UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to _________.
Commission File Number: 0-22219
FIRST SOUTH BANCORP, INC.
-------------------------
(Exact name of registrant as specified in its charter)
VIRGINIA 56-1999749
----------------------- -----------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
1311 CAROLINA AVENUE, WASHINGTON, NORTH CAROLINA 27889
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(Address of principal executive offices)
(Zip Code)
(252) 946-4178
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(Registrant's telephone number, including area code)
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 [ ]
Number of shares of common stock outstanding as of August 6, 2002:
4,343,943
CONTENTS
PART I. FINANCIAL INFORMATION PAGE
--------------------- ----
Item 1. Financial Statements
Consolidated Statements of Financial Condition as of
June 30, 2002 (unaudited) and December 31, 2001 1
Consolidated Statements of Operations for the Three
and Six Months Ended June 30, 2002 and 2001 (unaudited) 2
Consolidated Statements of Stockholders' Equity for the
Six Months Ended June 30, 2002 (unaudited) 3
Consolidated Statements of Cash Flows for the Six
Months Ended June 30, 2002 and 2001 (unaudited) 4
Notes to Consolidated Financial Statements (unaudited) 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 7
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 13
Item 2. Changes in Securities and Use of Proceeds 13
Item 3. Defaults Upon Senior Securities 13
Item 4. Submission of Matters to a Vote of Security Holders 13
Item 5. Other Information 14
Item 6. Exhibits and Reports on Form 8-K 14
Signatures 14
Exhibits 15
FIRST SOUTH BANCORP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
JUNE 30 DECEMBER 31
2002 2001
-------------- --------------
ASSETS (UNAUDITED)
Cash and due from banks $ 23,067,061 $ 20,292,541
Interest-bearing deposits in financial institutions 7,897,214 1,390,541
Investment securities - available for sale 54,478,274 54,061,442
Mortgage-backed securities - available for sale 35,709,109 43,903,624
Loans and leases receivable, net:
Held for sale 22,720,993 29,283,037
Held for investment 410,988,138 376,330,018
Premises and equipment, net 7,875,714 7,934,288
Deferred income taxes 382,807 652,566
Real estate owned 454,322 677,399
Federal Home Loan Bank of Atlanta stock, at cost
which approximates market 2,712,500 2,712,500
Accrued interest receivable 3,302,377 3,465,523
Intangible assets 5,341,843 5,248,944
Other assets 1,845,425 2,000,783
Note receivable 1,350,622 1,364,383
-------------- --------------
Total assets $ 578,126,399 $ 549,317,589
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand $ 179,116,889 $ 152,563,977
Savings 19,465,973 18,864,783
Large denomination certificates of deposit 74,910,582 63,318,050
Other time 233,335,751 240,841,695
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Total deposits 506,829,195 475,588,505
Borrowed money 4,809,131 5,441,340
Other liabilities 13,492,527 17,256,363
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Total liabilities 525,130,853 498,286,208
Common stock, $.01 par value, 8,000,000 shares authorized,
6,545,848 and 4,364,044 shares issued 65,458 43,640
Additional paid in capital 48,484,275 48,494,267
Retained earnings, substantially restricted 31,551,939 28,548,510
Treasury stock at cost, 2,148,371 and 2,099,560* shares (30,194,754) (28,703,532)
Accumulated other comprehensive income, net 3,088,628 2,648,496
-------------- --------------
Total stockholders' equity 52,995,546 51,031,381
-------------- --------------
Total liabilities and stockholders' equity $ 578,126,399 $ 549,317,589
============== ==============
*Adjusted for April 19, 2002 three-for-two stock split.
See Notes to Consolidated Financial Statements.
