsidiary); and (iii) the OTS may, for reasons of safety and soundness, impose more stringent restrictions on savings associations but may not exempt transactions from or otherwise abridge Section 23A or 23B. Exemptions from Section 23A or 23B may be granted only by the Federal Reserve Board, as is currently the case with respect to all FDIC-insured banks. The Bank has not been significantly affected by the rules regarding transactions with affiliates. The Bank's authority to extend credit to executive officers, directors and 10% shareholders, as well as entities controlled by such persons, is governed by Sections 22(g) and 22(h) of the Federal Reserve Act, and Regulation O thereunder. Among other things, these regulations generally require that such loans be made on terms and conditions substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. Generally, Regulation O also places individual and aggregate limits on the amount of loans the Bank may make to such persons based, in part, on the Bank's capital position, and requires certain board approval procedures to be followed. The OTS regulations, with certain minor variances, apply Regulation O to savings institutions. COMMUNITY REINVESTMENT ACT. Under the federal CRA, all federally-insured financial institutions have a continuing and affirmative obligation consistent with safe and sound operations to help meet all the credit needs of its delineated community. The CRA does not establish specific lending requirements or programs nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to meet all the credit needs of its delineated community. The CRA requires the federal banking agencies, in connection with regulatory examinations, to assess an institution's record of meeting the credit needs of its delineated community and to take such record into account in evaluating regulatory applications to establish a new branch office that will accept deposits, relocate an existing office, or merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution, among others. SAVINGS AND LOAN HOLDING COMPANY REGULATIONS HOLDING COMPANY ACQUISITIONS. The HOLA and OTS regulations issued thereunder generally prohibit a savings and loan holding company, without prior OTS approval, from acquiring more than 5% of the voting stock of any other savings association or savings and loan holding company or controlling the assets thereof. They also prohibit, among other things, any director or officer of a savings and loan holding company, or any individual who owns or controls more than 25% of the voting shares of such holding company, from acquiring control of any savings association not a subsidiary of such savings and loan holding company, unless the acquisition is approved by the OTS. HOLDING COMPANY ACTIVITIES. As a unitary savings and loan holding company, the Corporation generally is not subject to activity restrictions under the HOLA. If the Corporation acquires control of another savings association as a separate subsidiary other than in a supervisory acquisition, it would become a multiple savings and loan holding company. There generally are more restrictions on the activities of a multiple savings and loan holding company than on those of a unitary savings and loan holding company. The HOLA provides that, among other things, no multiple savings and loan holding company or subsidiary thereof which is not an insured association shall commence or continue for more than two years after becoming a multiple savings and loan association holding 28 company or subsidiary thereof, any business activity other than: (i) furnishing or performing management services for a subsidiary insured institution, (ii) conducting an insurance agency or escrow business, (iii) holding, managing, or liquidating assets owned by or acquired from a subsidiary insured institution, (iv) holding or managing properties used or occupied by a subsidiary insured institution, (v) acting as trustee under deeds of trust, (vi) those activities previously directly authorized by regulation as of March 5, 1987 to be engaged in by multiple bank holding companies or (vii) those activities authorized by the Federal Reserve Board as permissible for bank holding companies, unless the OTS by regulation, prohibits or limits such activities for savings and loan holding companies. Those activities described in (vii) above also must be approved by the OTS prior to being engaged in by a multiple savings and loan holding company. QUALIFIED THRIFT LENDER TEST. The HOLA provides that any savings and loan holding company that controls a savings association that fails the QTL test, as explained under "-- Federal Regulation of Savings Associations --Qualified Thrift Lender Test," must, within one year after the date on which the association ceases to be a QTL, register as and be deemed a bank holding company subject to all applicable laws and regulations. TAXATION FEDERAL TAXATION GENERAL. Union Financial and the Bank report their income on a fiscal year basis using the accrual method of accounting and are subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Bank's reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or Union Financial. TAX BAD DEBT RESERVES. Historically, savings institutions such as the Bank which met certain definitional tests primarily related to their assets and the nature of their business ("qualifying thrift") were permitted to establish a reserve for bad debts and to make annual additions thereto, which may have been deducted in arriving at their taxable income. The Bank's deduction with respect to "qualifying loans," which are generally loans secured by certain interests in real property, may have been computed using an amount based on the Bank's actual loss experience, or a percentage equal to 8% of the Bank's taxable income, computed with certain modifications and reduced by the amount of any permitted additions to the nonqualifying reserve. The Bank's deductions with respect to "qualifying real property loans," which are generally loans secured by certain interest in real property, were computed using an amount based on the Bank's actual loss experience, or a percentage equal to 8% of the Bank's taxable income, computed with certain modifications and reduced by the amount of any permitted additions to the non-qualifying reserve. The provisions repealing the current thrift bad debt rules were passed by Congress as part of "The Small Business Job Protection Act of 1996." The new rules eliminated the 8% of taxable income method for deducting additions to the tax bad debt reserves for all thrifts for tax years beginning after December 31, 1995. These rules also require that all institutions recapture all or a portion of their bad debt reserves added since the base year (last taxable year beginning before January 1, 1988). The Bank has previously recorded a deferred tax liability equal to the bad debt recapture and as such the new rules will have no effect on the net income or federal income tax expense. For taxable years beginning after December 31, 1995, the Bank's bad debt deduction has been determined under the experience method using a formula based on actual bad debt experience over a period of years. The new rules allow an institution to suspend bad debt reserve recapture for the 1996 and 1997 tax years if the institution's lending activity for those years is equal to or greater than the institution's average mortgage lending activity for the six taxable years preceding 1996, adjusted for inflation. For this purpose, only home purchase or home improvement loans are included and the institution can elect to have the tax years with the highest and lowest lending activity removed from the average calculation. If an institution is permitted to postpone the reserve recapture, it must begin its six year recapture no later than the 1998 tax year. The unrecaptured base year reserves will not be subject to recapture as long as the institution continues to carry on the business of banking. In addition, the balance of the pre-1988 bad debt reserves continue to 29 be subject to provisions of present law referred to below that require recapture in the case of certain excess distributions to shareholders. DISTRIBUTIONS. To the extent that the Bank makes "nondividend distributions" to Union Financial that are considered as made: (i) from the reserve for losses on qualifying real property loans, to the extent the reserve for such losses exceeds the amount that would have been allowed under the experience method; or (ii) from the supplemental reserve for losses on loans ("Excess Distributions"), then an amount based on the amount distributed will be included in the Bank's taxable income. Nondividend distributions include distributions in excess of the Bank's current and accumulated earnings and profits, distributions in redemption of stock, and distributions in partial or complete liquidation. However, dividends paid out of the Bank's current or accumulated earnings and profits, as calculated for federal income tax purposes, will not be considered to result in a distribution from the Bank's bad debt reserve. Thus, any dividends to Union Financial that would reduce amounts appropriated to the Bank's bad debt reserve and deducted for federal income tax purposes would create a tax liability for the Bank. The amount of additional taxable income attributable to an Excess Distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, if the Bank makes a "nondividend distribution," then approximately one and one-half times the amount so used would be includable in gross income for federal income tax purposes, assuming a 34% corporate income tax rate (exclusive of state taxes). See "REGULATION" for limits on the payment of dividends by the Bank. The Bank does not intend to pay dividends that would result in a recapture of any portion of its tax bad debt reserve. CORPORATE ALTERNATIVE MINIMUM TAX. The Code imposes a tax on alternative minimum taxable income ("AMTI") at a rate of 20%. The excess of the tax bad debt reserve deduction using the percentage of taxable income method over the deduction that would have been allowable under the experience method is treated as a preference item for purposes of computing the AMTI. In addition, only 90% of AMTI can be offset by net operating loss carryovers. AMTI is increased by an amount equal to 75% of the amount by which the Bank's adjusted current earnings exceeds its AMTI (determined without regard to this preference and prior to reduction for net operating losses). For taxable years beginning after December 31, 1986, and before January 1, 1996, an environmental tax of .12% of the excess of AMTI (with certain modification) over $2.0 million is imposed on corporations, including the Bank, whether or not an Alternative Minimum Tax ("AMT") is paid. DIVIDENDS-RECEIVED DEDUCTION AND OTHER MATTERS. Union Financial may exclude from its income 100% of dividends received from the Bank as a member of the same affiliated group of corporations. The corporate dividends-received deduction is generally 70% in the case of dividends received from unaffiliated corporations with which Union Financial and the Bank will not file a consolidated tax return, except that if Union Financial or the Bank owns more than 20% of the stock of a corporation distributing a dividend, then 80% of any dividends received may be deducted. OTHER FEDERAL TAX MATTERS. Other recent changes in the federal tax system could also affect the business of the Bank. These changes include limitations on the deduction of personal interest paid or accrued by individual taxpayers, limitations on the deductibility of losses attributable to investment in certain passive activities and limitations on the deductibility of contributions to individual retirement accounts. The Bank does not believe these changes will have a material effect on its operations. There have not been any IRS audits of Union Financial's or the Bank's federal income tax returns during the past five years. 30 STATE TAXATION SOUTH CAROLINA. The Bank is subject to tax under South Carolina law. South Carolina law allows a savings and loan association to use the federal bad debt deduction method for the purpose of computing net income subject to state tax, and the present South Carolina tax rate on taxable income is 6 percent. In order to calculate taxable income for South Carolina taxation purposes, a corporation begins with its federal taxable income and then modifies it to take into account certain adjustments. Adjustments which would be common to most financial institutions include an addition for state taxes deducted on the federal return, and a subtraction for interest on certain federal obligations and securities. South Carolina income tax is deductible for federal income tax purposes. In addition, Union Financial is subject to South Carolina taxes as a regular corporation and pays taxes based on its shareholders' equity. DELAWARE. As a Delaware holding company not earning income in Delaware, Union Financial is exempted from Delaware corporate income tax, but is required to file an annual report with and pay an annual franchise tax to the State of Delaware. ITEM 2. DESCRIPTION OF PROPERTY - -------------------------------- The Corporation owns its main office, located at 203 West Main Street in Union, South Carolina, which was opened in 1977. The Corporation also owns a banking center which opened in April 1989, located at 508 North Duncan By-Pass, Union, South Carolina and a branch office, acquired in 1997, in Laurens, South Carolina. The Corporation purchased property in Jonesville, South Carolina and opened a temporary office in July 1994. The net book value of the Corporation's investment in premises and equipment totaled approximately $4 million at September 30, 1998. See Note 4 of Notes to Consolidated Financial Statements. All property is in good condition and meets the operating needs of the Corporation. The Corporation owns various bookkeeping and accounting equipment. Certain data processing services are provided by an outside data processing center under a long-term contract. ITEM 3. LEGAL PROCEEDINGS - -------------------------- Neither Union Financial nor the Bank is engaged in any legal proceedings of a material nature at the present time. From time to time, the Bank is involved in routine legal proceedings occurring in the ordinary course of business wherein it enforces the Bank's security interest in mortgage loans the Bank has made. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------ No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended September 30, 1998. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER - -------------------------------------------------------------------------- MATTERS - ------- The information contained under the section captioned "Common Stock and Dividend Information" in the Annual Report to Shareholders ("Annual Report") is incorporated herein by reference. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ------------------------------------------------------------------------- RESULTS OF OPERATIONS - --------------------- The information contained in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Annual Report is incorporated herein by reference. 31 ITEM 7. FINANCIAL STATEMENTS - ----------------------------- The financial statements contained in the Annual Report are incorporated herein by reference. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - ------------------------------------------------------------------------ FINANCIAL DISCLOSURE - -------------------- No disagreement with the Corporation's independent accountants on accounting and financial disclosure has occurred during the two most recent fiscal years. PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; - ---------------------------------------------------------------------- COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT - ------------------------------------------------- For information concerning the Board of Directors of Union Financial, the information contained under the section captioned "Proposal I -- Election of Directors" and "Directors' Compensation" in the Proxy Statement is incorporated herein by reference. Reference is made to the cover page of this Form 10-KSB for information regarding compliance with section 16(a) of the Exchange Act. Certain executive officers of the Bank also serve as executive officers of Union Financial. The day-to-day management duties of the executive officers of Union Financial and the Bank relate primarily to their duties as to the Bank. The executive officers of Union Financial are as follows:
