UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 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 March 31, 2004
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number: 0-25859
1st STATE BANCORP, INC.
------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Virginia 56-2130744
------------------------------- --------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
445 S. Main Street, Burlington, North Carolina 27215
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(Address of Principal Executive Offices) (Zip Code)
(336) 227-8861
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Registrant' s Telephone Number, Including Area Code
N/A
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(Former Name, Former Address and Former Fiscal Year, if Changed
Since Last Report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
-- --
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of May 7, 2004, the issuer had 2,962,323 shares of common stock issued
and outstanding.
CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
=====================
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2004
(unaudited) and September 30, 2003..................................2
Consolidated Statements of Income for the Three
Months Ended March 31, 2004 and 2003 (unaudited)..................3
Consolidated Statements of Income for the Six Months
Ended March 31, 2004 and 2003 (unaudited).........................4
Consolidated Statements of Stockholders' Equity
and Comprehensive Income for the Six Months
Ended March 31, 2004 and 2003 (unaudited)....................5
Consolidated Statements of Cash Flows for the
Six Months Ended March 31, 2004 and 2003 (unaudited)................6
Notes to Consolidated Financial Statements.........................8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations...................................10
Item 3. Quantitative and Qualitative Disclosures About Market Risk...........19
Item 4. Controls and Procedures...............................................20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................................21
Item 2. Changes in Securities, Use of Proceeds and Issuer
Purchases of Equity Securities.......................................21
Item 3. Defaults Upon Senior Securities......................................22
Item 4. Submission of Matters to a Vote of Security Holders..................22
Item 5. Other Information....................................................22
Item 6. Exhibits and Reports on Form 8-K.....................................22
SIGNATURES....................................................................24
1st STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
MARCH 31, 2004 AND SEPTEMBER 30, 2003
(IN THOUSANDS, EXCEPT SHARE DATA)
At At
March 31, September 30,
2004 2003
------------------ ---------------
(Unaudited)
ASSETS
Cash and cash equivalents $ 8,385 $ 9,359
Investment securities:
Held to maturity (fair value of $22,088 and $19,397
at March 31, 2004 and September 30, 2003, respectively) 21,824 19,462
Available for sale (cost of $85,767 and $92,971
at March 31, 2004 and September 30, 2003, respectively) 85,368 91,709
Loans held for sale, at lower of cost or fair value 1,244 645
Loans receivable (net of allowance for loan losses of $3,892
and $3,856 at March 31, 2004 and September 30, 2003,
respectively) 230,584 225,725
Real estate owned 513 95
Federal Home Loan Bank stock, at cost 1,425 1,675
Premises and equipment 8,253 8,413
Accrued interest receivable 1,886 1,967
Other assets 3,387 3,590
----------- ----------
Total assets $ 362,869 $ 362,640
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposit accounts 264,413 262,712
Advances from Federal Home Loan Bank 28,500 31,500
Advance payments by borrowers for property taxes and insurance 215 57
Dividend payable 296 297
Other liabilities 5,131 5,373
----------- ----------
Total liabilities 298,555 299,939
----------- ----------
Stockholders' Equity:
Preferred stock, $0.01 par value, 1,000,000 shares authorized;
none issued -- --
Common stock, $0.01 par value, 7,000,000 shares authorized;
2,962,323 and 2,971,977 shares issued and outstanding
at March 31, 2004 and September 30, 2003, respectively 33 33
Additional paid-in capital 35,930 35,778
Unallocated ESOP shares (2,854) (3,141)
Deferred compensation payable in treasury stock 5,802 5,466
Treasury stock (13,448) (12,785)
Retained income - substantially restricted 39,094 38,118
Accumulated other comprehensive income (loss) - net unrealized
loss on investment securities available for sale (243) (768)
----------- ----------
Total stockholders' equity 64,314 62,701
----------- ----------
Total liabilities and stockholders' equity $ 362,869 $ 362,640
=========== ==========
See accompanying notes to the consolidated financial statements.
2
1st STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND 2003
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(Unaudited)
For the Three Months Ended
March 31,
------------------------------
2004 2003
---------- -----------
Interest income:
Interest and fees on loans $ 2,830 $ 3,295
Interest and dividends on investments 1,116 1,060
Overnight deposits 8 42
--------- ---------
Total interest income 3,954 4,397
--------- ---------
Interest expense:
Deposit accounts 886 1,169
Borrowings 303 276
--------- ---------
Total interest expense 1,189 1,445
--------- ---------
Net interest income 2,765 2,952
Provision for loan losses 60 60
--------- ---------
Net interest income after provision for loan losses 2,705 2,892
--------- ---------
Other income:
Customer service fees 240 214
Commissions from sales of annuities and mutual funds 93 159
Mortgage banking income, net 113 436
Securities gains, net 88 --
Other 56 62
--------- ---------
Total other income 590 871
--------- ---------
Operating expenses:
Compensation and related benefits 1,316 1,400
Occupancy and equipment 340 384
Real estate operations, net (1) 4
Other expenses 401 393
--------- ---------
Total operating expenses 2,056 2,181
--------- ---------
Income before income taxes 1,239 1,582
Income taxes 460 585
--------- ---------
Net income $ 779 $ 997
========= =========
Earnings per share:
Basic $ 0.28 $ 0.35
Diluted $ 0.26 $ 0.34
See accompanying notes to the consolidated financial statements.
3
1st STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE SIX MONTHS ENDED MARCH 31, 2004 AND 2003
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
For the Six Months Ended
March 31,
----------------------------
2004 2003
---------- ---------
Interest income:
Interest and fees on loans $ 5,684 $ 6,667
Interest and dividends on investments 2,300 2,212
Overnight deposits 17 85
--------- ---------
Total interest income 8,001 8,964
--------- ---------
Interest expense:
Deposit accounts 1,805 2,460
Borrowings 619 552
--------- ---------
Total interest expense 2,424 3,012
--------- ---------
Net interest income 5,577 5,952
Provision for loan losses 120 120
--------- ---------
Net interest income after provision for loan losses 5,457 5,832
--------- ---------
Other income:
Customer service fees 446 431
Commissions from sales of annuities and mutual funds 165 246
Mortgage banking income, net 211 837
Securities gains, net 185 --
Other 109 118
--------- ---------
Total other income 1,116 1,632
-------- ---------
Operating expenses:
Compensation and related benefits 2,648 2,745
Occupancy and equipment 683 735
Real estate operations, net (5) 9
Other expenses 833 839
--------- ---------
Total operating expenses 4,159 4,328
--------- ---------
Income before income taxes 2,414 3,136
Income taxes 877 1,156
--------- ---------
Net income $ 1,537 $ 1,980
========= =========
Earnings per share:
Basic $ 0.55 $ 0.70
Diluted $ 0.52 $ 0.67
See accompanying notes to the consolidated financial statements
4
1st STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS'
EQUITY AND COMPREHENSIVE INCOME
FOR THE SIX MONTHS ENDED MARCH 31, 2004 AND 2003 (UNAUDITED)
(In Thousands)
Deferred
compensation Accumulated
Additional Unallocated payable in other Total
Common paid-in ESOP treasury Treasury Retained comprehensive stockholders'
stock capital shares stock stock Income income (loss) equity
----- ---------- ----------- ------------ ------ ------ ------------- -------------
Balance at September 30, 2002 $33 35,623 (3,739) 5,466 (11,899) 35,258 827 61,569
Comprehensive income:
Net income -- -- -- -- -- 1,980 -- 1,980
Other comprehensive loss-unrealized
loss on securities available-for-sale
net of income taxes of $169 -- -- -- -- -- -- (262) (262)
-----
Total comprehensive income 1,718
Allocation of ESOP shares -- 72 298 -- -- -- -- 370
Acquisition of treasury stock -- -- -- -- (743) -- -- (743)
Cash dividends declared ($0.18 per share) -- -- -- -- -- (538) -- (538)
Cash dividends on unallocated ESOP shares -- -- -- -- -- 35 -- 35
--- ------ ------ ----- ------- ------ --- ------
Balance at March 31, 2003 $33 35,695 (3,441) 5,466 (12,642) 36,735 565 62,411
=== ====== ======= ===== ======== ====== === ======
Balance at September 30, 2003 $33 35,778 (3,141) 5,466 (12,785) 38,118 (768) 62,701
Comprehensive income:
Net income -- -- -- -- -- 1,537 -- 1,537
Other comprehensive income-unrealized
gain on securities available-for-sale
net of income taxes of $338 -- -- -- -- -- -- 525 525
------
Total comprehensive income 2,062
Allocation of ESOP shares -- 133 287 -- -- -- -- 420
Acquisition of treasury stock -- -- -- -- (663) -- -- (663)
Deferred compensation -- -- -- 336 -- -- -- 336
Exercise of stock options -- 19 -- -- -- -- -- 19
Cash dividends declared ($0.20 per share) -- -- -- -- -- (593) -- (593)
Cash dividends on unallocated ESOP shares -- -- -- -- -- 32 -- 32
--- ------ ------ ----- ------- ------ --- ------
Balance at March 31, 2004 $33 35,930 (2,854) 5,802 (13,448) 39,094 (243) 64,314
=== ====== ====== ===== ======= ====== ==== ======
See accompanying notes to the consolidated financial statements.
