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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission File No. 0-24532
FLAG FINANCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
Georgia 58-2094179
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
101 North Greenwood Street, LaGrange, Georgia 30240
(Address of principal executive offices)
(706) 845-5000
(Registrant's telephone number)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $1.00
par value
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. X
The aggregate market value of the Registrant's outstanding Common Stock held by
non-affiliates of the Registrant on March 25, 1998, was $34,165,600. There were
2,036,990 shares of Common Stock outstanding as of March 25, 1998.
Transitional Small Business Disclosure Format. Yes X No
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's 1997 Annual Report are incorporated by reference in
Part II hereof. Portions of the Registrant's Proxy Statement for the 1998 Annual
Meeting of Shareholders to be held on May 13, 1998 are incorporated by reference
in Part III hereof.
FLAG FINANCIAL CORPORATION
Annual Report on Form 10-K
For the Fiscal Year Ended December 31, 1997
Table of Contents
Item Page
Number Number
Part I
1. Business.............................................................. 1
2. Properties............................................................ 13
3. Legal Proceedings..................................................... 14
4. Submission of Matters to a Vote of Security Holders................... 14
Part II
5. Market for Registrant's Common Stock and Related Shareholder Matters.. 15
6. Selected Financial Data............................................... 15
7. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................. 15
8. Financial Statements and Supplementary Data .......................... 15
9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures ............................................... 15
Part III
10. Directors and Executive Officers of the Registrant ................... 16
11. Executive Compensation................................................ 16
12. Security Ownership of Certain Beneficial Owners and Management........ 16
13. Certain Relationships and Related Transactions........................ 16
PART IV
14. Exhibits, Financial Statement Schedules and Reports on Form 8-K....... 17
Signatures................ 20
Index of Exhibits ............ 22
PART I
ITEM 1. BUSINESS
SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
Certain of the matters discussed in this document and in documents
incorporated by reference herein, including matters discussed under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," may constitute forward-looking statements for purposes of the
Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as
amended, and as such may involve known and unknown risks, uncertainties and
other factors which may cause the actual results, performance or achievements of
the Company to be materially different from future results, performance or
achievements expressed or implied by such forward-looking statements. The words
"expect," "anticipate," "intend," "plan," "believe," "seek," "estimate," and
similar expressions are intended to identify such forward-looking statements.
The Company's actual results may differ materially from the results anticipated
in these forward-looking statements due to a variety of factors, including,
without limitation: the effects of future economic conditions; governmental
monetary and fiscal policies, as well as legislative and regulatory changes; the
risks of changes in interest rates on the level and composition of deposits,
loan demand, and the values of loan collateral, securities and interest rate
protection agreements, as well as interest rate risks; the effects of
competition from other commercial banks, thrifts, mortgage banking firms,
consumer finance companies, credit unions, securities brokerage firms, insurance
companies, money market and other mutual funds and other financial institutions
operating in the Company's market area and elsewhere, including institutions
operating locally, regionally, nationally and internationally, together with
such competitors offering banking products and services by mail, telephone, and
computer and the Internet; and the failure of assumptions underlying the
establishment of reserves for possible loan losses and estimations of values of
collateral and various financial assets and liabilities. All written or oral
forward-looking statements attributable to the Company are expressly qualified
in their entirety by these cautionary statements.
The Company
- -----------
FLAG Financial Corporation (the "Company") is the holding company for First
Federal Savings Bank of LaGrange (the "Bank"). The Company was incorporated
under the laws of the State of Georgia on February 9, 1993 at the direction of
the Bank for the purpose of becoming the holding company for the Bank. On March
1, 1994, FLAG Interim Corporation, a wholly-owned subsidiary of the Company
organized for the purpose of effecting the Reorganization, was merged with and
into the Bank, and the Company issued shares of its common stock to shareholders
of the Bank in exchange for all of the outstanding common stock of the Bank (the
"Reorganization"). As a result, shareholders of the Bank became shareholders of
the Company, with the same proportional interests in the Company as they
previously held in the Bank (excluding the nominal effect on their ownership
interest of the exercise of dissenters' rights by certain shareholders of the
Bank).
Following the Reorganization, the Bank continued its business operations as
a federally-chartered stock savings bank under the same name, charter and
bylaws. The directors, officers and employees of the Bank were unchanged
following the Reorganization. The directors of the Bank also serve as the
directors of the Company, and the Chairman of the Board, President and Chief
Executive Officer of the Bank serves as the Chairman of the Board, President and
Chief Executive Officer of the Company.
As a unitary thrift holding company, the Company is intended to facilitate
the Bank's ability to serve its customers' requirements for financial services.
The holding company structure permits diversification by the Company into a
broader range of financial services and other business activities than currently
are permitted to the Bank under applicable law. The holding company structure
also provides greater financial and operating flexibility than is permitted to
the Bank. Additionally, the Articles of Incorporation and Bylaws of the Company
contain terms that provide a degree of anti-takeover protection to the Company
that is currently unavailable to the Bank and its shareholders under regulations
of the Office of Thrift Supervision (the "OTS") but is permissible for the
Company under Georgia law. See "Supervision and Regulation" below. The Bank
On October 28, 1997, the Company entered into an Agreement and Plan of
Merger with Middle Georgia Bankshares, Inc., parent company of Citizens Bank,
Vienna, Georgia ("MGB"), purusant to which MGB will be merged with and into the
Company (the "Merger") and shareholders of MGB will receive 15.75 shares of
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Company common stock for each share of MGB common stock. The Merger is subject
to regulatory approval and approval by the shareholders of both corporations and
will be accounted for as a pooling of interests. Upon consummation of the
Merger, subject to the approval of the Board of Governors of the Federal Reserve
System (the "Federal Reserve") the Company would become a bank holding company,
and the Federal Reserve would replace the OTS as the Company's primarly federal
regulator. The combination is projected to be completed at the end of the first
quarter of 1998. See "Supervision and Regulation" below.
The Bank is a federally chartered stock savings bank headquartered in
LaGrange, Troup County, Georgia. The Bank was originally chartered by the State
of Georgia in January 1927 under the name "Home Building and Loan Association."
The Bank received its federal charter and changed its name to First Federal
Savings and Loan Association of LaGrange in 1955, and at that time its deposits
became insured by the Federal Savings and Loan Insurance Corporation (the
"FSLIC"). In December 1986, the Bank converted from a federal mutual savings and
loan association to a federal stock savings and loan association by selling
805,000 shares of Common Stock to the public pursuant to a plan of conversion
approved by the members of the institution. In June 1989, the Bank converted
from a federal stock savings and loan association to a federal stock savings
bank and changed its name to "First Federal Savings Bank of LaGrange." Based on
total assets of approximately $248 million at December 31, 1997, the Bank is the
7th largest of 34 thrift institutions headquartered in Georgia and the largest
financial institution headquartered in Troup County.
The Bank's deposits are now insured by the Federal Deposit Insurance
Corporation (the "FDIC"), as the successor to the FSLIC. Primarily for the
protection of depositors, the Bank is subject to comprehensive examination,
supervision and regulation by the OTS and the FDIC.
The Bank's business consists primarily of attracting deposits from the
general public and, with these and other funds, making residential mortgage
loans and, to a lesser extent, consumer loans, commercial loans, commercial real
estate loans, residential construction loans and securities investments. In
addition to deposits, sources of funds for the Bank's loans and other
investments include amortization and prepayment of loans, loan origination and
commitment fees, sales of loans or participations in loans, fees received for
servicing loans sold to others and advances from the Federal Home Loan Bank of
Atlanta ("FHLBA"). The principal sources of income for the Bank are interest and
fees collected on loans, including fees received for originating and selling
loans and for servicing loans sold to others, and, to a lesser extent, interest
and dividends collected on other investments and service charges on deposit
accounts. In addition, the Bank's wholly owned service corporation subsidiary,
Piedmont Mortgage Service, Inc., operates a full-service appraisal office under
the name of Piedmont Appraisal Service and offers certain securities brokerage
services under the name of Piedmont Investment Service. The principal expenses
of the Bank are interest paid on deposits, interest paid on FHLBA advances,
employee compensation, federal deposit insurance premiums, office expenses and
other overhead expenses.
