U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number: 0-25859
1st STATE BANCORP, INC.
--------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
VIRGINIA 56-2130744
------------------------------- --------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
445 S. MAIN STREET, BURLINGTON, NORTH CAROLINA 27215
--------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant' s Telephone Number, Including Area Code (336) 227-8861
--------------
N/A
--------------------------------------------------------------------------------
Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
As of February 10, 2003, the issuer had 2,999,407 shares of common
stock issued and outstanding.
CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
---------------------
Item 1. Financial Statements
Consolidated Balance Sheets as of December 31, 2002
(unaudited) and September 30, 2002......................... .....1
Consolidated Statements of Income for the Three Months Ended
December 31, 2002 and 2001 (unaudited)...........................2
Consolidated Statements of Stockholders' Equity and
Comprehensive Income for the Three Months Ended December
31, 2002 and 2001 (unaudited)....................................3
Consolidated Statements of Cash Flows for the Three Months
Ended December 31, 2002 and 2001 (unaudited).....................4
Notes to Consolidated Financial Statements...........................6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.........................................8
Item 3. Quantitative and Qualitative Disclosures About Market Risk..........16
Item 4. Controls and Procedures..............................................16
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings...................................................17
Item 2. Changes in Securities and Use of Proceeds...........................17
Item 3. Defaults Upon Senior Securities.....................................17
Item 4. Submission of Matters to a Vote of Security Holders.................17
Item 5. Other Information...................................................17
Item 6. Exhibits and Reports on Form 8-K....................................17
SIGNATURES...................................................................18
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 AND SEPTEMBER 30, 2002
(IN THOUSANDS, EXCEPT SHARE DATA)
AT AT
DECEMBER 31, SEPTEMBER 30,
2002 2002
------------ -------------
(Unaudited)
ASSETS
Cash and cash equivalents $ 15,311 18,865
Investment securities:
Held to maturity (fair value of $11,509 and $11,558
at December 31, 2002 and September 30, 2002, respectively) 11,110 11,114
Available for sale (cost of $75,232 and $77,213
at December 31, 2002 and September 30, 2002, respectively) 76,278 78,572
Loans held for sale, at lower of cost or fair value 8,429 6,798
Loans receivable (net of allowance for loan losses of $3,790
and $3,732 at December 31, 2002 and September 30, 2002,
respectively) 219,915 220,047
Federal Home Loan Bank stock, at cost 1,382 1,750
Real estate owned 183 183
Premises and equipment 8,464 7,972
Accrued interest receivable 1,722 2,272
Other assets 2,651 2,896
--------- ---------
Total assets $ 345,445 350,469
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposit accounts $ 251,234 260,667
Advances from Federal Home Loan Bank 25,000 20,000
Advance payments by borrowers for property taxes and insurance 130 54
Dividend payable 240 241
Other liabilities 6,739 7,938
--------- ---------
Total liabilities 283,343 288,900
--------- ---------
Stockholders' Equity:
Preferred stock, $0.01 par value, 1,000,000 shares authorized;
none issued -- --
Common stock, $0.01 par value, 7,000,000 shares authorized;
2,999,432 and 3,008,682 shares issued and outstanding at
December 31, 2002 and September 30, 2002, respectively 33 33
Additional paid-in capital 35,662 35,623
Unearned ESOP shares (3,588) (3,739)
Deferred compensation payable in treasury stock 5,466 5,466
Treasury stock (12,123) (11,899)
Retained income - substantially restricted 36,016 35,258
Accumulated other comprehensive income - net unrealized
gain on investment securities available for sale 636 827
--------- ---------
Total stockholders' equity 62,102 61,569
--------- ---------
Total liabilities and stockholders' equity $ 345,445 350,469
========= =========
See accompanying notes to the consolidated financial statements
1
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED DECEMBER 31, 2002 AND 2001
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
FOR THE THREE MONTHS ENDED
DECEMBER 31,
--------------------------
2002 2001
------- -------
Interest income:
Interest and fees on loans $ 3,372 3,905
Interest and dividends on investments 1,152 1,222
Overnight deposits 43 89
------- -------
Total interest income 4,567 5,216
------- -------
Interest expense:
Deposit accounts 1,291 2,094
Borrowings 276 276
------- -------
Total interest expense 1,567 2,370
------- -------
Net interest income 3,000 2,846
Provision for loan losses 60 60
------- -------
Net interest income after provision for loan losses 2,940 2,786
------- -------
Other income:
Service fees on loans sold (15) 6
Customer service fees 217 249
Commissions from sales of annuities and mutual funds 86 122
Mortgage banking income, net 449 416
Other 56 50
------- -------
Total other income 793 843
------- -------
Operating expenses:
Compensation and related benefits 1,377 1,564
Occupancy and equipment 351 303
Real estate operations, net 6 18
Other expenses 445 372
------- -------
Total operating expenses 2,179 2,257
------- -------
Income before income taxes 1,554 1,372
Income taxes 571 527
------- -------
Net income $ 983 845
======= =======
Net income per share:
Basic $ 0.35 $ 0.28
Diluted $ 0.33 $ 0.27
See accompanying notes to the consolidated financial statements.
