U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2002
[ ] 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
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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
--------------
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 April 30, 2002, the issuer had 3,289,607 shares of common stock
issued and outstanding.
1
CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
---------------------
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2002 (unaudited)
and September 30, 2001.............................................3
Consolidated Statements of Income for the Three Months
Ended March 31, 2002 and 2001 (unaudited)..........................4
Consolidated Statements of Income for the Six Months Ended
March 31, 2002 and 2001 (unaudited)................................5
Consolidated Statements of Stockholders' Equity and Comprehensive
Income for the Six Months Ended March 31, 2002 and 2001
(unaudited)........................................................6
Consolidated Statements of Cash Flows for the Six Months Ended
March 31, 2002 and 2001 (unaudited)................................7
Notes to Consolidated Financial Statements............................9
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.........................................12
Item 3. Quantitative and Qualitative Disclosures About Market Risk...........21
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings....................................................22
Item 2. Changes in Securities and Use of Proceeds............................22
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....................................................................23
2
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
MARCH 31, 2002 AND SEPTEMBER 30, 2001
(IN THOUSANDS)
AT AT
MARCH 31, SEPTEMBER 30,
2002 2001
---------- ------------
(Unaudited)
ASSETS
Cash and cash equivalents $ 12,260 25,981
Investment securities:
Held to maturity (fair value of $11,725 and $12,495
at March 31, 2002 and September 30, 2001, respectively) 11,618 12,169
Available for sale (cost of $90,848 and $54,689
at March 31, 2002 and September 30, 2001, respectively) 89,640 55,527
Loans held for sale, at lower of cost or fair value 2,444 3,291
Loans receivable (net of allowance for loan losses of $3,640
and $3,612 at March 31, 2002 and September 30, 2001,
respectively) 210,999 222,285
Real estate owned 2,252 1,981
Federal Home Loan Bank stock, at cost 1,650 1,650
Premises and equipment 8,202 8,414
Accrued interest receivable 2,791 2,542
Other assets 3,421 2,952
--------- --------
Total assets $ 345,277 336,792
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposit accounts 247,099 248,370
Advances from Federal Home Loan Bank 30,000 20,000
Advance payments by borrowers for property taxes and insurance 480 82
Dividend payable 263 263
Other liabilities 3,004 4,433
--------- --------
Total liabilities 280,846 273,148
--------- --------
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 35,601 35,588
Unallocated ESOP shares (4,035) (4,373)
Unearned compensation - management recognition plan (130) (518)
Deferred compensation 4,443 4,173
Treasury stock for deferred compensation (4,443) (4,173)
Retained income - substantially restricted 33,697 32,404
Accumulated other comprehensive income (loss) - net unrealized
gain (loss) on investment securities available for sale (735) 510
--------- --------
Total stockholders' equity 64,431 63,644
--------- --------
Total liabilities and stockholders' equity $ 345,277 336,792
========= ========
See accompanying notes to the consolidated financial statements.
3
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND 2001
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
FOR THE THREE MONTHS ENDED
MARCH 31,
--------------------------
2002 2001
------- --------
Interest income:
Interest and fees on loans $ 3,510 4,927
Interest and dividends on investments 1,357 1,119
Overnight deposits 52 195
------- ------
Total interest income 4,919 6,241
------- ------
Interest expense:
Deposit accounts 1,678 3,013
Borrowings 286 277
------- ------
Total interest expense 1,964 3,290
------- ------
Net interest income 2,955 2,951
Provision for loan losses 60 60
------- ------
Net interest income after provision for loan losses 2,895 2,891
------- ------
Other income:
Service fees on loans sold 24 22
Customer service fees 217 162
Commissions from sales of annuities and mutual funds 98 108
Mortgage banking income, net 350 193
Securities gains, net 47 --
Other 56 41
------- ------
Total other income 792 526
------- ------
Operating expenses:
Compensation and related benefits 1,584 1,431
Occupancy and equipment 311 331
Deposit insurance premiums 11 13
Real estate operations, net (50) 6
Other expenses 393 425
------- ------
Total operating expenses 2,249 2,206
------- ------
Income before income taxes 1,438 1,211
Income taxes 513 436
------- ------
Net income $ 925 775
======= ======
Earnings per share:
Basic $ 0.31 $ 0.26
Diluted $ 0.29 $ 0.24
See accompanying notes to the consolidated financial statements.
