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 June 30, 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
------------------------------------------- ------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
445 S. MAIN STREET, BURLINGTON, NORTH CAROLINA 27215
---------------------------------------------- ------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant' s Telephone Number, Including Area Code (336) 227-8861
--------------
N/A
--------------------------------------------------------------------------------
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 August 6, 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 June 30, 2002
(unaudited) and September 30, 2001...............................3
Consolidated Statements of Income for the Three Months Ended
June 30, 2002 and 2001 (unaudited)...............................4
Consolidated Statements of Income for the Nine Months Ended
June 30, 2002 and 2001 (unaudited)...............................5
Consolidated Statements of Stockholders' Equity and
Comprehensive Income for the Nine Months Ended June
30, 2002 and 2001 (unaudited)....................................6
Consolidated Statements of Cash Flows for the Nine Months
Ended June 30, 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..........23
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings...................................................24
Item 2. Changes in Securities and Use of Proceeds...........................24
Item 3. Defaults Upon Senior Securities.....................................24
Item 4. Submission of Matters to a Vote of Security Holders.................24
Item 5. Other Information...................................................24
Item 6. Exhibits and Reports on Form 8-K....................................24
SIGNATURES...................................................................25
2
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
JUNE 30, 2002 AND SEPTEMBER 30, 2001
(IN THOUSANDS)
AT AT
JUNE 30, SEPTEMBER 30,
2002 2001
----------- -------------
(Unaudited)
ASSETS
Cash and cash equivalents $ 19,939 25,981
Investment securities:
Held to maturity (fair value of $10,356 and $12,495
at June 30, 2002 and September 30, 2001, respectively) 10,118 12,169
Available for sale (cost of $88,157 and $54,689
at June 30, 2002 and September 30, 2001, respectively) 88,941 55,527
Loans held for sale, at lower of cost or fair value 1,194 3,291
Loans receivable (net of allowance for loan losses of $3,700
and $3,612 at June 30, 2002 and September 30, 2001,
respectively) 215,175 222,285
Real estate owned 2,226 1,981
Federal Home Loan Bank stock, at cost 1,750 1,650
Premises and equipment 8,074 8,414
Accrued interest receivable 2,171 2,542
Other assets 2,519 2,952
-------- --------
Total assets $352,107 336,792
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposit accounts 259,247 248,370
Advances from Federal Home Loan Bank 20,000 20,000
Advance payments by borrowers for property taxes and insurance 655 82
Dividend payable 263 263
Other liabilities 5,278 4,433
-------- --------
Total liabilities 285,443 273,148
-------- --------
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 35,610 35,588
Unallocated ESOP shares (3,895) (4,373)
Unearned compensation - management recognition plan -- (518)
Deferred compensation 4,471 4,173
Treasury stock for deferred compensation (4,471) (4,173)
Retained income - substantially restricted 34,438 32,404
Accumulated other comprehensive income - net unrealized
gain on investment securities available for sale 478 510
-------- --------
Total stockholders' equity 66,664 63,644
-------- --------
Total liabilities and stockholders' equity $352,107 336,792
======== ========
See accompanying notes to the consolidated financial statements.
(3)
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED JUNE 30, 2002 AND 2001
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
FOR THE THREE MONTHS ENDED
JUNE 30,
-----------------------------
2002 2001
----------- ----------
Interest income:
Interest and fees on loans $ 3,492 4,625
Interest and dividends on investments 1,413 1,182
Overnight deposits 50 230
----------- ---------
Total interest income 4,955 6,037
----------- ---------
Interest expense:
Deposit accounts 1,475 2,725
Borrowings 281 273
----------- ---------
Total interest expense 1,756 2,998
----------- ---------
Net interest income 3,199 3,039
Provision for loan losses 60 60
----------- ---------
Net interest income after provision for loan losses 3,139 2,979
----------- ---------
Other income:
Service fees on loans sold 26 21
Customer service fees 209 204
Commissions from sales of annuities and mutual funds 131 240
Mortgage banking income, net 155 338
Other 47 57
----------- ---------
Total other income 568 860
----------- ---------
Operating expenses:
Compensation and related benefits 1,512 1,616
Occupancy and equipment 315 336
Deposit insurance premiums 11 12
Real estate operations, net (24) 30
Other expenses 365 455
----------- ---------
Total operating expenses 2,179 2,449
----------- ---------
Income before income taxes 1,528 1,390
Income taxes 542 497
----------- ---------
Net income $ 986 893
=========== =========
Earnings per share:
Basic $ 0.32 $ 0.29
Diluted $ 0.31 $ 0.28
See accompanying notes to the consolidated financial statements.