1
FIRST SOUTH BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
----------------------------- ----------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Interest income:
Interest and fees on loans $ 7,673,884 $ 8,000,946 $ 15,141,300 $ 16,453,122
Interest and dividends on investments and deposits 1,511,202 2,230,161 3,091,196 4,640,850
------------ ------------ ------------ ------------
Total interest income 9,185,086 10,231,107 18,232,496 21,093,972
------------ ------------ ------------ ------------
Interest expense:
Interest on deposits 3,180,154 5,259,811 6,532,085 10,864,507
Interest on borrowings 17,667 37,910 26,941 400,371
------------ ------------ ------------ ------------
Total interest expense 3,197,821 5,297,721 6,559,026 11,264,878
------------ ------------ ------------ ------------
Net interest income before provision for possible
loan losses 5,987,265 4,933,386 11,673,470 9,829,094
Provision for possible loan losses 333,000 0 642,000 540,000
------------ ------------ ------------ ------------
Net interest income 5,654,265 4,933,386 11,031,470 9,289,094
------------ ------------ ------------ ------------
Other income:
Loan fees and service charges 1,082,447 932,193 2,101,159 1,684,095
Loan servicing fees 180,009 172,985 358,276 368,868
Gain on sale of real estate, net (10,199) 0 74,948 22,816
Gain on sale of mortgage loans and mortgage-
backed securities 384,855 390,893 748,453 1,162,059
Other income 273,496 193,530 431,951 305,571
------------ ------------ ------------ ------------
Total other income 1,910,608 1,689,601 3,714,787 3,543,409
------------ ------------ ------------ ------------
General and administrative expenses:
Compensation and fringe benefits 2,321,958 2,424,492 4,389,027 4,795,496
Federal insurance premiums 20,897 21,908 42,236 44,930
Premises and equipment 303,220 230,347 612,452 481,743
Advertising 54,876 49,313 115,955 84,228
Payroll and other taxes 211,239 177,267 432,797 374,904
Data processing expense 443,134 367,913 869,637 722,028
Amortization of intangible assets 158,888 142,643 313,143 286,866
Other 478,696 535,006 958,599 1,057,061
------------ ------------ ------------ ------------
Total general and administrative expenses 3,992,908 3,948,889 7,733,846 7,847,256
------------ ------------ ------------ ------------
Income before income taxes 3,571,965 2,674,098 7,012,411 4,985,247
Income taxes 1,218,902 1,090,354 2,480,773 2,036,491
------------ ------------ ------------ ------------
NET INCOME $ 2,353,063 $ 1,583,744 $ 4,531,638 $ 2,948,756
------------ ------------ ------------ ------------
Per share data (*):
Basic earnings per share $ 0.53 $ 0.37(*) $ 1.02 $ 0.68(*)
Diluted earnings per share $ 0.50 $ 0.35(*) $ 0.97 $ 0.66(*)
Dividends per share $ 0.17 $ 0.12(*) $ 0.34 $ 0.24(*)
Weighted average shares Basic 4,417,346 4,332,960(*) 4,427,747 4,341,397(*)
Weighted average shares Diluted 4,682,069 4,463,814(*) 4,661,549 4,461,109(*)
(*) Adjusted for April 19, 2002 three-for-two stock split.
See Notes to Consolidated Financial Statements.
2
FIRST SOUTH BANCORP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
SIX MONTHS ENDED JUNE 30, 2002
(UNAUDITED)
Accumulated
Retained Other
Additional Earnings, Comprehensive
Common Paid-in Substantially Treasury Income (Loss),
Stock Capital Restricted Stock Net Total
-------- ------------- ------------- ------------- ------------- -------------
Balance December 31, 2001 $ 43,640 $ 48,494,267 $ 28,548,510 $ (28,703,532) $ 2,648,496 $ 51,031,381
Net income 4,531,638 4,531,638
Three-for-two stock split paid in
form of a 50% stock dividend * 21,818 (21,818) --
Fractional shares paid (5,812) (5,812)
Other comprehensive income, net
of taxes 440,132 440,132
Exercise of stock options (9,992) 87,555 77,563
Acquisition of treasury shares (1,578,777) (1,578,777)
Dividends ($.34 per share) (1,500,579) (1,500,579)
-------- ------------- ------------- ------------- ------------- -------------
Balance June 30, 2002 $ 65,458 $ 48,484,275 $ 31,551,939 $ (30,194,754) $ 3,088,628 $ 52,995,546
-------- ------------- ------------- ------------- ------------- -------------
* April 19, 2002 three-for-two stock split.
See Notes to Consolidated Financial Statements.
