Back to GetFilings.com
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 September 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
------------------------------------------------------
(Address of principal executive offices)
(Zip Code)
(252) 946-4178
--------------
(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 November 6, 2002:
4,251,091
CONTENTS
PART I. FINANCIAL INFORMATION PAGE
--------------------- ----
Item 1. Financial Statements
Consolidated Statements of Financial Condition as of
September 30, 2002 (unaudited) and December 31, 2001 1
Consolidated Statements of Operations for the Three and
Nine Months Ended September 30, 2002 and 2001 (unaudited) 2
Consolidated Statements of Stockholders' Equity for the
Nine Months Ended September 30, 2002 (unaudited) 3
Consolidated Statements of Cash Flows for the Nine Months
Ended September 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
Item 3. Quantitative and Qualitative Disclosures About Market Risk 13
Item 4. Controls and Procedures 14
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings 14
Item 2. Changes in Securities and Use of Proceeds 14
Item 3. Defaults Upon Senior Securities 14
Item 4. Submission of Matters to a Vote of Security Holders 14
Item 5. Other Information 14
Item 6. Exhibits and Reports on Form 8-K 15
Signatures 15
Exhibits 18
FIRST SOUTH BANCORP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
SEPTEMBER 30 DECEMBER 31
2002 2001
---- ----
ASSETS (UNAUDITED)
Cash and due from banks $ 26,820,532 $ 20,292,541
Interest-bearing deposits in financial institutions 7,088,916 1,390,541
Investment securities - available for sale 55,936,730 54,061,442
Mortgage-backed securities - available for sale 32,886,038 43,903,624
Loans and leases receivable, net:
Held for sale 30,776,882 29,283,037
Held for investment 423,999,732 376,330,018
Premises and equipment, net 7,847,350 7,934,288
Deferred income taxes 0 652,566
Real estate owned 341,855 677,399
Federal Home Loan Bank of Atlanta stock, at cost
which approximates market 2,712,500 2,712,500
Accrued interest receivable 3,458,406 3,465,523
Intangible assets 5,253,278 5,248,944
Other assets 2,187,683 2,000,783
Note receivable 1,343,493 1,364,383
-------------- --------------
Total assets $ 600,653,395 $ 549,317,589
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand $ 190,511,819 $ 152,563,977
Savings 19,321,547 18,864,783
Large denomination certificates of deposit 79,060,519 63,318,050
Other time 235,472,393 240,841,695
-------------- --------------
Total deposits 524,366,278 475,588,505
Borrowed money 4,182,879 5,441,340
Other liabilities 20,148,641 17,256,363
-------------- --------------
Total liabilities 548,697,798 498,286,208
Common stock, $.01 par value, 8,000,000 shares authorized,
6,545,848 shares issued 65,458 65,458
Additional paid in capital 48,466,569 48,494,267
Retained earnings, substantially restricted 33,274,315 28,526,692
Treasury stock at cost, 2,240,719 and 2,099,560* shares (33,713,098) (28,703,532)
Accumulated other comprehensive income, net 3,862,353 2,648,496
-------------- --------------
Total stockholders' equity 51,955,597 51,031,381
-------------- --------------
Total liabilities and stockholders' equity $ 600,653,395 $ 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 NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
---------------------------- ----------------------------
2002 2001 2002 2001
---------------------------- ----------------------------
Interest income:
Interest and fees on loans $ 7,712,229 $ 7,816,507 $ 22,853,529 $ 24,269,629
Interest and dividends on investments and deposits 1,514,140 1,977,695 4,605,337 6,618,545
------------ ------------ ------------ ------------
Total interest income 9,226,369 9,794,202 27,458,866 30,888,174
------------ ------------ ------------ ------------
Interest expense:
Interest on deposits 3,030,039 4,534,211 9,562,124 15,398,718
Interest on borrowings 12,919 26,177 39,860 426,548
------------ ------------ ------------ ------------
Total interest expense 3,042,958 4,560,388 9,601,984 15,825,266
------------ ------------ ------------ ------------
Net interest income before provision for possible
loan losses 6,183,411 5,233,814 17,856,882 15,062,908
Provision for possible loan losses 430,000 50,000 1,072,000 590,000
------------ ------------ ------------ ------------
Net interest income 5,753,411 5,183,814 16,784,882 14,472,908
------------ ------------ ------------ ------------
Other income:
Loan fees and service charges 1,212,966 922,855 3,314,124 2,606,950
Loan servicing fees 182,816 196,184 541,093 565,052
Gain on sale of real estate, net 346 67,386 75,295 90,202
Gain on sale of mortgage loans and mortgage-
backed securities 502,958 474,516 1,251,410 1,636,575
Other income 222,347 272,320 654,297 577,891
------------ ------------ ------------ ------------
Total other income 2,121,433 1,933,261 5,836,219 5,476,670
------------ ------------ ------------ ------------
General and administrative expenses:
