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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
June 30, 2006
-----------------------
Commission File Number 0-15572
FIRST BANCORP
--------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
North Carolina 56-1421916
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
341 North Main Street, Troy, North Carolina 27371-0508
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(Address of Principal Executive Offices) (Zip Code)
(Registrant's telephone number, including area code) (910) 576-6171
---------------------------
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 twelve months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] YES [ ] NO
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer.
[ ] Large Accelerated Filer [X] Accelerated Filer [ ] Non-Accelerated Filer
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). [ ] YES [X] NO
The number of shares of the registrant's Common Stock outstanding on July 31,
2006 was 14,294,946.
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INDEX
FIRST BANCORP AND SUBSIDIARIES
Page
Part I. Financial Information
Item 1 - Financial Statements
Consolidated Balance Sheets -
June 30, 2006 and 2005
(With Comparative Amounts at December 31, 2005) 3
Consolidated Statements of Income -
For the Periods Ended June 30, 2006 and 2005 4
Consolidated Statements of Comprehensive Income -
For the Periods Ended June 30, 2006 and 2005 5
Consolidated Statements of Shareholders' Equity -
For the Periods Ended June 30, 2006 and 2005 6
Consolidated Statements of Cash Flows -
For the Periods Ended June 30, 2006 and 2005 7
Notes to Consolidated Financial Statements 8
Item 2 - Management's Discussion and Analysis of Consolidated
Results of Operations and Financial Condition 16
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 29
Item 4 - Controls and Procedures 31
Part II. Other Information
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds 32
Item 4 - Submission of Matters to a Vote of Security Holders 33
Item 6 - Exhibits 33
Signatures 34
Page 2
Part I. Financial Information
Item 1 - Financial Statements
First Bancorp and Subsidiaries
Consolidated Balance Sheets
June 30, December 31, June 30,
($ in thousands-unaudited) 2006 2005 (audited) 2005
------------------------------------------------------------------------------------------------
ASSETS
Cash & due from banks, noninterest-bearing $ 31,295 32,985 35,642
Due from banks, interest-bearing 83,894 41,655 41,741
Federal funds sold 22,029 28,883 20,700
----------- ----------- -----------
Total cash and cash equivalents 137,218 103,523 98,083
----------- ----------- -----------
Securities available for sale (costs of $118,549,
$114,662, and $118,958) 115,579 113,613 119,716
Securities held to maturity (fair values of $14,310,
$14,321, and $13,076) 14,333 14,172 12,820
Presold mortgages in process of settlement 2,586 3,347 2,063
Loans 1,635,899 1,482,611 1,425,856
Less: Allowance for loan losses (17,642) (15,716) (15,622)
----------- ----------- -----------
Net loans 1,618,257 1,466,895 1,410,234
----------- ----------- -----------
Premises and equipment 37,152 34,840 31,758
Accrued interest receivable 9,887 8,947 7,553
Intangible assets 49,070 49,227 49,373
Other 8,627 6,486 6,997
----------- ----------- -----------
Total assets $ 1,992,709 1,801,050 1,738,597
=========== =========== ===========
LIABILITIES
Deposits: Demand - noninterest-bearing $ 209,062 194,051 184,605
Savings, NOW, and money market 480,522 458,221 476,642
Time deposits of $100,000 or more 390,589 356,281 349,972
Other time deposits 510,495 486,024 459,661
----------- ----------- -----------
Total deposits 1,590,668 1,494,577 1,470,880
Securities sold under agreements to repurchase 30,602 33,530 1,850
Borrowings 195,013 100,239 101,239
Accrued interest payable 4,856 3,835 3,267
Other liabilities 11,655 13,141 7,159
----------- ----------- -----------
Total liabilities 1,832,794 1,645,322 1,584,395
----------- ----------- -----------
SHAREHOLDERS' EQUITY
Common stock, No par value per share
Issued and outstanding: 14,279,847,
14,229,148, and 14,170,722 shares 54,827 54,121 53,098
Retained earnings 107,151 102,507 100,902
Accumulated other comprehensive income (loss) (2,063) (900) 202
----------- ----------- -----------
Total shareholders' equity 159,915 155,728 154,202
----------- ----------- -----------
Total liabilities and shareholders' equity $ 1,992,709 1,801,050 1,738,597
=========== =========== ===========
See notes to consolidated financial statements.
Page 3
First Bancorp and Subsidiaries
Consolidated Statements of Income
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
($ in thousands, except share data-unaudited) 2006 2005 2006 2005
-------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Interest and fees on loans $ 29,215 22,732 55,977 44,091
Interest on investment securities:
Taxable interest income 1,402 1,411 2,731 2,566
Tax-exempt interest income 127 117 254 246
Other, principally overnight investments 571 447 1,068 719
------------ ------------ ------------ ------------
Total interest income 31,315 24,707 60,030 47,622
------------ ------------ ------------ ------------
INTEREST EXPENSE
Savings, NOW and money market 1,635 958 2,968 1,839
Time deposits of $100,000 or more 4,174 2,725 7,851 5,070
Other time deposits 5,004 3,007 9,436 5,481
Other, primarily borrowings 2,058 1,010 3,478 1,940
------------ ------------ ------------ ------------
Total interest expense 12,871 7,700 23,733 14,330
------------ ------------ ------------ ------------
Net interest income 18,444 17,007 36,297 33,292
Provision for loan losses 1,400 845 2,415 1,425
------------ ------------ ------------ ------------
Net interest income after provision
for loan losses 17,044 16,162 33,882 31,867
------------ ------------ ------------ ------------
NONINTEREST INCOME
Service charges on deposit accounts 2,225 2,145 4,299 4,153
Other service charges, commissions and fees 1,119 935 2,324 1,989
Fees from presold mortgages 244 285 511 523
Commissions from sales of insurance and financial products 325 314 764 609
Data processing fees 37 58 73 205
Securities gains 205 2 205 2
Other gains (losses) (311) (27) (378) (59)
------------ ------------ ------------ ------------
Total noninterest income 3,844 3,712 7,798 7,422
------------ ------------ ------------ ------------
NONINTEREST EXPENSES
Salaries 5,734 5,393 11,519 10,765
Employee benefits 1,786 1,791 3,567 3,305
------------ ------------ ------------ ------------
Total personnel expense 7,520 7,184 15,086 14,070
Net occupancy expense 858 723 1,674 1,462
Equipment related expenses 818 768 1,629 1,463
Intangibles amortization 60 73 121 146
Other operating expenses 3,808 3,512 7,283 6,834
------------ ------------ ------------ ------------
Total noninterest expenses 13,064 12,260 25,793 23,975
------------ ------------ ------------ ------------
Income before income taxes 7,824 7,614 15,887 15,314
Income taxes 3,029 2,962 6,101 5,946
------------ ------------ ------------ ------------
NET INCOME $ 4,795 4,652 9,786 9,368
============ ============ ============ ============
Earnings per share:
Basic $ 0.34 0.33 0.69 0.66
Diluted 0.33 0.32 0.68 0.65
Weighted average common shares outstanding:
Basic 14,296,159 14,159,117 14,275,472 14,132,347
Diluted 14,433,830 14,345,013 14,425,500 14,354,852
See notes to consolidated financial statements.
Page 4
First Bancorp and Subsidiaries
Consolidated Statements of Comprehensive Income
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
($ in thousands-unaudited) 2006 2005 2006 2005
---------------------------------------------------------------------------------------------
Net income $ 4,795 4,652 9,786 9,368
------- ------- ------- -------
Other comprehensive income (loss):
Unrealized gains (losses) on securities
available for sale:
Unrealized holding gains (losses) arising
during the period, pretax (1,621) 886 (1,717) (428)
Tax benefit (expense) 632 (343) 669 169
Reclassification to realized gains (205) (2) (205) (2)
Tax expense 80 1 80 1
Adjustment to minimum pension liability:
Additional pension charge related to unfunded
pension liability -- -- 16 (90)
Tax benefit (expense) -- -- (6) 35
------- ------- ------- -------
Other comprehensive income (loss) (1,114) 542 (1,163) (315)
------- ------- ------- -------
Comprehensive income $ 3,681 5,194 8,623 9,053
======= ======= ======= =======
See notes to consolidated financial statements.
Page 5
First Bancorp and Subsidiaries
Consolidated Statements of Shareholders' Equity
Accumulated
Common Stock Other Share-
---------------------------- Retained Comprehensive holders'
(In thousands, except per share - unaudited) Shares Amount Earnings Income (Loss) Equity
-----------------------------------------------------------------------------------------------------------------------
Balances, January 1, 2005 14,084 $ 51,614 96,347 517 148,478
Net income 9,368 9,368
Cash dividends declared ($0.34 per share) (4,813) (4,813)
Common stock issued under
stock option plan 51 585 585
Common stock issued into
dividend reinvestment plan 36 799 799
Tax benefit realized from exercise of
nonqualified stock options -- 100 100
Other comprehensive loss (315) (315)
------------ ------------ ------------ ------------ ------------
Balances, June 30, 2005 14,171 $ 53,098 100,902 202 154,202
============ ============ ============ ============ ============
Balances, January 1, 2006 14,229 $ 54,121 102,507 (900) 155,728
Net income 9,786 9,786
Cash dividends declared ($0.36 per share) (5,142) (5,142)
Common stock issued under
stock option plan 66 618 618
Common stock issued into
dividend reinvestment plan 37 815 815
Purchases and retirement of common stock (53) (1,112) (1,112)
Tax benefit realized from exercise of
nonqualified stock options -- 94 94
Stock-based compensation -- 291 291
Other comprehensive loss (1,163) (1,163)
------------ ------------ ------------ ------------ ------------
Balances, June 30, 2006 14,279 $ 54,827 107,151 (2,063) 159,915
============ ============ ============ ============ ============
See notes to consolidated financial statements.
Page 6
First Bancorp and Subsidiaries
Consolidated Statements of Cash Flows
Six Months Ended
June 30,
($ in thousands-unaudited) 2006 2005
----------------------------------------------------------------------------------------------------
Cash Flows From Operating Activities
Net income $ 9,786 9,368
Reconciliation of net income to net cash provided by operating activities:
Provision for loan losses 2,415 1,425
Net security premium amortization 45 39
Gain on sale of securities available for sale (205) (2)
Other losses 378 59
Net loan origination fees (costs) deferred 247 (224)
Depreciation of premises and equipment 1,382 1,336
Tax benefit from exercise of nonqualified stock options -- 100
Stock-based compensation expense 291 --
Amortization of intangible assets 121 146
Deferred income tax benefit (1,849) (394)
Origination of presold mortgages in process of settlement (31,781) (32,877)
Proceeds from sales of presold mortgages in process of settlement 32,542 32,585
Increase in accrued interest receivable (940) (721)
Decrease in other assets 213 2,044
Increase in accrued interest payable 1,021 590
Increase (decrease) in other liabilities (1,479) 116
--------- ---------
Net cash provided by operating activities 12,187 13,590
--------- ---------
Cash Flows From Investing Activities
Purchases of securities available for sale (23,565) (44,747)
Purchases of securities held to maturity (2,682) --
Proceeds from maturities/issuer calls of securities available for sale 18,248 13,117
Proceeds from maturities/issuer calls of securities held to maturity 3,186 1,168
Proceeds from sales of securities available for sale 1,575 8
Net increase in loans (154,743) (61,227)
Purchases of premises and equipment (3,730) (2,776)
--------- ---------
Net cash used by investing activities (161,711) (94,457)
--------- ---------
Cash Flows From Financing Activities
Net increase in deposits and repurchase agreements 93,163 83,962
Proceeds from borrowings, net 94,774 9,000
Cash dividends paid (5,133) (4,797)
Proceeds from issuance of common stock 1,433 1,384
Purchases and retirement of common stock (1,112) --
Tax benefit from exercise of nonqualified stock options 94 --
--------- ---------
Net cash provided by financing activities 183,219 89,549
--------- ---------
Increase in Cash and Cash Equivalents 33,695 8,682
Cash and Cash Equivalents, Beginning of Period 103,523 89,401
--------- ---------
Cash and Cash Equivalents, End of Period $ 137,218 98,083
========= =========
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest $ 22,712 13,740
Income taxes 7,571 5,771
Non-cash transactions:
Unrealized loss on securities available for sale, net of taxes (1,173) (260)
Foreclosed loans transferred to other real estate 774 2,128
See notes to consolidated financial statements.