4
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE SIX MONTHS ENDED MARCH 31, 2002 AND 2001
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
FOR THE SIX MONTHS ENDED
MARCH 31,
------------------------
2002 2001
-------- --------
Interest income:
Interest and fees on loans $ 7,399 10,017
Interest and dividends on investments 2,579 2,336
Overnight deposits 142 398
-------- --------
Total interest income 10,120 12,751
-------- --------
Interest expense:
Deposit accounts 3,773 5,990
Borrowings 562 580
-------- --------
Total interest expense 4,335 6,570
-------- --------
Net interest income 5,785 6,181
Provision for loan losses 120 120
-------- --------
Net interest income after provision for loan losses 5,665 6,061
-------- --------
Other income:
Service fees on loans sold 46 42
Customer service fees 466 318
Commissions from sales of annuities and mutual funds 220 219
Mortgage banking income, net 766 321
Securities gains, net 47 --
Other 106 83
-------- --------
Total other income 1,651 983
-------- --------
Operating expenses:
Compensation and related benefits 3,148 2,974
Occupancy and equipment 614 608
Deposit insurance premiums 23 25
Real estate operations, net (32) 6
Other expenses 753 836
-------- --------
Total operating expenses 4,506 4,449
-------- --------
Income before income taxes 2,810 2,595
Income taxes 1,040 919
-------- --------
Net income $ 1,770 1,676
======== ========
Earnings per share:
Basic $ 0.59 $ 0.56
Diluted $ 0.56 $ 0.53
See accompanying notes to the consolidated financial statements
5
1ST STATE BANCORP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
FOR THE SIX MONTHS ENDED MARCH 31, 2002 AND 2001 (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 $110 -- -- -- -- --
Total comprehensive income
Allocation of ESOP shares -- (12) 272 -- --
Deferred compensation -- -- -- -- 1,136
Treasury stock held for deferred
compensation -- -- -- -- --
Vesting of MRP shares -- -- -- 389 --
Cash dividends declared -- -- -- -- --
Cash dividends on unallocated ESOP shares
and unvested MRP shares -- -- -- -- --
--------- -------- ------ ----- -------
Balance at March 31, 2001 $ 33 35,575 (4,678) (907) 3,815
========= ======== ====== ===== =======
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 $801 -- -- -- -- --
Total comprehensive income
Allocation of ESOP shares -- 13 338 -- --
Deferred compensation -- -- -- -- 270
Treasury stock held for deferred compensation -- -- -- -- --
Vesting of MRP shares -- -- -- 388 --
Cash dividends declared -- -- -- -- --
Cash dividends on unallocated ESOP shares
and unvested MRP shares -- -- -- -- --
--------- -------- ------ ----- -------
Balance at March 31, 2002 $ 33 35,601 (4,035) (130) 4,443
========= ======== ====== ===== =======
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 -- 1,676 -- 1,676
Other comprehensive income-unrealized
gain on securities available-for-sale
net of income taxes of $110 -- -- 176 176
-------
Total comprehensive income 1,852
Allocation of ESOP shares -- -- -- 260
Deferred compensation -- -- -- 1,136
Treasury stock held for deferred
compensation (1,136) -- -- (1,136)
Vesting of MRP shares -- -- -- 389
Cash dividends declared -- (526) -- (526)
Cash dividends on unallocated ESOP shares
and unvested MRP shares -- 46 -- 46
------- ------- ------ -------
Balance at March 31, 2001 (3,815) 31,195 12 61,230
======= ======= ====== =======
Balance at September 30, 2001 (4,173) 32,404 510 63,644
Comprehensive income:
Net income -- 1,770 -- 1,770
Other comprehensive loss-unrealized
loss on securities available-for-sale net
of income taxes of $801 -- -- (1,245) (1,245)
-------
Total comprehensive income 525
Allocation of ESOP shares -- -- -- 351
Deferred compensation -- -- -- 270
Treasury stock held for deferred compensation (270) -- -- (270)
Vesting of MRP shares -- -- -- 388
Cash dividends declared -- (526) -- (526)
Cash dividends on unallocated ESOP shares
and unvested MRP shares -- 49 -- 49
------- ------- ------ -------
Balance at March 31, 2002 (4,443) 33,697 (735) 64,431
======= ======= ====== =======
See accompanying notes to the consolidated financial statements.