4
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE NINE MONTHS ENDED JUNE 30, 2002 AND 2001
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
FOR THE NINE MONTHS ENDED
JUNE 30,
-------------------------------
2002 2001
----------- ----------
Interest income:
Interest and fees on loans $ 10,891 14,642
Interest and dividends on investments 3,993 3,517
Overnight deposits 191 629
----------- -----------
Total interest income 15,075 18,788
----------- -----------
Interest expense:
Deposit accounts 5,248 8,715
Borrowings 843 853
----------- -----------
Total interest expense 6,091 9,568
----------- -----------
Net interest income 8,984 9,220
Provision for loan losses 180 180
----------- -----------
Net interest income after provision for loan losses 8,804 9,040
----------- -----------
Other income:
Service fees on loans sold 72 63
Customer service fees 675 522
Commissions from sales of annuities and mutual funds 351 459
Mortgage banking income, net 921 658
Securities gains, net 47 --
Other 153 141
----------- ----------
Total other income 2,219 1,843
----------- ----------
Operating expenses:
Compensation and related benefits 4,660 4,589
Occupancy and equipment 929 944
Deposit insurance premiums 34 37
Real estate operations, net (56) 36
Other expenses 1,119 1,292
----------- -----------
Total operating expenses 6,686 6,898
----------- -----------
Income before income taxes 4,337 3,985
Income taxes 1,582 1,416
----------- -----------
Net income $ 2,755 2,569
=========== ===========
Earnings per share:
Basic $ 0.91 $ 0.85
Diluted $ 0.87 $ 0.81
See accompanying notes to the consolidated financial statements
5
1ST STATE BANCORP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
FOR THE NINE MONTHS ENDED JUNE 30, 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 $76 -- -- -- -- --
Total comprehensive income
Allocation of ESOP shares -- (6) 409 -- --
Deferred compensation -- -- -- -- 1,346
Treasury stock held for deferred
Compensation -- -- -- -- --
Vesting of MRP shares -- -- -- 583 --
Cash dividends declared -- -- -- -- --
Cash dividends on unallocated ESOP shares
and unvested MRP shares -- -- -- -- --
-------- --------- ---------- ----------- -----------
Balance at June 30, 2001 $ 33 35,581 (4,541) (713) 4,025
======== ========= ========== =========== ===========
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 $22 -- -- -- -- --
Total comprehensive income
Allocation of ESOP shares -- 22 478 -- --
Deferred compensation -- -- -- -- 298
Treasury stock held for deferred
Compensation -- -- -- -- --
Vesting of MRP shares -- -- -- 518 --
Cash dividends declared -- -- -- -- --
Cash dividends on unallocated ESOP shares
and unvested MRP shares -- -- -- -- --
-------- --------- ---------- ----------- -----------
Balance at June 30, 2002 $ 33 35,610 (3,895) -- 4,471
======== ========= ========== =========== ===========
TREASURY
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 -- 2,569 -- 2,569
Other comprehensive income-unrealized
gain on securities available-for-sale
net of income taxes of $76 -- -- 122 122
----------
Total comprehensive income 2,691
Allocation of ESOP shares -- -- -- 403
Deferred compensation -- -- -- 1,346
Treasury stock held for deferred
Compensation (1,346) -- -- (1,346)
Vesting of MRP shares -- -- -- 583
Cash dividends declared -- (789) -- (789)
Cash dividends on unallocated ESOP shares
and unvested MRP shares -- 64 -- 64
----------- ------------- ------------ ----------
Balance at June 30, 2001 (4,025) 31,843 (42) 62,161
=========== ============= ============ ==========
Balance at September 30, 2001 (4,173) 32,404 510 63,644
Comprehensive income:
Net income -- 2,755 -- 2,755
Other comprehensive loss-unrealized
loss on securities available-for-sale
net of income taxes of $22 -- -- (32) (32)
----------
Total comprehensive income 2,723
Allocation of ESOP shares -- -- -- 500
Deferred compensation -- -- -- 298
Treasury stock held for deferred
Compensation (298) -- -- (298)
Vesting of MRP shares -- -- -- 518
Cash dividends declared -- (790) -- (790)
Cash dividends on unallocated ESOP shares
and unvested MRP shares -- 69 -- 69
----------- ------------- ------------ ----------
Balance at June 30, 2002 (4,471) 34,438 478 66,664
=========== ============= ============ ==========
See accompanying notes to the consolidated financial statements.