Page 7
First Bancorp and Subsidiaries
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
(unaudited) For the Periods Ended June 30, 2006 and 2005
--------------------------------------------------------------------------------
Note 1 - Basis of Presentation
In the opinion of the Company, the accompanying unaudited consolidated
financial statements contain all adjustments necessary to present fairly the
consolidated financial position of the Company as of June 30, 2006 and 2005 and
the consolidated results of operations and consolidated cash flows for the
periods ended June 30, 2006 and 2005. All such adjustments were of a normal,
recurring nature. Reference is made to the 2005 Annual Report on Form 10-K filed
with the SEC for a discussion of accounting policies and other relevant
information with respect to the financial statements. The results of operations
for the periods ended June 30, 2006 and 2005 are not necessarily indicative of
the results to be expected for the full year.
Note 2 - Accounting Policies
Note 1 to the 2005 Annual Report on Form 10-K filed with the SEC contains a
description of the accounting policies followed by the Company and discussion of
recent accounting pronouncements. The following paragraph updates that
information as necessary.
In July 2006, the Financial Accounting Standards Board (FASB) released FASB
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, an
interpretation of FASB Statement No. 109" (FIN 48). FIN 48 clarifies the
accounting and reporting for uncertainties in income tax law. FIN 48 prescribes
a comprehensive model for the financial statement recognition, measurement,
presentation and disclosure of uncertain tax positions taken or expected to be
taken in income tax returns. The Company will adopt FIN 48 in the first quarter
of 2007. The cumulative effect of applying the provisions of this interpretation
is required to be reported separately as an adjustment to the opening balance of
retained earnings in the year of adoption. The Company is in the process of
reviewing and evaluating FIN 48, and therefore the ultimate impact of its
adoption is not yet known.
On January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123 (revised 2004) (Statement 123(R)), "Share-Based Payment."
Statement 123(R) replaces FASB Statement No. 123 (Statement 123), "Accounting
for Stock-Based Compensation," and supersedes Accounting Principles Board
Opinion No. 25 (Opinion 25), "Accounting for Stock Issued to Employees."
Statement 123(R) requires that the compensation cost relating to share-based
payment transactions be recognized in the financial statements. Statement 123(R)
permits public companies to adopt its requirements using one of two methods. The
"modified prospective" method recognizes compensation for all stock options
granted after the date of adoption and for all previously granted stock options
that become vested after the date of adoption. The "modified retrospective"
method includes the requirements of the "modified prospective" method described
above, but also permits entities to restate prior period results based on the
amounts previously presented under Statement 123 for purposes of pro-forma
disclosures. The Company has elected to adopt Statement 123(R) under the
"modified prospective" method and accordingly will not restate prior period
results. See Note 4 for a more detailed description the Company's adoption of
Statement 123(R).
In May 2005, the FASB issued Statement of Financial Accounting Standards
No. 154 (Statement 154), "Accounting Changes and Error Corrections, a
replacement of APB Opinion No. 20 and FASB Statement No. 3." Statement 154
applies to all voluntary changes in accounting principle as well as to changes
required by an accounting pronouncement that does not include specific
transition provisions. Statement 154 eliminates the previous requirement that
the cumulative effect of changes in accounting principle be reflected in the
income statement in the period of change. Instead, to enhance the comparability
of prior period financial statements, Statement 154 requires that changes in
accounting principle be retrospectively applied. Under retrospective
application, the new accounting principle is applied as of the beginning of the
first period presented, as if that
Page 8
principle had always been used. Statement 154 carries forward the requirement
that an error be reported by restating prior period financial statement as of
the beginning of the first period. Statement 154 is effective for accounting
changes and corrections of errors made in fiscal years beginning after December
15, 2005. The initial adoption of Statement 154 did not have a material impact
on the Company's financial statements; however the adoption of this statement
could result in a material change to the way the Company reflects future changes
in accounting principles, depending on the nature of future changes in
accounting principles and whether specific transition provisions are included.
Note 3 - Reclassifications
Certain amounts reported in the period ended June 30, 2005 have been
reclassified to conform with the presentation for June 30, 2006. These
reclassifications had no effect on net income or shareholders' equity for the
periods presented, nor did they materially impact trends in financial
information.
Note 4 - Equity-Based Compensation Plans
At June 30, 2006, the Company had the following equity-based compensation
plans, all of which are stock option plans: the First Bancorp 2004 Stock Option
Plan, the First Bancorp 1994 Stock Option Plan, and four plans that were assumed
from acquired entities, which are all described below. The Company's
shareholders approved all equity-based compensation plans, except for those
assumed from acquired companies. As of June 30, 2006, the First Bancorp 2004
Stock Option Plan was the only plan that had shares available for future grants.
The First Bancorp 2004 Stock Option Plan and its predecessor plan, the
First Bancorp 1994 Stock Option Plan, were intended to serve as a means of
attracting, retaining and motivating key employees and directors and to
associate the interests of the plans' participants with those of the Company and
its shareholders. Stock option grants to non-employee directors have
historically had no vesting requirements, whereas, except as discussed below,
stock option grants to employees have generally had five-year vesting schedules
(20% vesting each year). In April 2004, the Company granted 128,000 options to
employees with no vesting requirements. These options were granted without any
vesting requirements for two reasons - 1) the options were granted primarily as
a reward for past performance and therefore had already been "earned" in the
view of the Committee, and 2) to potentially minimize the impact that any change
in accounting standards for stock options could have on future years' reported
net income. Employee stock option grants since the April 2004 grant have
reverted to having five year vesting periods. The Company's options provide for
immediate vesting if there is a change in control (as defined in the plans).
Under the terms of these two plans, options can have a term of no longer than
ten years, and all options granted thus far under these plans have had a term of
ten years. Except for grants to directors (see below), the Company cannot
estimate the amount of future stock option grants at this time. In the past,
stock option grants to employees have been irregular, generally falling into
three categories - 1) to attract and retain new employees, 2) to recognize
changes in responsibilities of existing employees, and 3) to periodically reward
exemplary performance. As it relates to directors, the Company has historically
granted 2,250 stock options to each of the Company's non-employee directors in
June of each year, and expects to continue doing so for the foreseeable future.
At June 30, 2006, there were 658,883 options outstanding related to these two
plans with exercise prices ranging from $4.45 to $22.12. At June 30, 2006, there
were 1,186,840 shares remaining available for grant under the First Bancorp 2004
Stock Option Plan.
Page 9
The Company also has four stock option plans as a result of assuming plans
of acquired companies. At June 30, 2006, there were 44,686 stock options
outstanding in connection with these plans, with option prices ranging from
$10.22 to $11.49.
The Company issues new shares when options are exercised.
Prior to January 1, 2006, the Company accounted for all of these plans
using the intrinsic value method prescribed by Opinion 25 and related
interpretations. Because all of the Company's stock options had an exercise
price equal to the market value of the underlying common stock on the date of
grant, no compensation cost had ever been recognized. On January 1, 2006, the
Company adopted Statement 123(R). Statement 123(R) supersedes Opinion 25 (and
related interpretations) and requires that the compensation cost relating to
share-based payment transactions be recognized in the financial statements.
Statement 123(R) permits public companies to adopt its requirements using one of
two methods. The "modified prospective" method recognizes compensation for all
stock options granted after the date of adoption and for all previously granted
stock options that become vested after the date of adoption. The "modified
retrospective" method includes the requirements of the "modified prospective"
method described above, but also permits entities to restate prior period
results based on the amounts previously presented under Statement 123 for
purposes of pro-forma disclosures. The Company has elected to adopt Statement
123(R) under the "modified prospective" method and accordingly will not restate
prior period results.
The Company measures the fair value of each option award on the date of
grant using the Black-Scholes option-pricing model. The Company determines the
assumptions used in the Black-Scholes option pricing model as follows: the
risk-free interest rate is based on the U.S. Treasury yield curve in effect at
the time of the grant; the dividend yield is based on the Company's dividend
yield at the time of the grant (subject to adjustment if the dividend yield on
the grant date is not expected to approximate the dividend yield over the
expected life of the option); the volatility factor is based on the historical
volatility of the Company's stock (subject to adjustment if historical
volatility is reasonably expected to differ from the past); the weighted-average
expected life is based on the historical behavior of employees related to
exercises, forfeitures and cancellations.
As noted above, prior to the adoption of Statement 123(R), the Company
applied Opinion 25 to account for its stock options. The following table
illustrates the effect on net income and earnings per share had the Company
accounted for share-based compensation in accordance with Statement 123(R) for
the periods indicated:
Three Months Six Months
Ended June 30, Ended June 30,
(In thousands except per share data) 2005 2005
------------ ------------
Net income, as reported $ 4,652 9,368
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (180) (232)
------------ ------------
Pro forma net income $ 4,472 9,136
============ ============
Earnings per share: Basic - As reported $ 0.33 0.66
Basic - Pro forma 0.32 0.65
Diluted - As reported 0.32 0.65
Diluted - Pro forma 0.31 0.64
For the three and six month periods ended June 30, 2006, the Company
recorded stock-based compensation expense in the income statement of $244,000
and $291,000, respectively. The Company recognized income tax benefits in the
income statement related to stock-based compensation of $78,000 for each of the
three and six month periods ended June 30, 2006, respectively. This stock-based
compensation expense related to the vesting of several stock option grants made
prior to January 1, 2006, as well as a grant of 29,250 options (2,250 options to
Page 10
each non-employee director of the Company) on June 1, 2006 with no vesting
requirements. This compensation expense was reflected as an adjustment to cash
flows from operating activities on the Company's Consolidated Statement of Cash
Flows. At June 30, 2006, the Company had $90,000 of unrecognized compensation
costs related to unvested stock options. The cost is expected to be amortized
over a weighted-average life of 1.8 years, with $22,000 being expensed in the
third quarter of 2006, $12,000 being expensed in the fourth quarter of 2006,
$47,000 being expensed in 2007 equally distributed among each of the four
quarters, and $3,000 being expensed in each of 2008, 2009 and 2010, equally
distributed among each of the four quarters of each year. In addition, as
discussed above, the Company granted 2,250 options, without vesting
requirements, to each of its non-employee directors on June 1, 2006 and expects
to continue this grant on June 1 of each year thereafter.