Compensation and fringe benefits 2,266,827 2,646,094 6,655,854 7,441,590
Federal insurance premiums 21,009 22,679 63,245 67,609
Premises and equipment 348,265 308,589 960,717 790,332
Advertising 47,956 76,021 163,911 160,249
Payroll and other taxes 214,541 185,210 647,338 560,114
Data processing expense 460,385 423,004 1,330,022 1,145,032
Amortization of intangible assets 161,262 156,517 474,405 443,382
Other 564,361 680,420 1,522,961 1,737,482
------------ ------------ ------------ ------------
Total general and administrative expenses 4,084,606 4,498,534 11,818,453 12,345,790
------------ ------------ ------------ ------------
Income before income taxes 3,790,238 2,618,541 10,802,648 7,603,788
Income taxes 1,335,735 1,081,653 3,816,508 3,118,144
------------ ------------ ------------ ------------
NET INCOME $ 2,454,503 $ 1,536,888 $ 6,986,140 $ 4,485,644
------------ ------------ ------------ ------------
Per share data (*):
Basic earnings per share $ 0.56 $ 0.36(*) $ 1.59 $ 1.04(*)
Diluted earnings per share $ 0.53 $ 0.34(*) $ 1.50 $ 1.00(*)
Dividends per share $ 0.17 $ 0.12(*) $ 0.51 $ 0.36(*)
Weighted average shares Basic 4,355,880 4,287,786(*) 4,403,670 4,323,527(*)
Weighted average shares Diluted 4,647,378 4,467,957(*) 4,654,174 4,463,392(*)
(*) 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
NINE MONTHS ENDED SEPTEMBER 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 6,986,140 6,986,140
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 1,213,857 1,213,857
Exercise of stock options (27,698) 255,814 228,116
Acquisition of treasury shares (5,265,380) (5,265,380)
Dividends ($.51 per share) (2,232,705) (2,232,705)
------------ ------------ ------------ ------------ ------------ ------------
Balance September 30, 2002 $ 65,458 $ 48,466,569 $ 33,274,315 $(33,713,098) $ 3,862,353 $ 51,955,597
------------ ------------ ------------ ------------ ------------ ------------
* 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)
Nine Months Ended
September 30
-----------------------------
2002 2001
-----------------------------
Operating activities:
Net Income (Loss) $ 6,986,140 $ 4,485,644
Adjustments to reconcile net income to net cash provided
in operating activities:
Provision for loan losses 1,072,000 590,000
Depreciation 464,899 374,979
ESOP compensation -- 1,181,588
Accretion of discounts on securities (139,896) (58,646)
Gain on disposal of premises and equipment and
real estate acquired in settlement of loans (157,403) (245,988)
Gain on sale of mortgage loans and mortgage-backed securities (1,251,410) (1,636,575)
Originations of loans held for sale, net (53,547,272) (20,823,470)
Proceeds from sale of loans held for sale 56,521,075 28,280,301
Other operating activities 2,616,751 1,049,263
------------ ------------
Net cash provided in operating activities 12,564,884 13,197,096
------------ ------------
Investing activities:
Purchases of investment securities -- (81,250)
Proceeds from principal repayments and sales of
mortgage-backed securities available for sale 11,322,869 73,127,191
Originations of loans held for investment, net of principal repayments (52,559,978) (18,943,317)
Proceeds from disposal of premises and equipment and
real estate acquired in settlement of loans 1,126,313 501,545
Purchases of FHLB Stock -- (61,200)
Purchases of premises and equipment (492,143) (1,192,006)
Repayment of note receivable 20,890 19,005
------------ ------------
Net cash provided (used) in investing activities (40,582,049) 53,369,968
------------ ------------
Financing activities:
Net increase in deposit accounts 48,777,773 7,175,297
Proceeds from FHLB borrowings 19,500,000 21,200,000
Repayments of FHLB borrowings (20,500,000) (66,900,000)
Purchase of treasury shares (5,265,380) (2,851,861)
Cash paid for fractional shares (5,812) --
Cash dividends paid (2,232,705) (1,557,611)
Stock options exercised 228,116 360,863
Net change in repurchase agreements (258,461) (638,071)
------------ ------------
Net cash provided (used) by financing activities 40,243,531 (43,211,383)
------------ ------------
Increase in cash and cash equivalents 12,226,366 23,355,681
Cash and cash equivalents, beginning of period 21,683,082 17,093,762
------------ ------------
Cash and cash equivalents, end of period $ 33,909,448 $ 40,449,443
============ ============
Supplemental disclosures:
Real estate acquired in settlement of loans $ 519,184 $ 766,172
Exchange of loans for mortgage-backed securities $ -- $ 12,298,148
Dividends declared, not paid $ 731,872 $ 518,511
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 nine month periods ended
September 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 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 nine month periods ended
September 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 nine month periods ended September 30, 2001 are based on weighted
average shares of common stock outstanding, excluding ESOP plan shares not
committed to be released, and treasury shares.