Position as of Name Age(a) September 30, 1998 - ---- ------ ------------------ Dwight V. Neese 48 President, Chief Executive Officer and Director Richard H. Flake 50 Executive Vice President - Chief Financial Officer Gerald L. Bolin 36 Vice President - Chief Operating Officer Wanda J. Wells 42 Vice President - Corporate Secretary
- -------------------- (a) At September 30, 1998. DWIGHT V. NEESE was appointed as President and Chief Executive Officer of the Bank effective September 5, 1995. Prior to joining Union Financial, Mr. Neese was Executive Vice President and Chief Operating Officer of Home Federal Savings Bank of South Carolina in Rock Hill. As President and Chief Executive Officer of Provident Community Bank and the Corporation, Mr. Neese is responsible for daily operations of the Bank and implementation of the policies and procedures approved by the Board of Directors. RICHARD H. FLAKE joined Union Financial in September 1995. Prior to joining Union Financial, Mr. Flake was Senior Vice President and Corporate Accounting Manager for United Financial Corporation in Greenwood, South Carolina. GERALD L. BOLIN joined Union Financial in September 1995. Prior to joining Union Financial, Mr. Bolin was Vice President and Director of Internal Audit and Compliance with Home Federal Savings Bank of South Carolina in Rock Hill. WANDA J. WELLS has been employed by Union Financial since 1975 and serves as the Corporation's Corporate Secretary. 32 ITEM 10. EXECUTIVE COMPENSATION - --------------------------------- The information contained under the section captioned "Executive Compensation" in the Proxy Statement is incorporated herein by reference. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------ (a) Security Ownership of Certain Beneficial Owners Information required by this item is incorporated herein by reference to the section captioned "Securities Ownership of Certain Beneficial Owners and Management" in the Proxy Statement. (b) Security Ownership of Management Information required by this item is incorporated herein by reference to the sections captioned "Proposal I -- Election of Directors" and "Securities Ownership of Certain Beneficial Owners and Management" in the Proxy Statement. (c) Management of Union Financial knows of no arrangements, including any pledge by any person of securities of Union Financial, the operation of which may at a subsequent date result in a change in control of the registrant. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------------------------------------------------------- The information required by this item is incorporated herein by reference to the section captioned "Proposal I -- Election of Directors" and "Transactions with Management" in the Proxy Statement. PART IV ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K - ------------------------------------------- (a) Exhibits 3(a) Certificate of Incorporation(1) 3(b) Bylaws(1) 3(c) Certificate of Amendment of Certificate of Incorporation dated January 22, 1997(2) 10(a) Employment Agreement with Dwight V. Neese(3) 10(b) Union Federal Savings and Loan Association 1987 Stock Option Plan(3) 10(c) Union Financial Bancshares, Inc. 1995 Stock Option Plan(4) 13 1998 Annual Report to Stockholders 21 Subsidiaries of the Registrant 23 Consent of Independent Auditor 27 Financial Data Schedule (b) No reports on Form 8-K have been filed during the last quarter of the fiscal year covered by this report. - ----------------------------------- (1) Incorporated herein by reference to Union Financial's Registration Statement on Form S-4 (File No. 33-80808) filed with the Securities and Exchange Commission on June 29, 1994. (2) Incorporated herein by reference to Exhibit 3 (c) to Union Financial's Form 10-KSB for the year ended September 30, 1997. (3) Incorporated herein by reference to Union Financial's Form 10-KSB for the year ended September 30, 1996. (4) Incorporated herein by reference to Exhibit A to Union Financial's Proxy Statement for its 1996 Annual Meeting of Stockholders. 33 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. UNION FINANCIAL BANCSHARES, INC. Date: December 28, 1998 By: /s/ Dwight V. Neese ----------------------------------- Dwight V. Neese President and Chief Executive Officer - Duly Authorized Representative Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ Dwight V. Neese By: --------------------------- ----------------------------------- Dwight V. Neese James W. Edwards Principal Executive Officer Director Date: December 28, 1998 Date: December __, 1998 By: /s/ Richard H. Flake By: --------------------------- ----------------------------------- Richard H. Flake David G. Russell (Principal Financial and Director Accounting Officer) Date: December 28, 1998 Date: December __, 1998 By: /s/ Mason G. Alexander By: /s/ Louis M. Jordan --------------------------- ----------------------------------- Mason G. Alexander Louis M. Jordan Director Director Date: December 28, 1998 Date: December __, 1998 By: /s/ William M. Graham By: --------------------------- ----------------------------------- William M. Graham Carl L. Mason Director Director Date: December 28, 1998 Date: December __, 1998 EX-13 2 EXHIBIT 13 EXHIBIT NO. 13 1998 ANNUAL REPORT TO SHAREHOLDERS EXHIBIT 13 December, 1998 Dear Fellow Shareholder: Union Financial Bancshares is a company focused on the future. With the clarity of a single vision to be the financial services provider of choice in the communities we serve, we are focused on building a strong foundation to sustain and strengthen Union Financial Bancshares and Provident Community Bank both now, and well into the new millennium. As Peter Drucker has said, "The best way to predict the future is to create it," and we are focused on aggressively creating Union Financial Bancshares' future. Before going into depth about our initiatives to secure the future, I am pleased to report on the current condition of our company and the impressive progress made during the last year. Net income increased from $1.444 million in fiscal 1997 to $1.550 million in fiscal 1998, an increase of 7.34%. Earnings per share increased from $1.17 in fiscal 1997 to $1.23 in fiscal 1998. Return on average assets for fiscal 1998 was 0.87%, down slightly from the previous year. Return on average shareholders' equity was 10.77%, also down slightly from the previous year, but well ahead of peers as identified by the America's Community Bankers' Policy Development and Economic Research Department and SNL Securities, a leading trade publication. Total assets of $189.286 million at fiscal year end were up $18.042 million over the total assets of $171.244 million at the end of 1997, an increase of 10.54%. The continued growth in total assets is primarily the result of 9.42% growth in the loan portfolio. The steady growth and increased earnings of Union Financial Bancshares are a result of good planning and hard work. The company utilizes a five-year Strategic Business Plan that is completely reviewed and rewritten each year through a collaborative effort of the officers and Board of Directors. The Board reviews the progress being made on the Strategic Business Plan on a quarterly basis and monitors the company's progress on meeting the goals of the Financial and Operating Plan on a monthly basis. Although the goals and objectives of the Strategic Business Plan and Financial and Operating Plan are long-term by design, the officers and Board of Directors are continually monitoring the market and regulatory environment to adjust the short-term goals and objectives when appropriate. The primary initiative of 1998 was the re-engineering of Provident Community Bank's retail delivery system. Although the existing branch network had served the company and market well for many years, the time had come to rethink the delivery of financial services and how to most effectively and efficiently serve the Bank's clients. The redesign and rebuilding of the Bank's facilities were wrapped around the concept of providing exceptional client service and state of the art financial products. The Bank's two largest branches, the North Duncan Bypass and Laurens Office, were gutted and totally rebuilt to cater to the Bank's clients and their ever changing financial needs. Central to the new theme was maintaining the warm atmosphere and personal attention that Provident had built its heritage on, while providing high tech automation and alternative methods of banking for those on the go. In addition, an innovative idea for banking in South Carolina was introduced with the opening of Provident's new Lending and Investment Center. This newest addition to Provident's network was customized to become a "boutique" of retail products and services. The Lending and Investment Center does not offer traditional teller services because it was designed to offer a full spectrum of consumer, commercial and mortgage loans and a complete line of alternative investment products. To make banking more accessible to those whose schedules make it difficult to do their banking during traditional banking hours, the Lending and Investment Center opens early each morning and stays open several evenings each week. This new facility also has a free-standing ATM for those who need to conduct their banking business 24 hours a day, 7 days a week. Another innovation for 1998 was the creation of Business Resource Centers in the remodeled North Duncan Bypass and Laurens Banking Centers. Provident recognized the vacuum being created by the consolidation in the banking industry and has repositioned itself to provide commercial services to existing clients and other businesses in the communities the Bank serves. The Business Resource Centers are equipped with computers, business software, video equipment, numerous business publications and many other planning and analytical tools for the business owner or manager. Provident associates have been trained to provide assistance to those interested in utilizing the new Business Resource Centers and many of the Bank's Lending Specialists are receiving extended commercial loan training. A final retail banking initiative for 1998 was the revamping and bundling of the Bank's products and services. Traditionally, banks have provided broad menus of products and services that have grown over time as deregulation, re-regulation, and consolidation have occurred. Provident recognized how complicated and disjointed banking had become for most people and decided to make it simple and more economical, once again. Provident also recognized that most people progress though normal life-cycles, or life-styles, and that their banking needs were similar and changed over time. Provident responded to this need by packaging its products and services into a progression of simple, but value- added "product bundles." Even though individual products and services are still available, the Bank's clients are quickly discovering the value of the new STARTING OUT, BUILDING A FOUNDATION, SECURING THE FUTURE, and REAPING THE BENEFITS product bundles. Three significant corporate initiatives were consummated in fiscal 1998 to further enhance the long-term value of the Corporation's common stock. First, Union Financial began offering its shareholders a Dividend Reinvestment Plan, or DRIP as it is often called, at the end of fiscal 1997. During fiscal 1998, 26,780 new shares of common stock were issued through automatic reinvestment of dividends and the option to purchase new shares. A total of $427,000 in new equity capital was raised through the DRIP Plan during 1998. Second, a 3-for-2 stock split was declared in January on the Corporation's outstanding shares of common stock. And third, Union Financial Bancshares announced in July that its common stock would be listed on the Nasdaq SmallCap Market under the symbol UFBS. Although the global economy weakened during the last half of the fiscal year and the stock market posted its worst quarterly returns in eight years, each of these initiatives was targeted at making shares of Union Financial Bancshares a more attractive investment for its' shareholders. At the close of fiscal 1998, two new initiatives were announced that will carry into the new year. First, it was announced that Provident Community Bank had entered into an agreement with CCB Financial's wholly-owned subsidiary, American Federal Bank, FSB, to purchase the deposits of American Federal's Union, South Carolina branch. This $14.6 million acquisition, while subject to regulatory approval, is expected to close in the first quarter of 1999. Second, it was announced that Provident would replace its modular office in Jonesville, South Carolina with a new facility designed to incorporate high tech automation in a warm atmosphere of exceptional client service. Construction of the new Jonesville Banking Center is expected to be finished in the second quarter of 1999. These are exciting times for Union Financial Bancshares and Provident Community Bank. We are focused on the future and have a clear vision of where we are going and how to get there. We manage our business in a long-term context, as an integrated whole, with the ultimate objective to enhance shareholder value. We understand that exceptional client service is essential to enhancing shareholder value and can only be delivered on a consistent basis by highly motivated associates working as an integrated team. The integration of the whole is brought full circle with our corporate philosophy of social responsibility to the growth and well-being of the communities we serve. Thank you for your continued interest and support. Sincerely, /s/ Dwight V. Neese Dwight V. Neese President & Chief Executive Officer TABLE OF CONTENTS Business........................................... 3 Selected Financial and Other Data.................. 4 Management's Discussion and Analysis of Financial Condition and Results of Operations............ 6 Independent Auditor's Report....................... 11 Consolidated Financial Statements.................. 12 Notes to Consolidated Financial Statements......... 17 Directors and Leadership Group..................... 35 Corporation Information............................ 36 Notice of Annual Meeting........................... 36 10-KSB Information................................. 36 Common Stock Information........................... 36 ============== BUSINESS Union Financial Bancshares, Inc. ("Union Financial") is the savings and loan holding company for Provident Community Bank (formerly known as Union Federal Savings Bank), ("the Bank"). Union Financial has engaged in no significant activity other than holding the stock of the Bank and engaging in certain passive investment activities. Union Financial and the Bank are collectively referred to as "the Corporation" in this annual report. The Bank is a federally-chartered capital stock savings bank headquartered in Union, South Carolina. The Bank, originally chartered in 1934, is a member of the Federal Home Loan Bank System. Its deposits are insured to the maximum limits allowable by the Federal Deposit Insurance Corporation ("FDIC") through the Savings Association Insurance Fund ("SAIF"). In August 1987, the Bank converted from a federal mutual savings and loan association to a federal capital stock savings and loan association. The Bank was known as Union Federal Savings and Loan Association until January 1992, when its shareholders approved a change to a federally chartered savings bank. In January, 1997, the Bank changed its name to Provident Community Bank. The business of the Bank consists primarily of attracting deposits from the general public and originating mortgage loans on residential properties located in South Carolina. The Bank also makes consumer and commercial loans, commercial real estate loans, construction loans, invests in federal government and agency obligations and purchases fixed and variable rate mortgage participation certificates. The principal sources of funds for the Bank's lending activities include deposits received from the general public and advances from the Federal Home Loan Bank. The Bank's principal expenses are interest paid on deposit accounts and other borrowings and expenses incurred in the operation of the Bank. The Bank's operations are conducted through its main office and three full-service banking centers, a mortgage banking center, and a lending and investment center, all of which are located in the upstate area of South Carolina. SELECTED FINANCIAL AND OTHER DATA The following tables set forth selected financial data of the Corporation for the periods indicated.