5
1st STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED MARCH 31, 2004 AND 2003
(UNAUDITED)
(In Thousands)
For the Six Months Ended
March 31,
2004 2003
--------- -----------
Cash flows from operating activities:
Net income $ 1,537 $ 1,980
Adjustment to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 120 120
Depreciation 342 394
Deferred tax expense (benefit) (51) 91
Amortization of premiums and discounts, net 6 (31)
Deferred compensation 120 120
Release of ESOP shares 420 370
Loan origination fees and unearned discounts
deferred, net of current amortization (26) (41)
Loss (gain) on sale of other real estate (12) 6
Gain on sale of investment securities available for sale (185) --
Net (gain) loss on sale of loans 27 (164)
Proceeds from loans held for sale 13,544 48,579
Originations of loans held for sale (14,170) (45,768)
Decrease (increase) in other assets (72) 203
Decrease in accrued interest receivable 81 449
Decrease in other liabilities (26) (2,809)
---------- --------
Net cash provided by operating activities 1,655 3,499
---------- --------
Cash flows provided by (used in) investing activities:
Proceeds from sale of FHLB stock 1,975 368
Purchases of FHLB stock (1,725) --
Purchases of investment securities held to maturity (6,368) (2,000)
Purchases of investment securities available for sale (30,575) (48,229)
Proceeds from sales of investment securities available for sale 10,993 --
Proceeds from maturities and issuer calls of investment securities
available for sale 26,969 66,485
Proceeds from maturities and issuer calls of investment securities
held to maturity 4,002 2
Net increase in loans receivable (5,121) (3,935)
Purchase of real estate acquired in settlement of loans (250) --
Purchases of premises and equipment (182) (768)
---------- ---------
Net cash provided by (used in) investing activities (282) 11,923
---------- ---------
(Continued)
6
1st STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
FOR THE SIX MONTHS ENDED MARCH 31, 2004 AND 2003
(UNAUDITED)
(In Thousands)
FOR THE SIX MONTHS ENDED
MARCH 31,
2004 2003
----------- -------------
Cash flows from financing activities:
Net increase (decrease) in deposits $ 1,701 $ (1,861)
Advances from the Federal Home Loan Bank 54,000 13,000
Repayments of advances from the Federal Home Loan Bank (57,000) (13,000)
Purchase of treasury stock (663) (743)
Exercise of stock options 19 --
Dividends paid on common stock (562) (446)
Increase in advance payments by borrowers for
property taxes and insurance 158 188
---------- ---------
Net cash used in financing activities (2,347) (2,862)
---------- ---------
Net increase (decrease) in cash and cash equivalents (974) 12,560
Cash and cash equivalents at beginning of period 9,359 18,865
---------- ---------
Cash and cash equivalents at end of period $ 8,385 $ 31,425
========== =========
Payments are shown below for the following:
Interest $ 2,420 $ 3,021
========== =========
Income taxes $ 1,276 $ 1,133
========== =========
Noncash investing and financing activities:
Unrealized gains (losses) on investment securities
available for sale $ 863 $ (431)
========== =========
Cash dividends declared but not paid $ 280 $ 279
========== =========
Cash dividends on unallocated ESOP shares $ 32 $ 35
========== =========
See accompanying notes to the consolidated financial statements.
7
1st STATE BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004 (UNAUDITED) AND SEPTEMBER 30, 2003
NOTE 1. NATURE OF BUSINESS
1st State Bancorp, Inc. (the "Company") was incorporated under the laws of
the Commonwealth of Virginia for the purpose of becoming the holding company for
1st State Bank (the "Bank") in connection with the Bank's conversion from a
North Carolina-chartered mutual savings bank to a North Carolina-chartered stock
savings bank (the "Converted Bank") pursuant to its Plan of Conversion (the
"Stock Conversion"). Upon completion of the Stock Conversion, the Converted Bank
converted from a North Carolina-chartered stock savings bank to a North Carolina
commercial bank (the "Bank Conversion"), retaining the name 1st State Bank (the
"Commercial Bank"), and the Commercial Bank succeeded to all of the assets and
liabilities of the Converted Bank. The Stock Conversion and the Bank Conversion
were consummated on April 23, 1999. The common stock of the Company began
trading on the Nasdaq National Market System under the symbol "FSBC" on April
26, 1999.
NOTE 2. BASIS OF PRESENTATION
The accompanying consolidated financial statements (which are unaudited,
except for the consolidated balance sheet at September 30, 2003, which is
derived from the September 30, 2003 audited consolidated financial statements)
have been prepared in accordance with accounting principles generally accepted
in the United States of America for interim financial information and with the
rules and regulations of the Securities and Exchange Commission. Accordingly,
they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. In the opinion of management, all adjustments (none of
which were other than normal recurring accruals) necessary for a fair
presentation of the financial position and results of operations for the periods
presented have been included.
The results of operations for the three and six month periods ended March
31, 2004 are not necessarily indicative of the results of operations that may be
expected for the year ending September 30, 2004. The preparation of consolidated
financial statements in accordance with accounting principles generally accepted
in the United States of America requires management to make certain estimates.
These amounts may be revised in future periods because of changes in the facts
and circumstances underlying their estimation.