The Company's financial performance has been determined primarily by the
results of operations of the Bank because the Company's only significant asset
is the common stock of the Bank. For information regarding the consolidated
financial condition and results of operations of the Company, the Bank and the
Bank's wholly owned subsidiary, Piedmont Mortgage Service, Inc., as of December
31, 1997 and 1996 and for the three years in the period ended December 31, 1997,
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements of the Company and the
related notes thereto which are contained in the Company's 1997 Annual Report
(the "1997 Annual Report"). The 1997 Annual Report is filed as Exhibit 13 to
this report. All average balances presented in this report were derived based on
monthly averages.
Employees
- ---------
As of December 31, 1997, the Bank had 116 full-time and 16 part-time
employees. The employees are not represented by any collective bargaining unit,
and the Bank considers its relationship with its employees to be good.
Competition
- -----------
The banking business is highly competitive. The Bank competes with
several other banking organizations in Troup and surrounding counties. The Bank
also competes with other financial service organizations including credit
unions, finance companies, and certain governmental agencies. To the extent that
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the Bank must maintain non interest earning reserves against deposits, it may
have be at a competitive disadvantage when compared with other financial service
organizations that are not required to maintain reserves against substantially
equivalent sources of funds. Also, other financial institutions with which the
Bank competes may have substantially greater resources and lending capabilities
due to the size of the organization.
Supervision and Regulation
General
- -------
As a federal savings bank, the Bank is subject to extensive regulation,
examination and supervision by the OTS, as its primary regulator, and the FDIC,
as its deposit insurer. The Bank is a member of the FDIC's Savings Association
Insurance Fund ("SAIF"), and its deposit accounts are insured up to applicable
limits by the FDIC. The deposit premiums paid by the Bank to the FDIC currently
paid to the SAIF. The Bank is also a member of the FHLBA. The Bank must file
reports with the OTS and the FDIC concerning its activities and financial
condition, and it must obtain regulatory approvals prior to entering into
certain transactions, such as mergers with, or acquisitions of, other depository
institutions. The OTS and the FDIC conduct periodic examinations to assess the
Bank's compliance with various regulatory requirements. This regulation and
supervision establishes a comprehensive framework of activities in which a
savings association can engage and is intended primarily for the protection of
the insurance fund and depositors. The Company, as a unitary thrift holding
company is subject to the regulation, examination and supervision of the OTS and
files certain reports with, and otherwise complies with, the rules and
regulations of the OTS and the Securities and Exchange Commission under the
federal securities laws.
The OTS and the FDIC have significant 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 allowance for loan losses for regulatory purposes. Any change in such
policies, whether by the OTS, the FDIC or the United States Congress, could have
a material adverse impact on the Company, the Bank, and the operations of both.
Upon consummation of the Merger, subject to the approval of the Federal
Reserve, the Company would become a bank holding company, and the Federal
Reserve would replace the OTS as the Company's primary federal regulator. This
change in primary regulators will likely result in an increased regulatory
burden for the Company. For example, the Company would be subject to certain
minimum capital requirements administered by the Federal Reserve. Failure to
meet the minimum capital requirements can initiate certain mandatory, and
possibly additional discretionary, actions by the Federal Reserve that, if
undertaken, could have a direct material effect on the financial position or
results of operations of the Company. The Company anticipates that it would be
able to satisfy such minimum capital requirements.
The following discussion is intended to be a summary of the material
statutes and regulations applicable to savings associations and their holding
companies generally and does not purport to be a comprehensive description of
all such statutes and regulations.
Regulation of Unitary Thrift Holding Companies
- ----------------------------------------------
As a unitary thrift holding company, the Company is subject to OTS
regulations, examinations, supervision and reporting requirements. In addition,
the OTS has enforcement authority over the Company and its non-savings
association subsidiaries. Among other things, this authority permits the OTS to
restrict or prohibit activities that are determined to be a serious risk to the
financial safety, soundness or stability of a subsidiary savings association.
The Home Owners' Loan Act, as amended ("HOLA") prohibits a unitary thrift
holding company, directly or indirectly, or through one or more subsidiaries,
from acquiring another savings association or holding company thereof, without
prior written approval of the OTS; acquiring or retaining, with certain
exceptions, more than 5.0% of a non-subsidiary savings association, a
non-subsidiary holding company or a non-subsidiary company engaged in activities
other than those permitted by HOLA; or acquiring or retaining control of a
depository institution that is not insured by the FDIC. In evaluating an
application by a holding company to acquire a savings association, the OTS must
3
consider the financial and managerial resources and future prospects of the
company and savings association involved, the effect of the acquisition on the
risk to the FDIC's insurance funds, the convenience and needs of the community
and competitive factors.
As a unitary thrift holding company, the Company generally is not
restricted under existing laws as to the types of business activities in which
it may engage, provided that the Bank continues to satisfy the qualified thrift
lender ("QTL") test. See "Regulation of Federal Savings Associations -- QTL
Test" for a discussion of the QTL requirements. Upon any non-supervisory
acquisition by the Company of another savings association or savings bank that
meets the QTL test, is deemed to be a savings association by the OTS and will be
held as a separate subsidiary, the Company would become a multiple thrift
holding company and would be subject to limitations on the types of business
activities in which it could engage. HOLA limits the activities of a multiple
thrift holding company and its non-insured association subsidiaries primarily to
activities permissible for bank holding companies under Section 4(c)(8) of the
Bank Holding Company Act of 1956, as amended (the "BHC Act"), subject to the
prior approval of the OTS, and to other activities authorized by OTS regulation.
The OTS is prohibited from approving any acquisition that would result in a
multiple thrift holding company controlling savings associations in more than
one state, subject to two exceptions: an acquisition of a savings association in
another state (i) in a supervisory transaction, and (ii) pursuant to authority
under the laws of the state of the association to be acquired that specifically
permit such acquisitions. The conditions imposed upon interstate acquisitions by
those states that have enacted authorizing legislation vary. Some states impose
conditions of reciprocity, which have the effect of requiring that the laws of
both the state in which the acquiring holding company is located (as determined
by the location of its subsidiary savings association) and the state in which
the association to be acquired is located, have each enacted legislation
allowing its savings associations to be acquired by out-of-state holding
companies on the condition that the laws of the other state authorize such
transactions on terms no more restrictive than those imposed on the acquirer by
the state of the target association. Some of these states also impose regional
limitations, which restrict such acquisitions to states within a defined
geographic region. Other states allow full nationwide banking without any
condition of reciprocity. Some states do not authorize interstate acquisitions
of savings associations.
Transactions between the Bank and the Company and its other subsidiaries
are also subject to various conditions and limitations. See "Regulation of
Federal Savings Associations -- Transactions with Related Parties." The Bank is
required to give 30-days written notice to the OTS prior to any declaration of
the payment of any dividends or other capital distributions to the Company. See
"Regulation of Federal Savings Associations -- Limitation on Capital
Distributions."
Congress has recently entertained various industry restructuring proposals
that would require all federal savings banks to convert to national or state
bank charters and to be subject to regulation as commercial banks. Under such
proposals all thrift holding companies, in turn, would be required to register
as bank holding companies under the BHC Act, and those holding companies that
were not unitary thrift holding companies on a specified date would become
subject to the activities restrictions set forth in the BHC Act as well as the
restrictions on affiliations with entities primarily engaged in securities
underwriting contained in the Glass-Steagall Act. While the outcome of the
ongoing efforts to merge the thrift industry into the banking industry and to
reorganize and consolidate the federal regulatory structure are uncertain at
this time, the foregoing proposal, if enacted, would cause the Company to be
regulated as a bank holding company. As such, the Company would be subject to
examination, regulation and periodic reporting under the BHC Act, as
administered by the Federal Reserve. The end result of such initiatives, and the
resulting impact on the Company's business and operations, are unclear at this
time.
