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 March 31, 2003.
[ ] 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 May 6, 2003: 4,139,330
CONTENTS
PART I. FINANCIAL INFORMATION PAGE
--------------------- ----
Item 1. Financial Statements
Consolidated Statements of Financial Condition as of
March 31, 2003 (unaudited) and December 31, 2002 1
Consolidated Statements of Operations for the Three
Months Ended March 31, 2003 and 2002 (unaudited) 2
Consolidated Statements of Stockholders' Equity for
the Three Months Ended March 31, 2003 (unaudited) 3
Consolidated Statements of Cash Flows for the Three
Months Ended March 31, 2003 and 2002 (unaudited) 4
Notes to Consolidated Financial Statements (unaudited) 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk 14
Item 4. Controls and Procedures 14
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings 15
Item 2. Changes in Securities and Use of Proceeds 15
Item 3. Defaults Upon Senior Securities 15
Item 4. Submission of Matters to a Vote of Security Holders 15
Item 5. Other Information 15
Item 6. Exhibits and Reports on Form 8-K 15
Signatures 16
Exhibits 19
FIRST SOUTH BANCORP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
MARCH 31 DECEMBER 31
2003 2002
-------------- --------------
ASSETS (UNAUDITED)
Cash and due from banks $ 29,027,430 $ 30,540,790
Interest-bearing deposits in financial institutions 1,278,565 3,931,369
Investment securities - available for sale 55,580,532 55,786,842
Mortgage-backed securities - available for sale 20,112,375 23,526,435
Loans and leases receivable, net:
Held for sale 29,052,090 38,664,967
Held for investment 473,341,817 452,248,942
Premises and equipment, net 7,690,065 7,825,003
Deferred income taxes 149,845 --
Real estate owned 130,795 401,632
Federal Home Loan Bank of Atlanta stock, at cost
which approximates market 2,402,500 2,402,500
Accrued interest receivable 3,074,147 3,403,195
Goodwill 4,218,576 4,218,576
Mortgage servicing rights 1,940,114 1,642,172
Prepaid expenses and other assets 4,648,963 2,544,807
Note receivable 1,321,729 1,336,194
-------------- --------------
Total assets $ 633,969,543 $ 628,473,424
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand $ 210,587,034 $ 199,615,945
Savings 19,721,250 18,950,380
Large denomination certificates of deposit 101,364,194 80,021,790
Other time 230,172,960 227,739,049
-------------- --------------
Total deposits 561,845,438 526,327,164
Borrowed money 11,017,627 38,194,727
Other liabilities 11,506,750 13,851,721
-------------- --------------
Total liabilities 584,369,815 578,373,612
Common stock, $.01 par value, 8,000,000 shares authorized,
6,545,848 shares issued 65,458 65,458
Additional paid-in capital 48,424,564 48,466,569
Retained earnings, substantially restricted 37,100,141 35,086,795
Treasury stock at cost, 2,395,247 and 2,099,561 shares (39,480,341) (37,317,469)
Accumulated other comprehensive income, net 3,489,906 3,798,459
-------------- --------------
Total stockholders' equity 49,599,728 50,099,812
-------------- --------------
Total liabilities and stockholders' equity $ 633,969,543 $ 628,473,424
============== ==============
See Notes to Consolidated Financial Statements.
1
FIRST SOUTH BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
---------------------------
2003 2002
---------------------------
Interest income:
Interest and fees on loans $ 7,912,639 $ 7,467,416
Interest and dividends on investments and deposits 1,228,693 1,579,994
------------ ------------
Total interest income 9,141,332 9,047,410
------------ ------------
Interest expense:
Interest on deposits 2,704,429 3,351,931
Interest on borrowings 37,536 9,274
------------ ------------
Total interest expense 2,741,965 3,361,205
------------ ------------
Net interest income before provision for
possible loan losses 6,399,367 5,686,205
Provision for possible loan losses 333,919 309,000
------------ ------------
Net interest income 6,065,448 5,377,205
------------ ------------
Noninterest income:
Loan fees and service charges 1,343,143 1,018,712
Loan servicing fees 138,616 178,267
Gain on sale of real estate, net 48,629 85,147
Gain on sale of mortgage loans 1,016,698 305,310
Gain on sale of mortgage-backed securities 168,938 58,288
Other income 203,992 158,455
------------ ------------
Total noninterest income 2,920,016 1,804,179
------------ ------------
Noninterest expenses:
Compensation and fringe benefits 2,644,781 2,189,320
Federal insurance premiums 22,038 21,339
Premises and equipment 362,808 309,232
Advertising 48,527 61,079
Payroll and other taxes 238,978 221,558
Data processing 463,845 426,503
Amortization of mortgage servicing rights 52,194 32,004
Other 586,481 479,903
------------ ------------
Total noninterest expenses 4,419,652 3,740,938
------------ ------------
Income before income taxes 4,565,812 3,440,446