NOTE 3. EARNINGS PER SHARE
For purposes of computing basic and diluted earnings per share, weighted
average shares outstanding excludes unallocated ESOP shares that have not been
committed to be released. The deferred compensation obligation discussed in Note
5 that is funded with shares of the Company's common stock has no net impact on
the Company's earnings per share computations. Diluted earnings per share
include the potentially dilutive effects of the Company's stock-based benefit
plans. There were no anti-dilutive stock options for the three and six months
ended March 31, 2004 and 2003. A reconciliation of the denominators of the basic
and diluted earnings per share computations is as follows:
THREE MONTHS ENDED
MARCH 31,
------------------------------
2004 2003
---------- -----------
Average shares issued and outstanding 2,963,492 2,995,606
Less: Unallocated ESOP shares (149,487) (179,585)
----------- ----------
Average basic shares for earnings per share 2,814,005 2,816,021
Add: Potential common stock pursuant to stock option plan 157,118 122,277
----------- ----------
Average dilutive shares for earnings per share 2,971,123 2,938,298
=========== ==========
8
SIX MONTHS ENDED
MARCH 31,
2004 2003
---------- -----------
Average shares issued and outstanding 2,966,391 2,999,280
Less: Unallocated ESOP shares (153,167) (183,449)
---------- ----------
Average basic shares for earnings per share 2,813,224 2,815,831
Add: Potential common stock pursuant to stock option plan 152,782 124,438
---------- ----------
Average dilutive shares for earnings per share 2,966,006 2,940,269
========== ==========
NOTE 4. EMPLOYEE STOCK OWNERSHIP PLAN ("ESOP")
The Company sponsors an employee stock ownership plan (the "ESOP") whereby
an aggregate number of shares amounting to 253,050 or 8% of the stock issued in
the conversion was purchased for future allocation to employees. The ESOP was
funded by an 11-year term loan from the Company in the amount of $4,899,000. The
loan is secured by the shares of stock purchased by the ESOP. During the three
and six months ended March 31, 2004 and 2003, 7,280 and 7,360 and 14,640 and
15,288 shares of stock were committed to be released and approximately $215,000
and $181,000 and $420,000 and $371,000, respectively of compensation expense was
recognized.
NOTE 5. DEFERRED COMPENSATION
Directors and certain executive officers participate in a deferred
compensation plan, which was approved by the Board of Directors on September 24,
1997. This plan generally provides for fixed payments beginning after the
participant retires. Each participant is fully vested in his account balance
under the plan. Directors may elect to defer their directors' fees and executive
officers may elect to defer 25% of their salary and 100% of bonus compensation.
Prior to the Stock Conversion, amounts deferred by each participant
accumulated interest at a rate equal to the highest rate of interest paid on the
Bank's one-year certificates of deposit. In connection with the Stock
Conversion, participants in the plan were given the opportunity to prospectively
elect to have their deferred compensation balance earn a rate of return equal to
the total return of the Company's stock. All participants elected this option
concurrent with the Stock Conversion, so the Company purchases its common stock
to fund this obligation. Refer to the Company's notes to consolidated financial
statements, incorporated by reference in the Company's 2003 Annual Report on
Form 10-K for a discussion of the Company's accounting policy with respect to
this deferred compensation plan and the related treasury stock purchased by the
Company to fund this obligation.
The expense related to this plan for each of the three and six months ended
March 31, 2004 and 2003 was $60,000 and $60,000 and $120,000 and $120,000,
respectively. This expense is included in compensation expense.
NOTE 6. STOCK OPTION AND INCENTIVE PLAN
On June 6, 2000, the Company's stockholders approved the 1st State Bancorp,
Inc. 2000 Stock Option and Incentive Plan (the "Plan"). The purpose of this plan
is to advance the interests of the Company through providing select key
employees and directors of the Bank with the opportunity to acquire shares. By
encouraging such stock ownership, the Company seeks to attract, retain and
motivate the best available personnel for positions of substantial
responsibility and to provide incentives to the key employees and directors.
Under the Plan, the Company granted 316,312 options to purchase its $0.01 par
value common stock. The exercise price per share is equal to the fair market
value per share on the date of the grant. Options granted under the Stock Option
Plan are 100% vested on the date of the grant, and all options expire 10 years
from the date of the grant. As a result of the one-time cash dividend of $5.17
paid on October 2, 2000, the exercise price for the options repriced from $18.44
to $14.71. There were 2,077 options exercised during the three months ended
March 31, 2004. No options were granted during the three and six months ended
March 31, 2004 and 2003. At March 31, 2004, 314,235 options are outstanding, all
of which are exercisable.
9
NOTE 7. MORTGAGE SERVICING RIGHTS
The rights to service mortgage loans for others are included in other
assets on the consolidated balance sheet. Mortgage servicing rights ("MSRs") are
capitalized based on the allocated cost that is determined when the underlying
loans are sold. MSRs are amortized over a period that approximates the life of
the underlying loan as an adjustment of servicing income. Impairment reviews of
MSRs are performed on a quarterly basis. As of March 31, 2004 and September 30,
2003, MSRs totaled $520,000 and $547,000, respectively, and no valuation
allowance was required.
Amortization expense totaled $57,000 and $71,000 for the six months ended
March 31, 2004 and 2003, respectively.
NOTE 8. STANDBY LETTERS OF CREDIT
In November 2002, the FASB issued Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others", which addressed the disclosure
to be made by a guarantor in its interim and annual financial statements about
its obligations under guarantees. FIN 45 requires the guarantor to recognize a
liability for the non-contingent component of the guarantee, such as the
obligation to stand ready to perform in the event that specified triggering
events or conditions occur. The initial measurement of this liability is the
fair value of the guarantee at inception. The recognition of the liability is
required even if it is not probable that payments will be required under the
guarantee or if the guarantee was issued with a premium payment or as part of a
transaction with multiple events. The initial recognition and measurement
provisions are effective for all guarantees within the scope of FIN 45 issued or
modified after March 31, 2003. The Company issues standby letters of credit
whereby the Company guarantees performance if a specified triggering event or
condition occurs (primarily nonperformance under construction contracts entered
into by construction customers). The guarantees generally expire within one year
and may be automatically renewed depending on the terms of the guarantee. The
maximum potential amount of undiscounted future payments related to standby
letters of credit at March 31, 2004 is $1.7 million. At March 31, 2004, the
Company has recorded no liability for the current carrying amount of the
obligation to perform as a guarantor and no contingent liability is considered
necessary as such amounts are deemed immaterial. Substantially all standby
letters of credit are secured by real estate and/or guaranteed by third parties
in the event the Company had to advance funds to fulfill the guarantee.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
When used in this Form 10-Q, the words or phrases "will likely result,"
"are expected to," "will continue," "is anticipated," "estimate," "project" or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties including changes in
economic conditions in our market area, changes in policies by regulatory
agencies, fluctuations in interest rates, demand for loans in our market area,
and competition that could cause actual results to differ materially from
historical earnings and those presently anticipated or projected. We wish to
caution you not to place undue reliance on any such forward-looking statements,
which speak only as of the date made. We wish to advise you that the factors
listed above could affect our financial performance and could cause our actual
results for future periods to differ materially from any opinions or statements
expressed with respect to future periods in any current statements.
We do not undertake, and specifically disclaim any obligation, to publicly
release the result of any revisions which may be made to any forward-looking
statements to reflect events or circumstances after the date of such statements
or to reflect the occurrence of anticipated or unanticipated events.
GENERAL
1st State Bancorp, Inc. was formed in November 1998 and became the holding
company for 1st State Bank on April 23, 1999.
Our business consists principally of attracting deposits from the general
public and investing these funds in loans secured by single-family residential
and commercial real estate, secured and unsecured commercial loans and consumer
10
loans. Our profitability depends primarily on our net interest income, which is
the difference between the income we receive on our loan and investment
securities portfolios and our cost of funds, which consists of interest paid on
deposits and borrowed funds. Net interest income also is affected by the
relative amounts of interest-earning assets and interest-bearing liabilities.
When interest-earning assets approximate or exceed interest-bearing liabilities,
any positive interest rate spread will generate net interest income. Our
profitability is also affected by the level of other income and operating
expenses. Other income consists of miscellaneous fees related to our loans and
deposits, mortgage banking income and commissions from sales of annuities and
mutual funds. Operating expenses consist of compensation and benefits, occupancy
related expenses, federal deposit insurance premiums, data processing,
advertising and other expenses.