Regulation of Federal Savings Associations
Business Activities
-------------------
The Bank derives its lending and investment powers from the HOLA, and the
regulations of the OTS thereunder. Under these laws and regulations, the Bank
may invest in mortgage loans secured by residential and commercial real estate,
commercial and consumer loans, certain types of debt securities, and certain
other assets. The Bank may also establish service corporations that may engage
in activities not otherwise permissible for the Bank, including certain real
estate equity investments and securities and insurance brokerage. These
investment powers are subject to various limitations, including: (i) a
prohibition against the acquisition of any corporate debt security that is not
4
rated in one of the four highest rating categories; (ii) a limit of 400% of an
association's capital on the aggregate amount of loans secured by nonresidential
real estate property; (iii) a limit of 20% of an association's assets on
commercial loans provided that amounts in excess of 10% of total assets are used
only for small business loans; (iv) a limit of 35% of an association's assets on
the aggregate amount of consumer loans and acquisitions of certain debt
securities; (v) a limit of 5.0% of assets on non-conforming loans (loans in
excess of the specific limitations of HOLA); and (vi) a limit of the greater of
5.0% of assets or an association's capital on certain construction loans made
for the purpose of financing what is or is expected to become residential
property.
Loans to One Borrower
---------------------
Under HOLA, savings associations are generally subject to the same limits
on loans to one borrower as are imposed on national banks. Generally, under
these limits, a savings association may not make a loan or extend credit to a
single or related group of borrowers in excess of 15% of the association's
unimpaired capital and surplus. An additional amount may be lent, equal to 10%
of unimpaired capital and surplus, if such loan or extension of credit is fully
secured by readily-marketable collateral. Such collateral is defined to include
certain debt and equity securities and bullion, but generally does not include
real estate.
QTL Test
--------
Under the QTL test, a savings association is required to maintain at least
65% of its "portfolio assets" in certain "qualified thrift investments" in at
least 9 months of the most recent 12-month period. "Portfolio assets" mean, in
general, an association's total assets less the sum of (i) specified liquid
assets up to 20% of total assets, (ii) certain intangibles, including goodwill
and credit card and purchased mortgage servicing rights, and (iii) the value of
property used to conduct the association's business. "Qualified thrift
investments" include various types of loans made for residential and housing
purposes, investments related to such purposes, including certain
mortgage-backed and related securities, and consumer loans up to 10% of the
association's portfolio assets. At December 31, 1997, the Bank maintained 69.02%
of its portfolio assets in qualified thrift investments.
A savings association that fails the QTL test must either operate under
certain restrictions on its activities or convert to a bank charter. The initial
restrictions include prohibitions against (i) engaging in any new activity not
permissible for a national bank, (ii) paying dividends not permissible under
national bank regulations, (iii) obtaining new advances from any FHLB, and (iv)
establishing any new branch office in a location not permissible for a national
bank in the association's home state. In addition, within one year of the date a
savings association ceases to meet the QTL test, any company controlling the
association would have to register under, and become subject to the requirements
of, the BHC Act. If the savings association does not requalify under the QTL
test within the three-year period after it failed the QTL test, it would be
required to terminate any activity and to dispose of any investment not
permissible for a national bank and would have to repay as promptly as possible
any outstanding advances from an FHLB. A savings association that has failed the
QTL test may requalify under the QTL test and be free of such limitations, but
it may do so only once.
Capital Requirements
--------------------
The OTS regulations require savings associations to meet three minimum
capital standards: a tangible capital ratio requirement of 1.5% of total assets
as adjusted under the OTS regulations, a leverage ratio requirement of 4.0% of
core capital to such adjusted total assets, and a risk-based capital ratio
requirement of 8.0% of core and supplementary capital to total risk-based
assets. In determining the amount of risk-weighted assets for purposes of the
risk-based capital requirement, a savings association must compute its
risk-based assets by multiplying its assets and certain off-balance sheet items
by risk-weights, which range from 0% for cash and obligations issued by the
United States Government or its agencies to 100% for consumer and commercial
loans, as assigned by the OTS based on the risks the OTS believes are inherent
in the type of asset.
5
Tangible capital is defined generally as common stockholders' equity
(including retained earnings), certain noncumulative perpetual preferred stock
and related earnings and minority interests in equity accounts of fully
consolidated subsidiaries, less intangibles other than certain purchased
mortgage servicing rights and investments in and loans to subsidiaries engaged
in activities not permissible for a national bank. Core capital is defined
similarly to tangible capital, but core capital also includes purchased credit
card relationships. Supplementary capital currently includes cumulative
preferred stock, long-term perpetual preferred stock, mandatory convertible
securities, subordinated debt and intermediate preferred stock and the allowance
for loan and lease losses. The allowance for loan and lease losses includable in
supplementary capital is limited to a maximum of 1.25% of risk-weighted assets,
and the amount of supplementary capital that may be included as total capital
cannot exceed the amount of core capital.
When determining its compliance with the risk-based capital requirement, a
savings association with "above normal" interest rate risk is required to deduct
a portion of such capital from its total capital to account for the "above
normal" interest rate risk. 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) resulting from a hypothetical 2.0%
increase or decrease in market rates of interest, divided by the estimated
economic value of the association's assets, as calculated in accordance with
guidelines set forth by the OTS. At the times when the 3-month Treasury bond
equivalent yield falls below 4.0%, an association may compute its interest rate
risk on the basis of a decrease equal to one-half of that Treasury rate rather
than on the basis of 2.0%. A savings association whose measured interest rate
risk exposure exceeds 2.0% would be considered to have "above normal" risk. The
interest rate risk component is an amount equal to one-half of the difference
between the association's measured interest rate risk and 2.0%, multiplied by
the estimated economic value of the association's assets. That dollar amount is
deducted from an association's total capital in calculating its risk-based
capital . Any required deduction for interest rate risk becomes effective on the
last day of the third quarter following the reporting date of the association's
financial data on which the interest rate risk was computed. The regulations
authorize the Director of the OTS to waive or defer an association's interest
rate risk component on a case-by-case basis. At December 31, 1997, the Bank was
not required to maintain any additional risk-based capital under this rule.
At December 31, 1997, the Company met each of the OTS capital requirements,
in each case on a fully phased-in basis. The table below presents the Company's
regulatory capital as compared to the OTS regulatory capital requirements at
December 31, 1997:
December 31,
Actual Required Excess
Amount % Amount % Amount %
------ - ------ - ------ -
(dollars in thousands)
Tier 1 capital......... $22,130 8.90% $6,471 4.00% $15,659 4.90%
Tangible capital....... 22,130 8.90 3,856 1.50 18,274 7.40
Risk-based capital..... 24,127 13.70 12,941 8.00 11,186 5.70
The OTS has adopted the Federal Financial Institutions Examination
Council's ("FFIEC") updated statement of policy entitled "Uniform Financial
Institutions Rating System" ("UFIRS") effective January 1, 1997. UFIRS is an
internal rating system used by the federal and state regulators for assessing
the soundness of financial institutions on a uniform basis and for identifying
those institutions requiring special supervisory attention. Under the previous
UFIRS, each financial institution was assigned a confidential composite rating
based on an evaluation and rating of five essential components of an
institution's financial condition and operations including Capital adequacy,
Asset quality, Management, Earnings, and Liquidity (the "CAMEL Rating"). In
updating UFIRS, the FFIEC increased its emphasis on the quality of risk
management practices and added a sixth component for sensitivity to market risk.
For most institutions, the FDIC has indicated that market risk primarily
reflects exposures to changes in interest rates. When regulators evaluate this
component, consideration is expected to be given to: management's ability to
identify, measure, monitor, and control market risk; the institution's size; the
nature and complexity of its activities and its risk profile; and the adequacy
of its capital and earnings in relation to its level of market risk exposure.
Market risk is rated based upon, but not limited to: an assessment of the
sensitivity of the financial institution's earnings or the economic value of its
capital to adverse changes in interest rates, foreign exchange rates, commodity
prices, or equity prices; management's ability to identify, measure, monitor,
and control exposure to market risk; and the nature and complexity of interest
rate risk exposure arising from nontrading positions.