3
FIRST SOUTH BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended
June 30
-----------------------------
2002 2001
-----------------------------
Operating activities:
Net Income (Loss) $ 4,531,638 $ 2,948,756
Adjustments to reconcile net income to net cash provided
in operating activities:
Provision for loan losses 642,000 540,000
Depreciation 304,068 254,665
ESOP compensation -- 55,223
Accretion of discounts on securities (93,264) (93,265)
Gain on disposal of premises and equipment and
real estate acquired in settlement of loans (151,593) (24,087)
Gain on sale of mortgage loans and mortgage-backed securities (748,453) (1,162,059)
Originations of loans held for sale, net (32,472,893) (10,587,966)
Proceeds from sale of loans held for sale 39,730,724 21,885,999
Other operating activities (3,538,230) 2,097,893
------------ ------------
Net cash provided in operating activities 8,203,997 15,915,159
------------ ------------
Investing activities:
Proceeds from principal repayments and sales of
mortgage-backed securities available for sale 8,633,503 59,596,422
Originations of loans held for investment, net of principal repayments (35,518,484) (15,067,071)
Proceeds from disposal of premises and equipment and
real estate acquired in settlement of loans 706,929 56,211
Purchases of FHLB Stock -- (61,200)
Purchases of premises and equipment (359,389) (329,689)
Repayment of note receivable 13,761 12,519
------------ ------------
Net cash provided (used) in investing activities (26,523,680) 44,207,192
------------ ------------
Financing activities:
Net (decrease) increase in deposit accounts 31,240,690 2,856,692
Proceeds from FHLB borrowings 19,500,000 21,200,000
Repayments of FHLB borrowings (20,500,000) (66,900,000)
Purchase of treasury shares (1,578,777) (1,183,728)
Cash paid for fractional shares (5,812)
Cash dividends paid (1,500,579) (1,039,100)
Stock options exercised 77,563 267,364
Net change in repurchase agreements 367,791 (953,853)
------------ ------------
Net cash provided (used) by financing activities 27,600,876 (45,752,625)
------------ ------------
Increase in cash and cash equivalents 9,281,193 14,369,726
Cash and cash equivalents, beginning of period 21,683,082 17,093,762
------------ ------------
Cash and cash equivalents, end of period $ 30,964,275 $ 31,463,488
============ ============
Supplemental disclosures:
Real estate acquired in settlement of loans $ 218,364 $ 38,994
Exchange of loans for mortgage-backed securities $ -- $ 10,200,223
Dividends declared, not paid $ 747,826 $ 518,759
See Notes to Consolidated Financial Statements.
4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. NATURE OF BUSINESS
First South Bancorp, Inc. (the "Company") was formed for the purpose of issuing
common stock and owning 100% of the stock of First South Bank (the "Bank") and
operating through the Bank a commercial banking business. The Bank has one
significant operating segment, the providing of general commercial banking
services to its markets located in eastern North Carolina. The common stock of
the Company is traded on the Nasdaq National Market System under the symbol
"FSBK".
NOTE 2. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements (except for the
audited Statement of Financial Condition at December 31, 2001) have been
prepared in accordance with generally accepted accounting principles and with
the instructions to Form 10-Q of Regulation S-X. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments necessary for a fair presentation of the financial
position and results of operations for the periods presented have been included,
none of which were other than normal recurring accruals. The financial
statements of the Company are presented on a consolidated basis with those of
the Bank. The results of operations for the three and six month periods ended
June 30, 2002 are not necessarily indicative of the results of operations that
may be expected for the year ended December 31, 2002.
NOTE 3. STOCK SPLIT
On March 28, 2002 the Company declared a three-for-two stock split, in the form
of a 50% stock dividend, payable April 19, 2002 to stockholders of record as of
April 8, 2002. Stockholders received one additional share of common stock for
every two shares held on the record date. All current and prior period share and
per share data has been adjusted to reflect the stock split.
NOTE 4. EARNINGS PER SHARE
Basic and diluted earnings per share for the three and six month periods ended
June 30, 2002 are based on weighted average shares of common stock outstanding,
excluding treasury shares. Basic and diluted earnings per share for the three
and six month periods ended June 30, 2001 are based on weighted average shares
of common stock outstanding, excluding ESOP plan shares not committed to be
released, and treasury shares.
Earnings per share have been calculated in accordance with Statement of Position
93-6, "Employers' Accounting for Employee Stock Ownership Plans" and Statement
of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share".
NOTE 5. DIVIDENDS DECLARED
On June 20, 2002, the Company declared a cash dividend of $0.17 per share,
payable on July 19, 2002 to stockholders of record as of July 3, 2002. This
dividend payment represents a payout ratio of 32.1% of the basic earnings for
the quarter ended June 30, 2002, and is the Company's twenty-first consecutive
quarterly cash dividend.
