U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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 December 31, 2001
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.
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(Exact Name of Registrant as Specified in Its Charter)
VIRGINIA 56-2130744
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(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)
Registrant' s Telephone Number, Including Area Code (336) 227-8861
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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
---- ----
As of February 14, 2002, the issuer had 3,289,607 shares of common stock
issued and outstanding.
CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
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Item 1. Financial Statements
Consolidated Balance Sheets as of December 31, 2001 (unaudited)
and September 30, 2001............................................1
Consolidated Statements of Income for the Three Months Ended
December 31, 2001 and 2000 (unaudited).............................2
Consolidated Statements of Stockholders' Equity and
Comprehensive Income for the Three Months Ended December 31,
2001 and 2000 (unaudited)..........................................3
Consolidated Statements of Cash Flows for the Three Months Ended
December 31, 2001 and 2000 (unaudited).............................4
Notes to Consolidated Financial Statements...........................6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..........................................9
Item 3. Quantitative and Qualitative Disclosures About Market Risk..........15
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings...................................................16
Item 2. Changes in Securities and Use of Proceeds...........................16
Item 3. Defaults Upon Senior Securities.....................................16
Item 4. Submission of Matters to a Vote of Security Holders.................16
Item 5. Other Information...................................................16
Item 6. Exhibits and Reports on Form 8-K....................................16
SIGNATURES...................................................................17
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2001 AND SEPTEMBER 30, 2001
(IN THOUSANDS)
AT AT
DECEMBER 31, SEPTEMBER 30,
2001 2001
------------ -------------
(Unaudited)
ASSETS
Cash and cash equivalents $ 14,279 $ 25,981
Investment securities:
Held to maturity (fair value of $11,798 and $12,495
at December 31, 2001 and September 30, 2001, respectively) 11,622 12,169
Available for sale (cost of $83,797 and $54,689
at December 31, 2001 and September 30, 2001, respectively) 83,503 55,527
Loans held for sale, at lower of cost or fair value 10,764 3,291
Loans receivable (net of allowance for loan losses of $3,588
and $3,612 at December 31, 2001 and September 30, 2001,
respectively) 213,617 222,285
Federal Home Loan Bank stock, at cost 1,650 1,650
Real estate owned 2,328 1,981
Premises and equipment 8,347 8,414
Accrued interest receivable 2,069 2,542
Other assets 3,008 2,952
---------- ---------
Total assets $ 351,187 336,792
========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposit accounts $ 257,274 248,370
Advances from Federal Home Loan Bank 25,000 20,000
Advance payments by borrowers for property taxes and insurance 258 82
Dividend payable 263 263
Other liabilities 4,455 4,433
---------- ---------
Total liabilities 287,250 273,148
---------- ---------
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;
3,289,607 shares issued and outstanding 33 33
Additional paid-in capital 35,596 35,588
Unearned ESOP shares (4,202) (4,373)
Unearned compensation - management recognition plan (324) (518)
Deferred compensation 4,324 4,173
Treasury stock for deferred compensation (4,324) (4,173)
Retained income - substantially restricted 33,013 32,404
Accumulated other comprehensive income/(loss) - net unrealized
gain/(loss) on investment securities available for sale (179) 510
---------- ---------
Total stockholders' equity 63,937 63,644
---------- ---------
Total liabilities and stockholders' equity $ 351,187 336,792
========== =========
See accompanying notes to the consolidated financial statements.
1
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED DECEMBER 31, 2001 AND 2000
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
FOR THE THREE MONTHS ENDED
DECEMBER 31,
---------------------------
2001 2000
------ ------
Interest income:
Interest and fees on loans $3,889 5,090
Interest and dividends on investments 1,222 1,217
Overnight deposits 89 203
------ ------
Total interest income 5,200 6,510
------ ------
Interest expense:
Deposit accounts 2,094 2,977
Borrowings 276 303
------ ------
Total interest expense 2,370 3,280
------ ------
Net interest income 2,830 3,230
Provision for loan losses 60 60
------ ------
Net interest income after provision for loan losses 2,770 3,170
------ ------
Other income:
Service fees on loans sold 22 20
Customer service fees 249 156
Commissions from sales of annuities and mutual funds 122 111
Mortgage banking income, net 416 128
Other 50 42
------ ------
Total other income 859 457
------ ------
Operating expenses:
Compensation and related benefits 1,564 1,543
Occupancy and equipment 303 277
Deposit insurance premiums 12 12
Real estate operations, net 18 --
Other expenses 360 411
------ ------
Total operating expenses 2,257 2,243
------ ------
Income before income taxes 1,372 1,384
Income taxes 527 483
------ ------
Net income $ 845 901
====== ======
Earnings per share:
Basic $ 0.28 $ 0.30
Diluted $ 0.27 $ 0.29
See accompanying notes to the consolidated financial statements.