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Limitation on Capital Distributions
-----------------------------------
OTS regulations currently impose limitations upon capital distributions by
savings associations, such as cash dividends, payments to repurchase or
otherwise acquire its shares, payments to stockholders of another institution in
a cash-out merger, and other distributions charged against capital. At least
30-days written notice must be given to the OTS of a proposed capital
distribution by a savings association, and capital distributions in excess of
specified earnings or by certain institutions are subject to approval by the
OTS. An association that has capital in excess of all fully phased-in regulatory
capital requirements before and after a proposed capital distribution and that
is not otherwise restricted in making capital distributions, could, after prior
notice but without the approval of the OTS, make capital distributions during a
calendar year equal to the greater of (i) 100% of its net earnings to date
during the calendar year plus the amount that would reduce by one-half its
"surplus capital ratio" (the excess capital over its fully phased-in capital
requirements) at the beginning of the calendar year, or (ii) 75% of its net
earnings for the previous four quarters. Any additional capital distributions
would require prior OTS approval. In addition, the OTS can prohibit a proposed
capital distribution, otherwise permissible under the regulation, if the OTS has
determined that the association is in need of more than normal supervision or if
it determines that a proposed distribution by an association would constitute an
unsafe or unsound practice. Furthermore, under the OTS prompt corrective action
regulations, the Bank would be prohibited from making any capital distribution
if, after the distribution, the Bank failed to meet its minimum capital
requirements, as described above. See "Prompt Corrective Regulatory Action."
The OTS has proposed regulations that would simplify the existing
procedures governing capital distributions by savings associations. Under the
proposed regulations, the approval of the OTS would be required only for an
association that is deemed to be in troubled condition or that is
undercapitalized or would be undercapitalized after the capital distribution. A
savings association would be able to make a capital distribution without notice
to or approval of the OTS if it is not held by a thrift holding company, is not
deemed to be in troubled condition, has received either of the two highest
composite supervisory ratings and would continue to be adequately capitalized
after such distribution. Notice would have to be given to the OTS by any
association that is held by a savings and loan holding company or that had
received a composite supervisory rating below the highest two composite
supervisory ratings. An association's capital rating would be determined under
the prompt corrective action regulations. See "Prompt Corrective Regulatory
Action."
Liquidity
---------
The Bank is required to maintain an average daily balance of liquid assets
(cash, certain time deposits, bankers' acceptances, specified United States
Government, state or federal agency obligations, shares of certain mutual funds
and certain corporate debt securities and commercial paper) equal to a monthly
average of not less than a specified percentage of its net withdrawable deposit
accounts plus short-term borrowings. This liquidity requirement may be changed
from time to time by the OTS to any amount within the range of 4.0% to 10.0%
depending upon economic conditions and the savings flows of member institutions,
and is currently 5.0%. OTS regulations also require each savings association to
maintain an average daily balance of short-term liquid assets at a specified
percentage (currently 1.0%) of the total of its net withdrawable deposit
accounts and borrowings payable in one year or less. Monetary penalties may be
imposed for failure to meet these liquidity requirements. The Bank's liquidity
ratio at December 31, 1997 was 9.68%, and its short-term liquidity ratio was
6.71%, which exceeded the applicable requirements.
Assessments
-----------
Savings associations are required by OTS regulation to pay assessments to
the OTS to fund the operations of the OTS. The general assessment, paid on a
semi-annual basis, is computed upon the savings association's total assets,
including consolidated subsidiaries, as reported in the association's latest
quarterly Thrift Financial Report.
Branching
---------
Subject to certain limitations, HOLA and the OTS regulations permit
federally chartered savings associations to establish branches in any state of
the United States. The authority to establish such a branch is available (i) in
states that expressly authorize branches of savings associations located in
7
another state and (ii) to an association that qualifies as a "domestic building
and loan association" under the Code of Federal Regulations, which imposes
qualification requirements similar to those for a "qualified thrift lender"
under HOLA. See "QTL Test." The authority for a federal savings association to
establish an interstate branch network would facilitate a geographic
diversification of the association's activities. This authority under HOLA and
the OTS regulations preempts any state law purporting to regulate branching by
federal savings associations.
Community Reinvestment
----------------------
Under the Community Reinvestment Act ("CRA"), as implemented by OTS
regulations, a savings association has a continuing and affirmative obligation
consistent with its safe and sound operation to help meet the credit needs of
its entire community, including low and moderate income neighborhoods. The CRA
does not establish specific lending requirements or programs for financial
institutions, nor does it limit an institution's discretion to develop the types
of products and services that it believes are best suited to its particular
community, consistent with the CRA. The CRA requires the OTS, in connection with
its examination of a savings association, to assess the association's record of
meeting the credit needs of its community and to take such record into account
in its evaluation of certain applications by such association. The CRA also
requires all institutions to make public disclosure of their CRA ratings.
In April 1995, the OTS and the other federal banking agencies adopted
amendments revising their CRA regulations. Among other things, the amended CRA
regulations substitute for the prior process-based assessment factors a new
evaluation system that would rate an institution based on its actual performance
in meeting community needs. In particular, the proposed system would focus on
three tests: (i) a lending test, to evaluate the institution's record of making
loans in its service areas; (ii) an investment test, to evaluate the
institution's record of investing in community development projects, affordable
housing and programs benefiting low or moderate income individuals and
businesses; and (iii) a service test, to evaluate the institution's delivery of
services through its branches, ATMs and other offices.
The joint agency CRA regulations provide that an institution evaluated
under a given test receive one of five ratings for that test: outstanding; high
satisfactory; low satisfactory; needs to improve; or substantial non-compliance.
The ratings for each test are then combined to produce an overall composite
rating of either outstanding, satisfactory (including both high and low
satisfactory,) needs to improve, or substantial non-compliance. In the case of a
retail-oriented institution, its lending test rating forms the basis for its
composite rating. That rating is then increased by up to two levels in the case
of outstanding or high satisfactory investment performance, increased by one
level in the case of outstanding service, and decreased by one level in the case
of substantial non-compliance in service. An institution found to have engaged
in illegal lending discrimination is rebuttably presumed to have a
less-than-satisfactory composite CRA rating. The Bank received an "outstanding"
CRA rating in its most recent examination.
Small savings associations are to be assessed pursuant to a streamlined
approach focusing on a lesser range of information and performance standards.
The term "small savings association" is defined as including associations with
less than $250 million in assets or an affiliate of a holding company with
banking and thrift assets of less than $1.0 billion, which would include the
Bank. An institution's CRA performance record is considered in certain
regulatory applications and may be used as a basis for denying an application.
Transactions with Related Parties
---------------------------------
The Bank's authority to engage in transactions with its "affiliates" is
limited by the OTS regulations and by Sections 23A and 23B of the Federal
Reserve Act ("FRA"). In general, an affiliate of the Bank is any company that
controls the Bank or any other company that is controlled by a company that
controls the Bank, excluding the Bank's subsidiaries other than those that are
insured depository institutions. The OTS regulations prohibit a savings
association (i) from lending to any of its affiliates that are engaged in
activities that are not permissible for bank holding companies under Section
4(c) of the BHC Act and (ii) from purchasing the securities of any affiliate
other than a subsidiary. Section 23A limits the aggregate amount of transactions
8
with any individual affiliate to 10% of the capital and surplus of the savings
association and also limits the aggregate amount of transactions with all
affiliates to 20% of the savings association's capital and surplus. Extensions
of credit to affiliates are required to be secured by collateral in an amount
and of a type described in Section 23A, and the purchase of low quality assets
from affiliates is generally prohibited. Section 23B provides that certain
transactions with affiliates, including loans and asset purchases, must be on
terms and under circumstances, including credit standards, that are
substantially the same or at least as favorable to the association as those
prevailing at the time for comparable transactions with nonaffiliated companies.
In the absence of comparable transactions, such transactions may only occur
under terms and circumstances, including credit standards, that in good faith
would be offered to or would apply to nonaffiliated companies.