2
1ST STATE BANCORP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED DECEMBER 31, 2002 AND 2001 (UNAUDITED)
(IN THOUSANDS)
DEFERRED
ADDITIONAL UNEARNED UNEARNED COMPENSATION
COMMON PAID-IN ESOP COMPENSATION PAYABLE IN
STOCK CAPITAL SHARES MRP TREASURY STOCK
------- ---------- -------- ------------ --------------
Balance at September 30, 2001 $ 33 35,588 (4,373) (518) 4,173
Comprehensive income:
Net income -- -- -- -- --
Other comprehensive loss-unrealized
loss on securities available-for-sale,
net of income taxes of $443 -- -- -- -- --
Total comprehensive income
Allocation of ESOP shares -- 8 171 -- --
Deferred compensation -- -- -- -- 151
Treasury stock held for deferred compensation -- -- -- -- --
Vesting of MRP shares -- -- -- 194 --
Cash dividend declared -- -- -- -- --
Cash dividend on unallocated ESOP shares
and unvested MRP shares -- -- -- -- --
-------- ------- ------- ----- ------
Balance at December 31, 2001 $ 33 35,596 (4,202) (324) 4,324
======== ======= ======= ===== ======
Balance at September 30, 2002 $ 33 35,623 (3,739) -- 5,466
Comprehensive income:
Net income -- -- -- -- --
Other comprehensive loss-unrealized
loss on securities available-for-sale,
net of income taxes of $122 -- -- -- -- --
Total comprehensive income
Allocation of ESOP shares -- 39 151 -- --
Acquisition of treasury shares -- -- -- -- --
Cash dividends declared -- -- -- -- --
Cash dividend on unallocated ESOP shares -- -- -- -- --
-------- ------- ------- ----- ------
Balance at December 31, 2002 $ 33 35,662 (3,588) -- 5,466
======== ======= ======= ===== ======
ACCUMULATED
OTHER TOTAL
TREASURY RETAINED COMPREHENSIVE STOCKHOLDERS'
STOCK INCOME INCOME (LOSS) EQUITY
-------- -------- -------------- -------------
Balance at September 30, 2001 (4,173) 32,404 510 63,644
Comprehensive income:
Net income -- 845 -- 845
Other comprehensive loss-unrealized
loss on securities available-for-sale,
net of income taxes of $443 -- -- (689) (689)
-------
Total comprehensive income 156
Allocation of ESOP shares -- -- -- 179
Deferred compensation -- -- -- 151
Treasury stock held for deferred compensation (151) -- -- (151)
Vesting of MRP shares -- -- -- 194
Cash dividend declared -- (263) -- (263)
Cash dividend on unallocated ESOP shares
and unvested MRP shares -- 27 -- 27
-------- ------- ----- -------
Balance at December 31, 2001 (4,324) 33,013 (179) 63,937
======== ======= ===== =======
Balance at September 30, 2002 (11,899) 35,258 827 61,569
Comprehensive income:
Net income -- 983 -- 983
Other comprehensive loss-unrealized
loss on securities available-for-sale,
net of income taxes of $122 -- -- (191) (191)
-------
Total comprehensive income 792
Allocation of ESOP shares -- -- -- 190
Acquisition of treasury shares (224) -- -- (224)
Cash dividends declared (240) -- -- (240)
Cash dividend on unallocated ESOP shares -- 15 -- 15
-------- ------- ----- -------
Balance at December 31, 2002 (12,123) 36,016 636 62,102
======== ======= ===== =======
See accompanying notes to the consolidated financial statements.
3
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED DECEMBER 31, 2002 AND 2001
(UNAUDITED)
(IN THOUSANDS)
FOR THE THREE MONTHS ENDED
DECEMBER 31,
--------------------------
2002 2001
-------- --------
Cash flows from operating activities:
Net income $ 983 845
Adjustment to reconcile net income to net cash provided by
(used in) operating activities:
Provision for loan losses 60 60
Depreciation 178 153
Deferred tax expense 32 155
Amortization of premiums and discounts, net (32) (13)
Deferred compensation 60 92
Release of ESOP shares 190 179
Vesting of MRP shares and dividends on unvested MRP shares -- 260
Loan origination fees and unearned discounts
deferred, net of current amortization (15) (54)
Net (gain) loss on sale of loans (10) 211
Proceeds from sales of loans held for sale 24,839 25,264
Originations of loans held for sale (26,460) (32,948)
Decrease in other assets 335 232
Decrease in accrued interest receivable 550 473
Increase (decrease) in other liabilities (1,261) 15
-------- --------
Net cash used in operating activities (551) (5,076)
-------- --------
Cash flows from investing activities:
Proceeds from sale of FHLB stock 368 --
Purchases of investment securities available for sale (32,233) (46,326)
Purchases of investment securities held to maturity -- (2,454)
Proceeds from maturities and issuer calls of investment securities
available for sale 34,250 17,231
Proceeds from maturities and issuer calls of investment securities
held to maturity 1 3,001
Net decrease in loans receivable 87 8,315
Purchases of premises and equipment (670) (86)
-------- --------
Net cash provided by (used in) investing activities 1,803 (20,319)
-------- --------
(Continued)
4
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
FOR THE THREE MONTHS ENDED DECEMBER 31, 2002 AND 2001
(UNAUDITED)
(IN THOUSANDS)
FOR THE THREE MONTHS ENDED
DECEMBER 31,
--------------------------
2002 2001
-------- --------
Cash flows from financing activities:
Net (decrease) increase in deposits $ (9,433) $ 8,904
Advances from the Federal Home Loan Bank 5,000 5,000
Purchase of treasury stock (224) (151)
Dividends paid on common stock (225) (236)
Increase in advance payments by borrowers for
property taxes and insurance 76 176
-------- --------
Net cash provided by (used in) financing activities (4,806) 13,693
-------- --------
Net decrease in cash and cash equivalents (3,554) (11,702)
Cash and cash equivalents at beginning of period 18,865 25,981
-------- --------
Cash and cash equivalents at end of period $ 15,311 $ 14,279
======== ========
Payments are shown below for the following:
Interest $ 1,583 $ 2,375
======== ========
Income taxes $ 54 $ 68
======== ========
Noncash activities:
Unrealized losses on investment securities
available for sale $ (313) $ (1,132)
======== ========
Cash dividends declared but not paid $ 225 $ 236
======== ========
Cash dividends on unallocated ESOP shares $ 15 $ 24
======== ========
Transfer from loans to real estate acquired in settlement of loans $ -- $ 347
======== ========
See accompanying notes to the consolidated financial statements.
5
1ST STATE BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002 (UNAUDITED) AND SEPTEMBER 30, 2002
NOTE 1. NATURE OF BUSINESS
1st State Bancorp, Inc. (the "Company") was incorporated under the laws of
the Commonwealth of Virginia for the purpose of becoming the holding company for
1st State Bank (the "Bank") in connection with the Bank's conversion from a
North Carolina-chartered mutual savings bank to a North Carolina-chartered stock
savings bank (the "Converted Bank") pursuant to its Plan of Conversion (the
"Stock Conversion"). Upon completion of the Stock Conversion, the Bank converted
from a North Carolina-chartered stock savings bank to a North Carolina
commercial bank (the "Bank Conversion"), retaining the name 1st State Bank (the
"Commercial Bank"), and the Commercial Bank succeeded to all of the assets and
liabilities of the Converted Bank. The Stock Conversion and the Bank Conversion
were consummated on April 23, 1999. The common stock of the Company began
trading on the Nasdaq National Market System under the symbol "FSBC" on April
26, 1999.
NOTE 2. BASIS OF PRESENTATION
The accompanying consolidated financial statements (which are unaudited,
except for the consolidated balance sheet at September 30, 2002, which is
derived from the September 30, 2002 audited consolidated financial statements)
have been prepared in accordance with accounting principles generally accepted
in the United States of America for interim financial information and with the
rules and regulations of the Securities and Exchange Commission. Accordingly,
they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. In the opinion of management, all adjustments (none of
which were other than normal recurring accruals) necessary for a fair
presentation of the financial position and results of operations for the periods
presented have been included.