6
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED JUNE 30, 2002 AND 2001
(UNAUDITED)
(IN THOUSANDS)
FOR THE NINE MONTHS ENDED
JUNE 30,
-----------------------------
2002 2001
---------- --------
Cash flows from operating activities:
Net income $ 2,755 2,569
Adjustment to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 180 180
Depreciation 474 469
Deferred tax expense (benefit) 495 (101)
Amortization of premiums and discounts, net (23) (18)
Deferred compensation 236 203
Release of ESOP shares 500 403
Vesting of MRP shares and dividends on unvested MRP shares 712 787
Loan origination fees and unearned discounts
deferred, net of current amortization (63) 6
Gain on sale of other real estate (4) --
Securities gains, net (47) --
Net loss on sale of loans 227 205
Proceeds from loans held for sale 49,134 37,260
Originations of loans held for sale (47,264) (35,183)
Decrease (increase) in other assets (41) 356
Decrease in accrued interest receivable 371 422
Increase (decrease) in other liabilities 117 (1,456)
---------- ----------
Net cash provided by operating activities 7,759 6,102
---------- ----------
Cash flows used in investing activities:
Purchase of FHLB stock (100) --
Purchase of investment securities held to maturity (3,958) (661)
Purchase of investment securities available for sale (78,127) (50,528)
Proceeds from sales of investment securities available for sale 1,811 --
Proceeds from maturities of investment securities available
for sale 42,923 6,148
Proceeds from maturities of investment securities
held to maturity 6,004 42,251
Net decrease (increase) in loans receivable 6,646 (1,065)
Proceeds from disposal of real estate acquired in
settlement of loans 107 --
Purchases of premises and equipment (134) (568)
---------- ----------
Net cash used in investing activities (24,828) (4,423)
---------- ----------
(Continued)
7
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
FOR THE NINE MONTHS ENDED JUNE 30, 2002 AND 2001
(UNAUDITED)
(IN THOUSANDS)
FOR THE NINE MONTHS ENDED
JUNE 30,
--------------------------
2002 2001
---------- --------
Cash flows from financing activities:
Net increase in deposits $ 10,877 $ 4,438
Advances from the Federal Home Loan Bank 29,000 5,000
Repayments of advances from Federal Home Loan Bank (29,000) (5,000)
Return of capital dividend payment -- (17,007)
Purchase of treasury stock for deferred compensation 298 1,346
Dividends paid on common stock (721) (725)
Increase in advance payments by borrowers for
property taxes and insurance 573 533
--------- --------
Net cash provided by (used in) financing activities 11,027 (11,415)
--------- ---------
Net decrease in cash and cash equivalents (6,042) (9,736)
Cash and cash equivalents at beginning of period 25,981 33,107
--------- --------
Cash and cash equivalents at end of period $ 19,939 $ 23,371
========= ========
Payments are shown below for the following:
Interest $ 6,085 $ 9,446
========= ========
Income taxes $ 1,534 $ 1,100
========= ========
Noncash investing and financing activities:
Deferred compensation to be settled in Company's stock $ 298 $ 1,346
========= ========
Unrealized gains (losses) on investment securities
available for sale $ (54) $ 198
========= ========
Cash dividends declared but not paid $ 244 $ 244
========= ========
Cash dividends on unallocated ESOP shares $ 69 $ 64
========= ========
Transfer from loans held for sale to loans receivable $ -- $ 686
========= ========
Transfer from loans to real estate acquired in settlement of loans $ 347 $ 1,981
========= ========
See accompanying notes to consolidated financial statements.
8
1ST STATE BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 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 nine month periods ended June
30, 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 June 30, 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
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 denominators of 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 nine months ended June 30, 2002 and 2001. A reconciliation of
the denominators of the basic and diluted earnings per share computations is as
follows:
THREE MONTHS ENDED
JUNE 30,
2002 2001
---------- ----------
Average shares issued and outstanding 3,289,607 3,289,607
Less: Unvested MRP shares (31,038) (72,862)
Less: Unallocated ESOP shares (216,108) (184,207)
---------- ----------
Average basic shares for earnings per share 3,042,461 3,032,538
Add: Unvested MRP shares 31,038 72,862
Add: Potential common stock pursuant to stock
option plan 90,660 86,684
---------- ----------
Average dilutive shares for earnings per share 3,164,159 3,192,084
========== ==========
9
NINE MONTHS ENDED
JUNE 30,
2002 2001
---------- ----------
Average shares issued and outstanding 3,289,607 3,289,607
Less: Unvested MRP shares (38,464) (80,472)
Less: Unallocated ESOP shares (224,280) (191,252)
---------- ----------
Average basic shares for earnings per share 3,026,863 3,017,883
Add: Unvested MRP shares 38,464 80,472
Add: Potential common stock pursuant to stock
option plan 88,561 72,147
---------- ----------
Average dilutive shares for earnings per share 3,153,888 3,170,502
========== ==========
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 $1,043,000 on its unallocated
shares of the Company's stock. The ESOP purchased an additional 51,374 shares
with this dividend. During the three and nine months ended June 30, 2002 and
2001, 7,179 and 7,045 and 24,382 and 21,134 shares of stock were committed to be
released and approximately $172,000 and $135,000 and $500,000 and $403,000 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 and nine months ended June
30, 2002 and 2001 was $72,000 and $68,000 and $236,000 and $203,000,
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 $192,000 and $260,000 and $712,000
and $787,000 associated with the MRP was recorded during the three and nine
months ended June 30, 2002 and 2001, respectively.