2
1ST STATE BANCORP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED DECEMBER 31, 2001 AND 2000 (UNAUDITED)
(IN THOUSANDS)
ADDITIONAL UNEARNED UNEARNED
COMMON PAID-IN ESOP COMPENSATION DEFERRED
STOCK CAPITAL SHARES MRP COMPENSATION
----- ------- ------ --- ------------
Balance at September 30, 2000 $ 33 35,587 (4,950) (1,296) 2,679
Comprehensive income:
Net income -- -- -- -- --
Other comprehensive income-unrealized
gain on securities available-for-sale,
net of income taxes of $68 -- -- -- -- --
Total comprehensive income
Allocation of ESOP shares -- (8) 137 -- --
Deferred compensation -- -- -- -- 249
Treasury stock held for deferred compensation -- -- -- -- --
Vesting of MRP shares -- -- -- 195 --
Cash dividend declared -- -- -- -- --
Cash dividend on unallocated ESOP shares
and unvested MRP shares -- -- -- -- --
--------- ---------- ----------- ------------ ------------
Balance at December 31, 2000 $ 33 35,579 (4,813) (1,101) 2,928
========= ========== =========== ============ ============
Balance at September 30, 2001 $ 33 35,588 (4,373) (518) 4,173
Comprehensive income:
Net income -- -- -- -- --
Other comprehensive loss-unrealized
loss on securities available-for-sale,
net of income taxes of $443 -- -- -- -- --
Total comprehensive income
Allocation of ESOP shares -- 8 171 -- --
Deferred compensation -- -- -- -- 151
Treasury stock held for deferred compensation -- -- -- -- --
Vesting of MRP shares -- -- -- 194 --
Cash dividend declared -- -- -- -- --
Cash dividend on unallocated ESOP shares
and unvested MRP shares -- -- -- -- --
--------- ---------- ----------- ------------ ------------
Balance at December 31, 2001 $ 33 35,596 (4,202) (324) 4,324
========= ========== =========== ============ ============
TREASURY ACCUMULATED
STOCK FOR OTHER TOTAL
DEFERRED RETAINED COMPREHENSIVE STOCKHOLDERS'
COMPENSATION INCOME INCOME (LOSS) EQUITY
------------ ------ ------------- ------
Balance at September 30, 2000 (2,679) 29,999 (164) 59,209
--
Comprehensive income: --
Net income -- 901 -- 901
Other comprehensive income-unrealized
gain on securities available-for-sale,
net of income taxes of $68 -- -- 102 102
-----------
Total comprehensive income 1,003
Allocation of ESOP shares -- -- -- 129
Deferred compensation -- -- -- 249
Treasury stock held for deferred compensation (249) -- -- (249)
Vesting of MRP shares -- -- -- 195
Cash dividend declared -- (263) -- (263)
Cash dividend on unallocated ESOP shares
and unvested MRP shares -- 22 -- 22
------------ -------------- ------------- -----------
Balance at December 31, 2000 (2,928) 30,659 (62) 60,295
============ ============== ============= ===========
Balance at September 30, 2001 (4,173) 32,404 510 63,644
--
Comprehensive income: --
Net income -- 845 -- 845
Other comprehensive loss-unrealized
loss on securities available-for-sale,
net of income taxes of $443 -- -- (689) (689)
------------
Total comprehensive income 156
Allocation of ESOP shares -- -- -- 179
Deferred compensation -- -- -- 151
Treasury stock held for deferred compensation (151) -- -- (151)
Vesting of MRP shares -- -- -- 194
Cash dividend declared -- (263) -- (263)
Cash dividend on unallocated ESOP shares
and unvested MRP shares -- 27 -- 27
------------ -------------- ------------- -----------
Balance at December 31, 2001 (4,324) 33,013 (179) 63,937
============ ============== ============= ===========
See accompanying notes to the consolidated financial statements.
