UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
Commission File Number 0-30062
CAPITAL BANK CORPORATION
(Exact name of registrant as specified in its charter)
North Carolina 56-2101930
(State of incorporation) (I.R.S. Employer
Identification Number)
4901 Glenwood Avenue
Raleigh, North Carolina 27612
(Address of principal executive office)
Registrant's telephone number, including area code: (919) 645-6400
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value per share Nasdaq National Market
(Title of Class) (Name of Exchange on Which Registered)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment of this
Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes |X| No |_|.
The aggregate market value of the registrant's Common Stock, no par value per
share, as of June 30, 2004, held by those persons deemed by the registrant to be
non-affiliates was approximately $87,363,642 (5,343,342 shares held by
non-affiliates at $16.35 per share). For purposes of the forgoing calculation
only, all directors, executive officers, and 5% shareholders of the registrant
have been deemed affiliates.
As of March 7, 2005, there were 6,593,787 shares of the registrant's Common
Stock, no par value per share, outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
Document Incorporated Where
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1. Portions of the registrant's Proxy Statement for the Annual Meeting Part III
of Shareholders to be held on May 26, 2005
CAPITAL BANK CORPORATION
Annual Report on Form 10-K
INDEX
PART I.................................................................................. ..............2
Item 1. Business..................................................................................2
Item 2. Properties...............................................................................10
Item 3. Legal Proceedings........................................................................10
Item 4. Submission of Matters to a Vote of Security Holders......................................10
PART II............................................................................... ...............11
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases .11
Item 6. Selected Financial Data..................................................................11
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....12
Item 7A. Quantitative and Qualitative Disclosures About Market Risk...............................30
Item 8. Financial Statements and Supplementary Data..............................................34
Item 9. Changes In and Disagreements With Accountants On Accounting and Financial Disclosure.....64
Item 9A. Controls and Procedures..................................................................64
PART III............................................................................. ................65
Item 10. Directors and Executive Officers of the Registrant.......................................65
Item 11. Executive Compensation...................................................................65
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters..................................................................................65
Item 13. Certain Relationships and Related Transactions...........................................65
Item 14. Principal Accountant Fees and Services...................................................65
PART IV............................................................................ ..................65
Item 15. Exhibits and Financial Statement Schedules.............................................65
Signatures........................................................................................67
PART I
Item 1. Business.
General
Capital Bank Corporation (the "Company") is a financial holding company
incorporated under the laws of North Carolina on August 10, 1998. The Company's
primary function is to serve as the holding company for its wholly-owned
subsidiaries, Capital Bank and Capital Bank Investment Services, Inc. In
addition, the Company has interest in two trusts, Capital Bank Statutory Trust I
and II (hereinafter collectively referred to as the "Trusts"). These Trusts are
not consolidated with the financial statements of the Company per the provisions
of FIN 46R. Capital Bank (the "Bank") was incorporated under the laws of the
State of North Carolina on May 30, 1997, and commenced operations as a
state-chartered banking corporation on June 20, 1997. The Bank is not a member
of the Federal Reserve System and has no subsidiaries. Capital Bank Investment
Services, Inc. ("CBIS") was incorporated under the laws of the State of North
Carolina on January 3, 2001 and commenced operations as a full service
investment company on March 1, 2001. In the third quarter of 2003 CBIS ceased
operations, but remains a subsidiary of the Company.
As of December 31, 2004, the Company had assets of approximately $882.3 million,
gross loans outstanding of approximately $654.9 million and deposits of
approximately $655.0 million. The Company's corporate office is located
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at 4901 Glenwood Avenue, Raleigh, North Carolina 27612, and its telephone number
is (919) 645-6400. In addition to the corporate office, the Company has four
branch offices in Raleigh, two in Cary, one in Siler City, one in Oxford, one in
Wake Forest, three in Sanford, two in Burlington, one in Graham, one in
Greensboro, three in Asheville and one in Hickory, North Carolina.
Capital Bank is a community bank engaged in the general commercial banking
business in Wake, Chatham, Granville, Alamance, Lee, Buncombe, Guilford and
Catawba Counties of North Carolina. Wake County has a diversified economic base,
comprised primarily of services, retail trade, government and manufacturing and
includes the City of Raleigh, the state capital. Lee, Granville and Chatham
counties are significant centers for various industries, including agriculture,
manufacturing, lumber and tobacco. Alamance and Guilford counties have a
diversified economic base, comprised primarily of manufacturing, agriculture,
retail and wholesale trade, government, services and utilities. Catawba County,
which includes the town of Hickory, is a regional center for manufacturing and
wholesale trade. The economic base of the city of Asheville, in Buncombe County,
is comprised primarily of services, medical, tourism and manufacturing
industries.
The Bank offers a full range of banking services, including the following:
checking accounts; savings accounts; NOW accounts; money market accounts;
certificates of deposit; loans for real estate, construction, businesses,
agriculture, personal uses, home improvement and automobiles; equity lines of
credit; credit loans; consumer loans; credit cards; individual retirement
accounts; safe deposit boxes; bank money orders; internet banking; electronic
funds transfer services including wire transfers; traveler's checks; various
investments; and free notary services to all Bank customers. In addition, the
Bank provides automated teller machine access to its customers for cash
withdrawals through nationwide ATM networks. At present, the Bank does not
provide the services of a trust department.
In the third quarter of 2004, the Bank began to offer non-insured investment
products and services through Capital Bank Financial Services, creating a
partnership with Capital Investment Group, a leading Raleigh, North Carolina
based broker-dealer. The Bank has hired four commission-based financial advisors
during 2004 to offer full-service brokerage to individual and corporate
customers. With the addition of the Financial Services division, Capital Bank
now has the ability to compete with much larger institutions in North Carolina.
The Trusts were formed for the sole purpose of issuing trust preferred
securities. The proceeds from such issuances were loaned to the Company in
exchange for the Debentures (as defined below), which are the sole assets of the
Trust. A portion of the proceeds from the issuance of the Debentures were used
by the Company to repurchase shares of Company common stock. The Company's
obligation under the Debentures constitutes a full and unconditional guarantee
by the Company of the Trust's obligations under the trust preferred securities.
The Trusts have no operations other than those that are incidental to the
issuance of the trust preferred securities.
Lending Activities and Deposits
Loan Types and Lending Policies. The Company makes a variety of loans, including
loans secured by real estate, loans for construction, loans for commercial
purposes and loans to individuals for personal and household purposes. During
2004, there were no large concentrations of credit to any particular industry.
The economic trends of the area served by the Company are influenced by the
significant industries within the region. Consistent with the Company's emphasis
on being a community-oriented financial institution, virtually all the Company's
business activity is with customers located in and around counties in which the
Company has banking offices. The ultimate collectibility of the Company's loan
portfolio is susceptible to changes in the market conditions of these geographic
regions.
The Company uses a centralized risk management process to ensure uniform credit
underwriting that adheres to the Bank's loan policy as approved annually by the
Board. Lending policies are reviewed on a regular basis to confirm that the
Company is prudent in setting its underwriting criteria. Credit risk is managed
through a number of methods including loan grading of commercial loans,
committee approval of larger loans and class and purpose coding of loans.
Management believes that early detection of credit problems through regular
contact with the Company's clients coupled with consistent reviews of the
borrowers' financial condition are important factors in overall credit risk
management.
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The following table sets forth, as of December 31, 2004, the approximate
composition of the Company's loan portfolio:
Loan Type Amount Percentage
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(In thousands)
Commercial $ 532,091 82%
Consumer 34,865 5%
Home Equity Lines 61,924 9%
Residential mortgages 25,987 4%
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$ 654,867 100%
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Deposits. The majority of the Company's deposit customers are individuals and
small to medium-size businesses located in Wake, Chatham, Granville, Alamance,
and Lee Counties, North Carolina and contiguous areas and the Asheville,
Greensboro and Hickory, North Carolina communities. The Company's deposit base
is well diversified, with no material concentration in a single industry or
group of related industries. Management of the Company does not believe that the
deposits or the business of the Company in general are seasonal in nature.
Deposits vary with local and national economic conditions, but not enough,
management believes, to have a material effect on planning and policy making.
The Company attempts to control deposit flow through the pricing of deposits and
promotional activities. Management believes that the Company's rates are
competitive with those offered by other institutions in the same geographic
area.
The following table sets forth the mix of depository accounts at the Company as
a percentage of total deposits as of December 31, 2004:
Non-interest bearing demand 10%
Interest checking 12%
Market rate investment 15%
Savings 2%
Time deposits:
Under $100,000 40%
Equal to or over $100,000 21%
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100%
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Competition
Commercial banking in North Carolina is extremely competitive in large part due
to statewide branching. The Company competes in its market area with some of the
largest banking organizations in the state and the country and other community
financial institutions, such as federally and state-chartered savings and loan
institutions and credit unions, as well as consumer finance companies, mortgage
companies and other lenders engaged in the business of extending credit. Many of
the Company's competitors have broader geographic markets, easier access to
capital and lower cost funding and higher lending limits than the Company and
are also able to provide more services and make greater use of media
advertising.
The enactment of legislation authorizing interstate banking has caused increases
in the size and financial resources of some of the Company's competitors. In
addition, as a result of interstate banking, out-of-state commercial banks may
acquire North Carolina banks and heighten the competition among banks in North
Carolina. Despite the competition in its market area, the Company believes that
it has certain competitive advantages that distinguish it from its competition.
The Company believes that its primary competitive advantages are its strong
local identity and affiliation with the communities it serves and its emphasis
on providing specialized services to small and medium-sized business
enterprises, as well as professional and upper-income individuals. The Company
offers customers modern, high-tech banking without forsaking community values
such as prompt, personal service and friendliness. The Company offers many
personalized services and attracts customers by being responsive and sensitive
to their individualized needs. The Company also relies on goodwill and referrals
from shareholders and satisfied customers, as well as traditional media to
attract new customers. To enhance a positive image in the community, the Company
supports and participates in local events and its officers and directors serve
on boards of local civic and charitable organizations.
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Employees
At March 1, 2005, the Company employed 241 persons, of which 224 were full-time
and 17 were part-time. None of its employees are represented by a collective
bargaining unit. The Company considers relations with its employees to be good.
Supervision and Regulation
Holding companies, banks and many of their non-bank affiliates are extensively
regulated under both federal and state law. The following is a brief summary of
certain statutes, rules and regulations affecting the Company and the Bank. This
summary is qualified in its entirety by reference to the particular statutory
and regulatory provisions referred to below and is not intended to be an
exhaustive description of the statutes or regulations applicable to the
Company's or the Bank's business. Supervision, regulation and examination of the
Company and the Bank by bank regulatory agencies is intended primarily for the
protection of the Bank's depositors rather than holders of the Company's common
stock.
The Company is also regulated by the Securities and Exchange Commission ("SEC")
as a result of its common stock being publicly traded. Due to recent
legislation, the regulatory compliance burden of being a publicly traded company
has increased significantly over the last few years.
Holding Company Regulation
General. The Company is a holding company registered with the Federal Reserve
under the Bank Holding Company Act of 1956 (the "BHCA"). As such, the Company
and the Bank are subject to the supervision, examination and reporting
requirements contained in the BHCA and the regulation of the Federal Reserve.
The BHCA requires that a bank holding company obtain the prior approval of the
Federal Reserve before: (i) acquiring direct or indirect ownership or control of
more than five percent of the voting shares of any bank; (ii) taking any action
that causes a bank to become a subsidiary of the bank holding company; (iii)
acquiring all or substantially all of the assets of any bank; or (iv) merging or
consolidating with any other bank holding company.
The BHCA generally prohibits a bank holding company, with certain exceptions,
from engaging in activities other than banking, or managing or controlling banks
or other permissible subsidiaries, and from acquiring or retaining direct or
indirect control of any company engaged in any activities other than those
activities determined by the Federal Reserve to be closely related to banking,
or managing or controlling banks, as to be a proper incident thereto. In
determining whether a particular activity is permissible, the Federal Reserve
must consider whether the performance of such an activity can reasonably be
expected to produce benefits to the public, such as greater convenience,
increased competition or gains in efficiency, that outweigh possible adverse
effects, such as undue concentration of resources, decreased or unfair
competition, conflicts of interest or unsound banking practices. For example,
banking, operating a thrift institution, extending credit or servicing loans,
leasing real or personal property, providing securities brokerage services,
providing certain data processing services, acting as agent or broker in selling
credit life insurance and certain other types of insurance underwriting
activities have all been determined by regulations of the Federal Reserve to be
permissible activities.
Pursuant to delegated authority, the Federal Reserve Bank of Richmond has
authority to approve certain activities of holding companies within its
district, including the Company, provided the nature of the activity has been
approved by the Federal Reserve. Despite prior approval, the Federal Reserve has
the power to order a holding company or its subsidiaries to terminate any
activity or to terminate its ownership or control of any subsidiary when it
believes that continuation of such activity or such ownership or control
constitutes a serious risk to the financial safety, soundness or stability of
any bank subsidiary of that bank holding company.
Financial Holding Companies. The Gramm-Leach-Bliley Financial Modernization Act
of 1999 (the "GLB"):
o allows bank holding companies meeting management, capital and the
Community Reinvestment Act of 1977 (the "CRA") standards to engage
in a substantially broader range of non-banking activities than was
permissible prior to enactment, including insurance underwriting and
making merchant banking investments in commercial and financial
companies;
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o allows insurers and other financial services companies to acquire
banks;
o removes various restrictions that applied to bank holding company
ownership of securities firms and mutual fund advisory companies;
and
o establishes the overall regulatory structure applicable to bank
holding companies that also engage in insurance and securities
operations.
The Company is authorized to operate as a financial holding company and
therefore is eligible to engage in the broader range of activities that are
permitted by the GLB. The GLB also is designed to modify other current financial
laws, including laws related to financial privacy and community reinvestment.
The new financial privacy provisions generally prohibit financial institutions,
including the Company, from disclosing nonpublic personal financial information
to nonaffiliated third parties unless customers have the opportunity to "opt
out" of the disclosure.
Mergers and Acquisitions. The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "IBBEA") permits interstate acquisitions of banks
and bank holding companies without geographic limitation, subject to any state
requirement that the bank has been organized for a minimum period of time, not
to exceed five years, and the requirement that the bank holding company, prior
to, or following the proposed acquisition, controls no more than 10% of the
total amount of deposits of insured depository institutions in the U.S. and no
more than 30% of such deposits in any state (or such lesser or greater amount
set by state law).
In addition, the IBBEA permits a bank to merge with a bank in another state as
long as neither of the states has opted out of the IBBEA prior to May 31, 1997.
The state of North Carolina has "opted in" to such legislation. In addition, a
bank may establish and operate a de novo branch in a state in which the bank
does not maintain a branch if that state expressly permits de novo interstate
branching. As a result of North Carolina's opt-in law, North Carolina law
permits unrestricted interstate de novo branching.
Additional Restrictions and Oversight. Subsidiary banks of a bank holding
company are subject to certain restrictions imposed by the Federal Reserve on
any extensions of credit to the bank holding company or any of its subsidiaries,
investments in the stock or securities thereof and the acceptance of such stock
or securities as collateral for loans to any borrower. A bank holding company
and its subsidiaries are also prevented from engaging in certain tie-in
arrangements in connection with any extension of credit, lease or sale of
property or furnishing of services. An example of a prohibited tie-in would be
any arrangement that would condition the provision or cost of services on a
customer obtaining additional services from the bank holding company or any of
its other subsidiaries.
The Federal Reserve may issue cease and desist orders against bank holding
companies and non-bank subsidiaries to stop actions believed to present a
serious threat to a subsidiary bank. The Federal Reserve also regulates certain
debt obligations, changes in control of bank holding companies and capital
requirements.
Under the provisions of the North Carolina law, the Company is registered with
and subject to supervision by the North Carolina Commissioner of Banks (the
"Commissioner").
Capital Requirements. The Federal Reserve has established risk-based capital
guidelines for bank holding companies. The minimum standard for the ratio of
capital to risk-weighted assets (including certain off balance sheet
obligations, such as standby letters of credit) is eight percent. At least half
of this capital must consist of common equity, retained earnings and a limited
amount of perpetual preferred stock and minority interests in the equity
accounts of consolidated subsidiaries, less certain goodwill items and other
adjustments ("Tier 1 capital"). The remainder ("Tier 2 capital") may consist of
mandatorily redeemable convertible debt securities and a limited amount of other
preferred stock, subordinated debt and loan loss reserves.
In addition, the Federal Reserve has established minimum leverage ratio
guidelines for bank holding companies. These guidelines provide for a minimum
leverage ratio of Tier 1 capital to adjusted average quarterly assets less
certain amounts ("Leverage Ratio") equal to three percent for bank holding
companies that meet certain specified criteria, including having the highest
regulatory rating. All other bank holding companies will generally be required
to maintain a Leverage Ratio of between four percent and five percent.
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The guidelines also provide that bank holding companies experiencing significant
growth, whether through internal expansion or acquisitions, will be expected to
maintain strong capital ratios well above the minimum supervisory levels without
significant reliance on intangible assets. The same heightened requirements
apply to bank holding companies with supervisory, financial, operational or
managerial weaknesses, as well as to other banking institutions if warranted by
particular circumstances or the institution's risk profile. Furthermore, the
guidelines indicate that the Board of Governors of the Federal Reserve System
(the "Federal Reserve Board") will continue to consider a "tangible Tier 1
Leverage Ratio" (deducting all intangibles) in evaluating proposals for
expansion or new activity. The Federal Reserve has not advised the Company of
any specific minimum Leverage Ratio or tangible Tier 1 Leverage Ratio applicable
to it.
As of December 31, 2004, the Company had Tier 1 risk-adjusted, total regulatory
capital and leverage capital of approximately 11.08%, 12.33% and 9.61%,
respectively, all in excess of the minimum requirements. Those same ratios as of
December 31, 2003 were 10.68%, 12.13% and 8.71%, respectively.
International Money Laundering Abatement and Financial Anti-Terrorism Act Of
2001. Title III of the USA Patriot Act of 2001 contains the International Money
Laundering Abatement and Financial Anti-Terrorism Act of 2001 (the "IMLAFA").
The anti-money laundering provisions of IMLAFA impose affirmative obligations on
a broad range of financial institutions, including banks, brokers, and dealers.
Among other requirements, IMLAFA requires all financial institutions to
establish anti-money laundering programs that include, at minimum, internal
policies, procedures, and controls; specific designation of an anti-money
laundering compliance officer; ongoing employee training programs; and an
independent audit function to test the anti-money laundering program. IMLAFA
requires financial institutions that establish, maintain, administer, or manage
private banking accounts for non-United States persons or their representatives
to establish appropriate, specific, and where necessary, enhanced due diligence
policies, procedures, and controls designed to detect and report money
laundering. Additionally, IMLAFA provides for the Department of Treasury to
issue minimum standards with respect to customer identification at the time new
accounts are opened. The Company has determined the impact that IMLAFA will have
on the Bank's operations is not material. The Bank has established policies and
procedures to ensure compliance with the IMLAFA that were approved by the Board
of Directors.
Bank Regulation
The Bank is subject to numerous state and federal statutes and regulations that
affect its business, activities, and operations, and is supervised and examined
by the Commissioner and the Federal Reserve. The Federal Reserve and the
Commissioner regularly examine the operations of banks over which they exercise
jurisdiction. They have the authority to approve or disapprove the establishment
of branches, mergers, consolidations and other similar corporate actions. They
also have authority to prevent the continuance or development of unsafe or
unsound banking practices and other violations of law. The Federal Reserve and
the Commissioner regulate and monitor all areas of the operations of banks and
their subsidiaries, including loans, mortgages, issuances of securities, capital
adequacy, loss reserves and compliance with the CRA as well as other laws and
regulations. Interest and certain other charges collected and contracted for by
banks are also subject to state usury laws and certain federal laws concerning
interest rates.
The deposit accounts of the Bank are insured by the Bank Insurance Fund (the
"BIF") of the Federal Deposit Insurance Corporation (the "FDIC") up to a maximum
of $100,000 per insured depositor. The FDIC issues regulations and conducts
periodic examinations, requires the filing of reports and generally supervises
the operations of its insured banks. This supervision and regulation is intended
primarily for the protection of depositors. Any insured bank that is not
operated in accordance with or does not conform to FDIC regulations, policies
and directives may be sanctioned for noncompliance. Civil and criminal
proceedings may be instituted against any insured bank or any director, officer
or employee of such bank for the violation of applicable laws and regulations,
breaches of fiduciary duties or engaging in any unsafe or unsound practice. The
FDIC has the authority to terminate insurance of accounts pursuant to procedures
established for that purpose.
Under the North Carolina corporation laws, the Company may not pay a dividend or
distribution, if after giving its effect, the Company would not be able to pay
its debts as they become due in the usual course of business or the Company's
total assets would be less than its liabilities. In general, the Company's
ability to pay cash dividends is dependent upon the amount of dividends paid by
the Bank. The ability of the Bank to pay dividends to the Company is
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subject to statutory and regulatory restrictions on the payment of cash
dividends, including the requirement under the North Carolina banking laws that
cash dividends be paid only out of undivided profits and only if the bank has
surplus of a specified level. The Federal Reserve also imposes limits on the
Bank's payment of dividends.
Like the Company, the Bank is required by federal regulations to maintain
certain minimum capital levels. The levels required of the Bank are the same as
required for the Company. At December 31, 2004, the Bank had Tier 1
risk-adjusted, total regulatory capital and leverage capital of approximately
10.23%, 11.48% and 8.87%, respectively, all in excess of the minimum
requirements.
The Bank is subject to insurance assessments imposed by the FDIC. The FDIC has
adopted a risk-based assessment schedule providing for annual assessment rates
ranging from 0% to .27% of an institution's average assessment base, applicable
to institutions insured by both the BIF and the Savings Association Insurance
Fund ("SAIF"). The actual assessment to be paid by each insured institution is
based on the institution's assessment risk classification, which focuses on
whether the institution is considered "well capitalized," "adequately
capitalized" or "under capitalized," as such terms are defined in the applicable
federal regulations. Within each of these three risk classifications, each
institution will be assigned to one of three subgroups based on supervisory risk
factors. In particular, regulators will assess supervisory risk based on whether
the institution is financially sound with only a few minor weaknesses (Subgroup
A), whether it has weaknesses which, if not corrected, could result in an
increased risk of loss to the BIF (Subgroup B) or whether such weaknesses pose a
substantial probability of loss to the BIF unless effective corrective action is
taken (Subgroup C). The FDIC also is authorized to impose one or more special
assessments in an amount deemed necessary to enable repayment of amounts
borrowed by the FDIC from the United States Treasury Department and all banks
are now required to pay additional annual assessments at rates set by the
Financing Corporation, which was established by the Competitive Equality Banking
Act of 1987.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
provides for, among other things, (i) publicly available annual financial
condition and management reports for certain financial institutions, including
audits by independent accountants, (ii) the establishment of uniform accounting
standards by federal banking agencies, (iii) the establishment of a "prompt
corrective action" system of regulatory supervision and intervention, based on
capitalization levels, with greater scrutiny and restrictions placed on
depository institutions with lower levels of capital, (iv) additional grounds
for the appointment of a conservator or receiver and (v) restrictions or
prohibitions on accepting brokered deposits, except for institutions which
significantly exceed minimum capital requirements. FDICIA also provides for
increased funding of the FDIC insurance funds and the implementation of
risk-based premiums.
