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UNITED STATES 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 September 30, 2004
Commission File Number 0-23971
Citizens South Banking Corporation
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 54-2069979
- ------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
519 South New Hope Road, Gastonia, North Carolina 28054-4040
------------------------------------------------------------
(Address of principal executive offices)
Registrant's telephone number, including area code: (704) 868-5200
Indicate by check |X| 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 |_|
Indicate by check whether the Registrant is an accelerated filer. Yes |X|
No |_|
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
Common stock, $0.01 par value
7,432,044 shares outstanding as of November 9, 2004.
Citizens South Banking Corporation
INDEX
Page
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PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements........................... 1
Consolidated Statements of Financial Condition
September 30, 2004 and December 31, 2003 .................. 1
Consolidated Statements of Operations
three months and nine months ended September 30, 2004
and 2003 .................................................. 2
Consolidated Statements of Comprehensive Income
nine months ended September 30, 2004 and 2003.............. 3
Consolidated Statements of Changes in Stockholders'
Equity nine months ended September 30, 2004 and 2003....... 4
Consolidated Statements of Cash Flows
nine months ended September 30, 2004 and 2003.............. 5
Notes to Consolidated Financial Statements..................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations......................... 9
Item 3. Quantitative and Qualitative Disclosures About
Market Risk................................................. 16
Item 4. Controls and Procedures..................................... 16
PART II. OTHER INFORMATION................................................ 16
SIGNATURES................................................................ 19
Exhibit 31.1 Certification of Chief Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002............................................ 20
Exhibit 31.2 Certification of Chief Financial Officer Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002....... 21
Exhibit 32.1 Statement of Chief Executive Officer Furnished
Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002............................................ 22
Exhibit 32.2 Statement of Chief Financial Officer Furnished
Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002............................................ 23
PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements
Citizens South Banking Corporation
Consolidated Statements of Financial Condition
(dollars in thousands, except per share data)
September 30, December 31,
2004 2003
------------- ------------
(unaudited)
Assets:
Cash and due from banks...................................................... $ 6,097 $ 5,374
Interest-earning bank balances............................................... 850 2,840
---------- ----------
Cash and cash equivalents................................................. 6,947 8,214
Investment securities available-for-sale, at fair value...................... 55,983 56,233
Mortgage-backed and related securities available-for-sale, at fair value..... 86,485 89,168
Loans receivable, net of unearned income..................................... 311,380 297,995
Allowance for loan losses.................................................... (2,916) (2,969)
---------- ----------
Loans, net................................................................ 308,464 295,026
Real estate owned ........................................................... 227 145
Accrued interest receivable.................................................. 1,614 1,943
Premises and equipment, net.................................................. 17,689 14,939
Federal Home Loan Bank stock................................................. 2,900 2,915
Cash value of bank-owned life insurance policies ............................ 12,779 12,317
Intangible assets............................................................ 7,659 7,985
Other assets................................................................. 6,039 6,866
---------- ----------
Total assets.............................................................. $ 506,786 $ 495,751
========== ==========
Liabilities and Stockholders' Equity:
Demand deposit accounts...................................................... $ 50,491 $ 43,686
Money market deposit accounts................................................ 67,410 48,189
Savings accounts ............................................................ 29,618 36,754
Time deposits................................................................ 224,085 213,817
---------- ----------
Total deposits............................................................ 371,604 342,446
Borrowed money............................................................... 55,819 58,981
Deferred compensation........................................................ 5,751 6,165
Other liabilities............................................................ 942 490
---------- ----------
Total liabilities......................................................... 434,116 408,082
Common stock, $0.01 par value, 20,000,000 shares authorized, 9,062,727
shares issued and outstanding at September 30, 2004 and
December 31, 2003......................................................... 91 91
Additional paid-in-capital................................................... 68,280 68,280
Unallocated common stock held by Employee Stock Ownership Plan .............. (1,842) (1,979)
Retained earnings, substantially restricted.................................. 29,967 28,824
Accumulated unrealized loss on securities available-for-sale, net of tax..... (439) (40)
Unearned compensation related to Recognition and Retention Plan.............. (1,712) (1,979)
Treasury stock of 1,610,683 shares at September 30, 2004, and 392,414
shares at December 31, 2003, at cost....................................... (21,675) (5,528)
---------- ----------
Total stockholders' equity................................................ 72,670 87,669
---------- ----------
Total liabilities and stockholders' equity ............................... $ 506,786 $ 495,751
========== ==========
See accompanying notes to consolidated financial statements.