OPERATIONS DATA: - --------------- Years Ended September 30, -------------------------------------------------------------- 1998 1997 1996 1995 1994 ---------- ---------- ---------- ---------- ---------- (Dollars In Thousands - Except Share Amounts) Interest income $ 13,405 $ 11,855 $ 9,004 $ 9,265 $ 8,767 Interest expense 7,549 6,647 5,050 5,260 3,888 ---------- ---------- ---------- ---------- ---------- Net interest income 5,856 5,208 3,954 4,005 4,879 Provision for loan losses -- (243) -- (105) (335) ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 5,856 4,965 3,954 3,900 4,544 Other income 1,038 953 506 381 275 Other expense (4,447) (3,616) (3,224) (2,588) (2,727) ---------- ---------- ---------- ---------- ---------- Income before income taxes and cumulative effect of a change in accounting principle 2,447 2,302 1,236 1,693 2,092 Income tax expense 897 858 374 639 776 ---------- ---------- ---------- ---------- ---------- Income before cumulative effect of a change in accounting 1,550 1,444 862 1,054 1,316 principle Cumulative effect of a change in accounting principle (2) -- -- -- -- 208 ---------- ---------- ---------- ---------- ---------- Net income $ 1,550 $ 1,444 $ 862 $ 1,054 $ 1,524 ---------- ---------- ---------- ---------- ---------- Income per common share: (1) Income before cumulative effect of a change in accounting $ 1.23 $ 1.17 $ 0.71 $ 0.89 $ 1.10 principle Cumulative effect of a change in accounting principle (2) -- -- -- -- 0.18 ---------- ---------- ---------- ---------- ---------- Net income per common share (Basic) $ 1.23 $ 1.17 $ 0.71 $ 0.89 $ 1.28 ---------- ---------- ---------- ---------- ---------- Net income per common share $ 1.15 $ 1.09 $ 0.69 $ 0.89 $ 1.28 (Diluted) ---------- ---------- ---------- ---------- ---------- Weighted average number of common shares outstanding (Basic) 1,264,615 1,230,747 1,212,460 1,181,859 1,189,251 Weighted average number of common shares outstanding (Diluted) 1,343,008 1,325,703 1,288,272 1,181,859 1,189,251
(1) All share and per share amounts have been restated for the 2:1 stock split occurring in July 1996 and the 3:2 stock split occurring in February 1998. (2) The Bank adopted Statement of Financial Standards No. 109, Accounting for Income Taxes ("SFAS 109"), effective October 1, 1993. The cumulative effect on prior years of adopting SFAS 109 on the Bank's financial statements was to increase net income by $208,000 ($0.26 per share) for the year ended September 30, 1994. -4-
FINANCIAL CONDITION: - ------------------- September 30, -------------------------------------------------- 1998 1997 1996 1995 1994 --------- -------- -------- -------- -------- (Dollars In Thousands) Total amount of: Assets $189,286 $171,244 $128,133 $120,879 $122,313 Short-term interest-bearing deposits 1,124 6,213 1,938 3,552 2,383 Investment securities 9,633 16,783 19,138 21,264 23,194 Mortgage-backed securities 19,922 6,883 14,658 18,616 19,946 Loans (net) 142,202 129,957 85,997 73,431 71,006 Deposit accounts 129,873 117,914 93,715 94,750 97,310 Shareholders' equity 15,300 13,527 12,254 11,856 10,693 Number of: Real estate loans outstanding 1,651 1,706 1,615 1,641 1,749 Deposit accounts 17,686 16,443 13,095 13,062 12,760 Banking centers 4 4 3 3 3 OTHER SELECTED DATA: - ---------------------- Years Ended September 30, -------------------------------------------------- 1998 1997 1996 1995 1994 --------- -------- -------- -------- -------- Interest rate spread during the year 3.11% 3.29% 3.01% 2.96% 4.04% Net yield on average interest- earning assets 3.42% 3.57% 3.46% 3.27% 4.29% Return on average assets 0.87% 0.92% 0.73% 0.83% 1.30% Return on average shareholders' equity 10.77% 11.21% 7.01% 9.38% 14.56% Dividend payout ratio 30.08% 30.13% 46.87% 37.40% 29.92% Operating expense to average assets 2.52% 2.31% 2.73% 2.05% 2.33% Ratio of average shareholders' equity to average assets 8.12% 8.24% 10.41% 8.88% 8.94% Cash dividends declared and paid per share of common stock (1) $ 0.37 $ 0.35 $ 0.33 $ 0.33 $ 0.38
(1) Restated to reflect 2:1 and 3:2 stock split. -5- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ASSET AND LIABILITY MANAGEMENT - ------------------------------ The Corporation is committed to following a program of asset and liability management in an effort to manage the fluctuations in earnings caused by movements in interest rates. A significant portion of the Corporation's income results from the spread, or net interest income, between the yield realized on its interest-earning assets and the rate of interest paid on its deposits. Differences in the timing and volume of repricing assets versus the timing and volume of repricing liabilities expose the Corporation to interest rate risk. Management's policies are directed at minimizing the impact of movements in interest rates on earnings. The Corporation continues to work to shorten the average life of its assets and to extend the term on its liabilities in an effort to help minimize the effects of rising interest rates. The Corporation enjoys an increasing net interest rate spread during periods of falling interest rates. The Corporation experiences a shrinking net interest rate spread in a rising interest rate environment. The Corporation's Asset and Liability Committee makes weekly pricing and marketing decisions on deposit and loan products in conjunction with managing the Corporation's interest rate risk. The Asset/Liability Committee of the Board of Directors reviews the Bank's securities portfolio, FHLB advances and other borrowings as well as the Bank's asset and liability policies. The Corporation has established policies and monitors results to control interest rate sensitivity. Although the Corporation utilizes measures such as static gap, which is simply the measurement of the difference between interest- sensitive assets and interest-sensitive liabilities repricing for a particular time period, just as important a process is the evaluation of how particular assets and liabilities are impacted by changes in interest rates or selected indices as they reprice. Asset/liability modeling techniques are utilized by the Corporation to assess varying interest rate and balance sheet mix assumptions. At September 30, 1998 the Corporation's exposure to interest rate risk, as calculated by the OTS and measured by the impact of changing interest rates on the Market Value of Portfolio Equity ("MVPE"), was as follows:
Rate Environment ---------------- Minus 200 Basis Points Flat Plus 200 Basis Points ---------------------- --------- --------------------- (In Thousands) Estimated Market Value of Assets $201,680 $194,640 $186,728 Estimated Market Value of Liabilities $177,011 $174,256 $171,069 MVPE $ 24,669 $ 20,384 $ 15,659 Increase/(decrease) in MVPE $ 4,285 $ -- $ (4,725)
The analysis above indicates that the Corporation would be negatively affected by an increase in interest rates and positively affected by a decrease in interest rates. YIELDS EARNED AND RATES PAID - ---------------------------- The Corporation's pretax earnings depend primarily on its net interest income, the difference between the income it receives on its loan portfolio and other investments and its cost of money, consisting primarily of interest paid on savings deposits and borrowings. Net interest income is affected by the average yield on interest-earning assets, the average rate on interest-bearing liabilities, and the ratio of interest-earning assets to interest-bearing liabilities. The following table sets forth, at or for the periods and dates indicated, the weighted average yields earned on the Corporation's interest-earning assets, the weighted average interest rates paid on the Corporation's deposit accounts and borrowings, the interest rate spread and net yield on interest-earning assets. -6-
At September 30, Years Ended September 30, ---------------- ------------------------------- 1998 1998 1997 1996 ---------------- -------- -------- -------- Average yield on earnings assets: Loans 8.01% 8.10% 8.24% 8.81% Investments (1) 5.41% 5.89% 6.88% 6.55% Mortgage-backed securities 7.20% 6.96% 6.76% 6.02% Total interest-earning assets 7.69% 7.83% 7.96% 7.88% ------ -------- -------- -------- Less: Average rate paid on deposits 4.40% 4.45% 4.36% 4.75% Average rate paid on borrowings 5.69% 5.70% 5.62% 6.01% Average Cost of Funds 4.70% 4.73% 4.67% 4.87% ------ -------- -------- -------- Average interest rate spread 2.99% 3.11% 3.29% 3.01% ------ -------- -------- -------- Net yield on average interest- earning assets 3.25% 3.42% 3.57% 3.46% ------ -------- -------- --------
(1) Includes investment securities, federal funds sold, interest-bearing time deposits, overnight interest-bearing deposits and Federal Home Loan Bank (FHLB) stock. RATE/VOLUME ANALYSIS - -------------------- The following table sets forth certain information regarding changes in interest income and interest expense of the Corporation for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume (changes in volume multiplied by old rate); (2) changes in rate (changes in rate multiplied by old volume); and (3) the total. Changes in rate/volume (change in rate multiplied by the change in volume) have been allocated to rate and volume variances consistently on a proportionate basis.
Years Ended September 30, --------------------------------------------------------- 1998 vs. 1997 1997 vs. 1996 ------------- ------------- Volume Rate Total Volume Rate Total -------- ------- ------- ------- ------- ------- (Dollars in Thousands) Change in interest income: Loans $ 2,100 $ 18 $ 2,118 $ 4,186 $ (875) $ 3,311 Mortgage-backed securities 36 18 54 (575) 17 (558) Investments (463) (159) (622) (95) 193 98 -------- ------- ------- ------- ------- ------- Total interest income 1,673 (123) 1,550 3,516 (665) 2,851 -------- ------- ------- ------- ------- ------- Change in interest expense: Deposits 758 120 878 609 (422) 187 Borrowings and other (2) 26 24 1,546 (136) 1,410 -------- ------- ------- ------- ------- ------- Total interest expense 756 146 902 2,155 (558) 1,597 -------- ------- ------- ------- ------- ------- Change in net interest income $ 917 $ (269) $ 648 $ 1,361 $ (107) $ 1,254 -------- ------- ------- ------- ------- -------
-7- RESULTS OF OPERATIONS - --------------------- COMPARISON OF YEARS ENDED SEPTEMBER 30, 1998 AND SEPTEMBER 30, 1997 - ------------------------------------------------------------------- Net income increased $106,000 from $1,444,000 in fiscal 1997 to $1,550,000 in fiscal 1998 primarily as a result of increased interest income from loans and increased non-interest income. Earnings per share (basic) increased $0.06 to $1.23 for the year ended September 30, 1998 from $1.17 for the same period in 1997. Total interest income increased $1,550,000, or 13.07%, from $11,855,000 in fiscal 1997 to $13,405,000 in fiscal 1998 due to the increase in the level of interest-earning average assets that more than offset a slight decrease in average yields. Average earning assets increased due primarily to higher loan production from the Mortgage Division. The loan production was financed by increased deposits and additional advances from the FHLB. Interest income on loans increased $2,118,000, or 21.73%, from $9,747,000 in fiscal 1997 to $11,865,000 in fiscal 1998. Interest income on investment and mortgage-backed securities decreased $615,000, or 30.07%, from $2,045,000 in fiscal 1997 to $1,430,000 in fiscal 1998. This reduction was due to a high level of security calls that occurred during fiscal 1998 along with declining interest rates on new securities. Interest expense increased 13.57% to $7,549,000 for fiscal 1998 from $6,647,000 for fiscal 1997. Interest expense increased $878,000 for deposits and $24,000 for other borrowings, respectively. Interest expense for deposits increased due to higher volumes (10.14% increase from fiscal 1997) along with a slight increase in the costs of deposits. Interest expense on other borrowings increased due to higher volumes and rates on FHLB advances throughout fiscal 1998 as compared to fiscal 1997. Provisions for loan losses are charges to earnings to bring the total allowance for loan losses to a level considered by management as adequate to provide for estimated loan losses based on management's evaluation of the collectibility of the loan portfolio. Provisions for loan losses decreased from $243,000 in fiscal 1997 to $0 in fiscal 1998. The decrease in the provision was due to the reduction in the Bank loan portfolio that is held for investment, along with the reduction in losses experienced in consumer loans. The Corporation experienced bad debt charge-offs, net of recoveries, of approximately $101,000 in fiscal 1998 compared to $114,000 for fiscal 1997. The loan reserves to total loans ratio excluding loans held for sale for fiscal 1998 was .79% compared to .80% for fiscal 1997. Non-interest income increased 8.92% to $1,038,000 for the year ended September 30, 1998 from $953,000 for the year ended September 30, 1997. Service charges and fees increased $81,000 to $791,000 primarily as a result of increased deposit account fees. Loan servicing fees (net) decreased $199,000 to $(111,000) for the year ended September 30, 1998 from $88,000 for the year ended September 30, 1997 primarily as a result of the establishment of a $108,000 loss provision for the Bank's loan servicing portfolio. Gain on sale of loans increased to $358,000 during the year ended September 30, 1998 from $96,000 for the year ended September 30, 1997 due to increased conventional mortgage loan sales. Non-interest expense increased 22.98% to $4,447,000 in fiscal 1998 from $3,616,000 in fiscal 1997. The increase in non-interest expense is the result of additional expenses absorbed with the purchase of the Laurens, S. C. branch along with the startup of the Mortgage Division. Both operations were established during the third quarter of fiscal 1997. COMPARISON OF YEARS ENDED SEPTEMBER 30, 1997 AND SEPTEMBER 30, 1996 - ------------------------------------------------------------------- Net income increased $582,000 from $862,000 in fiscal 1996 to $1,444,000 in fiscal 1997. Earnings per share increased $0.46 (basic) to $1.17 for the year ended September 30, 1997 from $.71 for the same period in 1996. Fiscal 1996 net income included a one-time FDIC assessment of $606,000 ($395,000 after taxes). On September 30, 1996 President Clinton signed the Omnibus Appropriations Bill which called for all financial institutions to share in recapitalizing the FDIC fund that insures deposits. Earnings before income taxes, gains and losses on the sale of loans and the effect of the FDIC special assessment were approximately $1,837,000 for fiscal 1996 and approximately $2,206,000 for fiscal 1997 or an increase of $369,000 or 20.09%. Total interest income increased $2,851,000, or 31.66%, from $9,004,000 in fiscal 1996 to $11,855,000 in fiscal 1997 due to the increased level of interest- earning assets more than offsetting a slight decrease in average yields. Average interest-earning assets increased due primarily to the purchase of adjustable rate loans during the year along with higher loan production as a result of the startup of a Mortgage Division within the Bank. The loan production was financed by advances from the FHLB. Interest income on loans increased $3,311,000, or 51.44%, from $6,436,000 in fiscal 1996 to $9,747,000 in fiscal 1997. Interest income on investment securities increased $136,000, or 9.97%, from $1,363,000 in fiscal 1996 to $1,499,000 in fiscal 1997. The increases in interest income on loans and investment securities were offset by decreases of $559,000 and $37,000 in interest income on mortgage-backed securities and on deposits and federal funds sold, respectively. Interest expense increased 31.62% to $6,647,000 for fiscal 1997 from $5,050,000 for fiscal 1996. Interest expense increased $187,000 and $1,410,000 for deposits and for other borrowings, respectively. Interest expense for deposits increased due to -8- increasing volumes as a result of the acquisition of a banking center location in Laurens, SC with acquired deposits of $20,144,000. Interest expense on other borrowings increased due