3
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED DECEMBER 31, 2001 AND 2000
(UNAUDITED)
(IN THOUSANDS)
FOR THE THREE MONTHS ENDED
DECEMBER 31,
----------------------------
2001 2000
-------- --------
Cash flows from operating activities:
Net income $ 845 901
Adjustment to reconcile net income to net cash provided by
(used in) operating activities:
Provision for loan losses 60 60
Depreciation 153 146
Deferred tax expense (benefit) 155 (38)
Amortization of premiums and discounts, net (13) (5)
Deferred compensation 92 68
Release of ESOP shares 179 129
Vesting of MRP shares and dividends on unearned MRP shares 260 263
Loan origination fees and unearned discounts
deferred, net of current amortization (54) 44
Net loss on sale of loans 211 63
Proceeds from sales of loans held for sale 25,264 6,195
Originations of loans held for sale (32,948) (5,164)
Decrease in other assets 232 111
Decrease in accrued interest receivable 473 90
Decrease in other liabilities (287) (1,643)
-------- -------
Net cash provided by (used in) operating activities (5,378) 1,220
-------- -------
Cash flows from investing activities:
Purchase of investment securities available for sale (46,326) --
Purchases of investment securities held to maturity (2,454) --
Proceeds from maturities of investment securities available for sale 17,231 60
Proceeds from maturities of investment securities
held to maturity 3,001 530
Net decrease (increase) in loans receivable 8,315 (5,608)
Purchases of premises and equipment (86) (402)
-------- -------
Net cash used in investing activities (20,319) (5,420)
-------- -------
(Continued)
4
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
FOR THE THREE MONTHS ENDED DECEMBER 31, 2001 AND 2000
(UNAUDITED)
(IN THOUSANDS)
FOR THE THREE MONTHS ENDED
DECEMBER 31,
------------------------------
2001 2000
---------- ---------
Cash flows from financing activities:
Net increase in deposits $ 8,904 $ 3,665
Advances from the Federal Home Loan Bank 5,000 5,000
Return of capital dividend payment -- (17,007)
Purchase of treasury stock for deferred compensation 151 249
Dividends paid on common stock (236) (241)
Increase in advance payments by borrowers for
property taxes and insurance 176 203
---------- ---------
Net cash provided by (used in) financing activities 13,995 (8,131)
---------- ---------
Net decrease in cash and cash equivalents (11,702) (12,331)
Cash and cash equivalents at beginning of period 25,981 33,107
---------- ---------
Cash and cash equivalents at end of period $ 14,279 $ 20,776
========== =========
Payments are shown below for the following:
Interest $ 2,375 $ 3,342
========== =========
Income taxes $ 68 $ 27
========== =========
Noncash investing and financing activities:
Unrealized gains (losses) on investment securities
available for sale $ (1,132) $ 170
========== =========
Cash dividends declared but not paid $ 236 $ 241
========== =========
Cash dividends on unallocated ESOP shares $ 24 $ 16
========== =========
Transfer from loans held for sale to loans receivable $ -- $ 686
========== =========
Transfer from loans to real estate acquired in settlement of loans $ 347 $ --
========== =========
See accompanying notes to the consolidated financial statements.
5
1ST STATE BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 (UNAUDITED) AND SEPTEMBER 30, 2001
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 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, 2001, which is
derived from the September 30, 2001 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 month period ended December 31,
2001 are not necessarily indicative of the results of operations that may be
expected for the year ended September 30, 2002. 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.
Certain amounts in the December 31, 2000 consolidated financial statements
(which are unaudited) have been reclassified to conform with the presentation
adopted in 2001. Such reclassifications did not change net income or
stockholders' equity as previously reported.
NOTE 3. EARNINGS PER SHARE
Earnings per share computations have been made only for the periods
subsequent to the Conversion. 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 includes the potentially dilutive
effects of the Company's benefit plans. There were no antidilutive stock options
for the three months ended December 31, 2001 and 2000. A reconciliation of the
denominators of the basic and diluted earnings per share computations is as
follows:
2001 2000
---- ----
Average shares issued and outstanding 3,289,607 3,289,607
Less: Unvested MRP shares (42,156) (84,319)
Less: Unallocated ESOP shares (232,123) (198,258)
--------- ---------
Average basic shares for earnings per share 3,015,328 3,007,030
Add: Unvested MRP shares 42,156 84,319
Add: Potential common stock pursuant to stock
option plan (See Note 7) 88,550 60,936
--------- ---------
Average dilutive shares for earnings per share 3,146,034 3,152,285
========= =========
6
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. In connection with
the special cash dividend, the ESOP received $1,308,000 on its shares of the
Company's stock. The ESOP purchased an additional 64,415 shares with this
dividend. During the three months ended December 31, 2001 and 2000, 8,696 and
7,097 shares of stock were committed to be released and approximately $179,000
and $129,000 of compensation expense was recognized, respectively.