As noted above, certain of the Company's stock option grants contain terms
that provide for a graded vesting schedule whereby portions of the award vest in
increments over the requisite service period. As provided for under Statement
123(R), the Company has elected to recognize compensation expense for awards
with graded vesting schedules on a straight-line basis over the requisite
service period for the entire award. Statement 123(R) requires companies to
recognize compensation expense based on the estimated number of stock options
and awards for which service is to be rendered. Over the past five years, there
have only been four forfeitures or expirations, totaling 9,600 options, and
therefore the Company assumes that all options granted will become vested.
The Company's only option grants for the first six months of 2006 and 2005
were grants of 29,250 and 31,500 options to non-employee directors on June 1,
2006 and 2005, respectively (2,250 option per director). The per share
weighted-average fair value of options granted during the six months ended June
30, 2006 and June 30, 2005, was $6.79, and $6.68, respectively, on the date of
the grant using the following weighted-average assumptions:
Six months Six months
ended ended
June 30, 2006 June 30, 2005
------------- -------------
Expected dividend yield 3.30% 3.07%
Risk-free interest rate 5.05% 3.84%
Expected life 7 years 7 years
Expected volatility 32.56% 32.99%
The following table presents information regarding the activity during the
first six months of 2006 related to all of the Company's stock options
outstanding:
All Options Outstanding
-------------------------------------------------------
Weighted-
Average
Weighted- Remaining Aggregate
Number of Average Contractual Intrinsic Value
Six months ended June 30, 2006 Shares Exercise Price Term ($000)
------------------------------------------- ---------- ---------- ---------- ----------
Outstanding at the beginning of the period 746,882 $ 15.75
Granted during the period 29,250 21.83
Exercised during the period 68,063 9.69
Forfeited or expired during the period 4,500 6.55
----------
Outstanding at end of period 703,569 $ 16.65 5.7 $ 3,523
========== ========== ========== ==========
Exercisable at June 30, 2006 651,944 $ 16.72 5.7 $ 3,219
========== ========== ========== ==========
The Company received $618,000 and $585,000 as a result of stock option
exercises during the six
Page 11
months ended June 30, 2006 and 2005, respectively. The intrinsic value of the
stock options exercised during the six months ended June 30, 2006 and 2005 was
$787,000 and $585,000, respectively. The Company recorded $94,000 and $100,000
in associated tax benefits from the exercise of nonqualified stock options
during the six months ended June 30, 2006 and 2005, respectively. In accordance
with Statement 123(R), this benefit is included as a financing activity in the
accompanying Statement of Cash Flows for periods subsequent to the adoption of
Statement 123(R), but continues to be reported as an operating activity in
periods prior to its adoption.
The following table presents information regarding the activity during the
first six months of 2006 related to the Company's stock options outstanding that
are nonvested:
Nonvested Options
-------------------------
Weighted-Average
Number of Grant-Date
Six months ended June 30, 2006 Shares Fair Value
------------------------------------------------------------ -------- ----------
Nonvested options outstanding at the beginning of the period 67,999 $4.75
Granted during the period -- --
Vested during the period (16,374) 4.83
Forfeited or expired during the period -- --
------
Nonvested options outstanding at end of period 51,625 $4.74
======
Note 5 - Earnings Per Share
Basic earnings per share were computed by dividing net income by the
weighted average common shares outstanding. Diluted earnings per share includes
the potentially dilutive effects of the Company's stock option plan. The
following is a reconciliation of the numerators and denominators used in
computing basic and diluted earnings per share:
For the Three Months Ended June 30,
---------------------------------------------------------------------------
2006 2005
------------------------------------ ------------------------------------
Income Shares Income Shares
($ in thousands except per (Numer- (Denom- Per Share (Numer- (Denom- Per Share
share amounts) ator) inator) Amount ator) inator) Amount
----------------------------- ---------- ---------- ---------- ---------- ---------- ----------
Basic EPS
Net income $ 4,795 14,296,159 $ 0.34 $ 4,652 14,159,117 $ 0.33
========== ==========
Effect of Dilutive Securities -- 137,671 -- 185,896
---------- ---------- ---------- ----------
Diluted EPS $ 4,795 14,433,830 $ 0.33 $ 4,652 14,345,013 $ 0.32
========== ========== ========== ========== ========== ==========
For the Six Months Ended June 30,
---------------------------------------------------------------------------
2006 2005
------------------------------------ ------------------------------------
Income Shares Income Shares
($ in thousands except per (Numer- (Denom- Per Share (Numer- (Denom- Per Share
share amounts) ator) inator) Amount ator) inator) Amount
----------------------------- ---------- ---------- ---------- ---------- ---------- ----------
Basic EPS
Net income $ 9,786 14,275,472 $ 0.69 $ 9,368 14,132,347 $ 0.66
========== ==========
Effect of Dilutive Securities -- 150,028 -- 222,505
---------- ---------- ---------- ----------
Diluted EPS $ 9,786 14,425,500 $ 0.68 $ 9,368 14,354,852 $ 0.65
========== ========== ========== ========== ========== ==========
For the three months ended June 30, 2006 and 2005, there were options of
220,980, and 189,230, respectively, that were antidilutive because the exercise
price exceeded the average market price for the period. For the six months ended
June 30, 2006, there were 220,980 antidilutive options, while there were no
antidilutive options for the six months ended June 30, 2005. Antidilutive
options have been omitted from the calculation of diluted
Page 12
earnings per share for the respective periods.
Note 6 - Asset Quality Information
Nonperforming assets are defined as nonaccrual loans, loans past due 90 or
more days and still accruing interest, restructured loans and other real estate.
Nonperforming assets are summarized as follows:
June 30, December 31, June 30,
($ in thousands) 2006 2005 2005
-----------------------------------------------------------------------------------------
Nonperforming loans:
Nonaccrual loans $ 3,973 1,640 3,806
Restructured loans 12 13 15
Accruing loans > 90 days past due -- -- --
------------ ------------ ------------
Total nonperforming loans 3,985 1,653 3,821
Other assets - primarily other real estate 2,024 1,421 2,520
------------ ------------ ------------
Total nonperforming assets $ 6,009 3,074 6,341
============ ============ ============
Nonperforming loans to total loans 0.24% 0.11% 0.27%
Nonperforming assets as a percentage of
loans and other real estate 0.37% 0.21% 0.44%
Nonperforming assets to total assets 0.30% 0.17% 0.36%
Allowance for loan losses to total loans 1.08% 1.06% 1.10%
--------------------------------------------------------------------------------
Note 7 - Deferred Loan Fees
Loans are shown on the Consolidated Balance Sheets net of net deferred loan
costs (fees) of ($64,000), $184,000, and $11,000 at June 30, 2006, December 31,
2005, and June 30, 2005, respectively.
Note 8 - Goodwill and Other Intangible Assets
The following is a summary of the gross carrying amount and accumulated
amortization of amortizable intangible assets as of June 30, 2006, December 31,
2005, and June 30, 2005 and the carrying amount of unamortized intangible assets
as of those same dates.
June 30, 2006 December 31, 2005 June 30, 2005
--------------------------- --------------------------- ---------------------------
Gross Carrying Accumulated Gross Carrying Accumulated Gross Carrying Accumulated
($ in thousands) Amount Amortization Amount Amortization Amount Amortization
------------------------ ------------ ------------ ------------ ------------ ------------ ------------
Amortizable intangible
assets:
Customer lists $ 394 131 394 115 394 101
Noncompete agreements 50 50 50 50 50 50
Core deposit premiums 2,441 1,116 2,441 1,011 2,441 881
------------ ------------ ------------ ------------ ------------ ------------
Total $ 2,885 1,297 2,885 1,176 2,885 1,032
============ ============ ============ ============ ============ ============
Unamortizable intangible
assets:
Goodwill $ 47,247 47,247 47,247
============ ============ ============
Pension $ 237 273 273
============ ============ ============
Amortization expense totaled $60,000 and $73,000 for the three months ended
June 30, 2006 and 2005, respectively. Amortization expense totaled $121,000 and
$146,000 for the six months ended June 30, 2006 and 2005, respectively.
Page 13
The following table presents the estimated amortization expense for each of
the five calendar years ending December 31, 2010 and the estimated amount
amortizable thereafter. These estimates are subject to change in future periods
to the extent management determines it is necessary to make adjustments to the
carrying value or estimated useful lives of amortized intangible assets.
Estimated Amortization
(Dollars in thousands) Expense
---------------------- ----------------------
2006 $ 242
2007 220
2008 219
2009 218
2010 218
Thereafter 592
----------------------
Total $ 1,709
======================
Note 9 - Pension Plans
The Company sponsors two defined benefit pension plans - a qualified
retirement plan (the "Pension Plan") which is generally available to all
employees, and a Supplemental Executive Retirement Plan (the "SERP Plan"), which
is for the benefit of certain senior management executives of the Company.
The Company recorded pension expense totaling $581,000 and $447,000 for the
three months ended June 30, 2006 and 2005, respectively, related to the Pension
Plan and the SERP Plan. The following table contains the components of the
pension expense for the three months ended June 30, 2006 and 2005.
For the Three Months Ended June 30,
------------------------------------------------------------------------------
2006 2005 2006 2005 2006 Total 2005 Total
(in thousands) Pension Plan Pension Plan SERP Plan SERP Plan Both Plans Both Plans
---------- ---------- ---------- ---------- ---------- ----------
Service cost - benefits earned during the period $ 341 284 79 62 420 346
Interest cost on projected benefit obligation 227 192 52 38 279 230
Expected return on plan assets (268) (237) -- -- (268) (237)
Net amortization and deferral 119 86 31 22 150 108
---------- ---------- ---------- ---------- ---------- ----------
Net periodic pension cost $ 419 325 162 122 581 447
========== ========== ========== ========== ========== ==========
The Company recorded pension expense totaling $1,162,000 and $894,000 for
the six months ended June 30, 2006 and 2005, respectively, related to the
Pension Plan and the SERP Plan. The following table contains the components of
the pension expense for the six months ended June 30, 2006 and 2005.
For the Six Months Ended June 30,
------------------------------------------------------------------------------
2006 2005 2006 2005 2006 Total 2005 Total
(in thousands) Pension Plan Pension Plan SERP Plan SERP Plan Both Plans Both Plans
---------- ---------- ---------- ---------- ---------- ----------
Service cost - benefits earned during the period $ 682 $ 568 158 124 840 692
Interest cost on projected benefit obligation 454 384 104 76 558 460
Expected return on plan assets (536) (474) -- -- (536) (474)
Net amortization and deferral 238 172 62 44 300 216
---------- ---------- ---------- ---------- ---------- ----------
Net periodic pension cost $ 838 $ 650 324 244 1,162 894
========== ========== ========== ========== ========== ==========
The Company's contributions to the Pension Plan are based on computations
by independent actuarial consultants and are intended to provide the Company
with the maximum deduction for income tax purposes. The contributions are
invested to provide for benefits under the Pension Plan. The Company estimates
that its contribution to the Pension Plan will be $945,000 during 2006.
Page 14
The Company's funding policy with respect to the SERP Plan is to fund the
related benefits through investments in life insurance policies, which are not
considered plan assets for the purpose of determining the SERP Plan's funded
status. The cash surrender values of the life insurance policies are included in
the line item "other assets." The Company estimates that its payments to
participants in the SERP Plan will be $25,000 in 2006.