to higher volumes required by the Mortgage Division and rates on FHLB advances throughout fiscal 1997. Provisions for loan losses increased $243,000 from $0 in fiscal 1996 to $243,000 in fiscal 1997. The provision was larger in fiscal 1997 due to the increased size of the loan portfolio. In fiscal 1997, the Corporation experienced bad debt charge-offs, net of recoveries, of approximately $114,000. The Corporation experienced bad debt charge-offs, net of recoveries, of approximately $79,000 in fiscal 1996. While future losses in the loan portfolio are probable, management feels that provisions for loan losses are adequate. Non-interest income increased 88.34% to $953,000 for the year ended September 30, 1997 from $506,000 for the year ended September 30, 1996. This increase was due primarily to increased fees from financial services from $411,000 in fiscal 1996 to $710,000 in fiscal 1997. In addition, gains recognized on the sale of loans and investments in the current year were $155,000 compared to $25,000 recognized in fiscal 1996.The servicing of loans purchased during the year was outsourced and therefore resulted in net servicing fee expense of $24,000 in fiscal 1997 compared to net servicing fee income in fiscal 1996 of $70,000. Non-interest expense increased 12.15% to $3,616,000 in fiscal 1997 from $3,224,000 in fiscal 1996. The increase in non-interest expense is a result of additional expenses absorbed with the purchase of the Laurens, S.C. banking center along with the startup of the Mortgage Division. YEAR 2000 - --------- The approach of the year 2000 ("Year 2000") presents significant issues for many financial, information, and operational systems. Many systems in use today may not be able to interpret dates after December 31, 1999, appropriately, because such systems allow only two digits to indicate the year in a date. The Year 2000 problems may occur in computer programs, computer hardware, or electronic devices that utilize computer chips to process any information that contains dates. Therefore, the issue is not limited to dates in computer programs but is a complex combination of problems that may exist in computer programs, data files, computer hardware, and other devices essential to the operation of the business. Further, companies must consider the potential impact that Year 2000 may have on services provided by third parties. Substantially all of the Year 2000 risk is related to the Bank's activities. The Bank has a formal Year 2000 Plan which includes a Year 2000 Task Force. The Plan has been reviewed by the senior management and the Board of Directors. Included in the Plan is a listing of all systems (whether in-house or provided/supported by third parties) which may be impacted by Year 2000 and a categorization of the systems by their potential impact on Bank operations. The Task Force has received Year 2000 plans from third parties identified during the assessment phase of the Year 2000 Plan. For systems that have been classified as critical to the operations of the Bank, contingency plans have been developed. Contingency plans may include utilization of alternate third party vendors, alternate processing methods and software, or manual processing. The plans have various activation dates (e.g., the date on which a third party processor fails to meet its Year 2000 compliance deadline). In addition to addressing its own Year 2000 issues, the Bank is in the process of assessing the impact of the Year 2000 on significant commercial borrowers. The Bank's Year 2000 readiness is reviewed and monitored by the Office of Thrift Supervision ("OTS"). The Bank's core processing systems are outsourced through a contract with The BISYS Group, Inc. ("BISYS"). BISYS has developed a Year 2000 Plan and provides the Bank with periodic updates. BISYS also has held Year 2000 workshops, whose objectives have been to assist the Bank in the development of its Year 2000 Plan, to provide updates on the BISYS Year 2000 plan, and training on the use of the BISYS Year 2000 test facility, whose function is to allow BISYS clients to test their systems' compatibility with the BISYS system. BISYS completed all program maintenance associated with Year 2000 prior to October 31, 1998, and expects a full year of testing prior to January 1, 2000. Like the Bank, BISYS Year 2000 activities are subject to OTS oversight. The incremental cost associated with the Bank's compliance is expected to be less than $50,000. The majority of all hardware upgrades began in 1995 as a result of the Bank's plan to increase efficiencies and eliminate obsolescence of some system components. Should the Bank or any of its third party service providers fail to complete Year 2000 measures in a timely manner, it would likely have a material adverse effect, whose amount cannot be reasonably estimated at this time. FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES - ---------------------------------------------------- At September 30, 1998, the Corporation's assets totaled $189,286,000, an increase of $18,042,000, or 10.54%, as compared to $171,244,000 at September 30, 1997. Investment and mortgage-backed securities increased $5,889,000 to $29,555,000 from $23,666,000 at September 30, 1997. Loans held for sale, net, increased $22,540,000 to $37,584,000 from $15,044,000 at September 30, 1997. The increase in loans held for sale, net, was partially funded by advances from the Federal Home Loan Bank and other borrowings which increased $3,462,000 from September 30, 1997 to the same period in 1998. The majority of the -9- increase in loans held for sale, net, represents fixed rate product purchased from other organizations through the Bank's Mortgage Division that will be sold into loan commitments. Loans held for investment, net, decreased $10,295,000 to $104,618,000 from $114,913,000 at September 30, 1997. The decrease was due to the high volume of refinancing activity in fixed rate product during fiscal 1998. Total deposits increased $11,959,000 from $117,944,000 at September 30, 1997 to $129,873,000 on September 30, 1998. The Bank experienced the significant deposit growth as a result of ongoing marketing promotions throughout fiscal 1998. There was also a 13.11% growth in shareholders' equity from September 30, 1997 to September 30, 1998. During fiscal 1998 the Corporation implemented a dividend reinvestment program that allows existing shareholders to reinvest dividends and make additional cash contributions to purchase stock. The Bank's liquidity, as measured by the ratio of cash, cash equivalents (not committed, pledged or required to liquidate specific liabilities) and investment securities to total deposits was approximately 14.66% at September 30, 1998. Assets that qualify as eligible liquidity are defined by applicable federal regulation and include cash and cash equivalents and certain types of United States Treasury and agency obligations, and other similar investments. The required ratio of such liquid investments is currently 4% of certain of the Bank's liabilities as defined by the OTS. The liquidity requirement is changed periodically by the OTS to reflect economic conditions. The Bank has relied upon deposit growth and loan repayments as its principal sources of liquidity. If deposit growth and loan repayments do not generate sufficient liquid funds in the future, the Bank may borrow additional funds from the FHLB or liquidate short-term investments. These sources of funds are intended to provide a secondary source of relatively liquid funds upon which the Bank may rely, if necessary. Commitments to fund loans in the ordinary course of business at September 30, 1998 were approximately $2,736,000. See Note 10 to the financial statements for further information about commitments and contingencies. As of September 30, 1998, the Bank exceeded the OTS's capital requirements. See Note 13 to the financial statements for further discussion of these capital requirements. IMPACT OF INFLATION AND CHANGING PRICES - --------------------------------------- The financial statements and related data presented herein 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. Unlike industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. However, non-interest expenses do reflect general levels of inflation. SUBSEQUENT EVENT - ---------------- On October 5, 1998, the Corporation, through its subsidiary, Provident Community Bank, entered into a definitive agreement with CCB Financial's wholly-owned subsidiary, American Federal Bank, FSB to purchase the deposits of American Federal's Union, South Carolina branch. The purchase is subject to regulatory approval and is anticipated to close by February, 1999. The acquisition will be accounted for as a purchase. -10- [LETTERHEAD OF ELLIOTT, DAVIS & COMPANY, L.L.P.] REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Shareholders and Board of Directors Union Financial Bancshares, Inc. and Subsidiary Union, South Carolina We have audited the accompanying consolidated balance sheets of UNION FINANCIAL BANCSHARES, INC. AND SUBSIDIARY as of September 30, 1998 and 1997, and the related consolidated statements of income, shareholders' equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. 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 consolidated financial position of UNION FINANCIAL BANCSHARES, INC. AND SUBSIDIARY as of September 30, 1998 and 1997 and the consolidated results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles. /s/ Elliott, Davis & Company, LLP Elliott, Davis & Company, LLP Greenville, South Carolina November 6, 1998 -11- UNION FINANCIAL BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS ---------------------------
September 30, -------------------------- 1998 1997 -------- -------- (In Thousands) Assets - ------ Cash $ 2,469 $ 1,608 Short term interest-bearing deposits 1,124 6,213 -------- -------- Total cash and cash equivalents 3,593 7,821 -------- -------- Investment and mortgage-backed securities: Held to maturity, at amortized cost (fair value 1998 - $2,744, 1997 - $7,927) 2,699 7,811 Available for sale, at fair value (amortized cost 1998 - $26,516, 1997 - $15,945) 26,856 15,855 -------- -------- Total investment and mortgage-backed securities 29,555 23,666 -------- -------- Loans, net Held for sale 37,584 15,044 Held for investment 104,618 114,913 -------- -------- Total loans, net 142,202 129,957 Office properties and equipment, net 4,020 3,009 Federal Home Loan Bank Stock, at cost 2,023 2,105 Accrued interest receivable 1,197 1,317 Mortgage servicing rights 3,270 805 Other assets 3,426 2,564 -------- -------- Total assets $189,286 $171,244 ======== ======== Liabilities - ----------- Deposit accounts $129,873 $117,914 Securities sold under repurchase agreements 895 504 Advances from the Federal Home Loan Bank and other borrowings 41,441 37,979 Accrued interest payable 336 314 Advances from borrowers for taxes and insurance 496 389 Other liabilities 945 617 -------- -------- Total liabilities 173,986 157,717 -------- -------- Commitments and contingencies - note 12 Shareholders' equity - -------------------- Serial preferred stock, no par value, authorized - 500,000 shares, issued and outstanding - None Common stock - $0.01 par value, authorized - 2,500,000 shares, issued and outstanding - 1,278,250 shares in 1998 and 827,700 shares in 1997 13 8 Additional paid-in capital 4,471 3,993 Accumulated other comprehensive income 148 (63) Retained earnings, substantially restricted 10,668 9,589 -------- -------- Total shareholders' equity 15,300 13,527 -------- -------- Total liabilities and shareholders' equity $189,286 $171,244 ======== ========
See notes to consolidated financial statements. -12- UNION FINANCIAL BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME ---------------------------------
For the Years Ended September 30, ------------------------------------ 1998 1997 1996 ---------- ---------- ---------- (In Thousands, Except Share Data) Interest Income: Loans $ 11,865 $ 9,747 $ 6,436 Deposits and federal funds sold 110 63 100 Securities available for sale: State and municipal 17 37 122 Other investments 980 1,128 1,832 Securities held to maturity: Other investments 433 880 514 ---------- ---------- ---------- Total interest income 13,405 11,855 9,004 ---------- ---------- ---------- Interest Expense: Deposit accounts 5,544 4,666 4,479 Advances from the FHLB and other 2,005 1,981 571 ---------- ---------- ---------- Total interest expense 7,549 6,647 5,050 ---------- ---------- ---------- Net Interest Income 5,856 5,208 3,954 Provision for loan losses -- (243) -- ---------- ---------- ---------- Net interest income after provision for loan losses 5,856 4,965 3,954 ---------- ---------- ---------- Non Interest Income: Fees for financial services 791 710 411 Loan servicing fees (111) 88 70 Net gains on sale of investments -- 59 20 Gains on sale of loans 358 96 5 ---------- ---------- ---------- Total non interest income 1,038 953 506 ---------- ---------- ---------- Non Interest Expense: Compensation and employee benefits 2,301 1,768 1,265 Occupancy and equipment 972 702 557 Deposit insurance premiums 54 93 821 Professional services 275 332 173 Real estate operations 10 (3) (2) Other 835 724 410 ---------- ---------- ---------- Total non interest expense 4,447 3,616 3,224 ---------- ---------- ---------- Income before income taxes 2,447 2,302 1,236 Provision for income taxes 897 858 374 ---------- ---------- ---------- Net Income $ 1,550 $ 1,444 $ 862 ========== ========== ========== Net Income per common share (Basic) $1.23 $1.17 $0.71 ========== ========== ========== Net Income per common share (Diluted) $1.15 $1.09 $0.69 ========== ========== ========== Dividends per common share $0.37 $0.35 $0.33 ========== ========== ========== Weighted average number of common shares outstanding 1,264,615 1,230,747 1,212,460 (Basic) ========== ========== ========== Weighted average number of common shares outstanding 1,343,008 1,325,703 1,288,272 (Diluted) ========== ========== ==========
See notes to consolidated financial statements. -13- UNION FINANCIAL BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY -----------------------------------------------
Retained Accumulated Common Stock Additional Earnings Other Total --------------------- Paid-In Substantially Comprehensive Shareholders' Shares Amount Capital Restricted Income Equity ------- ------ --------- ------------ -------- -------- (In Thousands, Except Share Data) Balance at September 30, 1995 $ 403,322 $ 4 $ 3,860 $ 8,120 $ (128) $ 11,856 Net income -- -- -- 862 -- 862 Other comprehensive income Unrealized losses on securities: Unrealized holding losses arising during period -- -- -- -- (101) -- ----- Other comprehensive income -- -- -- -- (101) (101) ----- ------ Comprehensive income 761 ----- Options exercised 2,321 -- 41 -- -- 41 Two-for-one stock split 405,643 4 (4) - - -- Cash dividend ($.33 per share) -- -- -- (404) -- (404) ------- ------ ------ ------- ------ ------- Balance at September 30, 1996 811,286 8 3,897 8,578 (229) 12,254 Net income -- -- -- 1,444 -- 1,444 Other comprehensive income Unrealized losses on securities: Unrealized holding gains arising during period -- -- -- -- 166 -- ----- Other comprehensive income -- -- -- -- 166 166 ----- ------ Comprehensive income 1,610 ----- Options exercised 16,414 -- 96 -- -- 96 Cash dividend ($.35 per share) -- -- -- (433) -- (433) ------- ------ ------ ------- ------ ------- Balance at September 30, 1997 827,700 8 3,993 9,589 (63) 13,527 Net income -- -- -- 1,550 -- 1,550 Other comprehensive income Unrealized losses on securities: Unrealized holding losses arising during period -- -- -- -- (211) -- ----- Other comprehensive income -- -- -- -- (211) (211) ----- ------ Comprehensive income 1,761 ----- Options exercised 9,920 -- 51 -- -- 51 Three-for-two stock split 413,850 4 -- (4) -- -- Dividend reinvestment plan contributions 26,780 1 427 -- -- 428 Cash dividend ($.37 per share) -- -- -- (467) -- (467) --------- ------ ------ ------- ------ ------- Balance at September 30, 1998 1,278,250 13 4,471 10,668 148 15,300 ========= ====== ====== ======= ====== =======