6
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED MARCH 31, 2002 AND 2001
(UNAUDITED)
(IN THOUSANDS)
FOR THE SIX MONTHS ENDED
MARCH 31,
--------------------------------
2002 2001
--------- --------
Cash flows from operating activities:
Net income $ 1,770 1,676
Adjustment to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 120 120
Depreciation 313 305
Deferred tax expense (benefit) 305 (325)
Amortization of premiums and discounts, net (21) (12)
Deferred compensation 164 135
Release of ESOP shares 351 260
Vesting of MRP shares and dividends on unvested MRP shares 520 527
Loan origination fees and unearned discounts
deferred, net of current amortization (75) (11)
Gain on sale of other real estate (5) --
Securities gains, net (47) --
Net loss on sale of loans 230 50
Proceeds from loans held for sale 41,951 17,646
Originations of loans held for sale (41,334) (18,707)
Decrease in other assets 27 25
Decrease (increase) in accrued interest receivable (249) 212
Decrease in other liabilities (1,995) (282)
--------- --------
Net cash provided by operating activities 2,025 1,619
--------- --------
Cash flows provided by (used in) investing activities:
Purchases of investment securities held to maturity (2,454) --
Purchase of investment securities available for sale (62,108) (6,999)
Proceeds from sales of investment securities available for sale 1,811 --
Proceeds from maturities of investment securities available for sale 24,208 3,108
Proceeds from maturities of investment securities
held to maturity 3,003 17,532
Net decrease (increase) in loans receivable 10,894 (5,812)
Proceeds from disposal of real estate acquired in
settlement of loans 81 --
Purchases of premises and equipment (101) (544)
--------- --------
Net cash provided by (used in) investing activities (24,666) 7,285
--------- --------
(Continued)
7
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
FOR THE SIX MONTHS ENDED MARCH 31, 2002 AND 2001
(UNAUDITED)
(IN THOUSANDS)
FOR THE SIX MONTHS ENDED
MARCH 31,
--------------------------------
2002 2001
--------- --------
Cash flows from financing activities:
Net increase (decrease) in deposits $ (1,271) $ 8,306
Advances from the Federal Home Loan Bank 21,000 5,000
Repayments of advances from Federal Home Loan Bank (11,000) (5,000)
Return of capital dividend payment -- (17,007)
Purchase of treasury stock for deferred compensation 270 1,136
Dividends paid on common stock (477) (480)
Increase in advance payments by borrowers for
property taxes and insurance 398 390
--------- ---------
Net cash provided by (used in) financing activities 8,920 (7,655)
--------- ---------
Net increase (decrease) in cash and cash equivalents (13,721) 1,249
Cash and cash equivalents at beginning of period 25,981 33,107
--------- ---------
Cash and cash equivalents at end of period $ 12,260 $ 34,356
========= =========
Payments are shown below for the following:
Interest $ 4,348 $ 6,598
========= =========
Income taxes $ 269 $ 937
========= =========
Noncash investing and financing activities:
Deferred compensation to be settled in Company's stock $ 270 $ 1,136
========= =========
Unrealized gains (losses) on investment securities
available for sale $ (2,046) $ 286
========= =========
Cash dividends declared but not paid $ 241 $ 241
========= =========
Cash dividends on unallocated ESOP shares $ 49 $ 46
========= =========
Transfer from loans held for sale to loans receivable $ -- $ 686
========= =========
Transfer from loans to real estate acquired in settlement of loans $ 347 $ 2,106
========= =========
See accompanying notes to consolidated financial statements.
8
1ST STATE BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002 (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 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, 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 and six month periods ended March
31, 2002 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 March 31, 2001 consolidated financial statements
have been reclassified to conform with the presentation adopted in 2002. 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 fully 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 stock-based benefit plans. There were no antidilutive
stock options for the three and six months ended March 31, 2002 and 2001. A
reconciliation of the denominators of the basic and diluted earnings per share
computations is as follows:
9
THREE MONTHS ENDED
MARCH 31,
2002 2001
---- ----
Average shares issued and outstanding 3,289,607 3,289,607
Less: Unvested MRP shares (42,156) (84,319)
Less: Unallocated ESOP shares (223,522) (191,213)
--------- ---------
Average basic shares for earnings per share 3,023,929 3,014,075
Add: Unvested MRP shares 42,156 84,319
Add: Potential common stock pursuant to stock
option plan 86,763 67,269
--------- ---------
Average dilutive shares for earnings per share 3,152,848 3,165,663
========= =========
SIX MONTHS ENDED
MARCH 31,
2002 2001
---- ----
Average shares issued and outstanding 3,289,607 3,289,607
Add: Unvested MRP shares issued (42,156) (84,319)
Less: Unallocated ESOP shares (227,870) (194,774)
--------- ---------
Average basic shares for earnings per share 3,019,581 3,010,514
Add: Unvested MRP shares 42,156 84,319
Add: Potential common stock pursuant to stock
option plan 87,666 64,165
--------- ---------
Average dilutive shares for earnings per share 3,149,403 3,158,998
========= =========
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 and six months ended March 31, 2002 and 2001, 8,507
and 6,992 and 17,203 and 14,089 shares of stock were committed to be released
and approximately $172,000 and $131,000 and $350,000 and $260,000 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
10
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 and six months ended March
31, 2002 and 2001 was $72,000 and $68,000 and $164,000 and $135,000,
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. Compensation expense of $260,000 and $263,000 and $520,000
and $527,000 associated with the MRP was recorded during the three and six
months ended March 31, 2002 and 2001, 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 of the stock. 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.
NOTE 8. NEW ACCOUNTING PRONOUNCEMENT
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 141 (Statement 141), "Business Combinations", and Statement of Financial
Accounting Standards No. 142 (Statement 142), "Goodwill and Other Intangible
Assets". Statement 141 requires that the purchase method of accounting be used
for all business combinations initiated after June 30, 2001. Statement 141 also
specifies criteria which must be met for intangible assets acquired in a
purchase method business combination to be recognized and reported apart from
goodwill. Statement 142 requires that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of Statement 142.
Statement 142 also requires that identifiable intangible assets with definite
useful lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with
Statement 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of". The adoption of SFAS No. 141 and SFAS No.
142 did not have a material effect on the Company's consolidated financial
statements other than providing enhanced disclosures for mortgage servicing
rights. As of January 1, 2002, the Company had no goodwill and had no intangible
assets related to deposit and branch purchase acquisitions.