A central feature of FDICIA is the requirement that the federal banking agencies
take "prompt corrective action" with respect to depository institutions that do
not meet minimum capital requirements. Pursuant to FDICIA, the federal bank
regulatory authorities have adopted regulations setting forth a five-tiered
system for measuring the capital adequacy of the depository institutions that
they supervise. Under these regulations, a depository institution is classified
in one of the following capital categories: "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized" and
"critically undercapitalized." An institution may be deemed by the regulators to
be in a capitalization category that is lower than is indicated by its actual
capital position if, among other things, it receives an unsatisfactory
examination rating with respect to asset quality, management, earnings or
liquidity. FDICIA provides the federal banking agencies with significantly
expanded powers to take enforcement action against institutions which fail to
comply with capital or other standards. Such action may include the termination
of deposit insurance by the FDIC or the appointment of a receiver or conservator
for the institution.
Banks are also subject to the CRA, which requires the appropriate federal bank
regulatory agency, in connection with its examination of a bank, to assess such
bank's record in meeting the credit needs of the community served by that bank,
including low and moderate-income neighborhoods. Each institution is assigned
one of the following four ratings of its record in meeting community credit
needs: "outstanding," "satisfactory," "needs to improve" or "substantial
noncompliance." The regulatory agency's assessment of the bank's record is made
available to the public. Further, such assessment is required of any bank which
has applied to (i) charter a national bank, (ii) obtain deposit insurance
coverage for a newly chartered institution, (iii) establish a new branch office
that will accept deposits, (iv) relocate an office or (v) merge or consolidate
with, or acquire the assets or assume the liabilities of, a federally regulated
financial institution. In the case of a bank holding company applying for
approval to acquire a bank or other bank holding company, the Federal Reserve
will assess the record of each subsidiary bank of the applicant bank holding
company, and such records may be the basis for denying the application.
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The GLB's "CRA Sunshine Requirements" call for financial institutions to
disclose publicly certain written agreements made in fulfillment of the CRA.
Banks that are parties to such agreements also must report to federal regulators
the amount and use of any funds expended under such agreements on an annual
basis, along with such other information as regulators may require.
Monetary Policy and Economic Controls
The Company and the Bank are directly affected by governmental policies and
regulatory measures affecting the banking industry in general. Of primary
importance is the Federal Reserve Board, whose actions directly affect the money
supply which, in turn, affects banks' lending abilities by increasing or
decreasing the cost and availability of funds to banks. The Federal Reserve
Board regulates the availability of bank credit in order to combat recession and
curb inflationary pressures in the economy by open market operations in United
States government securities, changes in the discount rate on member bank
borrowings, changes in reserve requirements against bank deposits and
limitations on interest rates that banks may pay on time and savings deposits.
Deregulation of interest rates paid by banks on deposits and the types of
deposits that may be offered by banks have eliminated minimum balance
requirements and rate ceilings on various types of time deposit accounts. The
effect of these specific actions and, in general, the deregulation of deposit
interest rates has generally increased banks' cost of funds and made them more
sensitive to fluctuations in money market rates. In view of the changing
conditions in the national economy and money markets, as well as the effect of
actions by monetary and fiscal authorities, no prediction can be made as to
possible future changes in interest rates, deposit levels, loan demand, or the
business and earnings of the Bank or the Company. As a result, banks, including
the Bank, face a significant challenge to maintain acceptable net interest
margins.
Executive Officers
The executive officers of the Company as of December 31, 2004 were as follows:
Name Age Position With Company
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B. Grant Yarber 40 President and Chief Executive Officer
Richard W. Edwards 45 Executive Vice President and Chief Financial Officer
Karen H. Priester 47 Senior Vice President and Chief Credit Officer
Grant Yarber serves as President and Chief Executive Officer for Capital Bank
Corporation and Capital Bank, overseeing the day-to-day operations of the Bank.
Mr. Yarber joined Capital Bank during the summer of 2003 as the Chief Credit
Officer and was then promoted to Chief Operating Officer and President before
his appointment to CEO. He had served previously as Chief Lending Officer and
Chief Credit Officer of MountainBank in Hendersonville, N.C. With more than 15
years of banking experience, Mr. Yarber has particular strength in lending and
credit management. His background includes leadership positions with Bank of
America, including Southeast Credit Manager and Regional Executive for Business
Banking and Professional/Executive Banking for Missouri and Illinois.
Rick Edwards serves as Executive Vice President and Chief Financial Officer for
Capital Bank Corporation and Capital Bank. In this position, Mr. Edwards is
responsible for the financial activities of the company, including investment
portfolio management, analyst relations and strategic planning. Mr. Edwards
previously held senior accounting and financial positions with some of the
country's top banking institutions in the Southeast. Mr. Edwards spent eight
years with Ernst & Young and held several management positions with Bank of
America. He also has served as the Chief Financial Officer at New South
Bancshares, Inc., a $1.4 billion savings bank, and later became the Chief
Accounting Officer at National Commerce Financial Corporation before joining
Capital Bank. Mr. Edwards is also a director and audit committee chair for
Hemagen Diagnostics, Inc. in Baltimore, MD.
Karen Priester serves as Senior Vice President and Chief Credit Officer for
Capital Bank Corporation and the Bank. Prior to this position, she was Regional
Credit Administrator and Wake County Senior Lender in her six years of
-9-
employment at Capital Bank. Ms. Priester has over twenty years of banking
experience, concentrating in the commercial lending and credit areas. In her
function as Chief Credit Officer, Ms. Priester is responsible for credit
quality, loan review, special assets, government lending, compliance, and the
credit department.
Website Access to Capital Bank Corporation's Filings with the Securities and
Exchange Commission
Since becoming an "accelerated filer," all of the Company's electronic filings
with the Securities and Exchange Commission ("SEC"), including the Annual Report
on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and
amendments to these reports filed or furnished pursuant to Section 13(a) or
15(d) of the Exchange Act have been made available at no cost on the
Corporation's web site, www.capitalbank-nc.com, as soon as reasonably
practicable after the Company filed such material with, or furnished it to, the
SEC. The Company's SEC filings are also available through the SEC's web site at
www.sec.gov. In addition, any reports the Company files with the SEC are
available at the SEC's Public Reference Room at 450 Fifth Street, N.W.,
Washington, DC 20549. Information may be obtained about the Public Reference
Room by calling the SEC at 1-800-SEC-0330.
Item 2. Properties.
The Company currently leases property located at 4901 Glenwood Avenue, Raleigh,
North Carolina for its principal offices and a branch office. The lease is for
approximately 21,600 square feet, of which approximately 18,600 square feet is
for the Company's principal offices and the remainder for the branch office. In
addition to this facility, the Company owns 12 properties throughout North
Carolina that are used as branch locations and which are located in Sanford (2),
Cary (2), Siler City, Oxford, Burlington (2), Graham, Greensboro, Hickory and
Raleigh. The Company also leases 10 other properties throughout North Carolina
that are used as branch locations, operations facilities or mortgage production
offices and which are located in Raleigh (3), Sanford, Asheville (3), Cary,
Pittsboro and Wake Forest. Management believes the terms of the various leases,
which are reviewed on an annual basis, are consistent with market standards and
were arrived at through arm's length bargaining.
Item 3. Legal Proceedings.
There are no pending material legal proceedings to which the Company is a party
or of which any of its property is subject. In addition, the Company is not
aware of any threatened litigation, unasserted claims or assessments that could
have a material adverse effect on the Company's business, operating results or
financial condition.
Item 4. Submission of Matters to a Vote of Security Holders
During the fourth quarter of the year ended December 31, 2004, there were no
matters submitted to a vote of the Company's shareholders.
-10-
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchase of Equity Securities.
Shares of Capital Bank Corporation common stock are traded on the Nasdaq
National Market under the symbol "CBKN." As of March 1, 2005, the Company had
approximately 1,588 holders of record of its common stock. The following table
sets forth, for the indicated periods, the high and low sales prices for the
common stock (based on published sources) and the cash dividend declared per
share of the Company's common stock:
Cash
Dividends
Per Share
2004 High Low Declared
---------------------------------------------------------------------
First Quarter $18.12 $15.45 $ 0.05
Second Quarter 17.06 15.20 0.05
Third Quarter 16.74 15.88 0.05
Fourth Quarter 18.98 15.97 0.06
Cash
Dividends
Per Share
2003 High Low Declared
---------------------------------------------------------------------
First Quarter $14.70 $12.95 $ 0.05
Second Quarter 15.98 13.20 0.05
Third Quarter 16.40 14.10 0.05
Fourth Quarter 16.93 15.09 0.05
Dividend Policy. The Company's shareholders are entitled to receive such
dividends or distributions as the Board of Directors authorizes in its
discretion. The Company's ability to pay dividends is subject to the
restrictions of the North Carolina Business Corporation Act. There are also
various statutory limitations on the ability of the Bank to pay dividends to the
Company. Subject to the legal availability of funds to pay dividends, during
fiscal year 2004, the Company declared and paid dividends totaling $0.21 per
share (see chart above for actual quarterly payouts). The Company intends to pay
approximately 20% to 30% of its annual net earnings to shareholders in the form
of annual cash dividends if such cash dividends are in the best interest of the
Company in the business judgment of its Board of Directors and are consistent
with maintaining the Company's status as a "well-capitalized" institution under
applicable banking laws and regulations.
Recent Sales of Unregistered Securities. The Company did not sell any securities
in the fiscal year ended December 31, 2004 which were not registered under the
Securities Act of 1933, as amended (the "Securities Act").
Repurchases of Equity Securities. Neither the Company nor any affiliated
purchasers made any purchases of Company equity securities registered pursuant
to Section 12 of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), during the fourth quarter ended December 31, 2004.
Item 6. Selected Financial Data.
The following table sets forth selected financial information for the Company
that has been derived from the financial statements and notes thereto included
elsewhere in this report. This information should be read in conjunction with
Management's Discussion and analysis of Financial Condition and Results of
Operations and the consolidated financial statements and notes thereto included
elsewhere in this report.
-11-
(In thousands, except share and per share data) As of and for the Years Ended December 31
2004 2003 2002 2001 2000
---------------------------------------------------------------
Selected Balance Sheet Data
Cash and Due From Banks $ 23,007 $ 22,408 $ 32,837 $ 15,173 $ 27,676
Federal Funds Sold and Sort Term Investments 4 3,202 18,696 944 750
Securities 160,580 165,913 155,304 73,702 61,947
Gross Loans 654,867 625,945 600,609 306,891 242,275
Allowance for Loan Losses 10,721 11,613 9,390 4,286 3,463
Total Assets 882,294 857,734 840,976 406,741 343,620
Deposits 654,976 629,619 644,887 304,443 279,094
Borrowings 102,320 114,591 97,858 50,000 15,000
Repurchase Agreements 16,755 11,014 13,081 11,167 9,804
Shareholders' Equity 77,738 72,923 75,471 36,983 35,015
Summary of Operations
Interest Income $ 42,391 $ 40,440 $ 36,244 $ 26,173 $ 23,751
Interest Expense 16,257 16,318 15,895 14,701 13,101
---------------------------------------------------------------
Net Interest Income 26,134 24,122 20,349 11,472 10,650
Provision for Loan Losses 1,038 8,247 4,190 1,215 1,110
---------------------------------------------------------------
Net Interest Income After Provision For Loan Losses 25,096 15,875 16,159 10,257 9,540
Other Operating Income 6,905 10,322 7,987 4,490 2,193
Other Operating Expense (1) 23,824 25,165 17,465 11,847 9,596
---------------------------------------------------------------
Pre-tax Net Income 8,177 1,032 6,681 2,900 2,137
Income Tax Expense (Benefit) 2,866 38 2,374 480 (36)
---------------------------------------------------------------
Net Income $ 5,311 $ 994 $ 4,307 $ 2,420 $ 2,173
===============================================================
Per Share Data
Net Income - Basic $ .79 $ .15 $ .79 $ .65 $ .61
Net Income - Diluted .77 .15 .76 .65 .59
Dividends .21 .20 .20 -- --
Book Value 11.76 11.15 11.44 10.28 9.57
Number of Common Shares Outstanding 6,612,787 6,541,495 6,595,784 3,597,339 3,658,689
As of and for the Years Ended December 31
2004 2003 2002 2001 2000
---------------------------------------------------------------
Selected Ratios
Return On Average Assets .60% .11% .66% .65% .73%
Return on Average Shareholders' Equity 7.04% 1.34% 7.43% 6.69% 6.21%
Dividend Payout Ratio 26% 133% 26% 0% 0%
Average Shareholders' Equity to Average Total
Assets 8.58% 8.55% 8.89% 9.69% 11.83%
Net Interest Margin (2) 3.28% 3.06% 3.38% 3.28% 3.78%
(1) Includes non-recurring merger related costs of $90,000 for year ended
December 31, 2000.
(2) On a tax equivalent basis
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion and analysis is intended to aid the reader in
understanding and evaluating the results of operations and financial condition
of the Company, the Bank and CBIS. In addition, the Company has interest in the
Trusts, but the Trusts are not consolidated with the Company per the provisions
of FIN 46R. This discussion is designed to provide more comprehensive
information about the major components of the Company's results of operations
and financial condition, liquidity, and capital resources than can be obtained
from reading the financial
-12-
statements alone. This discussion should be read in conjunction with the
Company's consolidated financial statements, the related notes and the selected
financial data presented elsewhere in this report.
Safe Harbor Discussion
Information set forth in this Annual Report on Form 10-K contains various
"forward looking statements" within the meaning of Section 27A of the Securities
Act and Section 21E of the Exchange Act, which statements represent the
Company's judgment concerning the future and are subject to risks and
uncertainties that could cause the Company's actual operating results and
financial position to differ materially from the forward looking statements.
Such forward looking statements can be identified by the use of forward looking
terminology such as "may," "will," "expect," "anticipate," "estimate,"
"believe," or "continue," or the negative thereof or other variations thereof or
comparable terminology.
The Company cautions that any such forward looking statements are further
qualified by important factors that could cause the Company's actual operating
results to differ materially from those in the forward looking statements,
including without limitation, the management of the Company's growth, the risks
associated with possible or completed acquisitions, the risks associated with
the Bank's loan portfolio, competition within the industry, dependence on key
personnel, government regulation and the other risk factors described herein
under "Risk Factors."
Overview. Capital Bank is a full-service state chartered community bank
conducting business throughout North Carolina. The Bank operates through four
North Carolina regions; Triangle, Sandhills, Triad and Western. The Bank was
incorporated on May 30, 1997 and opened its first branch in June of that same
year in Raleigh. In 1999, the shareholders of the Bank approved the
reorganization of the Bank into a bank holding company. In 2001, the Company
received approval to become a financial holding company.
In the third quarter of 2004, the Bank reintroduced non-insured investment
products and services through Capital Bank Financial Services (a division of the
Bank), creating a partnership with Capital Investment Group, a leading Raleigh,
North Carolina based broker-dealer. The Bank employs commission-based Financial
Advisors to offer full-service brokerage to individual and corporate customers.
As of December 31, 2004, the Company conducted no business other than holding
stock in the Bank and each of the Trusts.
As a community bank, the Bank's profitability depends primarily upon its levels
of net interest income, which is the difference between interest income from
interest-earning assets and interest expense on interest-bearing liabilities.
The Bank's operations are also affected by its provision for loan losses, other
operating income, and other operating expenses.
During 2004, the Company's focus was on the following priorities:
o Strong, sustainable earnings
o A sound credit culture
o Disciplined growth in existing or adjacent markets
o Unparalleled customer service by experienced community bankers
For the year ended December 31, 2004, the Company achieved record earnings as
net income exceeded $5 million for the first time in the Company's history and
net interest margin expanded 22 basis points for the year. Nonperforming assets
declined during the year and net charge-offs declined significantly. The Company
sold three branches in northern North Carolina and opened locations in the
higher growth markets of Greensboro, Wake Forest and Asheville. The Company
believes our "Service Worth Talking About" continues to enhance our customer
experience in all communities we serve.
The Company also strengthened its management team during the year appointing
Grant Yarber as Chief Executive Officer and hiring Rick Edwards as Chief
Financial Officer in April. In addition, new executives were hired for the
-13-
Sandhills region and the mortgage division during the year. The Company believes
it has an experienced management team that is dedicated to providing exceptional
value to its customers and shareholders.
Critical Accounting Policies and Estimates. The Company's discussion and
analysis of its financial condition and results of operations are based on the
Company's consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires the Company to make
estimates and judgments regarding uncertainties that affect the reported amounts
of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, the Company evaluates
its estimates, including those related to the reserve for loan losses,
investment and intangible asset values, income taxes, and contingencies and
litigation. The Company bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. The Company believes the following critical
accounting policies affect its more significant judgments and estimates used in
the preparation of its consolidated financial statements:
o Loan Loss Reserves - The Company records estimated loan loss
reserves based on known problem loans and estimated risk in the
existing loan portfolio. The reserve calculation takes into account
historic write-off trends and current market and economic
conditions. If economic conditions were to decline significantly or
the financial condition of the Bank's customers were to deteriorate,
resulting in an impairment of their ability to make payments,
additional reserves may be required.
o Investments - The Company records an investment impairment charge
when it believes an investment has experienced a decline in value
that is other than temporary. Future adverse changes in market
conditions and associated market values of investments could result
in losses or an inability to recover the carrying value of the
investments that may not be reflected in an investment's current
carrying value, thereby possibly requiring an impairment charge in
the future. In addition, accounting standard setters are evaluating
changes in accounting for unrealized losses on the Company's
investment portfolio which could require us to record and realize
certain unrealized losses through earnings.
o Valuation Allowances - The Company assesses the need to record a
valuation allowance to reduce its deferred tax assets to the amount
that is more likely than not to be realized. The Company considers
anticipated future taxable income and ongoing prudent and feasible
tax planning strategies in determining the need for the valuation
allowance which, at this time, it deems not to be necessary. In the
event the Company were to determine that it would not be able to
realize all or part of its net deferred tax asset in the future, an
adjustment to the deferred tax asset would be charged to income in
the period such determination was made.
o Goodwill - Goodwill is not amortized, but is reviewed for potential
impairment on an annual basis at the reporting unit level.
Identified intangible assets are amortized on a straight-line basis.
An impairment loss is recorded to the extent that the carrying
amount of goodwill exceeds its implied value.
o Impairment of Long-Lived Assets - Long-lived assets, including
identified intangible assets, are evaluated for impairment if events
or circumstances indicate a possible impairment. Such evaluations
are based on undiscounted cash flow projections. The disposal of
long-lived assets is measured based on the lower of the book or fair
value less the costs to sell.
Results of Operations. The Company reported net income of $5.3 million,
$994,000, and $4.3 million for the years ended December 31, 2004, 2003 and 2002,
respectively. On a fully diluted per share basis, net income for 2004, 2003, and
2002 was $.77, $.15, and $.76, respectively.
Year Ended December 31, 2004 Compared with Year Ended December 31, 2003
Net Interest Income. Net interest income is the difference between total
interest income and total interest expense and is the Company's principal source
of earnings. The amount of net interest income is determined by the volume of
interest-earning assets, the level of rates earned on those assets, and the
volume and cost of supporting funds. Net
-14-
interest income increased from $24.1 million in 2003 to $26.1 million in 2004,
an increase of $2.0 million or 8%. The increase during the period is primarily
due to increases in market rates on the Bank's interest-earning assets as its
loans shifted upwards with increases in the prime rate and premium amortization
slowed on its investment portfolio from lower prepayments. Over the last six
months of 2004, the Federal Reserve made five 25 basis point ("bp") upward
adjustments in the Open Market Committee's benchmark federal funds rate. Another
25 bp increase occurred on February 4, 2005. Since the Bank's loan portfolio
adjusts with prime at a faster rate than the time deposit portfolio, the
increasing rate environment has had a positive effect on net interest spread and
net interest margin. As the time deposits mature and reprice, the margin could
be negatively impacted based on pricing competition to retain these deposits. In
addition, the Bank's net interest income was positively affected by a shift in
the mix of its earning assets as the Bank replaced lower yielding federal funds
with higher yielding loans. Average federal funds and short term investments,
yielding only 1.14% in 2003, dropped by $6.0 million from December 31, 2003 to
December 31, 2004 while average loans, yielding 5.49% in 2004, increased by
almost $18.0 million. The increase in average loans takes into account the
effect of the following two nonrecurring transactions that occurred during the
period:
o The Company completed the sale of its Northern Region branches in
Warrenton, Seaboard and Woodland to other financial institutions in
September 2004. In those branch sales, the Company sold
approximately $39.6 million of deposits and $12.8 million of loans,
as well as other assets. The $39.6 million of deposits sold were
comprised of $2.0 million non-interest bearing demand, $11.8 million
of money market, savings and interest checking and $25.8 million of
time deposits. A pre-tax gain of $1.2 million was recognized on the
sale, which is included in non-interest income.
o In December 2004, the Company sold approximately $19.4 million of
its mortgage loans. In conjunction with this sale, a loss of
$320,000 was recorded in non-interest income. A charge-off of
$199,000 associated with these loans was taken in the third quarter
of 2004 for reserves previously established.
Despite these significant transactions, both of which would have had negative
effects on earning assets or interest-bearing liabilities, average earning
assets increased $9.3 million from December 31, 2003 to December 31, 2004 and
average interest-bearing liabilities increased by $2.0 million.
Net interest spread is the difference between rates earned on interest-earning
assets and the interest paid on deposits and other borrowed funds. Net interest
margin is the total of net interest income divided by average earning assets.
Average earning assets in 2004 were $817.1 million, up 1.15% when compared to
$807.8 million for 2003. The net interest margin was 3.28% on a fully tax
equivalent ("TE") basis in 2004, a 22 bp increase from the 2003 net interest
margin of 3.06%. On a TE basis, net interest spread was 3.06% and 2.85% for 2004
and 2003, respectively.
Interest income increased 5% in 2004 to $42.4 million from $40.4 million in
2003. This increase is primarily due to the growth in the Bank's loan portfolio
and increases in overall yield as discussed above. The average yield on
interest-earning assets for 2004 was 5.27%, a 19 bp increase from the 2003 yield
of 5.08%. The average loan portfolio as a percentage of earning assets was 80%
in 2004, up 2% from 2003. The average balances of loans, which had yields of
5.49% and 5.43% for 2004 and 2003, respectively, increased from $632.1 million
in 2003 to $650.1 million in 2004. The average balances of federal funds and
other short-term investments decreased from $16.7 million in 2003 to $10.7
million in 2004 as these funds were used to fund loan growth, and the average
yield in this category increased 32 bps from 1.14% to 1.46% over the same time
period. Investment yield increased on an TE basis from 4.10% in 2003 to 4.60% in
2004. This increase reflects increases in market interest rates over the last
year as mortgage backed security ("MBS") pay-downs have decreased from the prior
year when the borrowers making up the underlying securities moved to refinance
their mortgages. Increases in MBS payment speeds in the prior year accelerated
the amortization of premiums associated with the assets and decreased the
investment yield.