See notes to consolidated financial statements. -14- UNION FINANCIAL BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS -------------------------------------
For the Years Ended September 30, ------------------------------------------ 1998 1997 1996 ----------- ----------- ----------- (In Thousands) Operating activities: Net income $ 1,550 $ 1,444 $ 862 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Provision for loan losses -- 243 -- Amortization expense 561 106 -- Depreciation expense 221 188 165 Recognition of deferred income, net of costs (140) (7) (111) Deferral of fee income, net of costs 77 29 244 Gain on investment transactions -- (59) (20) Loans originated for sale (141,436) (61,806) (805) Proceeds from sale of loans 123,677 46,762 810 Gain on sale of loans held for sale (358) (96) (5) (Increase) decrease in accrued interest receivable 120 (196) (241) (Increase) decrease in other assets (862) 598 (614) (Increase) decrease in accrued interest payable (22) 235 49 Increase (decrease) in other liabilities 434 (830) 426 ----------- ----------- ----------- Net cash (used in) provided by operating activities (16,178) (13,389) 760 ----------- ----------- -----------
-15- UNION FINANCIAL BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) -------------------------------------------------
For the Years Ended September 30, ---------------------------------------- 1998 1997 1996 ------------ ---------- ---------- (In Thousands) Investing activities: Maturities of time deposits $ -- $ -- $ 99 Purchase of investment and mortgage-backed securities: Held to maturity -- (2,000) (11,617) Available for sale (20,368) (2,950) (10,228) Proceeds from maturity of investment and mortgage- backed securities: Held to maturity 4,497 500 500 Available for sale 7,978 4,450 4,568 Proceeds from sale of investment and mortgage-backed securities, Available for sale -- 8,281 16,563 Principal repayments on mortgage-backed securities: Held to maturity 616 137 242 Available for sale 1,388 1,712 6,387 Loan originations (43,568) (53,449) (37,078) Principal repayments of loans 49,520 24,588 23,951 Proceeds from sale of real estate acquire in settlement of loans 27 7 36 Purchase of mortgage servicing rights (2,814) -- -- Purchase of FHLB stock -- (1,380) (197) Redemption of FHLB stock 82 225 -- Purchase of office properties and equipment (1,231) (1,534) (116) ------------ ---------- ---------- Net cash used in investing activities (3,873) (21,413) (6,890) ------------ ---------- ---------- Financing activities: Proceeds from the exercise of stock options 51 96 41 Proceeds from dividend reinvestment plan 427 -- -- Dividends paid in cash (467) (433) (404) Proceeds from FHLB advances and other borrowings 117,891 99,440 43,763 Repayment of FHLB advances and other borrowings (114,038) (81,443) (36,355) Acquired deposits from purchased branch -- 17,223 -- Increase (decrease) in deposit accounts 11,959 4,055 (1,035) ------------ ---------- ---------- Net cash provided by financing activities 15,823 38,938 6,010 ------------ ---------- ---------- Net (decrease) increase in cash and cash equivalents (4,228) 4,136 (120) Cash and cash equivalents at beginning of year 7,821 3,685 3,805 ------------ ---------- ---------- Cash and cash equivalents at end of year $ 3,593 $ 7,821 $ 3,685 ============ ========== ==========
See notes to consolidated financial statements. -16- UNION FINANCIAL BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------ 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization - Union Financial Bancshares, Inc. ("Union Financial") was - ------------ incorporated in the State of Delaware in April 1994, for the purpose of becoming a thrift holding company for Provident Community Bank (formerly known as Union Federal Savings Bank), a federally chartered savings bank ("the Bank"). Provident Community Bank, founded in 1934, offers a complete array of financial services throughout four full service banking centers in two counties in South Carolina. The Bank offers a full range of financial services including checking, savings, time deposits, individual retirement accounts (IRAs), investment services, and secured and unsecured consumer loans. The Bank originates and services home loans and provides financing for small businesses and affordable housing. Accounting Principles - The accounting and reporting policies of the Corporation - --------------------- conform to generally accepted accounting principles and to general practice within the banking industry. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and disclosure of commitments and contingencies. Actual results could differ from those estimates. The following summarizes the more significant policies. Basis of Consolidation - The accompanying consolidated financial statements - ---------------------- include the accounts of Union Financial Bancshares, Inc. (the "Corporation") and its wholly owned subsidiary, Provident Community Bank (the "Bank") and its wholly owned subsidiary, Provident Financial Services, Inc. ("PFS"). PFS consists primarily of investment brokerage services. All inter corporation amounts and balances have been eliminated in consolidation. Cash and Cash Equivalents - Cash and cash equivalents include cash on hand and - ------------------------- amounts due from depository institutions, federal funds sold and short term, interest-bearing deposits. From time to time, the Corporation's cash deposits with other financial institutions may exceed the FDIC insurance limits. Investments - The Bank accounts for investment securities in accordance with - ----------- Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for -------------- Certain Investments in Debt and Equity Securities ("SFAS 115"). In accordance - ------------------------------------------------- with the Statement, debt securities that the Bank has the positive intent and ability to hold to maturity are classified as "held to maturity" securities and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling in the near term are classified as "trading" securities and reported at fair value, with unrealized gains and losses included in earnings. Debt and equity securities not classified as either held to maturity or trading securities are classified as "available for sale" securities and reported at fair value with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity. Transfers of securities between classifications will be accounted for at fair value. No securities have been classified as trading securities. Premiums and discounts on debt securities are amortized or accreted as adjustments to income over the estimated life of the security using a method approximating the level yield method. Gains or losses on the sale of securities are based on the specific identification method. The fair value of securities is based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Loans - Loans held for investment are recorded at cost. Mortgage loans consist - ----- principally of conventional one-to-four family residential loans and interim and permanent financing of non-residential loans that are secured by real estate. Commercial loans are made primarily on the strength of the borrower's general credit standing, the ability to generate repayment from income sources and the collateral securing such loans. Consumer loans generally consist of home equity loans, automobile and other personal loans. In many lending transactions, collateral is taken to provide an additional measure of security. Generally, the cash flow or earning power of the borrower represents the primary source of repayment, and collateral liquidation serves as a secondary source of repayment. The Corporation determines the need for collateral on a case-by-case or product-by-product basis. Factors considered include the current and prospective credit worthiness of the customer, terms of the instrument and economic conditions. Mortgage loans held for sale are valued at the aggregate lower of cost or market as determined by outstanding commitments from investors or current investor yield requirements calculated on the aggregate loan basis. -17- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Allowances for Estimated Losses - The Corporation maintains allowances for - ------------------------------- estimated loan losses, uncollected accrued interest receivable and losses on real estate acquired in settlement of loans. Loss provisions are charged to income when, in the opinion of management, such losses for which no provision has been made are probable. The allowance for loan losses is based upon an evaluation of the loan portfolio. The evaluation considers such factors as the delinquency status of loans, current economic conditions, the net realizable value of the underlying collateral and prior loan loss experience. The Corporation provides an allowance for uncollectible interest on accrued interest which is primarily related to loans more than ninety days delinquent and other loans determined by management to be uncollectible. This allowance is deducted from accrued interest for financial statement purposes. Recovery of the carrying value of loans is dependent to some extent on the future economic environment and operating and other conditions that may be beyond the Corporation's control. Unanticipated future adverse changes in such conditions could result in material adjustments to allowances (and future results of operation). Accounting for Impaired Loans - Impaired loans are accounted for in accordance - ----------------------------- with SFAS No. 114, Accounting by Creditors for Impairment of a Loan ------------------------------------------------ ("SFAS 114"), which was amended by SFAS No. 118. SFAS 114 requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical matter, at the loan's observable market value or fair value of the collateral if the loan is collateral dependent. The Corporation maintains an allowance for impaired loans based on a combination of evaluation of impairment of smaller balance, homogeneous loans (primarily consumer loans and 1-4 family real estate mortgages) and specific identification of impaired loans based on delinquency status and other factors related to the borrower's ability to repay the loan. The risk characteristics used to aggregate loans are collateral type, borrower's financial condition and geographic location. The Corporation generally determines a loan to be impaired at the time management believes that it is probable that the principal and interest may be uncollectible. Management has determined that, generally, a failure to make a payment within a 90-day period constitutes a minimum delay or shortfall and does not generally constitute an impaired loan. However, management reviews each past due loan on a loan-by-loan basis and may determine a loan to be impaired prior to the loan becoming over 90 days past due, depending upon the circumstances of that particular loan. A loan is classified as a nonaccrual loan at the time management believes that the collection of interest is improbable, generally when a loan becomes 90 days past due. The Corporation's policy for charge-off of impaired loans is on a loan-by-loan basis. At the time management believes the collection of interest and principal is remote, the loan is charged off. The Corporation's policy is to evaluate impaired loans based on the fair value of the collateral. Interest income from impaired loans is recorded using the cash method. As of and for the years ended September 30, 1998 and 1997, there were no impaired loans and the Corporation had recognized no interest income from impaired loans. Office Properties and Equipment - Office properties and equipment are presented - ------------------------------- at cost less accumulated depreciation. Depreciation is provided on the straight- line basis over the estimated useful lives of the assets. Estimated useful lives are 20-50 years for buildings and improvements and generally five to ten years for furniture, fixtures and equipment. The cost of maintenance and repairs is charged to expense as incurred, and improvements and other expenditures, which materially increase property lives, are capitalized. The costs and accumulated depreciation applicable to office properties and equipment retired or otherwise disposed of are eliminated from the related accounts, and any resulting gains or losses are credited or charged to income. Mortgage Servicing Rights - Effective October 1, 1996, the Corporation adopted - ------------------------- SFAS No. 122, Accounting for Mortgage Servicing Rights. The statement ---------------------------------------- eliminates the distinction between originated and purchased mortgage servicing rights. Since the adoption of SFAS 122, the Corporation capitalizes the allocated cost of originated mortgage servicing rights and records a corresponding increase in mortgage banking income. Purchased mortgage servicing rights are recorded at the lower of cost or market. Originated mortgage servicing rights are capitalized based on the allocated cost which is determined when the underlying loans are sold or securitized. MSRs are amortized in proportion to and over the period of estimated net servicing income using a method that is designed to approximated a level-yield method, taking into consideration the estimated prepayment of the underlying loans. For purposes of measuring impairment, MSRs are periodically reviewed for impairment based upon quarterly valuations. Such valuations are based on projections using a discounted cash flow method that includes assumptions regarding prepayments, servicing costs and other factors. Impairment is measured on a disaggregated basis for each pool of rights. -18- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Real Estate Acquired Through Foreclosure - Real estate acquired through - ---------------------------------------- foreclosure is stated at the lower of cost or estimated fair value less estimated costs to sell. Any accrued interest on the related loan at the date of acquisition is charged to operations. Costs relating to the development and improvement of property are capitalized to the extent that such costs do not exceed the estimated fair value less selling costs of the property, whereas those relating to holding the property are charged to expense. Deferred Loan Origination Fees - Nonrefundable loan fees and certain direct loan - ------------------------------ origination costs are deferred and recognized over the lives of the loans using the level yield method. Amortization of these deferrals is recognized as interest income. Sale of Loans - The Corporation frequently sells and retains servicing rights on - ------------- certain mortgage loans. Gains or losses on the sale of such loans are recognized when substantially all risks and rewards of ownership are transferred. If loan servicing is retained, the value of future servicing rights are considered in the determination of the amount of gain or loss. Income Taxes - The Bank accounts for income taxes in accordance with SFAS - ------------ No. 109, Accounting for Income Taxes. Under SFAS 109, deferred income taxes --------------------------- reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. A valuation allowance is established for deferred tax assets that may not be realized. Also, SFAS 109 eliminates, on a prospective basis, the exception from the requirement to record deferred taxes on tax basis bad debt reserves in excess of the base year amounts. The tax basis bad debt reserve that arose prior to the fiscal year 1988 (the base year amount) is frozen, and the book reserves at that date and all subsequent changes in book and tax basis reserves are included in the determination of deferred taxes. Fair Values of Financial Instruments - The following methods and assumptions - ------------------------------------ were used by the Corporation in estimating fair values of financial instruments as disclosed herein: Cash and short-term instruments - The carrying amounts of cash and short-term instruments approximate their fair value. Available for sale and held to maturity securities - Fair values for securities are based