The Bank's authority to extend credit to its directors, executive officers
and 10% stockholders, as well as to entities controlled by such persons, is
currently governed by the requirements of Sections 22(g) and 22(h) of the FRA
and Regulation O of the Federal Reserve thereunder. Among other things, these
provisions require that extensions of credit to insiders (i) be made on terms
that are substantially the same as, and follow credit underwriting procedures
that are not less stringent than, those prevailing for comparable transactions
with unaffiliated persons and that do not involve more than the normal risk of
repayment or present other unfavorable features with the exceptions of (1) the
benefit compensation must be widely available to employees of the bank and (2)
the benefit or compensation does not give preference to any insider over other
employees of the bank and (ii) not exceed certain limitations on the amount of
credit extended to such persons, individually and in the aggregate, which limits
are based, in part, on the amount of the association's capital. In addition,
extensions of credit in excess of certain limits must be approved by the
association's board of directors.
Enforcement
-----------
Under the Federal Deposit Insurance Act, as amended (the "FDI Act"), the
OTS has primary enforcement responsibility over savings associations and has the
authority to bring enforcement action against all "institution-affiliated
parties," including any controlling stockholder or any stockholder, attorney,
appraiser and accountant who knowingly or recklessly participates in any
violation of applicable law or regulation or breach of fiduciary duty or certain
other wrongful actions that causes or is likely to cause a more than a minimal
loss or other significant adverse effect on an insured savings association.
Civil penalties cover a wide range of violations and actions and range from
$5,000 for each day during which violations of law, regulations, orders and
certain written agreements and conditions continue, up to $1,000,000 per day for
such violations if the person obtained a substantial pecuniary gain as a result
of such violation or knowingly or recklessly caused a substantial loss to the
institution. Criminal penalties for certain financial institution crimes include
fines of up to $10 million and imprisonment for up to 30 years. In addition,
regulators have substantial discretion to take enforcement action against an
institution that fails to comply with its regulatory requirements, particularly
with respect to its capital requirements. Possible enforcement actions range
from the imposition of a capital plan and capital directive to receivership,
conservatorship or the termination of deposit insurance. Under the FDI Act, the
FDIC has the authority to recommend to the Director of OTS that enforcement
action be taken with respect to a particular savings association. If action is
not taken by the Director of the OTS, the FDIC has authority to take such action
under certain circumstances.
Standards for Safety and Soundness
----------------------------------
The FDI Act, as amended by the Federal Deposit Insurance Corporation
Improvement Act of 1991, as amended ("FDICIA") and the Riegle Community
Development and Regulatory Improvement Act of 1994 ("Community Development
Act"), requires the OTS, together with the other federal bank regulatory
agencies, to prescribe standards, by regulations or guidelines, relating to
internal controls, information systems and internal audit systems, loan
documentation, credit underwriting, interest rate risk exposure, asset growth,
asset quality, earnings, stock valuation and compensation, fees and benefits and
such other operational and managerial standards as the agencies deem
appropriate. The OTS and the federal bank regulatory agencies have adopted,
effective August 9, 1995, a set of guidelines prescribing safety and soundness
standards pursuant to FDICIA. The guidelines establish general standards
relating to internal controls and information systems, internal audit systems,
loan documentation, credit underwriting, interest rate exposure, asset growth
and compensation, fees and benefits. In general, the guidelines require, among
other things, appropriate systems and practices to identify and manage the risks
and exposures specified in the guidelines. The guidelines prohibit excessive
compensation as an unsafe and unsound practice and describe compensation as
excessive when the amounts paid are unreasonable or disproportionate to the
services performed by an executive officer, employee, director or principal
stockholder. The OTS and the other agencies determined that stock valuation
standards were not appropriate. In addition, the OTS adopted regulations that
authorize, but do not require, the OTS to order an institution that has been
given notice by the OTS that it is not satisfying any of such safety and
soundness standards to submit a compliance plan. If, after being so notified, an
9
institution fails to submit an acceptable compliance plan or fails in any
material respect to implement an accepted compliance plan, the OTS must issue an
order directing action to correct the deficiency and may issue an order
directing other actions of the types to which an undercapitalized association is
subject under the "prompt corrective action" provisions of FDICIA. See "Prompt
Corrective Regulatory Action." If an institution fails to comply with such an
order, the OTS may seek to enforce such order in judicial proceedings and to
impose civil money penalties.
Real Estate Lending Standards
-----------------------------
The OTS and the other federal banking agencies adopted regulations to
prescribe standards for extensions of credit that (i) are secured by real estate
or (ii) are made for the purpose of financing the construction of improvements
on real estate. The OTS regulations require each savings association to
establish and maintain written internal real estate lending standards that are
consistent with safe and sound banking practices and appropriate to the size of
the association and the nature and scope of its real estate lending activities.
The standards also must be consistent with accompanying OTS guidelines, which
include loan-to-value ratios for the different types of real estate loans.
Associations are also permitted to make a limited amount of loans that do not
conform to the proposed loan-to-value limitations so long as such exceptions are
reviewed and justified appropriately. The guidelines also list a number of
lending situations in which exceptions to the loan-to-value standards are
justified.
Prompt Corrective Regulatory Action
-----------------------------------
Under the OTS prompt corrective action regulations, the OTS is required to
take certain, and is authorized to take other, supervisory actions against
undercapitalized savings associations. For this purpose, a savings association
would be placed in one of five categories based on the association's capital.
Generally, a savings association is treated as "well capitalized" if its ratio
of total capital to risk-weighted assets is at least 10.0%, its ratio of Tier 1
(core) capital to risk-weighted assets is at least 6.0%, its ratio of Tier 1
(core) capital to total assets is at least 5.0%, and it is not subject to any
order or directive by the OTS to meet a specific capital level. A savings
association will be treated as "adequately capitalized" if its ratio of total
capital to risk-weighted assets is at least 8.0%, its ratio of Tier 1 (core)
capital to risk-weighted assets is at least 4.0%, and its ratio of Tier 1 (core)
capital to total assets is at least 4.0% (3.0% if the association receives the
highest rating on the CAMEL financial institutions rating system).
A savings association that has a total risk-based capital ratio of less
than 8.0% or a leverage ratio or a Tier 1 (core) capital ratio that is less than
4.0% (3.0% leverage ratio if the association receives the highest rating on the
CAMEL financial institutions rating system) is considered to be
"undercapitalized." A savings association that has a total risk-based capital
ratio of less than 6.0% or a Tier 1 (core) risk-based capital ratio or a
leverage ratio of less than 3.0% is considered to be "significantly
undercapitalized." A savings association that has a tangible capital to assets
ratio equal to or less than 2.0% is deemed to be "critically undercapitalized."
The elements of an association's capital for purposes of the prompt corrective
action regulations are defined generally as they are under the regulations for
minimum capital requirements. See "Capital Requirements."
The severity of the action authorized or required to be taken under the
prompt corrective action regulations increases as an association's capital
deteriorates within the three undercapitalized categories. All associations are
prohibited from paying dividends or other capital distributions or paying
management fees to any controlling person if, following such distribution, the
association would be undercapitalized. An undercapitalized association is
required to file a capital restoration plan within 45 days of the date the
association receives notice that it is within any of the three undercapitalized
categories. The OTS is required to monitor closely the condition of an
undercapitalized association and to restrict the asset growth, acquisitions,
branching and new lines of business of such an association. Significantly
undercapitalized associations are subject to restrictions on compensation of
senior executive officers; such an association may not, without OTS consent, pay
any bonus or provide compensation to any senior executive officer at a rate
exceeding the officer's average rate of compensation (excluding bonuses, stock
options and profit-sharing) during the 12 months preceding the month when the
association became undercapitalized. A significantly undercapitalized
association may also be subject, among other things, to forced changes in the
composition of its board of directors or senior management, additional
restrictions on transactions with affiliates, restrictions on acceptance of
deposits from correspondent associations, further restrictions on asset growth,
10
restrictions on rates paid on deposits, forced termination or reduction of
activities deemed risky and any further operational restrictions deemed
necessary by the OTS.
