UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
-------------------------
FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2005
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OR
/_/ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number: 0-24626
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COOPERATIVE BANKSHARES, INC.
----------------------------
(Exact name of registrant as specified in its charter)
North Carolina 56-1886527
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(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
201 Market Street, Wilmington, North Carolina 28401
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (910) 343-0181
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Former name, former address and former fiscal year,
if changed since last report.
N/A
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
/X/ Yes /_/ No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
/_/ Yes /X/ No
APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares
outstanding of each of the issuer's classes of common stock, as of the latest
practicable date. 4,300,316 shares at August 3, 2005
TABLE OF CONTENTS
Page
Part I Financial Information
Item 1 Financial Statements
Consolidated Statements of Financial Condition, June 30, 2005
and December 31, 2004 3
Consolidated Statements of Operations, for the three and six months ended
June 30, 2005 and 2004 4
Consolidated Statement of Stockholders' Equity, for the six months
ended June 30, 2005 5
Consolidated Statements of Cash Flows, for the six months ended
June 30, 2005 and 2004 6-7
Notes to Consolidated Financial Statements 8-10
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations 10-17
Item 3 Quantitative and Qualitative Disclosures About Market Risk 17
Item 4 Controls and Procedures 17
Part II Other Information
Item 1 Legal Proceedings 18
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 18
Item 3 Defaults Upon Senior Securities 18
Item 4 Submission of Matters to a Vote of Security Holders 18
Item 5 Other Information 18
Item 6 Exhibits 18-19
Signatures 20
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
JUNE 30, 2005 December 31, 2004*
--------------------- ---------------------
(UNAUDITED)
ASSETS
Cash and due from banks, noninterest-bearing $ 16,060,823 $ 12,031,627
Interest-bearing deposits in other banks 5,171,879 4,360,960
--------------------- ---------------------
Total cash and cash equivalents 21,232,702 16,392,587
Securities:
Available for sale (amortized cost of $43,605,582 in June 2005
and $44,432,476 in December 2004) 43,595,691 44,535,010
Held to maturity (estimated market value of $2,345,205 in June
2005 and $2,678,860 in December 2004) 2,343,527 2,659,595
FHLB stock 5,334,000 4,518,500
Loans held for sale 38,711,294 7,239,131
Loans 534,497,520 453,769,733
Less allowance for loan losses 5,287,337 4,353,227
--------------------- ---------------------
Net loans 529,210,183 449,416,506
Other real estate owned 16,003 -
Accrued interest receivable 2,598,692 2,085,164
Premises and equipment, net 9,150,782 8,597,015
Goodwill 1,461,543 1,461,543
Other assets 13,426,021 13,202,393
--------------------- ---------------------
Total assets $ 667,080,438 $ 550,107,444
===================== =====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 512,096,853 $ 414,757,904
Short-term borrowings 39,318,323 32,342,878
Escrow deposits 438,017 194,408
Accrued interest payable 307,683 190,689
Accrued expenses and other liabilities 2,873,562 2,629,188
Long-term obligations 63,080,022 53,082,676
--------------------- ---------------------
Total liabilities 618,114,460 503,197,743
--------------------- ---------------------
Stockholders' equity:
Preferred stock, $1 par value, 3,000,000 shares authorized,
no shares issued and outstanding - -
Common stock, $1 par value, 14,000,000 shares authorized,
4,300,316 and 2,860,764 shares issued and outstanding 4,300,316 2,860,764
Additional paid-in capital 2,686,393 2,673,233
Accumulated other comprehensive income (loss) (6,529) 67,672
Retained earnings 41,985,798 41,308,032
--------------------- ---------------------
Total stockholders' equity 48,965,978 46,909,701
--------------------- ---------------------
Total liabilities and stockholders' equity $ 667,080,438 $ 550,107,444
===================== =====================
Book value per common share** $ 11.39 $ 10.93
===================== =====================
*Derived from audited consolidated financial statements.
**The 2004 information is computed after giving the retroactive effect of a 3-for-2 stock split in the form of
a 50% stock dividend declared on January 19, 2005 and paid on February 24, 2005.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.
3
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2005 2004 2005 2004
----------------- ----------------- ----------------- ----------------
INTEREST INCOME:
Loans $ 8,665,774 $ 6,091,877 $ 15,919,452 $ 12,036,711
Securities 531,862 556,521 1,068,083 1,118,604
Other 28,020 7,886 48,510 17,767
Dividends on FHLB stock 59,482 37,371 108,476 73,107
----------------- ----------------- ----------------- ----------------
Total interest income 9,285,138 6,693,655 17,144,521 13,246,189
----------------- ----------------- ----------------- ----------------
INTEREST EXPENSE:
Deposits 2,761,724 1,471,973 4,844,215 2,978,798
Borrowed funds 918,451 692,385 1,636,345 1,364,395
----------------- ----------------- ----------------- ----------------
Total interest expense 3,680,175 2,164,358 6,480,560 4,343,193
----------------- ----------------- ----------------- ----------------
NET INTEREST INCOME 5,604,963 4,529,297 10,663,961 8,902,996
Provision for loan losses 650,000 300,000 975,000 520,000
----------------- ----------------- ----------------- ----------------
Net interest income after provision for loan losses 4,954,963 4,229,297 9,688,961 8,382,996
----------------- ----------------- ----------------- ----------------
NONINTEREST INCOME:
Gain on sale of loans 716,678 697,290 1,324,629 1,277,459
Service charges and fees on loans 250,423 122,385 403,411 192,098
Deposit-related fees 426,833 394,447 809,847 758,540
Bank-owned life insurance earnings 78,880 84,405 157,915 171,013
Other income, net 54,860 58,841 88,251 103,749
----------------- ----------------- ----------------- ----------------
Total noninterest income 1,527,674 1,357,368 2,784,053 2,502,859
----------------- ----------------- ----------------- ----------------
NONINTEREST EXPENSES:
Compensation and fringe benefits 2,582,502 2,409,441 5,105,259 4,705,847
Occupancy and equipment 857,240 810,112 1,714,484 1,634,417
Professional and examination fees 128,100 93,055 252,229 224,276
Advertising 127,676 117,990 243,950 242,970
Other 528,264 493,424 1,059,544 1,016,955
----------------- ----------------- ----------------- ----------------
Total noninterest expenses 4,223,782 3,924,022 8,375,466 7,824,465
----------------- ----------------- ----------------- ----------------
Income before income taxes 2,258,855 1,662,643 4,097,548 3,061,390
Income tax expense 867,942 539,061 1,558,998 1,019,337
----------------- ----------------- ----------------- ----------------
NET INCOME $ 1,390,913 $ 1,123,582 $ 2,538,550 $ 2,042,053
================= ================= ================= ================
NET INCOME PER SHARE:
Basic* $ 0.32 $ 0.26 $ 0.59 $ 0.48
================= ================= ================= ================
Diluted* $ 0.32 $ 0.26 $ 0.58 $ 0.47
================= ================= ================= ================
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic* 4,297,363 4,291,146 4,294,239 4,287,228
================= ================= ================= ================
Diluted* 4,373,929 4,363,722 4,373,057 4,366,872
================= ================= ================= ================
*The 2004 information is computed after giving the retroactive effect of a 3-for-2 stock split in the form of a 50% stock dividend
declared on January 19, 2005 and paid on February 24, 2005.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.