10
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 June 30, 2002 and September 30, 2001, MSRs
totaled $352,000 and $209,000, respectively, and no valuation allowance was
required.
Amortization expense totaled $43,000 and $56,000 for the nine months ended June
30, 2002 and 2001, respectively.
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
2002 $ 43,000
2003 38,000
2004 38,000
2005 38,000
2006 38,000
2007 and thereafter 14,000
--------
$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.
11
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 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.
12
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.
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 2002 AND SEPTEMBER 30, 2001
Total assets increased by $15.3 million or 4.5% from $336.8 million at
September 30, 2001 to $352.1 million at June 30, 2002. Increases in investment
securities were partially offset by decreases in cash and loans receivable, net.
Asset growth was primarily funded by increases in deposits.
Cash and cash equivalents decreased $6.1 million, or 23.5% from $26.0
million at September 30, 2001 to $19.9 million at June 30, 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 $33.4 million from $55.5
million at September 30, 2001 to $88.9 million at June 30, 2002. As market
interest rates fell during the nine months ended June 30, 2002, many of the
Company's callable investment securities were called by the issuers. During the
nine months ended June 30, 2002, we received $44.7 million in proceeds from
sales, maturities and issuer calls of investment securities available for sale.
We reinvested $78.1 in investment securities available for sale during this time
period.
Loans receivable, net decreased by $7.1 million, or 3.2%, from $222.3
million at September 30, 2001 to $215.2 million at June 30, 2002, and loans held
for sale decreased $2.1 million from $3.3 million at September 30, 2001 to $1.2
million at June 30, 2002. During the nine months ended June 30, 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 $49.3 million in fixed rate
mortgage loans during the nine months ended June 30, 2002 compared to $37.5
million for the nine months ended June 30, 2001. We continue to emphasize
commercial, commercial real estate, consumer loans and equity lines of credit
that carry variable rates and/or short term maturities. At June 30, 2002,
commercial, construction and commercial real estate loans totaled $118.2 million
and account for 53.9% of gross loans compared to $110.6 million and 48.9% at
September 30, 2001. One to four family residential loans at June 30, 2002
totaled $72.6 million or 33.2% of gross loans compared to $86.9 million or 38.5%
at September 30, 2001.
Deposits increased $10.8 million from $248.4 million at September 30, 2001
to $259.2 million at June 30, 2002. Certificates of deposit at June 30, 2002
totaled $160.8 million or 62.0% 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 $7.2 million
or 11.5% from $62.6 million at September 30, 2001 to $69.8 million at June 30,
2002.
Stockholders' equity increased by $3.1 million from $63.6 million at
September 30, 2001 to $66.7 million at June 30, 2002 as a result of net income
of $2.8 million, release of ESOP shares of $500,000, and vesting of MRP shares
of $518,000. These increases were offset by cash dividends declared of $721,000
and a decrease in unrealized losses on available for sale securities of $32,000.
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED JUNE 30, 2002 AND
2001
Net Income. We recorded net income of $986,000 for the quarter ended June
30, 2002, as compared to $893,000 for the quarter ended June 30, 2001,
representing an increase of $93,000, or 10.4%. For the three months ended June
30, 2002 basic and diluted earnings per share were $0.32 and $0.31,
respectively. The Company reported basic and diluted earnings per share for the
quarter ended June 30, 2001 of $0.29 and $0.28 per share, respectively. The
increase in net income resulted primarily from increased net interest income and
decreased operating expenses which were offset partially by decreased other
income and increased income taxes.
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 June 30, 2002 was $3.2 million, an
increase of $160,000 compared to the same quarter in the prior year. This
increase reflects a $1.1 million decrease in interest income that was more than
offset by the $1.2 million decrease in total interest expense. The average net
interest margin decreased 13 basis points from 3.76% for the three months ended
June 30, 2001 to 3.89% for the quarter ended June 30, 2002.