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 loans as an adjustment of income. Impairment reviews of MSRs are
performed on a quarterly basis. As of March 31, 2002 and September 30, 2001,
MSRs totaled $330,000 and $209,000, respectively, and no valuation allowance was
required.
Amortization expense totaled $17,000 and $23,000 for the six months ended
March 31, 2002 and 2001, respectively.
11
The estimated amortization expense for the mortgage servicing rights for the
years ended September 30, 2002, 2003, 2004, 2005 and 2006 and thereafter is as
follows:
ESTIMATED AMORTIZATION EXPENSE
(DOLLARS IN THOUSANDS)
2002 $36,000
2003 38,000
2004 38,000
2005 38,000
2006 38,000
2007 and thereafter 21,000
--------
$209,000
========
The estimation of future amortization expense presented above is based on
assumptions (such as estimates of prepayments of loans) subject to change in
future periods. Accordingly, the amortization expense in future periods may be
different from the amounts disclosed above to the extent that any of these
assumptions are modified due to a change in the underlying estimations.
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 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
12
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 local 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.
CRITICAL ACCOUNTING POLICIES
The Company's significant accounting policies are set forth in note 1 of
the consolidated financial statements as of September 30, 2001 which was filed
on Form 10-K. 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 information with respect to borrowers which
is not known to management at the time of the issuance of the consolidated
financial statements.
COMPARISON OF FINANCIAL CONDITION AT MARCH 31, 2002 AND SEPTEMBER 30, 2001
Total assets increased by $8.5 million or 2.5% from $336.8 million at
September 30, 2001 to $345.3 million at March 31, 2002. Increases in investment
securities were partially offset by decreases in cash and loans receivable, net.
Asset growth was primarily funded by increases in borrowed money.
Cash and cash equivalents decreased $13.7 million, or 52.7% from $26.0
million at September 30, 2001 to $12.3 million at March 31, 2002. Because of the
relatively low interest rates on overnight funds, we invested excess cash in
short term government agency securities to increase our yield on these funds.
Investment securities available for sale increased $34.1 million from $55.5
million at September 30, 2001 to $89.6 million at March 31, 2002. As market
interest rates fell during the six months ended March 31, 2002, many of the
Company's callable investment securities were called by the issuers. During the
six months ended March 31, 2002, we received $26.0 million in proceeds from
sales, maturities and issuer calls of investment securities available for sale.
We reinvested $62.1 in investment securities available for sale during this time
period.
Loans receivable, net decreased by $11.3 million, or 5.1%, from $222.3
million at September 30, 2001 to $211.0 million at March 31, 2002, and loans
held for sale decreased 27.3% from $3.3 million at September 30, 2001 to $2.4
million at March 31, 2002. During the six months ended March 31, 2002, our
mortgage originations, sales and prepayments were at record levels. The
attractive mortgage rate environment encouraged many borrowers to take advantage
of this opportunity to refinance their existing mortgage loans at lower interest
rates. We sold these longer term, lower rate mortgage loans to limit our
interest rate risk. The decrease in the loans held for sale resulted from timing
differences in the funding of loan sales. We sold $42.0 million in fixed rate
mortgage loans during the six months ended March 31, 2002 compared to $17.6
million for the six months ended March 31, 2001. We continue to emphasize
commercial, commercial real estate, consumer loans and equity lines of credit
that carry variable rates and/or short term
13
maturities. At March 31, 2002, commercial, construction and commercial real
estate loans totaled $114.0 million and account for 53.1% of gross loans
compared to $110.6 million and 48.9% at September 30, 2001. One to four family
residential loans at March 31, 2002 totaled $75.1 million or 35.0% of gross
loans compared to $86.9 million or 38.5% at September 30, 2001.
Deposits decreased $1.3 million from $248.4 million at September 30, 2001
to $247.1 million at March 31, 2002. Certificates of deposit at March 31, 2002
totaled $152.4 million or 61.7% of total deposits. At September 30, 2001,
certificates of deposit totaled $159.7 million or 64.3% of total deposits. We
continue to emphasize transaction accounts, which generally carry lower interest
rates than certificates of deposit. Transaction accounts increased $6.0 million
or 6.8% from $88.7 million at September 30, 2001 to $94.7 million at March 31,
2002.
Advances from the Federal Home Loan Bank increased to $30.0 million from
$20.0 million at September 30, 2001. The increased borrowings were short term
advances used to fund the timing differences of loan fundings and deposit flows.
Stockholders' equity increased by $787,000 from $63.6 million at September
30, 2001 to $64.4 million at March 31, 2002 as a result of net income of $1.8
million, release of ESOP shares of $351,000, and vesting of MRP shares of
$388,000. These increases were offset by cash dividends declared of $477,000 and
a change in unrealized losses on available for sale securities of $1.2 million.
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 (net of tax) of $510,000 at September 30, 2001. At March 31,
2002, bond prices were considerably lower than at September 30, 2001. During the
six months ended March 31, 2002, many of the Company's callable investment
securities were called by the issuers which were subsequently reinvested at
lower interest rates. The Company had an unrealized loss on available for sale
securities (net of tax) of $735,000 at March 31, 2002.