The results of operations for the three month period ended December 31,
2002 are not necessarily indicative of the results of operations that may be
expected for the year ended September 30, 2003. The preparation of consolidated
financial statements in accordance with accounting principles generally accepted
in the United States of America requires management to make certain estimates.
These amounts may be revised in future periods because of changes in the facts
and circumstances underlying their estimation.
Certain amounts in the December 31, 2001 consolidated financial statements
(which are unaudited) have been reclassified to conform with the presentation
adopted in 2002. Such reclassifications did not change net income or
stockholders' equity as previously reported.
NOTE 3. EARNINGS PER SHARE
For purposes of computing basic and diluted earnings per share, weighted
average shares outstanding excludes unallocated ESOP shares that have not been
committed to be released. The deferred compensation obligation discussed in note
5 that is funded with shares of the Company's common stock has no net impact on
the Company's earnings per share computations. Diluted earnings per share
includes the potentially dilutive effects of the Company's benefit plans. There
were no antidilutive stock options for the three months ended December 31, 2002
and 2001. A reconciliation of the denominators of the basic and diluted earnings
per share computations is as follows:
2002 2001
---- ----
Average shares issued and outstanding 3,002,877 3,289,607
Less: Unvested MRP shares -- (42,156)
Less: Unallocated ESOP shares (187,229) (232,123)
--------- ---------
Average basic shares for earnings per share 2,815,648 3,015,328
Add: Unvested MRP shares -- 42,156
Add: Potential common stock pursuant to stock
option plan (See Note 7) 126,396 88,550
--------- ---------
Average dilutive shares for earnings per share 2,942,044 3,146,034
========= =========
(continued)
6
NOTE 4. EMPLOYEE STOCK OWNERSHIP PLAN ("ESOP")
The Company sponsors an employee stock ownership plan (the "ESOP") whereby
an aggregate number of shares amounting to 253,050 or 8% of the stock issued in
the conversion was purchased for future allocation to employees. The ESOP was
funded by an 11 year term loan from the Company in the amount of $4,899,000. The
loan is secured by the shares of stock purchased by the ESOP. During the three
months ended December 31, 2002 and 2001, 7,728 and 8,696 shares of stock were
committed to be released and approximately $190,000 and $179,000 of compensation
expense was recognized, respectively.
NOTE 5. DEFERRED COMPENSATION
Directors and certain executive officers participate in a deferred
compensation plan, which was approved by the Board of Directors on September 24,
1997. This plan generally provides for fixed payments beginning after the
participant retires. Each participant is fully vested in his account balance
under the plan. Directors may elect to defer their directors' fees and executive
officers may elect to defer 25% of their salary and 100% of bonus compensation.
Prior to the Conversion, amounts deferred by each participant accumulated
interest at a rate equal to the highest rate of interest paid on the Bank's
one-year certificates of deposit. In connection with the Conversion,
participants in the plan were given the opportunity to prospectively elect to
have their deferred compensation balance earn a rate of return equal to the
total return of the Company's stock. All participants elected this option
concurrent with the Conversion, so the Company purchases its common stock to
fund this obligation. Refer to the Company's notes to consolidated financial
statements, incorporated by reference in the Company's 2002 Annual Report on
Form 10-K for a discussion of the Company's accounting policy with respect to
this deferred compensation plan and the related treasury stock purchased by the
Company to fund this obligation.
The expense related to this plan for the three months ended December 31,
2002 and 2001 was $60,000 and $92,000, respectively. This expense is included in
compensation expense.
NOTE 6. MANAGEMENT RECOGNITION PLAN
The Company has a Management Recognition Plan ("MRP") which serves as a
means of providing existing directors and officers of the bank with an ownership
interest in the company. On June 6, 2000, restricted stock awards of 126,482
shares were granted. The shares awarded under the MRP were issued from
authorized but unissued shares of common stock at no cost to the recipients. The
shares vest at a rate of 33 1/3% per year with a one-third immediate vest on the
date of the grant and annually thereafter. The Company recorded no compensation
expense associated with the MRP during the three months ended December 31, 2002
as all shares became fully vested in June 2002. Compensation expense of $260,000
associated with the MRP was recorded during the three months ended December 31,
2001.
NOTE 7. STOCK OPTION AND INCENTIVE PLAN
On June 6, 2000 the Company's stockholders approved the 1st State Bancorp,
Inc. 2000 Stock Option and Incentive Plan (the "Plan"). The purpose of this plan
is to advance the interests of the Company through providing select key
employees and directors of the Bank with the opportunity to acquire shares. By
encouraging such stock ownership, the Company seeks to attract, retain and
motivate the best available personnel for positions of substantial
responsibility and to provide incentives to the key employees and directors.
Under the Plan, the Company granted 316,312 options to purchase its $0.01 par
value common stock. The exercise price per share is equal to the fair market
value per share on the date of the grant. Options granted under the Stock Option
Plan are 100% vested on the date of the grant, and all options expire 10 years
from the date of the grant. As a result of the one-time cash dividend of $5.17
paid on October 2, 2000, the exercise price for the options repriced from $18.44
to $14.71. No options were exercised or granted during the three months ended
December 31, 2002 and 2001. At December 31, 2002, 316,312 options are
outstanding, all of which are exercisable.
NOTE 8. MORTGAGE SERVICING RIGHTS
The rights to service mortgage loans for others are included in other
assets on the consolidated balance sheet. Mortgage servicing rights ("MSRs") are
capitalized based on the allocated cost which is determined when the underlying
loans are sold. MSRs are amortized over a period which approximates the life of
the underlying loan as an adjustment of servicing income. Impairment reviews of
MSRs are performed on a quarterly basis. As of December 31, 2002 and September
30, 2002, MSRs totaled $407,000 and $370,000, respectively, and no valuation
allowance was required.
7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
When used in this Form 10-Q, the words or phrases "will likely result,"
"are expected to," "will continue," "is anticipated," "estimate," "project" or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties including changes in
economic conditions in our market area, changes in policies by regulatory
agencies, fluctuations in interest rates, demand for loans in our market area,
and competition that could cause actual results to differ materially from
historical earnings and those presently anticipated or projected. We wish to
caution you not to place undue reliance on any such forward-looking statements,
which speak only as of the date made. We wish to advise you that the factors
listed above could affect our financial performance and could cause our actual
results for future periods to differ materially from any opinions or statements
expressed with respect to future periods in any current statements.