13
Interest Income. The decrease in interest income for the three months ended
June 30, 2002 resulted from an increase of $6.4 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 1.46% from
7.48% for the three months ended June 30, 2001 to 6.02% for the three months
ended June 30, 2002. The increased volume of average interest-earning assets
increased interest income by approximately $120,000 and the decreased yield
decreased interest income by approximately $1.2 million. Average loans
outstanding decreased $13.9 million coupled with a decrease in average
interest-bearing overnight funds of $7.5 million were offset by an increase in
average investment securities of $27.9 million. We experienced unusually heavy
mortgage loan prepayments during the nine months ended June 30, 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 June
30, 2002 which resulted from an increase in average interest-bearing liabilities
of $2.4 million and a decrease in the cost of interest-bearing liabilities of
1.89% from 4.50% for the three months ended June 30, 2001 to 2.61% for the three
months ended June 30, 2002. Average deposits increased by $805,000 while average
FHLB advances increased $1.6 million for the three months ended June 30, 2002
compared to the same quarter in the prior year. The increase in average
interest-bearing liabilities increased interest expense by approximately $27,000
while the decrease in the average cost of interest-bearing liabilities decreased
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 June 30, 2002 compared to the quarter ended
June 30, 2001.
THREE MONTHS ENDED THREE MONTHS ENDED
JUNE 30, 2002 JUNE 30, 2001
DOLLARS IN THOUSANDS
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST
Assets:
Loans receivable (1) $214,339 $3,492 6.52% $228,239 $4,625 8.11%
Investment securities (2) 101,822 1,413 5.55 73,962 1,182 6.39
Interest-bearing overnight deposits 13,174 50 1.51 20,710 230 4.45
-------- ------ ----- -------- ------ -----
Total interest-earning assets (4) 329,335 4,955 6.02 322,911 6,037 7.48
Non interest-earning assets 22,601 23,327
-------- --------
Total assets $351,936 $346,238
======== ========
Liabilities and stockholders' equity:
Interest bearing checking 32,836 38 0.47 30,265 84 1.11
Money market investment accounts 26,232 83 1.26 21,186 179 3.38
Passbook and statement savings 28,457 102 1.44 26,486 143 2.16
Certificates of deposit 159,727 1,252 3.14 168,510 2,319 5.50
FHLB advances 21,593 281 5.20 20,000 273 5.45
-------- ------ ----- -------- ------ -----
Total interest-bearing liabilities 268,845 1,756 2.61 266,447 2,998 4.50
Non interest-bearing liabilities 17,450 18,040
-------- --------
Total liabilities 286,295 284,487
Stockholders' equity 65,641 61,751
-------- --------
Total liabilities and stockholders' equity $351,936 $346,238
======== ========
Net interest income $3,199 $3,039
====== ======
Interest rate spread 3.41% 2.98%
Net interest margin (3) 3.89% 3.76%
Ratio of average interest-earning assets 122.50% 121.19%
(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. 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 June 30, 2002 and 2001. The provision for loan losses was impacted by the
continued shift in the portfolio to commercial loans which require a larger
allocation of allowance for loan losses. The effects of this continued shift in
the portfolio were offset to a certain degree in 2002 by a decrease in total
loans. See also "Asset Quality."
Other Income. Other income decreased $292,000, or 34.0%, from $860,000 for
the quarter ended June 30, 2001 to $568,000 for the quarter ended June 30, 2002.
Mortgage banking income, net decreased $183,000 from $338,000 for the quarter
ended June 30, 2001 to $155,000 for the quarter ended June 30, 2002. The
decrease in mortgage banking income resulted from a decreased volume of loan
originations and sales. During the quarter ended June 30, 2002, we sold
fixed-rate mortgage loans held for sale of $7.2 million compared with sales of
$19.8 million in the prior year. Commissions from sales of annuities and mutual
funds decreased $109,000 from $240,000 for the quarter ended June 30, 2001 to
$131,000 for the quarter ended June 30, 2002. The decrease is the result of
decreased sales of
15
annuity and mutual funds. Sales of annuity and mutual funds totaled $3.0 million
for the quarter ended June 30, 2002 compared with sales of $4.9 million for the
quarter ended June 30, 2001.