4
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Unaudited)
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN COMPREHENSIVE RETAINED STOCKHOLDERS'
STOCK CAPITAL INCOME (LOSS) EARNINGS EQUITY
---------------- ---------------- ----------------- ----------------- -----------------
Balance, December 31, 2004 $ 2,860,764 $ 2,673,233 $ 67,672 $ 41,308,032 $ 46,909,701
Exercise of stock options 13,723 86,538 -- -- 100,261
Stock traded to exercise options
(4,522 shares) (4,522) (80,944) -- -- (85,466)
Tax benefit of stock option exercised -- 7,566 -- -- 7,566
3-for-2 stock split in the form
of a 50% dividend 1,430,351 -- -- (1,430,351) --
Other comprehensive
loss, net of taxes -- -- (74,201) -- (74,201)
Net income -- -- -- 2,538,550 2,538,550
Cash dividends ($.10 per share) -- -- -- (430,433) (430,433)
--------------- --------------- ----------------- ----------------- -----------------
Balance, June 30, 2005 $ 4,300,316 $ 2,686,393 $ (6,529) $ 41,985,798 $ 48,965,978
=============== =============== ================= ================= =================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.
5
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
SIX MONTHS ENDED
JUNE 30,
2005 2004
--------------------- ---------------------
OPERATING ACTIVITIES:
Net income $ 2,538,550 $ 2,042,053
Adjustments to reconcile net income to net cash
provided by operating activities:
Net accretion, amortization, and depreciation 493,835 505,073
Net gain on sale of loans (1,324,629) (1,277,459)
Provision for deferred income taxes (373,976) (201,172)
Loss on sale of premises and equipment 5,571 3,412
Loss on sales of foreclosed real estate -- (1,565)
Valuation losses on foreclosed real estate 11,584 16,400
Provision for loan losses 975,000 520,000
Proceeds from sale of loans held for sale 79,990,016 81,552,706
Loan originations held for sale (110,138,063) (80,179,066)
Changes in assets and liabilities:
Accrued interest receivable (513,528) (49,456)
Prepaid expenses and other assets 188,572 674,531
Accrued interest payable 116,994 13,322
Accrued expenses and other liabilities 244,374 686,975
--------------------- ---------------------
Net cash provided (used) by operating activities (27,785,700) 4,305,754
--------------------- ---------------------
INVESTING ACTIVITIES:
Purchases of securities available for sale -- (5,493,265)
Proceeds from maturity of securities available for sale -- 200,000
Repayments of mortgage-backed securities available for sale 825,727 2,575,050
Repayments of mortgage-backed securities held to maturity 316,301 790,422
Net purchases of FHLB stock (815,500) (499,900)
Loan originations, net of principal repayments (80,804,905) (30,235,695)
Proceeds from disposals of foreclosed real estate 14,870 16,535
Additions to other real estate owned (5,717) (9,487)
Purchases of premises and equipment (1,057,238) (300,339)
Proceeds from sale of premises and equipment 5,000 --
--------------------- ---------------------
Net cash used in investing activities (81,521,462) (32,956,679)
--------------------- ---------------------
FINANCING ACTIVITIES:
Net increase in deposits 97,338,949 13,392,910
Net change in short-term borrowings 6,975,445 (57,242)
Repayments on long-term obligations (2,654) (2,512)
Proceeds received on long-term obligations 10,000,000 10,000,000
Proceeds from issuance of common stock 22,361 46,506
Dividends paid (430,433) (343,292)
Net change in escrow deposits 243,609 157,852
--------------------- ---------------------
Net cash provided by financing activities 114,147,277 23,194,222
--------------------- ---------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 4,840,115 (5,456,703)
CASH AND CASH EQUIVALENTS:
BEGINNING OF PERIOD 16,392,587 18,393,365
--------------------- ---------------------
END OF PERIOD $ 21,232,702 $ 12,936,662
===================== =====================
(Continued)
6
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
SIX MONTHS ENDED
JUNE 30,
2005 2004
--------------------- ---------------------
Cash paid for:
Interest $ 6,363,566 $ 4,329,871
Income taxes 1,505,015 810,900
Summary of noncash investing and financing activities:
Transfer from loans to foreclosed real estate 36,740 305,678
Loans to faciliatate the sale of foreclosed real estate -- 111,725
Unrealized loss on securities available for sale,
net of taxes (74,201) (497,298)
Reclassifications between long-term obligations
and short-term borrowings 5,000,000 5,000,000
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Accounting Policies: The significant accounting policies followed by
-------------------
Cooperative Bankshares, Inc. (the "Company") for interim financial
reporting are consistent with the accounting policies followed for annual
financial reporting. These unaudited consolidated financial statements have
been prepared in accordance with Rule 10-01 of Regulation S-X, and, in
management's opinion, all adjustments of a normal recurring nature
necessary for a fair presentation have been included. The accompanying
consolidated financial statements do not purport to contain all the
necessary financial disclosures that might otherwise be necessary in the
circumstances and should be read in conjunction with the consolidated
financial statements and notes thereto in the Company's annual report for
the year ended December 31, 2004 (the "Annual Report"). The results of
operations for the six-month period ended June 30, 2005 are not necessarily
indicative of the results to be expected for the full year.