Interest expense remained relatively flat from 2004 when measured against 2003.
Interest expense in both years was $16.3 million. Average total interest-bearing
deposits, including savings, interest-bearing demand deposits and time deposits
declined slightly, from $600.9 million in 2003 to $597.7 million in 2004,
largely as a result of selling three branches which had deposits of $39.6
million. In addition, the average rate paid on interest-bearing deposits
declined 4 bps between 2003 and 2004 as those customers with time deposits
shortened up the terms on those deposits in anticipation of higher future rates.
The average rate on borrowings also declined from 3.55% in 2003 to 3.31% in
2004. This decline in a rising interest rate environment reflects the full year
effect of interest rate swap agreements put into effect in July of 2003 which
converted portions of the Bank's fixed rate long term debt to a floating rate.
We
-15-
would expect the cost of borrowings to increase in 2005 as rates continue to
increase. Decreases in interest expense in the areas discussed above were offset
by an increase in interest paid on subordinated debt associated with two trust
preferred offerings done in 2003. The average outstanding balance of
subordinated debt increased year over year from $7.1 million in 2003 to $20.6
million in 2004, adding an additional $470,000 of interest expense as a result
of the volume increase. Both subordinated debt issues are variable rate in
nature and should increase in expense for 2005.
The following two tables set forth certain information regarding the Company's
yield on interest-earning assets and cost of interest-bearing liabilities and
the component changes in net interest income. The first table reflects the
Company's effective yield on earning assets and cost of funds. Yields and costs
are computed by dividing income or expense for the year by the respective daily
average asset or liability balance. Changes in net interest income from year to
year can be explained in terms of fluctuations in volume and rate. The second
table presents further information on those changes.
-16-
Average Balances, Interest Earned or Paid, and Interest Yields/Rates
(Tax Equivalent Basis - Dollars in thousands) (1)
Year Ended December 31, 2004 Year Ended December 31, 2003
--------------------------------------------------------------------------
Average Amount Average Average Amount Average
Balance Earned Rate Balance Earned Rate
--------------------------------------------------------------------------
Assets
Loans receivable: (2)
Commercial $ 506,744 $ 27,487 5.42% $ 470,147 $ 24,563 5.22%
Consumer 37,841 2,536 6.70% 49,367 3,261 6.61%
Home equity 59,865 3,015 5.04% 49,686 2,631 5.30%
Residential mortgages (3) 45,671 2,666 5.84% 62,925 3,897 6.19%
--------------------------------------------------------------------------
Total loans 650,121 35,704 5.49% 632,125 34,352 5.43%
Investment securities (4) 156,300 7,195 4.60% 159,030 6,514 4.10%
Federal funds sold and other
interest on short term investments 10,683 156 1.46% 16,676 190 1.14%
--------------------------------------------------------------------------
Total interest earning assets 817,104 $ 43,055 5.27% 807,831 $ 41,056 5.08%
===================== =====================
Cash and due from banks 22,135 20,715
Other assets 51,449 47,505
Allowance for loan losses (11,465) (10,521)
--------- ---------
Total assets $ 879,223 $ 865,530
========= =========
Liabilities and Equity
Savings deposits $ 17,040 $ 45 0.26% $ 18,833 $ 71 0.38%
Interest-bearing demand deposits 188,855 2,250 1.19% 188,624 2,087 1.11%
Time deposits 391,783 9,487 2.42% 393,401 9,912 2.52%
--------------------------------------------------------------------------
Total interest bearing deposits 597,678 11,782 1.97% 600,858 12,070 2.01%
Borrowed funds 103,427 3,427 3.31% 110,107 3,911 3.55%
Subordinated debt 20,620 929 4.51% 7,123 248 3.48%
Repurchase agreements and fed
funds purchased 12,865 119 0.92% 14,457 89 0.62%
--------------------------------------------------------------------------
Total interest-bearing liabilities 734,590 $ 16,257 2.21% 732,545 $ 16,318 2.23%
===================== =====================
Non-interest bearing deposits 60,201 50,489
Other liabilities 9,009 8,523
--------- ---------
Total liabilities 803,800 791,557
Shareholders' equity 75,423 73,973
--------- ---------
Total liabilities and equity $ 879,223 $ 865,530
========= =========
Net interest spread (5) 3.06% 2.85%
Tax equivalent adjustment $ 664 $ 616
Net interest income and net
interest margin (6) $ 26,798 3.28% $ 24,738 3.06%
==================== ====================
Year Ended December 31, 2002
-----------------------------------
Average Amount Average
Balance Earned Rate
-----------------------------------
Assets
Loans receivable: (2)
Commercial $ 324,900 $ 19,573 6.02%
Consumer 36,408 2,852 7.83%
Home equity 39,483 2,368 6.00%
Residential mortgages (3) 69,267 4,808 6.94%
-----------------------------------
Total loans 470,058 29,601 6.30%
Investment securities (4) 119,925 6,604 5.51%
Federal funds sold and other
interest on short term investments 22,259 370 1.66%
-----------------------------------
Total interest earning assets 612,242 $ 36,575 5.97%
=====================
Cash and due from banks 15,965
Other assets 30,871
Allowance for loan losses (7,157)
----------
Total assets $ 651,921
==========
Liabilities and Equity
Savings deposits $ 19,103 $ 170 0.89%
Interest-bearing demand deposits 147,427 2,746 1.86%
Time deposits 296,790 9,651 3.25%
-----------------------------------
Total interest bearing deposits 463,320 12,567 2.71%
Borrowed funds 72,067 3,116 4.32%
Subordinated debt -- -- 0.00%
Repurchase agreements and fed
funds purchased 14,901 212 1.42%
-----------------------------------
Total interest-bearing liabilities 550,288 $ 15,895 2.89%
===================================
Non-interest bearing deposits 35,064
Other liabilities 8,610
----------
Total liabilities 593,962
Shareholders' equity 57,959
----------
Total liabilities and equity $ 651,921
==========
Net interest spread (5) 3.09%
Tax equivalent adjustment $ 331
Net interest income and net
interest margin (6) $ 20,680 3.38%
=====================
(1) The taxable equivalent basis is computed using a blended federal and state
rate of approximately 38%.
(2) Loans receivable include nonaccrual loans for which accrual of interest
has not been recorded.
(3) Includes loans held for sale.
(4) The average balance for investment securities exclude the effect of their
market-to-market adjustment, if any.
(5) Net interest spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing
liabilities.
(6) Net interest margin represents the net interest income divided by average
interest-earning assets.
-17-
Rate & Volume Variance Analysis
(Tax Equivalent Basis - Dollars in thousands) (1)
Years Ended Years Ended
December 31, 2004 December 31, 2003
vs. 2003 vs. 2002
Rate/ Rate/
Volume Rate Volume Total Volume Rate Volume Total
Variance Variance Variance Variance Variance Variance Variance Variance
--------------------------------------------- ------------------------------------------
Interest Income:
Loans receivable $ 978 $ 364 $ 10 $ 1,352 $ 10,206 $ (4,056) $ (1,399) $ 4,751
Investment securities (112) 807 (14) 681 2,153 (1,691) (552) (90)
Federal funds sold (69) 54 (19) (34) (93) (116) 29 (180)
--------------------------------------------- ------------------------------------------
Total interest income 797 1,225 (23) 1,999 12,266 (5,863) (1,922) 4,481
--------------------------------------------- ------------------------------------------
Interest Expense:
Savings and interest-bearing
demand deposits and other (16) 154 (1) 137 717 (1,184) (291) (758)
Time deposits (41) (386) 2 (425) 3,142 (2,174) (707) 261
Borrowed funds (237) (263) 16 (484) 1,645 (556) (294) 795
Subordinated debt 470 73 138 681 -- -- 248 248
Repurchase agreements and fed
funds purchased (10) 45 (5) 30 (6) (121) 4 (123)
--------------------------------------------- ------------------------------------------
Total interest expense 166 (377) 150 (61) 5,498 (4,035) (1,040) 423
--------------------------------------------- ------------------------------------------
Increase (decrease) in net interest
income $ 631 $ 1,602 $ (173) $ 2,060 $ 6,768 $ (1,828) $ (882) $ 4,058
============================================= ==========================================
(1) The taxable equivalent basis is computed using a blended federal and state
rate of approximately 38%.
Provision for Loan Losses. The provision for loan losses is the amount charged
against earnings for the purpose of establishing an adequate allowance for loan
losses. Loan losses are, in turn, charged to this allowance rather than being
reported as a direct expense. In 2004 and 2003, amounts expensed as loan loss
provisions were $1.0 million and $8.2 million, respectively. The amount of the
allowance for loan losses is established based on management's estimate of the
inherent risks associated with lending activities, estimated fair value of
collateral, past experience and present indicators such as delinquency rates and
current market conditions. The allowance is regularly reviewed and adjusted, as
necessary. Loans of $750,000 or more are subject to specific review for
impairment in accordance with Statement of Financial Accounting Standards No.
114. The allowance for loan losses was $10.7 million and $11.6 million on
December 31, 2004 and 2003, respectively, and represented approximately 1.64%
and 1.86% of total loans outstanding on those dates. During the year, the
company reclassified $311,000 of the allowance which related to loss exposure on
unfunded loan commitments and letters of credit into a separate other liability
account.
The Company experienced higher loan charge offs during 2003 when compared to
2004. Management believes that this was due in part to a weakened economy and in
part to some large credit issues identified in the second quarter of 2003. As a
result of those credit issues, management engaged two independent credit review
firms in the latter part of 2003 to perform a detailed analysis of the Bank's
loan portfolio. As a result of the review, management identified loans during
that period aggregating approximately $2.7 million that were classified as a
loss. In addition, management significantly increased its internal loan watch
list. During 2003, the Company charged off an aggregate of $6.0 million in
loans, net of $862,000 in recoveries. Of that amount, $4.3 million related to
five business customer relationships. During 2004, the Company charged off an
aggregate of $1.6 million in loans, net of $616,000 in recoveries. Included in
the charge offs for 2004 was $497,000 related to one loan that had been
classified as impaired at December 31, 2003 and for which a specific reserve of
$825,000 had been established at that time.
Also as a result of the 2003 loan review, the Company effected certain changes
to try to mitigate such credit losses going forward, including procedural
changes in the loan approval and credit review processes, changes in individual
lending limits and centralization of the Company's lending operations functions
into one facility. The Company also added a lender support area where all
consumer loans are centrally underwritten and approved.
Management has allocated the allowance for loan losses by category, as shown in
the following table. This allocation is based on management's assessment of the
risks associated with the different types of lending activities.
-18-
Allowance for Loan Losses by Category
At December 31,
--------------------------------------------------------------------------
(Dollars in thousands) 2004 2003
--------------------------------------------------------------------------
Allowance % of Loans to Allowance % of Loans to
Amount Total Loans Amount Total Loans
--------------------------------------------------------------------------
Commercial $ 9,323 82% $ 9,885 76%
Consumer 519 5% 1,012 7%
Residential mortgages 299 9% 210 8%
Equity lines 580 4% 506 9%
---------------------------------- ------------------------------------
$ 10,721 100% $ 11,613 100%
================================== ====================================
The following table shows changes in the allowance for loan losses arising from
loans charged off and recoveries on loans previously charged off by loan
category and additions to the allowance that have been charged to expenses.
Analysis of Allowance for Loan Losses
As of and For the
Years Ended
December, 31
------------------------------------
(Dollars in thousands) 2004 2003 2002
------------------------------------
Average amount of loans outstanding, net of unearned income $ 650,121 $632,125 $470,058
------------------------------------
Amount of loans outstanding at year end, net of unearned income 654,867 625,945 600,609
Reserve for loan losses:
Balance at beginning of period $ 11,613 $ 9,390 $ 4,286
Adjustment for loans acquired -- -- 4,593
Loans charged off:
Commercial 1,390 5,631 3,545
Consumer 504 637 470
Equity 1 5 --
Mortgage 340 613 --
------------------------------------
Total chargeoffs 2,235 6,886 4,015
------------------------------------
Recoveries of loans previously charged off:
Commercial 411 797 263
Consumer 94 58 73
Equity 4 -- --
Mortgage 107 7 --
------------------------------------
Total recoveries 616 862 336
------------------------------------
Net loans charged off 1,619 6,024 3,679
------------------------------------
Provision for loan losses 1,038 8,247 4,190
Reclassification to other liabilities (311) -- --
------------------------------------
Balance at December 31 $ 10,721 $ 11,613 $ 9,390
====================================
Ratio of net chargeoffs to average loans outstanding during the year 0.25% 0.95% 0.78%
====================================
Allowance for loan losses as a percent of total loans 1.64% 1.86% 1.56%
====================================
The following table shows the total of the nonperforming assets in the Company's
portfolio as of December 31, 2004 and 2003. Loans deemed to be impaired at
December 31, 2003 amounted to $3.0 million. There were no loans classified as
impaired at December 31, 2004. Average impaired loans during 2004 and 2003 were
$2.1 million and $3.2 million, respectively.
-19-
(Dollars in thousands) 2004 2003
------ ------
Nonperforming assets:
Nonaccrual loans - Commercial $3,964 $3,766
Nonaccrual loans - Mortgage 1,898 2,271
Nonaccrual loans - Construction 1,622 1,444
Nonaccrual loans - Consumer 312 258
Nonaccrual loans - Equity lines 415 271
------ ------
Total nonaccrual loans 8,211 8,010
Foreclosed properties 418 978
------ ------
Total nonperforming assets $8,629 $8,988
====== ======
Nonperforming assets to:
Loans outstanding at end of year 1.32% 1.44%
Total assets at end of year 0.98% 1.05%
Allowance for loan losses as a percent of
nonperforming loans 131% 145%
The allowance for loan losses decreased 2004 and many of the related allowance
ratios also declined. The decreases were largely attributable to the resolution
of the one impaired loan for which a specific reserve of $825,000 had been
established. The majority of our nonperforming loans are secured by real estate
collateral which should mitigate our exposure to losses compared those loans
that are unsecured or collateralized with other types of assets.
Other Operating Income. Other operating income was $6.9 million and $10.3
million for years ended December 31, 2004 and 2003, respectively, a decrease of
$3.4 million or 33%. The decrease in other operating income for 2004 is
primarily attributable to a substantial drop in fee income recorded by the
Bank's mortgage department as a result of industry-wide decreased mortgage
refinance business caused by increases in mortgage loan interest rates. Mortgage
origination fees fell 74% to $1.3 million for 2004 from the $4.9 million earned
in the twelve month period ended December 31, 2003. Securities gains also fell
96% during the period from $442,000 during the year ended December 31, 2003 to
$18,000 during the same period of 2004. The mortgage revenue and securities
gains decline between the two periods was partially offset by two significant
non-recurring transactions occurring in the third quarter of 2004 which were
discussed previously.
Fees associated with deposit accounts remained fairly flat year over year with
recorded balances of $2.9 million in both 2004 and 2003. The sale of the three
mature branches impacted service charges in the latter part of 2004 as the sold
branches had higher fee income than the newly opened branches. Total service
charges and fees as a percent of the average total deposit base increased from
..44% in 2003 to .45% in 2004.
Other Operating Expense. Other operating expense represents the costs of
operating the Company. Management regularly monitors all categories of other
operating expense in an attempt to improve productivity and operating
performance. Other operating expense decreased 5% to $23.8 million in 2004 from
$25.2 million in 2003. At December 31, 2003 there were 21 branches and the
average number of full time equivalent employees during the year was 220. At
December 31, 2004 there were 20 branches and the average number of full time
equivalent employees during the year was 216.
Salary and employee benefits expense for the years ended December 31, 2004 and
2003 were $12.1 million and $13.9 million, respectively. Commission expense
decreased from $2.2 million in 2003 to $728,000 in 2004. These commissions are
driven largely by mortgage fee income which decreased 74%. In addition, during
2003 the Company incurred $1.2 million in severance expenses related to certain
executive and senior officers who separated from the Company compared to
severance expenses during 2004 of only $61,000.
Occupancy expense increased from $2.2 million in 2003 to $2.4 million in 2004.
The increase was primarily a result of lease expenses associated with new
locations and additional space needed for expansion of existing departments.
Furniture and equipment expense increased from $1.5 million in 2003 to $1.7
million in 2004 due to the increase in assets associated with the new locations
and general expansion. Telecommunications expense increased from
-20-
$337,000 to $542,000 as we added bandwidth for more rapid data communication.
The increased bandwidth was required to implement upgrades in the data
processing software from its main data processing supplier. Public relations and
advertising costs increased 21% or $148,000 from $721,000 to $869,000 due to the
branch openings and deposit campaign in 2004.
Other expenses decreased from $4.0 million in 2003 to $3.9 million in 2004. The
primary cause for the decrease was a $310,000 write down in real estate owned
made in September of 2003. There were no such significant real estate write
downs in 2004. However, this decrease was partially offset by increases in other
areas including increased travel and entertainment expenses from $291,000 to
$416,000 and an increase in franchise taxes from $159,000 to $219,000. All such
increases were a direct result of changes in the business plan of the Company,
the changing of the footprint of the organization, or expansion of existing
departments.
Provision for Income Taxes. The Company recorded an income tax expense of $2.9
million in 2004 compared to $38,000 for 2003. The increase in income tax expense
is primarily the result of a significant increase in pretax net income year over
year. Pretax net income for 2004 was $8.2 million compared to $1.0 million for
2003. Pretax net income for 2003 includes the effect of several large loan
charge-offs, increases to the loan loss provision and severance expenses as
discussed above. The overall effective rate adjusted upwards from 3.7% in 2003
to 35.0% in 2004. The rate for 2003 reflects the impact of permanent differences
such as nontaxable municipal bond interest and insurance income on a smaller net
income base. See Notes to Consolidated Financial Statements - Note 12 - Income
Taxes.
Year Ended December 31, 2003 Compared with Year Ended December 31, 2002
Net Interest Income. Net interest income increased from $20.3 million in 2002 to
$24.1 million in 2003, an increase of $3.8 million or 19%. The increase during
the period is primarily due to increases in the average volume of
interest-bearing assets and liabilities as the Bank experienced internal growth.
The increase was negatively affected by a decline in market rates during 2003.
Rates dropped by 25 bps in July 2003. In 2002, the Federal Reserve held interest
rates steady for a majority of the year, but made one move in November that
resulted in an additional 50 bp drop in the prime rate to 4.25%. In addition,
during 2001, the prime rate dropped from 9.00% in January to 4.75% in December
with a decline in rates of at least 25 bps in every month of 2001 except July as
the Federal Reserve made 11 separate moves to reduce interest rates in efforts
to stimulate the economy. The Company felt the effects of these changes over an
extended period of time due to the long term repricing or maturity dates of some
of its assets and liabilities. Since the Bank's loan portfolio adjusts with
prime at a faster rate than the deposit portfolio, the declining rate
environments had a negative effect on net interest spread and net interest
margin. Average earning assets in 2003 were $807.8 million, up 32% when compared
to $612.2 million for 2002. The net interest margin was 3.06% in 2003, a 32 bp
decline from the 2002 net interest margin of 3.38%. Net interest spread was
2.85% and 3.09% for 2003 and 2002, respectively.
Interest income increased 12% in 2003 to $40.4 million from $36.2 million in
2002. This increase was primarily due to the growth in the Bank's loan
portfolio. The average yield on interest-earning assets for 2003 was 5.01%, a
decline of 91 bps from the 2002 yield of 5.92%. The decrease in average yield
during 2003 was primarily attributable to the overall decline in market rates as
explained above. The average loan portfolio as a percentage of earning assets
was 78% in 2003, up 1% from 2002. The average balances of loans, which had
yields of 5.43% and 6.30% for 2003 and 2002, respectively, increased from $470.1
million in 2002 to $632.1 million in 2003. The average balances of federal funds
and other short-term investments decreased from $22.3 million in 2002 to $16.7
million in 2003, and the average yield in this category dropped 52 bps from
1.66% to 1.14% over the same time period. Investment yield decreased from 5.23%
in 2002 to 3.71% in 2003. This decrease reflects the results of the decline in
market interest rates over the last three years as MBS pay-downs increased
significantly when the borrowers making up the underlying securities moved to
refinance their mortgages. Increases in MBS payment speeds accelerated the
amortization of premiums associated with the purchases and dropped the
investment yield.
Interest expense increased 3% in 2003 to $16.3 million from the $15.9 million
recorded during 2002. This increase was primarily due to a significant increase
in average interest-bearing deposits, which went from $463.3 million in 2002 to
$600.9 million in 2003. In addition, average borrowed funds increased year over
year from $72.7 million in 2002 to $110.3 million in 2003. Also, during 2003 the
Company incurred junior subordinated debt associated with two trust preferred
securities offerings. See Notes to Consolidated Financial Statements - Note 11 -
Subordinated Debentures. The income effects of increases in volume were
significantly offset by declines in rates during the period.
-21-
The average rates on interest-bearing deposits decreased from 2.71% in 2002 to
2.01% in 2003. The decrease in average rates during 2003 is reflective of the
overall decrease in market rates offered during 2003 as compared to the previous
year. As previously mentioned, the Bank's loan portfolio adjusts with prime at a
faster rate than its deposit portfolio as a result of the Federal Reserve's
actions to decrease interest rates. Much of the effect of the rapid rate
declines of 2001 did not take place on the deposit portfolio until 2002 and
2003. In particular, the average rate on time deposits, which represented 54% of
all interest bearing liabilities during 2003, dropped 73 bps in 2003 from 3.25%
in 2002 to 2.52% in 2003.
Provision for Loan Losses. In 2003 and 2002, amounts expensed as loan loss
provisions were $8.2 million and $4.2 million, respectively. The allowance for
loan losses was $11.6 million and $9.4 million on December 31, 2003 and 2002,
respectively, and represented approximately 1.86% and 1.56% of total loans
outstanding on those dates.
The Company experienced higher loan charge offs during 2003 when compared to the
previous year. Management believes that this is due in part to a weakened
economy and in part to some large credit issues identified in the second quarter
of 2003. As a result of these credit issues, management engaged two independent
credit review firms in the latter part of 2003 to perform a detailed analysis of
the Bank's loan portfolio. As a result of the review, management identified
loans during that period aggregating approximately $2.7 million that were
classified as a loss. In addition, management significantly increased its
internal loan watch list. During 2003, the Company charged off an aggregate of
$6.0 million in loans, net of $862,000 in recoveries. Of that amount, $4.3
million related to five business customer relationships. During 2002, the
Company charged off $3.7 million in loans, net of $336,000 in recoveries.