NOTE 5. DIVIDENDS DECLARED
On September 19, 2002, the Company declared a cash dividend of $0.17 per share,
payable on October 18, 2002 to stockholders of record as of October 2, 2002.
This dividend payment represents a payout ratio of 30.4% of the basic earnings
per share for the quarter ended September 30, 2002, and is the Company's
twenty-second 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 nine month periods ended September 30, 2002 and 2001 is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
---- ---- ---- ----
Net income $ 2,454,503 $ 1,536,888 $ 6,986,141 $ 4,485,644
Reclassification of (gains) losses
recognized in net income (30,177) (236,500) (82,843) (421,792)
Gains (losses) unrealized,
net of income taxes 803,902 2,175,953 1,296,700 2,858,068
------------ ------------ ------------ ------------
Other comprehensive income (loss) 773,725 1,939,453 1,213,857 2,436,276
------------ ------------ ------------ ------------
Comprehensive income $ 3,228,228 $ 3,476,341 $ 8,199,998 $ 6,921,920
============ ============ ============ ============
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 SEPTEMBER 30, 2002 AND DECEMBER 31, 2001
Total assets increased to $600.7 million at September 30, 2002 from $549.3
million at December 31, 2001, reflecting a 12.5% annualized internal growth
rate. Earning assets increased to $553.4 million at September 30, 2002 from
$507.7 million at December 31, 2001, reflecting net growth of the loan
portfolio, as discussed below. Earning assets were 92.1% of total assets at
September 30, 2002 and 92.4% at December 31, 2001.
Interest-bearing overnight deposits in financial institutions were $7.1 million
at September 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
$55.9 million at September 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 nine months ended September 30, 2002, the Bank sold $1.5
million of mortgage-backed securities. The Bank had no mortgage loans
securitized into mortgage-backed securities during the three and nine months
ended September 30, 2002. As a net result, the mortgage-backed securities
portfolio was $32.9 million at September 30, 2002, compared to $43.9 million at
December 31, 2001 (net of principal repayments).
Loans held for sale were $30.8 million at September 30, 2002 compared to $29.3
million at December 31, 2001. The Bank sold $15.3 million and $56.4 million of
loans during the three and nine months ended September 30, 2002, taking
advantage of improved current prices and protecting itself from the risk of a
rising interest rate environment. Loans and leases held for investment increased
to $424.0 million at September 30, 2002 from $376.3 million at December 31,
2001, reflecting a 16.9% annualized growth rate during the nine month period.
The net commercial loan portfolio increased to $261.8 million at September 30,
2002 from $198.2 million at December 31, 2001, reflecting a 42.8% annualized
growth rate. To support the risk associated with growth of its commercial loan
portfolio, the Bank maintained reserves for potential loan losses of $6.3
million at September 30, 2002, compared to $5.4 million at December 31, 2001.
The ratio of reserves for loan losses to total loans outstanding, net of loans
in process and deferred loan fees, was 1.4% at September 30, 2002 and 1.3% at
December 31, 2001.
Total deposits and borrowings increased to $528.5 million at September 30, 2002
from $481.0 million at December 31, 2001. Deposits increased to $524.4 million
at September 30, 2002 from $475.6 million at December 31, 2001. Checking
accounts increased 24.9% to $190.5 million at September 30, 2002 from $152.6
million at December 31, 2001, reflecting the Bank's efforts to attract more
lower costing core funds. Time deposits increased to $314.5 million at September
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 $4.2 million at
September 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 $52.0 million at September 30, 2002, compared to $51.0
million at December 31, 2001, reflecting current period earnings, an increase in
unrealized gains on available for sale securities, net of treasury stock
purchases and cash dividend payments. Accumulated other comprehensive income was
$3.9 million at September 30, 2002, compared to $2.6 million at December 31,
2001. At September 30, 2002, the Company's equity to assets ratio was 8.7%,
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 $51.7 million at September 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 prior period share and per share data has been adjusted to
reflect the stock split. Issued shares were 6,545,848 at September 30, 2002 and
December 31, 2001(adjusted for the stock split).