2
Citizens South Banking Corporation
Consolidated Statements of Operations (unaudited)
(in thousands, except per share data)
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
2004 2003 2004 2003
---- ---- ---- ----
Interest Income:
Loans....................................................... $ 4,044 $ 4,077 $ 11,752 $ 12,910
Investment securities....................................... 490 311 1,448 1,000
Interest-bearing deposits................................... 47 57 113 219
Mortgage-backed and related securities...................... 737 761 2,155 2,625
-------- -------- -------- --------
Total interest income..................................... 5,318 5,206 15,468 16,754
Interest Expense:
Deposits.................................................... 1,591 1,603 4,478 5,037
Borrowed funds.............................................. 467 599 1,362 1,779
-------- -------- -------- --------
Total interest expense.................................... 2,058 2,202 5,840 6,816
-------- -------- -------- --------
Net interest income......................................... 3,260 3,004 9,628 9,938
Provision for loan losses................................... 60 15 120 45
-------- -------- -------- --------
Net interest income after provision for loan losses....... 3,200 2,989 9,508 9,893
Noninterest Income:
Fee income on deposit accounts.............................. 644 614 1,801 1,791
Income on mortgage banking and other lending activities..... 140 241 427 754
Dividends on FHLB stock..................................... 24 21 69 79
Gain on sale of assets...................................... 13 108 483 168
Fair value adjustment on deferred compensation assets....... 45 (8) 80 179
Other noninterest income.................................... 210 183 707 630
-------- -------- -------- --------
Total noninterest income.................................. 1,076 1,159 3,567 3,601
Noninterest Expense:
Compensation and benefits................................... 1,504 1,511 4,596 4,498
Vesting expense for Recognition and Retention Plan.......... 0 0 267 0
Fair value adjustment on deferred comp. obligations......... 45 (8) 80 179
Occupancy and equipment expense............................. 510 349 1,286 993
Professional services....................................... 136 113 392 444
Amortization of intangible assets........................... 104 91 320 323
Loss on sale of assets...................................... 23 85 23 99
Prepayment penalty on FHLB advances......................... 0 1,289 0 1,289
Other noninterest expense................................... 942 718 2,360 2,217
-------- -------- -------- --------
Total noninterest expense................................. 3,264 4,148 9,324 10,042
Income before income taxes.................................. 1,012 0 3,751 3,452
Provision for income taxes.................................. 242 (94) 1,072 1,028
-------- -------- -------- --------
Net income.................................................. $ 770 $ 94 $ 2,679 $ 2,424
======== ======== ======== =======
Basic earnings per share.................................... $ 0.11 $ 0.01 $ 0.35 $ 0.28
Diluted earnings per share.................................. $ 0.11 $ 0.01 $ 0.34 $ 0.28
Basic average common shares outstanding..................... 7,213,577 8,596,575 7,755,483 8,670,591
Diluted average common shares outstanding................... 7,323,021 8,742,819 7,854,010 8,810,380
See accompanying notes to consolidated financial statements.
3
Citizens South Banking Corporation
Consolidated Statements of Comprehensive Income (unaudited)
(dollars in thousands)
Nine Months Ended
September 30,
-------------------------
2004 2003
---- ----
Net income................................................................ $ 2,679 $ 2,424
Other comprehensive income, net of tax:
Unrealized gains on securities available for sale:
Unrealized holding gains arising during period.................... 689 1,183
Reclassification adjustment for (gains) included in net income.... (290) (43)
---------- ----------
Other comprehensive income............................................ 399 1,140
---------- ----------
Comprehensive income ..................................................... $ 3,078 $ 3,564
---------- ----------
See accompanying notes to consolidated financial statements.
4
Citizens South Banking Corporation
Consolidated Statements of Changes in Stockholders' Equity (unaudited)
(dollars in thousands)
Nine Months Ended
September 30,
-------------------------
2004 2003
---- ----
Common stock:
At beginning of period......................................................... $ 91 $ 91
Issuance of common stock....................................................... 0 0
---------- ----------
At end of period............................................................... 91 91
---------- ----------
Additional paid-in-capital:
At beginning of period......................................................... 68,280 68,176
Allocation from shares purchased with loan from ESOP........................... 0 1
Exercise of options............................................................ 0 150
---------- ----------
At end of period............................................................... 68,280 68,327
---------- ----------
Unallocated common stock held by ESOP:
At beginning of period......................................................... (1,979) (2,162)
Allocation from shares purchased with loan from ESOP........................... 137 138
---------- ----------
At end of period............................................................... (1,842) (2,024)
---------- ----------
Retained earnings, substantially restricted:
At beginning of period......................................................... 28,823 28,739
Net income..................................................................... 2,679 2,424
Cash dividends declared on common stock........................................ (1,535) (1,614)
---------- ----------
At end of period............................................................... 29,967 29,549
---------- ----------
Accumulated unrealized gain on securities available for sale, net of tax:
At beginning of period......................................................... (40) 1,538
Other comprehensive results, net of tax........................................ (399) (1,139)
---------- ----------
At end of period............................................................... (439) 399
---------- ----------
Unearned compensation related to Recognition and Retention Plan:
At beginning of period......................................................... (1,979) 0
Vesting of shares for plan..................................................... 267 0
---------- ----------
At end of period............................................................... (1,712) 0
---------- ----------
Treasury Stock:
At beginning of period......................................................... (5,528) 0
Repurchase of common stock..................................................... (16,147) (4,675)
---------- ----------
At end of period............................................................... (21,675) (4,675)
---------- ----------
See accompanying notes to consolidated financial statements.
5
Citizens South Banking Corporation
Consolidated Statements of Cash Flows (unaudited)
(dollars in thousands)
Nine Months Ended
September 30,
-------------------------
2004 2003
---- ----
Cash flows from operating activities:
Net income........................................................................ $ 2,679 $ 2,424
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses..................................................... 120 45
Depreciation.................................................................. 743 494
Gain on sale of investments, available for sale............................... (454) (68)
Gain on sale of other assets ................................................. (6) (1)
Purchase of bank-owned life insurance......................................... 0 (3,000)
Deferred loan origination fees................................................ (36) 56
Allocation of shares to the ESOP.............................................. 137 140
Vesting of shares for the Recognition and Retention Plan...................... 267 0
Decrease in accrued interest receivable....................................... 329 130
Amortization of intangible assets ............................................ 320 323
Decrease in other assets...................................................... 477 772
Decrease in other liabilities................................................. (380) (2,204)
---------- ----------
Net cash provided by (used for) operating activities........................ 4,196 (889)
Cash flows from investing activities:
Net (increase) decrease in loans receivable....................................... (13,522) 11,106
Proceeds from the sale of investment securities................................... 2,266 7,000
Proceeds from the sale of mortgage-backed securities.............................. 6,432 11,233
Proceeds from the sale of other assets .......................................... 91 1,040
Maturities and prepayments of investment securities............................... 17,914 10,039
Maturities and prepayments of mortgage-backed securities.......................... 17,751 27,051
Purchases of investments.......................................................... (20,298) (30,850)
Purchases of mortgage-backed securities........................................... (21,330) (54,549)
Sale of FHLB stock................................................................ 15 64
Capital expenditures for premises and equipment................................... (3,513) (5,483)
---------- ----------
Net cash used for investment activities..................................... (14,194) (23,349)
Cash flows from financing activities:
Net increase (decrease) in deposits............................................... 29,158 (1,243)
Exercise of options............................................................... 0 150
Dividends paid to stockholders.................................................... (1,535) (1,615)
Repurchase of common stock........................................................ (16,147) (4,676)
Net increase (decrease) in borrowed money......................................... (3,162) 3,880
Increase in advances from borrowers for insurance and taxes....................... 417 270
---------- ----------
Net cash provided by (used for) financing activities........................ 8,731 (3,234)
Net decrease in cash and cash equivalents........................................... (1,267) (27,472)
Cash and cash equivalents at beginning of period.................................... 8,214 46,999
---------- ----------
Cash and cash equivalents at end of period.......................................... $ 6,947 $ 19,527
========== ==========
See accompanying notes to consolidated financial statements.