Also as a result of the loan review, the Company effected certain changes to try
to protect against such credit losses going forward, including procedural
changes in the loan approval and credit review processes, changes in individual
lending limits and centralization of the Company's lending functions into one
facility. The Company also added a lender support area where all consumer loans
are centrally underwritten and approved.
Other Operating Income. Other operating income was $10.3 million and $8.0
million for years ended December 31, 2003 and 2002, respectively, an increase of
29%. The increase in other operating income for 2003 was primarily attributable
to increases in fees associated with deposit accounts and a large increase in
fees associated with the Company's mortgage loan origination activities. The
large increase in fees associated with the mortgage loan origination activities
was a direct result of attractive mortgage rates during 2003 and 2002 due to the
lower interest rate environment. Mortgage loan origination fees increased from
$3.3 million during 2002 to $4.9 million for 2003. Fees associated with deposit
accounts increased primarily as a result of the increased volume of average
deposit accounts. However, the total average deposit base increased from $498.4
million in 2002 to $651.3 million in 2003. Service charges and fees increased
from $2.4 million in 2002 to $2.9 million in 2003. Total service charges and
fees as a percent of the average total deposit base dropped from .47% in 2002 to
..43% in 2003. Finally, the Company realized gains of $442,000 on the sale of
investment securities during 2003 versus a realized gain of $981,000 in 2002.
Other Operating Expense. Other operating expense increased 44% to $25.2 million
in 2003 from $17.5 million in 2002. The increase in 2003 reflects a full year of
expenses associated with the integration of the four additional branches in
connection with the acquisition of First Community Corporation in January 2002
and three additional branches in connection with the acquisition of High Street
Corporation in December 2002. At December 31, 2002 there were 21 branches and
the average number of full time equivalent employees was 173.
Salary and employee benefits expense for the years ended December 31, 2003 and
2002 were $13.9 million and $9.8 million, respectively. Increases were the
result of additional personnel hired as new branches and departments were added
or obtained through acquisition as discussed above. In addition, during 2003 the
Company incurred $1.2 million in severance expenses related to certain executive
and senior officers who separated from the Company. Commission expense increased
from $1.6 million in 2002 to $2.2 million in 2003. Because these commissions are
driven by the underlying mortgage fee income, the increase, $600,000, or 38%,
closely related to the increase in mortgage origination fees.
Occupancy expense increased from $1.6 million in 2002 to $2.2 million in 2003.
The increase was primarily a result of lease expenses associated with new
locations and additional space needed for expansion of existing departments.
Furniture and equipment expense increased from $1.1 million in 2002 to $1.5
million in 2003 due to the increase in these assets needed for the new locations
and general expansion. Other operating expenses increased from $3.0 million
-22-
in 2002 to $5.0 million in 2003. The increases in other operating expenses from
2002 to 2003 included a 76% increase in telephone expenses from $191,000 to
$337,000, a 37% increase in postage from $256,000 to $351,000, and a 25%
increase in public relations and advertising costs from $578,000 to $721,000. In
addition, courier costs, or those costs associated with getting customer
transactions to the Bank's outside processing center, increased due to the
additional branches being serviced by such couriers. All such increases were a
direct result of a full year of expense on the new branches or expansion of
existing departments. In the third quarter of 2003, the Bank also incurred write
downs of the carrying value of certain real estate held for sale of $310,000.
Provision for Income Taxes. Throughout 2002, the Company recorded income tax
expenses of $2.4 million. The Company recorded an income tax expense of $38,000
in 2003. The decrease in income tax expense was primarily the result of the loss
recorded in the third quarter of 2003 and an overall drop in net taxable income.
The third quarter loss reflects the significant charge-offs, the increase in the
allowance for loan losses and the related loan loss provision recorded during
that period. The overall effective rate dropped from 35.5% in 2002 to 3.7% in
2003. That rate reflects the impact of permanent differences such as nontaxable
municipal bond interest on a smaller net income base. Total permanent
differences in 2003 were $1.0 million in 2003 compared to $536,000 in 2002. The
largest single component of this increase was an increase in municipal bond
interest, which increased from $532,000 in 2002 to $997,000 in 2003. See Notes
to Consolidated Financial Statements - Note 12 - Income Taxes for additional
information on our tax expense.
Financial Condition. The Company's financial condition is measured in terms of
its asset and liability composition, asset quality, capital resources, and
liquidity. The growth and composition of assets and liabilities during 2004 and
2003 reflect the repositioning of the Company's markets and product lines as
several branches were sold or closed, three new branches were opened, a large
mortgage portfolio was sold and the Company experienced internal growth as a
result of its internal business development activities.
Total assets were $882.3 million and $857.7 million at December 31, 2004 and
2003, respectively. The increase in total assets of $24.6 million in 2004, or
3%, reflects strong internal growth considering the fact that, while the Company
completed no acquisitions during 2004, it did sell off approximately $40 million
in deposits and $32 million in loans in two non-routine transactions discussed
previously. The largest component of asset growth was the increase in loans.
Total liabilities increased from $784.7 million in 2003 to $804.6 million in
2004. The main cause for the increase between the periods is an increase in time
deposits of $25.1 million as the Company has used this source as its primary
means to fund loan growth.
Stockholders' equity increased from $72.9 million in 2003 to $77.7 million in
2004. The increase, $4.8 million or 7%, primarily reflects an increase of $3.9
million in retained earnings, comprised of $5.3 million of net income less
dividends of $1.4 million. Common stock increased $960,000, largely the result
of issuances of stock pursuant to stock options exercises.
Assets
Cash and Cash Equivalents. Cash and cash equivalents, including
non-interest-bearing and interest-bearing cash and federal funds sold, decreased
from $25.6 million in 2003 to $23.0 million in 2004. The decrease is primarily
the result of growth in loans and the outlay of cash needed to fund those loans
exceeding growth in deposits and borrowings.
Loan Portfolio. Total loans were $654.9 million and $625.9 million as of
December 31, 2004 and 2003, respectively. Loan growth, excluding the branch sale
and mortgage portfolio sold previously discussed, was $65 million or 11.1%
annualized. The increase was the result of internal growth as the Company
completed no acquisitions in 2004 and reflects improvement in our operations
during 2004. Accordingly, the Company's business development activities were key
factors in the growth of the loan portfolio during 2004. At December 31, 2004,
commercial loans, mortgage loans, consumer loans, and equity lines were $532.1
million, $26.0 million, $34.9 million, and $61.9 million, respectively. At
December 31, 2003, commercial loans, mortgage loans, consumer loans, and equity
lines were $474.3 million, $50.2 million, $42.9 million, and $58.4 million,
respectively. See Notes to Consolidated Financial Statements - Note 6 - Loans
and Allowances for Loan Losses. The commercial loan portfolio is comprised
mainly of loans to small and mid-sized businesses with revenues up to $25
million. There were no significant concentrations of credit to
-23-
any one industry, class, or category. The following table reflects the
maturities of the commercial loan portfolio and the mix of the commercial loans
that mature greater than one year in the loan portfolio between fixed rate and
adjustable rate notes.
(Dollars in thousands)
Commercial loans:
Due within one year $165,401
Due one through five years 316,312
Due after five years 50,378
--------
$532,091
========
Commercial loans due after 1 year:
Fixed rate $159,241
Variable rate 207,449
--------
$366,690
========
Although there were no large concentrations of credit to any particular
industry, the economic trends of the area served by the Company are influenced
by the significant industries within the region. The Company's primary business
activity is with customers located in the Research Triangle area of North
Carolina (Raleigh, Durham, and Chapel Hill) and its surrounding counties, the
Alamance County area (Burlington and Graham, North Carolina), and the Interstate
40 corridor between Asheville and Hickory, North Carolina. The ultimate
collectibility of the Company's loan portfolio is susceptible to changes in the
market conditions of these geographic regions.
The Company uses a centralized risk management process to ensure uniform credit
underwriting that adheres to Company policy. Lending policies are reviewed on a
regular basis to confirm that the Company is prudent in setting its underwriting
criteria. Credit risk is managed through a number of methods including loan
grading of commercial loans, committee approval of larger loans, and class and
purpose coding of loans. Management believes that early detection of credit
problems through regular contact with the Company's customers coupled with
consistent reviews of the borrowers' financial condition are important factors
in overall credit risk management.
Management charged off loans totaling $1.6 million, $6.0 million, and $3.7
million net of recoveries, as uncollectible during 2004, 2003 and 2002,
respectively. The large increase in the 2003 amount was the result of five large
commercial loan relationships that totaled $4.3 million, or 72% of the total
amount charged off, as well as continued softening in the economy and isolated
instances of specific business problems. At December 31, 2004 and 2003, the
allowance for loan losses as a percentage of total loans was 1.64% and 1.86%,
respectively. Management believes the allowance for loan losses of $10.7 million
at 2004 provides adequate coverage of the probable losses in the loan portfolio.
Investment Securities. Investment securities represent the second largest
component of earning assets. The Company's securities portfolio consists
primarily of debt securities issued by U.S. government agencies and securities
issued by Fannie Mae and Freddie Mac which have been segregated into one of two
categories: available for sale or held to maturity. The "available for sale"
classification allows flexibility in the management of interest rate risk,
liquidity, and loan portfolio growth while the "held to maturity" classification
protects the balance sheet against market value fluctuations in a rising rate
environment. The Company has the intent and the ability to hold "held to
maturity" securities until their maturity or prepayment. Securities available
for sale are carried at their fair value and the mark-to-market adjustment was
$497,000 in net unrealized gains at December 31, 2004. After considering
applicable tax benefits, the mark-to-market adjustment increased total
stockholders' equity by $305,000. Future fluctuations in stockholders' equity
may occur due to changes in the fair values of available for sale securities.
Growth of the investment securities portfolio in 2005 will depend on loan
growth, the interest rates available for reinvesting maturing securities and
changes in the interest rate yield curve. Due to an expected rising interest
rate environment, the Company may curtail or refrain from the reinvestment of
cash flows from its investment portfolio, instead using proceeds to pay off
wholesale funding liabilities and deleveraging the balance sheet thereby
improving capital ratios but lowering net interest income. The Company may also
increase the investment portfolio depending on core deposit growth.
-24-
On December 31, 2004 and 2003, the recorded value of investments totaled $154.3
million and $160.2 million, respectively. At December 31, 2004, $140.9 million
of these securities were classified as "available for sale" and recorded at
market value and $13.3 million were classified as "held to maturity" and
recorded at amortized cost. At December 31, 2003, all investments were
classified as "available for sale".
The Company has reviewed the investment portfolio and has not recorded any
"other than temporary" impairment. The Company anticipates that substantially
all of the book value of the investments will be recovered over the life of any
securities whose market value is below amortized cost.
The following table reflects the debt securities in the portfolio as of December
31, 2004 and 2003.
As of December 31,
-----------------------------------------------------------------------------------------------------
Available for Sale Held to Maturity
------------------------------------------------- ------------------------------------------------
(Dollars in thousands) 2004 2003 2004 2003
----------------------- ------------------------ ------------------------ ----------------------
Amortized Fair Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value Cost Value
----------------------- ------------------------ ------------------------ ----------------------
US Agency securities $ 35,511 $ 35,172 $ 35,747 $ 35,338 $ 5,000 $ 4,990 $ -- $ --
Municipal bonds 24,087 24,830 24,678 25,383 300 300 -- --
Mortgage-backed securities 80,851 80,944 99,177 99,495 8,036 7,983 -- --
----------------------- ------------------------ ------------------------ ----------------------
$ 140,449 $ 140,946 $ 159,602 $ 160,216 $ 13,336 $ 13,273 $ -- $ --
======================= ======================== ======================== ======================
The following table reflects the debt securities by contractual maturities as of
December 31, 2004. Expected maturities will differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties.
(Dollars in thousands) Available for Sale Held to Maturity
------------------------------- ------------------------------
Weighed Weighed
Carrying Average Carrying Average
Value Yield Value Yield
-----------------------------------------------------------------
US Agency securities:
After 1 but within 5 years $ 24,465 3.89% $ 5,000 4.07%
After 5 years 10,707 4.69% -- --
------------------------------- ------------------------------
Total US Agency securities 35,172 4.14% 5,000 4.07%
------------------------------- ------------------------------
Municipal bonds (1)
After 5 years 24,830 6.19% 300 4.50%
------------------------------- ------------------------------
Total Municipal bonds 24,830 6.19% 300 4.50%
------------------------------- ------------------------------
Mortgage-backed securities
After 1 but within 5 years 3,777 4.08% -- --
After 5 years 77,167 4.55% 8,036 4.67%
------------------------------- ------------------------------
Total Mortgage-backed securities 80,944 4.53% 8,036 4.67%
------------------------------- ------------------------------
$ 140,946 4.72% $ 13,336 4.44%
=============================== ==============================
(1) Municipal bonds shown at tax equivalent yield.
Money Market Investments and Federal Funds. At December 31, 2004 and 2003, the
Company had $975,000 and $3.8 million, respectively, in short-term money market
investments and federal funds. These figures include interest-bearing cash
accounts. The decrease between the periods was the result of a need to use
interest earning cash and Fed Funds to fund a growth in loans during a period
when deposits were declining.
Deposits. Total deposits increased from $629.6 million at December 31, 2003 to
$655.0 million at December 31, 2004. Of these amounts, $58.3 million and $65.7
million were in the form of non-interest-bearing demand deposits at December 31,
2003 and 2004, respectively, and $571.3 million and $589.3 million were in the
form of interest-bearing deposits at December 31, 2003 and 2004, respectively.
Balances in certificates of deposit of $100,000 and over were
-25-
$103.1 million and $135.3 million at December 31, 2003 and 2004, respectively.
The largest area of growth was in brokered deposits, which grew from $3.7
million at December 31, 2003 to $20.3 million at December 31, 2004 as the
Company used this form of wholesale funding to fund loan growth during the year
and to replace funding provided by the three sold branches.
The following table reflects the maturities of certificates of deposit of
$100,000 and over as of December 31, 2004:
Maturity Average
(Dollars in thousands) Amount Rate
----------------------
Three months or less $ 26,483 2.05%
Over three months to six months 65,622 2.28%
Over six months to twelve months 39,193 3.22%
Over twelve months 3,996 3.66%
----------------------
$ 135,294 2.55%
======================
Debt. At December 31, 2004 and 2003, the Company's outstanding advances with the
Federal Home Loan Bank ("FHLB") were $102.3 million and $114.6 million,
respectively. During the year ended December 31, 2004, the maximum outstanding
advances were $118.4 million. The Company had average outstanding FHLB advances
of $104.0 million and $110.3 million with effective costs of borrowing of 3.31%
and 3.55% at December 31, 2004 and 2003, respectively. At December 31, 2004,
approximately $67.3 million are fixed rate advances and $35.0 million are
variable rate advances including $25.0 million of long-term advances for which
the fixed interest rate has been converted to a variable rate through interest
rate swaps discussed below.
Capital Resources. Total shareholders' equity for 2004 and 2003, excluding
unrealized gains net of taxes on available for sale securities of $305,000 in
2004 and $377,000 in 2003, was $77.4 million and $72.5 million, respectively.
The increase is primarily the result of the change in retained earnings,
comprised of $5.3 million of net income less dividends of $1.4 million. Common
stock increased $960,000, largely the result of issuances of stock pursuant to
stock options exercises.
The Company paid cash dividends of $0.20 per share during 2003 and $0.21 per
share during 2004. At December 31, 2004, the Company had a leverage ratio of
9.61%, a Tier 1 capital ratio of 11.08%, and a risk based capital ratio of
12.33%. These ratios exceed the federal regulatory minimum requirements for a
"well capitalized" bank and increased from year-end 2003 levels. See Notes to
Consolidated Financial Statements - Note 14 - Regulatory Matters and
Restrictions for additional information on regulatory capital requirements.
The Board of Directors has also authorized the repurchase of up to 150,000
shares of the Company's common stock through public or private transactions. The
Company did not repurchase any shares in 2004. Management plans to utilize share
repurchases to manage the capital levels of the Company. Subsequent to year end,
we repurchased 20,000 shares at an average cost of $18.80 per share.
Asset/Liability Management. Asset/liability management functions to maximize
profitability within established guidelines for interest rate risk, liquidity,
and capital adequacy. Measurement and monitoring of liquidity, interest rate
risk, and capital adequacy are performed centrally through the Asset/Liability
Management Committee, and reported under guidelines established by management,
the Board of Directors and regulators. Oversight on asset/liability management
matters is provided by the Board of Directors through its Asset/Liability
Management Committee. See Item 7a. - Quantitative and Qualitative Disclosures
About Market Risk - for information about interest rate risk.
Liquidity management involves the ability to meet the cash flow requirements of
depositors wanting to withdraw funds or borrowers needing assurance that
sufficient funds will be available to meet their credit needs. To ensure the
Company is positioned to meet immediate and future cash demands, management
relies on internal analysis of its liquidity, knowledge of current economic and
market trends and forecasts of future conditions. Regulatory agencies set
certain minimum liquidity standards including the setting of a reserve
requirement by the Federal Reserve. The Company must submit weekly reports to
the Federal Reserve to ensure that it meets those requirements. At December 31,
2004, the Company met all of its liquidity requirements.
-26-
The Company had $23.0 million in its most liquid assets, cash and cash
equivalents at December 31, 2004. The Company's principal sources of funds are
deposits, short-term borrowings and capital. Core deposits (total deposits less
certificates of deposits in the amount of $100,000 or more), one of the most
stable sources of liquidity, together with equity capital funded $597.4 million
or 67.7% of total assets at December 31, 2004. At December 31, 2003, core
deposits and equity capital totaled $599.4 million or 69.9% of total assets.
The Company's liquidity can best be demonstrated by an analysis of its cash
flows. In 2004, the Company used a net increase in deposits of $25.3 million to
fund $28.9 million in net new internal loan growth. Excluding the effect of
$39.6 million in deposits sold and $12.8 million in loans sold as a result of
the sale of three branches in the third quarter and $18.7 million in loans sold
related to a specific loan portfolio, net deposit growth was $64.9 million and
net loans funded was $60.4 million. In addition, the Company had other financing
activities including net repayment of borrowings from the FHLB of $12.3 million.
Operating activities also provided $10.9 million of liquidity for the year ended
December 31, 2004, compared to $16.8 million and $911,000 in 2003 and 2002,
respectively. The principal elements of operating activities are net income,
increased for significant non-cash expenses for the provision for loan losses
and depreciation and amortization.
A secondary source of liquidity for the Company comes from investing activities,
principally the sales of, maturities of and cash flows from investment
securities. During 2003 and 2002, due to the declining interest rate
environment, the cash flow from mortgage-backed securities accelerated as
borrowers holding the underlying mortgages refinanced and certain securities
with call features were called. The cash received from these events, combined
with maturities, amounted to $103.6 million and $76.6 million in 2003 and 2002,
respectively. As rates began to rise, the refinance market slowed down and with
it, the cash flow from the mortgage-backed securities declined. Repayments on
these obligations in 2004 were $62.0 million. As of December 31, 2004, the
Company had negligible investment securities that would mature in the next 12
months, although certain MBS securities will have principal reductions and
agency securities may be called by the issuer. During 2004, the Company
purchased $56.8 million of investment securities to replace the securities sold,
called or matured during the same period and to meet liquidity needs.
Additional sources of liquidity are available to the Bank through the Federal
Reserve System and through membership in the FHLB system. As of December 31,
2004, the Bank had a maximum borrowing capacity of $176.5 million through the
FHLB of Atlanta. These funds can be made available with various maturities and
interest rate structures. Borrowings cannot exceed twenty percent of total
assets or twenty times the amount of FHLB stock owned by the borrowing bank. At
December 31, 2004, the Bank owned $6.3 million worth of FHLB stock or 6.2%
percent of its outstanding advances of $102.3 million. Borrowings are
collateralized by a blanket lien by the FHLB on the Bank's qualifying assets.
The Company also has sources of liquidity from other sources such as federal
funds lines, repurchased agreement lines and brokered CDs. These liquidity
sources require collateral in the case of repurchase agreements but are
generally unsecured or easily utilized by the Company.
The following table reflects expected maturities of contractual obligations and
expected expirations of ongoing commitments that affect the Company's liquidity.
-27-
Payments Due By Period
----------------------------------------------------------------------------
Less Than 1 - 3 3 - 5 More Than
(In thousands) 1 Year Years Years 5 Years Total
----------------------------------------------------------------------------
Contractual Obligations
FHLB Advances $ 10,000 $ 5,000 $ 11,861 $ 75,459 $ 102,320
Subordinated Debentures - -- -- 20,620 20,620
Operating Leases 1,164 2,036 2,813 5,899 11,912
----------------------------------------------------------------------------
$ 11,164 $ 7,036 $ 14,674 $ 101,978 $ 134,852
============================================================================
Amount of Commitment Expiration by Period
----------------------------------------------------------------------------
Less Than 1 - 3 3 - 5 More Than Total
1 Year Years Years 5 Years Committed
----------------------------------------------------------------------------
Commercial Commitments
Commercial Letters of Credit $ 1,359 $ -- $ -- $ -- $ 1,359
Other Commercial Loan Commitments 37,283 15,032 4,655 1,295 58,265
----------------------------------------------------------------------------
$ 38,642 $ 15,032 $ 4,655 $ 1,295 $ 59,624
============================================================================
Effects of Inflation. The Company's financial statements have been prepared in
accordance with generally accepted accounting principles, which require the
measurement of financial position and operating results in terms of historic
dollars without consideration for changes in the relative purchasing power of
money over time due to inflation. The rate of inflation has been relatively
moderate over the past few years; however, the effect of inflation on interest
rates can materially impact Bank operations, which rely on the spread between
the yield on earning assets and rates paid on deposits and borrowings as the
major source of earnings. Operating costs, such as salaries and wages, occupancy
and equipment costs, can also be negatively impacted by inflation.
Risk Factors
In addition to the other information provided in this Annual Report of Form
10-K, you should consider the following material risk factors carefully before
deciding to invest in the Company's securities. Additional risks and
uncertainties not presently known to the Company, that the Company currently
deems not material or that are similar to those faced by other companies in the
Company's industry or business in general, such as competitive conditions, may
also impact the Company's business operations. If any of the events described
below occur, our business, financial condition, or results of operations could
be materially adversely affected. In that event, the trading price of the
Company's common stock may decline, in which case the value of your investment
may decline as well.
Our Results Are Impacted by the Economic Conditions of Our Principal
Operating Regions
Our operations are concentrated throughout Central and Western North
Carolina. As a result of this geographic concentration, our results may
correlate to the economic conditions in these areas. Deterioration in
economic conditions in any of these market areas, particularly in the
industries on which these geographic areas depend, may adversely affect
the quality of our loan portfolio and the demand for our products and
services, and accordingly, our results of operations.
We Are Exposed to Risks in Connection with the Loans We Make
A significant source of risk for us arises from the possibility that
losses will be sustained because borrowers, guarantors and related parties
may fail to perform in accordance with the terms of their loans. We have
underwriting and credit monitoring procedures and credit policies,
including the establishment and review of the allowance for loan losses,
that we believe are appropriate to minimize this risk by assessing the
likelihood of nonperformance, tracking loan performance and diversifying
our loan portfolio. Such policies and procedures, however, may not prevent
unexpected losses that could adversely affect our results of operations.