Note 10 - Contingency
The Company recorded a loss amount of $6,320,000, or $0.44 per diluted
share, in the third quarter of 2005 to accrue for contingent tax loss exposure
involving the North Carolina Department of Revenue. In February 2006, the North
Carolina Department of Revenue announced a "Settlement Initiative" that offered
companies with certain transactions that had been challenged by the North
Carolina Department of Revenue the opportunity to resolve such matters with
reduced penalties by agreeing to participate in the initiative by June 15, 2006.
Although the Company believed that its tax returns complied with the relevant
statutes, the Board of Directors of the Company decided that it was in the best
interests of the Company to settle this matter by participating in the
initiative. Based on the terms of the initiative, the Company estimated that its
total liability to settle the matter will be approximately $4.3 million, net of
the federal tax benefit, or $2.0 million less than the amount that was
originally accrued. Accordingly, in March 2006, the Company adjusted its
originally reported 2005 earnings to reflect the impact of this subsequent event
by reducing originally reported tax expense for the three and twelve months
ended December 31, 2005 by $1,982,000, or $0.14 per diluted share. The Company
believes it has fully reserved for this liability and does not have any
additional state income tax exposure other than the ongoing interest that will
continue to accrue ($65,000 per quarter on an after-tax basis) until the
Settlement Initiative is completed and the Company pays the amounts due in
accordance with the settlement, which is expected to occur in the fourth quarter
of this year.
Note 11 - Pending Acquisitions
On January 20, 2006, the Company reported that it had agreed to purchase a
bank branch in Dublin, Virginia with approximately $20 million in deposits from
another financial institution. This transaction was completed in July 2006.
On April 26, 2006, the Company reported that it had agreed to purchase a
bank branch with approximately $25 million in deposits located in Carthage,
North Carolina from another financial institution. This transaction is expected
to close in September 2006.
Page 15
Item 2 - Management's Discussion and Analysis of Consolidated Results of
Operations and Financial Condition
CRITICAL ACCOUNTING POLICIES
The accounting principles followed by the Company and the methods of
applying these principles conform with accounting principles generally accepted
in the United States of America and with general practices followed by the
banking industry. Certain of these principles involve a significant amount of
judgment and/or use of estimates based on the Company's best assumptions at the
time of the estimation. The Company has identified three policies as being more
sensitive in terms of judgments and estimates, taking into account their overall
potential impact to the Company's consolidated financial statements - 1) the
allowance for loan losses, 2) tax uncertainties, and 3) intangible assets.
Allowance for Loan Losses
Due to the estimation process and the potential materiality of the amounts
involved, the Company has identified the accounting for the allowance for loan
losses and the related provision for loan losses as an accounting policy
critical to the Company's consolidated financial statements. The provision for
loan losses charged to operations is an amount sufficient to bring the allowance
for loan losses to an estimated balance considered adequate to absorb losses
inherent in the portfolio.
Management's determination of the adequacy of the allowance is based
primarily on a mathematical model that estimates the appropriate allowance for
loan losses. This model has two components. The first component involves the
estimation of losses on loans defined as "impaired loans." A loan is considered
to be impaired when, based on current information and events, it is probable the
Company will be unable to collect all amounts due according to the contractual
terms of the loan agreement. The estimated valuation allowance is the
difference, if any, between the loan balance outstanding and the value of the
impaired loan as determined by either 1) an estimate of the cash flows that the
Company expects to receive from the borrower discounted at the loan's effective
rate, or 2) in the case of a collateral-dependent loan, the fair value of the
collateral.
The second component of the allowance model is to estimate losses for all
loans not considered to be impaired loans. First, loans that have been risk
graded by the Company as having more than "standard" risk but are not considered
to be impaired are assigned estimated loss percentages generally accepted in the
banking industry. Loans that are classified by the Company as having normal
credit risk are segregated by loan type, and estimated loss percentages are
assigned to each loan type, based on the historical losses, current economic
conditions, and operational conditions specific to each loan type.
The reserve estimated for impaired loans is then added to the reserve
estimated for all other loans. This becomes the Company's "allocated allowance."
In addition to the allocated allowance derived from the model, management also
evaluates other data such as the ratio of the allowance for loan losses to total
loans, net loan growth information, nonperforming asset levels and trends in
such data. Based on this additional analysis, the Company may determine that an
additional amount of allowance for loan losses is necessary to reserve for
probable losses. This additional amount, if any, is the Company's "unallocated
allowance." The sum of the allocated allowance and the unallocated allowance is
compared to the actual allowance for loan losses recorded on the books of the
Company and any adjustment necessary for the recorded allowance to equal the
computed allowance is recorded as a provision for loan losses. The provision for
loan losses is a direct charge to earnings in the period recorded.
Although management uses the best information available to make
evaluations, future adjustments may be necessary if economic, operational, or
other conditions change. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the Company's
allowance for loan losses. Such agencies may require the Company to recognize
additions to the allowance based on the examiners' judgment about information
available to them at the time of their examinations.
Page 16
For further discussion, see "Nonperforming Assets" and "Summary of Loan
Loss Experience" below.
Tax Uncertainties
The Company reserves for tax uncertainties in instances when it has taken a
position on a tax return that may differ from the opinion of the applicable
taxing authority. In accounting for tax contingencies, the Company assesses the
relative merits and risks of certain tax transactions, taking into account
statutory, judicial and regulatory guidance in the context of the Company's tax
position. For those matters where it is probable that the Company will have to
pay additional taxes, interest or penalties and a loss or range of losses can be
reasonably estimated, the Company records reserves in the consolidated financial
statements. For those matters where it is reasonably possible but not probable
that the Company will have to pay additional taxes, interest or penalties and
the loss or range of losses can be reasonably estimated, the Company only makes
disclosures in the notes and does not record reserves in the consolidated
financial statements. The process of concluding that a loss is reasonably
possible or probable and estimating the amount of loss or range of losses and
related tax reserves is inherently subjective and future changes to the reserve
may be necessary based on changes in management's intent, tax law or related
interpretations, or other functions.
See Note 10 to the Consolidated Financial Statements above for information
related to a tax loss contingency accrual that was recorded in 2005.
Intangible Assets
Due to the estimation process and the potential materiality of the amounts
involved, the Company has also identified the accounting for intangible assets
as an accounting policy critical to the Company's consolidated financial
statements.
When the Company completes an acquisition transaction, the excess of the
purchase price over the amount by which the fair market value of assets acquired
exceeds the fair market value of liabilities assumed represents an intangible
asset. The Company must then determine the identifiable portions of the
intangible asset, with any remaining amount classified as goodwill. Identifiable
intangible assets associated with these acquisitions are generally amortized
over the estimated life of the related asset, whereas goodwill is tested
annually for impairment, but not systematically amortized. Assuming no goodwill
impairment, it is beneficial to the Company's future earnings to have a lower
amount assigned to identifiable intangible assets and higher amount of goodwill
as opposed to having a higher amount considered to be identifiable intangible
assets and a lower amount classified as goodwill.
For the Company, the primary identifiable intangible asset typically
recorded in connection with a whole-bank or bank branch acquisition is the value
of the core deposit intangible, whereas when the Company acquires an insurance
agency, the primary identifiable intangible asset is the value of the acquired
customer list. Determining the amount of identifiable intangible assets and
their average lives involves multiple assumptions and estimates and is typically
determined by performing a discounted cash flow analysis, which involves a
combination of any or all of the following assumptions: customer
attrition/runoff, alternative funding costs, deposit servicing costs, and
discount rates. The Company typically engages a third party consultant to assist
in each analysis. For the whole-bank and bank branch transactions recorded to
date, the core deposit intangible in each case has been estimated to have a ten
year life, with an accelerated rate of amortization. For insurance agency
acquisitions, the identifiable intangible assets related to the customer lists
were determined to have a life of ten to fifteen years, with amortization
occurring on a straight-line basis.
Subsequent to the initial recording of the identifiable intangible assets
and goodwill, the Company amortizes the identifiable intangible assets over
their estimated average lives, as discussed above. In addition, on at least an
annual basis, goodwill is evaluated for impairment by comparing the fair value
of the Company's reporting units to their related carrying value, including
goodwill (the Company's community banking operation is its only material
reporting unit). At its last evaluation, the fair value of the Company's
community banking operation exceeded its
Page 17
carrying value, including goodwill. If the carrying value of a reporting unit
were ever to exceed its fair value, the Company would determine whether the
implied fair value of the goodwill, using a discounted cash flow analysis,
exceeded the carrying value of the goodwill. If the carrying value of the
goodwill exceeded the implied fair value of the goodwill, an impairment loss
would be recorded in an amount equal to that excess. Performing such a
discounted cash flow analysis would involve the significant use of estimates and
assumptions.
The Company reviews identifiable intangible assets for impairment whenever
events or changes in circumstances indicate that the carrying value may not be
recoverable. The Company's policy is that an impairment loss is recognized,
equal to the difference between the asset's carrying amount and its fair value,
if the sum of the expected undiscounted future cash flows is less than the
carrying amount of the asset. Estimating future cash flows involves the use of
multiple estimates and assumptions, such as those listed above.
Current Accounting Matters
See Note 2 to the Consolidated Financial Statements above as it relates to
accounting standards that have been recently adopted by the Company.
RESULTS OF OPERATIONS
Overview
Net income for the three months ended June 30, 2006 was $4,795,000, or
$0.33 per diluted share, a 3.1% increase in diluted earnings per share compared
to earnings of $4,652,000, or $0.32 per diluted share, recorded in the second
quarter of 2005. Net income for the six months ended June 30, 2006 was
$9,786,000, or $0.68 per diluted share, a 4.6% increase in diluted earnings per
share from the net income of $9,368,000, or $0.65 per diluted share, reported
for the six months ended June 30, 2005.
The increase in loans and deposits over the past twelve months resulted in
an increase in the Company's net interest income when comparing the three and
six month periods of 2006 to comparable periods in 2005. Net interest income for
the second quarter of 2006 amounted to $18.4 million, an 8.4% increase over the
$17.0 million recorded in the second quarter of 2005. Net interest income for
the six months ended June 30, 2006 amounted to $36.3 million, a 9.0% increase
over the $33.3 million recorded in the same six month period in 2005.
The impact of the growth in loans and deposits on the Company's net
interest income was partially offset by declines in the Company's net interest
margin (tax-equivalent net interest income divided by average earning assets).
The Company's net interest margin for the second quarter of 2006 was 4.22%
compared to 4.31% for the second quarter of 2005. The Company's net interest
margin for the first six months of 2006 was 4.28% compared to 4.32% for the same
six months of 2005. The 4.22% net interest margin realized in the second quarter
of 2006 was an 11 basis point decrease from the first quarter of 2006 net
interest margin of 4.33%. The compressing margin is primarily due to deposit
rates paid by the Company rising by more than loan and investment yields. The
Company has also been negatively impacted by customers shifting their funds from
low cost deposits to higher cost deposits as rates have risen.