6
CITIZENS SOUTH BANKING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Basis of Presentation
In management's opinion, the accompanying consolidated financial
statements, which are unaudited, reflect all adjustments, consisting solely of
normal recurring accruals, necessary for a fair presentation of the financial
information as of and for the three- and nine-month periods ended September 30,
2004 and 2003, in conformity with accounting principles generally accepted in
the United States of America. Results for the three and nine months ended
September 30, 2004, are not necessarily indicative of the results that may be
expected for the year ending December 31, 2004.
The consolidated financial statements include the accounts of Citizens
South Banking Corporation (the "Company") and the Company's wholly owned
subsidiary, Citizens South Bank (the "Bank").
The organization and business of the Company, accounting policies
followed, and other related information are contained in the notes to the
consolidated financial statements of the Company as of December 31, 2003 and
2002, and for the years ended December 31, 2003, 2002, and 2001, filed as part
of the Company's annual report on Form 10-K. These consolidated financial
statements should be read in conjunction with the annual consolidated financial
statements.
The Company's critical accounting policy relates to the evaluation of the
allowance for loan losses, which is based on management's opinion of losses in
the Company's existing portfolio. The allowance for loan losses is established
through a provision for loan losses based on available information including the
composition of the loan portfolio, historical loan losses, specific impaired
loans, availability and quality of collateral, age of the various portfolios,
changes in local economic conditions, and loan performance and quality of the
portfolio. Different assumptions used in establishing the Company's allowance
for loan losses could result in material changes in the Company's consolidated
financial condition or consolidated results of operations. The Company's
policies with respect to the methodology for determining the allowance for loan
losses involve a higher degree of complexity and require management to make
subjective judgments that often require assumptions or estimates about uncertain
matters. These critical policies and their assumptions are periodically reviewed
with the Board of Directors.
In accordance with the Statement of Financial Accounting Standards
("SFAS") No. 123, Accounting for Stock-Based Compensation, as amended by SFAS
No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure -
An Amendment of FASB Statement No. 123, the Company has adopted the
disclosure-only option and elected to apply the provisions of APB No. 25 for
financial statement purposes. As such, no stock-based employee compensation cost
is reflected in net income for the Company's stock option plans.
Pro forma information regarding net income and earnings per share have
been determined as if the Company had accounted for its employee stock options
using the fair value method, and is presented in the following table.
7
Three months ended Nine months ended
September 30, September 30,
---------------------------- -----------------------------
2004 2003 2004 2003
---- ---- ---- ----
Net income (in thousands):
As reported $ 770 $ 94 $ 2,679 $ 2,424
Deduct: Total stock-based employee
compensation cost determined under
the fair value method, net of tax (2) (3) (19) (81)
----------- ------------ ------------ ------------
Pro forma $ 768 $ 91 $ 2,660 $ 2,343
----------- ------------ ------------ ------------
Basic earnings per share:
As reported $ 0.11 $ 0.01 $ 0.35 $ 0.28
Pro forma $ 0.11 $ 0.01 $ 0.34 $ 0.27
Diluted earnings per share:
As reported $ 0.11 $ 0.01 $ 0.34 $ 0.28
Pro forma $ 0.11 $ 0.01 $ 0.34 $ 0.27
The fair value of each option grant is estimated on the date of the grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions used for the nine-month periods ended September 30, 2004 and 2003:
dividend yield of 2.0%, expected volatility of 30%, risk-free investment rate of
3.5%, and expected lives of seven years.
Note 2 - Use of Estimates
The financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America which require
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
Note 3 - Earnings per Share
Earnings per share has been determined under the provisions of SFAS No.
128, Earnings Per Share. The only potential stock of the Company, as defined in
SFAS No. 128, Earnings Per Share, is stock options granted to various directors
and officers of the Bank. The following is a summary of the diluted earnings per
share calculation for the nine months ended September 30, 2004 and 2003 (dollars
in thousands, except per share data):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ----------------------------
2004 2003 2004 2003
---- ---- ---- ----
Net income............................... $ 770 $ 94 $ 2,679 $ 2,424
Weighted average outstanding shares ..... 7,213,577 8,596,575 7,755,483
8,670,591................................
Dilutive effect of stock options ........ 109,444 146,244 98,527 139,789
----------- --------- ---------- -------------
Weighted average diluted shares ......... 7,323,021 8,742,819 7,854,010 8,810,380
Diluted earnings per share............... $ 0.11 $ 0.01 $ 0.34 $ 0.28
8
Note 4 - Dividend Declaration
On October 18, 2004, the Board of Directors of the Company approved and
declared a regular cash dividend of six and one-half cents per share of common
stock to stockholders of record as of November 1, 2004, and payable on November
15, 2004.