2. Basis of Presentation: The accompanying unaudited consolidated financial
---------------------
statements include the accounts of Cooperative Bankshares, Inc.,
Cooperative Bank (the "Bank") and its wholly owned subsidiaries, Lumina
Mortgage Company, Inc. ("Lumina") and CS&L Holdings, Inc. ("Holdings"), and
Holdings' majority owned subsidiary, CS&L Real Estate Trust, Inc. (the
"REIT"). All significant intercompany items have been eliminated. Certain
items for prior periods have been reclassified to conform to the current
period presentation. These reclassifications have no effect on the net
income or stockholders' equity as previously reported.
3. Earnings Per Share: Earnings per share ("EPS") is calculated by
-------------------
dividing net income by the weighted average number of common shares
outstanding ("basic EPS") and the sum of the weighted average number of
common shares outstanding and potential common stock ("diluted EPS").
Potential common stock consists of stock options issued and outstanding. In
determining the number of shares of potential common stock, the treasury
stock method was applied. This method assumes that the number of shares
issuable upon exercise of the stock options is reduced by the number of
common shares assumed purchased at market prices with the proceeds from the
assumed exercise of the common stock options plus any tax benefits received
as a result of the assumed exercise. The following table provides a
reconciliation of income available to common stockholders and the average
number of shares outstanding for the periods below after giving the
retroactive effect of a 3-for-2 stock split in the form of a 50% stock
dividend declared on January 19, 2005 and paid on February 24, 2005:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2005 2004 2005 2004
----------------- ----------------- -------------- --------------
Net income (numerator) $ 1,390,913 $ 1,123,582 $ 2,538,550 $ 2,042,053
Shares for basic EPS (denominator) 4,297,363 4,291,146 4,294,239 4,287,228
Dilutive effect of stock options 76,566 72,576 78,818 79,644
--------------- ---------------- -------------- --------------
Shares for diluted EPS (denominator) 4,373,929 4,363,722 4,373,057 4,366,872
=============== ================ ============== ==============
For the periods ended June 30, 2005 and 2004, there were 0 and 4,000
options outstanding, respectively, that were not dilutive since the
exercise price did not exceed the average market price. These options have
been omitted from the calculation of the dilutive effect of stock options.
4. Comprehensive Income: Comprehensive income includes net income and all
--------------------
other changes to the Company's equity, with the exception of transactions
with shareholders ("other comprehensive income"). The Company's only
components of other comprehensive income relate to unrealized gains and
losses on available for sale securities. The following table sets forth the
components of other comprehensive income and total comprehensive income for
the three and six months ended June 30.
8
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2005 2004 2005 2004
---------------- ---------------- --------------- ---------------
Net income $ 1,390,913 $ 1,123,582 $ 2,538,550 $ 2,042,053
Other comprehensive income (loss)
Unrealized gains (losses) on available for sale securities 436,238 (1,149,854) (112,424) (753,483)
Income tax benefit (expense) (148,321) 390,950 38,223 256,185
---------------- ---------------- --------------- ---------------
Other comprehensive income (loss) 287,917 (758,904) (74,201) (497,298)
---------------- ---------------- --------------- ---------------
Comprehensive income $ 1,678,830 $ 364,678 $ 2,464,349 $ 1,544,755
================ ================ =============== ===============
5. Stock-Based Compensation: On January 1, 1996 the Company adopted
--------------------------
SFAS No. 123, "Accounting for Stock-Based Compensation." As permitted by
SFAS No. 123, the Company has chosen to continue to apply APB Opinion No.
25, "Accounting for Stock Issued to Employees" and related interpretations.
The option exercise price is the market price of the common stock on the
date the option is granted. Accordingly, no compensation cost has been
recognized for options granted under the Option Plan. Had compensation cost
for the Company's Option Plan been determined based on the fair value at
the grant dates for awards under the option plan consistent with the method
of SFAS No. 123, the Company's net income and net income per share would
have been reduced to the pro forma amounts indicated below.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------- --------------------------------
2005 2004 2005 2004
--------------- --------------- --------------- ---------------
Net income, as reported $ 1,390,913 $ 1,123,582 $ 2,538,550 $ 2,042,053
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects - - - (23,054)
--------------- --------------- --------------- ---------------
Pro forma net income $ 1,390,913 $ 1,123,582 $ 2,538,550 $ 2,018,999
=============== =============== =============== ===============
Earnings per share:
Basic-as reported $ 0.32 $ 0.26 $ 0.59 $ 0.48
=============== =============== =============== ===============
Basic-pro forma $ 0.32 $ 0.26 $ 0.59 $ 0.47
=============== =============== =============== ===============
Diluted-as reported $ 0.32 $ 0.26 $ 0.58 $ 0.47
=============== =============== =============== ===============
Diluted-pro forma $ 0.32 $ 0.26 $ 0.58 $ 0.46
=============== =============== =============== ===============
6. Recent Accounting Pronouncements: In December 2004, the FASB issued
----------------------------------
SFAS No. 123(R), "Accounting for Stock-Based Compensation (SFAS No.