on quoted market prices. The carrying values of restricted equity securities approximate fair values. Loans - For variable rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans (for example, one-to-four-family residential), credit-card loans, and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. Fair values for commercial real estate and commercial loans are estimated using discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values, where applicable. Deposit liabilities - The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying amounts of variable-rate, fixed- term money-market accounts and certificates of deposit (CD's) approximate their fair values at the reporting date. Fair values for fixed-rate CD's are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. Short-term borrowings - The carrying amounts of other short-term borrowings maturing within 90 days approximate their fair values. Fair values of other short-term borrowings are estimated using discounted cash flow analysis based on the Corporation's current incremental borrowing rates for similar types of borrowing arrangements. Long-term debt - The fair values of the Corporation's long-term debt are estimated using discounted cash flow analysis based on the Corporation's current incremental borrowing rates for similar types of borrowing arrangements. Accrued interest - The carrying amounts of accrued interest approximate their fair values. Off-balance-sheet instruments - Fair values for off-balance-sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counter parties' credit standings. Per-Share Data - SFAS 128, Earnings Per Share, issued in February 1997, - -------------- ------------------ simplifies the standard for computing earnings per share and makes them comparable to international earnings per share standards. It also requires the dual presentation of basic and diluted earnings per share on the face of the income statement. -19- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Basic earnings per share is computed by dividing net income by the weighted- average number of shares outstanding for the period. Diluted earnings per share is similar to the computation of basic earnings per share except that the denominator is increased to include the number of additional common share that would have been outstanding if the dilutive potential common shares had been issued. The dilutive effect of options outstanding under the Corporation's stock option plan is reflected in diluted earnings per share by the application of the treasury stock method. SFAS128 became effective for the Corporation as of September 30, 1998. As required by SFAS 128, all prior period earnings per share data presented has been restated to conform with the provisions of the statement. Share and per-share data have been restated to reflect stock splits issued in July 1996 and February 1998. Intangible Assets - Intangible assets, included in other assets, consist of core - ----------------- deposit premiums resulting from the Corporation's branch acquisition. During 1998, $212,000 of intangible expense was charged to operations. Core deposit intangibles are being amortized over 10 years using the straight-line method. Interest Income - Interest on loans is accrued and credited to income monthly - --------------- based on the principal balance outstanding and the contractual rate on the loan. The Corporation places loans on non-accrual status when they become greater than ninety days delinquent or when in the opinion of management, full collection of principal or interest is unlikely. The Corporation provides an allowance for uncollectible accrued interest on loans which are ninety days delinquent for all interest accrued prior to the loan being placed on non-accrual status. The loans are returned to an accrual status when full collection of principal and interest appears likely. Comprehensive Income - In June, 1997, the FASB issued SFAS No. 130, Reporting - -------------------- --------- Comprehensive Income, which establishes standards for reporting and display of - -------------------- comprehensive income and its components in a full set of general purposes financial statements. Under this statement, enterprises are required to classify items of "other comprehensive income" by their nature in the financial statement and display the balance of other comprehensive income separately in the equity section of a statement of financial position. Statement 130 is effective for both interim and annual periods beginning after December 15, 1997. Comparative financial statements provided for earlier periods are required to be reclassified to reflect the provisions of the statement. The adoption of this standard did not have a material effect on the Corporation. Reclassifications - Certain amounts in prior years' financial statements have - ----------------- been reclassified to conform with current year classifications. -20- 2. INVESTMENT AND MORTGAGE-BACKED SECURITIES Held to Maturity - Securities classified as held to maturity consisted of the - ---------------- following (in thousands):
September 30, 1998 ----------------------------------------- Gross Unrealized Amortized ------------------ Fair Cost Gains Losses Value ---------- -------- -------- -------- Investment Securities: U.S. Agency Obligations $ 1,500 $24 -- $1,524 Mortgage-backed Securities: GNMA 1,199 21 -- 1,220 ---------- -------- -------- -------- Total held to maturity $ 2,699 $45 -- $2,744 ========== ======== ======== ======== September 30, 1997 ----------------------------------------- Investment Securities: U.S. Agency Obligations $5,995 $ 51 ($29) $6,017 ---------- -------- -------- -------- Mortgage-backed Securities: GNMA 1,816 94 -- 1,910 Total held to maturity $7,811 $145 ($29) $7,927 ========== ======== ======== ========
Available for Sale - Securities classified as available for sale consisted of - ------------------ the following (in thousands):
September 30, 1998 ------------------------------------------- Gross Unrealized Amortized ------------------ Fair Cost Gains Losses Value ---------- -------- -------- -------- Investment Securities: U.S. Agency Obligations $ 7,668 $ 45 ($31) $ 7,682 Municipal Securities 449 2 -- 451 ---- -- --- ---- Total Investment Securities 8,117 47 (31) 8,133 ---------- -------- -------- -------- Mortgage-backed Securities: FHLMC 9,713 158 -- 9,871 FNMA 880 16 (2) 894 CMOs 7,806 157 (5) 7,958 ----- --- --- ----- Total Mortgage-backed Securities 18,399 331 (7) 18,723 ---------- -------- -------- -------- Total available for sale $26,516 $378 ($38) $26,856 ========== ======== ======== ======== September 30, 1997 ------------------------------------------- Gross Unrealized Amortized ------------------ Fair Cost Gains Losses Value ---------- -------- -------- -------- Investment Securities: U.S. Agency Obligations $10,429 $21 ($109) $10,341 Municipal Securities 449 -- (2) 447 ---- --- --- ---- Total Investment Securities 10,878 21 (111) 10,788 ---------- -------- -------- -------- Mortgage-backed Securities FHLMC 2,783 11 (8) 2,786 FNMA 1,388 11 (3) 1,396 CMOs 896 5 (16) 885 ---- --- ---- ---- Total Mortgage-backed Securities 5,067 27 (27) 5,067 Total available for sale $15,945 $48 ($138) $15,855 ========== ======== ======== ========
-21- 2. INVESTMENT AND MORTGAGE-BACKED SECURITIES (CONTINUED) Proceeds, gross gains and gross losses realized from the sales, calls and prepayments of available for sale securities were as follows for the years ended (in thousands):
September 30, ------------------------------- 1998 1997 1996 ------ ------ ------- Proceeds $7,978 $8,281 $21,131 ------ ------ ------- Gross gains -- 76 168 Gross losses -- 17 148 ------ ------ ------- Net gain on investment transactions $ 0 $ 59 $ 20 ====== ====== =======
The maturities of securities at September 30, 1998 are as follows (in thousands): Held to Maturity Available for Sale ----------------- ------------------- Amortized Fair Amortized Fair Cost Value Cost Value ------ ------ ------- ------- Due in one year or less $ 0 $ 0 $ 863 $ 861 Due after one year through five years 0 0 2,402 2,405 Due after five years through ten years 1,500 1,524 474 482 Due after ten years 1,199 1,220 22,777 23,108 ------ ------ ------- ------- Total investment and mortgage-backed securities $2,699 $2,744 $26,516 $26,856 ====== ====== ======= =======
The mortgage-backed securities held at September 30, 1998 mature between one and thirty years. The actual lives of those securities may be significantly shorter as a result of principal payments and prepayments. At September 30, 1998 and 1997, $10,383,000 and $9,013,000, respectively, of securities were pledged as collateral for certain deposits. At September 30, 1998, approximately $1,395,000 of the debt securities and $751,000 of mortgage-backed securities were adjustable rate securities. The adjustment periods range from monthly to annually and rates are adjusted based on the movement of a variety of indices. Investments in collateralized mortgage obligations ("CMOs") represent securities issued by agencies of the federal government. -22- 3. LOANS, NET Loans receivable consisted of the following (in thousands):
September 30, ------------------------- 1998 1997 -------- -------- Conventional real estate loans: Fixed rate residential Held for sale $ 37,584 $ 8,044 Held for investment 24,075 30,036 Fixed rate commercial 4,053 3,629 Adjustable rate residential Held for sale -- 7,000 Held for investment 48,531 57,365 Adjustable rate commercial 140 170 Construction loans 12,838 13 ,508 -------- -------- Total real estate loans 127,221 119,752 -------- -------- Other loans: Consumer and installment loans 9,797 9,957 Commercial loans 3,539 2,550 Consumer lines of credit 7,404 4,961 Loans secured by deposit accounts 1,551 183 -------- -------- Total other loans 22,291 17,651 -------- -------- Total loans 149,512 137,403 -------- -------- Less: Undisbursed portion of interim construction loans (6,625) (6,598) Allowance for loan losses (827) (928) Net deferred loan origination costs 142 80 -------- -------- Total, net $142,202 $129,957 ======== ======== Weighted-average interest rate of loans 8.01% 8.05%
Participations sold and serviced by the Corporation at September 30, 1998 and 1997 were approximately $164,396,000 and $64,730,000, respectively. The Corporation sells loans in the secondary market without recourse and retains servicing rights. Servicing loans for others consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and foreclosure processing. Loan servicing income is recorded on the accrual basis and includes servicing fees received from the investors as well as certain charges collected from the borrowers, such as late payment fees. In connection with these loans serviced for others, the Corporation held borrowers' escrow balances of $496,000 at September 30, 1998 and $389,000 at September 30, 1997. Adjustable rate real estate loans (approximately $48,671,000 and $64,535,000 at September 30, 1998 and 1997, respectively) are subject to rate adjustments annually and generally are adjusted based on movement of the Federal Home Loan Bank National Monthly Median Cost of Funds rate or the Constant Maturity Treasury index. The maximum loan rates can be adjusted is 200 basis points in any one year with a lifetime cap of 600 basis points. The Corporation made commercial real estate loans which totaled approximately $4,193,000 and $3,799,000 at September 30, 1998 and 1997, respectively. These loans are considered by management to contain a somewhat greater risk of uncollectibility due to the dependency on income production or future development and sale of the real estate. These commercial real estate loans are collateralized by housing for the aged, churches, motels, apartments and other improved real estate. Mortgage loans held for sale are stated at the lower of aggregate cost or market, net of discounts and deferred loan fees and are included in net loans in the consolidated balance sheets. Nonrefundable deferred origination fees and cost and discount points collected at loan closing, net of commitment fees paid, are deferred and recognized at the time of sale of the mortgage loans. Gain or loss on sales of mortgage loans is recognized based upon the difference between the selling price and the -23- 3. LOANS NET (CONTINUED) carrying amount of the mortgage loans sold. Other fees earned during the loan origination process are also included in net gain or loss on sales of mortgage loans. Mortgage servicing rights are accounted for in accordance with SFAS No. 122, Accounting for Mortgage Servicing Rights. SFAS No. 122 requires that an entity - ---------------------------------------- recognize, as separate assets, rights to service mortgage loans for others, whether purchased or originated, by allocating the total cost of loans between the loan and the mortgage servicing rights ("MSR") based on their relative fair values. Capitalized MSRs are amortized based on a method which approximates the proportion of current net servicing revenues to the total estimated net servicing revenues expected to be recognized over the average estimated remaining lives of the underlying loans. Capitalized MSRs are assessed for impairment based on their fair values. The Bank paid $2,687,000 for mortgage servicing rights for approximately $141,436,000 of loans in 1998. The amortization of servicing rights and excess servicing rights included in loan servicing fees amounted to $348,764, $19,171, and $0 in 1998, 1997, and 1996 respectively. The fair value of mortgage servicing rights at September 30, 1998 is approximately $3,270,000. Under OTS regulations, the Bank may not make loans to one borrower in excess of 15% of unimpaired capital. This limitation does not apply to loans made before August 9, 1989. At September 30, 1998, the Bank had loans outstanding to one borrower ranging up to $1,485,000 and was in compliance with this regulation. Also under current regulations, the Bank's aggregate commercial real estate loans may not exceed 400% of its capital as determined under regulatory requirements. These limitations are not expected to have a material impact on the Bank's ongoing operations. At September 30, 1998 and 1997, loans which are accounted for on a non-accrual basis or contractually past due ninety days or more totaled approximately $696,000 and $778,000, respectively. The amount the Corporation will ultimately realize from these loans could differ materially from their carrying value because of future developments affecting the underlying collateral or the borrower's ability to repay the loans. During the years ended September 30, 1998, 1997, and 1996, the Corporation recognized no interest income on loans past due 90 days or more, whereas, under the original terms of these loans, the Corporation would have recognized additional interest income of approximately $20,000, $36,000, and $34,000, respectively. The changes in the allowance for loan losses consisted of the following (in thousands):
Years Ended September 30, ---------------------------- 1998 1997 1996 ----- ----- ----- Balance at beginning of year $ 928 $ 799 $878 Provision for loan losses -- 243 -- (Charge-offs) recoveries, net (101) (114) (79) ----- ----- ----- Balance at end of year $ 827 $ 928 $799 ===== ===== =====
Directors and officers of the Corporation are customers of the Corporation in the ordinary course of business. Loans of directors and officers have terms consistent with those offered to other customers. Loans to officers and directors of the Corporation are summarized as follows (in thousands):
Years Ended September 30, ------------------------- 1998 1997 ------- ------ Balance at beginning of year $ 1,014 $ 712 Loans originated during the year 1,908 685 Loan repayments during the year (1,003) (383) ------- ------ Balance at end of year $ 1,919 $1,014 ======= ======
-24- 4. OFFICE PROPERTIES AND EQUIPMENT Office properties and equipment consisted of the following (in thousands):
September 30, -------------------------- 1998 1997 ------- ------- Land $ 660 $ 422 Building and improvements 2,859 2,096 Office furniture, fixtures and equipment 2,151 1,922 ------- ------- Total 5,670 4,440 Less accumulated depreciation (1,650) (1,431) ------- ------- Office properties and equipment - net $ 4,020 $ 3,009 ======= =======