5
NOTE 6. COMPREHENSIVE INCOME.
The Company applies the provisions of Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income". Comprehensive income
includes net income and all other changes to the Company's equity, with the
exception of transactions with shareholders ("other comprehensive income"). The
Company's only component of other comprehensive income relates to unrealized
gains and losses on available for sale securities.
Information concerning the Company's other comprehensive income for the three
and six month periods ended June 30, 2002 and 2001 is as follows:
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
------------ ------------ ------------ ------------
Net income $ 2,353,063 $ 1,583,744 $ 4,531,638 $ 2,948,756
Reclassification of (gains) losses
recognized in net income 5,622 (111,352) (52,666) (185,292)
Gains (losses) unrealized,
net of income taxes 1,118,948 (616,725) 492,798 682,115
------------ ------------ ------------ ------------
Other comprehensive income (loss) 1,124,570 (728,077) 440,132 496,823
------------ ------------ ------------ ------------
Comprehensive income $ 3,477,633 $ 855,667 $ 4,971,770 $ 3,445,579
============ ============ ============ ============
NOTE 7. FORWARD LOOKING STATEMENTS
This Form 10-Q contains certain forward looking statements consisting of
estimates with respect to the financial condition, results of operations and
other business of the Company that are subject to various factors which could
cause actual results to differ materially from those estimates. Factors that
could influence the estimates include changes in general and local market
conditions, legislative and regulatory conditions, and an adverse interest rate
environment.
6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The Company has engaged in no activity other than holding the stock of the Bank
and operating through the Bank a commercial banking business. Therefore, the
discussion below focuses primarily on the Bank's results of operations.
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 2002 AND DECEMBER 31, 2001
Total assets increased to $578.1 million at June 30, 2002 from $549.3 million at
December 31, 2001, reflecting a 10.5% annualized internal growth rate. Earning
assets increased to $534.5 million at June 30, 2002 from $507.7 million at
December 31, 2001, reflecting net growth of the commercial and consumer loan
portfolio, as discussed below. Earning assets were 92.5% of total assets at June
30, 2002 compared to 92.4% at December 31, 2001.
Interest-bearing overnight deposits in financial institutions were $7.9 million
at June 30, 2002, compared to $1.4 million at December 31, 2001. Overnight funds
are available to fund loan originations, liquidity management activities and
daily operations of the Bank. Investment securities available for sale were
$54.5 million at June 30, 2002 and $54.1 million at December 31, 2001. The Bank
may sell certain securities during favorable interest rate windows and
securitize certain mortgage loans previously held for sale into mortgage-backed
securities. During the three and six months ended June 30, 2002, the Bank sold
$1.5 million of mortgage-backed securities, respectively. The Bank had no
mortgage loans securitized into mortgage-backed securities during the three and
six months ended June 30, 2002. As a net result, the mortgage-backed securities
portfolio was $35.7 million at June 30, 2002, compared to $43.9 million at
December 31, 2001 (net of principal repayments).
Loans held for sale declined to $22.7 million at June 30, 2002 from $29.3
million at December 31, 2001. The Bank sold $15.4 million and $39.7 million of
mortgage loans during the three and six months ended June 30, 2002, taking
advantage of improved market prices due to the current lower interest rate
environment. Loans and leases held for investment increased to $411.0 million at
June 30, 2002 from $376.3 million at December 31, 2001, reflecting an 18.4%
annualized growth rate during the period. To support the risk associated with
its loan portfolio, the Bank maintained reserves for potential loan losses of
$5.9 million at June 30, 2002, compared to $5.4 million at December 31, 2001.
The ratio of reserves for loan losses to loans outstanding, net of loans in
process and deferred loan fees, was 1.3%, respectively, at June 30, 2002 and
December 31, 2001.
Total deposits and borrowings increased to $511.6 million at June 30, 2002 from
$481.0 million at December 31, 2001. Deposits increased to $506.8 million at
June 30, 2002 from $475.6 million at December 31, 2001. Checking accounts
increased 17.4% to $179.1 million at June 30, 2002 from $152.6 million at
September 30, 2000, reflecting the Bank's efforts to attract more lower costing
core funds. Time deposits increased to $308.2 million at June 30, 2002 from
$304.2 million at December 31, 2001, while repricing them at lower rates, and
collectively with checking account growth, allowed the Bank to achieve increased
net interest income. See Net Interest Income below. Borrowings, in the form of
repurchase agreements, amounted to $4.8 million at June 30, 2002 and $4.4
million at December 31, 2001, representing funds held in cash management
accounts for commercial banking customers.