123(R)." SFAS No. 123(R) establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods
or services. This Statement focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based
payment transactions. SFAS No. 123(R) requires that the fair value of such
equity instruments be recognized as an expense in the historical financial
statements as services are performed. Prior to SFAS No. 123(R), only
certain pro forma disclosures of fair value were required. This Statement
was amended on April 14, 2005 to make the provisions of this Statement
effective at the beginning of the next fiscal year that begins after June
15, 2005. Accordingly, we will adopt SFAS No. 123(R) on January 1, 2006.
The adoption of SFAS No. 123(R) is expected to have a material effect on
our consolidated financial statements.
9
7. Subsequent Event: On July 22, 2005, the Company announced that its Board of
----------------
Directors has authorized the issuance of up to $15 million of trust
preferred securities ("Trust Preferred Securities") for general corporate
purposes and to increase the regulatory capital of the Bank. The Company
intends to issue the Trust Preferred Securities in a pooled private
placement offering during the third quarter of fiscal 2005.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
Cooperative Bankshares, Inc. (the "Company") is a registered bank holding
company incorporated in North Carolina in 1994. The Company is the parent
company of Cooperative Bank (the "Bank"), a North Carolina chartered commercial
bank. Cooperative Bank, headquartered in Wilmington, North Carolina, was
chartered in 1898. The Bank provides financial services through 20 offices in
Eastern North Carolina. One of the Bank's subsidiaries, Lumina Mortgage Company,
Inc. ("Lumina") is a mortgage banking firm originating and selling residential
mortgage loans through 5 offices along the coast from North Myrtle Beach, South
Carolina, to Virginia Beach, Virginia. The Bank's other subsidiary, CS&L
Holdings, Inc. ("Holdings") is a holding company incorporated in Virginia for
CS&L Real Estate Trust, Inc. (the "REIT"), which is a real estate investment
trust.
Through its offices, the Bank provides a wide range of banking products,
including interest-bearing and noninterest-bearing checking accounts,
certificates of deposit, savings accounts and individual retirement accounts. It
offers an array of loan products: overdraft protection, commercial, consumer,
agricultural, real estate, residential mortgage and home equity loans. Also
offered are safe deposit boxes and automated banking services through ATMs and
Access24 Phone Banking. The Bank also offers free Online Banking and Bill Pay
for personal accounts. In addition, the Bank offers discount brokerage services,
annuity sales and mutual funds through a third party arrangement with UVEST
Investment Services.
The Bank opened its new Shipyard office on August 1, 2005, which was a
relocation of its Wilmington Long Leaf branch. The Bank is scheduled to move
another Wilmington branch to a more desirable location in 2005. The Bank began
utilizing its new Operations and Training Center in May 2005. On July 12, 2005,
the Company entered into a lease for a mortgage office of Lumina in Charlotte,
North Carolina. This office will open in the third quarter of 2005.
MISSION STATEMENT
It is the mission of the Company to provide the maximum in safety and security
for our depositors, an equitable rate of return for our stockholders, excellent
service for our customers, and to do so while operating in a fiscally sound and
conservative manner, with fair pricing of our products and services, good
working conditions, outstanding training and opportunities for our staff, along
with a high level of corporate citizenship.
MANAGEMENT STRATEGY
The Bank's lending activities have traditionally concentrated on the origination
of loans for the purpose of constructing, financing or refinancing residential
properties. In recent years the Bank has emphasized the origination of
nonresidential real estate loans and secured and unsecured consumer and business
loans. As of June 30, 2005, approximately $357 million, or 63%, of the Bank's
loan portfolio, which excludes loans held for sale, consisted of loans secured
by residential properties. This compares to approximately $309 million, or 68%
at December 31, 2004. The Bank originates adjustable rate and fixed rate loans.
As of June 30, 2005, adjustable rate and fixed rate loans totaled approximately
62% and 38%, respectively, of the Bank's total loan portfolio.
The Bank has chosen to sell a large percentage of its fixed rate mortgage loan
originations in the secondary market and through brokered arrangements. This
enables the Bank to invest these funds in commercial loans, while increasing fee
income and reducing interest rate risk.
INTEREST RATE SENSITIVITY ANALYSIS
Interest rate sensitivity refers to the change in interest spread resulting from
changes in interest rates. To the extent that interest income and interest
expense do not respond equally to changes in interest rates, or that all rates
do not change uniformly, earnings will be affected. Interest rate sensitivity,
at a point in time, can be analyzed using a static gap analysis that measures
the match in balances subject to repricing between interest-earning assets and
10
interest-bearing liabilities. Gap is considered positive when the amount of
interest rate sensitive assets exceeds the amount of interest rate sensitive
liabilities. Gap is considered negative when the amount of interest rate
sensitive liabilities exceeds the amount of interest rate sensitive assets. At
June 30, 2005, the Company had a one-year positive gap position of 5.7% as
compared to 8.8% at December 31, 2004. During a period of falling interest
rates, a positive gap would tend to adversely affect net interest income, while
a negative gap would tend to result in an increase in net interest income.