5. DEPOSIT ACCOUNTS Deposit accounts at September 30, were as follows (in thousands):
1998 1997 -------------------------------- -------------------------------- Rate Balance % Rate Balance % ------- ------- ------- ------- ------- ------- Account Type - ------------ NOW accounts: Commercial noninterest-bearing 0.00% $ 7,119 5.48% 0.00% $ 6,502 5.52% Noncommercial 1.33% 10,925 8.41% 1.33% 9,982 8.47% Money market checking accounts 3.40% 6,832 5.26% 3.89% 6,913 5.86% Regular savings 1.97% 11,849 9.13% 2.43% 11,652 9.88% ------- ------ -------- ------ Total demand and savings deposits 1.60% 36,725 28.28% 1.95% 35,049 29.73% ------- ------ -------- ------ Savings certificates: Up to 3.00% 29 0.02% 22 0.02% 3.01 %- 4.00% 55 0.04% -- 0.00% 4.01 %- 5.00% 19,393 14.93% -- 0.00% 5.01 %- 6.00% 68,969 53.11% 77,401 65.64% 6.01 %- 7.00% 4,702 3.62% 5,342 4.61% -------- ------ -------- ------ Total savings certificates 5.51% $ 93,148 71.72% 5.39% 82,765 70.27% -------- ------ -------- ------ Total deposit accounts 4.40% $129,873 100.00% 4.39% $117,914 100.00% ====== ======== ====== ====== ======== ======
As of September 30, 1998 and 1997, total deposit accounts include approximately $1,432,000 and $1,528,000, respectively, of deposits from the Corporation's officers, shareholders, employees or parties related to them. At September 30, 1998 and 1997, deposit accounts with balances of $100,000 and over totaled approximately $18,829,000 and $13,238,000, respectively. Savings certificates by maturity were as follows (in thousands):
September 30, ------------------------ 1998 1997 ------- ------- Maturity Date - ------------- Within 1 year $74,647 $60,910 After 1 but within 2 years 11,408 14,178 After 2 but within 3 years 2,038 4,017 Thereafter 5,055 3,660 ------- ------- Total certificate accounts $93,148 $82,765 ======= =======
-25- 5. DEPOSITS ACCOUNTS (CONTINUED) Interest expense on deposits consisted of the following (in thousands):
Years Ended September 30, -------------------------------------- 1998 1997 1996 ---- ---- ---- Account Type - ------------ NOW accounts and money market deposit accounts $ 410 $ 353 $ 264 Passbook and statement savings accounts 253 275 302 Certificate accounts 4,912 4,062 3,926 Early withdrawal penalties (31) (24) (13) ------ ------ ------ Total $5,544 $4,666 $4,479 ====== ====== ======
6. SECURITIES SOLD UNDER REPURCHASE AGREEMENTS Securities sold under repurchase agreements at September 30, 1998 and 1997, amounted to $895,000 and $504,000, respectively. U.S. government securities with a book value of $1,000,000 ($1,001,000 market value) at September 30, 1998, are used as collateral for the agreements. The Corporation enters into sales of securities under agreements to repurchase (reverse repurchase agreements). Fixed coupon reverse repurchase agreements are treated as financings. The obligations to repurchase securities sold are reflected as a liability and securities underlying the agreements continue to be reflected as assets in the Consolidated Balance Sheets. 7. ADVANCES FROM THE FEDERAL HOME LOAN BANK AND OTHER BORROWINGS At September 30, 1998 and 1997, the Bank had $41,441,000 and $37,979,000, respectively, of advances outstanding from the Federal Home Loan Bank and treasury, tax and loan deposits. The maturity of the advances from the Federal Home Loan Bank and treasury, tax and loan deposits is as follows (in thousands):
September 30, -------------------------- 1998 1997 ---- ---- Contractual Maturity: Within one year - fixed rate $19,441 $15,979 Within one year - adjustable rate 16,000 0 After one but within two years - fixed rate 1,000 5,000 After one but within two years - adjustable rate 5,000 17,000 ------- ------- Total Advances $41,441 $37,979 ======= ======= Weighted average rate 5.69% 6.00%
The Bank pledges as collateral to the advances their Federal Home Loan Bank Stock, and has entered into a blanket collateral agreement with the Federal Home Loan Bank whereby the Bank maintains, free of other encumbrances, qualifying mortgages (as defined) with unpaid principal balances equal to, when discounted at 75% of the unpaid principal balances, 100% of total advances. The amount of qualifying mortgages was $117,840,000 and $106,880,000, respectively, at September 30, 1998 and 1997. -26- 8. INCOME TAXES Income tax expense is summarized as follows (in thousands):
For the Years Ended September 30, ---------------------------------- 1998 1997 1996 ---- ---- ---- Current $1,094 $ 755 $ 540 Deferred 197 103 (166) ------ ----- ----- Total income taxes $ 897 $ 858 $ 374 ====== ===== =====
The provision for income taxes differed from amounts computed by applying the statutory federal rate of 34% to income before income taxes as follows (in thousands):
For the Years Ended September 30, ---------------------------------- 1998 1997 1996 ---- ---- ---- Tax at federal income tax rate $832 $783 $420 Increase (decrease) resulting from: State income taxes, net of federal benefit 96 91 57 Interest on municipal bonds (6) (10) (37) Other, net (25) (6) (66) ---- ---- ---- Total $897 $858 $374 ==== ==== ====
The tax effects of significant items comprising the Corporation's deferred taxes as of September 30, 1998 and 1997 are as follows (in thousands):
September 30, --------------------- 1998 1997 ---- ---- Deferred tax assets: Deferred loan fees $ -- $ 32 Book reserves in excess of tax basis bad debt reserves 331 177 Mark to market adjustment on securities 136 -- Book reserves in excess of tax basis mortgage servicing rights reserves 67 -- Total deferred tax asset 534 209 ---- ----- Deferred tax liabilities: Difference between book and tax property basis 210 157 Difference between book and tax Federal Home Loan Bank stock basis 100 100 Deferred loan fees 57 - Mark to market adjustment on securities -- 17 Tax bad debt reserve in excess of base year reserve - 94 Other 3 -- ---- ----- Total deferred tax liability 370 368 ---- ----- Net deferred tax asset (liability) $164 ($159) ==== =====
Net deferred tax assets of $164,000 at September 30, 1998, are included in other assets in the balance sheet. Net deferred tax liabilities of $159,000 at September 30, 1997, are included in other liabilities in the balance sheet. Legislation has been passed which repeals the "reserve" method of accounting for thrift bad debt reserves for the first tax year beginning after December 31, 1995 (the fiscal year ending September 30, 1999 for the Corporation which qualifies for deferral of the recapture under the "residential loan requirement"). This legislation requires all thrifts (including the Corporation) to account for bad debts using either the specific charge-off method (available to all thrifts) or the experience method (available only to thrifts that qualify as "small banks," i.e. under $500 million in assets). The Corporation currently uses the experience method of accounting for its tax bad debt reserves. The legislation also suspends recapture of bad debt reserves taken through 1987 (i.e., the base year reserve), but requires thrifts to recapture or repay bad debt deductions taken after 1987 over six years. 8. INCOME TAXES (CONTINUED) As of September 30, 1998, the bad debt reserve subject to recapture, for which deferred taxes have previously been provided, totaled approximately $275,000. As permitted under SFAS 109, no deferred tax liability is provided for approximately $1,636,000 ($621,000 approximate tax effect) of such tax bad debt reserves that arose prior to October 1, 1988. 9. EMPLOYEE BENEFITS The Corporation has a contributory profit-sharing plan which is available to all eligible employees. Annual employer contributions to the plan consist of an amount which matches participant contributions up to a maximum of 5% of a participant's compensation and a discretionary amount determined annually by the Corporation's Board of Directors. In addition, the corporation implemented a money purchase pension plan, effective October 1, 1996, in which all eligible employees participate. The annual contributions to the pension plan will be 5% of a participant's compensation. Employer expensed contributions to the plans were $182,000, $91,000, and $38,000 for the years ended September 30, 1998, 1997 and 1996, respectively. 10. FINANCIAL INSTRUMENTS The Corporation is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments are commitments to extend credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Corporation evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary by the Corporation upon extension of credit, is based on management's credit evaluation of the counter-party. Collateral held varies but may include accounts receivable, inventory, property, plant, and equipment and income- producing commercial properties. Those instruments involve, to varying degrees, elements of credit and interest- rate-risk in excess of the amount recognized in the Consolidated Balance Sheets. The contract amounts of those instruments reflect the extent of the Corporation's involvement in particular classes of financial instruments. The Corporation's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. The Corporation had loan commitments as follows (in thousands):
September 30, ----------------------- 1998 1997 ---- ---- Fixed interest rate commitments to extend credit $ 2,736 $ 1,290 Undisbursed portion of interim construction loans 6,393 6,598 Unused portion of credit lines (principally variable-rate consumer lines secured by real estate) 5,767 4,463 ------- ------- Total $14,896 $12,351 ======= =======
The Corporation has no additional financial instruments with off-balance sheet risk. The Corporation has not been required to perform on any financial guarantees during the past two years. The Corporation has not incurred any losses on its commitments in 1998, 1997 or 1996. -28- 10. FINANCIAL INSTRUMENTS (CONTINUED) The estimated fair values of the Corporation's financial instruments were as follows at September 30, 1998 (in thousands):
September 30, 1998 ------------------------------------- Carrying Amount Fair Value --------------- ---------- Financial assets - ---------------- Cash and cash equivalents $ 3,593 $ 3,593 Securities available for sale 26,856 26,856 Securities held to maturity 2,699 2,744 FHLB Stock 2,023 2,023 Loans 142,202 144,634 Accrued interest receivable 1,197 1,197 Financial liabilities - --------------------- Deposits $129,873 $128,850 Advances from FHLB and other borrowings 41,441 41,547 Securities sold under repurchase agreements 895 895 Off-balance-sheet asset (liabilities) - ------------------------------------- Commitments to extend credit $ 14,896 $ 14,896
September 30, 1997 ------------------------------------- Carrying Amount Fair Value --------------- ---------- Financial assets - ---------------- Cash and cash equivalents $ 7,821 $ 7,821 Securities available for sale 15,855 15,855 Securities held to maturity 7,811 7,927 FHLB Stock 2,105 2,105 Loans 129,957 131,887 Accrued interest receivable 1,317 1,317 Financial liabilities - --------------------- Deposits 117,914 115,332 Advances from FHLB and other borrowings 37,979 38,457 Securities sold under repurchase agreements 504 504 Off-balance-sheet asset (liabilities) Commitments to extend credit $ 12,351 $ 12,351
11. SUPPLEMENTAL CASH FLOW DISCLOSURES
For the Years Ended September 30, ---------------------------------- 1998 1997 1996 --------- -------- ---------- Cash paid for: Income taxes, net of refund $ 792 $ 873 $1,139 Interest 7,213 6,333 5,001 Non-cash transactions: Loans foreclosed -- -- 17 Unrealized gain (loss) on securities available for sale $ 340 $ 166 ($353)
-29- 12. COMMITMENTS AND CONTINGENCIES Concentrations of Credit Risk - The Corporation's business activity is - ----------------------------- principally with customers located in South Carolina. Except for residential loans in the Corporation's market area, the Corporation has no other significant concentrations of credit risk. Litigation - The Corporation is involved in legal actions in the normal course - ---------- of business. In the opinion of management, based on the advice of its general counsel, the resolution of these matters will not have a material adverse impact on future results of operations or the financial position of the Corporation. Potential Impact of Changes in Interest Rates - The Corporation's profitability - --------------------------------------------- depends to a large extent on its net interest income, which is the difference between interest income from loans and investments and interest expense on deposits and borrowings. Like most financial institutions, the Corporation's interest income and interest expense are significantly affected by changes in market interest rates and other economic factors beyond its control. The Corporation's interest-earning assets consist primarily of long-term, fixed rate mortgage loans and investments which adjust more slowly to changes in interest rates than its interest-bearing liabilities which are primarily term deposits and advances. Accordingly, the Corporation's earnings would be adversely affected during periods of rising interest rates. 13. STOCK OPTION AND OWNERSHIP PLANS The Corporation has a stock option incentive compensation plan through which the Board of Directors may grant stock options to officers and employees to purchase common stock of the Corporation at prices not less than 100 percent of the fair market value on the date of grant. The outstanding options expire ten years from the date of grant. The Corporation applies Accounting Principles Board (APB) Opinion 25 and related Interpretations in accounting for the plan. Accordingly, no compensation cost has been charged to operations. Had compensation cost for the plan been determined based on the fair value at the grant dates for awards under the plan consistent with the accounting method available under SFAS No. 123, Accounting for Stock-Based Compensation, the --------------------------------------- Corporations's net income and net income per common share would have been reduced to the pro forma amounts indicated below:
Years Ended September 30, ------------------------- 1998 1997 1996 ---- ---- ---- Net income (in thousands) As reported $1,550 $1,444 $ 862 Pro forma 1,532 1,443 859 Basic net income per common share As reported 1.23 1.17 .071 Pro forma 1.21 1.17 .071 Diluted net income per common share As reported $ 1.15 $ 1.09 $0.69 Pro forma 1.14 1.09 0.69
The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
Years Ended September 30, ------------------------- 1998 1997 1996 ---- ---- ---- Dividend yield 2% 2% 2% Expected volatility 17% 17% 10% Risk-free interest rate 6% 6% 5% Expected lives 10 years 10 years 10 years
A summary of the status of the plan as of September 30, 1998 and 1997, and changes during the years ending on those dates is presented below (all shares have been adjusted for the 2 for 1 stock split in July 1996 and 3:2 stock split in February 1998):
Shares Average Option Price Expiration Grant Date Granted Per Share Date - ---------- -------------------- ---------------- --------------- October, 1995 128,500 6.08 October, 2005 January, 1996 2,100 6.08 January, 2006 April, 1996 6,000 7.00 April, 2006 March, 1997 6,150 10.50 March, 2007 May, 1998 40,000 16.63 May, 2008 ------- Total Shares Granted 182,750
- 30 - 13. STOCK OPTION AND OWNERSHIP PLANS (CONTINUED) As of September 30, 1998, the number of shares exercisable were 79,557. Options were exercised as follows:
Average Exercise For the Years Ended September 30, Shares Exercised Price Per Share - ---------------------------------- ---------------- --------------- 1998 9,920 $5.09 1997 24,621 $3.94 1996 6,963 $5.93