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 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 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 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 2001 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 the three months ended December 31,
2001 and 2000 was $92,000 and $68,000, respectively. This expense is included in
compensation expense.
NOTE 6. MANAGEMENT RECOGNITION PLAN
The Company has a Management Recognition Plan ("MRP") which serves as a
means of providing existing directors and officers of the bank with an ownership
interest in the company. On June 6, 2000, restricted stock awards of 126,482
shares were granted. The shares awarded under the MRP were issued from
authorized but unissued shares of common stock at no cost to the recipients. The
shares vest at a rate of 33 1/3% per year with a one-third immediate vest on the
date of the grant and annually thereafter. Compensation expense of $260,000 and
$263,000 associated with the MRP was recorded during the three months ended
December 31, 2001 and 2000, respectively.
NOTE 7. 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 in fiscal year 2000. 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.
7
NOTE 8. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In June 1998 the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Certain Hedging Activities." In June 1999 the FASB
issued SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain
Hedging Activities, an Amendment of SFAS 133." SFAS No. 133 and SFAS No. 138
require that all derivative instruments be recorded on the balance sheet at
their respective fair values. Changes in the fair values of those derivatives
will be reported in earnings or other comprehensive income depending on the use
of the derivative and whether the derivative qualifies for hedge accounting.
SFAS No. 133 and SFAS No. 138 are effective for all fiscal quarters of all
fiscal years beginning after June 30, 2000; the Company adopted SFAS No. 133, as
amended by SFAS No. 138, on October 1, 2000.
On October 1, 2000, the Company had no embedded derivative instruments
requiring separate accounting treatment and had identified fixed rate conforming
mortgage loan commitments as its only freestanding derivative instrument. The
fair value of these commitments was not material and therefore the adoption of
SFAS No. 133 on October 1, 2000, did not have a material impact on the Company's
consolidated financial statements. On December 31, 2001 and September 30, 2001,
the Company had no embedded derivative instruments requiring separate accounting
treatment and had identified commitments to originate fixed rate loans
conforming to secondary market standards as its only freestanding derivative
instruments. The Company does not currently engage in hedging activities. The
commitments to originate fixed rate conforming loans totaled $925,000 and
$2,157,000 at December 31, 2001 and September 30, 2001, respectively. The fair
value of these commitments was less than $ 5,000 on these dates and therefore
the impact of applying SFAS 133 at December 31, 2001 and September 30, 2001 was
not material to the Company's consolidated financial statements.
NOTE 9. 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 which is determined when the underlying
loans are sold. MSRs are amortized over a period which 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 December 31, 2001 and September
30, 2001, MSRs totaled $266,000 and $209,000, respectively, and no valuation
allowance was required.
8
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. As a result, portions of this
discussion (as of dates and for periods prior to April 23, 1999) relate to the
financial condition and results of operations of 1st State Bank.
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
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 also is 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. 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.
The primary manner in which the economy impacts our business is our credit risk.
Most of our customers are small businesses in our immediate market area that are
more vulnerable to recent declines in the economy than larger, more diversified
companies whose revenues are supported by customers in a variety of locations.
Our customer base includes textile companies that are continuing to feel the
negative impact of the NAFTA legislation and the downturn in our local and
regional economy. Such changes may impact future operations and earnings.
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.
Beginning in the late 1980's, 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.
9
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2001 AND SEPTEMBER 30, 2001
Total assets increased by $14.4 million or 4.3% from $336.8 million at
September 30, 2001 to $351.2 million at December 31, 2001. Increases in
investment securities and loans held for sale were partially offset by decreases
in cash and loans receivable, net. Asset growth was funded by increases in
deposits and borrowed money.
Cash and cash equivalents decreased $11.7 million, or 45.0% from $26.0
million at September 30, 2001 to $14.3 million at December 31, 2001. Because of
the decrease in the overnight interest rate to 1.75% during the quarter ended
December 31, 2001, we invested excess cash in short term government agency
securities to increase our yield on these funds.
