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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
-------------------------
FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2004
---------------
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number: 0-24626
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COOPERATIVE BANKSHARES, INC.
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(Exact name of registrant as specified in its charter)
North Carolina 56-1886527
- ------------------------------ ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
201 Market Street, Wilmington, North Carolina 28401
- --------------------------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (910) 343-0181
--------------
Former name, former address and former fiscal year, if changed since last
report.
N/A
- --------------------------------------------------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 of 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.
/X/ Yes / / No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
/ / Yes /X/ No
APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares
outstanding of each of the issuer's classes of common stock, as of the latest
practicable date. 2,860,764 shares at July 30, 2004
----------------------------------
1
TABLE OF CONTENTS
Page
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Part I Financial Information
Item 1 Financial Statements
Consolidated Statements of Financial Condition, June 30, 2004 and
December 31, 2003 3
Consolidated Statements of Operations, for the three months and
six months ended June 30, 2004 and 2003 4
Consolidated Statement of Stockholders' Equity, for the six months
ended June 30, 2004 5
Consolidated Statements of Cash Flows, for the six months ended
June 30, 2004 and 2003 6-7
Notes to Consolidated Financial Statements 8-9
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations 10-16
Item 3 Quantitative and Qualitative Disclosures About Market Risk 17
Item 4 Controls and Procedures 17
Part II Other Information
Item 1 Legal Proceedings 18
Item 2 Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities 18
Item 3 Defaults Upon Senior Securities 18
Item 4 Submission of Matters to a Vote of Security Holders 18
Item 5 Other Information 18
Item 6 Exhibits and Reports on Form 8-K 19
Signatures 20
Exhibit 31.1 21
Exhibit 31.2 22
Exhibit 32 23
2
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30, 2004 December 31, 2003*
------------- ------------------
(unaudited)
ASSETS
Cash and due from banks, noninterest-bearing ................... $ 12,936,662 $ 14,400,034
Interest-bearing deposits in other banks ....................... -- 3,993,331
------------- -------------
Total cash and cash equivalents .............................. 12,936,662 18,393,365
Securities:
Available for sale (amortized cost of $45,866,038 in June 2004
and $43,180,913 in December 2003) ........................... 45,544,754 43,613,112
Held to maturity (estimated market value of $2,997,265 in June
2004 and $3,889,736 in December 2003) ....................... 3,016,187 3,806,376
FHLB stock ..................................................... 4,654,300 4,154,400
Loans held for sale ............................................ 6,270,315 6,375,275
Loans .......................................................... 434,822,516 404,820,362
Less allowance for loan losses ............................... 3,918,635 3,447,002
------------- -------------
Net loans .................................................. 430,903,881 401,373,360
Other real estate owned ........................................ 172,070 --
Accrued interest receivable .................................... 1,901,822 1,852,366
Premises and equipment, net .................................... 8,490,409 8,665,698
Goodwill ....................................................... 1,461,543 1,461,543
Other assets ................................................... 12,524,220 12,741,394
------------- -------------
Total assets ........................................... $ 527,876,163 $ 502,436,889
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits ....................................................... $ 380,595,343 $ 367,202,433
Short-term borrowings .......................................... 36,359,543 41,416,785
Escrow deposits ................................................ 357,285 199,433
Accrued interest payable ....................................... 193,389 180,067
Accrued expenses and other liabilities ......................... 2,893,978 2,207,003
Long-term obligations .......................................... 63,085,258 48,087,770
------------- -------------
Total liabilities ......................................... 483,484,796 459,293,491
Stockholders' equity:
Preferred stock, $1 par value, 3,000,000 shares authorized,
no shares issued and outstanding ............................. -- --
Common stock, $1 par value, 7,000,000 shares authorized,
2,860,764 and 2,849,447 shares issued and outstanding ........ 2,860,764 2,849,447
Additional paid-in capital ..................................... 2,673,233 2,638,044
Accumulated other comprehensive income (loss) .................. (212,047) 285,251
Retained earnings .............................................. 39,069,417 37,370,656
------------- -------------
Total stockholders' equity ................................ 44,391,367 43,143,398
------------- -------------
Total liabilities and stockholders' equity ............. $ 527,876,163 $ 502,436,889
============= =============
Book value per common share ...................................... $ 15.52 $ 15.14
============= =============
*Derived from audited consolidated financial statements.
The accompanying notes are an integral part of the consolidated financial
statements.