The Company's provision for loan losses amounted to $1,400,000 in the
second quarter of 2006, an increase of 65.7% over the $845,000 recorded in the
second quarter of 2005. The provision for loan losses for the first six months
of 2006 was $2,415,000, an increase of 69.5% over the $1,425,000 recorded in
first half of 2005. The higher provisions are a result of the strong loan growth
realized in 2006, as asset quality ratios have remained stable and compare
favorably to peers. Loan growth was $83 million in the second quarter of 2006
compared to $31 million in the second quarter of 2005, while loan growth was
$153 million for the first half of 2006 compared to $59 million for the first
half of 2005. The Company's ratios of annualized net charge-offs to average
loans were 9 basis points and 6 basis points for the three and six month periods
in 2006, respectively, compared to 8 basis
Page 18
points for each of the three and six month periods in 2005. The Company's level
of nonperforming assets to total assets was 0.30% at June 30, 2006 compared to
0.36% a year earlier.
Noninterest income amounted to $3.8 million in the second quarter of 2006,
a 3.6% increase from the $3.7 million recorded in the second quarter of 2005.
Noninterest income for the six months ended June 30, 2006 amounted to $7.8
million, an increase of 5.1% from the $7.4 million recorded in the first half of
2005.
Noninterest expenses amounted to $13.1 million in the second quarter of
2006, a 6.6% increase over the $12.3 million recorded in the comparable period
of 2005. Noninterest expenses for the six months ended June 30, 2006 amounted to
$25.8 million, a 7.6% increase from the $24.0 million recorded in the first six
months of 2005. The increase in noninterest expenses is primarily attributable
to costs associated with the Company's overall growth in loans, deposits and
branch network.
The Company's effective tax rate was 38%-39% for each of the three and six
month periods in 2005 and 2006.
The Company's annualized return on average assets for the second quarter of
2006 was 1.02% compared to 1.09% for the second quarter of 2005. The Company's
annualized return on average assets for the six months ended June 30, 2006 was
1.07% compared to 1.13% for the first half of 2005.
The Company's annualized return on average equity for the second quarter of
2006 was 11.83% compared to 12.07% for the second quarter of 2005. The Company's
annualized return on average equity for the six months ended June 30, 2006 was
12.30% compared to 12.32% for the first half of 2005.
Components of Earnings
Net interest income is the largest component of earnings, representing the
difference between interest and fees generated from earning assets and the
interest costs of deposits and other funds needed to support those assets.
Net interest income for the three month period ended June 30, 2006 amounted
to $18,444,000, an increase of $1,437,000, or 8.4%, from the $17,007,000
recorded in the second quarter of 2005. Net interest income on a taxable
equivalent basis for the three months ended June 30, 2006, amounted to
$18,569,000, an increase of $1,451,000, or 8.5%, from the $17,118,000 recorded
in the second quarter of 2005. Management believes that analysis of net interest
income on a tax-equivalent basis is useful and appropriate because it allows a
comparison of net interest income amounts in different periods without taking
into account the different mix of taxable versus non-taxable investments that
may have existed during those periods.
Net interest income for the six months ended June 30, 2006 amounted to
$36,297,000, an increase of $3,005,000, or 9.0%, from the $33,292,000 recorded
in the first six months of 2005. Net interest income on a taxable equivalent
basis for the six months ended June 30, 2006 amounted to $36,548,000, an
increase of $3,032,000, or 9.0%, from the $33,516,000 recorded in the first six
months of 2005.
There are two primary factors that cause changes in the amount of net
interest income recorded by the Company - 1) growth in loans and deposits, and
2) the Company's net interest margin. For the three and six month periods ended
June 30, 2006, growth in loans and deposits were the primary cause for the
increases in net interest income, as the Company's net interest margins in 2006
were slightly lower than those realized in 2005.
For internal purposes and in the discussion that follows, the Company
evaluates its net interest income on a tax-equivalent basis by adding the tax
benefit realized from tax-exempt securities to reported interest income. The
following tables present net interest income analysis on a taxable-equivalent
basis.
Page 19
For the Three Months Ended June 30,
-----------------------------------------------------------------------------
2006 2005
------------------------------------- -------------------------------------
Interest Interest
Average Average Earned Average Average Earned
($ in thousands) Volume Rate or Paid Volume Rate or Paid
---------- ---------- ---------- ---------- ---------- ----------
Assets
Loans (1) $1,593,070 7.36% $ 29,215 $1,409,118 6.47% $ 22,732
Taxable securities 118,172 4.76% 1,402 119,180 4.75% 1,411
Non-taxable securities (2) 12,058 8.38% 252 10,712 8.54% 228
Short-term investments 40,927 5.60% 571 53,835 3.33% 447
---------- ---------- ---------- ----------
Total interest-earning assets 1,764,227 7.15% 31,440 1,592,845 6.25% 24,818
---------- ----------
Liabilities
Savings, NOW and money
market deposits $ 475,558 1.38% $ 1,635 $ 477,311 0.81% $ 958
Time deposits >$100,000 380,229 4.40% 4,174 359,487 3.04% 2,725
Other time deposits 507,359 3.96% 5,004 447,634 2.69% 3,007
---------- ---------- ---------- ----------
Total interest-bearing deposits 1,363,146 3.18% 10,813 1,284,432 2.09% 6,690
Securities sold under agreements
to repurchase 29,102 3.76% 273 420 1.91% 2
Borrowings 109,422 6.54% 1,785 76,513 5.28% 1,008
---------- ---------- ---------- ----------
Total interest-bearing liabilities 1,501,670 3.44% 12,871 1,361,365 2.27% 7,700
---------- ----------
Non-interest-bearing deposits 206,635 182,461
Net yield on interest-earning
assets and net interest income 4.22% $ 18,569 4.31% $ 17,118
========== ==========
Interest rate spread 3.71% 3.98%
Average prime rate 7.90% 5.91%
--------------------------------------------------------------------------------
(1) Average loans include nonaccruing loans, the effect of which is to lower
the average rate shown.
(2) Includes tax-equivalent adjustments of $125,000 and $111,000 in 2006 and
2005, respectively, to reflect the tax benefit that the Company receives
related to its tax-exempt securities, which carry interest rates lower than
similar taxable investments due to their tax exempt status. This amount has
been computed assuming a 39% tax rate and is reduced by the related
nondeductible portion of interest expense.
--------------------------------------------------------------------------------
Page 20
For the Six Months Ended June 30,
-----------------------------------------------------------------------------
2006 2005
------------------------------------- -------------------------------------
Interest Interest
Average Average Earned Average Average Earned
($ in thousands) Volume Rate or Paid Volume Rate or Paid
---------- ---------- ---------- ---------- ---------- ----------
Assets
Loans (1) $1,554,763 7.26% $ 55,977 $1,396,167 6.37% $ 44,091
Taxable securities 116,541 4.73% 2,731 111,214 4.65% 2,566
Non-taxable securities (2) 11,940 8.53% 505 11,026 8.60% 470
Short-term investments 40,137 5.37% 1,068 46,598 3.11% 719
---------- ---------- ---------- ----------
Total interest-earning assets 1,723,381 7.05% 60,281 1,565,005 6.17% 47,846
---------- ----------
Liabilities
Savings, NOW and money
market deposits $ 471,659 1.27% $ 2,968 $ 475,997 0.78% $ 1,839
Time deposits >$100,000 372,847 4.25% 7,851 350,987 2.91% 5,070
Other time deposits 501,103 3.80% 9,436 436,256 2.53% 5,481
---------- ---------- ---------- ----------
Total interest-bearing deposits 1,345,609 3.04% 20,255 1,263,240 1.98% 12,390
Securities sold under agreements
to repurchase 29,708 3.63% 535 210 1.92% 2
Borrowings 91,486 6.49% 2,943 76,598 5.10% 1,938
---------- ---------- ---------- ----------
Total interest-bearing liabilities 1,466,803 3.26% 23,733 1,340,048 2.16% 14,330
---------- ----------
Non-interest-bearing deposits 201,865 177,567
Net yield on interest-earning
assets and net interest income 4.28% $ 36,548 4.32% $ 33,516
========== ==========
Interest rate spread 3.79% 4.01%
Average prime rate 7.66% 5.67%
--------------------------------------------------------------------------------
(1) Average loans include nonaccruing loans, the effect of which is to lower
the average rate shown.
(2) Includes tax-equivalent adjustments of $251,000 and $224,000 in 2006 and
2005, respectively, to reflect the tax benefit that the Company receives
related to its tax-exempt securities, which carry interest rates lower than
similar taxable investments due to their tax exempt status. This amount has
been computed assuming a 39% tax rate and is reduced by the related
nondeductible portion of interest expense.
--------------------------------------------------------------------------------
Average loans outstanding for the second quarter of 2006 were $1.593
billion, which was 13.1% higher than the average loans outstanding for the
second quarter of 2005 ($1.409 billion). Average loans outstanding for the six
months ended June 30, 2006 were $1.555 billion, which was 11.4% higher than the
average loans outstanding for the six months ended June 30, 2005 ($1.396
billion).
The mix of the Company's loan portfolio remained substantially the same at
June 30, 2006 compared to December 31, 2005 with approximately 86% of the
Company's loans being real estate loans, 9% being commercial, financial, and
agricultural loans, and the remaining 5% being consumer installment loans.
Average total deposits outstanding for the second quarter of 2006 were
$1.570 billion, which was 7.0% higher than the average deposits outstanding for
the second quarter of 2005 ($1.467 billion). Average deposits outstanding for
the six months ended June 30, 2006 were $1.547 billion, which was 7.4% higher
than the average deposits outstanding for the six months ended June 30, 2005
($1.441 billion). Generally, the Company can reinvest funds from deposits at
higher yields than the interest rate being paid on those deposits, and therefore
increases in deposits typically result in higher amounts of net interest income
for the Company.
See additional discussion regarding reasons for and the nature of the
growth in loans and deposits in the section entitled "Financial Condition"
below. The effect of the higher amounts of average loans and deposits was to
increase net interest income in 2006.
As derived from the tables above, yields on interest earning assets and
liabilities are higher for the periods presented in 2006 compared to 2005, which
is a result of the rising rate environment that began in the third quarter
Page 21
of 2004. From July 1, 2004 to June 30, 2006, the Federal Reserve raised
short-term interest rates 17 times totaling 425 basis points. The tables also
indicate that the interest-bearing liability rates paid by the Company have
risen by more than yields realized on interest-earning assets. For each of the
three and six month periods ended June 30, 2006, interest-earning asset yields
have increased by approximately 90 basis points, whereas the average rate paid
on interest-bearing liabilities has risen by 110-117 basis points. This
narrowing spread was caused by rates paid on most of the Company's categories of
interest-bearing liabilities increasing by more than the increases in yields
realized on most of the Company's earning assets, as well as a higher
concentration of the Company's funding sources being comprised of time deposits
and borrowings, the highest cost funding sources for the Company. As a result of
the narrowed interest rate spread, the Company's net interest margin
(tax-equivalent net interest income divided by average earning assets) has
declined in 2006, with the Company's net interest margin amounting to 4.22% in
the second quarter of 2006 compared to 4.31% in the second quarter of 2005, and
the Company's net interest margin amounting to 4.28% for the six months ended
June 30, 2006 compared to 4.32% for the same six months of 2005.
See additional information regarding net interest income in the section
entitled "Interest Rate Risk."