During the quarter ended September 30, 2002, the Company purchased 104,048
shares of its common stock through open market and private purchases, totaling
approximately $3.7 million, pursuant to a stock repurchase plan adopted by the
board of directors. These shares are being held as treasury stock, at cost. At
September 30, 2002, treasury shares held were 2,240,719 totaling $33.7 million,
compared to 2,099,560 shares totaling $28.7 million at December 31, 2001.
On September 19, 2002 the Company declared a quarterly cash dividend of $0.17
per share, payable October 18, 2002 to stockholders of record as of October 2,
2002. This dividend payment represents a payout ratio of 30.4% of the basic
earnings for the quarter ended September 30, 2002, and is the Company's
twenty-second consecutive quarterly cash dividend.
COMPARISON OF OPERATING RESULTS - THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002
AND 2001
GENERAL. Net income for the three and nine months ended September 30, 2002 was
$2.5 million and $7.0 million, compared to $1.5 million and $4.5 million for the
three and nine months ended September 30, 2001. Basic earnings per share was
$0.56 and $1.59 per share for the three and nine months ended September 30,
2002, compared to $0.36 and $1.04 per share for the three and nine months ended
September 30, 2001, adjusted for the stock split. Diluted earnings per share was
$0.53 and $1.50 per share for the three and nine months ended September 30,
2002, compared to $0.34 and $1.00 per share for the three and nine months ended
September 30, 2001, adjusted for the stock split.
INTEREST INCOME. Interest income was $9.2 million and $27.5 million for the
three and nine months ended September 30, 2002, compared to $9.8 million and
$30.9 million for the three and nine months ended September 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 effect of reducing interest income.
Average interest-earning assets were $543.0 million and $526.8 million for the
three and nine months ended September 30, 2002, compared to $499.4 million and
$509.1 million for the three and nine months ended September 30, 2001,
reflecting the net portfolio growth during the current periods. The yield on
average interest-earning assets was 6.8% and 7.0% for the three and nine months
ended September 30, 2002, compared to 7.8% and 8.1% for the three and nine
months ended September 30, 2001.
8
INTEREST EXPENSE. Interest expense on deposits and borrowings was $3.0 million
and $9.6 million for the three and nine months ended September 30, 2002,
compared to $4.6 million and $15.8 million for the three and nine months ended
September 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 $520.4 million and $502.9
million for the three and nine months ended September 30, 2002, compared to
$474.1 million and $482.7 million for the three and nine months ended September
30, 2001. The effective cost of average deposits and borrowings was 2.3% and
2.6% for the three and nine months ended September 30, 2002, compared to 3.9%
and 4.4% for the three and nine months ended September 30, 2001.
NET INTEREST INCOME. Net interest income was $6.2 million and $17.9 million for
the three and nine months ended September 30, 2002, compared to $5.2 million and
$15.1 million for the three and nine months ended September 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
4.5% and 4.4% for the three and nine months ended September 30, 2002, compared
to 4.0% and 3.7% for the three and nine months ended September 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 nine months ended September
30, 2002, compared to 4.2% and 4.0% for the three and nine months ended
September 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 loan portfolio.
PROVISION FOR LOAN LOSSES. The Bank recorded $430,000 and $1.1 million of
provisions for loan losses during the three and nine months ended September 30,
2002, compared to $50,000 and $590,000 recorded in the three and nine months
ended September 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 $2.1 million and $5.8 million for the
three and nine months ended September 30, 2002, compared $1.9 million and $5.5
million for the three and nine months ended September 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 $1.4 million and $3.9
million for the three and nine months ended September 30, 2002, compared to $1.1
million and $3.7 million for the three and nine months ended September 30, 2001.
The increase in fees and service charges during the current periods is
attributable to a greater volume of loans and checking deposits discussed above.
In addition, the Bank recorded $503,000 and $1.3 million of gains from sales of
loans and mortgage-backed securities during the three and nine months ended
September 30, 2002, compared to $475,000 and $1.6 million during the three and
nine months ended September 30, 2001.