3
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
------------ ------------ ------------ -------------
Interest income:
Loans ...................................................... $ 6,091,877 $ 6,572,050 $12,036,711 $13,136,122
Securities ................................................. 556,521 528,897 1,118,604 1,131,988
Other ...................................................... 7,886 14,185 17,767 23,991
Dividends on FHLB stock .................................... 37,371 37,849 73,107 83,424
----------- ------------ ----------- -----------
Total interest income ................................. 6,693,655 7,152,981 13,246,189 14,375,525
----------- ------------ ----------- -----------
Interest expense:
Deposits ................................................... 1,471,973 1,904,065 2,978,798 3,942,326
Borrowed funds ............................................. 692,385 889,958 1,364,395 1,781,900
----------- ------------ ----------- -----------
Total interest expense ................................ 2,164,358 2,794,023 4,343,193 5,724,226
----------- ------------ ----------- -----------
Net interest income .......................................... 4,529,297 4,358,958 8,902,996 8,651,299
Provision for loan losses .................................... 300,000 180,000 520,000 380,000
----------- ------------ ----------- -----------
Net interest income after provision for loan losses ... 4,229,297 4,178,958 8,382,996 8,271,299
----------- ------------ ----------- -----------
Noninterest income:
Gain on sale of loans ..................................... 697,290 1,156,740 1,277,459 2,134,197
Service charges and fees on loans ......................... 122,385 153,269 192,098 302,420
Deposit-related fees ...................................... 394,447 376,644 758,540 633,515
Bank-owned life insurance earnings ........................ 84,405 89,910 171,013 186,984
Other income, net ......................................... 58,841 41,879 103,749 94,004
----------- ------------ ----------- -----------
Total noninterest income .............................. 1,357,368 1,818,442 2,502,859 3,351,120
----------- ------------ ----------- -----------
Noninterest expense:
Compensation and fringe benefits .......................... 2,409,441 2,478,979 4,705,847 4,747,569
Occupancy and equipment ................................... 810,112 660,138 1,634,417 1,307,569
Professional and examination fees ......................... 93,055 112,461 224,276 213,708
Advertising ............................................... 117,990 145,541 242,970 266,097
Real estate owned ......................................... (1,527) 15,651 (1,096) 33,541
Other ..................................................... 494,951 466,964 1,018,051 929,517
----------- ------------ ----------- -----------
Total noninterest expense ............................... 3,924,022 3,879,734 7,824,465 7,498,001
----------- ------------ ----------- -----------
Income before income taxes ................................... 1,662,643 2,117,666 3,061,390 4,124,418
Income tax expense ........................................... 539,061 694,427 1,019,337 1,313,529
----------- ------------ ----------- -----------
Net income ................................................... $ 1,123,582 $ 1,423,239 $ 2,042,053 $ 2,810,889
=========== ============ =========== ===========
Net income per share:
Basic ..................................................... $ 0.39 $ 0.50 $ 0.71 $ 0.99
=========== ============ =========== ===========
Diluted ................................................... $ 0.39 $ 0.49 $ 0.70 $ 0.97
=========== ============ =========== ===========
Weighted average common shares outstanding:
Basic ..................................................... 2,860,764 2,847,847 2,858,152 2,846,313
=========== ============ =========== ===========
Diluted ................................................... 2,909,148 2,895,190 2,911,248 2,891,285
=========== ============ =========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
4
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Unaudited)
Accumulated
Additional other Total
Common paid-in comprehensive Retained stockholders'
stock capital income (loss) earnings equity
------ ------------ ------------- -------- -------------
Balance, December 31, 2003 ................. $ 2,849,447 $ 2,638,044 $ 285,251 $ 37,370,656 $ 43,143,398
Exercise of stock options ................ 14,000 104,625 -- -- 118,625
Stock traded to exercise options
(2,683 shares) ......................... (2,683) (69,436) (72,119)
Other comprehensive
loss, net of taxes ...................... -- -- (497,298) -- (497,298)
Net income ............................... -- -- -- 2,042,053 2,042,053
Cash dividends ($.12 per share) .......... -- -- -- (343,292) (343,292)
------------ ------------ ------------ ------------ ------------
Balance, June 30, 2004 ..................... $ 2,860,764 $ 2,673,233 $ (212,047) $ 39,069,417 $ 44,391,367
============ ============ ============ ============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
5
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
2004 2003
----------- -----------
OPERATING ACTIVITIES:
Net income $ 2,042,053 $ 2,810,889
Adjustments to reconcile net income to net cash
provided by operating activities:
Net accretion, amortization, and depreciation 505,073 648,648
Net gain on sale of loans (1,277,459) (2,259,078)
Provision for deferred income taxes (201,172) (151,752)
Loss on sale of premises and equipment 3,412 -
Loss (gain) on sales of foreclosed real estate (1,565) 3,711
Valuation losses on foreclosed real estate 16,400 116,543
Provision for loan losses 520,000 380,000
Proceeds from sale of loans held for sale 81,552,706 136,366,033
Loan originations held for sale (80,179,066) (136,047,055)
Changes in assets and liabilities:
Accrued interest receivable (49,456) 120,247
Prepaid expenses and other assets 674,531 (1,060,909)
Accrued interest payable 13,322 (35,887)
Accrued expenses and other liabilities 686,975 (1,466,816)
------------ -------------
Net cash provided (used) by operating activities 4,305,754 (575,426)
------------ -------------
INVESTING ACTIVITIES:
Purchases of securities available for sale (5,493,265) -
Proceeds from maturity of securities available for sale 200,000 -
Repayments of mortgage-backed securities available for sale 2,575,050 5,926,289
Repayments of mortgage-backed securities held to maturity 790,422 1,052,741
Net sales (purchases) of FHLB stock (499,900) 50,100
Loan originations, net of principal repayments (30,235,695) (4,431,624)
Proceeds from disposals of foreclosed real estate 16,535 87,807
Additions to other real estate owned (9,487) (8,236)
Purchases of premises and equipment (300,339) (1,746,387)
Proceeds from sale of premises and equipment - 1,691
------------ -------------
Net cash provided (used) in investing activities (32,956,679) 932,381
------------ -------------
FINANCING ACTIVITIES:
Net increase in deposits 13,392,910 16,373,435
Net change in short-term borrowings (57,242) (629,003)
Repayments on long-term obligations (2,512) (2,378)
Proceeds received on long-term obligations 10,000,000 -
Proceeds from issuance of common stock 46,506 184,508
Dividends paid (343,292) (284,795)
Net change in escrow deposits 157,852 180,251
------------ -------------
Net cash provided by financing activities 23,194,222 15,822,018
------------ -------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (5,456,703) 16,178,973
CASH AND CASH EQUIVALENTS:
BEGINNING OF PERIOD 18,393,365 11,858,603
------------ -------------
END OF PERIOD $ 12,936,662 $ 28,037,576
============ =============
(Continued)
6
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
Six Months Ended
June 30,
2004 2003
--------------- ----------------
Cash paid for:
Interest $ 4,329,871 $ 5,760,113
Income taxes 810,900 1,537,652
Summary of noncash investing and financing activities:
Transfer from loans to foreclosed real estate 305,678 479,462
Loans to faciliatate the sale of foreclosed real estate 111,725 -
Unrealized loss on securities available for sale,
net of taxes (497,298) (137,211)
Reclassifications between long-term obligations
and short-term borrowings 5,000,000 10,000,000
The accompanying notes are an integral part of the consolidated financial
statements.