We Compete With Larger Companies for Business
-28-
The banking and financial services business in our market areas continues
to be a competitive field and is becoming more competitive as a result of:
o Changes in regulations;
o Changes in technology and product delivery systems; and
o The accelerating pace of consolidation among financial services
providers.
We may not be able to compete effectively in our markets, and our results
of operations could be adversely affected by the nature or pace of change
in competition. We compete for loans, deposits and customers with various
bank and nonbank financial services providers, many of which have
substantially greater resources including higher total assets and
capitalization, greater access to capital markets and a broader offering
of financial services.
Our Trading Volume Has Been Low Compared With Larger Banks
The trading volume in the Company's common stock on the NASDAQ National
Market has been comparable to other similarly-sized banks. Nevertheless,
this trading is relatively low when compared with more seasoned companies
listed on the NASDAQ National Market or other consolidated reporting
systems or stock exchanges. Thus, the market in the Company's common stock
may be limited in scope relative to other companies.
We Depend Heavily on Our Key Management Personnel
The Company's success depends in part on its ability to retain key
executives and to attract and retain additional qualified management
personnel who have experience both in sophisticated banking matters and in
operating a small to mid-size bank. Competition for such personnel is
strong in the banking industry and we may not be successful in attracting
or retaining the personnel we require. We expect to effectively compete in
this area by offering financial packages that include incentive-based
compensation and the opportunity to join in the rewarding work of building
a growing bank.
Technological Advances Impact Our Business
The banking industry is undergoing technological changes with frequent
introductions of new technology-driven products and services. In addition
to improving customer services, the effective use of technology increases
efficiency and enables financial institutions to reduce costs. Our future
success will depend, in part, on our ability to address the needs of our
customers by using technology to provide products and services that will
satisfy customer demands for convenience as well as to create additional
efficiencies in our operations. Many of our competitors have substantially
greater resources than we do to invest in technological improvements. We
may not be able to effectively implement new technology-driven products
and services or successfully market such products and services to our
customers.
Government Regulations May Prevent or Impair Our Ability to Pay Dividends,
Engage in Acquisitions or Operate in Other Ways
Current and future legislation and the policies established by federal and
state regulatory authorities will affect our operations. We are subject to
supervision and periodic examination by the Federal Deposit Insurance
Corporation and the North Carolina State Banking Commission. Banking
regulations, designed primarily for the protection of depositors, may
limit our growth and the return to you, our investors, by restricting
certain of our activities, such as:
o The payment of dividends to our shareholders;
o Possible mergers with or acquisitions of or by other
institutions;
o Our desired investments;
o Loans and interest rates on loans;
o Interest rates paid on our deposits;
o The possible expansion of our branch offices; and/or
o Our ability to provide securities or trust services.
-29-
We also are subject to capitalization guidelines set forth in federal
legislation, and could be subject to enforcement actions to the extent
that we are found by regulatory examiners to be undercapitalized. We
cannot predict what changes, if any, will be made to existing federal and
state legislation and regulations or the effect that such changes may have
on our future business and earnings prospects. The cost of compliance with
regulatory requirements including those imposed by the Securities and
Exchange Commission may adversely affect our ability to operate
profitably.
There Are Potential Risks Associated With Future Acquisitions and
Expansions
We intend to continue to explore expanding our branch system through
selective acquisitions of existing banks or bank branches in the Research
Triangle area and other North Carolina markets. We cannot say with any
certainty that we will be able to consummate, or if consummated,
successfully integrate, future acquisitions, or that we will not incur
disruptions or unexpected expenses in integrating such acquisitions. In
the ordinary course of business, we evaluate potential acquisitions that
would bolster our ability to cater to the small business, individual and
residential lending markets in North Carolina. In attempting to make such
acquisitions, we anticipate competing with other financial institutions,
many of which have greater financial and operational resources. In
addition, since the consideration for an acquired bank or branch may
involve cash, notes or the issuance of shares of common stock, existing
shareholders could experience dilution in the value of their shares of our
common stock in connection with such acquisitions. Any given acquisition,
if and when consummated, may adversely affect our results of operations or
overall financial condition.
In addition, we may expand our branch network through de novo branches in
existing or new markets. These de novo branches will have expenses in
excess of revenues for varying periods after opening which could decrease
our reported earnings.
Compliance with Changing Regulation of Corporate Governance and Public
Disclosure May Result in Additional Risks and Expenses
Changing laws, regulations and standards relating to corporate governance
and public disclosure, including the Sarbanes-Oxley Act of 2002 and new
SEC regulations, are creating uncertainty for companies such as ours.
These laws, regulations and standards are subject to varying
interpretations in many cases, and as a result, their application in
practice may evolve over time as new guidance is provided by regulatory
and governing bodies, which could result in continuing uncertainty
regarding compliance matters and higher costs necessitated by ongoing
revisions to disclosure and governance practices. We are committed to
maintaining high standards of corporate governance and public disclosure.
As a result, our efforts to comply with evolving laws, regulations and
standards have resulted in, and are likely to continue to result in,
increased expenses and a diversion of management time and attention. In
particular, our efforts to comply with Section 404 of the Sarbanes-Oxley
Act of 2002 and the related regulations regarding management's required
assessment of our internal control over financial reporting and our
external auditors' audit of that assessment has required the commitment of
significant financial and managerial resources. We expect these efforts to
require the continued commitment of significant resources. Further, the
members of our Board of Directors, members of the Audit or Compensation
committees, our chief executive officer, our chief financial officer and
certain other of our executive officers could face an increased risk of
personal liability in connection with the performance of their duties. As
a result, our ability to attract and retain executive officers and
qualified Board and committee members could be more difficult. In
addition, it may become more difficult and more expensive to obtain
director and officer liability insurance.
Recent Accounting Developments. Please refer to Notes to Consolidated Financial
Statements - Note 1 - Summary of Significant Accounting Policies for a
discussion of recent accounting developments.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company hopes to reach its strategic financial objectives through the
effective management of market risk. Like many financial institutions, the
Company's most significant market risk exposure is interest rate risk. The
Company's primary goal in managing interest rate risk is to minimize the effect
that changes in interest rates have on interest
-30-
income and expense. This is accomplished through the active management of asset
and liability portfolios, which includes the strategic pricing of asset and
liability accounts and ensuring a proper maturity combination of assets and
liabilities. The goal of these activities is the development of maturity and
repricing opportunities in the Company's portfolios of assets and liabilities
that will produce consistent net interest income during periods of changing
interest rates. The Company's Asset/Liability Committee ("ALCO"), made up of
members of management and the Board, monitors loan, investment, and liability
portfolios to ensure comprehensive management of interest rate risk. These
portfolios are analyzed to ensure proper fixed and variable-rate mixes under
several interest rate scenarios.
The asset/liability management process is intended to accomplish relatively
stable net interest margins and assure liquidity by coordinating the amounts,
maturities, or repricing opportunities of earning assets, deposits, and borrowed
funds. The ALCO has the responsibility to determine and achieve the most
appropriate volume and combination of earning assets and interest-bearing
liabilities, and ensure an adequate level of liquidity and capital, within the
context of corporate performance objectives. The ALCO also sets policy
guidelines and establishes long-term strategies with respect to interest rate
risk exposure and liquidity. The ALCO meets regularly to review the Company's
interest rate risk and liquidity positions in relation to present and
prospective market and business conditions, and adopts balance sheet management
strategies intended to ensure that the potential impact of earnings and
liquidity as a result of fluctuations in interest rates is within acceptable
guidelines.
In 2003, the Bank began using financial instruments, commonly known as
derivatives, to manage various financial risks. The derivatives used presently
by the Bank consist of interest rate swaps and swaptions. A derivative is a
financial instrument that derives its cash flows, and therefore its value, by
reference to an underlying instrument, index, or referenced interest rate. The
Bank uses derivatives to hedge its interest-bearing liabilities. These hedges
resulted in a net increase in net interest income of $490,000 in 2004 and
$238,000 in 2003. The Company anticipates the benefit to net interest income of
the swaps and swaptions will decrease in 2005 as short-term interest rates
continue to increase.
Derivative contracts are written in amounts referred to as notional amounts.
Notional amounts only provide the basis for calculating payments between
counterparties and do not represent amounts to be exchanged between parties and
are not a measure of financial risk. On December 31, 2004, the Bank had
derivative financial instruments outstanding with notional amounts totaling
$25.0 million. See Notes to Consolidated Financial Statements - Note 10 -
Derivative Financial Instruments for additional information.
As a financial institution, most of the Company's assets and liabilities are
monetary in nature. This differs greatly from most commercial and industrial
companies balance sheets, which are comprised primarily of fixed assets or
inventories. Movements in interest rates and actions of the Board of Governors
of the Federal Reserve System ("FRB") to regulate the availability and cost of
credit have a greater effect on a financial institution's profitability than do
the effects of higher costs for goods and services. Through its balance sheet
management function, which is monitored by the ALCO, the Company is positioned
to respond to changing needs for liquidity, changes in interest rates and
inflationary trends.
The Company utilizes an outside asset liability management advisory firm to help
management evaluate interest rate risk and develop asset/liability management
strategies. One tool used is a computer simulation model which projects the
Company's performance under different interest rate scenarios. Analyses are
prepared quarterly which evaluate the Company's performance in a base strategy
that reflects the Company's 2004 and 2005 operating plan. Three interest rate
scenarios (Flat, Rising and Declining) are applied to the base strategy to
determine the effect of changing interest rates on net interest income. The
December 31, 2004 analysis indicates that interest rate risk exposure over a
twelve-month time horizon is within the guidelines established by the Board of
Directors.
The Company's interest rate sensitivity is illustrated in the following table.
The Company continues to be "asset sensitive" at December 31, 2004 as its assets
reprice faster than its liabilities. The table reflects rate-sensitive positions
at December 31, 2004, and is not necessarily indicative of positions on other
dates. The carrying amounts of interest rate sensitive assets and liabilities
are presented in the periods in which they next reprice to market rates or
mature and are aggregated to show the interest rate sensitivity gap. To reflect
anticipated prepayments, certain asset and liability categories are shown in the
table using estimated cash flows rather than contractual cash flows.
-31-
Interest Rate Sensitivity
Within One to Two to After
One Year Two Years Five Years Five Years Total
(Dollars in thousands)
Assets
Securities and other interest-earning
assets (1) $ 50,409 $ 32,501 $ 58,211 $ 19,459 $ 160,580
Federal funds sold 975 -- -- -- 975
Loans and leases (2) 492,296 34,832 111,257 5,761 644,146
----------------------------------------------------------------
Total interest-earning assets 543,680 67,333 169,468 25,220 805,701
Noninterest-earning assets -- -- -- 76,593 76,593
----------------------------------------------------------------
$ 543,680 $ 67,333 $ 169,468 $ 101,813 $ 882,294
================================================================
Liabilities
Non Maturity Interest-Bearing Deposits (3) $ 65,921 $ 71,720 $ 55,794 $ -- $ 193,435
Other Time Deposits 259,763 60,284 75,807 14 395,868
Borrowings 42,122 15,387 26,107 35,459 119,075
Subordinated Debt -- -- -- 20,620 20,620
----------------------------------------------------------------
Total interest-bearing liabilities 367,806 147,391 157,708 56,093 728,998
Non Maturity Non-Interest-Bearing Deposits (3) 8,208 8,209 24,627 24,629 65,673
Other Noninterest-bearing liabilities -- -- -- 9,885 9,885
Equity -- -- -- 77,738 77,738
----------------------------------------------------------------
376,014 155,600 182,335 168,345 882,294
================================================================
Interest-rate sensitivity gap $ 167,666 $ (88,267) $ (12,867) $ (66,532) $ --
================================================================
Cumulative interest-rate sensitivity gap $ 167,666 $ 79,399 $ 66,532 $ --
==================================================
(1) Securities based on amortized cost
(2) Loans and leases include loans held for sale and are net of unearned
income
(3) Projected runoff of deposits that do not have a contractual maturity date
was computed based on decay rate assumptions developed by bank regulators
to assist banks in addressing FDICIA rule 305
For the upcoming twelve month period in the Flat rate scenario, the Company is
projected to earn $30.0 million in net interest income. In the Rising rate
scenario, which contemplates a 200 bp increase in interest rates over a twelve
month period, the Company is expected to see its annualized net interest income
improve by $2.2 million, or 7.23%. Conversely, the Company will see a decline in
net interest income of $980,000, or 3.27%, if rates decline 200 bps, as is
contemplated in the Declining rate scenario.
The table does not reflect the impact of the hedging strategies mentioned above.
These interest rate hedges, accounted for as Fair Value Hedges, were designed to
convert $25.0 million of long-term advances from fixed rates to a variable rate
which is reset quarterly based on LIBOR. The swaps are collateralized by certain
investment securities and mature as follows:
-32-
Effective
Year Amount Variable Rate
------------------------------------------------------
2009 $ 10,000,000 LIBOR + 1.87
2011 15,000,000 LIBOR + 2.02
Item 8. Financial Statements and Supplementary Data.
-33-
Capital Bank Corporation
Consolidated Balance Sheets
December 31, 2004 and 2003
(In thousands, except share data)
2004 2003
-----------------------
Assets
Cash and due from banks:
Interest-earning $ 971 $ 569
Noninterest earning 22,036 21,839
Federal funds sold and short term investments 4 3,202
Investment securities - available for sale, at fair value (Note 4) 140,946 160,216
Investment securities - held to maturity, at amortized cost (Note 4) 13,336 --
Federal Home Loan Bank stock (Note 5) 6,298 5,697
Loans-net of unearned income and deferred fees (Note 6) 654,867 625,945
Less allowance for loan losses (10,721) (11,613)
--------- ---------
Net loans 644,146 614,332
--------- ---------
Premises and equipment, net (Note 7) 15,608 14,190
Bank owned life insurance 13,500 9,429
Deposit premium and goodwill, net (Note 3) 13,065 14,530
Deferred income tax (Note 12) 5,985 6,492
Accrued interest receivable and other assets 6,399 7,238
--------- ---------
Total assets $ 882,294 $ 857,734
========= =========
Liabilities and Shareholders' Equity
Deposits (Note 8):
Demand, non-interest bearing $ 65,673 $ 58,350
Savings and interest bearing checking 93,116 84,701
Money market deposit accounts 100,319 115,751
Time deposits less than $100,000 260,574 267,673
Time deposits $100,000 and greater 135,294 103,144
--------- ---------
Total deposits 654,976 629,619
--------- ---------
Repurchase agreements and fed funds purchased (Note 9) 16,755 11,014
Federal Home Loan Bank advances (Note 9) 102,320 114,591
Subordinated debentures (Note 11) 20,620 20,620
Accrued interest payable and other liabilities 9,885 8,967
--------- ---------
Total liabilities 804,556 784,811
--------- ---------
Commitments and contingencies (Notes 13, 14, 16 and 17)
Shareholders' equity:
Common stock, no par value; 20,000,000 shares authorized, 6,612,787
and 6,541,495 issued and outstanding as of 2004 and 2003, respectively 68,341 67,381
Accumulated other comprehensive income 305 377
Retained earnings 9,092 5,165
--------- ---------
Total shareholders' equity 77,738 72,923
--------- ---------
Total liabilities and shareholders' equity $ 882,294 $ 857,734
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
-34-
Capital Bank Corporation
Consolidated Statements of Operations
For the Years Ended December 31, 2004, 2003, and 2002
(In thousands except per share data)
2004 2003 2002
-------- -------- --------
Interest income:
Loans and fees on loans $ 35,704 $ 34,352 $ 29,601
Investment securities 6,531 5,898 6,273
Federal funds and other interest income 156 190 370
-------- -------- --------
Total interest income 42,391 40,440 36,244
-------- -------- --------
Interest expense:
Deposits 11,782 12,070 12,567
Borrowings and repurchase agreements 4,475 4,248 3,328
-------- -------- --------
Total interest expense 16,257 16,318 15,895
-------- -------- --------
Net interest income 26,134 24,122 20,349
Provision for loan losses 1,038 8,247 4,190
-------- -------- --------
Net interest income after provision for loan losses 25,096 15,875 16,159
-------- -------- --------
Other operating income:
Service charges and fees 2,948 2,858 2,350
Net gain on sale of securities 18 442 981
Mortgage origination fees 1,288 4,864 3,294
Gain on sale of branches 1,164 -- --
Loss on sale of mortgage loan portfolio (320) -- --
Other fees and income 1,807 2,158 1,362
-------- -------- --------
Total other operating income 6,905 10,322 7,987
-------- -------- --------
Other operating expenses:
Personnel 12,125 13,895 9,821
Occupancy 2,366 2,226 1,557
Data processing 1,130 1,164 917
Furniture and equipment 1,683 1,469 1,141
Amortization of intangibles 247 310 180
Advertising 869 721 578
Professional fees 989 1,017 304
Telecommunications 542 337 191
Other 3,873 4,026 2,776
-------- -------- --------
Total other operating expenses 23,824 25,165 17,465
-------- -------- --------
Net income before income tax expense 8,177 1,032 6,681
Income tax expense 2,866 38 2,374
-------- -------- --------
Net income $ 5,311 $ 994 $ 4,307
======== ======== ========
Net income per share - basic $ .79 $ .15 $ .79
======== ======== ========
Net income per share - diluted $ .77 $ .15 $ .76
======== ======== ========
Dividends per share $ .21 $ .20 $ .20
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
-35-
Capital Bank Corporation
Consolidated Statements of Changes in Shareholders' Equity
For the Years Ended December 31, 2004, 2003, and 2002
(In thousands, except share and per share data)
Accumulated
Other
Number Common Comprehensive Retained
of Shares Stock Income (Loss) Earnings Total
------------ ------------ -------------- ------------ --------
Balance at January 1, 2002 3,597,339 $ 34,109 $ 568 $ 2,306 $ 36,983
Repurchase of outstanding common stock (365,334) (4,945) -- -- (4,945)
Issuance of common stock for compensation 5,622 57 -- -- 57
Issuance of common stock for options excercised 147,645 990 -- -- 990
Issuance of common stock for acquisition of
subsidiaries 3,210,512 38,486 -- -- 38,486
Net income -- -- -- 4,307 4,307
Unrealized gain on securities, net of deferred tax
expense of $456 -- -- 725 -- 725
--------
Comprehensive income 5,032
Cash dividends ($0.20 per share) -- -- -- (1,132) (1,132)
---------- ---------- -------- -------- --------
Balance at December 31, 2002 6,595,784 68,697 1,293 5,481 75,471
Repurchase of outstanding common stock (182,500) (2,701) -- -- (2,701)
Issuance of common stock for compensation 2,357 24 -- -- 24
Issuance of common stock for options excercised 125,854 1,171 -- -- 1,171
Noncash compensation -- 190 -- -- 190
Net income -- -- -- 994 994
Unrealized loss on securities, net of deferred tax
benefit of $577 -- -- (916) -- (916)
--------
Comprehensive income 78
Cash dividends ($0.20 per share) -- -- -- (1,310) (1,310)
---------- ---------- -------- -------- --------
Balance at December 31, 2003 6,541,495 67,381 377 5,165 72,923
Issuance of common stock for compensation 2,028 22 -- -- 22
Issuance of common stock for options excercised 69,264 938 -- -- 938
Net income -- -- -- 5,311 5,311
Unrealized loss on securities, net of deferred tax
benefit of $45 -- -- (72) -- (72)
--------
Comprehensive income 5,239
Cash dividends ($0.21 per share) -- -- -- (1,384) (1,384)
---------- ---------- -------- -------- --------
Balance at December 31, 2004 6,612,787 $ 68,341 $ 305 $ 9,092 $ 77,738
========== ========== ======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
-36-
Capital Bank Corporation
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2004, 2003, and 2002
(In thousands)
2004 2003 2002
----------------------------------------
Net income $ 5,311 $ 994 $ 4,307
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization of intangibles 247 310 180
Writedown of intangible assets -- 10 --
Depreciation 1,480 1,459 1,228
Gain(loss) on disposal of equipment 70 (160) --
Amortization of premiums/discounts on securities, net 637 1,971 922
Gain on sale of investments (18) (442) (981)
Funding of held for sale loans (69,893) (259,041) (191,608)
Proceeds from sale of held for sale loans 71,334 264,447 181,366
Provision for loan losses 1,038 8,247 4,190
Deferred tax (benefit) expense 523 (564) 130
Issuance of stock for compensation 22 24 57
Other noncash compensation -- 190 --
Gain on sale of branches (1,164) -- --
Loss on sale of mortgage portfolio 320 -- --
Changes in assets and liabilities:
Accrued interest receivable and other assets 1,130 222 710
Accrued interest payable and other liabilities (110) (885) 410
-------- --------- ---------
Net cash provided by operating activities 10,927 16,782 911
-------- --------- ---------
Cash flows from investing activities:
Net increase in loans (64,755) (37,620) (23,946)
Additions to premises and equipment (3,871) (2,712) (1,145)
Proceeds from sale of equipment 645 622 1
Net (purchase) sale of Federal Home Loan Bank stock (600) (681) 91
Purchase of securities available for sale (17,014) (43,462) (33,851)
Purchase of securities held to maturity (15,477) -- --
Purchase of mortgage-backed securities available for sale (24,317) (73,051) (71,883)
Purchase of bank owned life insurance (3,500) (6,000) --
Proceeds from calls/maturities of securities available for sale 33,945 87,704 35,124
Proceeds from sales of securities available for sale 25,920 15,859 41,434
Proceeds from calls/maturities of securities held to maturity 2,140 -- --
Capitalized purchase costs of acquisitions -- (38) (47)
Proceeds from sale of mortgage portfolio 18,667 -- --
Net cash paid in branch sale (23,054) -- --
Net cash acquired from acquisitions -- -- 20,695
-------- --------- ---------
Net cash used by investing activities (71,271) (59,379) (33,527)
-------- --------- ---------
The accompanying notes are an integral part of these consolidated financial
statements.