No stock options have been forfeited during the years ended September 30, 1998, 1997, and 1996. At September 30, 1998, 8,900 shares were available for grant. The Plan also provides for stock appreciation rights ("SARs"). To date, no SARs have been granted. Employees participate in stock ownership through the profit sharing plan (see Note 9). During the fiscal year 1998, the Corporation implemented a dividend reinvestment plan that allows existing shareholders to reinvest their dividends for the purchase of additional Union Financial Bancshares stock. In addition, the plan can accept cash contributions up to a maximum of $50,000 annually for the purchase of Union Financial Bancshares stock. The plan currently offers a 5% discount on all purchases and does not charge purchase fees. 14. SHAREHOLDERS' EQUITY, DIVIDEND RESTRICTIONS AND REGULATORY MATTERS On August 7, 1987, the Bank completed its conversion from a federally chartered mutual association to a federally chartered stock association. A special liquidation account was established by the Bank for the preconversion retained earnings of approximately $3,718,000. The liquidation account will be maintained for the benefit of depositors who held a savings or demand account as of the March 31, 1986 eligibility or the June 30, 1987 supplemental eligibility record dates who continue to maintain their deposits at the Bank after the conversion. In the event of a future liquidation (and only in such an event), each eligible and supplemental eligible account holder who continues to maintain his or her savings account will be entitled to receive a distribution from the liquidation account. The total amount of the liquidation account will be decreased in an amount proportionately corresponding to decreases in the savings account balances of eligible and supplemental eligible account holders on each subsequent annual determination date. Except for payment of dividends by the Bank to Union Financial and repurchase of the Bank's stock, the existence of the liquidation account will not restrict the use or application of such net worth. The Bank is prohibited from declaring cash dividends on its common stock or repurchasing its common stock if the effect thereof would cause its net worth to be reduced below either the amount required for the liquidation account or the minimum regulatory capital requirement. In addition, the Bank is also prohibited from declaring cash dividends and repurchasing its own stock without prior regulatory approval in any amount in a calendar year in excess of 100% of its current year's net income to the date of any such dividend or repurchase, plus 50% of the excess of its capital at the beginning of the year over its regulatory capital requirement. Under present regulations of the Office of Thrift Supervision ("OTS"), the Bank must have core capital (leverage requirement) equal to 4.0% of assets, of which 1.5% must be tangible capital, excluding goodwill. The Bank must also maintain risk-based regulatory capital as a percent of risk weighted assets at least equal to 8.0%. In measuring compliance with capital standards, certain adjustments must be made to capital and total assets. - 31 - 14. SHAREHOLDERS' EQUITY, DIVIDEND RESTRICTIONS AND REGULATORY MATTERS (CONTINUED) At September 30, 1998 and 1997, the Bank had the following actual and required capital amounts and ratios (in thousands):
September 30, 1998 -------------------------------------- Tangible Core Risk-Based Capital Capital Capital ---------- ---------- ---------- Actual Capital $14,945 $14,945 $14,945 Unrealized gains on available for sale securities (148) (148) (148) Goodwill and other intangible assets (1,873 (1,873) (1,873) Allowances for loan and lease losses (1) -- -- 994 --- --- --- Total Adjusted capital 12,924 12,924 13,918 Minimum Capital Requirement 2,824 7,530 8,454 ------- ------- ------- Regulatory Capital Excess $10,100 $ 5,394 $ 5,464 ------- ------- ------- Regulatory Capital Ratio 6.86% 6.86% 13.17% September 30, 1997 -------------------------------------- Tangible Core Risk-Based Capital Capital Capital ---------- ---------- ---------- Actual Capital $13,088 $13,088 $13,088 Unrealized losses on available for sale securities 63 63 63 Goodwill and other intangible assets (2,009) (2,009) (2,009) General allowance for loan losses (1) -- -- 928 --- --- --- Total Adjusted capital 11,142 11,142 12,070 Minimum Capital Requirement 2,556 5,111 7,310 ------- ------- ------- Regulatory Capital Excess $ 8,586 $ 6,031 $ 4,760 ------- ------- ------- Regulatory Capital Ratio 6.54% 6.54% 13.21%
(1) Limited to 1.25% of risk-weighted assets The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and discretionary actions by regulators that, if undertaken, could have a material adverse effect on the corporation. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classifications are also subject to qualitative judgements by the regulators about components, risk weightings and other factors. As of the most recent regulatory examination, the Bank was in compliance with the regulatory capital requirements. There are no conditions or events that management believes have changed the Bank's compliance with the guidelines since that examination. 15. RECENTLY ISSUED ACCOUNTING STANDARDS The Financial Accounting Standards Board recently issued four new accounting standards that will affect accounting, reporting, and disclosure of financial information by the Bank. Adoption of these standards is not expected to have a material impact on financial condition or results of operations. The following is a summary of the standards and their required implementation dates: SFAS No. 131, Disclosure about Segments of an Enterprise and Related ------------------------------------------------------ Information -- This statement establishes standards for the way public - ----------- enterprises are to report information about operating segments in annual financial statements and requires those enterprises to report selected information about operating segments in interim financial reports issued to shareholders. Statement 131 is effective for financial statements for periods beginning after December 15, 1997. In the initial year of application, comparative information for earlier years is to be restated unless it is impractical to do so. -32- 15. RECENTLY ISSUED ACCOUNTING STANDARDS (CONTINUED) SFAS No. 132, Employers' Disclosures about Pensions and other Post-Retirement --------------------------------------------------------------- Benefits- This statement deals principally with employers' disclosures about - -------- defined benefit plans and other post-retirement benefit plans. This statement is effective for the Bank for the fiscal year beginning October 1, 1998. SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities-This ------------------------------------------------------------ statement establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative. The statement is effective for the Bank for the fiscal year beginning October 1, 1999 and may not be applied retroactively. SFAS No. 134, Accounting for Mortgage-Backed Securities Retained after the ------------------------------------------------------------ Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise- - ------------------------------------------------------------------------------- This statement is effective for the first quarter beginning after December 15, 1998. This statement conforms the subsequent accounting for securities retained after the securitization of mortgage loans by a mortgage banking enterprise with the subsequent accounting for securities retained after the securitization of other types of assets by a non mortgage banking enterprise. The adoption of this standard is not expected to have a material effect on the Bank's financial statements. 16. UNION FINANCIAL BANCSHARES, INC. FINANCIAL INFORMATION (PARENT CORPORATION ONLY) Condensed financial information for Union Financial is presented as follows (in thousands):
Condensed Balance Sheets September 30, - ------------------------ ------------------------------ 1998 1997 ---------- ---------- Assets: Cash and cash equivalents $ 35 $ 400 Investment in subsidiary 14,922 13,086 Other 28 42 ------- ------- Total Assets $15,300 $13,528 ======= ======= Liabilities and Shareholders' Equity: Liabilities $ -- $ -- Shareholders' Equity 15,300 13,528 ------- ------- Total Liabilities and Shareholders' Equity $15,300 $13,528 ======= ======= Condensed Statements of Income For Years Ended September 30, - ------------------------------------------------ ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- Equity in undistributed earnings of subsidiary $ 1,610 $ 1,477 $ 893 Other expense, net (60) (33) (31) ------- ------- ------- Net income $ 1,550 $ 1,444 $ 862 ======= ======= =======
-33- 16. UNION FINANCIAL BANCSHARES, INC. FINANCIAL INFORMATION (PARENT CORPORATION ONLY) (CONTINUED)
Condensed Statements of Cash Flows For Years Ended September 30, - ---------------------------------- ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- Operating Activities: Net income $ 1,550 $ 1,444 $ 862 Adjustments to reconcile net income to net cash used by operating activities: Equity in undistributed earnings of subsidiary (1,610) (1,477) (893) Decrease in other assets (1) (1) 14 18 ------- ------- ------- Net cash used by operating activities (61) (19) (13) ------- ------- ------- Financing Activities: Dividends received from subsidiary -- 500 500 Dividend reinvestment plan contributions 427 -- -- Dividends paid (467) (433) (404) Proceeds from the exercise of stock options 51 96 41 ------- ------- ------- Net cash provided by financing activities 11 163 137 ------- ------- ------- Net increase (decrease) in cash and cash equivalents (50) 144 124 Cash and cash equivalents at beginning of year 400 256 132 ------- ------- ------- Cash and cash equivalents at end of year $ 350 $ 400 $ 256 ======= ======= =======
-34- BOARD OF DIRECTORS UNION FINANCIAL BANCSHARES AND SUBSIDIARIES
MASON G. ALEXANDER CARL L. MASON Director, Mid-South Management Company CHAIRMAN Retired JAMES W. EDWARDS Dean of Academics, USC-Union DWIGHT V. NEESE President and Chief Executive Officer WILLIAM M. GRAHAM Provident Community Bank Owner, Graham's Flowers DAVID G. RUSSELL LOUIS M. JORDAN Self-employed accountant President, Jordan's Ace Hardware, Inc. LEADERSHIP GROUP PROVIDENT COMMUNITY BANK BENJAMIN D. AIKEN DAVID L. GARRETT Assistant Vice President Vice President Internal Audit & Compliance Manager Mortgage Loan Acquisitions Manager CAROLYN H. BELUE ROBERT J. GREGORY, JR. Assistant Vice President Assistant Vice President Operational & Systems Administration Manager Mortgage Lending Specialist GERALD L. BOLIN GEORGE E. HALL, JR. Vice President Vice President Chief Operating Officer Retail Banking Manager CLEMMIE W. BOYD SUZANNE M. LOWERY Assistant Vice President Assistant Vice President Jonesville Banking Center Manager Wholesale Lending Processing Manager HOLLY COFFER DWIGHT V. NEESE Assistant Vice President President Financial Accounting Manager Chief Executive Officer GREGORY S. DUNCAN MICHAEL H. VANDERFORD Vice President Vice President Credit Administration Manager Mortgage Lending Manager RICHARD H. FLAKE WANDA J. WELLS Executive Vice President Vice President & Corporate Secretary Chief Financial Officer Human Resource Manager EMMA S. GARNER GERALD B. WYATT Assistant Vice President Vice President Collections Officer Consumer Lending Manager
-35- CORPORATE INFORMATION COMMON STOCK INFORMATION - ------------------------ Union Financial Bancshares, Inc.'s (UFBS) common stock is quoted on the Nasdaq SmallCap market.. As of September 30, 1998, the bid and ask prices for Union Financial Bancshares, Inc. was $13.50 and $15.00, respectively. Quotations are obtained form the National Daily Quotation Service. These quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commissions and may not necessarily reflect actual transactions. As of September 30, 1998, there were 523 shareholders of record and 1,278,250 shares of common stock issued and outstanding. This does not reflect the number of persons or entities who held their stock in nominee or "street" names. DIVIDEND INFORMATION - -------------------- During the year ended September 30, 1998, the Corporation declared and paid a cash dividend of $.37 per share. See Note 13 to the financial statements for information regarding certain limitations imposed on the Bank's ability to pay cash dividends to the holding company DIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN - --------------------------------------------- The Corporation has a dividend reinvestment program that allow shareholders to purchase additional shares with corporate dividends and additional cash purchases. Details of the program are outlined in the dividend reinvestment prospectus. To receive more information, please contact Shareholder Services at the corporate address. 10-KSB INFORMATION ------------------ A copy of the Form 10-KSB filed with the Securities and Exchange Commission, will be furnished to shareholders upon written request to the Corporate Secretary, Union Financial Bancshares, Inc., 203 West Main Street, Union, South Carolina 29379. ANNUAL MEETING OF SHAREHOLDERS ------------------------------ The Annual Meeting of Shareholders will convene at the Community Room of the University of South Carolina, Union Campus, Academy and North Mountain Street, Union, South Carolina on January 20, 1999 at 2:00 p.m.. ADDITIONAL INFORMATION ---------------------- If you are receiving duplicate mailing of shareholder reports due to multiple accounts, we can consolidate the mailings without affecting your account registration. To do this, or for additional information, contact our Shareholder Relations Officer, at the Corporate address shown below. CORPORATE OFFICES - ----------------- 203 West Main Street Union, South Carolina 29379 (888) 427-9002 TRANSFER AGENT - -------------- Registrar & Transfer Company 10 Commerce Drive Cranford, New Jersey 07016 (800) 456-0596 INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS - ---------------------------------------- Elliott, Davis & Company, LLP 870 South Pleasantburg Drive Greenville, SC 29607-6286 (864) 242-3370 SPECIAL COUNSEL - --------------- Muldoon, Murphy & Faucette 5101 Wisconsin Avenue, N.W. Washington, D.C. 20016 (202) 362-0840 GENERAL COUNSEL - --------------- Whitney, White and Diamaduros 203 West South Street Union, South Carolina 29379 (864) 427-5661 STOCK INFORMATION - ----------------- Interstate/Johnson Lane Interstate Tower P. O. Box 1012 Charlotte, NC 28201-10123 (800) 929-1003 Trident Securities, Inc. 4601 Six Forks Road Raleigh, NC 27609 (800) 222-2618 Wheat First Union P. O. Box 10586 Greenville, SC 29603 (800) 695-5104 SHAREHOLDER SERVICES OFFICER - ---------------------------- Wanda J. Wells Union Financial Bancshares, Inc. 203 West Main Street Union, SC 29379 (864) 429-1861 - 36 - EX-21 3 EXHIBIT 21 EXHIBIT NO. 21 SUBSIDIARIES OF REGISTRANT
Percentage Jurisdiction or State Subsidiaries Owned of Incorporation ------ ---------------- Provident Community Bank 100% United States Provident Financial Services, Inc. (a) 100% South Carolina
- --------------- (a) A wholly-owned subsidiary of Provident Community Bank. EX-23 4 EXHIBIT 23 [ELLIOTT, DAVIS & COMPANY, L.L.P. APPEARS HERE] CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS We consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-3628) pertaining to the 1987 Stock Option Plan and the 1995 Stock Option Plan of Union Financial Bancshares, Inc. of our report dated November 6, 1998, with respect to the consolidated financial statements of Union Financial Bancshares, Inc. and subsidiary incorporated by reference in the Annual Report on Form 10-KSB for the year ended September 30, 1998. /s/ Elliott, Davis & Company, L.L.P. December 28, 1998 Greenville, South Carolina EX-27 5 EXHIBIT 27
9 This schedule contains financial information extracted from the consolidated financial statements of Union Financial Bancshares, Inc. for the year ended September 30, 1998 and is qualified in its entirety by reference to such financial statements. 1,000 12-MOS SEP-30-1998 OCT-01-1997 SEP-30-1998 2,469 1,124 0 0 26,856 2,699 2,744 142,202 827 189,286 129,873 41,441 2,672 0 0 0 15,300 0 189,286 11,865 997 543 13,405 5,544 7,549 5,856 0 0 4,447 2,447 2,447 0 0 1,550 1.23 1.15 3.42 696 0 0 1,979 928 (127) 26 827 827 0 0
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