During a period of rising interest rates, a positive gap would tend to result in
an increase in net interest income while a negative gap would tend to adversely
affect net interest income. It is important to note that certain shortcomings
are inherent in static gap analysis. Although certain assets and liabilities may
have similar maturities or periods of repricing, they may react in different
degrees to changes in market interest rates. For example, a part of the
Company's adjustable-rate mortgage loans are indexed to the National Monthly
Median Cost of Funds to SAIF-insured institutions. This index is considered a
lagging index that may lag behind changes in market rates. The one-year or less
interest-bearing liabilities also include checking, savings and money market
deposit accounts. Experience has shown that the Company sees relatively modest
repricing on these types of transaction accounts. Management takes this into
consideration in determining acceptable levels of interest rate risk.
When Lumina gives a rate lock commitment to a customer, there is a concurrent
"lock in" for the loan with a secondary market investor under a best efforts
delivery mechanism. Therefore, interest rate risk is mitigated because any
commitment to fund a loan available for sale is concurrently hedged by a
commitment from an investor to purchase the loan under the same terms. Loans are
usually sold within 60 days after closing.
LIQUIDITY
The Company's goal is to maintain adequate liquidity to meet potential funding
needs of loan and deposit customers, pay operating expenses and meet regulatory
liquidity requirements. Maturing securities, principal repayments of loans and
securities, deposits, income from operations and borrowings are the main sources
of liquidity. The Bank has been granted a line of credit by the Federal Home
Loan Bank of Atlanta ("FHLB") in an amount of up to 25% of the Bank's total
assets. At June 30, 2005, the Bank's borrowed funds from the FHLB equaled 14.3%
of its total assets. Scheduled loan repayments are a relatively predictable
source of funds, unlike deposits and loan prepayments that are significantly
influenced by general interest rates, economic conditions and competition.
At June 30, 2005, the estimated market value of liquid assets (cash, cash
equivalents, marketable securities and loans held for sale) was approximately
$105.9 million, which represents 17.2% of deposits and borrowed funds as
compared to $70.8 million or 14.2% of deposits and borrowed funds at December
31, 2004. The increase in liquid assets was due to increases in loans held for
sale and cash and cash equivalents.
The Company's primary uses of liquidity are to fund loans and to make
investments. Management considers current liquidity levels adequate to meet the
Company's cash flow requirements taking into consideration management's
intention to issue up to $15 million in Trust Preferred Securities during the
third fiscal quarter of 2005. If the loan portfolio continues to increase as it
has in 2005, additional funding sources, such as brokered deposits or loan sales
may need to be considered.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL COMMITMENTS
At June 30, 2005, outstanding off-balance sheet commitments to extend credit
totaled $64.8 million, and the undisbursed portion of construction loans was
$65.5 million. The Bank continued to be obligated to make future payments under
contracts, such as debt and lease agreements, the amounts of which were
consistent with the amounts at December 31, 2004 other than the increase in
borrowed funds of $17.0 million and the increase in deposits of $97.3 million at
June 30, 2005. For further information see "Financial Condition at June 30, 2005
compared to December 31, 2004".
CAPITAL
Stockholders' equity at June 30, 2005, was $49.0 million, up 4.4% from $46.9
million at December 31, 2004. Stockholders' equity at June 30, 2005, includes an
unrealized loss net of tax of $7,000 as compared to an unrealized gain net of
tax at December 31, 2004, of $68,000 on securities available for sale marked to
estimated fair market value.
Under the capital regulations of the FDIC, the Bank must satisfy minimum
leverage ratio requirements and risk-based capital requirements. Banks
supervised by the FDIC must maintain a minimum leverage ratio of core ("Tier I")
capital to average adjusted assets ranging from 3% to 5%. At June 30, 2005, the
Bank's ratio of Tier I capital was 7.50%. The FDIC's risk-based capital rules
11
require banks supervised by the FDIC to maintain risk-based capital to
risk-weighted assets of at least 8.00%. Risk-based capital for the Bank is
defined as Tier I capital plus the balance of allowance for loan losses. At June
30, 2005, the Bank had a ratio of qualifying total capital to risk-weighted
assets of 10.33%.
The Company, as a bank holding company, is also subject, on a consolidated
basis, to the capital adequacy guidelines of the Board of Governors of the
Federal Reserve (the "Federal Reserve Board"). The capital requirements of the
Federal Reserve Board are similar to those of the FDIC governing the Bank. The
Company currently exceeds all of its capital requirements. Management expects
the Company to continue to exceed these capital requirements without altering
current operations or strategies.
The Company's Board of Directors approved a quarterly cash dividend of $.05 per
share, paid on July 15, 2005 to stockholders of record as of July 1, 2005. Any
future payment of dividends is dependent on the financial condition and capital
needs of the Company, requirements of regulatory agencies and economic
conditions in the marketplace.
CRITICAL ACCOUNTING POLICIES
The Bank's most significant critical accounting policies are those that govern
accounting for loans and its allowance for loan losses and goodwill. A critical
accounting policy is one that is both very important to the portrayal of the
Company's financial condition and results, and requires a difficult, subjective
or complex judgment by management. What makes these judgments difficult,
subjective and/or complex is the need to make estimates about the effects of
matters that are inherently uncertain. For further information on the allowance
for loan losses, see the "Critical Accounting Policies" and the "Financial
Condition" in Management's Discussion and Analysis and Note 3 of "Notes to
Consolidated Financial Statements" included in the Annual Report on Form 10-K
filed with the SEC on March 30, 2005. For further information on goodwill, see
the "Critical Accounting Policies" in Management's Discussion and Analysis and
Note 13 of "Notes to Consolidated Financial Statements" included in the Annual
Report on Form 10-K filed with the SEC on March 30, 2005.