We do not undertake, and specifically disclaim any obligation, to publicly
release the result of any revisions which may be made to any forward-looking
statements to reflect events or circumstances after the date of such statements
or to reflect the occurrence of anticipated or unanticipated events.
GENERAL
1st State Bancorp, Inc. was formed in November 1998 and became the holding
company for 1st State Bank on April 23, 1999. As a result, portions of this
discussion (as of dates and for periods prior to April 23, 1999) relate to the
financial condition and results of operations of 1st State Bank.
Our business consists principally of attracting deposits from the general
public and investing these funds in loans secured by single-family residential
and commercial real estate, secured and unsecured commercial loans and consumer
loans. Our profitability depends primarily on our net interest income which is
the difference between the income we receive on our loan and investment
securities portfolios and our cost of funds, which consists of interest paid on
deposits and borrowed funds. Net interest income also is affected by the
relative amounts of interest-earning assets and interest-bearing liabilities.
When interest-earning assets approximate or exceed interest-bearing liabilities,
any positive interest rate spread will generate net interest income. Our
profitability also is affected by the level of other income and operating
expenses. Other income consists of miscellaneous fees related to our loans and
deposits, mortgage banking income and commissions from sales of annuities and
mutual funds. Operating expenses consist of compensation and benefits, occupancy
related expenses, federal deposit insurance premiums, data processing,
advertising and other expenses.
Our operations are influenced significantly by local economic conditions
and by policies of financial institution regulatory authorities. Our cost of
funds is influenced by interest rates on competing investments and by rates
offered on similar investments by competing financial institutions in our market
area, as well as general market interest rates. These factors can cause
fluctuations in our net interest income and other income. Lending activities are
affected by the demand for financing of real estate and other types of loans,
which in turn is affected by the interest rates at which such financing may be
offered. In addition, local economic conditions can impact the credit risk of
our loan portfolio, in that local employers may be required to eliminate
employment positions of many of our borrowers, and small businesses and other
commercial borrowers may experience a downturn in their operating performance
and become unable to make timely payments on their loans. Management evaluates
these factors in estimating its allowance for loan losses, and changes in these
economic conditions could result in increases or decreases to the provision for
loan losses.
Our business emphasis has been to operate as a well-capitalized, profitable
and independent community-oriented financial institution dedicated to providing
quality customer service. We are committed to meeting the financial needs of the
communities in which we operate. We believe that we can be more effective in
servicing our customers than many of our nonlocal competitors because of our
ability to quickly and effectively provide senior management responses to
customer needs and inquiries. Our ability to provide these services is enhanced
by the stability of our senior management team.
Beginning in the late 1980's, we have sought to gradually increase the
percentage of our assets invested in commercial real estate loans, commercial
loans and consumer loans, which have shorter terms and adjust more frequently to
changes in interest rates than single-family residential mortgage loans. These
loans generally carry added risk when compared to a single family residential
mortgage loan, so we have concurrently increased our allowance for loan losses
as we have originated these loans.
8
CRITICAL ACCOUNTING POLICIES
The Company's significant accounting policies are set forth in note 1 of
the consolidated financial statements as of September 30, 2002 which was filed
on Form 10-K. Of these significant accounting policies, the Company considers
its policy regarding the allowance for loan losses to be its most critical
accounting policy, because it requires management's most subjective and complex
judgments. In addition, changes in economic conditions can have a significant
impact on the allowance for loan losses and therefore the provision for loan
losses and results of operations. The Company has developed appropriate policies
and procedures for assessing the adequacy of the allowance for loan losses,
recognizing that this process requires a number of assumptions and estimates
with respect to its loan portfolio. The Company's assessments may be impacted in
future periods by changes in economic conditions, the impact of regulatory
examinations, and the discovery of information with respect to borrowers which
is not known to management at the time of the issuance of the consolidated
financial statements.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2002 AND SEPTEMBER 30, 2002
Total assets decreased by $5.0 million or 1.4% from $350.5 million at
September 30, 2002 to $345.4 million at December 31, 2002. An increase in loans
held for sale was offset by decreases in cash and cash equivalents and
investment securities. This increase was funded by a $5.0 million increase in
short-term borrowings from the Federal Home Loan Bank of Atlanta. Deposits
decreased by $9.4 million or 3.6% from $260.7 million at September 30, 2002 to
$251.2 million at December 31,2002. This decrease resulted from the runoff of
$10.4 million of certificates of deposits held by municipalities as part of the
Company's asset liability strategy. This decrease in certificates of deposit was
offset partially by growth in transaction accounts.
Cash and cash equivalents decreased $3.6 million, or 19.0% from $18.9
million at September 30, 2002 to $15.3 million at December 31, 2002. Because of
the decrease in the overnight interest rate to 1.25% during the quarter ended
December 31, 2002, we minimized our investment in cash and cash equivalents
during the quarter ended December 31, 2002.
Investment securities available for sale decreased $2.3 million from $78.6
million at September 30, 2002 to $76.3 million at December 31, 2002. During the
quarter ended December 31, 2002, we purchased $32.2 million of securities and
received $34.3 million in proceeds from maturities and issuer calls of
investment securities available for sale. As market rates remained low during
the quarter ended December 31, 2002, many of the Company's callable investments
were called by the issuers.
Loans held for sale increased by $1.6 million from $6.8 million at
September 30, 2002 to $8.4 million at December 31, 2002. Loans receivable, net
decreased $132,000 from $220.0 million at September 30, 2002 to $219.9 million
at December 31, 2002. The increase in loans held for sale resulted from
increased lending activity and timing differences in the funding of loan sales.
During the quarter our mortgage originations and prepayments continued at record
levels. Mortgage rates declined to record low levels during the quarter, and
many borrowers took advantage of this opportunity to refinance their existing
mortgage loans. Mortgage loans secured by single family dwellings decreased by
$4.8 million during the quarter as a result of the tremendous refinancing
activity. During the quarter ended December 31, 2002, increases in commercial,
construction and home equity line loans offset most of this mortgage loan
decrease.
Stockholders' equity increased by $533,000 from $61.6 million at September
30, 2002 to $62.1 million at December 31, 2002 as a result of net income of
$983,000 and release of ESOP shares of $190,000. These increases were offset by
cash dividends to stockholders declared of $225,000, purchases of treasury stock
of $224,000 and a decrease in unrealized gain on available for sale securities
of $191,000
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED DECEMBER 31, 2002 AND
2001
Net Income. We recorded net income of $983,000 for the quarter ended
December 31, 2002, as compared to $845,000 for the quarter ended December 31,
2001, representing an increase of $138,000, or 16.0%. For the three months ended
December 31, 2002, basic and diluted earnings per share were $0.35 and $0.33,
respectively, compared to the basic and diluted earnings per share for the
quarter ended December 31, 2001 of $0.28 and $0.27, respectively. The increase
in net income resulted primarily from increased net interest income and
decreased operating expenses that were offset partially by decreased other
income and increased income tax expense. The increase in net interest income
resulted from higher net interest margins. The average prime interest rate for
the quarter ended December 31, 2002 was 4.46%, a decrease of 71 basis points
from 5.17% which was the average prime for the quarter ended December 31, 2001.