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND
2001
Net Income. We recorded net income of $925,000 for the quarter ended March
31, 2002, as compared to $775,000 for the quarter ended March 31, 2001,
representing an increase of $150,000, or 19.4%. For the three months ended March
31, 2002 basic and diluted earnings per share were $0.31 and $0.29,
respectively. The Company reported basic and diluted earnings per share for the
quarter ended March 31, 2001 of $0.26 and $0.24 per share, respectively. The
increase in net income resulted primarily from increased other income that was
offset partially by increased income taxes and operating expenses.
Net Interest Income. Net interest income, the difference between interest
earned on loans and investments and interest paid on interest-bearing
liabilities, for the three months ended March 31, 2002 was $3.0 million, an
increase of $4,000 compared to the same quarter in the prior year. This increase
reflects a $1.3 million decrease in interest income that was mostly offset by
the $1.3 million decrease in total interest expense. The average net interest
margin decreased 2 basis points from 3.67% for the three months ended March 31,
2001 to 3.65% for the quarter ended March 31, 2002.
Interest Income. The decrease in interest income for the three months ended
March 31, 2002 resulted from an increase of $1.9 million in average
interest-earning assets compared to the same quarter in the prior year which was
more than offset by a decrease in yield on interest-earning assets of 1.68% from
7.76% for the three months ended March 31, 2001 to 6.08% for the three months
ended March 31, 2002. The increased volume of average interest-earning assets
increased interest income by approximately $37,000 and the decreased yield
decreased interest income by approximately $1.4 million. Average loans
outstanding decreased $17.0 million coupled with a decrease in average
interest-bearing overnight funds of $2.4 million were offset by an increase in
average investment securities of $21.3 million. We experienced unusually heavy
mortgage loan prepayments during the six months ended March 31, 2002 as
borrowers took advantage of the attractive mortgage rates and refinanced their
existing mortgage loans. During this time we invested the loan prepayments and
excess overnight funds into investment securities.
Interest Expense. Interest expense decreased in the three months ended
March 31, 2002 due to a decrease in average interest-bearing liabilities of $6.1
million and a decrease in the cost of interest-bearing liabilities of 1.90% from
4.87% for the three months ended March 31, 2001 to 2.97% for the three months
ended March 31, 2002. Average deposits decreased by $9.1 million while average
FHLB advances increased $3.0 million for the three months ended March 31, 2002
compared to the same quarter in the prior year. The decrease in average
interest-bearing liabilities decreased interest expense by approximately $74,000
while the decrease in the average cost of interest-bearing liabilities increased
interest expense by approximately $1.3 million.
14
The following table presents average balances and average rates earned/paid
by the Company for the quarter ended March 31, 2002 compared to the quarter
ended March 31, 2001.
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 2002 MARCH 31, 2001
---------------------------------- ---------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST
------- -------- ----- ------- -------- -----
(DOLLARS IN THOUSANDS)
Assets:
Loans receivable (1) $215,058 $3,510 6.53% $232,084 $4,927 8.49%
Investment securities (2) 96,821 1,357 5.61 75,511 1,119 5.93
Interest-bearing overnight deposits 11,762 52 1.77 14,129 195 5.53
-------- ------ ----- -------- ------ -----
Total interest-earning assets (3) 323,641 4,919 6.08 321,724 6,241 7.76
Non interest-earning assets 22,414 26,126
-------- --------
Total assets $346,055 $347,850
======== ========
Liabilities and stockholders' equity:
Interest bearing checking 31,320 36 0.46 29,772 125 1.67
Money market investment accounts 27,465 86 1.25 21,470 233 4.35
Passbook and statement savings 27,060 102 1.51 26,880 157 2.34
Certificates of deposit 154,984 1,454 3.75 171,816 2,498 5.82
FHLB advances 23,444 286 4.88 20,444 277 5.41
-------- ------ ----- -------- ------ -----
Total interest-bearing liabilities 264,273 1,964 2.97 270,382 3,290 4.87
Non interest-bearing liabilities 17,321 16,642
-------- --------
Total liabilities 281,594 287,024
Stockholders' equity 64,461 60,826
-------- --------
Total liabilities and stockholders' equity $346,055 $347,850
======== ========
Net interest income $2,955 $2,951
====== ======
Interest rate spread 3.11% 2.89%
====== ======
Net interest margin (4) 3.65% 3.67%
====== ======
Ratio of average interest-earning assets 122.46% 118.99%
====== ======
___________
(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 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 $60,000 for both the three months
ended March 31, 2002 and 2001.
Other Income. Other income increased $266,000, or 50.6%, from $526,000 for
the quarter ended March 31, 2001 to $792,000 for the quarter ended March 31,
2002. Mortgage banking income, net increased $157,000 from $193,000 for the
quarter ended March 31, 2001 to $350,000 for the quarter ended March 31, 2002.
During the quarter ended March 31, 2002, we sold fixed-rate mortgage loans held
for sale of $16.7 million and recognized net gains of $350,000 on these sales.
During the quarter ended March 31, 2001, we sold fixed-rate mortgage loans held
for sale of $11.4 million and recognized a $193,000 gain on these sales.