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Accounting Policies: The significant accounting policies followed by
---------------------
Cooperative Bankshares, Inc. (the "Company") for interim financial
reporting are consistent with the accounting policies followed for annual
financial reporting. These unaudited consolidated financial statements have
been prepared in accordance with Rule 10-01 of Regulation S-X, and, in
management's opinion, all adjustments of a normal recurring nature
necessary for a fair presentation have been included. The accompanying
consolidated financial statements do not purport to contain all the
necessary financial disclosures that might otherwise be necessary in the
circumstances and should be read in conjunction with the consolidated
financial statements and notes thereto in the Company's annual report for
the year ended December 31, 2003 (the "Annual Report"). The results of
operations for the six-month period ended June 30, 2004 are not necessarily
indicative of the results to be expected for the full year.
2. Basis of Presentation: The accompanying unaudited consolidated financial
----------------------
statements include the accounts of Cooperative Bankshares, Inc.,
Cooperative Bank (the "Bank") and its wholly owned subsidiaries, Lumina
Mortgage Company, Inc. ("Lumina") and CS&L Holdings, Inc. ("Holdings"), and
Holdings' majority owned subsidiary, CS&L Real Estate Trust, Inc. (the
"REIT"). All significant intercompany items have been eliminated. Certain
items for prior periods have been reclassified to conform to the current
period presentation. These reclassifications have no effect on the net
income or stockholders' equity as previously reported.
3. Earnings per Share: Earnings per share (EPS) are calculated by dividing net
-------------------
income by the weighted average number of common shares outstanding (basic
EPS) and the sum of the weighted average number of common shares
outstanding and potential common stock (diluted EPS). Potential common
stock consists of stock options issued and outstanding. In determining the
number of shares of potential common stock, the treasury stock method was
applied. This method assumes that the number of shares issuable upon
exercise of the stock options is reduced by the number of common shares
assumed purchased at market prices with the proceeds from the assumed
exercise of the common stock options plus any tax benefits received as a
result of the assumed exercise. The following table provides a
reconciliation of income available to common stockholders and the average
number of shares outstanding for the periods below:
Three months ended Six months ended
June 30, June 30,
2004 2003 2004 2003
----------- ----------- ----------- -----------
Net income (numerator) $ 1,123,582 $ 1,423,239 $ 2,042,053 $ 2,810,889
Shares for basic EPS (denominator) 2,860,764 2,847,947 2,858,152 2,846,313
Dilutive effect of stock options 48,384 47,243 53,096 44,972
----------- ----------- ----------- -----------
Shares for diluted EPS (denominator) 2,909,148 2,895,190 2,911,248 2,891,285
=========== =========== =========== ===========
For the six months ended June 30, 2004 and 2003, there were 4,000 and 4,204
options outstanding respectively that were antidilutive since the exercise price
exceeds the average market price. The options have been omitted from the
calculation of the dilutive effect of stock options.
8
4. Comprehensive Income: Comprehensive income includes net income and all
----------------------
other changes to the Company's equity, with the exception of transactions
with shareholders ("other comprehensive income"). The Company's only
components of other comprehensive income relate to unrealized gains and
losses on available for sale securities. The following table sets forth the
components of other comprehensive income and total comprehensive income for
the three and six months ended June 30:
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
----------- ----------- ----------- -----------
Net income $ 1,123,582 $ 1,423,239 $ 2,042,053 $ 2,810,889
Other comprehensive loss
Unrealized losses on available for sale securities (1,149,854) (114,400) (753,483) (286,820)
Income tax benefit 390,950 38,896 256,185 149,609
----------- ----------- ----------- -----------
Other comprehensive loss (758,904) (75,504) (497,298) (137,211)
----------- ----------- ----------- -----------
Comprehensive income $ 364,678 $ 1,347,735 $ 1,544,755 $ 2,673,678
=========== =========== =========== ===========
5. Stock-Based Compensation: On January 1, 1996 the Company adopted SFAS No.
--------------------------
123, "Accounting for Stock-Based Compensation". As permitted by SFAS No.