The repricing of certificates of deposits decreased the Company's cost of funds
to offset the decrease in asset yield which resulted from the lower prevailing
interest rates during the quarter ended December 31, 2002.
Net Interest Income. Net interest income, the difference between interest
earned on loans and investments and interest paid on interest-bearing
liabilities, increased by $154,000 or 5.4% for the three months ended December
31, 2002, compared to the same quarter in the prior year. This decrease results
from a $649,000 decrease in interest income that was more than offset by
9
the $803,000 decrease in total interest expense. The average net interest rate
spread increased 43 basis points from 2.80% for the three months ended December
31, 2001 to 3.23% for the quarter ended December 31, 2002.
Interest Income. The decrease in interest income for the three months ended
December 31, 2002 was the result of a decrease of $2.2 million in average
interest-earning assets compared to the same quarter in the prior year and a
decrease in yield on interest-earning assets of 75 basis points from 6.38% for
the three months ended December 31, 2001 to 5.63% for the three months ended
December 31, 2002. Average investment securities decreased $518,000 and average
interest-bearing overnight funds decreased $4.4 million for the quarter compared
to the prior year. These decreases were offset in part by an increase in average
loans receivable of $2.7 million. We experienced unusually heavy prepayments
during the quarter as borrowers took advantage of the attractive mortgage rates
and refinanced existing mortgage loans. The majority of the mortgage loans
originated during the quarter were sold in the secondary market. The origination
of commercial, construction and home equity loans during the quarter ended
December 31, 2002 offset the decrease in first mortgage loans.
Interest Expense. Interest expense decreased in the three months ended
December 31, 2002 due to a decrease in average interest-bearing liabilities of
$3.4 million and a decrease in the cost of interest-bearing liabilities of 118
basis points from 3.58% for the three months ended December 31, 2001 to 2.40%
for the three months ended December 31, 2002. Average interest-bearing deposits
decreased by $3.6 million while average FHLB advances increased $218,000 for the
three months ended December 31, 2002 compared to the same quarter in the prior
year. The decrease in average interest-bearing liabilities decreased interest
expense by approximately $28,000 and the decrease in the average cost of
interest-bearing liabilities decreased interest expense by approximately
$775,000.
The following table presents average balances and average rates earned/paid
by the Company for the quarter ended December 31, 2002 compared to the quarter
ended December 31, 2001.
THREE MONTHS ENDED THREE MONTHS ENDED
DECEMBER 31, 2002 DECEMBER 31, 2001
DOLLARS IN THOUSANDS
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST YIELD/COST BALANCE INTEREST YIELD/COST
Assets:
Loans receivable (1) $226,969 $3,372 5.94% $224,268 $3,905 6.96%
Investment securities (2) 84,869 1,152 5.43 85,387 1,222 5.72
Interest-bearing overnight deposits 12,928 43 1.33 17,288 90 2.08
-------- ------ ----- -------- ------ -----
Total interest-earning assets (4) 324,766 4,567 5.63 326,943 5,217 6.38
Non interest-earning assets 19,192 21,785
-------- --------
Total assets $343,958 $348,728
======== ========
Liabilities and stockholders' equity
Interest bearing checking 33,712 39 0.46 30,839 40 0.52
Money market investment accounts 21,595 58 1.08 28,732 119 1.65
Passbook and statement savings 29,208 81 1.11 26,218 111 1.69
Certificates of deposit 156,527 1,113 2.84 158,868 1,824 4.59
FHLB advances 20,272 276 5.46 20,054 276 5.50
-------- ------ ----- -------- ------ -----
Total interest-bearing liabilities 261,314 1,567 2.40 264,711 2,370 3.58
Non interest-bearing liabilities 20,770 20,101
-------- --------
Total liabilities 282,084 284,812
Stockholders' equity 61,874 63,916
-------- --------
Total liabilities and stockholders' equity $343,958 $348,728
======== ========
Net interest income 3,000 2,847
Interest rate spread 3.23% 2.80%
Net interest margin (3) 3.69% 3.48%
Ratio of average interest-earning assets
to average interest-bearing liabilities 124.28% 123.51%
________
(1) Includes nonaccrual loans and loans held for sale, net of discounts and
allowance for loan losses.
(2) Includes FHLB of Atlanta stock.
(3) Represents net interest income divided by the average balance of
interest-earning assets.
(4) Due to immateriality, the interest income and yields related to certain tax
exempt assets have not been adjusted to reflect a fully taxable equivalent
yield.
10
Provision for Loan Losses. We charge provisions for loan losses to earnings
to maintain the total allowance for loan losses at a level we consider adequate
to provide for probable loan losses, based on existing loan levels and types of
loans outstanding, nonperforming loans, prior loss experience, general economic
conditions and other factors. We estimate the allowance using an allowance for
loan losses model which takes into considerations all of these factors. Our
policies require the review of assets on a regular basis, and we assign risk
grades to loans based on the relative risk of the credit, considering such
factors as repayment experience, value of collateral, guarantors, etc. Our
credit management systems have resulted in low loss experience; however, there
can be no assurances that such experience will continue. We believe we use the
best information available to make a determination with respect to the allowance
for loan losses, recognizing that future adjustments may be necessary depending
upon a change in economic conditions. The provision for loan losses was $60,000
and net charge-offs were $2,000 for the year quarter December 31, 2002 compared
with a provision of $60,000, and net charge-offs of $84,000 for the quarter
ended December 31, 2001. Nonperforming assets at December 31, 2002 and September
30, 2002 were $4.8 million and $4.4 million, respectively. The majority of the
non-performing loans resulted from two unrelated, unique credits which are not
necessarily indicative of the credit quality of the entire portfolio. There was
no significant impact on the provision as these loans are well secured by
property and equipment. The provision for the quarter ended December 31, 2002
was positively impacted by the decrease in charge-offs which was offset by the
shift in the loan portfolio to commercial loans which receive higher allocations
in the allowance for loan losses model. The Company made no significant changes
to the allowance for loan losses methodology during the period which impacted
the provision for loan losses.