7
Stockholders' equity was $53.0 million at June 30, 2002, compared to $51.0
million at December 31, 2001, reflecting current period earnings and an increase
in unrealized gains on available for sale securities, due primarily to the
recent decline in market rates. Accumulated other comprehensive income was $3.1
million at June 30, 2002, compared to $2.6 million at December 31, 2001. At June
30, 2002, the Company's equity to assets ratio was 9.2%, compared to 9.3% at
December 31, 2001. See "Consolidated Statements of Stockholders' Equity" for
additional information.
As a North Carolina chartered commercial bank, the Bank must meet various
capital standards required by federal and state banking regulatory agencies. The
Bank's stand-alone capital was $50.2 million at June 30, 2002, substantially in
excess of all regulatory capital requirements. See "Liquidity and Capital
Resources" below for additional information.
On March 28, 2002, the Company declared a three-for-two stock split, in the form
of a 50% stock dividend, payable April 19, 2002 to stockholders of record as of
April 8, 2002. All current and prior period share and per share data has been
adjusted to reflect the stock split. Issued shares (adjusted for the stock
split) increased to 6,545,848 at June 30, 2002 from 4,364,044 at December 31,
2001.
During the quarter ended June 30, 2002, the Company purchased 31,981 shares of
its common stock through open market and private purchases, totaling
approximately $1.0 million, pursuant to a stock repurchase plan adopted by the
board of directors. These shares are being held as treasury stock, at cost. At
June 30, 2002, treasury shares held were 2,148,371 totaling $30.2 million,
compared to 2,099,560 shares totaling $28.7 million at December 31, 2001.
On June 20, 2002 the Company declared a quarterly cash dividend of $0.17 per
share, payable July 19, 2002 to stockholders of record as of July 3, 2002. This
dividend payment represents a payout ratio of 32.1% of the basic earnings for
the quarter ended June 30, 2002, and is the Company's twenty-first consecutive
quarterly cash dividend.
COMPARISON OF OPERATING RESULTS - THREE AND SIX MONTHS ENDED JUNE 30, 2002 AND
2001
GENERAL. Net income for the three and six months ended June 30, 2002 was $2.4
million and $4.5 million, compared to $1.6 million and $2.9 million for the
three and six months ended June 30, 2001. Basic earnings per share was $0.53 and
$1.02 per share for the three and six months ended June 30, 2002, compared to
$0.37 and $0.68 per share for the three and six months ended June 30, 2001,
adjusted for the stock split. Diluted earnings per share was $0.50 and $0.97 per
share for the three and six months ended June 30, 2002, compared to $0.35 and
$0.66 per share for the three and six months ended June 30, 2001, adjusted for
the stock split.
INTEREST INCOME. Interest income was $9.2 million and $18.2 million for the
three and six months ended June 30, 2002, compared to $10.2 million and $21.1
million for the three and six months ended June 30, 2001. This decrease is
primarily attributable to the general decline in interest rates, which resulted
in a decline in average yield on interest-earning assets between the respective
periods. During 2001, the Federal Reserve made a series of interest rate
reductions, which has the affect of reducing interest income. Average
interest-earning assets were $526.2 million and $518.7 million for the three and
six months ended June 30, 2002, compared to $505.6 million and $512.8 million
for the three and six months ended June 30, 2001, reflecting the net portfolio
growth during the current periods. The yield on average interest-earning assets
was 7.0% for both the three and six months ended June 30, 2002, compared to 8.1%
and 8.2% for the three and six months ended June 30, 2001.
8
INTEREST EXPENSE. Interest expense on deposits and borrowings was $3.2 million
and $6.6 million for the three and six months ended June 30, 2002, compared to
$5.3 million and $11.3 million for the three and six months ended June 30, 2001.