Note 5 - Stock Repurchase Program
On May 17, 2004, the Board of Directors of the Company authorized the
repurchase of up to 815,000 shares, or approximately 10%, of the Company's
outstanding shares of common stock. The stock repurchase program may be carried
out through open market purchases, block trades, and negotiated private
transactions. The stock may be repurchased on an ongoing basis and will be
subject to the availability of stock, general market conditions, the trading
price of the stock, alternative uses for capital, and the Company's financial
performance. As of September 30, 2004, management had repurchased a total of
706,000 shares at an average price of $13.03 per share and had 109,000 shares
remaining to be repurchased under this plan. Management will consider
repurchasing additional shares of common stock of the Company at prices
management considers to be attractive and in the best interests of both the
Company and its stockholders. Any repurchased shares will be held as treasury
stock and will be available for general corporate purposes.
In October 2003, the Company authorized the repurchase of up to 879,900
shares, or approximately 10%, of the outstanding shares. This repurchase program
was completed in May 2004, with the repurchase of 877,235 shares at an average
price of $13.80. Also, in March 2003 the Company authorized the repurchase of up
to 343,027 shares, or approximately 3.8% of the outstanding shares. This program
was completed in September 2003, with the repurchase of 342,200 shares at an
average price of $13.66.
Note 6 - Impact of Recently Issued Accounting Standards
In March 2004, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 105, Application of Accounting Principles to Loan
Commitments. This Staff Accounting Bulletin summarizes the views of the staff
regarding the application of accounting principles generally accepted in the
United States of America to loan commitments accounted for as derivative
instruments. The adoption of this Staff Accounting Bulletin did not have a
material impact on the consolidated financial statements of the Company.
9
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward Looking Statements
From time to time, the Company may publish forward looking statements
relating to such matters as anticipated financial performance, business
prospects, technological developments, new products, and similar matters. The
Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward looking statements provided that the Company notes that a variety of
factors could cause the Company's actual results to differ materially from the
anticipated results expressed in the Company's forward looking statements.
Factors that may cause actual results to differ materially from those projected
in the forward looking statements include, but are not limited to, general
economic conditions that are less favorable than expected, changes in market
interest rates that result in reduced interest margins, risks in the loan
portfolio, including prepayments, that are greater than expected, legislation or
regulatory changes that have a less than favorable impact on the business of the
Company are enacted, and competitive pressures increase significantly.
Statements included in this report should be read in conjunction with the
Company's Annual Report on Form 10-K, which is incorporated into this discussion
by this reference. Forward looking statements speak only as of the date they are
made and the Company does not undertake to update forward looking statements to
reflect circumstances or events that occur after the date of the forward looking
statements or to reflect the occurrence of unanticipated events. Accordingly,
past results and trends should not be used by investors to anticipate future
results or trends.
Comparison of Financial Condition
Assets. Total assets of the Company increased by $11.0 million, or 2.2%,
from $495.8 million as of December 31, 2003, to $506.8 million as of September
30, 2004. This increase in assets was primarily funded by a $29.2 million
increase in deposits, the effects of which were partially offset by the
repayment of $3.2 million in borrowed funds and the repurchase of 1,230,000
shares of the Company's common stock for $16.1 million. During the nine-month
period cash and cash equivalents decreased by $1.3 million, or 15.4%, to $6.9
million, primarily due to the repurchase of common stock and an increase in
outstanding loans. Also during the period, mortgage-backed securities decreased
$2.7 million, or 3.0%, to $86.5 million and investment securities decreased by
$250,000, or 0.4%, to $56.0 million. During the nine-month period, the Company
sold $6.4 million in mortgage-backed securities and $2.3 million in investment
securities, partly in an effort to reduce the Company's level of interest rate
risk. Also, during the period, the Company had $17.9 million in investment
securities that either matured or were called, the effects of which were offset
by purchases of $20.3 million. The Company also purchased $21.3 million in
mortgage-backed securities and received an additional $17.8 million in principal
payments on mortgage-backed securities. Management expects the investment and
mortgage-backed securities portfolios to decrease as a percentage of total
assets as the cash flows generated from these investments are reinvested into
the loan portfolio.
Loans receivable increased by $13.4 million, or 4.5%, to $311.4 million at
September 30, 2004, as the origination of commercial and consumer loans began to
outpace prepayments on residential mortgage loans. From December 31, 2003 to
September 30, 2004, the percentage of residential mortgage loans to gross loans
decreased from 38.3% to 31.2%. Management will seek to continue to grow the
commercial and consumer loan portfolios in a safe and sound manner with an
emphasis on adjustable-rate loans and shorter-term fixed rate loans. Management
expects that these short-term and adjustable-rate commercial and consumer loans
will have a positive impact on the Company's net interest margin if short-term
interest rates continue to increase.
10
Allowance for loan losses and nonperforming assets. The Company has
established a systematic methodology for determining the adequacy of the
allowance for loan losses. This methodology is set forth in a formal policy and
considers all loans in the portfolio. Specific allowances are established for
certain individual loans that management considers impaired. The remainder of
the portfolio is segmented into groups of loans with similar risk
characteristics for evaluation and analysis. Management's periodic evaluation of
the allowance is consistently applied and based on inherent losses in the
portfolio, past loan loss experience, risks inherent in the different types of
loans, the estimated value of any underlying collateral, current economic
conditions, the borrower's financial position, and other relevant internal and
external factors that may affect loan collectibility. The allowance for loan
losses is increased by charging provisions for loan losses against income. As of
September 30, 2004, the allowance for loan losses was $2.9 million. Management
believes that this amount meets the requirement for losses on loans that
management considers to be impaired, for known losses, and for incurred losses
inherent in the remaining loan portfolio. Although management believes that it
uses the best information available to make such determinations, future
adjustments to the allowance for loan losses may be necessary and results of
operations could be significantly adversely affected if circumstances differ
substantially from the assumptions used in making the determinations. The
following table presents an analysis of changes in the allowance for loan losses
for the periods and information with respect to nonperforming assets at the
dates indicated.