During the quarter ended December 31, 2002 commercial, construction and
home equity loans continued to increase as well as the percentages of these
loans to the total portfolio. Although these loans normally have a relatively
short maturity management believes that there is greater risk inherent in these
loans than the typical one-to-four family residential mortgage loan. Therefore,
management assigns these types of loans a higher risk weighting in the analysis
of the loan loss reserve. The commercial loans that have been originated are
loans made to businesses to either produce a product, sell a product or provide
a service. Many of these loans are asset-based loans which are loans where
repayment is based primarily on the cash flow from operations and secondarily
on, the liquidation of assets such as inventory and accounts receivable.
Other Income. Other income decreased $50,000, or 5.9%, from $843,000 for
the quarter ended December 31, 2001 to $793,000 for the quarter ended December
31, 2002. Customer service fees decreased $32,000, or 12.9% from $249,000 for
the quarter ended December 31, 2001 to $217,000 for the quarter ended December
31, 2002. This decrease results from a shift of accounts into products that have
lower service charges. As a result of the mortgage loan refinancing activity,
the heavy loan prepayments caused the Company's amortization of mortgage
servicing rights to exceed the loan servicing fees received for the quarter
ended December 31, 2002 by $15,000 which compares with mortgage servicing fees
of $6,000 for the quarter ended December 31, 2001.
Operating Expenses. Total operating expenses were $2.2 million for the
quarter ended December 31, 2002, a decrease of $78,000, or 3.5% over the $2.3
million recorded for the three months ended December 31, 2001. Compensation and
related benefits expense decreased $187,000 from $1.6 million for the quarter
ended December 31, 2001 to $1.4 million for the quarter ended December 31, 2002.
Of this decrease, $260,000 resulted from lower MRP expense in the quarter ended
December 31, 2002. Compensation and related benefits expense for the quarter
ended December 31, 2001 included $260,000 of MRP expense which was not present
in 2002 as the final vesting date for the MRPs was June 6, 2002. Partially
offsetting this decrease was increased personnel expense related to increased
number of employees and increased salary and benefit costs. Occupancy and
equipment expense increased $48,000, or 15.8% from $303,000 for the quarter
ended December 31, 2001 to $351,000 for the quarter ended December 31, 2002.
This increase was primarily the result of increased depreciation and increased
property taxes. Expenses incurred in operating real estate owned were $18,000
for the three months ended December 31, 2001 compared to expenses of $6,000 for
the quarter ended December 31, 2002. Other expenses increased $73,000 from
$372,000 reported in the quarter ended December 31, 2001 to $445,000 for the
quarter ended December 31, 2002. This increase was related to larger
expenditures for marketing and advertising expenses and expenses related to
operating a public company.
Income Tax Expense. Income tax expense increased $44,000 from tax expense
of $527,000 for the quarter ended December 31, 2001 to $571,000 for the quarter
ended December 31, 2002. The effective tax rates were 36.7% and 38.4% for the
quarters ended December 31, 2002 and 2001, respectively. The decrease in the
effective rate was primarily due to a decrease in non-deductible expenses over
the prior period.
COMMITMENTS, CONTINGENCIES AND OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet risk
including commitments to extend credit under existing lines of credit and
commitments to sell loans. These instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the consolidated balance sheets.
11
Off-balance sheet financial instruments whose contract amounts represent
credit and interest rate risk are summarized as follows:
December 31, 2002 September 30, 2002
----------------- ------------------
(dollars in thousands)
Commitments to originate new loans 3,769 1,435
Unfunded commitments to extend credit under existing
equity line and commercial lines of credit 70,316 56,200
Commercial letters of credit 300 266
Commitments to sell loans held for sale 12,319 2,157
The Company does not have any special purpose entities or other similar
forms of off-balance sheet financing arrangements.
Commitments to originate new loans or to extend credit are agreements to
lend to a customer as long as there is no violation of any condition established
in the contract. Loan commitments generally expire within 30 to 45 days. Most
equity line commitments are for a term of 15 years, and commercial lines of
credit are generally renewable on an annual basis. Commitments generally have
fixed expiration dates or other termination clauses and may require payment of a
fee. Since many of the commitments are expected to expire without being drawn
upon, the total commitment amounts do not necessarily represent future cash
requirements. The Company evaluates each customer's creditworthiness on a
case-by-case basis. The amounts of collateral obtained, if deemed necessary by
the Company upon extension of credit, is based on management's credit evaluation
of the borrower.
Commitments to sell loans held for sale are agreements to sell loans to a
third party at an agreed upon price. At December 31, 2002, the aggregate fair
value of these commitments exceeded the book value of the loans to be sold.
CONTRACTUAL OBLIGATIONS
As of December 31, 2002
Payments due by period
----------------------
(Dollars in thousands)
Less than
1 year 1-3 years 4-5 years Over 5 years Total
-------- --------- --------- ------------ -------
Deposits $214,890 26,415 9,929 -- 251,234
Advances from FHLB 5,000 -- -- 20,000 25,000
Lease obligations 19 38 42 47 146
-------- ------ ----- ------ -------
Total contractual cash
obligations $219,909 26,453 9,971 20,047 276,380
======== ====== ===== ====== =======
ASSET QUALITY
At December 31, 2002, the Company had approximately $4.8 million in
non-performing assets (nonaccrual loans and real estate owned) or 1.40% of total
assets. At September 30, 2002, non-performing assets were $4.4 million or 1.25%
of total assets. At both December 31, 2002 and September 30, 2002, impaired
loans totaled $3.7 million, as defined by Statement of Financial Accounting
Standards No. 114, "Accounting by Creditors for Impairment of a Loan." The
impaired loans at December 31, 2002 and September 30, 2002 result from two
unrelated commercial loan customers, both of which have loans secured by
commercial real estate and business assets in Alamance County. At both December
31, 2002 and September 30, 2002, the entire $3.7 million of the impaired loans
are on non-accrual status, and their related reserve for loan losses totaled
$160,000. The average carrying value of impaired loans was $3.7 million during
the three months ended December 31, 2002. Interest income of $40,000 has been
recorded on impaired loans in the three months ended December 31, 2002. The
Bank's net chargeoffs for the three months ended December 31, 2002 were $2,000.
The Bank's allowance for loan losses was $3.8 million at December 31, 2002 and
$3.7 million at September 30, 2002. As a result of our continued shift toward
commercial, construction, consumer and home equity loans, the recent decrease in
residential mortgage loans, the increase in non-performing loans as a percentage
of total loans as well as the continued decline in the local and regional
economy, the ratio of the allowance for loan losses to total loans, net of loans
in process and deferred loan fees increased to 1.69% at December 31, 2002
compared to 1.67% at September 30, 2002.