The decline in interest expense reflects the Bank's efforts of attracting lower
costing core checking accounts and repricing new and maturing certificates of
deposit, reflecting the current lower interest rate environment. Average
deposits and borrowings were $503.7 million and $494.1 million for the three and
six months ended June 30, 2002, compared to $478.7 million and $486.1 million
for the three and six months ended June 30, 2001. The effective cost of average
deposits and borrowings was 2.5% and 2.7% for the three and six months ended
June 30, 2002, compared to 4.4% and 4.6% for the three and six months ended June
30, 2001.
NET INTEREST INCOME. Net interest income was $6.0 million and $11.7 million for
the three and six months ended June 30, 2002, compared to $4.9 million and $9.8
million for the three and six months ended June 30, 2001. The interest rate
spread (the difference between the effective yield on average earning assets and
the effective cost of average deposits and borrowings) was 4.4% for both the
three and six months ended June 30, 2002, compared to 3.7% and 3.6% for the
three and six months ended June 30, 2001. The net yield on interest-earning
assets (net interest income divided by average interest assets) was 4.6% and
4.5% for the three and six months ended June 30, 2002, compared to 3.9% and 3.8%
for the three and six months ended June 30, 2001. The current period increases
in net interest income reflect the Bank's success in restructuring its deposit
cost combined with the net growth of its commercial and consumer loan portfolio.
PROVISION FOR LOAN LOSSES. The Bank recorded $333,000 and $642,000 of provisions
for loan losses during the three and six months ended June 30, 2002, compared to
none recorded during the three months ended June 30, 2001 and $540,000 recorded
in the six months ended June 30, 2001. These provisions were necessary to
support the risk associated with the growth in the Bank's loan portfolio.
Provisions are charged to current operations and the Bank believes the resulting
allowance for loan losses is adequate to absorb probable losses on loans that
may become uncollectible. Additions to the allowance for loan losses are based
on a review and classification of the loan portfolio and other factors, such as
past collection experience, changes in the nature and volume of the loan
portfolio, risk characteristics of individual loans or groups of similar loans
and underlying collateral, overall portfolio quality and current and prospective
economic conditions. The Bank believes the current level of its reserves for
loan losses is adequate to provide for probable future losses, however, there
are no assurances that future losses, if any, will not exceed estimated amounts.
NONINTEREST INCOME. Noninterest income was $1.9 million and $3.7 million for the
three and six months ended June 30, 2002, compared $1.7 million and $3.5 million
for the three and six months ended June 30, 2001. Noninterest income consists of
fees and service charges earned on loans, service charges on deposit accounts,
gains from sales of loans and mortgage-backed securities and other miscellaneous
income. Fees and service charges were $1.3 million and $2.5 million for the
three and six months ended June 30, 2002, compared to $1.1 million and $2.1
million for the three and six months ended June 30, 2001. The increase in fees
and services charges during the current periods is attributable to a greater
volume of loans and checking deposits discussed above. In addition, the Bank
recorded $385,000 and $748,000 of gains from sales of loans and mortgage-backed
securities during the three and six months ended June 30, 2002, compared to
$391,000 and $1.2 million during the three and six months ended June 30, 2001.
NONINTEREST EXPENSE. Noninterest expenses were $4.0 million and $7.7 million for
the three and six months ended June 30, 2002, compared to $3.9 million and $7.8
million for the three and six months ended June 30, 2001. The largest component
of these expenses, compensation and fringe benefits, was $2.3 million and $4.4
million for the three and six months ended June 30, 2002, compared to
9
$2.4 million and $4.8 million for the three and six months ended June 30, 2001.
The termination of the Employee Stock Ownership Plan ("ESOP") in December 2001
had a positive impact, as no ESOP expense was incurred in the quarter ended June
30, 2002, compared to $312,601 recorded during the quarter ended June 30, 2001.
A portion of the cost savings recognized from the ESOP termination has been
offset by a 6.2% growth in fulltime equivalent employees from 209 at June 30,
2001 to 222 at June 30, 2002. Since June 30, 2001, the Bank has opened four new
full-service banking offices and created a new leasing division.
Data processing expense has grown proportionately with the growth in the number
of customer accounts and transaction activity, primarily attributable to both
internal growth and the four new full-service banking offices opened since June
30, 2001. The amortization of intangible assets relates to the amortization of
deposit premiums associated with previously reported branch purchases. Other
noninterest expenses including premises and equipment, repairs, printing,
advertising, and office supplies have also grown proportionately from period to
period with the growth in assets, deposits and full-service banking office
locations.