At and For the Three At and For the Nine
Months Ended September 30, Months Ended September 30,
----------------------------- -----------------------------
2004 2003 2004 2003
---- ---- ---- ----
(dollars in thousands) (dollars in thousands)
Allowance for loan losses:
Beginning of period ............. $ 2,902 $ 3,002 $ 2,969 $ 2,995
Add:
Provision for loan losses.... 60 15 120 45
Recoveries................... 2 3 3 5
Less:
Charge-offs.................. 48 13 176 38
---------- --------- ---------- ----------
End of period.................... $ 2,916 $ 3,007 $ 2,916 $ 3,007
Nonaccrual loans................. $ 1,570 $ 1,102 $ 1,570 $ 1,102
Real estate owned................ 227 169 227 169
---------- --------- ---------- ----------
Nonperforming assets............. $ 1,797 $ 1,271 $ 1,797 $ 1,271
Allowance for loan losses as a
percentage of total loans... 0.94% 1.01% 0.94% 1.01%
Nonperforming loans to
total loans................. 0.50% 0.38% 0.50% 0.38%
Nonperforming assets to
total assets............... 0.35% 0.26% 0.35% 0.26%
Liabilities. Total liabilities increased by $26.0 million, or 6.4%, from
$408.1 million as of December 31, 2003, to $434.1 million as of September 30,
2004. This increase was primarily due to a $29.2 million, or 8.5%, increase in
total deposits, the effects of which were partly offset by a $3.2 million, or
5.4%, decrease in borrowed funds. Core deposits (checking accounts, savings
accounts and money market accounts) increased by $18.9 million, or 14.7%, during
the nine month period to $147.5 million. This was primarily due to a
11
continued emphasis on increasing the Company's number of retail and business
checking account customers. Time deposits increased during the nine-month period
by $10.3 million, or 4.8%, to $224.1 million. This increase was largely due to a
marketing campaign during the second quarter commemorating the Bank's 100th
anniversary. During the nine-month period, the Company reduced its outstanding
borrowed funds by $3.2 million. This reduction was primarily due to the
repayment of Federal Home Loan Bank daily rate advances that were used to fund
an increase in loan demand at the end of 2003. These Federal Home Loan Bank
advances were repaid from proceeds received from the increase in local deposits.
Stockholders' Equity. Total stockholders' equity decreased by $15.0
million, or 17.1%, from $87.7 million as of December 31, 2003, to $72.7 million
as of September 30, 2004. The decrease in stockholders' equity was primarily due
to the repurchase of 1,230,000 shares of common stock for $16.1 million, at an
average cost of $13.13 per share. In October 2003, the Company authorized the
repurchase of up to 879,900 shares, or approximately 10%, of the outstanding
shares of common stock. This repurchase program was completed in May 2004 and
the Board of Directors of the Company subsequently authorized the repurchase of
an additional 815,000 shares, or approximately 10%, of the Company's outstanding
shares of common stock. As of September 30, 2004, management had repurchased a
total of 706,000 shares under the current program at an average price of $13.03
per share and had 109,000 shares remaining to be repurchased. Management will
consider repurchasing additional shares of common stock of the Company at prices
that management considers to be attractive and in the best interests of both the
Company and its stockholders. Any repurchased shares will be held as treasury
stock and will be available for general corporate purposes. In addition, the
Company paid cash dividends totaling $1.5 million during the nine-month period,
representing $0.195 per share, and posted a $399,000 increase in unrealized
losses on available for sale securities due to an increase in market interest
rates. These decreases in equity were partially offset by $2.7 million in
earnings during the period.
Comparison of Results of Operations for the Three Months Ended September 30,
2004 and 2003
General. Net income for the three months ended September 30, 2004,
amounted to $770,000, or $0.11 per diluted share, as compared to $94,000, or
$0.01 per diluted share, for the three months ended September 30, 2003. Earnings
for the quarter ended September 30, 2003, reflected a $1.3 million pretax
prepayment penalty associated with the restructuring of $15.0 million in
borrowed money. Excluding the $1.3 million prepayment penalty, earnings for the
quarter ended September 30, 2003, would have been approximately $880,000, or
$0.10 per diluted share, based on an effective tax rate of 39%.
Net interest income. Net interest income increased by $256,000, or 8.5%,
to $3.3 million for the three months ended September 30, 2004. Interest income
increased by $112,000, or 2.2%, primarily as a result of a $4.1 million, or
0.9%, increase in the average outstanding balance of interest-earning assets to
$452.8 million for the three months ended September 30, 2004. The increase in
average interest-earning assets was primarily the result of a $6.3 million, or
2.1%, increase in average outstanding loans to $330.2 million. The Company's
average yield on earning assets remained flat during the comparable periods,
increasing by one basis point to 4.70% for the quarter ended September 30, 2004.
Interest expense decreased by $144,000, or 6.5%, for the comparable quarters.
This reduction in interest expense was due to a 32 basis point, or 13.9%,
reduction in the average cost of funds to 1.99%. This decrease in the cost of
funds was partially offset by a $31.5 million, or 8.3%, increase in the average
balance of interest-bearing liabilities to $409.4 million. Average
interest-bearing liabilities increased primarily as a result of a $16.8 million,
or 15.1%, increase in average core deposits (checking accounts, savings accounts
and money market accounts), coupled with a $13.4 million, or 6.2%, increase in
time deposits. The net interest margin improved 15 basis points, or 6.2%, to
2.58% for the quarter ended September 30, 2004, compared to 2.43% for the
quarter ended September 30, 2003. This increase in the net interest margin was
primarily the result of increased yields
12
on prime-based consumer and commercial loans due to three recent 25 basis point
increases in the prime-lending rate by the Federal Reserve Bank. Approximately
58% of the Company's loans have interest rates that are tied to the
prime-lending rate.