Investment securities available for sale increased $28.0 million from $55.5
million at September 30, 2001 to $83.5 million at December 31, 2001. During the
quarter ended December 31, 2001, we purchased $46.3 million of securities and
received $17.2 million in proceeds from maturities and issuer calls of
investment securities available for sale. We shifted funds from interest-bearing
overnight funds into investment securities during the quarter to increase our
yield.
Loans receivable, net decreased by $8.7 million, or 3.9%, from $222.3
million at September 30, 2001 to $213.6 million at December 31, 2001. This
decrease was offset somewhat by a $7.5 million increase in loans held for sale.
Loans held for sale increased 227.3% from $3.3 million at September 30, 2001 to
$10.8 million at December 31, 2001. This increase resulted from increased
lending activity and timing differences in the funding of loan sales. During the
quarter our mortgage originations and prepayments were at record levels.
Mortgage rates declined to record low levels during the quarter, and many
borrowers took advantage of this opportunity to refinance their existing
mortgage loans.
Stockholders' equity increased by $300,000 from $63.6 million at September
30, 2001 to $63.9 million at December 31, 2001 as a result of net income of
$845,000, release of ESOP shares of $179,000, and vesting of MRP shares of
$194,000. These increases were offset by cash dividends declared of $236,000 and
a change in unrealized losses on available for sale securities of $689,000. In
the aftermath of the September 11, 2001 terrorist strikes, bond prices increased
sharply that created the Company's unrealized gain on available for sale
securities of $510,000 at September 30, 2001. During the quarter ended December
31, 2001, bond prices backed down to their previous levels and the Company had
an unrealized loss on available for sale securities of $179,000 at December 31,
2001.
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED DECEMBER 31, 2001 AND
2000
Net Income. We recorded net income of $845,000 for the quarter ended
December 31, 2001, as compared to $901,000 for the quarter ended December 31,
2000, representing a decrease of $56,000, or 6.2%. For the three months ended
December 31, 2001, basic and diluted earnings per share were $0.28 and $0.27,
respectively. The Company reported basic and diluted earnings per share for the
quarter ended December 31, 2000 of $0.30 and $0.29, respectively. The decrease
in net income resulted primarily from decreased net interest income and
increased income taxes that were offset partially by increased other income. The
decline in net interest income resulted from lower net interest margins. These
decreased margins resulted primarily from the eleven interest rate cuts by the
Federal Reserve during calendar 2001. These rate cuts caused a greater reduction
in the average yield on earning assets than in 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 $400,000 or 12.4% for the three months ended December
31, 2001, compared to the same quarter in the prior year. This decrease results
from a $1.3 million decrease in interest income that was partially offset by the
$910,000 decrease in total interest expense. The average net interest rate
spread decreased 37 basis points from 3.15% for the three months ended December
31, 2000 to 2.78% for the quarter ended December 31, 2001.
Interest Income. The decrease in interest income for the three months ended
December 31, 2001 was the result of an increase of $4.6 million in average
interest-earning assets compared to the same quarter in the prior year that was
offset by a decrease in yield on interest-earning assets of 1.72% from 8.08% for
the three months ended December 31, 2000 to 6.36% for the three months ended
December 31, 2001. The increased volume of average interest-earning assets
increased interest income by approximately $30,000 and the decreased yield
decreased interest income by approximately $1.3 million. An increase in average
investment securities of $6.8 million coupled with an increase in average
interest-bearing overnight funds of $4.9 million increased interest-earning
assets for the quarter compared to the prior year. These increases were offset
in part
10
by a decrease in average loans receivable of $7.2 million. Our average mortgage
loans decreased by $11.2 million during the quarter ended December 31, 2001
compared to the quarter ended December 31, 2000. We experienced unusually heavy
prepayments during the quarter as borrowers took advantage of the attractive
mortgage rates and refinanced existing mortgage loans. The majority of the
mortgage loans originated during the quarter were sold in the secondary market.
Average commercial loans increased $4.8 million for the quarter ended December
31, 2001 as compared to the same quarter in the prior year.