123, the Company has chosen to continue to apply APB Opinion No. 25,
"Accounting for Stock Issued to Employees" and related interpretations. The
option exercise price is the market price of the common stock on the date
the option is granted. Accordingly, no compensation cost has been
recognized for options granted under the Option Plan. Had compensation cost
for the Company's Option Plan been determined based on the fair value at
the grant dates for awards under the option plan consistent with the method
of SFAS No. 123, the Company's net income and net income per share would
have been reduced to the pro forma amounts indicated below.
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Net income, as reported $1,123,582 $1,423,239 $2,042,053 $2,810,889
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects -- -- (23,054) --
---------- ---------- ---------- ----------
Pro forma net income $1,123,582 $1,423,239 $2,018,999 $2,810,889
========== ========== ========== ==========
Earnings per share:
Basic-as reported $ 0.39 $ 0.50 $ 0.71 $ 0.99
========== ========== ========== ==========
Basic-pro forma $ 0.39 $ 0.50 $ 0.71 $ 0.99
========== ========== ========== ==========
Diluted-as reported $ 0.39 $ 0.49 $ 0.70 $ 0.97
========== ========== ========== ==========
Diluted-pro forma $ 0.39 $ 0.49 $ 0.69 $ 0.97
========== ========== ========== ==========
9
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Cooperative Bankshares, Inc. (the "Company") is a registered bank holding
company incorporated in North Carolina in 1994. The Company is the parent
company of Cooperative Bank (the "Bank"), a North Carolina chartered commercial
bank. Cooperative Bank, headquartered in Wilmington, North Carolina, was
chartered in 1898. The Bank provides financial services through 21 offices in
Eastern North Carolina. One of the Bank's subsidiaries, Lumina Mortgage Company,
Inc. ("Lumina") is a mortgage banking firm originating and selling residential
mortgage loans through offices in Wilmington, North Carolina; North Myrtle
Beach, South Carolina; and Virginia Beach, Virginia. The Bank's other
subsidiary, CS&L Holdings, Inc. ("Holdings"), is a holding company incorporated
in Virginia for CS&L Real Estate Trust, Inc. (the "REIT"), which is a real
estate investment trust.
Through its offices, the Bank provides a wide range of banking products,
including interest-bearing and noninterest-bearing checking accounts,
certificates of deposit and individual retirement accounts which are insured up
to the applicable limits of the Federal Deposit Insurance Corporation ("FDIC").
It offers an array of loan products: overdraft protection, commercial, consumer,
agricultural, real estate, residential mortgage and home equity loans. Also
offered are safe deposit boxes, ATMs and Access24 Phone Banking, as well as,
online banking and bill payment. In addition, the Bank offers discount brokerage
services, annuity sales and mutual funds through a third party arrangement with
UVEST Investment Services.
MISSION STATEMENT
It is the mission of the Company to provide the maximum in safety and security
for our depositors, an equitable rate of return for our stockholders, excellent
service for our customers, and to do so while operating in a fiscally sound and
conservative manner, with fair pricing of our products and services, good
working conditions, outstanding training and opportunities for our staff, along
with a high level of corporate citizenship.
MANAGEMENT STRATEGY
Cooperative Bank's lending activities have traditionally concentrated on the
origination of loans for the purpose of constructing, financing or refinancing
residential properties. In recent years however, the Bank has emphasized
origination of nonresidential real estate loans and secured and unsecured
consumer and business loans. As of June 30, 2004, approximately $290 million, or
66%, of the Bank's loan portfolio, which excludes loans held for sale, consisted
of loans secured by residential properties. This compared to approximately $267
million, or 66% at December 31, 2003. The Bank originates adjustable rate and
fixed rate loans. As of June 30, 2004, adjustable rate and fixed rate loans
totaled approximately 67% and 33%, respectively, of the Bank's total loan
portfolio.
The Bank has chosen to sell a larger percentage of its fixed rate mortgage loan
originations in the secondary market and through brokered arrangements. This
enables the Bank to reinvest these funds in commercial loans, while increasing
fee income.
INTEREST RATE SENSITIVITY ANALYSIS
Interest rate sensitivity refers to the change in interest spread resulting from
changes in interest rates. To the extent that interest income and interest
expense do not respond equally to changes in interest rates, or that all rates
do not change uniformly, earnings will be affected. Interest rate sensitivity,
at a point in time, can be analyzed using a static gap analysis that measures
the match in balances subject to repricing between interest-earning assets and
interest-bearing liabilities. Gap is considered positive when the amount of
interest rate sensitive assets exceeds the amount of interest rate sensitive
liabilities. Gap is considered negative when the amount of interest rate
sensitive liabilities exceeds the amount of interest rate sensitive assets. At
June 30, 2004, the Bank had a one-year positive gap position of 5.4%. During a
period of rising interest rates, a positive gap would tend to result in an
increase in net interest income while a negative gap would tend to adversely
affect net interest income. During a period of falling interest rates, a
positive gap would tend to adversely affect net interest income, while a
negative gap would tend to result in an increase in net interest income. It is
important to note that certain shortcomings are inherent in
10
using a static gap analysis. Although certain assets and liabilities may have
similar maturities or periods of repricing, they may react in different degrees
to changes in market interest rates. For example, a part of the Company's
adjustable-rate mortgage loans are indexed to the National Monthly Median Cost
of Funds to SAIF-insured institutions. This index is considered a lagging index
that may lag behind changes in market rates. The one-year or less
interest-bearing liabilities also include checking, savings, and money market
deposit accounts. Experience has shown that the Company sees relatively modest
repricing of these transaction accounts. Management takes this into
consideration in determining acceptable levels of interest rate risk.