The provision for loan losses amounted to $1,400,000 in the second quarter
of 2006 compared to $845,000 in the second quarter of 2005, and the provision
for loan losses for the first six months of 2006 was $2,415,000 compared to
$1,425,000 for the first six months of 2005. The higher provisions for loan
losses in 2006 compared to 2005 are a result of the strong loan growth realized
in 2006, as asset quality ratios have remained stable and compare favorably to
peers. Loan growth was $83 million in the second quarter of 2006 compared to $31
million in the second quarter of 2005, while loan growth was $153 million for
the first half of 2006 compared to $59 million for the first half of 2005. The
Company's ratios of annualized net charge-offs to average loans were 9 basis
points and 6 basis points for the three and six month periods in 2006,
respectively, compared to 8 basis points for each of the three and six month
periods in 2005. The Company's level of nonperforming assets to total assets was
0.30% at June 30, 2006 compared to 0.36% a year earlier.
Noninterest income amounted to $3,844,000 for the second quarter of 2006, a
3.6% increase from $3,712,000 recorded in the second quarter of 2005.
Noninterest income for the six months ended June 30, 2006 amounted to
$7,798,000, an increase of 5.1% from the $7,422,000 recorded in the first half
of 2005. The increases were primarily a result of general growth in the
Company's customer base and increased usage of credit cards and debit cards by
the Company's customers (which impacted the line item "other service charges,
commissions and fees").
These increases were partially offset by a $132,000 decrease in data
processing income in the first six months of 2006 compared to 2005. The
Company's data processing subsidiary makes its excess data processing
capabilities available to area financial institutions for a fee. At January 1,
2005, the Company had five community bank customers using this service. Three of
these customers terminated their contracts with the Company in the latter half
of 2005, which resulted in the decrease in data processing fee income. The
Company intends to continue to market this service to area banks, but does not
currently have any near-term prospects for additional business.
Also negatively impacting noninterest income for each of the three and six
month periods ended June 30, 2006 were higher amounts of "other losses," which
were only partially offset by higher amounts of securities gains in 2006. Gains
from sales of securities and "other losses" amounted to a net loss of $106,000
in the second quarter of 2006 compared to a net loss of $25,000 in the second
quarter of 2005. For the six months ended June 30, 2006, gains from sales of
securities and "other losses" amounted to a net loss of $173,000 compared to a
net loss of $57,000 in the first half of 2005. During the second quarter of
2006, the Company recorded an "other loss" of $230,000 related to a merchant
card customer of the Company that sells furniture over the internet. The
furniture store did not deliver furniture that its customers had ordered and
paid for, and was unable to refund their credit card purchases. As the furniture
store's credit card processor, the Company became liable for the amounts that
were required to be refunded. Through June 30, 2006, the Company had funded
$240,000 in customer refunds, while the total exposure is believed to be
approximately $1.9 million. The Company is vigorously pursuing repayment of
these advances from the furniture store. The furniture store is under new
management and intends to repay the Company for all funds advanced. Although the
furniture store has begun repaying the Company, the Company
Page 22
determined that recording a $230,000 loss was prudent to reserve for this
situation. The Company reports outstanding advances related to this situation as
an "other asset," and within the line item - "Other assets - primarily other
real estate" in asset quality tables, while the corresponding reserve is
classified as a valuation allowance within other assets. The Company sold
securities for a gain of $205,000 during the second quarter of 2006 partially in
response to this loss situation.
Noninterest expenses amounted to $13,064,000 in the second quarter of 2006,
a 6.6% increase over the $12,260,000 in 2005. Noninterest expenses for the six
months ended June 30, 2006 amounted to $25,793,000, a 7.6% increase from the
$23,975,000 recorded in the first six months of 2005. The increase in
noninterest expenses occurred in all categories and is associated with the
overall growth of the Company in terms of branch network, employees and customer
base. In accordance with the new accounting requirements regarding stock-based
compensation that were effective on January 1, 2006, the Company recorded stock
option expense of $244,000 ($166,000 after-tax effect) and $291,000 ($212,000
after-tax effect) for the three and six month periods ended June 30, 2006,
respectively - see Note 4 to the Consolidated Financial Statements above for
additional discussion. Noninterest expenses for the second quarter of 2005 were
impacted by several expenses that did not recur in 2006 totaling approximately
$500,000, including; immediately vested post-retirement benefits granted to the
Company's CEO totaling $196,000, external Sarbanes-Oxley costs related to the
prior year SOX certification of $181,000, and public relation expenses of
$123,000 associated with the Company's sponsorship of the 2005 U.S. Open Golf
Tournament that was held in the Company's largest market - Moore County, North
Carolina.
The provision for income taxes was $3,029,000 in the second quarter of
2006, an effective tax rate of 38.7%, compared to $2,962,000 in the second
quarter of 2005, an effective tax rate of 38.9%. The provision for income taxes
was $6,101,000 for the six months ended June 30, 2006, an effective tax rate of
38.4%, compared to $5,946,000 for the six months ended June 30, 2005, an
effective tax rate of 38.8%. The Company expects its effective tax rate to
remain at approximately 38-39% for the foreseeable future.
The Consolidated Statements of Comprehensive Income reflect "Other
Comprehensive Loss" of $1,114,000 during the second quarter of 2006 and "Other
Comprehensive Loss" of $1,163,000 for the six months ended June 30, 2006,
compared to "Other Comprehensive Income" of $542,000 for the second quarter of
2005 and "Other Comprehensive Loss" of $315,000 for the six months ended June
30, 2005. The primary component of other comprehensive loss for the periods
presented relates to changes in unrealized holding gains/losses of the Company's
available for sale securities. The Company's available for sale securities
portfolio is predominantly comprised of fixed rate bonds that increase in value
when market yields for fixed rate bonds decrease and decline in value when
market yields for fixed rate bonds increase. Except for a brief decrease in bond
yields in the second quarter of 2005, generally rising short-term and long-term
bond yields in the marketplace have resulted in significant declines in value of
the Company's available for sale securities portfolio.
Page 23
FINANCIAL CONDITION
Total assets at June 30, 2006 amounted to $1.99 billion, 14.6% higher than
a year earlier. Total loans at June 30, 2006 amounted to $1.64 billion, a 14.7%
increase from a year earlier, and total deposits amounted to $1.59 billion at
June 30, 2006, an 8.1% increase from a year earlier.
The following tables present information regarding the nature of the
Company's growth since June 30, 2005.
July 1, 2005 to Balance at Balance at Total Percentage growth,
June 30, 2006 beginning of Internal Growth from end of percentage excluding
period Growth Acquisitions period growth acquisitions
------------------------------ ---------- ---------- ---------- ---------- ---------- ----------
($ in thousands)
Loans $1,425,856 210,043 -- 1,635,899 14.7% 14.7%
========== ========== ========== ==========
Deposits - Noninterest bearing $ 184,605 24,457 -- 209,062 13.2% 13.2%
Deposits - Savings, NOW, and
Money Market 476,642 3,880 -- 480,522 0.8% 0.8%
Deposits - Time>$100,000 349,972 40,617 -- 390,589 11.6% 11.6%
Deposits - Time<$100,000 459,661 50,834 -- 510,495 11.1% 11.1%
---------- ---------- ---------- ----------
Total deposits $1,470,880 119,788 -- 1,590,668 8.1% 8.1%
========== ========== ========== ==========
January 1, 2006 to
June 30, 2006
------------------------------
Loans $1,482,611 153,288 -- 1,635,899 10.3% 10.3%
========== ========== ========== ==========
Deposits - Noninterest bearing $ 194,051 15,011 -- 209,062 7.7% 7.7%
Deposits - Savings, NOW, and
Money Market 458,221 22,301 -- 480,522 4.9% 4.9%
Deposits - Time>$100,000 356,281 34,308 -- 390,589 9.6% 9.6%
Deposits - Time<$100,000 486,024 24,471 -- 510,495 5.0% 5.0%
---------- ---------- ---------- ----------
Total deposits $1,494,577 96,091 -- 1,590,668 6.4% 6.4%
========== ========== ========== ==========
The Company experienced strong loan and deposit growth during the first
half of 2006, with loans increasing by $153 million, or 20.8% on an annualized
basis, and deposits increasing by $96 million, or 13.0% on an annualized basis.
For the twelve months preceding June 30, 2006, the Company's loans increased by
$210 million, or 14.7% and deposits increased $120 million, or 8.1%. The Company
opened two de novo branches and two loan production offices in 2005, while in
the first half of 2006, the Company opened one loan production office and
upgraded one loan production office to a full service branch, which has
contributed to the internal growth. In the second half of 2006, the Company
plans to open two de novo branches and convert two loan production offices to
full service branches. Additionally, the Company completed a branch purchase of
$20 million in deposits (no loans) in July 2006 and expects to complete the
purchase of another branch in September 2006 with approximately $25 million in
deposits and $5 million in loans.
The mix of the Company's loan portfolio remains substantially the same at
June 30, 2006 compared to December 31, 2005 with approximately 86% of the
Company's loans being real estate loans, 9% being commercial, financial, and
agricultural loans, and the remaining 5% being consumer installment loans. The
majority of the Company's real estate loans are personal and commercial loans
where real estate provides additional security for the loan.
Page 24
Nonperforming Assets
Nonperforming assets are defined as nonaccrual loans, loans past due 90 or
more days and still accruing interest, restructured loans and other real estate.
Nonperforming assets are summarized as follows:
June 30, December 31, June 30,
($ in thousands) 2006 2005 2005
-----------------------------------------------------------------------------------------
Nonperforming loans:
Nonaccrual loans $ 3,973 1,640 3,806
Restructured loans 12 13 15
Accruing loans > 90 days past due -- -- --
------------ ------------ ------------
Total nonperforming loans 3,985 1,653 3,821
Other assets - primarily other real estate 2,024 1,421 2,520
------------ ------------ ------------
Total nonperforming assets $ 6,009 3,074 6,341
============ ============ ============
Nonperforming loans to total loans 0.24% 0.11% 0.27%
Nonperforming assets as a percentage of
loans and other real estate 0.37% 0.21% 0.44%
Nonperforming assets to total assets 0.30% 0.17% 0.36%
Allowance for loan losses to total loans 1.08% 1.06% 1.10%
Management has reviewed the collateral for the nonperforming assets,
including nonaccrual loans, and has included this review among the factors
considered in the evaluation of the allowance for loan losses discussed below.
Nonperforming loans (which includes nonaccrual loans and restructured
loans) as of June 30, 2006, December 31, 2005, and June 30, 2005 totaled
$3,985,000, $1,653,000, and $3,821,000, respectively. Nonperforming loans as a
percentage of total loans amounted to 0.24%, 0.11%, and 0.27%, at June 30, 2006,
December 31, 2005, and June 30, 2005, respectively. The variances in the dollar
amount of nonperforming loans among the periods has been primarily due to
changes in nonaccrual loans, as restructured loans have not changed
significantly. In the fourth quarter of 2005, the collection process for several
of the Company's largest nonaccrual loan relationships reached a conclusion and
their principal balances were reduced to zero either as a result of cash
received or the recording of a charge-off. This resulted in the amount of the
Company's nonperforming loans at December 31, 2005 reaching their lowest level
in over five years. In 2006, the Company has experienced more typical activity
within its nonaccrual loan category, and the amount of nonaccrual loans
increased to more normal levels. Although nonperforming loans increased from
December 31, 2005 to June 30, 2006, the 0.24% ratio of nonperforming loans to
total loans at June 30, 2006 is lower than the 0.27% ratio at June 30, 2005 and
compares favorably to industry averages. The largest nonaccrual relationship at
June 30, 2006 amounted to $338,000.