Our operations are influenced significantly by local economic conditions
and by policies of financial institution regulatory authorities. Our cost of
funds is influenced by interest rates on competing investments and by rates
offered on similar investments by competing financial institutions in our market
area, as well as general market interest rates. These factors can cause
fluctuations in our net interest income and other income. Lending activities are
affected by the demand for financing of real estate and other types of loans,
which in turn is affected by the interest rates at which such financing may be
offered. In addition, local economic conditions can impact the credit risk of
our loan portfolio, in that local employers may be required to eliminate
employment positions of many of our borrowers, and small businesses and other
commercial borrowers may experience a downturn in their operating performance
and become unable to make timely payments on their loans. Management evaluates
these factors in estimating its allowance for loan losses, and changes in these
economic conditions could result in increases or decreases to the provision for
loan losses.
Our business emphasis has been to operate as a well capitalized, profitable
and independent community-oriented financial institution dedicated to providing
quality customer service. We are committed to meeting the financial needs of the
communities in which we operate. We believe that we can be more effective in
servicing our customers than many of our nonlocal competitors because of our
ability to quickly and effectively provide senior management responses to
customer needs and inquiries. Our ability to provide these services is enhanced
by the stability of our senior management team.
Over the years, we have sought to gradually increase the percentage of our
assets invested in commercial real estate loans, commercial loans and consumer
loans, which have shorter terms and adjust more frequently to changes in
interest rates than single-family residential mortgage loans. These loans
generally carry added risk when compared to a single-family residential mortgage
loan, so we have concurrently increased our allowance for loan losses as we have
originated these loans.
Due to a general slowdown in the economy beginning in 2000, the Federal
Reserve acted to provide a stimulus through a series of interest rate reductions
that lowered the prime rate from 9.50% in January 2001 to 4.00% in June 2003.
These reductions in prime tended to negatively impact the Company's net interest
margin and net interest spread which resulted in lower net interest income for
the Company. The Company's asset growth has been slower as a result of heavy
refinancing as customers have taken advantage of these attractive interest
rates. The fee income associated with the heavy refinancing volume has replaced
some of the lost net interest income. Now as the refinancing activity has
slowed, the Company is looking to replace lost net interest income possibly with
leverage strategies. During periods of slow loan demand, the Company purchases
more investments, and the Company uses short-term borrowings as an alternative
to deposits for funding certain assets. The Company's balance sheet is currently
asset sensitive, that is, rate sensitive assets exceed rate sensitive
liabilities. We expect an increase in net interest income during periods of
rising interest rates and decreased net interest income during periods of
falling interest rates.
CRITICAL ACCOUNTING POLICIES
The Company's significant accounting policies are set forth in Note 1 of
the consolidated financial statements as of September 30, 2003, which was filed
on the Company's Annual Report on Form 10-K for the fiscal year ended September
30, 2003. Of these significant accounting policies, the Company considers its
policy regarding the allowance for loan losses to be its most critical
accounting policy, because it requires management's most subjective and complex
judgments. In addition, changes in economic conditions can have a significant
impact on the allowance for loan losses and therefore the provision for loan
losses and results of operations. The Company has developed appropriate policies
and procedures for assessing the adequacy of the allowance for loan losses,
recognizing that this process requires a number of assumptions and estimates
with respect to its loan portfolio. The Company's assessments may be impacted in
future periods by changes in economic conditions, the impact of regulatory
examinations, and the discovery of
11
information with respect to borrowers that is not known to management at the
time of the issuance of the consolidated financial statements.
COMPARISON OF FINANCIAL CONDITION AT MARCH 31, 2004 AND SEPTEMBER 30, 2003
Total assets were relatively flat from September 30, 2003 to March 31,
2004. Assets increased to $362.9 million at March 31, 2004 from $362.6 million
at September 30, 2003. Increases in loans receivable, net and loans held for
sale were offset by decreases in investment securities. Deposits increased by
$1.7 million from $262.7 million at September 30, 2003 to $264.4 million at
March 31, 2004. These increases were offset by decreases in advances from the
Federal home loan Bank. Borrowings from the Federal Home Loan Bank of Atlanta
decreased $3.0 million from $31.5 million at September 30, 2003 to $28.5 million
at March 31, 2004.
Investment securities available for sale decreased $5.7 million from $91.1
million at September 30, 2003 to $85.4 million at March 31, 2004. During the six
months ended March 31, 2004, we purchased $30.6 million of securities and
received $38.0 million in proceeds from sales, maturities and issuer calls of
investment securities available for sale. Investment securities held to maturity
increased $2.4 million from $19.5 million at September 30, 2003 to $21.8 million
at March 31, 2004. During the six months ended March 31, 2004, we purchased $6.4
million of securities and received $4.0 million in proceeds from maturities and
issuer calls of investment securities held to maturity.
Loans held for sale increased to $1.2 million at March 31, 2004 from
$645,000 at September 30, 2003. Loans receivable, net increased from $225.7
million at September 30, 2003 to $230.6 million at March 31, 2004. The increase
in loans held for sale resulted from timing differences in the funding of loan
sales. During the six months ended March 31, 2004, mortgage originations were
considerably slower than in previous quarters as refinance activity slowed down
in response to higher mortgage interest rates. During this same period, the
Company saw growth in commercial loans and equity lines.
Stockholders' equity increased by $1.6 million from $62.7 million at
September 30, 2003 to $64.3 million at March 31, 2004 as a result of net income
of $1.5 million, release of ESOP shares of $420,000 and a decrease in unrealized
loss on available for sale securities of $525,000. These increases were
partially offset by cash dividends to stockholders declared of $561,000 and
purchases of treasury stock of $663,000.
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND
2003
NET INCOME. We recorded net income of $779,000 for the quarter ended March
31, 2004, as compared to $997,000 for the quarter ended March 31, 2003,
representing a decrease of $218,000, or 21.9%. For the three months ended March
31, 2004, basic and diluted earnings per share were $0.28 and $0.26,
respectively, compared to the basic and diluted earnings per share for the
quarter ended March 31, 2003 of $0.35 and $0.34, respectively. The decrease in
net income resulted primarily from decreased net interest income and decreased
other income that were offset partially by decreased operating expenses and
decreased income tax expense. The decrease in net interest income resulted from
lower net interest margins. The average prime interest rate for the quarter
ended March 31, 2004 was 4.00%, a decrease of 25 basis points from 4.25%, which
was the average prime for the quarter ended March 31, 2003. The repricing of
loans and investments decreased the Company's average asset yield by 75 basis
points whereas the average cost of funds decreased only 47 basis points during
the quarter ended March 31, 2003.
NET INTEREST INCOME. Net interest income, the difference between interest
earned on loans and investments and interest paid on interest-bearing
liabilities, decreased by $187,000 or 6.8% for the three months ended March 31,
2004, compared to the same quarter in the prior year. This decrease results from
a $443,000 decrease in interest income that was partially offset by the $256,000
decrease in total interest expense. The average net interest rate spread
decreased 28 basis points from 3.21% for the three months ended March 31, 2003
to 2.93% for the quarter ended March 31, 2004.
INTEREST INCOME. The decrease in interest income for the three months ended
March 31, 2004 was the result of a decrease in yield on interest-earning assets
of 75 basis points from 5.39% for the three months ended March 31, 2003 to 4.64%
for the three months ended March 31, 2004. This decrease was partially offset by
an increase of $14.7 million in average interest-earning assets compared to the
same quarter in the prior year. Average investment securities increased $24.9
million, average interest-bearing overnight funds decreased $11.1 million and
average loans receivable increased
12
$918,000. The increase in average interest-earning assets increased interest
income by approximately $299,000 and the decrease in the average asset yield
decreased interest income by approximately $742,000.