FINANCIAL CONDITION AT JUNE 30, 2005 COMPARED TO DECEMBER 31, 2004
The Company's total assets increased 21.3% to $667.1 million at June 30, 2005,
as compared to $550.1 million at December 31, 2004. The primary causes of the
increase in assets were increases of $80.7 million (17.8%) in loans, $31.5
million (434.8%) in loans held for sale and $4.8 million (29.5%) in cash and
cash equivalents which were funded primarily by an increase in deposits of $97.3
million (23.5%), short-term borrowings of $7.0 million (21.6%) and long-term
obligations of $10.0 million (18.8%). The increase in loans and deposits was a
result of continued growth in newer branches and being located in vibrant
markets. The majority of the loan growth occurred in construction and land
development loans which grew $30.4 million (47.5%) and commercial real estate
loans which grew $27.5 million (25.3%) over the six month period ending June 30,
2005, due to the economic expansion in the Bank's market area and the Bank's
increased emphasis on commercial lending. Loans held for sale increased because
management designated additional loans for sale to assist in future liquidity
needs. The largest increase in deposits was in the thirteen and twenty-two month
certificates and checking accounts. The increase in the certificates was due to
the Bank offering competitive promotional rates on reasonably short term
deposits in an effort to foster deposit growth. The Bank continues to emphasize
obtaining business accounts, which is the reason for the checking account
increase. The Bank also attracted an additional $26.0 million in internet
deposits during the six month period ending June 30, 2005. Internet deposits are
usually obtained from other financial institutions with terms primarily of one
to two years. Borrowed funds which are collateralized through an agreement with
the FHLB for advances increased $16 million since December 31, 2004. These
advances are secured by the Bank's investment in FHLB stock and qualifying first
mortgage loans. Loans made at Lumina are held for sale and are funded by a
short-term borrowing at another financial institution, which increased $652,000
since December 31, 2004 and are collateralized by Lumina's loans held for sale.
The Company's nonperforming assets (loans 90 days or more delinquent and
foreclosed real estate) were $585,000, or 0.09% of assets, at June 30, 2005,
compared to $207,000, or 0.04% of assets, at December 31, 2004. Foreclosed real
estate increased to $16,000 at June 30, 2005, from $0 at December 31, 2004. The
Company assumes an aggressive position in collecting delinquent loans and
disposing of foreclosed assets to minimize balances of nonperforming assets and
continues to evaluate the loan and real estate portfolios to provide loss
reserves as considered necessary. For further information see "Comparison of
Operating Results - Provision and Allowance for Loan Losses."
12
COMPARISON OF OPERATING RESULTS
OVERVIEW
The net income of the Company depends primarily upon net interest income. Net
interest income is the difference between the interest earned on loans, the
securities portfolio and interest-earning deposits and the cost of funds,
consisting principally of the interest paid on deposits and borrowings. The
Company's operations are materially affected by general economic conditions, the
monetary and fiscal policies of the Federal government, and the policies of
regulatory authorities. Yields and costs have increased because of the increase
in loans and deposits, as well as the actions taken by the Federal Reserve over
the past several months to increase interest rates.
NET INCOME
Net income for the three and six-month periods ended June 30, 2005, increased
23.8% to $1.4 million and 24.3% to $2.5 million respectively, as compared to the
same periods last year. The increase in net income for the three and six-month
periods ended June 30, 2005 can be attributed to an increase in net interest
income of $1.1 million and $1.8 million respectively, as well as an increase in
noninterest income of $170,000 and $281,000 respectively. For further
information see the captions "Noninterest Income" and "Noninterest Expense."
INTEREST INCOME
For the three-month period ended June 30, 2005, interest income increased 38.7%
as compared to the same period a year ago. The average balance of
interest-earning assets increased 23.9% and the average yield increased 65 basis
points as compared to the same period a year ago. Interest income increased
29.4% for the six-month period ended June 30, 2005, as compared to the same
period a year ago. The increase in interest income can be attributed to the
yield on average interest-earning assets increasing to 5.99% as compared to
5.49% for the same period a year ago. In addition, the average balance of
interest-earning assets increased 18.6% for the six month period ended June 30,
2005, as compared to the same period a year ago.
INTEREST EXPENSE
Interest expense increased 70.0% for the three-month period ended June 30, 2005,
as compared to the same period a year ago. This increase was due to the average
cost of interest-bearing liabilities increasing 75 basis points and the average
balance of interest-bearing liabilities increasing 23.4% as compared to the same
period a year ago. In the six-month period ended June 30, 2005, interest expense
increased 49.2% as compared to the same period a year ago. The average balance
of interest-bearing liabilities increased 17.5% as compared to the same period a
year ago. The cost of interest-bearing liabilities increased to 2.53% as
compared to 1.99% for the same period last year.
NET INTEREST INCOME
Net interest income for the three and six-month periods ended June 30, 2005, as
compared to the same period a year ago, increased 23.7% and 19.8% respectively.
The increase was due to interest-earning assets increasing more than
interest-bearing liabilities. This can be attributed to the increase in
noninterest bearing checking accounts and the retention of earnings.
13
AVERAGE YIELD/COST ANALYSIS
The following table contains information relating to the Company's average
balance sheet and reflects the average yield on assets and average cost of
liabilities for the periods indicated. Such annualized yields and costs are
derived by dividing income or expense by the average balances of assets or
liabilities, respectively, for the periods presented. The average loan portfolio
balances include nonaccrual loans.