If one or more grounds exist for appointing a conservator or receiver for
an association, the OTS may require the association to issue additional debt or
stock, sell assets, be acquired by a depository association holding company or
combine with another depository association. The OTS and the FDIC have a broad
range of grounds under which they may appoint a receiver or conservator for an
insured depository association. Under FDICIA, the OTS is required to appoint a
receiver (or with the concurrence of the FDIC, a conservator) for a critically
undercapitalized association within 90 days after the association becomes
critically undercapitalized or, with the concurrence of the FDIC, to take such
other action that would better achieve the purposes of the prompt corrective
action provisions. Such alternative action can be renewed for successive 90-day
periods. However, if the association continues to be critically undercapitalized
on average during the quarter that begins 270 days after it first became
critically undercapitalized, a receiver must be appointed, unless the OTS makes
certain findings with which the FDIC concurs and the Director of the OTS and the
Chairman of the FDIC certify that the association is viable. In addition, an
association that is critically undercapitalized is subject to more severe
restrictions on its activities, and is prohibited, without prior approval of the
FDIC from, among other things, entering into certain material transactions or
paying interest on new or renewed liabilities at a rate that would significantly
increase the association's weighted average cost of funds.
Where appropriate, the OTS can impose corrective action by a thrift holding
company under the "prompt corrective action" provisions of FDICIA.
Insurance of Deposit Accounts
-----------------------------
Pursuant to FDICIA, the FDIC established a new risk-based assessment
system for determining the deposit insurance assessments to be paid by insured
depository institutions. Under the new assessment system, which began in 1993,
the FDIC assigns an institution to one of three capital categories based on the
institution's financial information as of the reporting period ending seven
months before the assessment period. The three capital categories consist of (i)
well capitalized, (ii) adequately capitalized or (iii) undercapitalized. The
FDIC also assigns an institution to one of three supervisory subcategories
within each capital group. The supervisory subgroup to which an institution is
assigned is based on a supervisory evaluation provided to the FDIC by the
institution's primary federal regulator and information that the FDIC determines
to be relevant to the institution's financial condition and the risk posed to
the deposit insurance funds. An institution's assessment rate depends on the
capital category and supervisory category to which it is assigned. Under the
regulation, there are nine assessment risk classifications (i.e., combinations
of capital groups and supervisory subgroups) to which different assessment rates
are applied. Assessment rates originally ranged from 0.04% (for the Bank
Insurance Fund (the "BIF"), which primarily insures commercial banks) or 0.23%
(for the SAIF) of deposits for an institution in the highest category (i.e.,
well-capitalized and financially sound, with no more than a few minor
weaknesses) to 0.31% of deposits for an institution in the lowest category
(i.e., undercapitalized and substantial supervisory concern). These rates were
established for both funds to achieve a designated ratio of reserves to insured
deposits (i.e., 1.25%) within a specified period of time.
Once the designated ratio for the BIF was reached in May 1995, the FDIC
reduced the assessment rate applicable to BIF deposits in two stages, so that,
beginning in 1996, the deposit insurance premiums for 92% of all BIF members in
the highest capital and supervisory categories were set at $2,000 per year,
regardless of deposit size. The FDIC elected to retain the assessment rate range
of 23 to 31 basis points for SAIF members given the undercapitalized nature of
that insurance fund.
Recognizing that the disparity between the SAIF and BIF premium rates have
adverse consequences for SAIF-insured institutions and other banks with SAIF
assessed deposits, including reduced earnings and an impaired ability to raise
funds in capital markets and to attract deposits, in July 1995, the FDIC, the
Treasury Department, and the OTS released statements outlining a proposed plan
to recapitalize the SAIF, the principal feature of which was a special one-time
assessment on depository institutions holding SAIF-insured deposits, which was
intended to recapitalize the SAIF at a reserve ratio of 1.25%. This proposal
contemplated elimination of the disparity between the assessment rates on BIF
and SAIF deposits following recapitalization of the SAIF.
11
A variation of this proposal designated the Deposit Insurance Funds Act of
1996 (the "Funds Act") was enacted by Congress as part of omnibus budget
legislation and signed into law on September 30, 1996. As directed by the Funds
Act, the FDIC has implemented a special one-time assessment of approximately
65.7 basis points (0.657%) on a depository institution's SAIF-insured deposits
held as of March 31, 1995, (or approximately 52.6 basis points on SAIF deposits
acquired by banks in certain qualifying transactions). The Bank recorded charges
against earnings for the special assessment in the quarter ended September 30,
1996 in the amount of approximately $1,156,000.
In addition, on December 24, 1996, in order to avoid collecting more than
needed to maintain the SAIF's capitalization rate at 1.25 percent of aggregate
insured deposits, the FDIC adopted in final a revision in the SAIF assessment
rate schedule which retroactively effected, as of December 11, 1996, (i) a
widening in the assessment rate spread among institutions in the different
capital and risk assessment categories, (ii) an overall reduction of the
assessment rate range assessable on SAIF deposits of from 0 to 27 basis points,
and (iii) a special interim assessment rate range for the last quarter of 1996
of from 18 to 27 basis points on institutions subject to assessments with
respect to certain bonds issued in the late 1980s by the Financing Corporation
("FICO") to recapitalize the now-defunct FSLIC. Effective January 1, 1997, FICO
assessments are imposed on both BIF- and SAIF-insured deposits in annual amounts
presently estimated at 1.29 basis points and 6.44 basis points, respectively.
The Bank anticipates that the net effect of the decrease in the premium
assessment rate on SAIF deposits will result in a reduction in their total
deposit insurance premium assessments, assuming no further changes in announced
premium assessment rates. During 1997, SAIF assessments totalled approximately
$186,000 for the Bank.
Accounting for Bad Debt Reserves
--------------------------------
The Small Business Job Protection Act of 1996 repealed the reserve method
of accounting for bad debts by thrift institutions, effective for taxable years
beginning after 1995. As a result, large thrift institutions with more than $500
million in assets are no longer able to deduct additions to a reserve for bad
debts but are permitted to deduct bad debts only as they occur. In addition, a
large thrift institution generally is required to recapture (i.e., take into
income) its post-1987 additions to its bad debt reserve, that is, the amount by
which its bad debt reserve exceeds the balance of such reserve as of the end of
its last taxable year ending before 1988.
Small thrift institutions with not more than $500 million in assets, such
as the Bank, are no longer permitted to make additions to their bad debt
reserves based upon a percentage of the Bank's taxable income (the "PTI Method")
but may make additions to their bad debt reserves based upon the Bank's actual
loss experience (the "Experience Method") in lieu of deducting bad debts only as
they occur. In the case of a small thrift institution, the recapture of
post-1987 additions to its bad debt reserve is limited to the amount of
recapture that reduces the reserve to the balance it would have had if the
institution had always computed its additions to reserves under the Experience
Method.
The excess reserves are recaptured into income over a period of six
years, which may be extended to seven or eight years if the thrift meets a
residential loan requirement. The Bank had no excess reserves. Thus, it was not
subject to any recapture.
The remainder of the Bank's pre-1988 bad debt reserves is subject to
recapture if the Bank ceases to qualify as a bank for federal income tax
purposes, or if the Bank makes certain distributions to the Company in excess of
the Bank's current and accumulated earnings and profits, distributions in
redemption of stock, or distributions in partial or complete liquidation. In the
event of a distribution considered to be made from its bad debt reserves, the
amount restored to income would be the amount which, when reduced by the amount
of tax on such income, is equal to the amount of the distribution. The Bank does
not intend to make any distribution that would result in recapture of any
portion of its pre-1988 bad debt reserves.
Federal Home Loan Bank System
-----------------------------
The Bank is a member of the FHLBA, which is one of the regional FHLBs
composing the FHLB System. Each FHLB provides a central credit facility
primarily for its member institutions. The Bank, as a member of the FHLBA, is
required to acquire and hold shares of capital stock in the FHLBA in an amount
at least equal to the greater of 1.0% of the aggregate principal amount of its
unpaid residential mortgage loans and similar obligations at the beginning of
each year or 1/20 of its advances (borrowings) from the FHLBA. The Bank was in
compliance with this requirement at December 31, 1997, with an investment in
FHLBA stock of $2,081,900. Any advances from a FHLB must be secured by specified
types of collateral, and all long-term advances may be obtained only for the
purpose of providing funds for residential housing finance.