-37-
Capital Bank Corporation
Consolidated Statements of Cash Flows (Continued)
For the Years Ended December 31, 2004, 2003, and 2002
(In thousands)
2004 2003 2002
--------------------------------------
Cash flows from financing activities:
Net increase (decrease) in deposits $ 64,911 $(15,268) $ 51,718
Net increase (decrease) in repurchase agreements 5,741 (2,067) 1,914
Proceeds from Federal Home Loan Bank borrowings 42,500 71,000 86,123
Principal repayments of Federal Home Loan Bank borrowings (54,771) (54,267) (66,969)
Proceeds from subordinated debentures, net of issuance costs -- 20,120 --
Repurchase of outstanding common stock -- (2,701) (4,945)
Exercise of stock options 679 1,171 990
Cash dividends paid (1,315) (1,314) (799)
-------- -------- --------
Net cash provided by financing activities 57,745 16,674 68,032
-------- -------- --------
Net change in cash and cash equivalents (2,599) (25,923) 35,416
Cash and cash equivalents at beginning of year 25,610 51,533 16,117
-------- -------- --------
Cash and cash equivalents at end of year $ 23,011 $ 25,610 $ 51,533
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
-38-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. Summary of Significant Accounting Policies
Organization and Nature of Operations
Capital Bank Corporation (the "Company") is a financial holding company
incorporated under the laws of North Carolina on August 10, 1998. The
Company's primary function is to serve as the holding company for its
wholly-owned subsidiaries, Capital Bank and Capital Bank Investment
Services, Inc. In addition, the Company has interest in two trusts,
Capital Bank Statutory Trust I and II (hereinafter collectively referred
to as the "Trusts"). The Trusts are not consolidated with the financial
statements of the Company per the provisions of FIN 46R. Capital Bank (the
"Bank") was incorporated under the laws of North Carolina on May 30, 1997
and commenced operations on June 20, 1997. The Bank is not a member of the
Federal Reserve System and has no subsidiaries. The Bank is a community
bank engaged in general commercial banking, providing a full range of
banking services. The majority of the Bank's customers are individuals and
small to medium-size businesses. The Bank's primary source of revenue is
interest earned from loans to customers and from invested cash and
securities and non-interest income derived from various fees.
The Bank operates throughout North Carolina with branch facilities located
in Raleigh (4), Sanford (3), Burlington (2), Asheville (3), Greensboro,
Cary (2), Oxford, Hickory, Siler City, Graham, and Wake Forest. The
Company's corporate headquarters are located on Glenwood Avenue in
Raleigh, North Carolina.
The Trusts were formed for the sole purpose of issuing trust preferred
securities. The proceeds from such issuances were loaned to the Company in
exchange for the Debentures (as defined below), which are the sole assets
of the Trust. A portion of the proceeds from the issuance of the
Debentures were used by the Company to repurchase shares of Company common
stock. The Company's obligation under the Debentures constitutes a full
and unconditional guarantee by the Company of the Trust's obligations
under the trust preferred securities. The Trusts have no operations other
than those that are incidental to the issuance of the trust preferred
securities. See Note 11 - Subordinated Debentures.
The Company has no operations other than those of its subsidiaries.
Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany accounts
and transactions have been eliminated in consolidation.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. The
more significant estimates that are particularly susceptible to
significant change relate to the determination of the allowance for loan
losses, valuation of goodwill and intangible assets, valuation of
investments, and tax assets, liabilities and expense. Actual results could
differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include demand and time deposits (with original
maturities of 90 days or less) at other institutions, federal funds sold
and other short term investments. Generally, federal funds are purchased
and sold for one-day periods. At times, the Bank places deposits with high
credit quality financial institutions in amounts which may be in excess of
federally insured limits. Banks are required to maintain reserve and
clearing balances with the Federal Reserve Bank (the "FRB"). Accordingly,
the Bank has amounts restricted for this purpose of $11,696 included in
"cash and due from banks" on the Consolidated Balance Sheet at December
31, 2004.
Securities
-39-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Investments in certain securities are classified into three categories and
accounted for as follows:
1. Securities Held to Maturity - Debt securities that the institution
has the positive intent and ability to hold to maturity are
classified as held to maturity and reported at amortized cost; or
2. Trading Securities - Debt and equity securities that are bought and
held principally for the purpose of selling in the near term are
classified as trading securities and reported at fair value, with
unrealized gains and losses included in earnings; or
3. Securities Available for Sale - Debt and equity securities not
classified as either held to maturity securities or trading
securities are classified as available for sale securities and
reported at fair value, with unrealized gains and losses reported as
other comprehensive income, a separate component of shareholders'
equity.
The initial classification of securities is determined at the date of
purchase. Gains and losses on sales of securities, computed based on
specific identification of the adjusted cost of each security, are
included in other income at the time of the sales.
Premiums and discounts on debt securities are recognized in interest
income using the level interest yield method over the period to maturity,
or when the debt securities are called.
Loans Held for Sale
Mortgage loans held for sale are valued at the lower of cost or market as
determined by outstanding commitments from investors or current investor
yield requirements, calculated on the aggregate loan basis. At December
31, 2004 and 2003, there were approximately $3.4 million and $4.8 million,
respectively, in loans held for sale which are classified as loans on the
balance sheet.
Through the normal course of originating loans held for sale, the
customer's interest rate is fixed upon lock-in by the customer. The Bank
enters into a best efforts commitment to sell the loan to an investor
after the rate lock-in by the customer. Rate lock commitments for loans
held for sale are valued based on the value to be realized upon sale to an
investor less any value attributable to the servicing rights which are
also sold to the investor.
Loans and Allowance for Loan Losses
Loans are stated at the amount of unpaid principal, reduced by an
allowance for loan losses and net deferred loan origination fees and
costs. Interest on loans is calculated by using the simple interest method
on daily balances of the principal amount outstanding. Deferred loan fees
and costs are amortized to interest income over the contractual life of
the loan using the level interest yield method.
A loan is considered impaired, based on current information and events, if
it is probable that the Bank will be unable to collect the scheduled
payments of principal and interest when due according to the contractual
terms of the loan agreement. Uncollateralized loans are measured for
impairment based on the present value of expected future cash flows
discounted at the historical effective interest rate, while all
collateral-dependent loans are measured for impairment based on the fair
value of the collateral.
There were no loans classified as impaired at December 31, 2004. Loans
deemed to be impaired at December 31, 2003 amounted to $3.0 million and
the related allowance for loan losses was $825,000. Average impaired loans
during 2004 and 2003 were $2.1 million and $3.2 million, respectively.
Interest income recognized on loans classified as impaired was $175,000
for the year ended December 31, 2004.
The Bank uses several factors in determining if a loan is impaired. The
internal asset classification procedures include a thorough review of
significant loans and lending relationships and include the accumulation
of related data. This data includes loan payment status, borrowers'
financial data and borrowers' operating factors such as cash flows,
operating income or loss, etc. It is possible that these factors and
management's evaluation of the adequacy of the allowance for loan losses
will change.
The allowance for loan losses is established through a provision for loan
losses charged to expense. Loans are charged against the allowance for
loan losses when management believes that the collectibility of the
principal is unlikely. The allowance is an amount that management believes
will be adequate to absorb
-40-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
probable losses on existing loans that may become uncollectible, based on
evaluations of the collectibility of loans and prior loan loss experience.
The evaluations take into consideration such factors as changes in the
nature and volume of the loan portfolio, overall portfolio quality, review
of specific problem loans, and current economic conditions and trends that
may affect the borrowers' ability to pay.
Income Recognition on Impaired and Nonaccrual Loans
Loans, including impaired loans, are generally classified as nonaccrual if
they are past due as to maturity or payment of principal or interest for a
period of more than 90 days, unless such loans are well-secured and in the
process of collection. If a loan or a portion of a loan is classified as
doubtful or as partially charged off, the loan is generally classified as
nonaccrual. Loans that are on a current payment status or past due less
than 90 days may also be classified as nonaccrual if repayment in full of
principal and/or interest is in doubt.
Loans may be returned to accrual status when all principal and interest
amounts contractually due (including arrearages) are reasonably assured of
repayment within an acceptable period of time, and there is a sustained
period of repayment performance (generally a minimum of six months) of
interest and principal by the borrower in accordance with the contractual
terms.
While a loan is classified as nonaccrual and the future collectibility of
the recorded loan balance is doubtful, collections of interest and
principal are generally applied as a reduction to the principal
outstanding, except in the case of loans with scheduled amortizations
where the payment is generally applied to the oldest payment due. When the
future collectibility of the recorded loan balance is expected, interest
income may be recognized on a cash basis. In the case where a nonaccrual
loan had been partially charged-off, recognition of interest on a cash
basis is limited to that which would have been recognized on the recorded
loan balance at the contractual interest rate. Receipts in excess of that
amount are recorded as recoveries to the allowance for loan losses until
prior charge-offs have been fully recovered.
Foreclosed Assets
Any assets acquired as a result of foreclosure are valued at the lower of
the recorded investment in the loan or fair value less estimated costs to
sell. The recorded investment is the sum of the outstanding principal loan
balance and foreclosure costs associated with the loan. Any excess of the
recorded investment over the fair value of the property received is
charged to the allowance for loan losses. Valuations will be periodically
performed by management and any subsequent write-downs due to the carrying
value of a property exceeding its estimated fair value less estimated
costs to sell are charged against other expenses.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation
and amortization. Depreciation and amortization are computed by the
straight-line method based on estimated service lives of assets. Useful
lives range from 3 to 10 years for furniture and equipment. The cost of
leasehold improvements is being amortized using the straight-line method
over the terms of the related leases. Repairs and maintenance are charged
to expense as incurred.
Upon disposition, the asset and related accumulated depreciation or
amortization are relieved and any gains or losses are reflected in
operations.
Income Taxes
Deferred tax asset and liability balances are determined by application to
temporary differences of the tax rate expected to be in effect when taxes
will become payable or receivable. Temporary differences are differences
between the tax basis of assets and liabilities and their reported amounts
in the consolidated financial statements that will result in taxable or
deductible amounts in future years. The effect on deferred taxes of a
change in tax rates is recognized in income in the period that includes
the enactment date. A valuation allowance is recorded for deferred tax
assets if the Company determines that it is more likely than not that some
portion or all of the deferred tax assets will not be realized.
Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities
The Company applies a financial-components approach that focuses on
control when accounting and reporting for transfers and servicing of
financial assets and extinguishments of liabilities. Under that
-41-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
approach, after a transfer of financial assets, an entity recognizes the
financial and servicing assets it controls and the liabilities it has
incurred, derecognizes financial assets when control has been surrendered,
and derecognizes liabilities when extinguished. This approach provides
consistent standards for distinguishing transfers of financial assets that
are sales from transfers that are secured borrowings.
Derivatives
The Company uses derivatives to manage interest rate risk. The instruments
consist of interest rate swaps and swaptions. A derivative is a financial
instrument that derives its cash flows, and therefore its value, by
reference to an underlying instrument, index, or referenced interest rate.
The Bank uses derivatives, accounted for as fair value hedges, to hedge
its fixed rate interest-bearing liabilities.
Under SFAS 133, derivatives are recorded in the balance sheet at fair
value. For fair value hedges, the change in the fair value of the
derivative and the corresponding change in fair value of the hedged risk
in the underlying item being hedged are accounted for in earnings. Any
difference in these two changes in fair value results in hedge
ineffectiveness that results in a net impact to earnings.
Derivative contracts are written in amounts referred to as notional
amounts. Notional amounts only provide the basis for calculating payments
between counterparties and do not represent amounts to be exchanged
between parties and are not a measure of financial risk.
Stock Option Plans
The Company has a stock-based incentive compensation plan covering certain
officers and directors. The Company grants stock options under the
incentive plan for a fixed number of shares with an exercise price equal
to the fair value of the shares on the date of grant. The Company has
elected to account for these stock option grants in accordance with
Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock
Issued to Employees, and accordingly, recognizes no compensation expense
for these stock option grants.
The Company discloses pro forma net income and earnings per share in these
notes as if compensation was measured under the fair value based method
promulgated under Statement of Financial Accounting Standards ("SFAS") No.
123, Accounting for Stock-Based Compensation. Under the fair value based
method, compensation cost is measured at the grant date of the option
based on the value of the award and is recognized over the service period,
which is usually the vesting period. Had compensation expense for the
stock option plans been determined consistent with SFAS No. 123, the
Company's net income and net income per share for the years ended December
31, 2004, 2003 and 2002 would have been reduced to the pro forma amounts
indicated below. These pro forma amounts may not be representative of the
effect on reported net income in future years.
(In thousands, except per share data) 2004 2003 2002
---------------------------------------
Net income As reported $5,311 $ 994 $4,307
Pro forma 5,095 922 3,474
Net income per share - Basic As reported $ 0.79 $ 0.15 $ 0.79
Pro forma 0.76 0.14 0.64
Net income per share - Diluted As reported $ 0.77 $ 0.15 $ 0.76
Pro forma 0.74 0.14 0.62
The Company is required to disclose the pro forma effects on net income as
if it had recorded compensation based on the fair value of options
granted. The fair values of the options granted in 2004, 2003 and 2002 are
estimated on the date of the grants using the Black-Scholes option-pricing
model. Option pricing models require the use of highly subjective
assumptions, including expected stock volatility, which when changed can
materially affect fair value estimates. The fair values were estimated
using the following weighted-average assumptions:
-42-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2004 2003 2002
-------------------------------------
Dividend yield 1.04% 1.20% 1.46%
Expected volatility 27.7% 28.0% 29.7%
Riskfree interest rate 3.92% 3.72% 3.93%
Expected life 7 years 7 years 7 years
The weighted average fair value of options granted during 2004, 2003 and
2002 was $5.99, $5.15, and $4.47, respectively.
Net Income Per Share
The Company follows SFAS No. 128, Earnings Per Share. In accordance with
SFAS No. 128, the Company has presented both basic and diluted EPS on the
face of the Consolidated Statements of Operations. Basic EPS excludes
dilution and is computed by dividing income available to common
shareholders by the weighted average number of common shares outstanding
for the period. The weighted average number of shares outstanding for
2004, 2003, and 2002 were as follows:
2004 2003 2002
------------------------------------------
(In thousands, except number of shares)
Income available to stockholders - basic and diluted $ 5,311 $ 994 $ 4,307
========== ========== ==========
Shares used in the computation of earnings per share:
Weighted average number of shares outstanding - basic 6,712,502 6,655,926 5,467,735
Incremental shares from assumed exercise of stock
options 173,198 137,946 195,214
---------- ---------- ----------
Weighted average number of shares outstanding - diluted 6,885,700 6,793,872 5,662,949
========== ========== ==========
Comprehensive Income
The Company follows SFAS No. 130, Reporting Comprehensive Income. SFAS No.
130 establishes standards for reporting and displaying comprehensive
income (loss) and its components (revenues, expenses, gains, and losses)
in general-purpose financial statements.
The Company's only components of other comprehensive income relate to
unrealized gains and losses on available for sale securities. Information
concerning the Company's other comprehensive income (loss) for the years
ended December 31, 2004, 2003 and 2002 is as follows:
2004 2003 2002
------------------------------------------
(In thousands)
Unrealized (losses) gains on securities available for sale $ (99) $ (1,051) $ 2,162
Reclassification of gains recognized in net income (18) (442) (981)
Income tax benefit (expense) 45 577 (456)
---------- ---------- ----------
Other comprehensive income (loss) $ (72) $ (916) $ 725
========== ========== ==========
Segment Information
The Company follows the provisions of SFAS No. 131 Disclosures about
Segments of an Enterprise and Related Information. SFAS 131 requires that
public business enterprises report certain information about operating
segments in their annual financial statements and in condensed financial
statements of interim periods issued to shareholders. It also requires
that the public business enterprises report related disclosures
-43-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
and descriptive information about products and services provided by
significant segments, geographic areas, and major customers, differences
between the measurements used in reporting segment information and those
used in the enterprise's general-purpose financial statements, and changes
in the measurement of segment amounts from period to period.
Operating segments are components of an enterprise about which separate
financial information is available that is evaluated regularly by the
chief operating decision maker in deciding how to allocate resources, and
in assessing performance. The Company has determined that it has one
significant operating segment, the providing of general commercial
financial services to customers located in the single geographic area of
North Carolina. The various products are those generally offered by
community banks, and the allocation of resources is based on the overall
performance of the institution, versus the individual branches or
products.
Reclassifications
Certain items included in the 2003 and 2002 financial statements have been
reclassified to conform to the 2004 presentation. These reclassifications
have no effect on net income or shareholders' equity previously reported.
New Pronouncements
In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment. This
standard is a revision of SFAS No. 123, Accounting for Stock-Based
Compensation, and supersedes Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, and its related implementation
guidance. SFAS No. 123R requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the
financial statements based on their fair values and is effective for the
first interim or annual reporting period beginning after June 15, 2005.
The Company expects to adopt SFAS No. 123R on July 1, 2005, using the
standard's modified prospective application method. Adoption of SFAS No.
123R will not affect the Company's cash flows or financial position, but
it will reduce reported income and earnings per share because the Company
will be required to recognize compensation expense for share purchase
rights granted under its employee stock option and employee stock purchase
plans, whereas the Company has not been required to record such expense
under current accounting rules. Under SFAS No. 123R, the Company will
recognize compensation expense for the fair value of its share purchase
rights over the vesting period. The Company has not performed all of the
final calculations for expensing stock options but the estimated impact is
presented under the heading "Stock Option Plans" in Note 1 - Significant
Accounting Policies. In addition, the Company has other plans and
liabilities impacted by SFAS No. 123R. These are obligations which may be
settled in the Company's shares. The most material obligations are
deferred compensation plans for directors and advisory board members. The
Company is evaluating alternatives for these plans to minimize the impact
to the Company's net income, including payment of shares due under the
plans prior to the effective date of SFAS No. 123R. If SFAS No. 123R were
effective as of December 31, 2004, the impact on pretax income would have
been approximately $1.0 million based on a share price of $18.75 per
share.
2. Significant Activities
On January 18, 2002, the Company acquired First Community Financial
Corporation ("First Community"), the holding company for Community Savings
Bank, Inc. ("Community Savings Bank"). As a result of the acquisition, the
Company issued an additional 1.9 million shares of common stock. The
transaction was accounted for under the purchase method and was intended
to qualify as a tax-free reorganization under Section 368(a) of the
Internal Revenue Code.
On December 1, 2002, the Company acquired High Street Corporation ("High
Street"), the holding company for High Street Banking Company ("High
Street Bank"). As a result of the acquisition, the Company issued an
additional 1.3 million shares of common stock. The transaction was
accounted for under the purchase method and is intended to qualify as a
tax-free reorganization under Section 368(a) of the Internal Revenue Code.
The following table reflects the unaudited pro forma combined results of
operations for the year ended December 31, 2002 assuming these
acquisitions had occurred at the beginning of fiscal 2002:
-44-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2002
-------
(In thousands, except per share amounts)
Net interest income $24,436
Net income 3,530
Net earnings per diluted share 0.51
In management's opinion, these unaudited pro forma amounts are not
necessarily indicative of what actual combined results of operations might
have been if the acquisitions had been effective at the beginning of
fiscal 2002.
A summary of estimated fair values of assets acquired and liabilities
assumed was as follows:
(In thousands) First High
Community Street Total
--------- --------- ---------
Loans receivable $ 134,149 $ 126,175 $ 260,324
Premises and equipment 5,424 3,050 8,474
Deposit premium 782 976 1,758
Goodwill 3,835 5,319 9,154
Other assets 52,661 28,333 80,994
Deposits (156,241) (132,485) (288,726)
Borrowings (16,414) (12,290) (28,704)
Other liabilities (3,342) (1,446) (4,788)
--------- --------- ---------
Investment in subsidiary, net of dividends to shareholders
and capitalized acquisition costs $ 20,854 $ 17,632 $ 38,486
========= ========= =========
During 2003, the Company made several changes to its branch structure
including the consolidation of two branches in Oxford into one main Oxford
facility in a new location and the opening of an additional branch in
Raleigh. In addition, during the third quarter of 2003, the Company made
the decision to discontinue the operations of CBIS. CBIS will remain an
inactive subsidiary of the Company. Also during 2003, the Company entered
into two separate offerings of trust preferred securities, one in June by
Trust I and the other in December by Trust II. See Notes to Consolidated
Financial Statements - Note 11 - Subordinated Debentures for additional
information on these Trusts.
During 2004, the Company made additional changes to its branch structure
including the sale of three branches in Warrenton, Seaboard and Woodland
to other financial institutions in the third quarter. Included in the sale
were approximately $39.6 million of deposits and $12.8 million of loans,
as well as other assets. With the closing of the branch sale, the Company
was required to make payments of $23.0 million dollars to cover the excess
of liabilities over assets assumed by the acquiring companies. A one time
gain was recorded for $1.2 million in connection with this sale. In
addition, the Company opened three new branches during the year, one each
in Wake Forest, Asheville and Greensboro, North Carolina. Also during
2004, the Company sold a mortgage portfolio which was being serviced by an
independent organization and which had been acquired as a part of a
previous bank acquisition. The sale included approximately $19.2 million
in loans and $152,000 in foreclosed assets. The Company recorded a
$320,000 one time loss on this sale.
3. Goodwill and Other Intangible Assets
Net assets of companies acquired in purchase transactions are recorded at
fair value at the date of acquisition, and as such, the historical cost
basis of individual assets and liabilities are adjusted to reflect their
fair value. Identified intangibles are amortized on a straight-line basis
over the period benefited. In 2002, the Company adopted SFAS No. 142
Goodwill and Other Intangible Assets and accordingly, goodwill is no
longer amortized, but is reviewed for potential impairment at least
annually at the reporting unit level. An impairment loss is recorded to
the extent that the carrying amount of goodwill exceeds its implied fair
value.
-45-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Other intangible assets are evaluated for impairment if events and
circumstances indicate a possible impairment. Such evaluation of other
intangible assets is based on undiscounted cash flow projections. No
impairment charges were recorded in 2004 based on the evaluation and a
$10,000 charge was recorded in 2003 related to the shutdown of CBIS.
As of December 31, 2004 and 2003, intangible assets, primarily deposit
premiums paid for acquisitions, and goodwill were as follows:
Accumulated
(In thousands) Gross Amortization Net
--------------------------------------
At December 31, 2004
From January 2002 acquisition of First Community:
Deposit premium $ 782 $ (404) $ 378
Goodwill 3,834 -- 3,834
-------- -------- --------
4,616 (404) 4,212
-------- -------- --------
From December 2002 acquisition of High Street:
Deposit premium 976 (337) 639
Goodwill 5,381 -- 5,381
-------- -------- --------
6,357 (337) 6,020
-------- -------- --------
From April 2000 branch acquisitions:
Goodwill 1,996 (347) 1,649
From June 1997 branch acquisitions:
Goodwill 2,164 (980) 1,184
-------- -------- --------
$ 15,133 $ (2,068) $ 13,065
======== ======== ========
Accumulated
Gross Amortization Net
--------------------------------------
At December 31, 2003
From January 2002 acquisition of First Community:
Deposit premium $ 782 $ (304) $ 478
Goodwill 3,834 -- 3,834
-------- -------- --------
4,616 (304) 4,312
-------- -------- --------
From December 2002 acquisition of High Street:
Deposit premium 976 (190) 786
Goodwill 5,381 -- 5,381
-------- -------- --------
6,357 (190) 6,167
-------- -------- --------
From April 2000 branch acquisitions:
Goodwill 3,471 (604) 2,867
From June 1997 branch acquisitions:
Goodwill 2,164 (980) 1,184
-------- -------- --------
$ 16,608 $ (2,078) $ 14,530
======== ======== ========
Deposit premiums are amortized over a period of up to 10 years using an
accelerated method. During 2004 and 2003, deposit premiums were reduced by
amortization expenses of $247,000 and $310,000, respectively. In addition,
during 2004, goodwill was reduced by $1.2 million in connection with
deposits sold in branch sales. Estimated amortization expenses for the
next five fiscal years are as follows:
-46-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Year Ended
(In thousands) December 31,
------------
2005 $212,000
2006 185,000
2007 161,000
2008 137,000
2009 113,000
4. Securities
Securities at December 31, 2004 and 2003 are summarized as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(In thousands) Cost Gains Losses Value
---------- ----------- ----------- -----------
2004
----
Available for sale:
U.S. Agency obligations $ 35,511 $ 86 $ 425 $ 35,172
Municipal bonds 24,087 828 85 24,830
Mortgage-backed securities 80,851 427 334 80,944
-------- -------- -------- --------
140,449 1,341 844 140,946
-------- -------- -------- --------
Held to maturity:
U.S. Agency obligations $ 5,000 $ 2 $ 12 4,990
Municipal bonds 300 -- -- 300
Mortgage-backed securities 8,036 15 68 7,983
-------- -------- -------- --------
13,336 17 80 13,273
-------- -------- -------- --------
$153,785 $ 1,358 $ 924 $154,219
======== ======== ======== ========
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(In thousands) Cost Gains Losses Value
---------- ----------- ----------- -----------
2003
----
Available for sale:
U.S. Agency obligations $ 35,747 $ 87 $ 507 $ 35,327
Municipal bonds 24,678 769 64 25,383
Mortgage-backed securities 99,189 859 542 99,506
-------- -------- -------- --------
$159,614 $ 1,715 $ 1,113 $160,216
======== ======== ======== ========
The amortized cost and estimated market values of securities at December
31, 2004 by contractual maturities are shown below. Expected maturities
will differ from contractual maturities because borrowers may have the
right to call or prepay obligations with or without call or prepayment
penalties.