Interest Expense. Interest expense decreased in the three months ended
December 31, 2001 due to a decrease in average interest-bearing liabilities of
$1.7 million and a decrease in the cost of interest-bearing liabilities of 135
basis points from 4.93% for the three months ended December 31, 2000 to 3.58%
for the three months ended December 31, 2001. Average interest-bearing deposits
decreased by $98,000 and average FHLB advances decreased $1.6 million for the
three months ended December 31, 2001 compared to the same quarter in the prior
year. The decrease in average interest-bearing liabilities decreased interest
expense by approximately $23,000 and the decrease in the average cost of
interest-bearing liabilities decreased interest expense by approximately
$887,000. During the quarter ended December 31, 2001, average money market
investment accounts increased by $9.8 million over the comparable quarter in the
prior year. The lower rate environment caused some depositors to shift from
longer term fixed rate certificates of deposit into the more liquid money market
accounts. We have continued to attract some commercial customers that had excess
liquidity during the quarter ended December 31, 2001 which they invested in
money market accounts. Average certificates of deposit decreased $9.8 million in
the three months ended December 31, 2001 compared to the previous quarter in the
prior year. The level of certificates of deposits obtained from governmental
units depends upon many factors including the level of interest rates and the
Bank's loan demand. The average balance of time deposits held by governmental
units decreased $13.6 million in the quarter ended December 31, 2001 as compared
with the same quarter in the prior year. This was offset in part by an increase
of $3.8 million in the average balance of other certificates of deposits.
11
The following table presents average balances and average rates earned/paid by
the Company for the quarter ended December 31, 2001 compared to the quarter
ended December 31, 2000.
THREE MONTHS ENDED THREE MONTHS ENDED
DECEMBER 31, 2001 DECEMBER 31, 2000
DOLLARS IN THOUSANDS
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST
Assets:
Loans receivable (1) $224,268 $3,889 6.94% $231,424 $5,090 8.80%
Investment securities (2) 85,387 1,222 5.72 78,560 1,217 6.20
Interest-bearing overnight deposits 17,288 90 2.08 12,340 203 6.59
-------- ------ ---- -------- ------ ----
Total interest-earning assets (4) 326,943 5,201 6.36 322,324 6,510 8.08
Non interest-earning assets 21,785 21,881
-------- --------
Total assets $348,728 $344,205
======== ========
Liabilities and stockholders' equity
Interest bearing checking 30,839 15 0.19 30,469 92 1.21
Money market investment accounts 28,732 144 2.00 18,912 255 5.40
Passbook and statement savings 26,218 111 1.69 26,718 159 2.38
Certificates of deposit 158,868 1,824 4.59 168,656 2,471 5.86
FHLB advances 20,054 276 5.51 21,630 303 5.60
-------- ------ ---- -------- ------ ----
Total interest-earning liabilities 264,711 2,370 3.58 266,385 3,280 4.93
Non interest-earning liabilities 20,101 17,995
-------- --------
Total liabilities 284,812 284,380
Stockholders' equity 63,916 59,825
-------- --------
Total liabilities and stockholders' equity $348,728 $344,205
======== ========
Net interest income 2,831 3,230
Interest rate spread 2.78% 3.15%
Net interest margin (3) 3.46% 4.01%
Ratio of average interest-earning assets 123.51% 121.00%
(1) Includes nonaccrual loans and loans held for sale, net of discounts and
allowance for loan losses.
(2) Includes FHLB of Atlanta stock.
(3) Represents net interest income divided by the average balance of
interest-earning assets.
(4) 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.
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 absorb probable losses based on prior loss experience, volume and type of
lending we conduct, industry standards, current economic conditions, past due
loans in our loan portfolio and other factors. Provisions for loan losses
totaled $60,000 for both the three months ended December 31, 2001 and 2000.
Other Income. Other income increased $402,000, or 88.0%, from $457,000 for
the quarter ended December 31, 2000 to $859,000 for the quarter ended December
31, 2001. Mortgage banking income, net increased $288,000 from $128,000 for the
quarter ended December 31, 2000 to $416,000 for the quarter ended December 31,
2001. During the quarter ended December 31, 2001, we sold fixed-rate mortgage
loans held for sale of $25.3 million and recognized net gains of $416,000 on the
sale of these loans. During the quarter ended December 31, 2000, we sold
fixed-rate mortgage loans held for sale of $6.2 million and recognized net gains
of $128,000 from the sale of these loans. Customer service fees increased
$93,000, or 59.6% from $156,000 for the quarter ended December 31, 2001 to
$249,000 for the quarter ended December 31, 2000. This increase results from
growth in the number of transaction accounts and increased service charges.