When Lumina gives a rate lock commitment to a customer, there is a concurrent
"lock in" for the loan with a secondary market investor under a best efforts
delivery mechanism. Therefore, interest rate risk is mitigated because any
commitments to fund a loan available for sale are concurrently hedged by a
commitment from an investor to purchase the loan under the same terms. Loans are
usually sold within 60 days after closing.
LIQUIDITY
The Company's goal is to maintain adequate liquidity to meet potential funding
needs of loan and deposit customers, pay operating expenses, and meet regulatory
liquidity requirements. Maturing securities, principal repayments of loans and
securities, deposits, income from operations and borrowings are the main sources
of liquidity. The Bank has been granted a line of credit by the Federal Home
Loan Bank of Atlanta ("FHLB") in an amount of up to 25% of the Bank's total
assets. At June 30, 2004, the Bank's borrowed funds from the FHLB equaled 17.6%
of its total assets. Scheduled loan repayments are a relatively predictable
source of funds, unlike deposits and loan prepayments that are significantly
influenced by general interest rates, economic conditions and competition.
At June 30, 2004, the estimated market value of liquid assets (cash, cash
equivalents, marketable securities and loans held for sale) was approximately
$67.7 million, which represents 14.1% of deposits and borrowed funds as compared
to $72.3 million or 15.8% of deposits and borrowed funds at December 31, 2003.
The decrease in liquid assets was primarily due to a decrease in cash and cash
equivalents.
The Company's primary uses of liquidity are to fund loans and to make
investments. At June 30, 2004, outstanding off-balance sheet commitments to
extend credit totaled $43.5 million, and the undisbursed portion of construction
loans was $50.9 million. Management considers current liquidity levels adequate
to meet the Company's cash flow requirements.
CAPITAL
Stockholders' equity at June 30, 2004, was $44.4 million, up 2.9% from $43.1
million at December 31, 2003. Stockholders' equity at June 30, 2004, includes an
unrealized loss net of tax, of $212,000 as compared to an unrealized gain net of
tax at December 31, 2003, of $285,000 on securities available for sale marked to
estimated fair market value.
Under the capital regulations of the FDIC, the Bank must satisfy minimum
leverage ratio requirements and risk-based capital requirements. Banks
supervised by the FDIC must maintain a minimum leverage ratio of core (Tier I)
capital to average adjusted assets ranging from 3% to 5%. At June 30, 2004, the
Bank's ratio of Tier I capital was 8.37%. The FDIC's risk-based capital rules
require banks supervised by the FDIC to maintain risk-based capital to
risk-weighted assets of at least 8.00%. Risk-based capital for the Bank is
defined as Tier I capital plus the balance of allowance for loan losses. At June
30, 2004, the Bank had a ratio of qualifying total capital to risk-weighted
assets of 11.93%.
The Company, as a bank holding company, is also subject, on a consolidated
basis, to the capital adequacy guidelines of the Board of Governors of the
Federal Reserve (the "Federal Reserve Board"). The capital requirements of the
Federal Reserve Board are similar to those of the FDIC governing the Bank. The
Company currently exceeds all of its capital requirements. Management expects
the Company to continue to exceed these capital requirements without altering
current operations or strategies.
11
On June 22, 2004, the Company's Board of Directors approved a quarterly cash
dividend of $.07 per share, a 40% increase over the previous dividend. The
dividend was paid on July 16, 2004 to stockholders of record as of July 1, 2004.
This brings the total dividend for the year to $.12 per share. Any future
payment of dividends is dependent on the financial condition and capital needs
of the Company, requirements of regulatory agencies, and economic conditions in
the marketplace.
CRITICAL ACCOUNTING POLICY
The Bank's most significant critical accounting policy is the determination of
its allowance for loan losses and goodwill. A critical accounting policy is one
that is both very important to the portrayal of the Company's financial
condition and results, and requires a difficult, subjective or complex judgment
by management. What makes these judgments inherently difficult, subjective
and/or complex is the need to make estimates about the effects of matters that
are inherently uncertain. For further information on the allowance for loan
losses, see the "Critical Accounting Policy" and the "Financial Condition" in
Management's Discussion and Analysis and Note 3 of "Notes to Consolidated
Financial Statements" included in the 2003 Annual Report. For further
information on goodwill, see the "Critical Accounting Policy" in Management's
Discussion and Analysis and Note 13 of "Notes to Consolidated Financial
Statements" included in the 2003 Annual Report.
FINANCIAL CONDITION AT JUNE 30, 2004, COMPARED TO DECEMBER 31, 2003
The Company's total assets increased 5.1% to $527.9 million at June 30, 2004, as
compared to $502.4 million at December 31, 2003. The major change in the assets
is an increase of $30.0 million (7.4%) in loans which was funded by an increase
in deposits of $13.4 million (3.6%) and an increase of $10.0 million in FHLB
advances which is included in long-term obligations. A decrease of $5.5 million
(29.7%) in cash and cash equivalents was attributable to the loan increase. The
increase in loans and deposits can be attributed to opening new branches and
being located in vibrant markets.