-47-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(Dollars in thousands) Available for Sale Held to Maturity
----------------------- -----------------------
Estimated Estimated
Amortized Market Amortized Market
Cost Value Cost Value
----------------------- -----------------------
US Agency securities:
Due after one year through five years $ 24,702 $ 24,465 $ 5,000 $ 4,990
Due after five years through ten years 3,918 3,943 -- --
Due after ten years 6,891 6,764 -- --
----------------------- -----------------------
Total US Agency securities 35,511 35,172 5,000 4,990
----------------------- -----------------------
Municipal bonds
Due after five years through ten years 8,063 8,313 300 300
Due after ten years 16,024 16,517 -- --
----------------------- -----------------------
Total Municipal bonds 24,087 24,830 300 300
----------------------- -----------------------
Mortgage-backed securities
Due after one year through five years 3,764 3,777 -- --
Due after five years through ten years 4,355 4,402 -- --
Due after ten years 72,732 72,765 8,036 7,983
----------------------- -----------------------
Total Mortgage-backed securities 80,851 80,944 8,036 7,983
----------------------- -----------------------
$140,449 $140,946 $ 13,336 $ 13,273
======================= =======================
The following table shows the gross unrealized losses and fair value of
the Company's investments with unrealized losses that are not deemed to be
other-than-temporarily impaired, aggregated by investment category and
length of time that individual securities have been in a continuous
unrealized loss position, at December 31, 2004:
(Dollars in thousands) Less Than 12 Months 12 Months or Greater Total
----------------------------------------------------------------------
Unrealized Unrealized Unrealized
Description of Security Fair Value Losses Fair Value Losses Fair Value Losses
----------------------------------------------------------------------------------------------------------------------
Available for sale
Direct obligations of U.S.
government agencies $18,568 $ 181 $ 6,756 $ 244 $25,324 $ 425
Municipal bonds 1,569 43 1,268 42 2,837 85
Federal agency mortgage-
backed securities 20,537 131 10,030 203 30,567 334
----------------------------------------------------------------------
40,674 355 18,054 489 58,728 844
----------------------------------------------------------------------
Held to maturity
Direct obligations of U.S.
government agencies 3,982 12 -- -- 3,982 12
Mortgage-backed
securities 2,842 68 -- -- 2,842 68
----------------------------------------------------------------------
6,824 80 -- -- 6,824 80
----------------------------------------------------------------------
$47,498 $ 435 $18,054 $ 489 $65,552 $ 924
======================================================================
Government Agency Obligations. The unrealized losses on the Company's
investments in direct obligations of U.S. government agencies were the
result of interest rate increases. The contractual terms of these
investments do not permit the issuer to settle the securities at a price
materially less than the amortized cost of the investment. Because the
Company has the ability and intent to hold these investments until a
recovery of fair value, which may be maturity, the Company does not
consider these investments to be other-than-temporarily impaired at
December 31, 2004.
Federal Agency Mortgage-Backed Securities. The unrealized losses on the
Company's investment in agency mortgage-backed securities issued by FNMA,
FHLMC, and GNMA were caused by interest rate increases.
-48-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The Company purchased most of these investments at either a discount or a
premium relative to their face amount, and the contractual cash flows of
each is guaranteed by the issuer organization. Accordingly, it is expected
that the securities would not be settled at a price materially less than
the amortized cost of the Company's investment. Because the decline in
market value is attributable to changes in interest rates and not credit
quality and because the Company has the ability to hold these investments
until a recovery of fair value, which may be maturity, the Company does
not consider these investments to be other-than-temporarily impaired at
December 31, 2004.
During the years ended December 31, 2004, 2003 and 2002, the Company had
gross realized gains of $18,000, $442,000 and $981,000, respectively, on
sales of available for sale securities with book values of $25.9 million,
$15.4 million and $40.5 million.
Securities with an amortized cost of $66.8 million were pledged as of
December 31, 2004 to secure public deposits, repurchase agreements, and
FHLB advances.
5. Federal Home Loan Bank Stock
During 2004, in order to raise additional capital, the Federal Home Loan
Bank ("FHLB") restructured the stock ownership requirements in order to be
a member of the FHLB System. As a member, the Bank is required to maintain
an investment in capital stock of the FHLB in an amount equal to 0.20% of
its total assets as of December 31st of the prior year (up to a maximum of
$25.0 million) plus 4.5% of its outstanding FHLB advances. No ready market
exists for the FHLB stock, and it has no quoted market value, therefore,
cost approximates market at December 31, 2004 and 2003.
6. Loans and Allowance for Loan Losses
The composition of the loan portfolio by loan classification at December
31, 2004 and 2003 is as follows:
(In thousands) 2004 2003
------------------------
Commercial $ 531,834 $ 474,104
Consumer 34,865 42,929
Home equity lines 61,925 58,430
Residential mortgages 26,020 50,437
--------- ---------
654,644 625,900
Less deferred loan fees (costs), net (223) (45)
--------- ---------
$ 654,867 $ 625,945
========= =========
A summary of activity in the allowance for loan losses for the years ended
December 31, 2004, 2003, and 2002 is as follows:
-49-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(In thousands) 2004 2003 2002
-----------------------------------
Balance at beginning of year $ 11,613 $ 9,390 $ 4,286
Allowance for loan losses transferred from acquired companies -- -- 4,593
Provision for loan losses 1,038 8,247 4,190
Loans charged-off, net of recoveries (1,619) (6,024) (3,679)
Reclassified (311)
-------- -------- -------
Balance at end of year $ 10,721 $ 11,613 $ 9,390
======== ======== =======
During the year, the Company reclassified $311,000 of the allowance which
related to loss exposure on unfunded loan commitments and letters of
credit into a separate other liability account.
At December 31, 2004, nonperforming assets consisted of nonaccrual loans
in the amount of $8.2 million and foreclosed real estate of $418,000. At
December 31, 2003, nonperforming assets consisted of nonaccrual loans in
the amount of $8.0 million and foreclosed real estate of $978,000.
Unrecognized income on nonaccrual loans at December 31, 2004 and 2003 was
$275,000 and $262,000, respectively. At December 31, 2004 and 2003, there
were no loans past due greater than 90 days still accruing interest.
In the normal course of business, certain directors and executive officers
of the Company, including their immediate families and companies in which
they have an interest, may be loan customers. Total loans to such groups
at December 31, 2004 and activity during the year ended December 31, 2004,
is summarized as follows:
(In thousands) 2004 2003 2002
------------------------------------
Beginning balance $ 23,392 $ 15,288 $ 8,286
New loans 16,737 14,562 13,015
Principal repayments (8,844) (4,048) (6,013)
Reclassifications -- (2,410) --
-------- -------- --------
Ending balance $ 31,285 $ 23,392 $ 15,288
======== ======== ========
In addition, such groups had available lines of credit in the amount of
$7.7 million at December 31, 2004. The Company paid an aggregate of
approximately $1.0 million, $922,000, and $705,000 to companies owned by
members of the board of directors for leased space, equipment,
construction and consulting services during 2004, 2003 and 2002,
respectively.
7. Premises and Equipment
Premises and equipment at December 31, 2004 and 2003 are as follows:
-50-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2004 2003
----------------------
(In thousands)
Land $ 4,813 $ 4,679
Buildings and leasehold improvements 8,863 8,492
Furniture and equipment 9,488 8,344
Automobiles 324 256
Construction in progress 959 2
-------- --------
24,447 21,773
Less accumulated depreciation and amortization (8,839) (7,583)
-------- --------
$ 15,608 $ 14,190
======== ========
8. Deposits
At December 31, 2004, the scheduled maturities of certificates of deposit
are as follows:
Weighted
Average
(In thousands) Balance Rate
-------- --------
2005 $259,763 2.16%
2006 60,284 3.15%
2007 64,757 3.17%
2008 2,749 2.98%
2009 and thereafter 8,315 3.93%
-------- --------
$395,868 2.52%
======== ========
9. Borrowings
Short term borrowed funds. Following is an analysis of short-term borrowed
funds at December 31, 2004 and 2003:
End of Period Daily Average Balance Maximum
---------------------- ---------------------- Outstanding
Weighted Interest At Any
(Dollars in thousands) Balance Avg Rate Balance Rate Month End
---------------------- ---------------------- ------------
2004
Fed funds purchased $ 1,573 2.70% $ 564 1.77% $ 2,137
Repurchase agreements 15,182 1.68% 12,301 0.89% 17,875
-------- -----------------------
$ 16,755 $ 12,865 0.92%
======== =======================
2003
Fed funds purchased $ -- n/a $ 177 1.41% $ --
Repurchase agreements 11,014 0.53% 14,280 0.61% 16,358
-------- -----------------------
$ 11,014 $ 14,457 0.62%
======== =======================
Interest on federal funds purchased totaled $10,000 in 2004 and $3,000 in
2003. Repurchase agreements are collateralized by U.S. government agency
and mortgage-backed securities with carrying values of $17.8 million and
fair values of $17.7 million at December 31, 2004. Interest expense on
securities sold under agreements to repurchase totaled $109,000 in 2004
and $86,000 in 2003.
Federal Home Loan Bank Advances. Advances from the FHLB had a weighted
average rate of 4.08% and 4.21% at December 31, 2004 and 2003,
respectively, and were collateralized by certain 1 - 4 family mortgages,
multifamily first mortgage loans, home equity loans and qualifying
commercial loans totaling
-51-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
$103.5 million and $93.7 million at year-end 2004 and 2003, respectively.
In addition, the Company pledged certain investment securities with an
amortized cost of $25.2 million and $32.3 million at December 31, 2004 and
2003. See Note 4 - Securities.
At December 31, 2004, the scheduled maturities of FHLB advances were as
follows:
Weighted
Average
(Dollars in thousands) Balance Rate
----------- -----------
2005 $ 10,000 3.93%
2006 -- --
2007 5,000 2.11%
2008 -- --
2009 and thereafter 87,320 4.21%
----------- -----------
$ 102,320 4.08%
=========== ===========
At December 31, 2004, the Company had an additional $74.6 million of
credit available with the FHLB.
10. Derivative Financial Instruments
The Company maintains positions in derivative financial instruments to
manage interest rate risk, to facilitate asset/liability management
strategies, and to manage other risk exposures.
In July 2003, the Company entered into interest rate swap agreements to
convert portions of its fixed rate FHLB advances to floating interest
rates. Because of the effectiveness of the swap agreements against the
related debt instruments, the adjustments needed to record the swaps at
fair value were offset by the adjustments needed to record the related
debt instruments at fair value and the net difference between those
amounts were not material.
These interest rate hedges, accounted for as fair value hedges, have an
aggregated notional amount of $25.0 million and reset quarterly at
variable rates based on 90 day LIBOR. The counterparty for these hedges is
a firm with an investment grade rating by a nationally recognized
investment rating service. The swaps are collateralized by certain
investment securities and are summarized as follows:
Effective
Maturity Amount Variable Rate
------------------------------------------------------
2009 $ 10,000,000 LIBOR + 1.87
2011 15,000,000 LIBOR + 2.02
11. Subordinated Debentures
In June 2003 and December 2003, the Company formed the Trusts. Each issued
10,000 of its floating rate capital securities (the "trust preferred
securities"), with a liquidation amount of $1,000 per capital security, in
pooled offerings of trust preferred securities. The Trusts sold their
common securities to the Company for an aggregate of $620,000, resulting
in total proceeds from each offering equal to $10,310,000 or $20,620,000
in aggregate. The Trusts then used these proceeds to purchase $20,620,000
in principal amount of the Company's Floating Rate Junior Subordinated
Deferrable Interest Debentures (the "Debentures"). Following payment by
the Company of a placement fee and other expenses of the offering, the
Company's net proceeds from the offering aggregated $20.0 million.
The trust preferred securities have a 30 year maturity and are redeemable
after 5 years with certain exceptions. Prior to the redemption date, the
trust preferred securities may be redeemed at the option of the Company
after the occurrence of certain events, including without limitation
events that would have a negative tax effect on the Company or the Trusts,
would cause the trust preferred securities to no longer
-52-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
qualify as Tier 1 capital, or would result in the Trusts being treated as
an investment company. The Trusts' ability to pay amounts due on the trust
preferred securities is solely dependent upon the Company making payment
on the Debentures. The Company's obligation under the Debentures
constitutes a full and unconditional guarantee by the Company of the
Trusts' obligations under the trust preferred securities.
The securities associated with both trusts are floating rate, based on 90
day LIBOR, and adjust quarterly. Those associated with Trust I, originally
issued in June 2003, adjust at LIBOR + 3.10% while the securities
associated with Trust II, issued in December 2003, adjust at LIBOR +
2.85%.
The Debentures, which are subordinate and junior in right of payment to
all present and future senior indebtedness and certain other financial
obligations of the Company, are the sole assets of the Trusts and the
Company's payment under the Debentures is the sole source of revenue for
the Trusts.
Per the provisions of FIN 46R, the assets and liabilities of the Trusts
are not consolidated into the consolidated financial statements of the
Company. Interest on the Debentures is included in the Company's Condensed
Consolidated Statements of Income as interest expense. The Debentures are
presented as a separate category of long-term debt on the Consolidated
Statements of Financial Condition entitled "Subordinated Debentures." For
regulatory purposes, the $20.0 million of trust preferred securities
qualifies as Tier 1 capital, subject to certain limitations, or Tier 2
capital in accordance with regulatory reporting requirements.
12. Income Taxes
Income taxes charged to operations for the years ended December 31, 2004,
2003, and 2002 consist of the following components:
(In thousands) 2004 2003 2002
-----------------------------
Current income tax expense $2,343 $ 602 $2,244
Deferred income tax expense (benefit) 523 (564) 130
------ ------ ------
Total income tax expense $2,866 $ 38 $2,374
====== ====== ======
Income taxes for the years ended December 31, 2004, 2003 and 2002 were
allocated as follows:
(In thousands) 2004 2003 2002
------------------------------
Income from continuing operations $ 2,866 $ 38 $2,374
Stockholders' equity, for unrealized gains (losses) on
securities available for sale (45) (577) 456
Stockholders' equity, for compensation expense for tax
purposes in excess of financial reporting purposes (259) -- --
------------------------------
$ 2,562 $ (539) $2,830
==============================
A reconciliation of the difference between income tax expense and the
amount computed by applying the statutory federal income tax rate of 34%
is as follows:
-53-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Amount % of Pretax Income
---------------------------------- ----------------------------------
(Dollars in thousands) 2004 2003 2002 2004 2003 2002
------------------------------------------------------------------------------ ----------------------------------
Tax expense at statutory rate on income
before taxes $ 2,780 $ 351 $ 2,272 34.00% 34.00% 34.00%
State taxes, net of federal benefit 372 112 200 4.55% 10.85% 2.99%
Increase (reduction) in taxes resulting
from:
Tax exempt interest on investment
securities (366) (339) (181) -4.48% -32.85% -2.71%
Non-taxable life insurance income (50) (62) (46) -0.61% -6.01% -0.69%
Other, net 130 (24) 129 1.59% -2.31% 1.94%
---------------------------------- ---------------------------------
$ 2,866 $ 38 $ 2,374 35.05% 3.68% 35.53%
================================== =================================
Significant components of deferred tax assets and liabilities at December
31, 2004 and 2003 are as follows:
(In thousands) 2004 2003
--------------------
Deferred tax assets:
Allowance for loan losses $ 4,224 $ 4,477
Deferred compensation 1,496 1,645
Net operating loss carryforwards 1,022 1,306
Directors fees 845 697
Contributions carryforwards 13 171
------- -------
Total deferred tax assets 7,600 8,296
------- -------
Deferred tax liabilities:
Unrealized security gains (192) (250)
Depreciation (608) (535)
Purchase accounting adjustments (206) (338)
FHLB stock (304) (304)
Other (305) (377)
------- -------
Total deferred tax liabilites (1,615) (1,804)
------- -------
Net deferred tax assets $ 5,985 $ 6,492
======= =======
At December 31, 2004 and 2003, the Company had net deferred tax assets of
$6.0 million and $6.5 million, respectively. A valuation allowance is
provided when it is more likely than not that some portion of the deferred
tax asset will not be realized. In management's opinion, it is more likely
than not that the results of future operations will generate sufficient
taxable income to recognize the deferred tax assets.
Included in deferred tax assets are the tax benefits derived from net
operating loss carryforwards totaling $3.0 million relating to a prior
acquisition which expire in various amounts through 2022. Management
expects to use be able to utilize all of these carryforward amounts before
they expire.
13. Leases
The Company has noncancelable operating leases for its corporate office
and branch locations that expire at various times through 2027. Future
minimum lease payments under the leases for years subsequent to December
31, 2004 are as follows:
-54-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(In thousands)
2005 $ 1,164
2006 1,028
2007 1,008
2008 1,000
2009 1,000
Thereafter 6,712
-------
$11,912
=======
During 2004, 2003, and 2002, payments under operating leases were $1.2
million, $1.1 million, and $806,000, respectively.
14. Regulatory Matters and Restrictions
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal and state banking agencies.
Failure to meet minimum capital requirements can initiate certain
mandatory, and possibly additional discretionary, actions by regulators
that, if undertaken, could have a direct material effect on the
consolidated financial statements. Quantitative measures established by
regulation to ensure capital adequacy require the Bank to maintain minimum
amounts and ratios, as set forth in the table below. As of June 30, 2004,
the most recent notification from regulators, the Bank was categorized as
"well capitalized" by regulatory authorities. There are no conditions or
events since that date that management believes could have an adverse
effect on the Bank's category. Management believes that as of December 31,
2004, the Company meets all capital requirements to which it is subject.
The Bank, as a North Carolina banking corporation, may pay dividends only
out of undivided profits as determined pursuant to North Carolina General
Statues Section 53-87. At December 31, 2004, the undivided profits of the
Bank totaled $5.5 million. However, regulatory authorities may limit
payment of dividends by any bank when it is determined that such a
limitation is in the public interest and is necessary to ensure financial
soundness of the bank.
To be categorized as well capitalized, the Company and the Bank must
maintain minimum amounts and ratios. The Company's actual capital amounts
and ratios as of December 31, 2004 and 2003 and the minimum requirements
are presented in the following table.
Minimum Requirements To Be:
Actual Adequately Capitalized Well Capitalized
--------------------- ---------------------- ---------------------
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
-------- -------- --------- -------- -------- --------
2004
----
Total Capital (to Risk Weighted Assets) $ 92,971 12.33% $ 60,310 8.00% $ 75,387 10.00%
Tier I Capital (to Risk Weighted Assets) 83,528 11.08% 30,155 4.00% 45,232 6.00%
Tier I Capital (to Average Assets) 83,528 9.61% 34,783 4.00% 43,479 5.00%
2003
----
Total Capital (to Risk Weighted Assets) $ 84,692 12.13% $ 55,853 8.00% $ 69,817 10.00%
Tier I Capital (to Risk Weighted Assets) 74,572 10.68% 27,927 4.00% 41,890 6.00%
Tier I Capital (to Average Assets) 74,572 8.71% 34,262 4.00% 42,827 5.00%
15. Employee Benefit Plans
401(k) Plan
-55-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The Company maintains a 401(k) plan (the "Plan") for the benefit of its
employees, which includes provisions for employee contributions, subject
to limitation under the Internal Revenue Code, with the Company to match
contributions up to 6% of the employee's salary. The Plan provides that
employees' contributions are 100% vested at all times and the Company's
contributions vest 20% after the second year of service, an additional 20%
after the third and fourth years of service and the remaining 40% after
the fifth year of service. Further, the Company may make additional
contributions on a discretionary basis. Aggregate contributions for 2004,
2003, and 2002 were $366,000, $387,000, and $342,000, respectively.
16. Stock Options
The Company has stock option plans providing for the issuance of up to
650,000 options to purchase shares of the Company's stock to officers and
directors. At December 31, 2004, options for 162,510 shares of common
stock remained available for future issuance. In addition, there were
approximately 567,000 options which were assumed under various plans from
previously acquired financial institutions, of which approximately 288,000
remain outstanding.
Grants of options are made by the Board or the Compensation Committee. All
grants must be at no less than fair market value on the date of grant,
must be exercised no later than 10 years from the date of grant, and may
be subject to some vesting provisions.
A summary of the activity during the years ending December 31, 2004, 2003
and 2002 of the Company's stock option plans, including the weighted
average exercise price ("WAEP") is presented below:
2004 2003 2002
----------------------------------------------------------------------------
Shares WAEP Shares WAEP Shares WAEP
-------- -------- -------- -------- -------- --------
Outstanding at beginning of year 704,540 $ 10.40 786,366 $ 9.70 416,694 $ 10.43
Granted 84,250 17.85 81,000 15.82 16,000 12.54
Assumed in connection with acquisitions -- -- -- -- 502,977 8.13
Exercised (69,264) 9.80 (125,854) 9.31 (147,645) 6.71
Terminated (26,002) 13.58 (36,972) 11.16 (1,660) 10.25
-------- -------- -------- -------- -------- --------
Outstanding at end of year 693,524 $ 11.25 704,540 $ 10.40 786,366 $ 9.70
======== ======== ======== ======== ======== ========
Options exercisable at year-end 580,010 $ 10.31 590,560 $ 9.66 720,394 $ 9.61
======== ======== ======== ======== ======== ========
The following table summarizes information about the Company's stock
options at December 31, 2004:
Weighted
Average
Remaining
Number Contractual Number
Exercise Price Outstanding Life in Years Exercisable
----------------------- ------------ ------------------ ------------
$6.62 - $9.00 266,570 4.72 263,820
$9.01 - $12.00 166,201 5.73 165,237
$12.01 - $15.00 95,192 3.67 87,992
$15.01 - $18.00 98,811 8.29 27,711
$18.01 - $18.37 66,750 9.99 35,250
------------ ------------------ ------------
693,524 5.83 580,010
============ ================== ============
-56-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
17. Financial Instruments with Off-Balance Sheet Risk and Concentrations of
Credit Risk
To meet the financial needs of its customers, the Company is party to
financial instruments with off-balance sheet risk in the normal course of
business. At December 31, 2004, these financial instruments were comprised
entirely of unused lines of credit. These instruments involve, to varying
degrees, elements of credit risk in excess of the amount recognized in the
balance sheet.