12
The following table presents an analysis of our nonperforming assets:
At At At
December 31, September 30, December 31,
2002 2002 2001
--------- --------- --------
Nonperforming loans:
Nonaccrual loans $ 4,659 $ 4,204 $ 380
Loans 90 days past due and accruing -- -- -
Restructured loans -- -- -
--------- --------- --------
Total nonperforming loans 4,659 4,204 380
Other real estate 183 183 2,328
--------- --------- --------
Total nonperforming assets $ 4,842 $ 4,387 $ 2,708
========= ========= ========
Nonperforming loans to loans receivable, net 2.12% 1.91% 0.18%
Nonperforming assets as a percentage
of loans and other real estate owned 2.20% 1.99% 1.25%
Nonperforming assets to total assets 1.40% 1.25% 0.77%
Regulations require that we classify our assets on a regular basis. There
are three classifications for problem assets: substandard, doubtful and loss. We
regularly review our assets to determine whether any assets require
classification or re-classification. At December 31, 2002, we had $5.4 million
in classified assets consisting of $5.2 million in substandard and loss loans
and $183,000 in real estate owned. At September 30, 2002, we had $5.1 million in
substandard assets consisting of $4.9 million in loans and $183,000 in real
estate owned.
In addition to regulatory classifications, we also classify as "special
mention" and "watch" assets that are currently performing in accordance with
their contractual terms but may become classified or nonperforming assets in the
future. At December 31, 2002, we have identified approximately $1.2 million in
assets classified as special mention and $30.6 million as watch.
LIQUIDITY AND CAPITAL RESOURCES
The Bank must meet certain liquidity requirements established by the State
of North Carolina Office of the Commissioner of Banks (the "Commissioner"). At
December 31, 2002, the Bank's liquidity ratio exceeded such requirements.
Liquidity generally refers to the Bank's ability to generate adequate amounts of
funds to meet its cash needs. Adequate liquidity guarantees that sufficient
funds are available to meet deposit withdrawals, fund loan commitments, maintain
adequate reserve requirements, pay operating expenses, provide funds for debt
service, pay dividends to stockholders and meet other general commitments.
Our primary sources of funds are deposits, principal and interest payments
on loans, proceeds from the sale of loans, and to a lesser extent, advances from
the FHLB of Atlanta. While maturities and scheduled amortization of loans are
predictable sources of funds, deposit flows and mortgage prepayments are greatly
influenced by general interest rates, economic conditions and local competition.
Our most liquid assets are cash and cash equivalents. The levels of these
assets are dependent on our operating, financing, lending and investing
activities during any given period. At December 31, 2002, cash and cash
equivalents totaled $15.3 million. We have other sources of liquidity should we
need additional funds. During the three months ended December 31, 2002, we sold
loans totaling $24.8 million. Additional sources of funds include FHLB of
Atlanta advances. Other sources of liquidity include loans and investment
securities designated as available for sale, which totaled $84.7 million at
December 31, 2002.
We anticipate that we will have sufficient funds available to meet our
current commitments. At December 31, 2002, we had $3.8 million in commitments to
originate new loans, $70.3 million in unfunded commitments to extend credit
under existing equity lines and commercial lines of credit and $300,000 in
standby letters of credit. At December 31, 2002, certificates of deposit, which
are scheduled to mature within one year, totaled $114.0 million. We believe that
a significant portion of such deposits will remain with us.
The FDIC requires the Bank to meet a minimum leverage capital requirement
of Tier I capital to assets ratio of 4%. The FDIC also requires the Bank to meet
a ratio of total capital to risk-weighted assets of 8%, of which 4% must be in
the form of Tier
13
I capital. The Commissioner requires the Bank at all times to maintain certain
minimum capital levels. The Bank was in compliance with all capital requirements
of the FDIC and the Commissioner at December 31, 2002 and is deemed to be "well
capitalized."
The Federal Reserve also mandates capital requirements on all bank holding
companies, including 1st State Bancorp, Inc. These capital requirements are
similar to those imposed by the FDIC on the Bank. At December 31, 2002, the
Company was in compliance with the capital requirements of the Federal Reserve.
On October 2, 2000, the Company paid a one-time special cash distribution
of $5.17 to its stockholders. The distribution was made to manage the Company's
capital and enhance shareholder value. Returning capital to the stockholders
reduced the Company's equity to asset ratio from 21.2% to 17.2%. The Company's
equity to asset ratio at December 31, 2002 was 18.0%. The Company's capital
level is sufficient to support future growth.
The Company has declared cash dividends per common share of $0.08 for the
first quarter in fiscal 2003 and fiscal 2002. The Company's ability to pay
dividends is dependent upon earnings. The Company's dividend payout ratio for
the three months ended December 31, 2002, September 30, 2002 and December 31,
2001 was 24.2%, 26.4% and 29.6%, respectively.
ACCOUNTING ISSUES
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 141 (SFAS No. 141), "Business Combinations", and Statement of Financial
Accounting Standards No. 142 (SFAS No. 142), "Goodwill and Other Intangible
Assets". SFAS No. 141 requires that the purchase method of accounting be used
for all business combinations initiated after June 30, 2001. SFAS No. 141 also
specifies criteria which must be met for intangible assets acquired in a
purchase method business combination to be recognized and reported apart from
goodwill. SFAS No. 142 requires that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of SFAS No. 142.
SFAS No. 142 also requires that identifiable intangible assets with definite
useful lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with
Statement 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of". The adoption of SFAS No. 141 and SFAS No.
142 did not have a material effect on the Company's consolidated financial
statements other than providing enhanced disclosures for mortgage servicing
rights. For the periods presented herein, the Company had no goodwill and had no
intangible assets related to deposit and branch purchase acquisitions.
On October 3, 2001, the FASB issued Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" (SFAS No. 144), which addresses financial accounting and reporting for
the impairment or disposal of long-lived assets. While SFAS No. 144 supercedes
SFAS No. 121 (Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of), it retains many of the fundamental
provisions of SFAS No. 121. SFAS No. 144 also supersedes the accounting and
reporting provisions of FASB Opinion No. 30 (Reporting the Results of Operations
- Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions) for
the disposal of a segment of a business. However, it retains the requirement in
Opinion No. 30 to report separately discontinued operations and extends the
reporting to a component of an entity that either has been disposed of (by sale,
abandonment, or in a distribution to owners) or is classified as held for sale.