The Company's nonperforming assets (loans 90 days or more delinquent and
foreclosed real estate) were $684,000 or .13% of assets, at June 30, 2004,
compared to $267,000, or .05% of assets, at December 31, 2003. Foreclosed real
estate, consisting of only one property, increased to $172,000 at June 30, 2004,
from $0 at December 31, 2003. The Company assumes an aggressive position in
collecting delinquent loans and disposing of foreclosed assets to minimize
balances of nonperforming assets and continues to evaluate the loan and real
estate portfolios to provide loss reserves as considered necessary. For further
information see "Comparison of Operating Results - Provision and Allowance for
Loan Losses".
COMPARISON OF OPERATING RESULTS
OVERVIEW
The net income of the Company depends primarily upon net interest income. Net
interest income is the difference between the interest earned on loans, the
securities portfolio and interest-earning deposits and the cost of funds,
consisting principally of the interest paid on deposits and borrowings. The
Company's operations are materially affected by general economic conditions, the
monetary and fiscal policies of the Federal government, and the policies of
regulatory authorities. Yields and costs have declined because of the actions
the Federal Reserve has taken since 2001 to reduce interest rates in hopes of
spurring the economy.
NET INCOME
Net income for the three and six-month periods ended June 30, 2004, decreased
21.1% to $1.1 million and 27.4% to $2.0 million respectively, as compared to the
same periods last year. The decrease in net income for the six-month period
ended June 30, 2004 can be attributed to a decrease in noninterest income of
$848,000 and an increase in noninterest expense of $326,000. For further
information see the captions "Noninterest Income" and "Noninterest Expense."
12
INTEREST INCOME
For the three-month period ended June 30, 2004, interest income decreased 6.4%
as compared to the same period a year ago. The average balance of
interest-earning assets increased 2.6% but the average yield decreased 53 basis
points as compared to the same period a year ago. Interest income decreased 7.9%
for the six-month period ended June 30, 2004, as compared to the same period a
year ago. The decrease in interest income can be attributed to the yield on
average interest-earning assets decreasing to 5.49% as compared to 6.04% for the
same period a year ago. The average balance of interest-earning assets increased
1.4% for the six month period ended June 30, 2004, as compared to the same
period a year ago. The increase in the average balance of interest-earning
assets had a positive effect on interest income while the reduction in yield had
a negative impact on interest income.
INTEREST EXPENSE
Interest expense decreased 22.5% for the three-month period ended June 30, 2004,
as compared to the same period a year ago. This decrease was due to the average
cost of interest-bearing liabilities decreasing 59 basis points as compared to
the same period a year ago. In the six-month period ended June 30, 2004,
interest expense decreased 24.1% as compared to the same period a year ago. The
average balance of interest-bearing liabilities decreased 0.7% as compared to
the same period a year ago. The cost of interest-bearing liabilities decreased
to 1.99% as compared to 2.61% for the same period last year.
NET INTEREST INCOME
Net interest income for the three and six-month periods ended June 30, 2004, as
compared to the same period a year ago, increased 3.9% and 2.9% respectively.
The increase was due to interest-earning assets increasing more than
interest-bearing liabilities. In addition, there was a larger decrease in the
cost of liabilities versus the yield on assets. This can be attributed to the
Bank's success in obtaining both low and no cost deposits. See "Average
Yield/Cost Analysis" table for further information on interest income and
interest expense.
13
AVERAGE YIELD/COST ANALYSIS
The following tables contain information relating to the Company's average
balance sheet and reflects the average yield on assets and average cost of
liabilities for the periods indicated. Such annualized yields and costs are
derived by dividing income or expense by the average balances of assets or
liabilities, respectively, for the periods presented. The average loan portfolio
balances include nonaccrual loans.