Customer service fees increased $55,000, or 34.0% from
15
$162,000 for the quarter ended March 31, 2001 to $217,000 for the quarter ended
March 31, 2002. This increase results primarily from growth in the number of
transaction accounts and increased service charges. Gains on sales of investment
securities of $47,000 were recognized during the quarter ended March 31, 2002
that were not present in the prior year.
Operating Expenses. Total operating expenses were $2.2 million for each of
the quarters ended March 31, 2002 and March 31, 2001. Compensation and related
benefits expense increased $153,000, or 10.6% from $1.4 million for the quarter
ended March 31, 2001 to $1.6 million for the quarter ended March 31, 2002. This
increase was primarily the result of increased salary and benefit costs and
additional employees. During the quarter ended March 31, 2002, the Company
recognized net income from real estate operations of $50,000 compared to the net
losses from real estate operations of $6,000 that were expensed during the
quarter ended March 31, 2001.
Income Tax Expense. Income tax expense increased $77,000 from tax expense
of $436,000 for the quarter ended March 31, 2001 to $513,000 for the quarter
ended March 31, 2002. The increase resulted from a $227,000 increase in income
before income taxes. The effective tax rates were 35.7% and 36.0% for the
quarters ended March 31, 2002 and 2001, respectively.
COMPARISON OF OPERATING RESULTS FOR THE SIX MONTHS ENDED MARCH 31, 2002 AND 2001
Net Income. We recorded net income of $1.8 million for the six months ended
March 31, 2002, an increase of $94,000 over the $1.7 million reported in the six
months ended March 31, 2001. For the six months ended March 31, 2002, basic and
diluted earnings per share were $0.59 and $0.56, respectively. The Company
reported basic and diluted earnings per share for the six months ended March 31,
2001 of $0.56 and $0.53, respectively. The increase in net income resulted
primarily from increased other income which was partially offset by decreased
net interest income and increased operating expenses and income taxes. The
decline in the net interest income resulted primarily from the interest rate
cuts by the Federal Reserve during calendar 2001. The rate cuts 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 $396,000 or 6.4% for the six months ended March 31,
2002, compared to the same six months in the prior year. This decrease reflects
a $2.6 million decrease in interest income that was partially offset by the $2.2
million decrease in total interest expense. The average net interest margin
decreased 28 basis points from 3.84% for the six months ended March 31, 2001 to
3.56% for the six months ended March 31, 2002.
Interest Income. The decrease in interest income for the six months ended
March 31, 2002 was due a decrease in yield on interest-earning assets of 1.70%
from 7.92% for the six months ended March 31, 2001 to 6.22% for the six months
ended March 31, 2002 that was partially offset by an increase of $3.3 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 $131,000 and the decreased yield decreased interest
income by approximately $2.8 million. An increase in average investment
securities of $13.8 million coupled with an increase in average interest-bearing
overnight funds of $1.5 million increased interest-earning assets for the six
months compared to the prior year. These increases were offset in part by a
decrease in average loans outstanding of $12.0 million. We experienced unusually
heavy mortgage loan prepayments during the six months ended March 31, 2002 as
borrowers took advantage of the attractive mortgage rates and refinanced their
existing mortgage loans. During this time we invested the loan prepayments into
investment securities.
Interest Expense. Interest expense decreased in the six months ended March
31, 2002 due to a decrease in average interest-bearing liabilities of $3.9
million and a decrease in the cost of interest-bearing liabilities of 1.62% from
4.90% for the six months ended March 31, 2001 to 3.28% for the six months ended
March 31, 2002. Average deposits decreased by $4.5 million while average FHLB
advances increased $589,000 for the six months ended March 31, 2002 compared to
the same six months in the prior year. The decrease in average interest-bearing
liabilities decreased interest expense by approximately $95,000 and the decrease
in the average cost of interest-bearing liabilities decreased interest expense
by approximately $2.1 million.
16
The following table presents average balances and average rates earned/paid
by the Company for the six months ended March 31, 2002 compared to the six
months ended March 31, 2001.
SIX MONTHS ENDED SIX MONTHS ENDED
MARCH 31, 2002 MARCH 31, 2001
---------------------------------- ------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST
------- -------- ------ ------- -------- ------
DOLLARS IN THOUSANDS
Assets:
Loans receivable (5) $219,783 $7,399 6.73% $231,747 $10,017 8.64%
Investment securities (6) 90,909 2,579 5.67 77,118 2,336 6.06
Interest-bearing overnight deposits 14,634 142 1.94 13,143 398 6.07
-------- ------ ----- -------- ------ -----
Total interest-earning assets (7) 325,326 10,120 6.22 322,008 12,751 7.92
Non interest-earning assets 22,118 23,977
-------- --------
Total assets $347,444 $345,985
======== ========
Liabilities and stockholders' equity:
Interest bearing checking 31,060 77 0.49 30,118 258 1.71
Money market investment accounts 28,167 205 1.45 20,170 447 4.43
Passbook and statement savings 26,619 213 1.60 26,799 317 2.36
Certificates of deposit 156,999 3,278 4.18 170,216 4,968 5.84
FHLB advances 21,639 562 5.19 21,050 580 5.51
-------- ------ ----- -------- ------ -----
Total interest-earning liabilities 264,484 4,335 3.28 268,353 6,570 4.90
Non interest-earning liabilities 18,736 17,310
-------- --------
Total liabilities 283,220 285,663
Stockholders' equity 64,225 60,322
-------- --------
Total liabilities and stockholders' equity $347,445 $345,985
======== ========
Net interest income $5,785 $6,180
====== ======
Interest rate spread 2.94% 3.02%
====== ======
Net interest margin (8) 3.56% 3.84%
====== ======
Ratio of average interest-earning assets 123.00% 119.99%
====== ======
_____________
(5) Includes nonaccrual loans and loans held for sale, net of discounts and
allowance for loan losses.