12
Operating Expenses. Total operating expenses were $2.3 million for the
quarter ended December 31, 2001, an increase of $14,000, or 0.6% over the $2.2
million recorded for the three months ended December 31, 2000. Occupancy and
equipment expense increased $26,000, or 9.4% from $277,000 for the quarter ended
December 31, 2000 to $303,000 for the quarter ended December 31, 2001. This
increase was primarily the result of increased depreciation expense from the new
check imaging hardware and software, which was not present in the same quarter
of the prior year. Expenses incurred in operating real estate owned were $18,000
for the three months ended December 31, 2001 which were not present in the prior
year.
Income Tax Expense. Income tax expense increased $44,000 from tax expense
of $483,000 for the quarter ended December 31, 2000 to $527,000 for the quarter
ended December 31, 2001. The effective tax rates were 38.4% and 34.9% for the
quarters ended December 31, 2001 and 2000, respectively. The increase in the
effective rate was primarily due to an increase in non-deductible expenses over
the prior period.
ASSET QUALITY
At December 31, 2001, we had approximately $2.7 million in non-performing
assets (nonaccrual loans and real estate owned) or 0.77% of total assets. At
September 30, 2001, non-performing assets were $2.9 million or 0.85% of total
assets. At December 31, 2001 and September 30, 2001, impaired loans totaled $3.7
million and $2.5 million, respectively, as defined by Statement of Financial
Accounting Standards No. 114, "Accounting by Creditors for Impairment of a
Loan." The impaired loans at December 31, 2001 result from two unrelated
commercial loan customers, both of which have loans secured by commercial real
estate and business assets in Alamance County. At December 31, 2001, none of the
impaired loans is on non-accrual status, and their related reserve for loan
losses totaled $150,000. There was no impact on the provision as management had
already anticipated the loans' performance in setting the allowance for loan
losses in previous periods. The average carrying value of impaired loans was
$3.0 million during the three months ended December 31, 2001. Interest income of
$59,000 has been recorded on impaired loans in the three months ended December
31, 2001. The Bank's net chargeoffs for the three months ended December 31, 2001
and 2000 were $84,000 and $32,000, respectively. The allowance for loan losses
was $3.6 million or 1.65% of outstanding loans at December 31, 2001. This
compares to 1.60% at September 30, 2001 and 1.53% at December 31, 2000. As a
result of our continued shift toward higher risk commercial, consumer and home
equity loans and the recent runoff of residential mortgage loans as well as the
continued decline in the local and regional economy, the ratio of the allowance
for the loan losses to total loans, net of loans in process and deferred loan
fees increased to 1.65% at December 31, 2001 compared to 1.60% at September 30,
2001.
The following table presents an analysis of our nonperforming assets:
At At At
December 31, September 30, December 31,
2001 2001 2000
---- ---- ----
Nonperforming loans:
Nonaccrual loans $ 380 $ 878 $ 2,963
Loans 90 days past due and accruing
- - -
Restructured loans
- - -
Total nonperforming loans
380 878 2,963
Other real estate 2,328 1,981 70
------- ------- -------
Total nonperforming assets $ 2,708 $ 2,859 $ 3,033
======= ======== =======
Nonperforming loans to loans receivable, net 0.18% 0.39% 1.29%
Nonperforming assets as a percentage
of loans and other real estate owned 1.25% 1.27% 1.32%
Nonperforming assets to total assets 0.77% 0.85% 0.87%
13
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 December 31, 2001, we had $ 3.3 million
in classified assets consisting of $957,000 in substandard and loss loans and
$2.3 million 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 December 31, 2001, we have identified approximately $4.6 million in
assets classified as special mention and $33.2 million as watch. Included in the
watch asset total are five loans with an aggregate outstanding balance of $3.8
million at December 31, 2001 to a company affiliated with one of our directors.
In addition, the director has the ability to borrow an additional $246,000 from
us under a line of credit. All the loans are secured by a first lien on all
company assets, including accounts receivable, inventory, equipment, furniture
and real property occupied by the borrower. In addition, the director has
personally guaranteed repayment of the loans. At December 31, 2001, such loans
were current with respect to their payment terms and were performing in
accordance with the related loan agreements. Based on an analysis of the
borrower's current financial statements received in January 2002, 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 a
nonperforming asset 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
December 31, 2001, 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 December 31, 2001, cash and cash
equivalents totaled $14.3 million. We have other sources of liquidity should we
need additional funds. During the three months ended December 31, 2001 and 2000,
we sold loans totaling $25.3 million and $6.2 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 $94.3 million at December 31, 2001.