Operating Expenses. Total operating expenses were $2.2 million for the
quarters ended June 30, 2002, a decrease of $270,000 from the $2.4 million for
the quarter ended June 30, 2001. Compensation and related benefits expense
decreased $104,000, or 6.4% from $1.6 million for the quarter ended June 30,
2001 to $1.5 million for the quarter ended June 30, 2002. Of this decrease
$68,000 was related to lower MRP expense in the quarter ended June 30, 2002 as
the final vesting date for the MRPs was June 6, 2002. Also contributing to lower
compensation expense was a decrease in incentives paid related to the lower
volume of mortgage originations and decreased annuity and mutual fund sales
during the quarter ended June 30, 2002 as compared with the quarter ended June
30, 2001. During the quarter ended June 30, 2002, the Company recognized net
income from real estate operations of $24,000 compared to the net losses from
real estate operations of $30,000 that were expensed during the quarter ended
June 30, 2001. Other operating expenses were $365,000 for the quarter ended June
30, 2002, a decrease of $90,000 from the $455,000 for the quarter ended June 30,
2001. Expenses for the quarter ended June 30, 2001 included expenses necessary
for the installation of the Bank's check imaging system.
Income Tax Expense. Income tax expense increased $45,000 from tax expense
of $497,000 for the quarter ended June 30, 2001 to $542,000 for the quarter
ended June 30, 2002. The increase resulted from a $138,000 increase in income
before income taxes. The effective tax rates were 35.5% and 35.8% for the
quarters ended June 30, 2002 and 2001, respectively.
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTHS ENDED JUNE 30, 2002 AND 2001
Net Income. We recorded net income of $2.8 million for the nine months
ended June 30, 2002, an increase of $186,000 over the $2.6 million reported in
the nine months ended June 30, 2001. For the nine months ended June 30, 2002,
basic and diluted earnings per share were $0.91 and $0.87, respectively. The
Company reported basic and diluted earnings per share for the nine months ended
June 30, 2001 of $0.85 and $0.81, respectively. The increase in net income
resulted primarily from increased other income and decreased operating expenses
which was partially offset by decreased net interest income and increased 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 interest income than in interest expense for
the nine months ended June 30, 2002.
Net Interest Income. Net interest income, the difference between interest
earned on loans and investments and interest paid on interest-bearing
liabilities, decreased by $236,000 or 2.6% for the nine months ended June 30,
2002, compared to the same nine months in the prior year. This decrease reflects
a $3.7 million decrease in interest income that was partially offset by the $3.5
million decrease in total interest expense. The average net interest margin
decreased 14 basis points from 3.81% for the nine months ended June 30, 2001 to
3.67% for the nine months ended June 30, 2002.
Interest Income. The decrease in interest income for the nine months ended
June 30, 2002 was due to a decrease in yield on interest-earning assets of 1.62%
from 7.77% for the nine months ended June 30, 2001 to 6.15% for the nine months
ended June 30, 2002 that was partially offset by an increase of $4.3 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 $250,000 and the decreased yield decreased interest
income by approximately $4.0 million. Average investment securities increased
interest-earning assets by $18.6 million for the nine months compared to the
prior year. These increases were offset in part by a decrease in average loans
outstanding of $12.7 million and a decrease in interest-bearing overnight
deposits of $1.6 million. We experienced unusually heavy mortgage loan
prepayments during the nine months ended June 30, 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 nine months ended June
30, 2002 due to a decrease in average interest-bearing liabilities of $1.8
million and a decrease in the cost of interest-bearing liabilities of 1.71% from
4.76% for the nine months ended June 30, 2001 to 3.05% for the nine months ended
June 30, 2002. Average deposits decreased by $2.8 million while average FHLB
advances increased $1.0 million for the nine months ended June 30, 2002 compared
to the same nine months in the prior year. The decrease in average
interest-bearing liabilities decreased interest expense by approximately $64,000
and the decrease in the average cost of interest-bearing liabilities decreased
16
interest expense by approximately $3.4 million.
The following table presents average balances and average rates earned/paid
by the Company for the nine months ended June 30, 2002 compared to the nine
months ended June 30, 2001.
NINE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, 2002 JUNE 30, 2001
DOLLARS IN THOUSANDS
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST
Assets:
Loans receivable (5) $217,934 $10,891 6.66% $230,603 $14,642 8.47%
Investment securities (6) 94,589 3,993 5.63 76,001 3,517 6.17
Interest-bearing overnight deposits 14,097 191 1.81 15,722 629 5.33
-------- ------- ------ -------- ------- ------
Total interest-earning assets (8) 326,620 15,075 6.15 322,326 18,788 7.77
Non interest-earning assets 22,270 23,755
-------- --------
Total assets $348,890 $346,081
======== ========
Liabilities and stockholders' equity
Interest bearing checking 31,658 115 0.48 30,172 338 1.49
Money market investment accounts 27,504 288 1.39 20,507 630 4.10
Passbook and statement savings 27,232 316 1.55 26,694 460 2.30
Certificates of deposit 157,852 4,530 3.83 169,661 7,287 5.73
FHLB advances 21,697 842 5.18 20,699 853 5.49
-------- ------ ----- -------- ------ ------
Total interest-earning liabilities 265,943 6,091 3.05 267,733 9,568 4.76
Non interest-earning liabilities 18,176 17,675
------ ------
Total liabilities 284,120 285,408
Stockholders' equity 64,771 60,673
-------- --------
Total liabilities and stockholders' equity $348,890 $346,081
======== ========
Net interest income $8,984 $9,220
====== ======
Interest rate spread 3.10% 3.01%
Net interest margin (7) 3.67% 3.81%
Ratio of average interest-earning assets 122.82% 120.39%
(5) Includes nonaccrual loans and loans held for sale, net of discounts and
allowance for loan losses.