12
The FHLBs are required to provide funds for the resolution of insolvent
thrifts and to contribute funds for affordable housing programs. These
requirements could reduce the amount of earnings that the FHLBs can pay as
dividends to their members and could also result in the FHLBs imposing a higher
rate of interest on advances to their members. If dividends were reduced, or
interest on future FHLB advances increased, the Bank's net interest income would
likely also be reduced.
Federal Reserve System
----------------------
The Bank is subject to provisions of the FRA and the Federal Reserve's
regulations pursuant to which depository institutions may be required to
maintain non-interest-earning reserves against their deposit accounts and
certain other liabilities. Currently, reserves must be maintained against
transaction accounts (primarily NOW and regular checking accounts). The Federal
Reserve regulations generally require that reserves be maintained in the amount
of 3.0% of the aggregate of transaction accounts up to $52.0 million. The amount
of aggregate transaction accounts in excess of $52.0 million are currently
subject to a reserve ratio of 10.0%, which ratio the Federal Reserve may adjust
between 8.0% and 12.0%. The Federal Reserve regulations currently exempt $4.3
million of otherwise reservable balances from the reserve requirements, which
exemption is adjusted by the Federal Reserve at the end of each year. The Bank
is in compliance with the foregoing reserve requirements. Because required
reserves must be maintained in the form of either vault cash, a
non-interest-bearing account at a Federal Reserve Bank, or a pass-through
account as defined by the Federal Reserve, the effect of this reserve
requirement is to reduce the Bank's interest-earning assets. The balances
maintained to meet the reserve requirements imposed by the Federal Reserve may
be used to satisfy liquidity requirements imposed by the OTS. FHLB System
members are also authorized to borrow from the Federal Reserve discount window,
but Federal Reserve regulations require such institutions to exhaust all FHLB
sources before borrowing from a Federal Reserve Bank.
ITEM 2. PROPERTIES
The Company and the Bank operate from a main office which contains
approximately 28,400 square feet of usable office space and is located on
approximately two acres of land at 101 North Greenwood Street, LaGrange,
Georgia. The Bank owns both the building and the land.
The Bank also operates three full-service branch offices and one
drive-through facility in LaGrange. One of the full-service branches contains
approximately 360 square feet of office space in the Winn-Dixie Marketplace
grocery store at 908 Hogansville Road in LaGrange. This office is leased by the
Bank for $3,000 per month pursuant to a lease that expires in August 2001. A
second full-service branch office is located at 1795 West Point Road at Lee's
Crossing in LaGrange. This office contains approximately 2,700 square feet of
office space on one acre of land, and both the land and the building are owned
by the Bank. The third full-service branch office is located at 1417 LaFayette
Parkway in LaGrange. This office contains approximately 2,300 square feet of
office space on 1.2 acres of land, and it has three drive through lanes. Both
the building and the land are owned by the Bank. The drive-through facility is
located at 306 Vernon Street in LaGrange. This facility contains approximately
1,800 square feet of space, and both the building and the land are owned by the
Bank.
The Bank leases approximately 2,760 square feet of office space at 5669
Whitesville Road, Suite A, Columbus, Georgia, where its loan production office
is located. The monthly lease payments are $3,133 for 1998, $3,251 for 1999, and
$3,329 for the 2000. The lease expires on December 31, 2000.
The Bank leases approximately 600 square feet of office space at 200
Broad Street, Suite D, LaGrange, Georgia. This office space is where Piedmont
Mortgage Service, Inc., operating under the name "Piedmont Appraisal Service,"
is located. The lease requires monthly lease payments of $1,000 and expires on
March 15, 1999.
The Bank leases approximately 2,500 square feet of office space at 205
North Lewis Street, Suites 2 and 3, LaGrange, Georgia. This office space is the
location for the Bank's Deposit Operations and Leasing department. The lease
requires monthly lease payments of $1,939 and expires in December 2001.
The net book value of the Company's investment in land, premises,
furniture, fixtures and equipment, totaled approximately $6.4 million at
December 31, 1997. See Note 4 of Notes to Consolidated Financial Statements
13
contained in the Company's 1997 Annual Report, which information is incorporated
by reference in Item 8 hereof. Most of the Bank's data processing equipment is
held by the Bank under capitalized leases, and the Bank uses an independent
service bureau for most of its data processing needs.
All of the Company's and the Bank's offices are in good condition and
are adequate for the Company's and the Bank's current and foreseeable needs.
The Bank is unaware of any potential environmental liability that it
may incur in connection with any properties or other assets owned by it.
14
ITEM 3. LEGAL PROCEEDINGS
The Bank is periodically involved as plaintiff or defendant in various
legal actions in the ordinary course of its business. During August 1992 through
October 1995, the Bank entered into a series of leases and secured loans with
Bennett Funding Group, Inc. and certain of its affiliates ("Bennett Funding").
Bennett Funding allegedly operated in a fraudulent manner and are now the
subject of bankruptcy proceedings, In re Bennett Funding Group, Inc., et al,
Case No. 96-61376 et seq., which are pending in the United States Bankruptcy
Court for the Northern District of New York. These leases and loans have an
aggregate principal balance of $2.05 million.
After a series of negotiations, the Bank has settled its disputes with
the bankruptcy trustee under the terms of a Settlement Agreement. The Settlement
Agreement has been approved by the Bankruptcy Court and executed by the Bank and
the trustee. The settlement provides for a "split" between the Bank and the
trustee on all cash collections on leases which collateralize the loans at
issue.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted by the Company to a vote of its shareholders
during the fourth quarter of 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
Information relating to the market for, holders of and dividends paid
on the Company's Common Stock is set forth under the caption "Corporate
Information-Stock Prices and Dividends" on page 40 of the Company's 1997 Annual
Report. Such information is incorporated herein by reference. The 1997 Annual
Report is filed as Exhibit 13 to this report.
ITEM 6. SELECTED FINANCIAL DATA
Selected consolidated financial data for the Company and its
subsidiaries for each year of the five-year period ended December 31, 1997 is
set forth under the caption "Financial Highlights" on page 4 of the 1997 Annual
Report. Such financial data is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
A discussion of the consolidated financial condition and results of
operations of the Company and its subsidiaries at and for the dates and periods
covered by the financial statements set forth in the 1997 Annual Report is set
forth under the caption "Management's Discussion and Analysis of Financial
Condition and Results of Operations" on pages 5 through 13 of the 1997 Annual
Report. Such discussion is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following consolidated financial statements of the Company and its
subsidiaries, together with the Report of Independent Certified Public
Accountants thereon, which are set forth on pages 14 through 37 of the 1997
Annual Report, are incorporated herein by reference:
Consolidated Balance Sheets at December 31, 1997 and 1996
Consolidated Statements of Operations for each of the three years in
the period ended December 31, 1997
15
Consolidated Statements of Changes in Stockholders' Equity for each of
the three years in the period ended December 31, 1997
Consolidated Statements of Cash Flows for each of the three years in
the period ended December 31, 1997
Notes to Consolidated Financial Statements
The Company is not required to furnish the supplementary financial
information specified by Item 302 of Regulation S-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On February 20, 1997, the Company engaged Porter Keadle Moore, LLP as
independent accountants to audit the Company's financial statements for the
fiscal year ending December 31, 1997, and elected not to renew the engagement of
the Company's previous independent accountants, Robinson, Grimes & Company, P.C.
No adverse opinions or disclaimers of opinion were given by Robinson, Grimes &
Company, P.C. during the fiscal years ended December 31, 1995, and 1996, nor
were any of their opinions qualified as to uncertainty, audit scope, or
accounting principle, during the time Robinson, Grimes & Company, P.C. during
the fiscal years ended December 31, 1995, 1996, and the subsequent interim
period through February 20, 1997, as described in Items 304(a) (1) (iv) and (v)
of Regulation S-K. The decision was approved by the Company's Audit Committee
and Board of Directors.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relating to the directors of the Company is set forth under
the captions "Proposal 1 - Election of Directors-Nominees" and "Proposal 1 -
Election of Directors-Information Regarding Nominees and Continuing Directors"
in the Company's Proxy Statement for its 1998 Annual Meeting of Shareholders to
be held on May 13, 1998. Such information is incorporated herein by reference.