We anticipate that we will have sufficient funds available to meet our
current commitments. At December 31, 2001, we had $11.7 million in commitments
to originate new loans, $59.0 million in unfunded commitments to extend credit
under existing equity lines and commercial lines of credit and $220,000 in
standby letters of credit. At December 31, 2001, certificates of deposit, which
are scheduled to mature within one year, totaled $131.5 million. We believe that
a significant portion of such deposits will remain with us.
The 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 December 31, 2001 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 December 31, 2001, 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 to its stockholders. The distribution was made to manage the Company's
capital and enhance shareholder value. Returning capital to the stockholders
reduced the
14
Company's equity to asset ratio from 21.2% to 17.2%. The Company's equity to
asset ratio at December 31, 2001 was 18.2%. The Company's capital level is
sufficient to support future growth.
The Company has declared cash dividends per common share of $0.08 for each
of the three months ended December 31, 2001, September 30, 2001 and December 31,
2000. The Company's ability to pay dividends is dependent upon earnings. The
Company's dividend payout ratio for the three months ended December 31, 2001,
September 30, 2001 and December 31, 2000 was 29.6%, 32.0% and 27.6%,
respectively.
ACCOUNTING ISSUES
The FASB has issued Statements of Accounting Standards No. 141, Business
Combinations (SFAS 141) and No. 142, Goodwill and Other Intangible Assets (SFAS
142). SFAS 141 requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001 as well as all purchase
method business combinations completed after June 30, 2001. SFAS 141 requires
that intangible assets that meet certain criteria be recognized as assets apart
from goodwill. SFAS 142 addresses financial accounting and reporting for
acquired goodwill and other intangible assets. SFAS 142 addresses how intangible
assets that are acquired individually or with a group of other assets (but not
those acquired in a business combination) should be accounted for in financial
statements upon their acquisition. SFAS 142 also addresses how goodwill and
other intangible assets should be accounted for after they have been initially
recognized in the financial statements. SFAS 142 is required to be applied
starting with fiscal years beginning after December 15, 2001, and early
application is permitted for entities with fiscal years beginning after March
31, 2001, under certain conditions. Impairment losses for goodwill and
intangible assets with indefinite useful lives that arise due to the initial
application of SFAS 142 (resulting from a transitional impairment test) are to
be reported as the cumulative effect of a change in accounting principle.
Adoption of SFAS 141 and SFAS 142 are not expected to have a material impact on
the Company's consolidated financial statements.
On October 3, 2001, the FASB issued Statement of Financial Accounting
Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets (SFAS No. 144), which addresses financial accounting and reporting for
the impairment or disposal of long-lived assets. While SFAS No. 144 supersedes
SFAS No. 121 (Accounting for the Impairment of Long-Lived Assets and for Long-
Lived Assets to Be Disposed Of), it retains many of the fundamental provisions
of SFAS No. 121.
SFAS No. 144 also supersedes the accounting and reporting provisions of
FASB Opinion No. 30 (Reporting the Results of Operations - Reporting the Effects
of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions) for the disposal of a segment of
a business. However, it retains the requirement in Opinion No. 30 to report
separately discontinued operations and extends the reporting to a component of
an entity that either has been disposed of (by sale, abandonment, or in a
distribution to owners) or is classified as held for sale. By broadening the
presentation of discontinued operations to include more disposal transactions,
the FASB has enhanced management's ability to provide information that helps
financial statement users to assess the effects of disposal transactions on the
ongoing operations of an entity. The provisions of SFAS No. 144 are effective
for financial statements issued for fiscal years beginning after December 15,
2001, and interim periods within those fiscal years. Adoption of SFAS No. 144 is
not expected to have a material impact on the Company's consolidated financial
statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company monitors whether material changes in market risk have occurred
since September 30, 2001. The Company does not believe that any material adverse
changes in market risk exposures occurred since September 30, 2001.
15
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a.) Exhibits. None.
(b.) Reports on Form 8-K. During the quarter ended December 31,
2001, the registrant did not file any current reports on
Form 8-K.
16
SIGNATURES
Pursuant to the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
1ST STATE BANCORP, INC.
/s/ James C. McGill
Date: February 14, 2002 ---------------------------------------
James C. McGill
President and Chief Executive Officer
(Principal Executive Officer)
/s/ A. Christine Baker
Date: February 14, 2002 ---------------------------------------
A. Christine Baker
Executive Vice President
Treasurer and Secretary
(Principal Financial and Accounting Officer)
17