At June 30, 2006, December 31, 2005, and June 30, 2005, the recorded
investment in loans considered to be impaired was $1,225,000, $338,000, and
$1,956,000, respectively, all of which were on nonaccrual status. At June 30,
2006, December 31, 2005, and June 30, 2005, the related allowance for loan
losses for all impaired loans was $311,000, $100,000, and $629,000,
respectively. At June 30, 2006, December 31, 2005, and June 30, 2005, there was
$618,000, $0, and $178,000 in impaired loans for which there was no related
allowance. The average recorded investments in impaired loans during the six
month period ended June 30, 2006, the year ended December 31, 2005, and the six
months ended June 30, 2005 were approximately $782,000, $1,474,000, and
$1,891,000, respectively. For the same periods, the Company recognized no
interest income on those loans during the period that they were considered to be
impaired.
Other nonperforming assets - primarily other real estate - amounted to
$2,024,000, $1,421,000, and $2,520,000 at June 30, 2006, December 31, 2005 and
June 30, 2005, respectively. Included in this category at June 30, 2006 was the
aforementioned $240,000 merchant card receivable - see additional information in
the "Components of
Page 25
Earnings" section above within the discussion of noninterest income. The
Company's management has reviewed recent appraisals of its other real estate and
believes that their fair values, less estimated costs to sell, equal or exceed
their respective carrying values at the dates presented. In July 2006, the
Company completed the sale of two pieces of its other real estate totaling
$440,000 at a total gain of approximately $50,000.
Summary of Loan Loss Experience
The allowance for loan losses is created by direct charges to operations.
Losses on loans are charged against the allowance in the period in which such
loans, in management's opinion, become uncollectible. The recoveries realized
during the period are credited to this allowance.
The Company has no foreign loans, few agricultural loans and does not
engage in significant lease financing or highly leveraged transactions.
Commercial loans are diversified among a variety of industries. The majority of
the Company's real estate loans are primarily various personal and commercial
loans where real estate provides additional security for the loan. Collateral
for virtually all of these loans is located within the Company's principal
market area.
The provision for loan losses amounted to $1,400,000 in the second quarter
of 2006 compared to $845,000 in the second quarter of 2005, and the provision
for loan losses for the first six months of 2006 was $2,415,000 compared to
$1,425,000 for the first six months of 2005. The increases are primarily the
result of the strong loan growth realized in 2006, as asset quality ratios
remained stable. Loan growth was $153 million in the first half of 2006 compared
to $59 million in the first half of 2005. The Company's ratio of annualized net
charge-offs to average loans amounted to 6 basis points for the first half of
2006 compared to 8 basis points for the first half of 2005. The Company's ratio
of nonperforming assets to total assets was 0.30% at June 30, 2006 compared to
0.36% at June 30, 2005.
At June 30, 2006, the allowance for loan losses amounted to $17,642,000,
compared to $15,716,000 at December 31, 2005 and $15,622,000 at June 30, 2005.
The allowance for loan losses as a percentage of total loans did not vary
significantly among the periods presented, amounting to 1.08% at June 30, 2006,
1.06% at December 31, 2005, and 1.10% at June 30, 2005.
Management believes the Company's reserve levels are adequate to cover
probable loan losses on the loans outstanding as of each reporting date. It must
be emphasized, however, that the determination of the reserve using the
Company's procedures and methods rests upon various judgments and assumptions
about economic conditions and other factors affecting loans. No assurance can be
given that the Company will not in any particular period sustain loan losses
that are sizable in relation to the amounts reserved or that subsequent
evaluations of the loan portfolio, in light of conditions and factors then
prevailing, will not require significant changes in the allowance for loan
losses or future charges to earnings. See "Critical Accounting Policies -
Allowance for Loan Losses" above.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for loan losses
and value of other real estate. Such agencies may require the Company to
recognize adjustments to the allowance or the carrying value of other real
estate based on their judgments about information available at the time of their
examinations.
Page 26
For the periods indicated, the following table summarizes the Company's
balances of loans outstanding, average loans outstanding, changes in the
allowance for loan losses arising from charge-offs and recoveries, and additions
to the allowance for loan losses that have been charged to expense.
Six Months Twelve Months Six Months
Ended Ended Ended
June 30, December 31, June 30,
($ in thousands) 2006 2005 2005
----------- ----------- -----------
Loans outstanding at end of period $ 1,635,899 1,482,611 1,425,856
=========== =========== ===========
Average amount of loans outstanding $ 1,554,763 1,422,419 1,396,167
=========== =========== ===========
Allowance for loan losses, at
beginning of period $ 15,716 14,717 14,717
Total charge-offs (613) (2,363) (680)
Total recoveries 124 322 160
----------- ----------- -----------
Net charge-offs (489) (2,041) (520)
----------- ----------- -----------
Additions to the allowance charged to expense 2,415 3,040 1,425
----------- ----------- -----------
Allowance for loan losses, at end of period $ 17,642 15,716 15,622
=========== =========== ===========
Ratios:
Net charge-offs (annualized) as a percent of average loans 0.06% 0.14% 0.08%
Allowance for loan losses as a
percent of loans at end of period 1.08% 1.06% 1.10%
Based on the results of the Company's loan analysis and grading program and
management's evaluation of the allowance for loan losses at June 30, 2006, there
have been no material changes to the allocation of the allowance for loan losses
among the various categories of loans since December 31, 2005.
Liquidity, Commitments, and Contingencies
The Company's liquidity is determined by its ability to convert assets to
cash or acquire alternative sources of funds to meet the needs of its customers
who are withdrawing or borrowing funds, and to maintain required reserve levels,
pay expenses and operate the Company on an ongoing basis. The Company's primary
liquidity sources are net income from operations, cash and due from banks,
federal funds sold and other short-term investments. The Company's securities
portfolio is comprised almost entirely of readily marketable securities, which
could also be sold to provide cash.
In addition to internally generated liquidity sources, the Company has the
ability to obtain borrowings from the following three sources - 1) an
approximately $398 million line of credit with the Federal Home Loan Bank (of
which $128 million was outstanding at June 30, 2006), 2) a $50 million overnight
federal funds line of credit with a correspondent bank (none of which was
outstanding at June 30, 2006), and 3) an approximately $71 million line of
credit through the Federal Reserve Bank of Richmond's discount window (none of
which was outstanding at June 30, 2006).
The Company's liquidity decreased slightly from December 31, 2005 to June
30, 2006, as a result of loan growth that exceeded deposit growth during the
first half of the year. Loans increased during the first half of 2006 by $153
million compared to deposit growth of $96 million. The Company's loan to deposit
ratio was 102.8% at June 30, 2006 compared to 99.2% at December 31, 2005. The
higher growth in loans compared to deposits is the primary factor in the Company
increasing its outstanding borrowings from $100 million at December 31, 2005 to
$195 million at June 30, 2006.
Page 27
The Company's management believes its liquidity sources, including unused
lines of credit, are at an acceptable level and remain adequate to meet its
operating needs in the foreseeable future. The Company will continue to monitor
its liquidity position carefully and will explore and implement strategies to
increase liquidity if deemed appropriate.
The amount and timing of the Company's contractual obligations and
commercial commitments has not changed materially since December 31, 2005,
detail of which is presented in Table 18 on page 56 of the Company's 2005 Form
10-K.
See Note 10 to the Consolidated Financial Statements above for information
related to a tax contingency
The Company is not involved in any legal proceedings that, in management's
opinion, could have a material effect on the consolidated financial position of
the Company.
Off-Balance Sheet Arrangements and Derivative Financial Instruments
Off-balance sheet arrangements include transactions, agreements, or other
contractual arrangements in which the Company has obligations or provides
guarantees on behalf of an unconsolidated entity. The Company has no off-balance
sheet arrangements of this kind other than repayment guarantees associated with
trust preferred securities.
Derivative financial instruments include futures, forwards, interest rate
swaps, options contracts, and other financial instruments with similar
characteristics. The Company has not engaged in significant derivative
activities through June 30, 2006, and has no current plans to do so.
Capital Resources
The Company is regulated by the Board of Governors of the Federal Reserve
Board (FED) and is subject to securities registration and public reporting
regulations of the Securities and Exchange Commission. The Company's banking
subsidiary is regulated by the Federal Deposit Insurance Corporation (FDIC) and
the North Carolina Office of the Commissioner of Banks. The Company is not aware
of any recommendations of regulatory authorities or otherwise which, if they
were to be implemented, would have a material effect on its liquidity, capital
resources, or operations.
The Company must comply with regulatory capital requirements established by
the FED and FDIC. Failure to meet minimum capital requirements can initiate
certain mandatory, and possibly additional discretionary, actions by regulators
that, if undertaken, could have a direct material effect on the Company's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Company must meet specific capital
guidelines that involve quantitative measures of the Company's assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The Company's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors. These capital standards require the Company to
maintain minimum ratios of "Tier 1" capital to total risk-weighted assets and
total capital to risk-weighted assets of 4.00% and 8.00%, respectively. Tier 1
capital is comprised of total shareholders' equity calculated in accordance with
generally accepted accounting principles, excluding accumulated other
comprehensive income (loss), less intangible assets, and total capital is
comprised of Tier 1 capital plus certain adjustments, the largest of which for
the Company is the allowance for loan losses. Risk-weighted assets refer to the
on- and off-balance sheet exposures of the Company, adjusted for their related
risk levels using formulas set forth in FED and FDIC regulations.
In addition to the risk-based capital requirements described above, the
Company is subject to a leverage capital requirement, which calls for a minimum
ratio of Tier 1 capital (as defined above) to quarterly average total assets
Page 28
of 3.00% to 5.00%, depending upon the institution's composite ratings as
determined by its regulators. The FED has not advised the Company of any
requirement specifically applicable to it.
At June 30, 2006, the Company's capital ratios exceeded the regulatory
minimum ratios discussed above. The following table presents the Company's
capital ratios and the regulatory minimums discussed above for the periods
indicated.
June 30, December 31, June 30,
2006 2005 2005
------------ ------------ ------------
Risk-based capital ratios:
Tier I capital to Tier I risk adjusted assets 10.55% 10.52% 10.81%
Minimum required Tier I capital 4.00% 4.00% 4.00%
Total risk-based capital to
Tier II risk-adjusted assets 12.27% 11.51% 11.83%
Minimum required total risk-based capital 8.00% 8.00% 8.00%
Leverage capital ratios:
Tier I leverage capital to
adjusted most recent quarter average assets 9.04% 8.62% 8.73%
Minimum required Tier I leverage capital 4.00% 4.00% 4.00%
The Company's capital ratios decreased from June 30, 2005 to December 31,
2005 primarily as a result of the Company's strong balance sheet growth. In
April 2006, the Company issued an additional $25 million in trust preferred
securities, which qualify as regulatory capital and resulted in an increase to
the Company's capital ratios.
The Company's bank subsidiary is also subject to similar capital
requirements as those discussed above. The bank subsidiary's capital ratios do
not vary materially from the Company's capital ratios presented above. At June
30, 2006, the Company's bank subsidiary exceeded the minimum ratios established
by the FED and FDIC.