9
NONINTEREST EXPENSE. Noninterest expenses were $4.1 million and $11.8 million
for the three and nine months ended September 30, 2002, compared to $4.5 million
and $12.3 million for the three and nine months ended September 30, 2001. The
largest component of these expenses, compensation and fringe benefits, was $2.3
million and $6.7 million for the three and nine months ended September 30, 2002,
compared to $2.6 million and $7.4 million for the three and nine months ended
September 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 three and nine months ended September 30, 2002, compared to $372,000 and
$950,000 recorded in the three and nine months ended September 30, 2001. A
portion of the cost savings recognized from the ESOP termination has been offset
by an 8.2% growth in fulltime equivalent employees to 225 at September 30, 2002
from 208 at September 30, 2001. Since September 30, 2001, the Bank has opened
four new full-service banking offices, a loan production office 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
September 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 $1.3 million and $3.8 million for the three
and nine months ended September 30, 2002, compared to $1.1 million and $3.1
million for the three and nine months ended September 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
guidelines established by the State of North Carolina Office of the Commissioner
of Banks (the "Commissioner"). The Bank's liquidity ratio at September 30, 2002,
as calculated under such guidelines, 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
September 30, 2002, the Bank had cash, deposits in banks, investment securities,
mortgage-backed securities, FHLB stock and loans held for sale totaling $156.2
million, or 29.6% of total deposits and borrowings, compared to $151.6 million,
or 31.5% of total deposits and borrowings at December 31, 2001.
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.
10
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 September 30, 2002 and December 31, 2001.
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
11
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.
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.
12
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 recorded in past business combinations.
Goodwill of $225,055 was recorded on the books of the Company at September 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 of 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 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the possible chance of loss from unfavorable changes in market
prices and rates. These changes may result in a reduction of current and future
period net interest income, which is the favorable spread earned from the excess
of interest income on interest-earning assets over interest expense on
interest-bearing liabilities.
The Company considers interest rate risk to be its most significant market risk,
which could potentially have the greatest impact on operating earnings. The
structure of the Company's loan and deposit portfolios is such that a
significant decline in interest rates may have a negative impact on net market
values and net interest income. The Company monitors whether material changes in
market risk have occurred since December 31, 2001. The Company does not believe
that any material adverse changes in market risk exposures occurred since
December 31, 2001.
13
The current period earnings growth reflects the Company's success of increasing
its net interest income during an environment of declining interest rates. The
Company has made significant progress in restructuring its loan portfolio, in
attracting lower costing core checking accounts and repricing higher costing
certificates of deposit at lower rates, collectively allowing the Company to
maintain more consistent net interest income.
ITEM 4. CONTROLS AND PROCEDURES
Within 90 days prior to the date of this report, the Company carried out an
evaluation, under the supervision and with the participation of the principal
executive officer and principal financial officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures. Based
on this evaluation, the principal executive officer and principal financial
officer concluded that the Company's disclosure controls and procedures are
effective in timely alerting them to material information required to be
included in its periodic SEC reports. It should be noted that the design of any
system of controls is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions,
regardless of how remote.
In addition, the Company reviewed its internal controls, and there have been no
significant changes in its internal controls or in other factors that could
significantly affect those controls subsequent to the date of the last
evaluation.
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
ITEM 5. OTHER INFORMATION
Not applicable
14
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
The following exhibit is filed herewith:
Exhibit
Number Title
- ------ -----
99 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
b) Reports on Form 8-K
Not applicable
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Quarterly Report on Form 10-Q to be signed on
its behalf by the undersigned thereunto duly authorized.
FIRST SOUTH BANCORP, INC.
/s/ William L. Wall
-------------------------
William L. Wall
Executive Vice President
Chief Financial Officer
(Principal Financial Officer)
/s/ Kristie W. Hawkins
-------------------------
Kristie W. Hawkins
Controller
Treasurer
(Principal Accounting Officer)
Date: November 13, 2002
15
CERTIFICATION
I, Thomas A. Vann, President and Chief Executive Officer of First South Bancorp,
Inc., certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of First South Bancorp,
Inc.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report.
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report.
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date.
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors (or persons performing the equivalent
function):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls.
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: November 13, 2002 /s/ Thomas A. Vann
-------------------------------------
Thomas A. Vann
President and Chief Executive Officer
16
CERTIFICATION
I, William L. Wall, Executive Vice President and Chief Financial Officer of
First South Bancorp, Inc., certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of First South Bancorp,
Inc.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report.
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report.
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date.
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors (or persons performing the equivalent
function):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: November 13, 2002 /s/ William L. Wall
-------------------------------------
William L. Wall
Executive Vice President and
Chief Financial Officer
17