For the three months ended
JUNE 30, 2005 JUNE 30, 2004
------------------------------------------- -----------------------------------------
(DOLLARS IN THOUSANDS) Average Average
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
-------------- ------------- ------------ -------------- ------------ ------------
Interest-earning assets:
Interest-bearing deposits in other banks $ 3,884 $ 28 2.88% $ 3,413 $ 8 0.94%
Securities:
Available for sale 43,881 503 4.59% 46,997 516 4.39%
Held to maturity 2,489 29 4.66% 3,320 41 4.94%
FHLB stock 5,322 59 4.43% 4,302 37 3.44%
Loan portfolio 551,963 8,666 6.28% 432,420 6,092 5.64%
-------------- ----------- ------------- ----------
Total interest-earning assets 607,539 9,285 6.11% 490,452 6,694 5.46%
Non-interest earning assets 29,109 28,003
--------------- -------------
Total assets $ 636,648 $ 518,455
=============== =============
Interest-bearing liabilities:
Deposits 442,273 2,762 2.50% 348,247 1,472 1.69%
Borrowed funds 101,498 918 3.62% 92,551 693 3.00%
--------------- ----------- ------------- ----------
Total interest-bearing liabilities 543,771 $ 3,680 2.71% 440,798 $ 2,165 1.96%
----------- ----------
Non-interest bearing liabilities 44,460 32,830
--------------- -------------
Total liabilities 588,231 473,628
Stockholders' equity 48,417 44,827
--------------- -------------
Total liabilities and stockholders' equity $ 636,648 $ 518,455
=============== =============
Net interest income $ 5,605 $ 4,529
=========== ==========
Interest rate spread 3.40% 3.50%
============= =========
Net yield on interest-earning assets 3.69% 3.69%
Percentage of average interest-earning
assets to average interest-bearing
liabilities 111.7% 111.3%
============= =========
14
For the six months ended
JUNE 30, 2005 JUNE 30, 2004
-------------------------------------------- ---------------------------------------
(DOLLARS IN THOUSANDS) Average Average
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
--------------- ------------ ------------ -------------- ----------- ------------
Interest-earning assets:
Interest-bearing deposits in other banks $ 3,746 $ 49 2.62% $ 3,923 $ 18 0.92%
Securities:
Available for sale 44,082 1,008 4.57% 46,755 1,027 4.39%
Held to maturity 2,556 60 4.69% 3,535 91 5.15%
FHLB stock 4,997 108 4.32% 4,218 73 3.46%
Loan portfolio 517,399 15,920 6.15% 424,445 12,037 5.67%
-------------- ------------ ------------ -----------
Total interest-earning assets 572,780 17,145 5.99% 482,876 13,246 5.49%
Non-interest earning assets 27,191 26,814
-------------- ------------
Total assets $ 599,971 $ 509,690
============== ============
Interest-bearing liabilities:
Deposits 417,255 4,844 2.32% 346,167 2,979 1.72%
Borrowed funds 94,296 1,637 3.47% 89,302 1,364 3.05%
-------------- ------------ ------------ -----------
Total interest-bearing liabilities 511,551 $ 6,481 2.53% 435,469 $ 4,343 1.99%
------------ -----------
Non-interest bearing liabilities 41,360 31,348
-------------- ------------
Total liabilities 552,911 466,817
Stockholders' equity 47,060 42,873
-------------- ------------
Total liabilities and stockholders' equity $ 599,971 $ 509,690
============== ============
Net interest income $ 10,664 $ 8,903
============ ==========
Interest rate spread 3.46% 3.50%
============= ==========
Net yield on interest-earning assets 3.72% 3.69%
Percentage of average interest-earning
assets to average interest-bearing
liabilities 112.0% 110.9%
============= ==========
15
PROVISION AND ALLOWANCE FOR LOAN LOSSES
During the six-month period ended June 30, 2005 the Bank had net charge-offs
against the allowance for loan losses of $41,000 compared to $48,000 for the
same period in 2004. The Bank added $975,000 to the allowance for loan losses
for the current six-month period as compared to $520,000 for the same period
last year, increasing the balance to $5.3 million at June 30, 2005. The increase
in the provision for loan losses was caused by the increase in the loan
portfolio and the Bank's increased emphasis on commercial loans. The asset
quality of the Bank remained at a desirable level. This brings the ratio of
allowance for loan losses to total loans to 0.92% at June 30, 2005 as compared
to 0.94% at December 31, 2004. This percentage declined because of the increase
in loans in the Bank's portfolio. Management considers the current level of the
allowance to be appropriate based on loan composition, the current level of
delinquencies and other nonperforming assets, overall economic conditions and
other factors. Future increases to the allowance may be necessary, however, due
to changes in loan composition or loan volume, changes in economic or market
area conditions and other factors. Additionally, various regulatory agencies, as
an integral part of their examination process, periodically review the Company's
allowance for loan losses. Such agencies may require the recognition of
adjustments to the allowance for loan losses based on their judgments of
information available to them at the time of their examination.
NONINTEREST INCOME
Noninterest income increased by 11.2% for the six-month period ended June 30,
2005, as compared to the same period a year ago. The change in noninterest
income can be primarily attributed to service charges and fees on loans
increasing $211,000. This increase was primarily caused by an increase in
brokered loan fees.
In the three-month period ended June 30, 2005, noninterest income increased
12.5% as compared to the same period last year. Service charges and fees on
loans increased $128,000 for the three-month period ended June 30, 2005 as
compared to the same period a year ago. The reason for this increase is the same
as stated above for the six-month period.
NONINTEREST EXPENSE
For the six-month period ended June 30, 2005, noninterest expense increased 7.0%
as compared to the same period last year. Compensation and fringe benefits
increased $399,000 due to increases in costs of benefits, staffing levels,
incentive pay and normal increases in salaries.
In the three-month period ended June 30, 2005, noninterest expense increased
7.6% as compared to the same period last year. This increase can primarily be
attributed to compensation and fringe benefits increasing $173,000. The reason
for this change is identical to the one stated above for the six-month period
ended June 30, 2005.