INTEREST EXPENSE. Interest expense decreased in the three months ended
March 31, 2004 due to a decrease in the cost of interest-bearing liabilities of
47 basis points from 2.18% for the three months ended March 31, 2003 to 1.71%
for the three months ended March 31, 2004. This decrease was partially offset by
an increase in average interest-bearing liabilities of $12.9 million. Average
interest-bearing deposits increased by $4.5 million while average FHLB advances
increased $8.4 million for the three months ended March 31, 2004 compared to the
same quarter in the prior year. The increase in average interest-bearing
liabilities increased interest expense by approximately $127,000 and the
decrease in the average cost of interest-bearing liabilities decreased interest
expense by approximately $383,000.
The following table presents average balances and average rates earned/paid by
the Company for the quarter ended March 31, 2004 compared to the quarter ended
March 31, 2003.
Three Months Ended Three Months Ended
March 31, 2004 March 31, 2003
-------------------------------- ----------------------------------
(Dollars in Thousands)
Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
------- -------- ---------- ------- -------- ----------
Assets:
Loans receivable (1)......................... $ 229,683 $ 2,830 4.93% $ 228,764 $ 3,295 5.76%
Investment securities (2).................... 107,811 1,116 4.14 82,921 1,060 5.11
Interest-bearing overnight deposits ......... 3,556 8 0.91 14,669 42 1.15
------------ --------- ----- ----------- --------- ------
Total interest-earning assets (3).......... 341,050 3,954 4.64 326,354 4,397 5.39
Non interest-earning assets.................. 20,970 21,001
------------ -----------
Total assets............................... $ 362,020 $ 347,355
============ ===========
Liabilities and stockholders' equity:
Interest bearing checking.................... 35,538 18 0.21 33,018 36 0.44
Money market investment accounts............. 19,212 32 0.66 22,485 54 0.96
Passbook and statement savings............... 29,834 45 0.60 29,321 80 1.09
Certificates of deposit...................... 163,530 791 1.93 158,776 999 2.52
FHLB advances................................ 30,280 303 4.01 21,900 276 5.05
------------ --------- ----- ----------- --------- ------
Total interest-bearing liabilities......... 278,394 1,189 1.71 265,500 1,445 2.18
Non interest-bearing liabilities............. 19,822 19,356
------------ -----------
Total liabilities.......................... 298,216 284,856
Stockholders' equity......................... 63,804 62,499
------------ -----------
Total liabilities and stockholders' equity $ 362,020 $ 347,355
============ ===========
Net interest income.......................... $ 2,765 $ 2,952
========= =========
Interest rate spread......................... 2.93% 3.21%
==== ====
Net interest margin (4)...................... 3.24% 3.62%
==== ====
Ratio of average interest-earning assets to
average interest-bearing liabilities........ 122.51% 122.92%
====== ======
--------
(1) Includes nonaccrual loans and loans held for sale, net of discounts and
allowance for loan losses.
(2) Includes FHLB of Atlanta stock.
(3) Due to immateriality, the interest income and yields related to certain tax
exempt assets have not been adjusted to reflect a fully taxable equivalent
yield.
(4) Represents net interest income divided by the average balance of
interest-earning assets.
13
PROVISION FOR LOAN LOSSES. We charge provisions for loan losses to earnings
to maintain the total allowance for loan losses at a level we consider adequate
to provide for probable loan losses, based on existing loan levels and types of
loans outstanding, nonperforming loans, prior loss experience, general economic
conditions and other factors. We estimate the allowance using an allowance for
loan losses model which takes into considerations all of these factors. Our
policies require the review of assets on a regular basis, and we assign risk
grades to loans based on the relative risk of the credit, considering such
factors as repayment experience, value of collateral, guarantors, etc. Our
credit management systems have resulted in low loss experience; however, there
can be no assurances that such experience will continue. We believe we use the
best information available to make a determination with respect to the allowance
for loan losses, recognizing that future adjustments may be necessary depending
upon a change in economic conditions.
The provision for loan losses was $60,000 and net charge-offs were $36,000
for the three months ended March 31, 2004 compared with a provision of $60,000,
and net charge-offs of $0 for the three months ended March 31, 2003.
Nonperforming loans at March 31, 2004 and September 30, 2003 were $4.0 million
and $4.2 million, respectively. The majority of the non-performing loans
resulted from two unrelated, distinct credits which are not necessarily
indicative of the credit quality of the entire portfolio. There was no
significant impact on the provision as these loans are well secured by property
and equipment.
OTHER INCOME. Other income decreased $281,000 from $871,000 for the three
months ended March 31, 2003 to $590,000 for the three months ended March 31,
2004. Mortgage banking income, net decreased $323,000 from $436,000 for the
three months ended March 31, 2003 to $113,000 for the three months ended March
31, 2004. This decrease results from a decrease in volume of mortgage loan
originations and sales. We sold loans totaling $6.7 million in the three months
ended March 31, 2004 compared with sales of $23.8 million in the previous year
for the comparable period. The increase in mortgage interest rates slowed the
volume of mortgage originations and sales. Given the current level of mortgage
interest rates, the Company believes that mortgage banking income will continue
to decrease in future quarters due to lower refinancing activity. Commissions
from sales of annuities and mutual funds decreased $66,000 from $159,000 for the
quarter ended March 31, 2003 to $93,000 for the quarter ended March 31, 2004.
This decrease results from lower sales of annuities and mutual funds. The
Company recorded gains on sales of investments of $88,000 in the three months
ended March 31, 2004 which were not present in the prior year.
OPERATING EXPENSES. Total operating expenses were $2.1 million and $2.2
million for the three months ended March 31, 2004 and 2003, respectively.
Expenses incurred in operating real estate owned were $4,000 for the three
months ended March 31, 2003 compared to income of $1,000 for the three months
ended March 31, 2004. The Company has been able to control expenses during this
period of slower asset growth.
INCOME TAX EXPENSE. Income tax expense decreased $125,000 from tax expense
of $585,000 for the three months ended March 31, 2003 to $460,000 for the three
months ended March 31, 2004. The effective tax rates were 37.1% and 37.0% for
the three months ended March 31, 2004 and 2003, respectively.
COMPARISON OF OPERATING RESULTS FOR THE SIX MONTHS ENDED MARCH 31, 2004 AND 2003
NET INCOME. We recorded net income of $1.5 million for the six months ended
March 31, 2004, a decrease of $500,000, or 25.0% over the $2.0 million reported
in the six months ended March 31, 2003. For the six months ended March 31, 2004,
basic and diluted earnings per share were $0.55 and $0.52, respectively. The
Company reported basic and diluted earnings per share for the six months ended
March 31, 2003 of $0.70 and $0.67, respectively. The decrease in net income
resulted primarily from decreased net interest income and decreased other
income. These decreases in income were partially offset by decreased operating
expenses and decreased income taxes. The decrease in the net interest income
resulted from lower net interest margins. The average prime interest rate for
the six months ended March 31, 2004 was 4.00%, a decrease of 35 basis points
from 4.35% which was the average prime for the six months ended March 31, 2003.
The rate decrease caused a greater reduction in the average yield on earning
assets than the average rate paid on interest-bearing liabilities.
NET INTEREST INCOME. Net interest income, the difference between interest
earned on loans and investments and interest paid on interest-bearing
liabilities, decreased by $376,000 or 6.7% for the six months ended March 31,
2004, compared to the same six months in the prior year. This decrease reflects
a $963,000 decrease in interest income that was partially offset by the $588,000
decrease in total interest expense. The average net interest rate spread
decreased 27 basis points from 3.22% for the six months ended March 31, 2003 to
2.95% for the six months ended March 31, 2004.