INCOME TAXES. Income tax expense was $1.2 million and $2.5 million for the three
and six months ended June 30, 2002, compared to $1.1 million and $2.0 million
for the three and six months ended June 30, 2001. The change in the amounts of
income tax provisions reflects the changes in pretax income and the estimated
income tax rates in effect during the respective periods.
LIQUIDITY AND CAPITAL RESOURCES
As a state chartered commercial bank, the Bank must meet certain liquidity
requirements established by the State of North Carolina Office of the
Commissioner of Banks (the "Commissioner"). The Bank's liquidity ratio at June
30, 2002, as calculated under such requirements, exceeded the requirements.
Liquidity generally refers to the Bank's ability to generate adequate amounts of
funds to meet its cash needs. Adequate liquidity guarantees that sufficient
funds are available to meet deposit withdrawals, fund future loan commitments,
maintain adequate reserve requirements, pay operating expenses, provide funds
for debt service, pay dividends to stockholders, and meet other general
commitments. At June 30, 2002, the Bank had cash, deposits in banks, investment
securities, mortgage-backed securities, FHLB stock and loans held for sale
totaling $146.6 million, or 25.4% of total assets, compared to $151.6 million at
December 31, 2001 or 27.6% of total assets.
The Bank believes it can meet future liquidity needs with existing funding
sources. The Bank's primary source of funds are deposits, payments on loans and
mortgage-backed securities, maturities of investment securities, earnings and
funds provided from operations, the ability to borrow from the FHLB of Atlanta
and the availability of loans held for sale. While scheduled repayments of loans
and mortgage-backed securities are relatively predictable sources of funds,
deposit flows and general market interest rates, economic conditions and
competition substantially influence loan prepayments. The Bank also attempts to
manage its deposit pricing in order to maintain a desired deposit mix.
The FDIC requires the Bank to meet a minimum leverage capital requirement of
Tier I capital (consisting of retained earnings and common stockholder's equity,
less any intangible assets) to assets ratio of 4%. The FDIC also requires the
Bank to meet a ratio of total capital to risk-weighted assets of 8%, of which at
least 4% must be in the form of Tier I capital. The Commissioner requires the
Bank at all times to maintain a capital surplus of not less than 50% of common
capital stock. The Bank was in compliance with all capital requirements of the
FDIC and the Commissioner at June 30, 2002 and December 31, 2001.
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IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements of the Company have been prepared in
accordance with generally accepted accounting principles, which require the
measurement of financial position and operating results in terms of historical
dollars without considering the change in relative purchasing power of money
over time and due to inflation. Unlike most industrial companies, nearly all
assets and liabilities of the Company are monetary. As a result, interest rates
have greater impact on the Company's performance than do the effects of general
levels of inflation. Interest rates do not necessarily move in the same
direction or to the same extent as the price of goods and services. The impact
of inflation upon the Company is reflected in the cost and prices it pays for
goods and services.
CRITICAL ACCOUNTING POLICIES
The Company has identified the policies below as critical to its business
operations and the understanding of its results of operations. The impact and
any associated risks related to these policies on the Company's business
operations is discussed throughout Management's Discussion and Analysis of
Financial Condition and Results of Operations where such policies affect
reported and expected financial results.
USE OF ESTIMATES. 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. Estimates affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates.
LOANS IMPAIRMENT AND ALLOWANCE FOR LOAN LOSSES. 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 or 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.
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.
The allowance for loan losses is increased by charges to income and decreased by
charge-offs (net of recoveries). Management's periodic evaluation of the
adequacy of the allowance is based on the Bank's past loan loss experience,
known and inherent risks in the portfolio, adverse situations that may affect
the borrower's ability to repay, the estimated value of any underlying
collateral, and current economic conditions. While management believes that it
has established the allowance in accordance with accounting principles generally
accepted in the United States of America and has taken into account the views of
its regulators and the current economic environment, there can be no assurance
that in the future the Bank's regulators or risks in its portfolio will not
require further increases in the allowance.
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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 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.
FAIR VALUES OF FINANCIAL INSTRUMENTS. Statement of Financial Accounting
Standards No. 107, "Disclosures about Fair Value of Financial Instruments"
("SFAS No. 107"), 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 with respect to future economic conditions. Different
assumptions could significantly affect these estimates, accordingly, the net
realizable value could be materially different from the estimates. In addition,
the estimates are only indicative of individual financial instruments' values
and should not be considered an indication of the fair value of the Company
taken as a whole.