INCOME TAXES
The effective tax rate for the six-month periods ended June 30, 2005 and 2004
was 38.0% and 33.3% respectively. The effective tax rate for the three-month
periods ended June 30, 2005 and 2004 was 38.4% and 32.4% respectively. The
higher rate in 2005 resulted principally from a change in organizational
structure, which included the formation of Holdings and the REIT, that the
company implemented in December 2002. In addition to the benefits for which the
revised structure was implemented, it also resulted in reduced state income
taxes. State taxing authorities have recently announced that they will
vigorously pursue taxpayers who have utilized certain organizational structures
that result in reduced state income taxes, including the structure the Company
has utilized. While the Company believes its tax position is sound, it has
decided to modify its business plan in 2005 and subsequent years in response to
that announcement. For further information on income taxes see "Income Taxes" in
Management's Discussion and Analysis and Note 10 of "Notes to Consolidated
Financial Statements" included in the Annual Report.
16
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This document, as well as other written communications made from time to time by
Cooperative Bankshares, Inc. and subsidiaries and oral communications made from
time to time by authorized officers of the Company, may contain statements
relating to the future results of the Company (including certain projections,
such as earnings projections and business trends) that are considered
"forward-looking statements" as defined in the Private Securities Litigation
Reform Act of 1995 (the PSLRA). Such forward-looking statements may be
identified by the use of such words as "intend," "believe," "expect," "should,"
"planned," "estimated" and "potential." For these statements, the Company claims
the protection of the safe harbor for forward-looking statements contained in
the PSLRA. The Company's ability to predict future results is inherently
uncertain and the company cautions you that a number of important factors could
cause actual results to differ materially from those currently anticipated in
any forward-looking statement. These factors include among others; changes in
market interest rates and general and regional economic conditions, changes in
government regulations, changes in accounting principles and the quality or
composition of the loan and investment portfolios and other factors that may be
described in the Company's quarterly reports on Form 10-Q and in its annual
report on Form 10-K, each filed with the Securities and Exchange Commission,
which are available at the Securities and Exchange Commission's Internet website
(www.sec.gov) and to which reference is hereby made.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's primary market risk is interest rate risk. Interest rate risk is
the result of differing maturities or repricing intervals of interest-earning
assets and interest-bearing liabilities and the fact that rates on these
financial instruments do not change uniformly. These conditions may impact the
earnings generated by the Company's interest-earning assets or the cost of its
interest-bearing liabilities, thus directly impacting the Company's overall
earnings. The Company's management actively monitors and manages interest rate
risk. One way this is accomplished is through the development of, and adherence
to, the Company's asset/liability policy. This policy sets forth management's
strategy for matching the risk characteristics of the Company's interest-earning
assets and interest-bearing liabilities so as to mitigate the effect of changes
in the rate environment. The Company's market risk profile has not changed
materially since December 31, 2004.
ITEM 4 - CONTROLS AND PROCEDURES
The Company's management, including the Company's principal executive officer
and principal financial officer, has evaluated the effectiveness of the
Company's "disclosure controls and procedures", as such term is defined in Rule
13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended,
(the "Exchange Act"). Based upon their evaluation, the principal executive
officer and principal financial officer concluded that, as of the end of the
period covered by this report, the Company's disclosure controls and procedures
were effective for the purpose of ensuring that the information required to be
disclosed in the reports that the Company files or submits under the Exchange
Act with the Securities and Exchange Commission (the "SEC") (1) is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms, and (2) is accumulated and communicated to the Company's
management, including its principal executive and principal financial officers,
as appropriate to allow timely decisions regarding required disclosure. In
addition, based on that evaluation, no change in the Company's internal control
over financial reporting occurred during the quarter ended June 30, 2005 that
has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
17
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
(1) Annual Meeting of Stockholders, April 29, 2005
(a) Election of Directors
FOR AGAINST WITHHELD
--- ------- --------
Number % of Number % of Number % of
of Votes Votes of Votes Votes of Votes Votes
PAUL G. BURTON 3,459,631 99.313 -- -- 23,940 0.687
H. THOMPSON KING, III 3,459,631 99.313 -- -- 23,940 0.687
R. ALLEN RIPPY 3,459,253 99.302 -- -- 24,318 0.698
The following directors are serving terms of office that
continue through 2006 and 2007, as noted:
James D. Hundley, M.D. 2007
O. Richard Wright, Jr. 2007
Russell M. Carter 2007
Frederick Willetts, III 2006
F. Peter Fensel, Jr. 2006
(b) Amend Articles of Incorporation to increase authorized
shares of common stock
FOR AGAINST WITHHELD
--- ------- --------
Number % of Number % of Number % of
of Votes Votes of Votes Votes of Votes Votes
3,394,426 97.441 74,184 2.13 14,961 0.429
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
Exhibit 3.1(1) Articles of Incorporation
Exhibit 3.2(2) Articles of Amendment to Articles of Incorporation
Exhibit 3.3(1) Bylaws, as amended
Exhibit 11.1 Statement re: Computation of Per Share Earnings (See
note 3 to Unaudited Consolidated Financial Statements
on page 8)
18
Exhibit 31.1 Rule 13a-14(a) Certification of Chief Executive
Officer
Exhibit 31.2 Rule 13a-14(a) Certification of Chief Financial
Officer
Exhibit 32 Certificate Pursuant to 18 U.S.C. Section 1350
(1) Incorporated by reference to the Registrant's Registration Statement on
Form S-4 (Reg. No. 33-79206) filed with the SEC.
(2) Incorporated by reference to Registrant's Proxy Statement filed with the
SEC on March 31, 2005
19
SIGNATURES
Pursuant to the requirements 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.
Dated: August 11, 2005 Cooperative Bankshares, Inc.
/s/ Frederick Willetts, III
---------------------------------------------
Frederick Willetts, III
President/Chief Executive Officer
Dated: August 11, 2005 /s/ Todd L. Sammons
---------------------------------------------
Todd L. Sammons
Senior Vice President/Chief Financial Officer
20