By broadening the presentation of discontinued operations to include more
disposal transactions, the FASB has enhanced management's ability to provide
information that helps financial statement users to assess the effects of
disposal transactions on the ongoing operations of an entity. The provisions of
SFAS No. 144 are effective for financial statements issued for fiscal years
beginning after December 15, 2001, and interim periods within those fiscal
years. Adoption of SFAS No. 144 did not have a material impact on the Company's
consolidated financial statements.
In June 2002, the FASB issued Statement of Financial Accounting Standards
No. 146 (SFAS No. 146), "Accounting for Costs Associated with Exit or Disposal
Activities," which addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." This Statement applies to costs associated
with an exit activity that does not involve an entity newly acquired in a
business combination or with a disposal activity covered by SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets." Those costs
include, but are not limited to, the following: a) termination benefits provided
to current employees that are involuntarily terminated under the terms of a
benefit arrangement that, in substance, is not an ongoing benefit arrangement or
an individual deferred compensation contract (hereinafter referred to as
one-time termination benefits), b) costs to terminate a contract that is not a
capital lease and c) costs to consolidate facilities or relocate employees. This
Statement does not apply to costs associated with the retirement of a long-lived
asset covered by FASB Statement No. 143, "Accounting for Asset Retirement
Obligations." A liability for a cost associated with an exit or disposal
activity shall be recognized and measured initially at its fair value in the
period in which the liability is incurred. A liability for a cost associated
with an exit or disposal activity is incurred when the
14
definition of a liability is met. The provisions of this Statement are effective
for exit or disposal activities that are initiated after December 31, 2002, with
early application encouraged. This statement will impact the Company to the
extent it engages in exit or disposal activities in future periods.
In September 2002, the FASB issued Statement of Financial Accounting
Standards No. 147 (SFAS No. 147), "Accounting for Certain Financial
Institutions", which brings all business combinations involving financial
institutions, except mutual financial institutions, into the scope of Statement
141, "Business Combinations". SFAS No. 147 requires that all acquisitions of
financial institutions that meet the definition of a business, including
acquisitions of part of a financial institution that meet the definition of a
business, must be accounted for in accordance with SFAS No. 141 and the related
intangibles accounted for in accordance with SFAS No. 142. SFAS No. 147 removes
such acquisitions from the scope of Statement 72 (SFAS No. 72, "Accounting for
Certain Acquisitions of Banking or Thrift Institutions", which was adopted in
February 1983 to address financial institutions acquisitions during a period
when many of such acquisitions involved "troubled" institutions. SFAS No. 147
also amends SFAS No. 144 to include in its scope long-term customer relationship
intangibles of financial institutions. SFAS No. 147 is generally effective
immediately and provides guidance with respect to amortization and impairment of
intangibles recognized in connection with acquisitions previously within the
scope of SFAS No. 72. Adoption of SFAS No. 147 did not impact the Company as the
Company has no goodwill and no intangible assets related to deposit and branch
acquisitions.
In November 2002, the FASB issued Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others", which addresses the disclosure
to be made by a guarantor in its interim and annual financial statements about
its obligations under guarantees. FIN 45 requires the guarantor to recognize a
liability for the non-contingent component of the guarantee, such as the
obligation to stand ready to perform in the event that specified triggering
events or conditions occur. The initial measurement of this liability is the
fair value of the guarantee at inception. The recognition of the liability is
required even if it is not probable that payments will be required under the
guarantee or if the guarantee was issued with a premium payment or as part of a
transaction with multiple events. The disclosure requirements are effective for
interim and annual financial statements ending after December 15, 2002. The
initial recognition and measurement provisions are effective for all guarantees
within the scope of FIN 45 issued or modified after December 31, 2002. The
Company issues standby letters of credit whereby the Company guarantees
performance if a specified triggering event or condition occurs (primarily
nonperformance under construction contracts entered into by construction
customers.) The guarantees generally expire within one year and may be
automatically renewed depending on the terms of the guarantee. The maximum
potential amount of undiscounted future payments related to standby letters of
credit at December 31, 2002 is $300,000. At December 31, 2002, the Company has
recorded no liability for the current carrying amount of the obligation to
perform as a guarantor and no contingent liability is considered necessary, as
such amounts are deemed immaterial. Substantially all standby letters of credit
are secured by real estate and/or guaranteed by third parties in the event the
Company had to advance funds to fulfill the guarantee.
In December 2002, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure' (SFAS 148) an amendment of FASB
Statement No. 123, Accounting for Stock-Based Compensation (SFAS 123), which
provides alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The transition provisions of the statement are
effective for financial statements for fiscal years ending after December 15,
2002 while the disclosure requirements are effective for interim periods
beginning after December 15, 2002, with early application encouraged. The
adoption of SFAS 148 will require enhanced disclosures for the Company's
stock-based employee compensation plan effective January 1, 2003.
15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company monitors whether material changes in market risk have occurred
since September 30, 2002. The Company does not believe that any material adverse
changes in market risk exposures occurred since September 30, 2002.
ITEM 4. CONTROLS AND PROCEDURES
(a) Within 90 days prior to the date of this report, we carried out an
evaluation, under the supervision and with the participation of our principal
executive officer and principal financial officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based on this
evaluation, our principal executive officer and principal financial officer
concluded that our disclosure controls and procedures are effective in timely
alerting them to material information required to be included in our periodic
SEC reports.
(b) In addition, there have been no significant changes in our internal
controls or in other factors that could significantly affect those controls
subsequent to the date of their last evaluation.
16
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a.) Exhibits
99 Certification
(b.) Reports on Form 8-K. During the quarter ended December 31, 2002, the
registrant did not file any current reports on Form 8-K.
17
SIGNATURES
Pursuant to the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
1ST STATE BANCORP, INC.
Date: February 14, 2003 /s/ James C. McGill
--------------------------------------------
James C. McGill
President and Chief Executive Officer
(Principal Executive Officer)
Date: February 14, 2003 /s/ A. Christine Baker
--------------------------------------------
A. Christine Baker
Executive Vice President
Treasurer and Secretary
(Principal Financial and Accounting Officer)
18
CERTIFICATION
I, James C. McGill, President and Chief Executive Officer of 1st State Bancorp,
Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of 1st State Bancorp,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: February 14, 2003
By: /s/ James C. McGill
--------------------------------------------
Name: James C. McGill
Title: President and Chief Executive Officer
CERTIFICATION
I, A. Christine Baker, Secretary, Treasurer and Chief Financial Officer of 1st
State Bancorp, Inc,, certify that:
1. I have reviewed this quarterly report on Form 10-Q of 1st State Bancorp,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: February 14, 2003
By: /s/ A. Christine Baker
-------------------------------------
Name: A. Christine Baker
Title: Secretary, Treasurer and
Chief Financial Officer