SHARE REPURCHASES
During the second quarter of 2006, the Company repurchased 53,000 shares
of its common stock at an average price of $20.97 per share. At June 30, 2006,
the Company had approximately 262,000 shares available for repurchase under
existing authority from its board of directors. The Company may repurchase these
shares in open market and privately negotiated transactions, as market
conditions and the Company's liquidity warrant, subject to compliance with
applicable regulations. See also Part II, Item 2 "Unregistered Sales of Equity
Securities and Use of Proceeds."
Item 3. Quantitative and Qualitative Disclosures About Market Risk
INTEREST RATE RISK (INCLUDING QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK)
Net interest income is the Company's most significant component of
earnings. Notwithstanding changes in volumes of loans and deposits, the
Company's level of net interest income is continually at risk due to the effect
that changes in general market interest rate trends have on interest yields
earned and paid with respect to the various categories of earning assets and
interest-bearing liabilities. It is the Company's policy to maintain portfolios
of earning assets and interest-bearing liabilities with maturities and repricing
opportunities that will afford protection, to the extent practical, against wide
interest rate fluctuations. The Company's exposure to interest rate risk is
analyzed on a regular basis by management using standard GAP reports, maturity
reports, and an asset/liability software model that simulates future levels of
interest income and expense based on current interest rates, expected future
interest rates, and various intervals of "shock" interest rates. Over the years,
the Company has been able to maintain a fairly consistent yield on average
earning assets (net interest margin). Over
Page 29
the past five calendar years the Company's net interest margin has ranged from a
low of 4.23% (realized in 2001) to a high of 4.58% (realized in 2002). During
that five year period the prime rate of interest has ranged from a low of 4.00%
to a high of 9.50%.
Using stated maturities for all instruments except mortgage-backed
securities (which are allocated in the periods of their expected payback) and
securities and borrowings with call features that are expected to be called
(which are included in the period of their expected call), at June 30, 2006 the
Company had $369.5 million more in interest-bearing liabilities that are subject
to interest rate changes within one year than earning assets. This generally
would indicate that net interest income would experience downward pressure in a
rising interest rate environment and would benefit from a declining interest
rate environment. However, this method of analyzing interest sensitivity only
measures the magnitude of the timing differences and does not address earnings,
market value, or management actions. Also, interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. In addition to the effects of "when" various rate-sensitive products
reprice, market rate changes may not result in uniform changes in rates among
all products. For example, included in interest-bearing liabilities at June 30,
2006 subject to interest rate changes within one year are deposits totaling
$221.9 million comprised of NOW, savings, and certain types of money market
deposits with interest rates set by management. These types of deposits
historically have not repriced coincidentally with or in the same proportion as
general market indicators. Interest rate caps and floors which are in place for
a portion of the Company's variable rate loans can also impact its repricing
characteristics.
Overall, the Company believes that in the near term (twelve months), net
interest income would not likely experience significant downward pressure from
rising interest rates. Similarly, management would not expect a significant
increase in near term net interest income from falling interest rates.
Generally, when rates change, the Company's interest-sensitive assets that are
subject to adjustment reprice immediately at the full amount of the change,
while the Company's interest-sensitive liabilities that are subject to
adjustment reprice at a lag to the rate change and typically not to the full
extent of the rate change. The net effect is that in the twelve month horizon,
as rates change, the impact of having a higher level of interest-sensitive
liabilities is substantially negated by the later and typically lower
proportionate change these liabilities experience compared to interest sensitive
assets. The general discussion in this paragraph applies most directly in a
"normal" interest rate environment in which longer term maturity instruments
carry higher interest rates than short term maturity instruments, and is less
applicable in periods in which there is a "flat" interest rate curve, which is
discussed in the following paragraph.
Since the second half of 2004, the Federal Reserve has increased the
discount rate 17 times totaling 425 basis points. However the impact of these
rate increases has not had an equal effect on short-term interest rates and
long-term interest rates in the marketplace. In the marketplace, short-term
rates have risen by a significantly higher amount than have longer-term interest
rates. For example, from June 30, 2004 to June 30, 2006, the interest rate on
three-month treasury bills rose by 371 basis points, whereas the interest rate
for seven-year treasury notes increased by just 95 basis points. This has
resulted in what economists refer to as a "flat yield curve", which means that
short-term interest rates are substantially the same as long-term interest
rates. This is an unfavorable interest rate environment for many banks,
including the Company, as short-term interest rates generally drive the
Company's deposit pricing and longer-term interest rates generally drive loan
pricing. When these rates converge, as they have recently (particularly in the
last six months), the "profit" spread the Company realizes between loan yields
and deposit rates narrows, which reduces the Company's net interest margin.
In addition to the negative impact of the flat yield curve interest rate
environment, the Company's net interest margin has also been negatively impacted
by the mix of the Company's deposit growth being more concentrated in the
categories of time deposits and time deposits greater than $100,000. These are
the Company's highest cost categories of deposits and adjust upwards when rates
change to a greater extent than the Company's other categories of deposits.
Page 30
The factors just discussed are the primary reasons for the Company
experiencing a decline in its net interest margin for the second consecutive
quarter. The Company's net interest margin was 4.37% in the fourth quarter of
2005, 4.33% in the first quarter of 2006 and 4.22% in the second quarter of
2006. Based on rate projections the Company has reviewed, the Company expects
its net interest margin to continue to experience compression for each of the
two remaining quarters of 2006.
The Company has no market risk sensitive instruments held for trading
purposes, nor does it maintain any foreign currency positions.
See additional discussion of the Company's net interest margin in the
"Components of Earnings" section above.
Item 4. Controls and Procedures
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our chief
executive officer and chief financial officer, of the effectiveness of the
design and operation of our disclosure controls and procedures, which are our
controls and other procedures that are designed to ensure that information
required to be disclosed in our periodic reports with the SEC is recorded,
processed, summarized and reported within the required time periods. Disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed is communicated to
our management to allow timely decisions regarding required disclosure. Based on
the evaluation, our chief executive officer and chief financial officer
concluded that our disclosure controls and procedures are effective in allowing
timely decisions regarding disclosure to be made about material information
required to be included in our periodic reports with the SEC. In addition, no
change in our internal control over financial reporting has occurred during, or
subsequent to, the period covered by this report that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting.
FORWARD-LOOKING STATEMENTS
Part I of this report contains statements that could be deemed
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934 and the Private Securities Litigation Reform Act, which
statements are inherently subject to risks and uncertainties. Forward-looking
statements are statements that include projections, predictions, expectations or
beliefs about future events or results or otherwise are not statements of
historical fact. Such statements are often characterized by the use of
qualifying words (and their derivatives) such as "expect," "believe,"
"estimate," "plan," "project," or other statements concerning opinions or
judgment of the Company and its management about future events. Factors that
could influence the accuracy of such forward-looking statements include, but are
not limited to, the financial success or changing strategies of the Company's
customers, the Company's level of success in integrating acquisitions, actions
of government regulators, the level of market interest rates, and general
economic conditions. For additional information that could affect the matters
discussed in this paragraph, see the "Risk Factors" section of the Company's
2005 Annual Report on Form 10-K.
Page 31
Part II. Other Information
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
--------------------------------------------------------------------------------------------------------------------
Total Number of
Shares Purchased as Maximum Number of
Part of Publicly Shares that May Yet Be
Total Number of Shares Average Price Paid per Announced Plans or Purchased Under the
Period Purchased Share Programs Plans or Programs (1)
----------------------- --------------- --------------- --------------- --------------------
April 1, 2006 to April
30, 2006 -- -- -- 315,015
May 1, 2006 to May 31,
31, 2006 20,000 21.06 20,000 295,015
June 1, 2006 to June
30, 2006 33,000 20.92 33,000 262,015
--------------- --------------- --------------- ---------------
Total 53,000 20.97 53,000 262,015(2)
=============== =============== =============== ===============
Footnotes to the Above Table
----------------------------
(1) All shares available for repurchase are pursuant to publicly announced
share repurchase authorizations. On July 30, 2004, the Company announced
that its Board of Directors had approved the repurchase of 375,000 shares
of the Company's common stock. The repurchase authorization does not have
an expiration date. There are no plans or programs the Company has
determined to terminate prior to expiration, or under which the Company
does not intend to make further purchases.
(2) The above table above does not include shares that were used by option
holders to satisfy the exercise price of the Company's call options issued
by the Company to its employees and directors pursuant to the Company's
stock option plans. There were no such exercises during the three months
ended June 30, 2006.
Page 32
Item 4 - Submission of Matters to a Vote of Security Holders
The following proposal was considered and acted upon at the annual meeting
of shareholders of the Company held on May 3, 2006:
Proposal 1
A proposal to elect eighteen (18) directors to serve until the next
annual meeting of shareholders and until their successors are elected
and qualified.
Voted Withheld
Nominee For Authority
------- ---------- ---------
Jack D. Briggs 11,972,114 98,978
R. Walton Brown 11,982,139 88,593
H. David Bruton, M.D. 11,975,233 95,859
David L. Burns 11,981,399 89,693
John F. Burns 11,863,703 207,389
Mary Clara Capel 11,982,579 88,513
Goldie Wallace-Gainey 10,753,809 1,317,283
James H. Garner 11,939,170 131,922
James G. Hudson, Jr. 11,981,995 89,097
Jerry L. Ocheltree 11,980,291 90,801
George R. Perkins, Jr. 11,669,059 402,033
Thomas F. Philips 11,918,262 152,830
Edward T. Taws 11,976,452 94,640
Frederick L. Taylor II 11,943,771 127,321
Virginia C. Thomasson 11,981,387 89,705
A. Jordan Washburn 11,977,503 93,589
Dennis A. Wicker 11,973,880 97,212
John C. Willis 11,976,162 94,930
Proposal 2
A proposal to ratify the appointment of Elliott Davis, PLLC as the
independent registered public accounting firm of the Company for 2006.
For 11,887,304 Against 124,074 Abstain 59,713
---------- ------- ------
Item 6 - Exhibits
The following exhibits are filed with this report or, as noted, are
incorporated by reference. Management contracts, compensatory plans and
arrangements are marked with an asterisk (*).
3.a. Copy of Articles of Incorporation of the Company and amendments thereto
were filed as Exhibits 3.a.i through 3.a.v to the Company's Quarterly
Report on Form 10-Q for the period ended June 30, 2002, and are
incorporated herein by reference.
3.b Copy of the Amended and Restated Bylaws of the Company was filed as
Exhibit 3.b to the Company's Annual Report on Form 10-K for the year
ended December 31, 2003, and is incorporated herein by reference.
Page 33
4 Form of Common Stock Certificate was filed as Exhibit 4 to the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30,
1999, and is incorporated herein by reference.
31.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 302(a) of the Sarbanes-Oxley Act of 2002.
31.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 302(a) of the Sarbanes-Oxley Act of 2002.
32.1 Chief Executive Officer Certification Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2 Chief Financial Officer Certification Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
Copies of exhibits are available upon written request to: First Bancorp, Anna G.
Hollers, Executive Vice President, P.O. Box 508, Troy, NC 27371
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FIRST BANCORP
August 8, 2006 BY: James H. Garner
---------------------------
James H. Garner
President, Chief Executive
Officer
(Principal Executive Officer),
Treasurer and Director
August 8, 2006 BY: Anna G. Hollers
---------------------------
Anna G. Hollers
Executive Vice President,
Chief Operating Officer
and Secretary
August 8, 2006 BY: Eric P. Credle
---------------------------
Eric P. Credle
Senior Vice President
and Chief Financial Officer
Page 34