Provision for loan losses. The provision for loan losses amounted to
$60,000 for the three months ended September 30, 2004, compared to $15,000 for
the three months ended September 30, 2003. The allowance for loan losses was
$2.9 million, or 0.94% of total loans, as of September 30, 2004, compared to
$3.0 million, or 1.01% of total loans, as of September 30, 2003. While the
Company continues to emphasize commercial loans and consumer loans that are
generally secured by real estate, in addition to residential mortgage loans, the
Company's ratio of nonperforming loans to total loans remains below our peer
group average, at 0.50% of total loans on September 30, 2004, compared to 0.28%
of total loans on September 30, 2003. Approximately 98% of the Company's
nonperforming loans at September 30, 2004, were secured by real estate.
Noninterest income. Noninterest income decreased to $1.1 million for the
three months ended September 30, 2004, as compared to $1.2 million for the three
months ended September 30, 2003. This represented a decrease of $83,000, or
7.2%. This decrease was primarily due to a $101,000, or 41.9 %, decrease in fees
generated from mortgage brokerage and other lending activities. Mortgage
brokerage activity has decreased due to higher interest rates resulting in fewer
residential loan originations. Management expects that the level of residential
loan originations in 2004 will continue to be significantly less than the 2003
level. The decreases in noninterest income were partly offset by a $30,000, or
4.9%, increase in fee income on deposit accounts and a $27,000, or 14.8%,
increase in other income. Fee income on deposits improved due to an increased
number of deposit customers. Management has focused on growing the number of
deposit customers and increasing the number of banking products used by existing
customers. The increase in other noninterest income was primarily due to an
increase in the cash value of bank-owned life insurance, resulting from the
purchase of an additional $3.0 million in bank-owned life insurance in 2003.
Also, the Company experienced a $53,000 increase in the fair value adjustment on
deferred compensation assets, the effects of which are offset by a corresponding
increase in noninterest expense.
During the quarter ended September 30, 2004, the Company recognized a gain
of $13,000 on the sale of miscellaneous fixed assets. During the quarter ended
September 30, 2003, the Company recognized a gain of $108,000 from the sale of
$3.9 million in mortgage-backed securities.
Noninterest expense. Noninterest expense decreased from $4.1 million for
the quarter ended September 30, 2003, to $3.3 million for the quarter ended
September 30, 2004. This represents a decrease of $884,000, or 21.3%. This
decrease was partly due to a $1.3 million prepayment penalty associated with the
restructuring of $15.0 million in borrowed funds. Excluding this prepayment
penalty, noninterest expense for the quarter ended September 30, 2003, would
have been $2.8 million, which is $405,000, or 14.2%, less than the quarter ended
September 30, 2004. During the third quarter of 2004 occupancy and equipment
expense increased by $161,000, or 46.1%, and other expenses increased by
$224,000, or 31.2%, compared to the third quarter of 2003. These increases were
primarily due to expenses associated with relocating an existing branch office
to a more visible location, renovations to two existing offices to improve
customer service, opening a new full service office, adding ATMs to three
existing offices, moving the corporate office to a more accessible location,
consolidating the back office functions into one location, and updating the
Company's computer system. These improvements in the Company's infrastructure
should enable the Company to pursue additional growth both internally through
offering improved products and services and externally through acquisitions in
order to enhance the franchise value of the Company. Also, the Company
experienced a $53,000 increase in the fair value adjustment on deferred
compensation, the effects of which are offset by a corresponding increase in
other noninterest income. There were also smaller increases in noninterest
expense for professional services of
13
$23,000, or 20.4%, due to expenses associated with compliance with the
Sarbanes-Oxley Act of 2002 and organizational costs related to the Company's
Hispanic banking project which began operation in the fourth quarter of 2004.
Losses on the sale of assets amounted to $23,000 for the quarter ended
September 30, 2004, resulting from the sale of foreclosed properties and
miscellaneous fixed assets. For the quarter ended September 30, 2003, the
Company recognized a loss of $85,000 resulting from the sale of $6.8 million in
mortgage-backed securities.
Income taxes. Income taxes amounted to $242,000, or 23.9% of taxable
income, for the quarter ended September 30, 2004, as compared to a $94,000 tax
benefit for the quarter ended September 30, 2003. The 23.9% effective tax rate
for the third quarter of 2004 was primarily due to having a higher percentage of
net income before taxes being derived from tax-advantaged sources than in
previous quarters. These tax-advantaged sources include investments such as
municipal securities and bank-owned life insurance. As the Company continues to
increase the amount of income derived from interest income on loans and fee
income on deposits, the effective tax rate is expected to increase.
Comparison of Results of Operations for the Nine Months Ended September 30, 2004
and 2003
General. Net income for the nine months ended September 30, 2004, amounted
to $2.7 million, or $0.34 per diluted share, as compared to $2.4 million, or
$0.28 per diluted share, for the nine months ended September 30, 2003. Earnings
for the nine months ended September 30, 2003, reflected a $1.3 million pretax
prepayment penalty associated with the restructuring of $15.0 million in
borrowed money. Excluding the $1.3 million prepayment penalty, earnings for the
nine months ended September 30, 2003, would have been approximately $3.2
million, or $0.36 per diluted share, based on an effective tax rate of 39%.
Net interest income. Net interest income decreased by $310,000, or 3.1%,
to $9.6 million for the nine months ended September 30, 2004. Interest income
decreased by $1.3 million, or 7.7%, primarily as a result of a 35 basis point,
or 7.0%, decrease in the average yield on earning assets to 4.66%. The decrease
in yield was primarily due to a 50 basis point decrease in the prime lending
rate during the second quarter of 2003, the effects of which were partially
offset by three recent 25 basis point increases in the prime-lending rate. In
addition, the average outstanding balance of interest earning assets decreased
by $7.7 million, or 1.7%, to $444.4 million. This decrease in average interest
earning assets related to the Company's funding of the repurchase of $21.3
million shares of common stock. Interest expense decreased by $976,000, or
14.3%, to $5.8 million during the comparable periods. This reduction in interest
expense was due to a 45 basis point, or 18.7%, reduction in the average cost of
funds to 1.96%. This decrease in the cost of funds was partially offset by a
$17.3 million, or 4.6%, increase in the average balance of interest-bearing
liabilities to $396.0 million. Average interest-bearing liabilities increased
primarily as a result of a $13.0 million increase in average core deposits
(checking accounts, savings accounts and money market accounts). The net
interest margin was 2.58% for the nine months ended September 30, 2004, compared
to 2.67% for the nine months ended September 30, 2003. This decrease was
primarily due to an increased level of mortgage loan refinancings that resulted
in higher levels of liquidity and decreased yields on loans.