For the three months ended
JUNE 30, 2004 JUNE 30, 2003
--------------------------------------------------------------------------------------
(Dollars in thousands) Average Average
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
------------ ------------- ------------- ------------- ------------- ----------
Interest-earning assets:
Interest-bearing deposits in other banks $3,413 $ 8 0.94% $4,983 $ 14 1.12%
Securities:
Available for sale 46,997 516 4.39% 37,715 436 4.62%
Held to maturity 3,320 41 4.94% 7,254 93 5.13%
FHLB stock 4,302 37 3.44% 3,798 38 4.00%
Loan portfolio 432,420 6,092 5.64% 424,247 6,572 6.20%
---------- ---------- ----------- ----------
Total interest-earning assets 490,452 6,694 5.46% 477,997 7,153 5.99%
Non-interest earning assets 28,003 27,861
---------- -----------
Total assets $518,455 $505,858
========== ===========
Interest-bearing liabilities:
Deposits 348,247 1,472 1.69% 348,301 1,904 2.19%
Borrowed funds 92,551 693 3.00% 90,803 890 3.92%
---------- ---------- ----------- ----------
Total interest-bearing liabilities 440,798 $2,165 1.96% 439,104 $2,794 2.55%
---------- ----------
Non-interest bearing liabilities 32,830 26,059
---------- -----------
Total liabilities 473,628 465,163
Stockholders' equity 44,827 40,695
---------- -----------
Total liabilities and stockholders' equity $518,455 $505,858
========== ===========
Net interest income $4,529 $4,359
========= ==========
Interest rate spread 3.50% 3.44%
========= ========
Net yield on interest-earning assets 3.69% 3.65%
Percentage of average interest-earning
assets to average interest-bearing
liabilities 111.3% 108.9%
========= ========
14
For the six months ended
JUNE 30, 2004 JUNE 30, 2003
--------------------------------------------------------------------------------------
(Dollars in thousands) Average Average
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
------------ ------------- ------------- ------------- ------------- ----------
Interest-earning assets:
Interest-bearing deposits in other banks $ 3,923 $ 18 0.92% $ 4,269 $ 24 1.12%
Securities:
Available for sale 46,755 1,027 4.39% 39,027 930 4.77%
Held to maturity 3,535 91 5.15% 7,519 202 5.37%
FHLB stock 4,218 73 3.46% 3,961 83 4.19%
Loan portfolio 424,445 12,037 5.67% 421,554 13,136 6.23%
-------- -------- -------- --------
Total interest-earning assets 482,876 13,246 5.49% 476,330 14,375 6.04%
Non-interest earning assets 26,814 27,064
-------- --------
Total assets $509,690 $503,394
======== ========
Interest-bearing liabilities:
Deposits 346,167 2,979 1.72% 346,573 3,942 2.27%
Borrowed funds 89,302 1,364 3.05% 92,138 1,782 3.87%
-------- -------- -------- --------
Total interest-bearing liabilities 435,469 $ 4,343 1.99% 438,711 $ 5,724 2.61%
-------- --------
Non-interest bearing liabilities 31,348 24,916
-------- --------
Total liabilities 466,817 463,627
Stockholders' equity 42,873 39,766
-------- --------
Total liabilities and stockholders' equity $509,690 $503,393
======== ========
Net interest income $ 8,903 $ 8,651
======== ========
Interest rate spread 3.50% 3.43%
====== ======
Net yield on interest-earning assets 3.69% 3.63%
Percentage of average interest-earning
assets to average interest-bearing
liabilities 110.90% 108.60%
====== ======
PROVISION AND ALLOWANCE FOR LOAN LOSSES
During the six-month period ended June 30, 2004 the Bank had net charge-offs
against the allowance for loan losses of $48,000 compared to $206,000 for the
same period in 2003. This decrease was primarily due to one credit relationship
being charged off during the first quarter of 2003. The Bank added $520,000 to
the allowance for loan losses for the current six-month period increasing the
balance to $3.9 million at June 30, 2004. This brings the ratio of allowance for
loan losses to total loans up to .89% at June 30, 2004 as compared to .84% at
December 31, 2003.
15
This percentage continues to rise because of the increase in retail banking
loans in the Bank's portfolio. Management considers the current level of the
allowance to be appropriate based on loan composition, the current level of
delinquencies and other nonperforming assets, overall economic conditions and
other factors. Future increases to the allowance may be necessary, however, due
to changes in loan composition or loan volume, changes in economic or market
area conditions and other factors. Additionally, various regulatory agencies, as
an integral part of their examination process, periodically review the Company's
allowance for loan losses. Such agencies may require the recognition of
adjustments to the allowance for loan losses based on their judgments of
information available to them at the time of their examination.
NONINTEREST INCOME
Noninterest income decreased by 25.3% for the six-month period ended June 30,
2004, as compared to the same period a year ago. The change in noninterest
income can be attributed to gain on sale of loans and service charges and fees
on loans decreasing $857,000 and $110,000 respectively. These changes were
primarily caused by a reduction in mortgage banking activities caused by lower
refinancing volumes. Deposit related fees increased $125,000 primarily due to a
new service the Bank offered beginning in April 2003, for checking accounts with
non-sufficient funds.
In the three-month period ended June 30, 2004, noninterest income decreased
25.4% as compared to the same period last year. The gain on sale of loans and
service charges and fees on loans decreased $459,000 and $31,000 respectively,
for the three-month period ended June 30, 2004 as compared to the same period a
year ago. The reasons for these decreases are the same as stated above for the
six-month period. Other noninterest income increased by $17,000 (40.5%) for the
three-month period ended June 30, 2004, as compared to the same period a year
ago largely because of increased income due to annuity and mutual funds sales
through UVEST Investment Services.
NONINTEREST EXPENSE
For the six-month period ended June 30, 2004, noninterest expense increased 4.4%
as compared to the same period last year. Occupancy and equipment and other
expense increased $327,000 and $89,000 respectively, which was primarily caused
by the opening of four new branches since May of 2003. Real estate owned expense
decreased $35,000 for the six-month period ended June 30, 2004, as compared to
the same period a year ago, primarily because the Bank owned no more than one
property during this period. In addition, the Bank made a small profit on the
sale of a property and is receiving rent payments on the one property it
currently owns.
In the three-month period ended June 30, 2004, noninterest expense increased
1.1% as compared to the same period last year. This increase can be attributed
to occupancy and equipment and other expense increasing $150,000 and $28,000
respectively. The reasons for these changes are identical to the six-month
period ended June 30, 2004. Compensation and fringe benefits decreased $70,000
during the three-month period ended June 30, 2004 as compared to the same period
a year ago. This decrease was caused by a reduction in the amount of employee
commissions due to a reduction in mortgage banking activities caused by lower
refinancing volumes.