14
INTEREST INCOME. The decrease in interest income for the six months ended
March 31, 2004 was due to a decrease in yield on interest-earning assets of 81
basis points from 5.51% for the six months ended March 31, 2003 to 4.70% for the
six months ended March 31, 2004 that was partially offset by an increase of
$14.2 million in average interest-earning assets compared to the same period in
the prior year. The increased volume of average interest-earning assets
increased interest income by approximately $592,000 and the decreased yield
decreased interest income by approximately $1.6 million. Average investment
securities increased $25.0 million compared with the prior year. This increase
was offset in part by a decrease in average loans receivable of $165,000 and a
decrease of $10.0 million in average interest bearing overnight funds.
INTEREST EXPENSE. Interest expense decreased in the six months ended March
31, 2004 due to a decrease in the cost of interest-bearing liabilities of 54
basis points from 2.29% for the six months ended March 31, 2003 to 1.75% for the
six months ended March 31, 2004 that was partially offset by an increase of
$14.2 million in average interest-bearing liabilities. Average deposits
increased by $3.4 million, and average FHLB advances increased $10.8 million for
the six months ended March 31, 2004 compared to the same six months in the prior
year. The increase in average interest-bearing liabilities increased interest
expense by approximately $317,000 and the decrease in the average cost of
interest-bearing liabilities decreased interest expense by approximately
$905,000.
The following table presents average balances and average rates earned/paid
by the Company for the six months ended March 31, 2004 compared to the six
months ended March 31, 2003.
Six Months Ended Six Months Ended
March 31, 2004 March 31, 2003
-------------------------------- -------------------------------------
(Dollars in Thousands)
Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
-------- -------- ---------- ------- -------- ----------
Assets:
Loans receivable (1)......................... $ 227,691 $ 5,684 4.99% $ 227,857 $ 6,667 5.85%
Investment securities (2).................... 108,883 2,300 4.22 83,906 2,212 5.27
Interest-bearing overnight deposits ......... 3,786 17 0.91 13,789 85 1.24
------------ --------- ------ ---------- --------- -----
Total interest-earning assets (3).......... 340,360 8,001 4.70 325,552 8,964 5.51
Non interest-earning assets.................. 20,879 19,996
------------ ----------
Total assets............................... $ 361,239 $ 345,548
============ ==========
Liabilities and stockholders' equity:
Interest bearing checking.................... 35,822 38 0.21 33,369 74 0.45
Money market investment accounts............. 19,406 65 0.67 21,945 112 1.02
Passbook and statement savings............... 30,095 92 0.61 29,264 161 1.10
Certificates of deposit...................... 160,301 1,610 2.01 157,639 2,113 2.68
FHLB advances................................ 31,863 619 3.89 21,077 552 5.25
------------ --------- ------ ---------- --------- -----
Total interest-bearing liabilities......... 277,487 2,424 1.75 263,294 3,012 2.29
Non interest-bearing liabilities............. 20,401 20,055
------------ ----------
Total liabilities.......................... 297,888 283,349
Stockholders' equity......................... 63,351 62,199
------------ ----------
Total liabilities and stockholders' equity $ 361,239 $ 345,548
============ ==========
Net interest income.......................... $ 5,577 $ 5,952
========= =========
Interest rate spread......................... 2.95% 3.22%
====== =====
Net interest margin (4)...................... 3.28% 3.66%
====== =====
Ratio of average interest-earning assets to
average interest-bearing liabilities........ 122.66% 123.65%
====== ======
---------
(1) Includes nonaccrual loans and loans held for sale, net of discounts and
allowance for loan losses.
(2) Includes FHLB of Atlanta stock.
(3) Due to immateriality, the interest income and yields related to certain tax
exempt assets have not been adjusted to reflect a fully taxable equivalent
yield.
(4) Represents net interest income divided by the average balance of
interest-earning assets.
PROVISION FOR LOAN LOSSES. The provision for loan losses is charged to
earnings to maintain the total allowance for loan losses at a level considered
adequate to absorb estimated probable losses inherent in the loan portfolio
based on existing loan levels and types of loans outstanding, nonperforming
loans, prior loan loss experience, general economic conditions and other
factors. Provisions for loan losses totaled $120,000 for both the six months
ended March 31, 2004 and 2003. The provision for loan losses was impacted by the
continued shift in the portfolio to commercial loans which require a larger
allocation of allowance for loan losses. The effects of this continued shift in
the portfolio were offset to a certain degree in 2004 by a decrease in
nonperforming loans. The Company has completed the foreclosure on some of the
nonperforming loans and shifted those assets into real estate owned. Most of the
real estate owned is under contract. The sale of these properties should be
completed during the next quarter.
OTHER INCOME. Other income decreased $500,000 from $1.6 million for the six
months ended March 31, 2003 to $1.1 million for the six months ended March 31,
2004. Mortgage banking income, net decreased $626,000 from $837,000 for the six
months ended March 31, 2003 to $211,000 for the six months ended March 31, 2004.
This decrease results from a decrease in volume of mortgage loan originations
and sales. We sold loans totaling $13.6 million in the six months ended March
31, 2004 compared with sales of $45.8 million in the previous year for the
comparable period. The increase in mortgage interest rates slowed the volume of
mortgage originations and sales. Given the current level of mortgage interest
rates, the Company believes that mortgage banking income will continue to
decrease in future quarters due to lower refinancing activity. Commissions from
sales of annuities and mutual funds decreased $81,000 from $246,000 for the six
months ended March 31, 2003 to $165,000 for the six months ended March 31, 2004.
This decrease results from lower sales of annuities and mutual funds. The
Company recorded gains on sales of investments of $185,000 in the six months
ended March 31, 2004 which were not present in the prior year.
OPERATING EXPENSES. Total operating expenses were $4.2 million and $4.3
million for the six months ended March 31, 2004 and 2003, respectively. Expenses
incurred in operating real estate owned were $9,000 for the six months ended
March 31, 2003 compared to income of $5,000 for the six months ended March 31,
2004. The Company has been able to control expenses during this period of slower
asset growth.
INCOME TAX EXPENSE. Income tax expense decreased $300,000 from tax expense
of $1.2 million for the six months ended March 31, 2003 to $877,000 for the six
months ended March 31, 2004. The effective tax rates were 36.3% and 36.9% for
the six months ended March 31, 2004 and 2003, respectively. The decrease in the
effective rate was primarily due to an increase in the ratio of state
non-taxable income as a percentage of net income before taxes.
COMMITMENTS, CONTINGENCIES AND OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet risk
including commitments to extend credit under existing lines of credit and
commitments to sell loans. These instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the consolidated balance sheets.
Off-balance sheet financial instruments whose contract amounts represent
credit and interest rate risk are summarized as follows:
March 31, 2004 September 30, 2003
-------------- ------------------
(Dollars in thousands)
Commitments to originate new loans $ 1,196 $ 1,552
Commitments to originate new loans held for sale 326 278
Unfunded commitments to extend credit under existing
equity line and commercial lines of credit 56,537 57,237
Commercial letters of credit 1,692 326
Commitments to sell loans held for sale 1,755 1,630
16
The Company does not have any special purpose entities or other similar
forms of off-balance sheet financing arrangements.
Commitments to originate new loans or to extend credit are agreements to
lend to a customer as long as there is no violation of any condition established
in the contract. Loan commitments generally expire within 30 to 45 days. Most
equity line commitments are for a term of 15 years, and commercial lines of
credit are generally renewable on an annual basis. Commitments generally have
fixed expiration dates or other termination clauses and may require payment of a
fee. Since many of the commitments are expected to expire without being drawn
upon, the total commitment amounts do not necessarily represent future cash
requirements. The Company evaluates each customer's creditworthiness on a
case-by-case basis. The amounts of collateral obtained, if deemed necessary by
the Company upon extension of credit, is based on management's credit evaluation
of the borrower.