(6) Includes FHLB of Atlanta stock.
(7) 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.
(8) 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, 2002 and 2001.
Other Income. Other income increased $668,000, or 68.0%, from $983,000 for
the six months ended March 31, 2001 to $1.7 million for the six months ended
March 31, 2002. Mortgage banking income, net increased $445,000 from $321,000
for the six months ended March 31, 2001 to $766,000 for the six months ended
March 31, 2002. During the six months ended March 31, 2002, we sold fixed-rate
mortgage loans held for sale of $42.0 million and recognized net gains of
$766,000 on these sales. During the six months ended March 31, 2001, we sold
fixed-rate mortgage loans held for sale of $17.7 million and recognized net
gains of $321,000 on these loan sales. Customer service fees increased
17
$148,000, or 46.5% from $318,000 for the six months ended March 31, 2001 to
$466,000 for the six months ended March 31, 2002. This increase results
primarily from growth in the number of transaction accounts and increased
service charges. Gains on sales of investment securities of $47,000 were
recognized during the six months ended March 31, 2002 that were not present in
the prior year.
Operating Expenses. Total operating expenses were $4.5 million for the six
months ended March 31, 2002, an increase of $57,000, or 1.3% over the $4.4
million recorded for the six months ended March 31, 2001. Compensation and
related benefits expense increased $174,000, or 5.9% from $3.0 million for the
six months ended March 31, 2001 to $3.1 million for the six months ended March
31, 2002. This increase resulted from increased salary and benefit costs as well
as an increase in number of employees. The Company recognized income from real
estate operations of $32,000 during the six months ended March 31, 2002 compared
to expenses of $6,000 in the same period in the prior year.
Income Tax Expense. Income tax expense increased $121,000 from tax expense
of $919,000 for the six months ended March 31, 2001 to $1.0 million for the six
months ended March 31, 2002. The increase resulted from a $215,000 increase in
income before income taxes. The effective tax rates were 37.0% and 35.4% for the
six months ended March 31, 2002 and 2001, respectively. The increase in the
effective tax rate was primarily due to an increase in non-deductible expenses
over the prior period.
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 amount represents
credit and interest rate risk are summarized as follows:
MARCH 31, 2002 SEPTEMBER 30, 2001
-------------- ------------------
(DOLLARS IN THOUSANDS)
Commitments to originate new loans $ 14,659 $ 9,119
Commitments to originate new loans held for sale -- 241
Unfunded commitments to extend credit under existing
equity line and commercial lines of credit 65,794 56,907
Commercial letters of credit 368 256
Commitments to sell loans held for sale 2,202 2,157
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, 2002, the aggregate fair value
of these commitments exceeded the book value of the loans to be sold.
18
CONTRACTUAL OBLIGATIONS
As of March 31, 2002
PAYMENTS DUE BY PERIOD
----------------------
LESS THAN
1 YEAR 1-3 YEARS 4-5 YEARS OVER 5 YEARS TOTAL
----------- --------- --------- ------------ -----
Deposits $ 222,048 17,443 7,608 -- 247,099
Short-term borrowings 10,000 -- -- -- 10,000
Long-term borrowings -- -- -- 20,000 20,000
Lease obligations 19 56 42 38 155
--------- ------ ----- ------ -------
Total contractual cash
Obligations $ 232,067 17,499 7,650 20,038 277,254
========= ====== ===== ====== =======
ASSET QUALITY
At March 31, 2002, we had approximately $4.0 million in non-performing
assets (nonaccrual loans and real estate owned) or 1.16% of total assets. At
September 30, 2001, non-performing assets were $2.9 million or 0.85% of total
assets. At March 31, 2002 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 increase in impaired loans at March 31, 2002 result from two
unrelated commercial loan customers, both of which have loans secured by
commercial real estate and business assets in Alamance County. At March 31,
2002, $1.3 million of the impaired loans is on non-accrual status, and their
related reserve for loan losses totaled $160,000. 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 $3.7 million and $3.0 million during the three and
six months ended March 31, 2002, respectively. Interest income of $54,000 and
$113,000 has been recorded on impaired loans in the three and six months ended
March 31, 2002, respectively. The Bank's net chargeoffs for the three and six
months ended March 31, 2002 were $7,000 and $92,000, respectively. The Bank's
allowance for loan losses was $3.6 million at March 31, 2002 as well as
September 30, 2001 and March 31, 2002. As a result of our continued shift toward
commercial, construction, consumer and home equity loans, the recent decrease in
residential mortgage loans, the increase in non-performing loans as a percentage
of total loans as well as the continued decline in the local and regional
economy, the ratio of the allowance for loan losses to total loans, net of loans
in process and deferred loan fees increased to 1.70% at March 31, 2002 compared
to 1.60% at September 30, 2001.