Provision for loan losses. The provision for loan losses amounted to
$120,000 for the nine months ended September 30, 2004, compared to $45,000 for
the nine months ended September 30, 2003. The allowance for loan losses was $2.9
million, or 0.94% of total loans, as of September 30, 2004, compared to $3.0
million, or 1.01% as of September 30, 2003. While the Company continues to
emphasize commercial loans and consumer loans that are generally secured by real
estate, in addition to residential mortgage loans, the Company's ratio of
nonperforming loans to total loans remains below our peer group average, at
0.50%
14
of total loans on September 30, 2004, compared to 0.28% of total loans on
September 30, 2003. Approximately 98% of the Company's nonperforming loans at
September 30, 2004, were secured by real estate.
Noninterest income. Noninterest income decreased by $34,000, or 0.9%, to
$3.6 million for the nine months ended September 30, 2004. This decrease was
primarily due to a $327,000, or 43.4%, decrease in fee income from mortgage
brokerage and other lending activities resulting from decreased levels of
residential loan originations. Management expects that the level of residential
loan originations in 2004 will continue to be significantly less than the 2003
level. Also, during the period, the fair value adjustment on deferred
compensation assets decreased by $99,000, the effects of which were offset by a
corresponding decrease in noninterest expense. These decreases were mostly
offset by a $77,000, or 12.2%, increase in other noninterest income, which was
primarily due to the purchase of $3.0 million in bank-owned life insurance.
Also, fee income on deposit accounts increased slightly due to an increased
number of deposit customers. Management has focused on growing the number of
deposit customers and increasing the number of banking products used by existing
customers.
During the nine months ended September 30, 2004, the Company recognized a
gain of $483,000 on the sale of $2.3 million in investment securities, $6.4
million in mortgage-backed securities, and $91,000 in foreclosed properties and
other miscellaneous fixed assets. The purpose of the sale of securities was to
offset the expense from the vesting of a portion of the shares of stock issued
by the Company's Recognition and Retention Plan approved by the shareholders in
2003 and to reduce the Company's level of interest rate risk. During the nine
months ended September 30, 2003, the Company recognized a gain of $168,000
resulting from the sale of $5.0 million in investment securities and $3.9
million in mortgage-backed securities.
Noninterest expense. Noninterest expense decreased $718,000, or 7.2%, to
$9.3 million for the nine months ended September 30, 2004. During the nine
months ended September 30, 2003, the Company recognized a $1.3 million
prepayment penalty related to the restructure of $15.0 million in advances.
Excluding this item, noninterest expenses would have been $8.8 million. This
would have resulted in an increase of $571,000, or 6.5%, from the comparable
periods. This increase was partly due to the $267,000 expense from the vesting
of a portion of the stock issued through the Company's Recognition and Retention
Plan. Also, occupancy and equipment expense increased by $293,000, or 29.5%, and
other noninterest expense increased by $144,000, or 6.5%. These increases were
primarily due to expenses associated with relocating an existing branch office
to a more visible location, renovations to two existing offices to improve
customer service, opening a new full service office, adding ATMs to three
existing offices, moving the corporate office to a more accessible location,
consolidating the back office functions into one location, and updating the
Company's computer system. These improvements in the Company's infrastructure
should enable the Company to pursue additional growth both internally through
offering improved products and services and externally through acquisitions in
order to enhance the franchise value of the Company. These increases were
offset, in part, by a $52,000, or 11.7%, decrease in professional services and a
$99,000 reduction in the fair value adjustment on deferred compensation assets,
the effects of which were offset by a corresponding decrease of noninterest
income.
Losses on the sale of assets amounted to $23,000 for the nine months ended
September 30, 2004, resulting from the sale of foreclosed properties and
miscellaneous fixed assets. For the nine months ended September 30, 2003, the
Company recognized a loss of $99,000 resulting from the sale of $7.3 million in
mortgage-backed securities and $2.0 million in investment securities.
Income taxes. Income taxes amounted to $1.1 million, or 28.6% of taxable
income, for the nine months ended September 30, 2004, as compared to $1.0
million, or 29.8% of taxable income, for the nine
15
months ended September 30, 2003. This increase in income taxes is primarily due
to a $299,000 increase in net income before taxes. The reduction in the
estimated effective rate was due to an increase in the percentage of earnings
derived from tax-advantaged assets such as municipal securities and bank-owned
life insurance.
Liquidity, Market Risk, and Capital Resources
The objectives of the Company's liquidity management policy include
providing adequate funds to meet the cash needs of both borrowers and
depositors, to provide for the on-going operations of the Company, and to
capitalize on opportunities for expansion. Liquidity management addresses the
Company's ability to meet deposit withdrawals on demand or at contractual
maturity, to repay borrowings as they mature, and to fund new loans and
investments as opportunities arise. The primary sources of internally generated
funds are principal and interest payments on loans receivable, increases in
local deposits, cash flows generated from operations, and cash flows generated
by investments. If the Company requires funds beyond its internal funding
capabilities, it may rely upon external sources of funds such as brokered
deposits and Federal Home Loan Bank of Atlanta ("FHLB") advances. The Company
has $71.1 million in additional advances available from its line of credit from
the FHLB. The FHLB functions as a central reserve bank providing credit for
member financial institutions. As a member of the FHLB, we are required to own
capital stock in the FHLB and we are authorized to apply for advances on the
security of such stock and certain of our mortgage loans and other assets
(principally securities that are obligations of, or guaranteed by, the U.S.