Commitments to sell loans held for sale are agreements to sell loans to a
third party at an agreed upon price. At March 31, 2004, the aggregate fair value
of these commitments exceeded the book value of the loans to be sold.
CONTRACTUAL OBLIGATIONS
As of March 31, 2004
PAYMENTS DUE BY PERIOD
(DOLLARS IN THOUSANDS)
LESS THAN
1 YEAR 1-3 YEARS 4-5 YEARS OVER 5 YEARS TOTAL
--------- --------- --------- ------------ -----
Deposits $229,567 23,343 11,503 -- 264,413
Advances from FHLB 8,500 -- 20,000 -- 28,500
Lease obligations 18 41 42 26 127
-------- ------- -------- ---- -------
Total contractual cash
obligations $238,085 23,384 31,545 26 293,040
======== ======= ======== ==== =======
ASSET QUALITY
At March 31, 2004, the Company had approximately $4.5 million in
nonperforming assets (nonaccrual loans and real estate owned) or 1.23% of total
assets. At September 30, 2003, nonperforming assets were $4.2 million or 1.17%
of total assets. At March 31, 2004 and September 30, 2003, impaired loans
totaled $3.7 million and $3.8 million, respectively, as defined by Statement of
Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment
of a Loan." The impaired loans at March 31, 2004 and September 30, 2003 result
from two and three, respectively, unrelated commercial loan customers, each of
which have loans secured by commercial real estate and business assets in
Alamance County. At March 31, 2004, the entire $3.7 million of the impaired
loans are on non-accrual status, and their related reserve for loan losses
totaled $160,000. The average carrying value of impaired loans was $3.7 million
during the six months ended March 31, 2004. Interest income of $98,000 has been
recorded on impaired loans in the six months ended March 31, 2004. The Bank's
net chargeoffs for the six months ended March 31, 2004 were $84,000. The Bank's
allowance for loan losses was $3.9 million at March 31, 2004 and September 30,
2003, and the ratio of the allowance for loan losses to total loans, net of
loans in process and deferred loan fees was 1.66% and 1.68% at March 31, 2004
and September 30, 2003, respectively.
The following table presents an analysis of our nonperforming assets:
At At At
March 31, September 30, March 31,
2004 2003 2003
---- ---- ----
Nonperforming loans:
Nonaccrual loans $ 3,951 $ 4,153 $ 4,414
Loans 90 days past due and accruing -- -- --
Restructured loans -- -- --
------------- -------------- -----------
Total nonperforming loans 3,951 4,153 4,414
Other real estate 513 95 177
------------- -------------- -----------
Total nonperforming assets $ 4,464 $ 4,248 $ 4,591
============= ============== ===========
Nonperforming loans to loans receivable, net 1.71% 1.84% 1.97%
Nonperforming assets as a percentage
of loans and other real estate owned 1.93% 1.88% 2.05%
Nonperforming assets to total assets 1.23% 1.17% 1.32%
17
Regulations require that we classify our assets on a regular basis. There
are three classifications for problem assets: substandard, doubtful and loss. We
regularly review our assets to determine whether any assets require
classification or re-classification. At March 31, 2004, we had $5.0 million in
classified assets consisting of $4.5 million in substandard loans, $24,000 in
loss loans and $513,000 in real estate owned. At September 30, 2003, we had $4.9
million in substandard assets consisting of $4.8 million in loans and $95,000 in
real estate owned. At March 31, 2003, we had $5.0 million in substandard and
loss loans and $177,000 in real estate owned.
In addition to regulatory classifications, we also classify as "special
mention" and "watch" assets that are currently performing in accordance with
their contractual terms but may become classified or nonperforming assets in the
future. At March 31, 2004, we have identified approximately $5.3 million in
assets classified as special mention and $29.3 million as watch. At March 31,
2003, we had identified approximately $1.1 million in assets classified as
special mention and $30.7 million as watch.
Included in the total of special mention assets are five loans with an
aggregate outstanding balance of $4.4 million at March 31, 2004 to a company
affiliated with one of our directors. At December 31, 2003, these loans had been
classified as watch. In addition, the director has the ability to borrow an
additional $35,956 from us under a line of credit. At September 30, 2003, the
aggregate outstanding balance was $4.5 million with additional availability of
$172,000. All the loans are secured by a first lien on all assets, including
accounts receivable, inventory, equipment, furniture and real property occupied
by the borrower. In addition, the director and his spouse have personally
guaranteed repayment of the loans. At March 31, 2004, such loans were current
with respect to their payment terms and, except for the waiver of certain debt
covenants by the Bank, were performing in accordance with the related loan
agreements. Based on an analysis of the borrower's current financial statements
received in April 2004, management has concerns that the borrower may have
difficulty in complying with the present loan repayment terms on an ongoing
basis. Accordingly, this loan may become an impaired loan in future periods.
Management will continue to closely monitor the performance of these loans in
future periods.
LIQUIDITY AND CAPITAL RESOURCES
The Bank must meet certain liquidity requirements established by the State
of North Carolina Office of the Commissioner of Banks (the "Commissioner"). At
March 31, 2004, the Bank's liquidity ratio exceeded such requirements. Liquidity
generally refers to the Bank's ability to generate adequate amounts of funds to
meet its cash needs. Adequate liquidity guarantees that sufficient funds are
available to meet deposit withdrawals, fund loan commitments, maintain adequate
reserve requirements, pay operating expenses, provide funds for debt service,
pay dividends to stockholders and meet other general commitments.
Our primary sources of funds are deposits, principal and interest payments
on loans, proceeds from the sale of loans, and to a lesser extent, advances from
the FHLB of Atlanta. While maturities and scheduled amortization of loans are
predictable sources of funds, deposit flows and mortgage prepayments are greatly
influenced by general interest rates, economic conditions and local competition.
Our most liquid assets are cash and cash equivalents. The levels of these
assets are dependent on our operating, financing, lending and investing
activities during any given period. At March 31, 2004, cash and cash equivalents
totaled $8.4 million. We have other sources of liquidity should we need
additional funds. During the three and six months ended March 31, 2004, we sold
loans totaling $6.7 million and $12.9 million, respectively. Additional sources
of funds include FHLB of Atlanta advances. Other sources of liquidity include
loans and investment securities designated as available for sale, which totaled
$86.6 million at March 31, 2004.
18
We anticipate that we will have sufficient funds available to meet our
current commitments. At March 31, 2004, we had $1.2 million in commitments to
originate new loans, $56.5 million in unfunded commitments to extend credit
under existing equity lines and commercial lines of credit and $1.7 million in
standby letters of credit. At March 31, 2004, certificates of deposit, which are
scheduled to mature within one year, totaled $126.8 million. We believe that a
significant portion of such deposits will remain with us.
The Federal Deposit Insurance Corporation ("FDIC") requires the Bank to
meet a minimum leverage capital requirement of Tier I capital to assets ratio of
4%. The FDIC also requires the Bank to meet a ratio of total capital to
risk-weighted assets of 8%, of which 4% must be in the form of Tier I capital.
The Commissioner requires the Bank at all times to maintain certain minimum
capital levels. The Bank was in compliance with all capital requirements of the
FDIC and the Commissioner at March 31, 2004 and is deemed to be "well
capitalized."
The Federal Reserve also mandates capital requirements on all bank holding
companies, including 1st State Bancorp, Inc. These capital requirements are
similar to those imposed by the FDIC on the Bank. At March 31, 2004, the Company
was in compliance with the capital requirements of the Federal Reserve.