INCOME TAXES
The effective tax rate for the six-month periods ended June 30, 2004 and 2003,
was 33.3% and 31.8% respectively. The lower rate in 2003 was the result of the
formation of Holdings and the REIT in December 2003, which caused an adjustment
to taxes. The effective tax rate for the three-month periods ended June 30, 2004
and 2003 was 32.4% and 32.8% respectively.
NOTE REGARDING FORWARD-LOOKING STATEMENTS
In addition to historical information contained herein, the discussion contains
forward-looking statements that involve risks and uncertainties. Economic
circumstances, the Company's operations, and the Company's actual results could
differ significantly from those discussed in the forward-looking statements.
Some of the factors that could cause or contribute to such differences are
discussed herein, but also include changes in the economy and interest rates in
the nation, changes in the Company's regulatory environment and the Company's
market area.
16
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's primary market risk is interest rate risk. Interest rate risk is
the result of differing maturities or repricing intervals of interest-earning
assets and interest-bearing liabilities and the fact that rates on these
financial instruments do not change uniformly. These conditions may impact the
earnings generated by the Company's interest-earning assets or the cost of its
interest-bearing liabilities, thus directly impacting the Company's overall
earnings. The Company's management actively monitors and manages interest rate
risk. One way this is accomplished is through the development of, and adherence
to, the Company's asset/liability policy. This policy sets forth management's
strategy for matching the risk characteristics of the Company's interest-earning
assets and interest-bearing liabilities so as to mitigate the effect of changes
in the rate environment. The Company's market risk profile has not changed
significantly since December 31, 2003.
ITEM 4 - CONTROLS AND PROCEDURES
As of the end of the period covered by this report, management of the Company
carried out an evaluation, under the supervision and with the participation of
the Company's principal executive officer and principal financial officer, of
the effectiveness of the Company's disclosure controls and procedures. Based on
this evaluation, the Company's principal executive officer and principal
financial officer concluded that the Company's disclosure controls and
procedures are effective in ensuring that information required to be disclosed
by the Company in reports that it files or submits under the Securities Exchange
Act of 1934, as amended, is recorded, processed, summarized and reported, within
the time periods specified in the Securities and Exchange Commission's rules and
forms. It should be noted that the design of the Company's disclosure controls
and procedures is based in part upon certain reasonable assumptions about the
likelihood of future events, and there can be no reasonable assurance that any
design of disclosure controls and procedures will succeed in achieving its
stated goals under all potential future conditions, regardless of how remote,
the Company's principal executive and financial officers have concluded that the
Company's disclosure controls and procedures are, in fact, effective at a
reasonable assurance level.
There have been no changes in the Company's internal control over financial
reporting (to the extent that elements of internal control over financial
reporting are subsumed within disclosure controls and procedures) identified in
connection with the evaluation described in the above paragraph that occurred
during the Company's last fiscal quarter, that has materially affected, or is
reasonable likely to materially affect, the Company's internal control over
financial reporting.
17
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
(a) Not applicable
(b) Not applicable
(c) Not applicable
(d) Not Applicable
(e) Not Applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
(a) Not applicable
(b) Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
(1) Annual Meeting of Stockholders, April 30, 2004
(a) Election of Directors
FOR AGAINST WITHHELD
--- ------- --------
Number % of Number % of Number % of
of Votes Votes of Votes Votes of Votes Votes
James D. Hundley 2,379,706 90.00 150 -- 266,739 10.00
O. Richard Wright, Jr. 2,379,706 90.00 150 -- 266,739 10.00
Russell M. Carter 2,379,630 90.00 150 -- 266,815 10.00
(b) Stockholder Proposal
FOR AGAINST WITHHELD
--- ------- --------
Number % of Number % of Number % of
of Votes Votes of Votes Votes of Votes Votes
565,892 21.38 1,429,013 53.99 651,690 24.62
ITEM 5. OTHER INFORMATION
None
18
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 10.12 Change in Control Protection Agreement of O. C.
Burrell, Jr.
Exhibit 10.13 Change in Control Protection Agreement of Todd L.
Sammons
Exhibit 10.14 Change in Control Protection Agreement of Dickson
B. Bridger
Exhibit 31.1 Rule 13a-14(a) Certification of the Chief Executive
Officer
Exhibit 31.2 Rule 13a-14(a) Certification of the Chief Financial
Officer
Exhibit 32 Certificate pursuant to 18 U.S.C. Section 1350
(b) Reports on Form 8-K.
The Company filed a current report on Form 8-K dated April 22,
2004 to report first quarter earnings and a current Report on
Form 8-K dated July 21, 2004 to report second quarter earnings.
The Company filed a current report on Form 8-K dated July 1, 2004
to report the declaration of a dividend.
19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: August 11, 2004 Cooperative Bankshares, Inc.
/s/ Frederick Willetts, III
----------------------------------------
Frederick Willetts, III
President/Chief Executive Officer
Dated: August 11, 2004 /s/ Todd L. Sammons
----------------------------------------
Todd L. Sammons
Senior Vice President/Chief Financial
Officer
20