(6) Includes FHLB of Atlanta stock.
(7) Represents net interest income divided by the average balance of
interest-earning assets.
(8) 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. 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 $180,000 for both the nine months
ended June 30, 2002 and 2001. The provision for loan losses was impacted by the
continued shift in the portfolio to commercial loans which require a larger
allocation of allowance for loan losses. The effects of this continued shift in
the portfolio were offset to a certain degree in 2002 by a decrease in total
loans. See also "Asset Quality."
Other Income. Other income increased $376,000, or 20.4%, from $1.8 million
for the nine months ended June 30, 2001 to $2.2 million for the nine months
ended June 30, 2002. Mortgage banking income, net increased $263,000
17
from $658,000 for the nine months ended June 30, 2001 to $921,000 for the nine
months ended June 30, 2002. During the nine months ended June 30, 2002, we sold
fixed-rate mortgage loans held for sale of $49.3 million compared with sales of
$37.5 million during the nine months ended June 30, 2001. Customer service fees
increased $153,000, or 29.3% from $522,000 for the nine months ended June 30,
2001 to $675,000 for the nine months ended June 30, 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 nine months ended June 30, 2002 that were not present in
the prior year. Commissions from the sales of annuities and mutual funds
decreased $108,000 from $459,000 for the nine months ended June 30, 2001 to
$351,000 for the nine months ended June 30, 2002. This decrease was the result
of diminished sales of annuities and mutual funds. Sales of these non-insured
products were $6.5 million for the nine months ended June 30, 2002, a decrease
of $1.5 million from the $8.0 million sold in the same period in the prior year.
Operating Expenses. Total operating expenses were $6.7 million for the nine
months ended June 30, 2002, a decrease of $212,000, or 3.1% over the $6.9
million recorded for the nine months ended June 30, 2001. Compensation and
related benefits expense increased $71,000 from $4.6 million for the nine months
ended June 30, 2001 to $4.7 million for the nine months ended June 30, 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 $56,000 during the nine months ended June 30, 2002 compared to
expenses of $36,000 in the same period in the prior year. Other operating
expenses decreased $173,000 from $1.3 million for the nine months ended June 30,
2001 to $1.1 million for the nine months ended June 30, 2002.
Income Tax Expense. Income tax expense increased $166,000 from tax expense
of $1.4 million for the nine months ended June 30, 2001 to $1.6 million for the
nine months ended June 30, 2002. The increase resulted from a $352,000 increase
in income before income taxes. The effective tax rates were 36.5% and 35.5% for
the nine months ended June 30, 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 amounts represent credit
and interest rate risk are summarized as follows:
June 30, 2002 September 30, 2001
------------- ------------------
(dollars in thousands)
Commitments to originate new loans 5,537 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 70,316 56,907
Commercial letters of credit 425 256
Commitments to sell loans held for sale 1,143 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-
18
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 June 30, 2002, the aggregate fair value of
these commitments exceeded the book value of the loans to be sold.
CONTRACTUAL OBLIGATIONS
As of June 30, 2002
Payments due by period
----------------------
(Dollars in thousands)
Less than
1 year 1-3 years 4-5 years Over 5 years Total
------------ --------- --------- ------------ -----
Deposits $ 230,914 19,986 8,347 -- 259,247
Long-term borrowings -- -- -- 20,000 20,000
Lease obligations 19 56 42 38 155
----------- --------- ------ ------- --------
Total contractual cash
obligations $ 230,933 20,042 8,389 20,038 279,402
=========== ========= ====== ======= ========
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.
ASSET QUALITY
At June 30, 2002, the Company had approximately $6.0 million in non-performing
assets (nonaccrual loans and real estate owned) or 1.69% of total assets. At
September 30, 2001, non-performing assets were $2.9 million or 0.85% of total
assets. At June 30, 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 impaired loans at June 30, 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 September 30, 2001, the impaired loans
resulted from real estate loans secured by commercial real estate in Alamance
County owned by two unrelated commercial loan customers. At June 30, 2002, $3.3
million of the impaired loans are on non-accrual status, and their related
reserve for loan losses totaled $160,000. At September 30, 2001, $433,000 of
impaired loans was on nonaccrual status, and their related reserve for losses
totaled $45,000. 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 $3.8 million during the three and nine months ended June 30, 2002,
respectively. Interest income of $50,000 and $146,000 has been recorded on
impaired loans in the three and nine months ended June 30, 2002, respectively.