On October 2, 2000, the Company paid a one-time special cash distribution
of $5.17 per share to its stockholders. The distribution was made to manage the
Company's capital and enhance shareholder value. Returning capital to the
stockholders reduced the Company's equity to asset ratio from 21.2% to 17.2%.
The Company's equity to asset ratio at March 31, 2004 was 17.7%. The Company's
capital level is sufficient to support future growth.
The Company has declared cash dividends per common share of $0.10 for each
of the three months ended March 31, 2004, September 30, 2003 and March 31, 2003.
The Company's ability to pay dividends is dependent upon earnings. The Company's
dividend payout ratio for the three months ended March 31, 2004, September 30,
2003 and March 31, 2003 was 38.5%, 31.2% and 29.4%, respectively.
ACCOUNTING MATTERS
In March 2004, the SEC released Staff Accounting Bulletin No. 105 -
Application of Accounting Principles to Loan Commitments. This bulletin requires
all registrants to begin accounting for their issued loan commitments (including
interest rate lock commitments) subject to Statement 133 as written options.
Treatment as a written option would require those loan commitments to be
reported as liabilities until either they are exercised (and a loan is made) or
they expire unexercised. Staff Accounting Bulletin No. 105 must be applied to
loan commitments that are issued after March 31, 2004. The adoption of Staff
Accounting Bulletin No. 105 is not expected to have a material impact on the
consolidated financial statements.
In January 2003, FASB Interpretation No. 46, "Consolidation of Variable
Interest Entities, an interpretation of ARB No. 51", (Interpretation 46) was
issued. Interpretation 46 addresses the consolidation by business enterprises of
variable interest entities as defined in the Interpretation. Interpretation 46
applies immediately to variable interests in variable interest entities created
after January 31, 2003, and to variable interests in variable interest entities
obtained after January 31, 2003. In December 2003, the FASB issued FASB
Interpretation No. 46 (revised December 2003), "Consolidation of Variable
Interest Entities", which addresses how a business enterprise should evaluate
whether it has a controlling financial interest in an entity through means other
than voting rights and accordingly should consolidate the entity. FIN 46R
replaces FASB Interpretation No. 46, "Consolidation of Variable Interest
Entities", which was issued in January 2003. The Company will be required to
apply FIN 46R to variable interests in VIEs created after December 31, 2003. The
application of this revised interpretation is not expected to have a material
effect on the consolidated financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the possible chance of loss from unfavorable changes in
market prices and rates. These changes may result in a reduction of current and
future period net interest income, which is the favorable spread earned from the
excess of interest income on interest-earning assets over interest expense on
interest-bearing liabilities.
The Company considers interest rate risk to be its most significant market
risk, which could potentially have the greatest impact on operating earnings.
The structure of the Company's loan and deposit portfolios is such that a
significant decline in interest rates may adversely impact net market values and
net interest income.
19
The Company monitors whether material changes in market risk have occurred
since September 30, 2003. The Company does not believe that any material adverse
changes in market risk exposures have occurred since September 30, 2003.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, management of the
Company carried out an evaluation, under the supervision and with the
participation of the Company's principal executive officer and principal
financial officer, of the effectiveness of the Company's disclosure controls and
procedures. Based on this evaluation, the Company's principal executive officer
and principal financial officer concluded that the Company's disclosure controls
and procedures are effective in ensuring that information required to be
disclosed by the Company in reports that it files or submits under the
Securities Exchange Act of 1934, as amended, is recorded, processed, summarized
and reported, within the time periods specified in the Securities and Exchange
Commission's rules and forms. It should be noted that the design of the
Company's disclosure controls and procedures is based in part upon certain
reasonable assumptions about the likelihood of future events, and there can be
no reasonable assurance that any design of disclosure controls and procedures
will succeed in achieving its stated goals under all potential future
conditions, regardless of how remote, but the Company's principal executive and
financial officers have concluded that the Company's disclosure controls and
procedures are, in fact, effective at a reasonable assurance level.
In addition, there have been no changes in the Company's internal control
over financial reporting identified in connection with the evaluation described
in the above paragraph that occurred during the Company's last fiscal quarter,
that has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
20
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we are a party to various legal proceedings incident to
our business. There currently are no legal proceedings to which we are a party,
or to which any of our property was subject, except as described in the
following paragraph, and none which are expected to result in a material loss.
There are no pending regulatory proceedings to which we are a party or to which
any of our properties is subject which are expected to result in a material
loss.
A civil action was filed against 1st State Bank and Brokers, Incorporated
by Michael Locklar in Davidson County Superior Court, in the State of North
Carolina on May 16, 2003. Mr. Locklar has alleged in the action that 1st State
Bank granted him an option to purchase certain real property located in Davidson
County, North Carolina, which 1st State Bank wrongfully sold to Brokers,
Incorporated for $150,000 in breach of the option granted to Mr. Locklar. Mr.
Locklar is seeking to set aside the conveyance of property to Brokers,
Incorporated and to purchase the property from 1st State Bank for the option
price. Brokers, Incorporated has filed a cross-claim against 1st State Bank
seeking indemnification in the form of return of the purchase price they paid
for the property, damages and attorneys fees should Locklar be successful in
setting aside the real estate conveyance. 1st State Bank intends to vigorously
contest Mr. Locklar's allegations.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF
SECURITIES
(a) Not applicable
(b) Not applicable
(c) Not applicable
(d) Not applicable
(e) The following table sets forth information regarding the Company's
repurchases of its Common Stock during the quarter ended March 31,
2004.
(c)
TOTAL NUMBER
OF SHARES (d)
PURCHASED MAXIMUM
(a) AS PART OF NUMBER OF SHARES
TOTAL (b) PUBLICLY THAT MAY YET BE
NUMBER OF AVERAGE ANNOUNCED PLANS PURCHASED UNDER
SHARES PRICE PAID OR THE PLANS OR
PERIOD PURCHASED PER SHARE PROGRAMS PROGRAMS
------ --------- ---------- ---------------- ----------------
January 2004 688 $29.38 688 (1)
Beginning date: January 29
Ending date: January 30
February 2004 4,950 $29.41 4,950 (1)
Beginning date: February 3
Ending date: February 23
5,638 $29.40 5,638 (1)
Total
(1) On August 20, 2002, the Company announced a 10% stock repurchase
program to acquire up to 328,961 shares of the Company's common stock over a
period of 18 months. These share purchases complete this repurchase program.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Stockholders was held on February 3,
2004. At this meeting, 2,971,285 shares of the Company's common stock
were represented in person or by proxy.
Stockholders voted in favor of the election of three nominees for
director. The voting results for each nominee were as follows:
VOTES IN FAVOR VOTES
NOMINEE OF ELECTION WITHHELD
------- -------------- --------
James A. Barnwell, Jr. 2,595,101 2,405
James G. McClure 2,596,201 1,305
T. Scott Quakenbush 2,595,019 2,379
There were no broker nonvotes on the matter.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS.
---------
3.2 Bylaws, as amended of 1st State Bancorp, Inc.
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
22
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
32 Section 1350 Certification
(b) REPORTS ON FORM 8-K.
--------------------
The Registrant filed the following Current Reports on Form
8-K during the quarter ended March 31, 2004:
DATE OF REPORT ITEM(S) REPORTED FINANCIAL STATEMENTS FILED
-------------- ---------------- --------------------------
January 28, 2004 7, 12 N/A
February 25, 2004 5 N/A
23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
1st STATE BANCORP, INC.
Date: May 13, 2004 /s/ James C. McGill
--------------------------------------------
James C. McGill
President and Chief Executive Officer
(Principal Executive Officer)
Date: May 13, 2004 /s/ A. Christine Baker
--------------------------------------------
A. Christine Baker
Executive Vice President
Treasurer and Secretary
(Principal Financial and Accounting Officer)