Fair values have been estimated using data which management considers as the
best available, and estimation methodologies deemed suitable for the pertinent
category of financial instrument.
OFF-BALANCE SHEET RISK. The Company is a party to financial instruments with
off-balance sheet risk in the normal course of business to meet the financing
needs of its customers and to reduce its own exposure to fluctuations in
interest rates. These financial instruments include commitments to extend credit
and involve, to varying degrees, elements of credit and interest rate risk in
excess of the amount recognized in the balance sheet.
The Company's exposure to credit loss in the event of non-performance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual amount of those instruments. The Company uses the
same credit policies in making commitments and conditional obligations as it
does for on-balance sheet instruments.
SEGMENT INFORMATION
The Company adopted SFAS No. 131, "Disclosure About Segments of an Enterprise
and Related Information", on October 1, 1998. SFAS No. 131 specifies revised
guidelines for determining an entity's operating segments and the type and level
of financial information to be disclosed. The adoption of SFAS No. 131 did not
have a material effect on the Company's financial statements, as management has
determined that the Bank operates in only one business segment.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
141, "Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible
Assets". SFAS Nos. 141 and 142 changed the accounting for business combinations
and goodwill in two significant ways. First, SFAS No. 141 requires that the
purchase method of accounting be used in all business combinations initiated
after June 30, 2001. Use of the pooling-of-interests method is prohibited.
Second, SFAS No. 142 changes the accounting for goodwill from an amortization
method to an impairment only approach. Upon the adoption of SFAS No. 142, the
Company ceased amortization of goodwill
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recorded in past business combinations. Goodwill of $225,055 was recorded on the
books of the Company at June 30, 2002 and December 31, 2001, respectively.
The goodwill was assigned to the related reporting units in the Company and will
be tested for impairment at least annually. The tests will involve the
comparison if the reporting units fair value to its carrying value, including
goodwill. If necessary, the implied fair value of the goodwill will be compared
to the carrying value to determine if an allowance is necessary. The provisions
of SFAS No. 142 are effective for fiscal years beginning after December 15,
2001. The Company's adoption of the provisions of SFAS No. 142 for its fiscal
year ending December 31, 2002 and did not have a material effect on its
financial condition or results of operations.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations". SFAS 143 requires that obligations associated with the retirement
of tangible long-lived assets be recorded as a liability when those obligations
are incurred, with the amount of liability initially measured at fair value.
SFAS No. 143 will be effective for fiscal years beginning after June 15, 2002,
though early adoption is encouraged. The application of this statement is not
expected to have a material impact on the Company's financial statements.
In July 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets". SFAS No. 144 supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets to be Disposed Of". SFAS No.
144 applies to all long-lived assets including discontinued operations, and
amends Accounting Principles Board Opinion No. 30, "Reporting the Effect of
Disposal of a Segment of a Business, Extraordinary, Unusual and Infrequently
Occurring Events and Transactions". SFAS No. 144 requires that long-lived assets
that are to be disposed of by sale be measured at the lower of book or fair
value, less cost to sell. SFAS No. 144 is effective for fiscal years beginning
after December 15, 2001 and its provisions are expected to be applied
prospectively. The application of this statement is not expected to have a
material impact on the Company's financial statements.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is currently not engaged in any material legal proceedings. From
time to time, the Bank is a party to legal proceedings within the ordinary
course of business wherein it enforces its security interest in loans, and other
matters of similar nature.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
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ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits: Exhibit 99.1 Certification
B. Reports on Form 8-K: A Form 8-K was filed on June 28, 2005 under
Item 5: Other Events, reporting the Company had completed a
previously announced 5% stock repurchase program and had adopted
a new program to repurchase and additional 5% of its issued and
outstanding shares of common stock, representing 219,874 shares.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FIRST SOUTH BANCORP, INC.
Date: August 13, 2002 /s/ William L. Wall
----------------------------------
William L. Wall
Executive Vice President
Chief Financial Officer
(Principal Financial Officer)
Date: August 13, 2002 /s/ Kristie W. Hawkins
----------------------------------
Kristie W. Hawkins
Controller
Treasurer
(Principal Accounting Officer)
14