Government) provided certain creditworthiness standards have been met. Advances
are made pursuant to several different credit programs. Each credit program has
its own interest rate and range of maturities. Depending on the program,
limitations on the amount of advances are based on the financial condition of
the member institution and the adequacy of collateral pledged to secure the
credit. The Company may also solicit brokered deposits for providing funds for
asset growth; however, to date, the Company has not used such deposits to
supplement its liquidity position. The Company believes that it has sufficient
sources of liquidity to fund the cash needs of both borrowers and depositors, to
provide for the on-going operations of the Company, and to capitalize on
opportunities for expansion.
In the normal course of business, various commitments are outstanding that
are not reflected in the consolidated financial statements. Commitments to
extend credit and undisbursed advances on customer lines of credit are
agreements to lend to a customer as long as there is no violation of any
condition established in the contract. The funding of these commitments and
previously approved undisbursed lines of credit could effect the Company's
liquidity position. At September 30, 2004, the Company had loan commitments of
$11.8 million, unused lines of credit of $72.2 million, and undisbursed
construction loan proceeds of $11.1 million. The Company believes that it has
adequate resources to fund loan commitments and lines of credit as they arise.
The Company does not have any special purpose entities or other similar forms of
off-balance sheet financing.
The Company's most significant form of market risk is interest rate risk,
as the Company's assets and liabilities are sensitive to changes in interest
rates. The Company's Asset / Liability Committee ("ALCO") is responsible for
monitoring its level of interest rate risk and ensuring compliance with
Board-adopted limits. There were no changes in the Company's asset or liability
composition that could result in a material change in the Company's analysis of
interest rate sensitivity as discussed in the Company's Annual Report on Form
10-K for the year ended December 31, 2003.
The Bank is subject to various regulatory capital requirements
administered by the banking regulatory agencies. As of September 30, 2004,
Citizens South Bank's capital exceeded all applicable regulatory requirements.
Citizens South Bank's Tier I capital was $59.5 million, or 12.0% of adjusted
total assets. The minimum Tier I capital ratio is 4.00%. Failure to meet minimum
capital requirements can
16
initiate certain mandatory and possibly discretionary actions by the regulators
that, if undertaken, could have a direct material effect on the Bank's financial
statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Bank must meet specific capital guidelines that
involve quantitative measures of the Bank's assets, liabilities, and certain
off-balance sheet items as calculated under regulatory accounting practices. The
Bank's capital amounts and classifications are subject to qualitative judgments
by the regulators about components, risk-weightings, and other factors.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
The information required by this item is included above in Item 2,
Management's Discussion and Analysis of Financial Condition and Results of
Operations, under the caption "Liquidity, Market Risk, and Capital Resources."
ITEM 4. Controls and Procedures
Under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief Financial
Officer, the Company has evaluated the effectiveness of the design and operation
of its disclosure controls and procedures (as defined in Rule 13a-15(e) and
15d-15(e) under the Exchange Act) as of the end of the period covered by this
report. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that, as of the end of the period covered by this
report, the Company's disclosure controls and procedures were effective to
ensure that information required to be disclosed in the reports that the Company
files or submits under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the SEC's rules and forms and in
timely alerting them to material information relating to the Company (or its
consolidated subsidiaries) required to be filed in its periodic SEC filings.
There has been no change in the Company's internal control over financial
reporting identified in connection with the quarterly evaluation that occurred
during the Company's last fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
PART II. OTHER INFORMATION
Legal Proceedings
There are various claims and lawsuits in which the Bank is periodically
involved incidental to the Company's business. In the opinion of management, no
material loss is expected from any of such pending claims or lawsuits.
17
Changes in Securities and Use of Proceeds
During the three-month period ended September 30, 2004, the Company
repurchased 70,000 shares of common stock for $908,000, at an average cost of
$12.98 per share as detailed in the following table:
- ------------------------------------------------------------------------------------------------------------------
Total Number Average Price Total Number of Shares Maximum Number of Shares that May
Period of Shares Paid per Share Purchased as Part of the be Purchased Under Current
Purchased Current Repurchase Plan Repurchase Plan
- ------------------------------------------------------------------------------------------------------------------
July 30,000 $13.02 666,000 149,000
- ------------------------------------------------------------------------------------------------------------------
August 20,000 $12.89 686,000 129,000
- ------------------------------------------------------------------------------------------------------------------
September 20,000 $13.00 706,000 109,000
- ------------------------------------------------------------------------------------------------------------------
Total 70,000 $12.98 706,000 109,000
- ------------------------------------------------------------------------------------------------------------------
On May 17, 2004, the Board of Directors of the Company authorized the
repurchase of up to 815,000 shares, or approximately 10% of the Company's
outstanding shares of common stock. The stock repurchase program may be carried
out through open market purchases, block trades, and negotiated private
transactions. The stock may be repurchased on an ongoing basis and will be
subject to the availability of stock, general market conditions, the trading
price of the stock, alternative uses for capital, and the Company's financial
performance. As of September 30, 2004, management had repurchased a total of
706,000 shares at an average price of $13.03 per share and had 109,000 shares
remaining to be repurchased under this plan.
Defaults Upon Senior Securities
Not applicable.
Submission of Matters to a Vote of Security Holders
There were no meetings of the shareholders during the quarter ended
September 30, 2004.
18
Exhibits.
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Written statement of Chief Executive Officer furnished pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Written statement of Chief Financial Officer furnished pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed by the undersigned thereunto
duly authorized.
Citizens South Banking Corporation
Date: November 9, 2004 By: /s/ Kim S. Price
-------------------------------------
Kim S. Price
President and Chief Executive Officer
Date: November 9, 2004 By: /s/ Gary F. Hoskins
-------------------------------------
Gary F. Hoskins
Executive Vice President,
Chief Financial Officer and Treasurer
20