The Company's exposure to credit loss in the event of nonperformance by
the other party is represented by the contractual amount of those
instruments. The Company uses the same credit policies in making these
commitments as they do for on-balance sheet instruments. The amount of
collateral obtained, if deemed necessary by the Company, upon extension of
credit is based on management's credit evaluation of the borrower.
Collateral held varies but may include trade accounts receivable,
property, plant, and equipment and income-producing commercial properties.
Since many unused lines of credit expire without being drawn upon, the
total commitment amounts do not necessarily represent future cash
requirements.
Unused lines of credit were $123.2 million and $115.3 million,
respectively, at the end of 2004 and 2003. Outstanding letters of credit
were $1.4 million and $1.6 million, respectively, at December 31, 2004 and
2003.
The Bank's lending is concentrated primarily in Wake, Chatham, Alamance,
Buncombe, Catawba, Granville, and Lee counties in North Carolina.
18. Fair Value of Financial Instruments
SFAS No. 107, Disclosures about Fair Value of Financial Instruments,
requires the disclosure of estimated fair values for financial
instruments. Quoted market prices, if available, are utilized as an
estimate of the fair value of financial instruments. Because no quoted
market prices exist for a significant part of the Company's financial
instruments, the fair value of such instruments has been derived based on
management's assumptions with respect to future economic conditions, the
amount and timing of future cash flows and estimated discount rates.
Different assumptions could significantly affect these estimates.
Accordingly, the net amounts ultimately collected could be materially
different from the estimates presented below. In addition, these estimates
are only indicative of the values of individual financial instruments and
should not be considered an indication of the fair value of the Company
taken as a whole.
The fair values of cash and due from banks, Federal funds sold, interest
bearing deposits in banks and accrued interest receivable/payable are
equal to the carrying value due to the nature of the financial
instruments. The estimated fair values of investment securities are
provided in Note 4 - Securities.
The fair value of the net loan portfolio has been estimated using the
present value of expected cash flows, discounted at an interest rate
giving consideration to estimated prepayment risk and credit loss factors.
The fair value of the Bank's loan portfolio at December 31, 2004 and 2003
was as follows:
(In thousands) 2004 2003
---------------------
Loans:
Carrying amount $644,146 $614,332
Estimated fair value 643,663 617,705
The deposit liabilities and repurchase agreements with no stated
maturities are predominately at variable rates and, accordingly, the fair
values have been estimated to equal the carrying amounts (the amount
payable on demand), totaling $275.9 million and $269.8 million at December
31, 2004 and 2003, respectively.
The fair values of certificates of deposits and advances from the FHLB are
estimated by discounting the future cash flows using the current rates
offered for similar deposits and advances with the same remaining
-57-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
maturities. The carrying value and estimated fair values of certificates
of deposit, FHLB advances and subordinated debt at December 31, 2004 and
2003 were as follows:
(In thousands) 2004 2003
------------------------
Certificates of deposits:
Carrying amount $395,868 $370,817
Estimated fair value 395,348 373,286
Advances from the FHLB:
Carrying amount $102,320 $114,591
Estimated fair value 102,762 115,203
Subordinated Debt
Carrying amount $ 20,620 $ 20,620
Estimated fair value 21,170 20,718
There is no material difference between the carrying amount and estimated
fair value of off-balance sheet items totaling $124.6 million and $116.9
million at December 31, 2004 and 2003, respectively, which are primarily
comprised of unfunded loan commitments.
The Company's remaining assets and liabilities are not considered
financial instruments.
-58-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
19. Parent Company Financial Information
Condensed financial information of the financial holding company of the
Bank at December 31, 2004 and 2003 and for the years ended December 31,
2004, 2003, and 2002 is presented below:
(In thousands)
Condensed Balance Sheets 2004 2003
-----------------
Assets:
Cash $ 5,885 $ 3,514
Equity investment in subsidiary 92,020 90,245
Other assets 1,126 495
------- -------
Total assets $99,031 $94,254
======= =======
Liabilities:
Subordinated debentures $20,620 $20,630
Deferred tax liabilities 192 237
Dividends payable 397 327
Other liabilities 84 137
------- -------
Total liabilities 21,293 21,331
------- -------
Shareholders' equity:
Common stock 65,385 64,425
Accumulated other comprehensive income 305 377
Retained earnings 12,048 8,121
------- -------
Total shareholders' equity 77,738 72,923
------- -------
Total liabilities and shareholders' equity $99,031 $94,254
======= =======
(In thousands)
Condensed Statements of Operations 2004 2003 2002
------------------------------------
Dividends from wholly-owned subsidiaries $ 4,000 $ 750 $ 2,750
Undistributed earnings of subsidiaries 1,892 401 1,570
Other income 66 15 --
Interest expense (929) (249) --
Other expenses (17) (4) (13)
-------- -------- --------
Net income before tax benefits 5,012 913 4,307
Income tax benefit 299 81 --
-------- -------- --------
Net income $ 5,311 $ 994 $ 4,307
======== ======== ========
-59-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(In thousands)
Condensed Statements of Cash Flows 2004 2003 2002
------------------------------------
Operating activities:
Net income $ 5,311 $ 994 $ 4,307
Equity in undistributed earnings of subsidiary (1,892) (401) (1,570)
Net change in other assets and liabilities (693) (200) --
-------- -------- --------
Cash flow provided by operating activities 2,726 393 2,737
-------- -------- --------
Investing activities:
Additional investment in subsidiaries -- (14,594) --
-------- -------- --------
Cash flow used in investing activities -- (14,594) --
-------- -------- --------
Financing activities:
Proceeds from issuance of common stock 960 1,171 990
Payments to repurchase common stock -- (2,677) (4,945)
Proceeds from issuance of subordinated debentures, net
of issuance costs -- 20,120 --
Dividends paid (1,315) (1,314) (799)
Net cash from acquisitions -- -- 2,429
-------- -------- --------
Cash flow provided by (used in) financing activities (355) 17,300 (2,325)
-------- -------- --------
Net increase in cash and cash equivalents 2,371 3,099 412
Cash and cash equivalents, beginning of year 3,514 415 3
-------- -------- --------
Cash and cash equivalents, end of year $ 5,885 $ 3,514 $ 415
======== ======== ========
-60-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
20. Supplemental Disclosure of Cash Flow Information
2004 2003 2002
--------------------------------------
(In thousands)
Cash payments for interest $ 16,131 $ 16,552 $ 15,237
========= ========= =========
Cash payments for income taxes $ 1,398 $ 1,008 $ 1,775
========= ========= =========
Dividends payable $ 397 $ 328 $ 332
========= ========= =========
Transfers from loans to real estate acquired
through foreclosure $ 1,221 $ 854 $ 1,708
========= ========= =========
Purchase of First Community:
Loans, net of reserves $ -- $ -- $(134,149)
Investments -- -- (39,001)
Other assets acquired -- -- (10,435)
Goodwill and deposit premium -- -- (4,617)
Deposits -- -- 156,241
Borrowings -- -- 16,414
Other liabilities assumed -- -- 3,342
Issuance of stock -- -- 20,854
--------- --------- ---------
Net cash and cash equivalents acquired $ -- $ -- $ 8,649
========= ========= =========
Purchase of High Street:
Loans, net of reserves $ -- $ -- $(126,175)
Investments -- -- (12,275)
Other assets acquired -- -- (7,062)
Goodwill and deposit premium -- -- (6,295)
Deposits -- -- 132,485
Borrowings -- -- 12,290
Other liabilities assumed -- -- 1,446
Issuance of stock -- -- 17,632
--------- --------- ---------
Net cash and cash equivalents acquired $ -- $ -- $ 12,046
========= ========= =========
Sale of Northern Region branches
Loans, net of reserves $ 12,830 $ -- $ --
Property and equipment 258 -- --
Other assets and liabilities, net 1,030 -- --
Goodwill written off 1,218 -- --
Deposits (39,554) -- --
Net gain on sale 1,164 -- --
--------- --------- ---------
Net cash and cash equivalents sold $ (23,054) $ -- $ --
========= ========= =========
Sale of mortgage portfolio
Loans, net of reserves $ 18,722 $ -- $ --
Real estate owned 152 -- --
Other assets and liabilities, net 113 -- --
Net loss on sale (320) -- --
--------- --------- ---------
Net cash and cash equivalents acquired $ 18,667 $ -- $ --
========= ========= =========
-61-
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
21. Selected Quarterly Financial Data (Unaudited)
Selected unaudited quarterly balances and results for the years ended
December 31, 2004 and 2003 are as follows:
2004
---------------------------------------------------
Three Months Ended
---------------------------------------------------
(In thousands, except per share data) Dec. 31 Sept. 30 June 30 March 31
---------------------------------------------------
Assets $ 882,294 $ 875,713 $ 885,754 $ 891,703
Loans 654,867 657,359 657,537 642,407
Investment securities 160,580 154,694 150,340 159,349
Deposits 654,976 647,037 671,796 678,817
Shareholders' equity 77,738 76,370 72,615 75,440
Net interest income $ 6,945 $ 6,689 $ 6,231 $ 6,269
Provision for loan losses 357 268 297 116
Other operating income 1,480 2,280 1,544 1,601
Other operating expenses 5,938 6,179 6,070 5,637
Income taxes 740 872 517 737
--------- --------- --------- ---------
Net income $ 1,390 $ 1,650 $ 891 $ 1,380
========= ========= ========= =========
Net income per share - Basic $ .21 $ .25 $ .13 $ .21
========= ========= ========= =========
Net income per share - Diluted $ .20 $ .24 $ .13 $ .20
========= ========= ========= =========
2003
---------------------------------------------------
Three Months Ended
---------------------------------------------------
(In thousands, except per share data) Dec. 31 Sept. 30 June 30 March 31
---------------------------------------------------
Assets $ 857,734 $ 871,780 $ 908,677 $ 856,076
Loans 625,945 637,745 645,525 622,015
Investment securities 165,913 166,940 161,938 155,835
Deposits 629,619 656,030 684,180 652,690
Shareholders' equity 72,923 70,776 75,144 76,512
Net interest income $ 6,274 $ 5,941 $ 5,972 $ 5,935
Provision for loan losses (12) 4,963 2,696 600
Other operating income 1,898 3,080 2,739 2,605
Other operating expenses 5,847 7,593 5,777 5,948
Income taxes 766 (1,392) (47) 711
--------- --------- --------- ---------
Net income (loss) $ 1,571 $ (2,143) $ 285 $ 1,281
========= ========= ========= =========
Net income (loss) per share - Basic $ .24 $ (.32) $ .04 $ .19
========= ========= ========= =========
Net income (loss) per share - Diluted $ .24 $ (.32) $ .04 $ .19
========= ========= ========= =========
-62-
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Capital Bank Corporation
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of changes in shareholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Capital Bank Corporation at December 31, 2004 and 2003, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2004 in conformity with accounting principles generally accepted in
the United States of America. These financial statements are the responsibility
of the Company's management; our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Note 3 to the consolidated financial statements, in 2002 the
Company adopted the provisions of Statement of Financial Accounting Standards
No. 142, Goodwill and Other Intangible Assets, and Statement of Financial
Accounting Standards No. 147, Acquisition of Certain Financial Institutions.
/s/ PricewaterhouseCoopers, LLP
March 10, 2005
-63-
Item 9. Changes In and Disagreements With Accountants On Accounting and
Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures. The Company's management,
under the supervision of and with the participation of the Company's Chief
Executive Officer and Chief Financial Officer, has evaluated the effectiveness
of the Company's disclosure controls and procedures, as such term is defined in
Rules 13a-15(e) and 15d-15(e) under the Exchange Act as of the end of the period
covered by this report. Based on such evaluation, the Company's Chief Executive
Officer and Chief Financial Officer have concluded that, as of the end of such
period, the Company's disclosure controls and procedures are effective in that
they are reasonably designed to ensure that all material information relating to
the Company required to be included in the Company's reports filed or submitted
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the rules and forms of the Securities and Exchange
Commission.
Changes in Internal Control Over Financial Reporting. There have not been any
changes in the Company's internal control over financial reporting ("ICOFR"), as
such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act,
during the Company's fiscal quarter ended December 31, 2004 that have materially
affected, or are reasonable likely to materially affect, the Company's ICOFR.
From time to time, the Company makes changes to its ICOFR that are intended to
enhance the effectiveness of its ICOFR and which do not have a material effect
on its overall ICOFR.
Management's Report on Internal Control Over Financial Reporting. The Company's
management is responsible for establishing and maintaining adequate ICOFR, as
that term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under
Section 404 of the Sarbanes Oxley Act of 2002, management is required to assess
the effectiveness of the Company's ICOFR. Management's evaluation of the
Company's ICOFR has not yet been completed. Pursuant to Securities and Exchange
Commission Release No. 34-50754 (which, subject to certain conditions, provides
up to 45 additional days beyond the due date of this Form 10-K for the filing of
management's annual report on ICOFR required by Item 308(a) of Regulation S-K
and the related attestation report of the independent registered public
accounting firm, as required by Item 308(b) of Regulation S-K), management's
annual report on ICOFR and the related attestation report of the registered
public accounting firm are not filed herein and are expected to be filed no
later than April 30, 2005.
Limitations on the Effectiveness of Controls. The Company's management,
including the Chief Executive Officer and Chief Financial Officer, does not
expect that the Company's disclosure controls or the Company's internal control
over financial reporting will prevent all errors or fraud.
A company's ICOFR is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted
accounting principles. A company's ICOFR includes those policies and procedures
that (i) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of
the company; (ii) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures of
the company are being made only in accordance with authorizations of management
and directors of the company; and (iii) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition
of the company's assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
Further, the design of disclosure controls and internal control over financial
reporting must reflect the fact that there are resource constraints, and the
benefits of controls must be considered relative to their costs. Because of the
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control
-64-
issues and instances of fraud, if any, within the Company have been detected.
The Company plans to continue to evaluate the effectiveness of its disclosure
controls and procedures and its ICOFR on an ongoing basis and will take action
as appropriate.
PART III
This Part incorporates certain information from the definitive proxy statement
(the "2005 Proxy Statement") for the Company's 2005 Annual Meeting of
Shareholders, to be filed with the SEC on or about April 25, 2005 which is not
later than 120 days after the end of the Company's fiscal year.
Item 10. Directors and Executive Officers of the Registrant.
Information concerning the Company's executive officers is included under the
caption "Executive Officers" on page 9 of this report. Information concerning
the Company's directors and filing of certain reports of beneficial ownership is
incorporated by reference to the sections entitled "Proposal 1 : Election of
Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the
2005 Proxy Statement. Information concerning the audit committee of the
Company's Board of Directors is incorporated by reference to the section
entitled "Information About Our Board of Directors - Board of Director
Committees - Audit Committee" in the 2005 Proxy Statement. There have been no
material changes to the procedures by which security holders may recommend
nominees to the Company's Board of Directors since the date of the Company's
Proxy Statement for the Company's 2004 Annual Meeting of Shareholders.
We have adopted a Code of Business Conduct and Ethics (our "Code of Ethics")
that applies to our employees, officers and directors. The complete Code of
Ethics is available on our website at www.capitalbank-nc.com. If at any time it
is not available on our website, we will provide a copy upon written request
made to our Corporate Secretary, Capital Bank Corporation, 4901 Glenwood Avenue,
Raleigh, North Carolina 27612 (telephone - 919-645-6400). Information on our
website is not part of this report. If we amend or grant any waiver from a
provision of our Code of Ethics that applies to our executive officers, we will
publicly disclose such amendment or waiver as required by applicable law,
including by posting such amendment or waiver on our website at
www.capitalbank-nc.com or by filing a Current Report on Form 8-K.
Item 11. Executive Compensation.
This information is incorporated by reference from the section entitled
"Compensation" in the 2005 Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
This information is incorporated by reference from the sections entitled
"Principal Shareholders" and "Compensation - Equity Compensation Plan
Information" in the 2005 Proxy Statement.
Item 13. Certain Relationships and Related Transactions.
This information is incorporated by reference from the section entitled
"Compensation - Certain Transactions" in the 2005 Proxy Statement.
Item 14. Principal Accountant Fees and Services
This information is incorporated by reference from the section entitled
"Proposal 2: Ratification of Appointment of Independent Accountants - Audit Fee
Firm Summary" in the 2005 Proxy Statement.
PART IV
Item 15. Exhibits and Financial Statement Schedules.
-65-
(a)(1) Financial Statements. The financial statements and information listed
below are included in this report in Part I, Item 8:
Financial Statements and Information
------------------------------------
Consolidated Balance Sheets as of December 31, 2004 and 2003
Consolidated Statements of Operations for the years ended December 31,
2004, 2003 and 2002
Consolidated Statements of Changes in Shareholders' Equity for the years
ended December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the years ended December 31,
2004, 2003 and 2002
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
(a)(2) Financial Statement Schedules. All applicable financial statement
schedules required under Regulation S-X and pursuant to Industry Guide 3 under
the Securities Act have been included in the Notes to the Consolidated Financial
Statements.
(a)(3) Exhibits. The exhibits required by Item 601 of Regulation S-K are listed
in the Exhibit Index immediately following the signature pages to this report.
-66-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in Raleigh, North
Carolina, on the 11th day of March, 2005.
CAPITAL BANK CORPORATION
By: /s/ B. Grant Yarber
-------------------------------------
B. Grant Yarber
President and Chief Executive Officer
-67-
SIGNATURES AND POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints B. Grant Yarber, Richard W. Edwards and Steven E.
Crouse, and each of them, with full power to act without the other, his true and
lawful attorneys-in-fact and agents, with full powers of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any or all amendments to this report, and to file the same,
with all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully for all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents, or their substitutes, may
lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant in
the capacities indicated and on March 11, 2005.
Signature Title
--------- -----
/s/ B. Grant Yarber
- ------------------------ President and Chief Executive Officer and Director
B. Grant Yarber (Principal Executive Officer)
/s/ Richard W. Edwards
- ------------------------ Chief Financial Officer
Richard W. Edwards (Principal Financial Officer)
/s/ Steven E. Crouse
- ------------------------ Chief Accounting Officer
Steven E. Crouse (Principal Accounting Officer)
/s/ Charles F. Atkins
- ------------------------ Director
Charles F. Atkins
/s/ William C. Burkhardt
- ------------------------ Director
William C. Burkhardt
/s/ Leopold I. Cohen
- ------------------------ Director
Leopold I. Cohen
/s/ William R. Gilliam
- ------------------------ Vice Chairman of the Board of Directors
William R. Gilliam
-68-
/s/ John F. Grimes, III
- ------------------------ Director
John F. Grimes, III
/s/ Robert L. Jones
- ------------------------ Director
Robert L. Jones
/s/ Oscar A. Keller, III
- ------------------------ Chairman of the Board of Directors
Oscar A. Keller, III
/s/ Oscar A. Keller, Jr.
- ------------------------ Director
Oscar A. Keller, Jr.
/s/ James D. Moser, Jr.
- ------------------------ Director
James D. Moser, Jr.
/s/ George R. Perkins, III
- ------------------------ Director
George R. Perkins, III
/s/ Don W. Perry
- ------------------------ Director
Don W. Perry
/s/ Carl H. Ricker, Jr.
- ------------------------ Director
Carl H. Ricker, Jr.
/s/ J. Rex Thomas
- ------------------------ Director
J. Rex Thomas
/s/ Samuel J. Wornom, III
- ------------------------- Director
Samuel J. Wornom, III
-69-
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
3.01(1) Articles of Incorporation of the Company
3.02(2) Bylaws of the Company, as amended to date
4.01(1) Specimen Common Stock Certificate of the Company
4.02 In accordance with Item 601(b)(4)(iii)(A) of Regulation S-K,
certain instruments respecting long- term debt of the
registrant have been omitted but will be furnished to the
Commission upon request.
10.01(1,3) Equity Incentive Plan
10.02(1,3) Deferred Compensation Plan for Outside Directors
10.03(3,4) Employment Agreement dated April 21, 2004 between B. Grant
Yarber and Capital Bank Corporation
10.04(3,4) Employment Agreement dated April 16, 2004 between Richard W.
Edwards and Capital Bank Corporation.
10.05(3,5) Change of Control Agreement dated May 3, 2004 between Karen H.
Priester and Capital Bank.
10.06(6) Lease Agreement, dated November 16, 1999, between Crabtree
Park, LLC and the Company.
10.07(2) Agreement, dated November 2001 between Fiserv Solutions, Inc.
and the Company.
21 Subsidiaries of the Registrant
23 Consent of Independent Registered Public Accounting Firm
31.01 Certification of Chief Executive Officer Pursuant to Rule
13a-14(a) or Rule 15d-14(a), As Adopted Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.02 Certification of Chief Accounting Officer Pursuant to Rule
13a-14(a) or Rule 15d-14(a), As Adopted Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.01 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted
Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.
[This exhibit is being furnished pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and shall not, except to the extent
required by that act, be deemed to be incorporated by reference
into any document or filed herewith for purposes of liability
under the Securities Exchange Act of 1934, as amended, or the
Securities Act of 1933, as amended, as the case may be.]
32.02 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted
Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.
[This exhibit is being furnished pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and shall not, except to the extent
required by that act, be deemed to be incorporated by reference
into any document or filed herewith for purposes of liability
under the Securities Exchange Act of 1934, as amended, or the
Securities Act of 1933, as amended, as the case may be.]
1. Incorporated by reference to the Company's Registration Statement on
Form S-4 filed with the SEC on October 19, 1998, as amended on
November 10, 1998, December 21, 1998 and February 8, 1999.
2. Incorporated by reference to the Company's Annual Report on Form
10-K filed with the SEC on March 29, 2002.
3. Denotes a management contract or compensatory plan, contract or
arrangement.
4. Incorporated by reference to the Company's Quarterly Report on Form
10-Q filed with the SEC on May 7, 2004.
5. Incorporated by reference to the Company's Quarterly Report on Form
10-Q filed with the SEC on August 3, 2004.
6. Incorporated by reference to the Company's Annual Report on Form
10-K filed with the SEC on March 27, 2000.
-70-