Pursuant to Instruction 3 to Item 401(b) of Regulation S-K and General
Instruction G(3) to Form 10-K, information relating to the executive officers of
the Company and the Bank is set forth in Item 4(A) of this report under the
caption "Executive Officers of the Registrant." Information regarding compliance
with Section 16(a) of the Securities Exchange Act of 1934, as amended, by
directors and executive officers of the Company and the Bank is set forth under
the caption "Compliance with Section 16(a) of the Securities Exchange Act of
1934" in the Proxy Statement referred to in Item 10 above. Such information is
incorporated herein by reference. To the Company's knowledge, no person was the
beneficial owner of more than 10% of the Company's common stock during 1997.
ITEM 11. EXECUTIVE COMPENSATION
Information relating to executive compensation and the sale of stock to
certain directors is set forth under the captions "Proposal 1 - Election of
Directors - Director Compensation" and "Executive Compensation" in the Proxy
Statement referred to above. Such information is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding ownership of the Company's common stock as of
December 31, 1997, by certain persons is set forth under the captions "Voting -
Stock Ownership" and "Proposal 1 - Election of Directors - Information Regarding
Nominees and Continuing Directors" in the Proxy Statement referred to in Item 10
above. Such information is incorporated herein by reference.
16
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain transactions between the Bank and
affiliates of the Company and the Bank is set forth under the caption "Executive
Compensation - Loans to Management" in the Proxy Statement referred to in Item
10 above. Such information is incorporated herein by reference.
PART IV
Exhibit No. Description
- ---------- -----------
2 Agreement and Plan of Merger, dated October 28, 1997, by and
between the Company and Middle Georgia Bankshares, Inc. (Annex A
to the Joint Proxy Statement/Prospectus included in the Company's
Registration Statement on Form S-4, as amended (File No.
333-44011)
3.1 (i) Articles of Incorporation of the Company, as amended through
October 15, 1993 (Exhibit 3.1(i) to the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1993)
(ii) Bylaws of the Company, as amended through September 16, 1993
(Exhibit 3.1(ii) to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1993)
Tax Sharing Agreement dated March 1, 1994, among the Company, the
Bank and Piedmont Mortgage Service, Inc. (Exhibit 10.1 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1993)
10.2 Management Contracts and Compensatory Plans:
a. Employment Agreement between John S. Holle and the Bank
dated as of January 1, 1993 (Exhibit 10.4 to the Company's
Registration Statement on Form S-4, Registration No.
33-58392)
b. Employment Agreement between Ellison C. Rudd and the Bank
dated as of January 1, 1995 - (Exhibit 10.3b to the
Company's 10-K for the fiscal year ended December 31, 1995)
c. 1986 Stock Option and Incentive Plan (Exhibit 10.1 to the
Company's Registration Statement on Form S-4, Registration
No. 33-58392)
d. FLAG Financial Corporation 1994 Employees Stock Incentive Plan
(Exhibit 10.6 to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1993)
e. FLAG Financial Corporation 1994 Directors Stock Incentive Plan
(Exhibit 10.7 to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1993)
f. Profit Sharing Thrift Plan, as amended through November 1,
1992 (Exhibit 10.2 to the Company's Registration Statement
on Form S-4, Registration No. 33-58392)
g. Pension Retirement Plan (Exhibit 10.3 to the Company's
Registration Statement on Form S-4, Registration No.
33-58392)
11 Statement regarding computation of per share earnings
13 1997 Annual Report
21 Subsidiaries (Exhibit 21 to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1994)
17
(b) Reports on Form 8-K.
A Current Report on Form 8-K dated October 28, 1997 regarding the
merger with Middle Georgia Bankshares, Inc. was filed in the
fourth quarter, 1997.
(c) See Item 14(a)(3) above.
(d) See Item 14(a)(2) above.
- ------------------
+ All or portions of page 4 and pages 5 through 40 of the Company's 1997 Annual
Report, as indicated in this report, are incorporated herein by reference. Other
than as noted herein, the Company's 1997 Annual Report is furnished to the
Securities and Exchange Commission solely for its information and is not deemed
to be "filed" with the Securities and Exchange Commission or subject to the
liabilities of Section 18 of the Securities Exchange Act of 1934, as amended.
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.
FLAG FINANCIAL CORPORATION
(Registrant)
Date: March 30, 1998 By: /S/ John S. Holle
--------------------------------
John S. Holle
Chairman of the Board, President
and Chief Executive Officer
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 indicated on March 30, 1998.
Signature Title
/s/ John S. Holle
- ------------------- Chairman of the Board, President and
John S. Holle Chief Executive Officer
/s/ Ellison C. Rudd Executive Vice President, Chief Financial
- ------------------- Officer, Treasurer and Director
Ellison C. Rudd (Principal Financial and Accounting Officer)
/s/ Dr. Albert Glenn Bailey
- ---------------------------
Dr. Albert Glenn Bailey Director
/s/ H. Speer Burdette, III
- ---------------------------
H. Speer Burdette, III Director
/s/ Fred A. Durand, III
- ---------------------------
Fred A. Durand, III Director
/s/ Kelly R. Linch
- ---------------------------
Kelly R. Linch Director
/s/ Gordon M. Smith
- ---------------------------
Gordon M. Smith Director
18
/s/ John W. Stewart, Jr.
- ---------------------------
John W. Stewart, Jr. Director
/s/ Dr. Steven P. Teaver
- ---------------------------
Dr. Steven P. Teaver Director
/s/ Robert W. Walters
- ---------------------------
Robert W. Walters Director
19
FLAG FINANCIAL CORPORATION
Index of Exhibits
The following exhibits are filed as part of or incorporated by reference in
this report. Where such filing is made by incorporation by reference to a
previously filed registration statement or report, such registration statement
or report is identified in parentheses.
Exhibit No. Description
3.1 (i) Articles of Incorporation of the Company, as amended
through October 15, 1993 (Exhibit 3.1(i) to the Company's
Annual Report on Form 10-K for the fiscal year ended
December 31, 1993)
(ii) Bylaws of the Company, as amended through September
16, 1993 (Exhibit 3.1(ii) to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1993)
10.1 Agreement and Plan of Merger and Reorganization dated
February 28, 1994 among the Bank, the Company and FLAG
Interim Savings Bank (Exhibit 2.1 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31,
1993)
10.2 Tax Sharing Agreement dated March 1, 1994, among the
Company, the Bank and Piedmont Mortgage Service, Inc.
(Exhibit 10.1 of the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1993)
10.3 Management Contracts and Compensatory Plans:
a. Employment Agreement between John S. Holle and the Bank
dated as of January 1, 1993 (Exhibit 10.4 to the Company's
Registration Statement on Form S-4, Registration No.
33-58392)
b. Employment Agreement between Ellison C. Rudd and the Bank
dated as of January 1, 1995 - (Exhibit 10.3 b to the
Company's 10-K for the fiscal year ended December 31, 1995)
c. 1986 Stock Option and Incentive Plan (Exhibit 10.1 to the
Company's Registration Statement on Form S-4, Registration
No. 33-58392)
d. FLAG Financial Corporation 1994 Employees Stock Incentive
Plan (Exhibit 10.6 to the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1993)
20
e. FLAG Financial Corporation 1994 Directors Stock Incentive
Plan (Exhibit 10.7 to the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1993)
f. Profit Sharing Thrift Plan, as amended through November 1,
1992 (Exhibit 10.2 to the Company's Registration Statement
on Form S-4, Registration No. 33-58392)
g. Pension Retirement Plan (Exhibit 10.3 to the Company's
Registration Statement on Form S-4, Registration No.
33-58392)
11 Statement regarding computation of per share earnings -
13 1997 Annual Report
21 Subsidiaries (Exhibit 21 to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1994)
- ---------------
+ All or portions of page 4 and pages 5 through 40 of the Company's 1997 Annual
Report, as indicated in this report, are incorporated herein by reference. Other
than as noted herein, the Company's 1996 Annual Report is furnished to the
Securities and Exchange Commission solely for its information and is not deemed
to be "filed" with the Securities and Exchange Commission or subject to the
liabilities of Section 18 of the Securities Exchange Act of 1934, as amended.
21