The following table presents an analysis of our nonperforming assets:
AT AT AT
MARCH 31, SEPTEMBER 30, MARCH 31,
2002 2001 2001
---- ---- ----
Nonperforming loans:
Nonaccrual loans $ 1,747 $ 878 $ 2,963
Loans 90 days past due and accruing -- -- -
Restructured loans -- -- -
--------- -------- --------
Total nonperforming loans 1,747 878 2,963
Other real estate 2,252 1,981 70
--------- -------- --------
Total nonperforming assets $ 3,999 $ 2,859 $ 3,033
========= ======== ========
Nonperforming loans to loans receivable, net 0.83% 0.39% 1.30%
Nonperforming assets as a percentage
of loans and other real estate owned 1.88% 1.27% 1.32%
Nonperforming assets to total assets 1.16% 0.85% 0.87%
19
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, 2002, we had $3.2 million in
classified assets consisting of $942,000 in substandard and loss loans and $2.3
million in real estate owned. At September 30, 2001, we had $3.6 million in
classified assets consisting of $1.6 million in substandard and loss loans and
$2.0 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 March 31, 2002, we have identified approximately $4.6 million in
assets classified as special mention and $30.6 million as watch. At September
30, 2001, we classified $4.5 million as special mention and $32.9 million as
watch. Included in the watch asset total are five loans with an aggregate
outstanding balance of $3.7 million at March 31, 2002 to a company affiliated
with one of our directors. In addition, the director has the ability to borrow
an additional $430,000 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 March 31,
2002, 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 April 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 a future period. 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, 2002, 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, 2002, cash and cash equivalents
totaled $12.2 million. We have other sources of liquidity should we need
additional funds. During the three and six months ended March 31, 2002, we sold
loans totaling $16.7 million and $42.0 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
$92.1 million at March 31, 2002.
We anticipate that we will have sufficient funds available to meet our
current commitments. At March 31, 2002, we had $14.7 million in commitments to
originate new loans, $65.8 million in unfunded commitments to extend credit
under existing equity lines and commercial lines of credit and $368,000 in
standby letters of credit. At March 31, 2002, certificates of deposit, which are
scheduled to mature within one year, totaled $127.3 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 March 31, 2002 and is
deemed to be "well capitalized."
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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, 2002, 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 Company's equity to asset ratio from 21.2% to 17.2%. The Company's
equity to asset ratio at March 31, 2002 was 18.7%. 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 March 31, 2002, September 30, 2001 and March 31, 2001.
The Company's ability to pay dividends is dependent upon earnings. The Company's
dividend payout ratio for the three months ended March 31, 2002, September 30,
2001 and March 31, 2001 was 27.6%, 32.0% and 33.3%, respectively.
ACCOUNTING ISSUES
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 141 (Statement 141), "Business Combinations", and Statement of Financial
Accounting Standards No. 142 (Statement 142), "Goodwill and Other Intangible
Assets". Statement 141 requires that the purchase method of accounting be used
for all business combinations initiated after June 30, 2001. Statement 141 also
specifies criteria which must be met for intangible assets acquired in a
purchase method business combination to be recognized and reported apart from
goodwill. Statement 142 will require that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of Statement 142.
Statement 142 will also require that identifiable intangible assets with
definite useful lives be amortized over their respective estimated useful lives
to their estimated residual values, and reviewed for impairment in accordance
with Statement 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of". The adoption of SFAS No. 141 and SFAS No.
142 did not have a material effect on the Company's consolidated financial
statements other than providing enhanced disclosures for mortgage servicing
rights. As of January 1, 2002, the Company had no goodwill and had no intangible
assets related to deposit and branch purchase acquisitions.
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
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.
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.
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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
The Company's Annual Meeting of Stockholders was held on January 29, 2002.
At this meeting 2,746,622 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
Richard C. Keziah 2,696,666 49,956
Ernest A. Koury, Jr. 2,696,666 49,956
Richard H. Shirley 2,693,820 52,802
There were no broker nonvotes on the matter.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a.) Exhibits. None.
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(b.) Reports on Form 8-K. During the quarter ended March 31, 2002, the
-------------------
registrant did not file any current reports on Form 8-K.
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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: May 13, 2002 ---------------------------------------------
James C. McGill
President and Chief Executive Officer
(Principal Executive Officer)
/s/ A. Christine Baker
Date: May 13, 2002 ---------------------------------------------
A. Christine Baker
Executive Vice President
Treasurer and Secretary
(Principal Financial and Accounting Officer)
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