The Bank's net chargeoffs for the three and nine months ended June 30, 2002 were
$0 and $91,000, respectively. The Bank's allowance for loan losses was $3.7
million at June 30, 2002 and $3.6 million at September 30, 2001. 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
19
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 1.69% at June 30, 2002 compared
to 1.60% at September 30, 2001.
The following table presents an analysis of our nonperforming assets:
At At At
June 30, September 30, June 30,
2002 2001 2001
---- ---- ----
Nonperforming loans:
Nonaccrual loans $3,728 $ 878 $ 1,112
Loans 90 days past due and accruing -- -- --
Restructured loans -- -- --
------ --------- ---------
Total nonperforming loans 3,728 878 1,112
Other real estate 2,226 1,981 1,981
------ --------- ---------
Total nonperforming assets $5,954 $ 2,859 $ 3,093
====== ========= =========
Nonperforming loans to loans receivable, net 1.73% 0.39% 0.50%
Nonperforming assets as a percentage
of loans and other real estate owned 2.74% 1.27% 1.38%
Nonperforming assets to total assets 1.69% 0.85% 0.89%
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 June 30, 2002, we had $5.6 million in
classified assets consisting of $3.4 million in substandard and loss loans and
$2.2 million in real estate owned. At September 30, 2001, we had $3.6 million in
substandard assets consisting of $1.6 million in 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 June 30, 2002, we have identified approximately $2.3 million in
assets classified as special mention and $31.3 million as watch.
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
June 30, 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 June 30, 2002, cash and cash equivalents
totaled $19.9 million. We have other sources of liquidity should we need
additional funds. During the three and nine months ended June 30, 2002, we sold
loans totaling $7.2 million and $49.3 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
$90 million at June 30, 2002.
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We anticipate that we will have sufficient funds available to meet our
current commitments. At June 30, 2002, we had $5.5 million in commitments to
originate new loans, $70.3 million in unfunded commitments to extend credit
under existing equity lines and commercial lines of credit and $425,000 in
standby letters of credit. At June 30, 2002, certificates of deposit, which are
scheduled to mature within one year, totaled $132.5 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 June 30, 2002 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 June 30, 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 June 30, 2002 was 18.9%. 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 quarters in fiscal 2002 and fiscal 2001. The Company's ability to pay
dividends is dependent upon earnings. The Company's dividend payout ratio for
the three months ended June 30, 2002, September 30, 2001 and June 30, 2001 was
25.8%, 32.0% and 28.6%, 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 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. For the periods presented herein, the Company had no goodwill and had no
intangible assets related to deposit and branch purchase acquisitions.
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 supercedes
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
21
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.
In June 2002, the FASB issued Statement of Financial Accounting Standards
No. 146 (Statement 146), "Accounting for Costs Associated with Exit or Disposal
Activities," which addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." This Statement applies to costs associated
with an exit activity that does not involve an entity newly acquired in a
business combination or with a disposal activity covered by FASB Statement No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets. Those costs
include, but are not limited to, the following: a) termination benefits provided
to current employees that are involuntarily terminated under the terms of a
benefit arrangement that, in substance, is not an ongoing benefit arrangement or
an individual deferred compensation contract (hereinafter referred to as
one-time termination benefits), b) costs to terminate a contract that is not a
capital lease and c) costs to consolidate facilities or relocate employees. This
Statement does not apply to costs associated with the retirement of a long-lived
asset covered by FASB Statement No. 143, Accounting for Asset Retirement
Obligations. A liability for a cost associated with an exit or disposal activity
shall be recognized and measured initially at its fair value in the period in
which the liability is incurred. A liability for a cost associated with an exit
or disposal activity is incurred when the definition of a liability is met. The
provisions of this Statement are effective for exit or disposal activities that
are initiated after December 31, 2002, with early application encouraged. The
impact of adoption on the Company is not known at this time.
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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
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a.) Exhibits.
--------
99 Certification
(b.) Reports on Form 8-K. During the quarter ended June 30, 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: August 14, 2002 James C. McGill
President and Chief Executive Officer
(Principal Executive Officer)
/s/ A. Christine Baker
--------------------------------------------
Date: August 14, 2002 A. Christine Baker
Executive Vice President
Treasurer and Secretary
(Principal Financial and Accounting Officer)
25