Income taxes 1,722,907 1,261,871
------------ ------------
NET INCOME $ 2,842,905 $ 2,178,575
============ ============
Per share data (*):
Basic earnings per share $ 0.68 $ 0.49(*)
Diluted earnings per share $ 0.64 $ 0.47(*)
Dividends per share $ 0.20 $ 0.17(*)
Weighted average shares Basic 4,162,358 4,438,208(*)
Weighted average shares Diluted 4,423,319 4,641,088(*)
(*) 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
THREE MONTHS ENDED MARCH 31, 2003
(UNAUDITED)
Accumulated
Retained Other
Additional Earnings, Comprehensive
Common Paid-in Substantially Treasury Income (Loss),
Stock Capital Restricted Stock Net Total
-------- ------------- ------------ ------------- ----------- ------------
Balance December 31, 2002 $ 65,458 $ 48,466,569 $ 35,086,795 $ (37,317,469) $ 3,798,459 $ 50,099,812
Net income 2,842,905 2,842,905
Other comprehensive income, net
of taxes (308,553) (308,553)
Exercise of stock options (42,005) 265,121 223,116
Acquisition of treasury shares (2,427,993) (2,427,993)
Dividends ($.20 per share) (829,559) (829,559)
-------- ------------- ------------ ------------- ----------- ------------
Balance March 31, 2003 $ 65,458 $ 48,424,564 $ 37,100,141 $ (39,480,341) $ 3,489,906 $ 49,599,728
======== ============= ============ ============= =========== ============
See Notes to Consolidated Financial Statements.
3
FIRST SOUTH BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Three Months Ended
March 31
----------------------------
2003 2002
------------ ------------
Operating activities:
Net Income $ 2,842,905 $ 2,178,575
Adjustments to reconcile net income to net cash provided
in operating activities:
Provision for loan losses 333,919 309,000
Depreciation 168,868 150,170
Amortization of discounts on securities, net (46,632) (46,632)
Gain on disposal of premises and equipment and
real estate owned (48,629) (108,684)
Gain on loans held for sale and mortgage-backed securities (1,185,636) (363,598)
Originations of loans held for sale, net (32,382,838) (18,917,738)
Proceeds from sale of loans held for sale 39,368,328 24,350,509
Other operating activities (4,495,319) 279,230
------------ ------------
Net cash provided in operating activities 4,554,966 7,830,832
------------ ------------
Investing activities:
Proceeds from principal repayments and sales of
mortgage-backed securities available for sale 6,982,359 5,638,544
Originations of loans held for investment, net of principal repayments (21,445,578) (20,344,268)
Proceeds from disposal of premises and equipment and
real estate owned 338,250 590,673
Purchases of premises and equipment (33,930) (112,713)
Repayment of note receivable 14,465 6,799
------------ ------------
Net cash used in investing activities (14,144,434) (14,220,965)
------------ ------------
Financing activities:
Net increase in deposit accounts 35,518,274 13,773,346
Proceeds from FHLB borrowings 58,400,000 1,000,000
Repayments of FHLB borrowings (85,400,000) (2,000,000)
Purchase of treasury shares (2,427,993) (559,844)
Cash dividends paid (712,992) (533,581)
Proceeds from exercise of stock options 223,116 77,563
Net change in repurchase agreements (177,101) (238,597)
------------ ------------
Net cash provided by financing activities 5,423,304 11,518,887
------------ ------------
Increase (decrease) in cash and cash equivalents (4,166,164) 5,128,754
Cash and cash equivalents, beginning of period 34,472,159 21,683,082
------------ ------------
Cash and cash equivalents, end of period $ 30,305,995 $ 26,811,836
============ ============
Supplemental disclosures:
Real estate acquired in settlement of loans $ 18,784 $ 167,399
Exchange of loans for mortgage-backed securities $ 3,644,085 $ --
Dividends declared, not paid $ 830,120 $ 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 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 quarter ended March 31,
2003 are not necessarily indicative of the results of operations that may be
expected for the year ended December 31, 2003.
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 share
and per share data for the quarter ended March 31, 2002 has been adjusted to
reflect the stock split.
NOTE 4. EARNINGS PER SHARE. Basic and diluted earnings per share for the quarter
ended March 31, 2003 and 2002 are based on weighted average shares of common
stock outstanding, excluding treasury shares. Diluted earnings per share include
the potentially dilutive effects of the Company's stock option plan.
NOTE 5. DIVIDENDS DECLARED. On March 20, 2003, the Company declared a cash
dividend of $0.20 per share, payable April 18, 2003 to stockholders of record as
of April 7, 2003. This dividend payment represents a payout ratio of 29.4% of
the basic earnings per share for the quarter ended March 31, 2003, and is the
Company's twenty-fourth consecutive quarterly cash dividend.
NOTE 6. GOODWILL. The Company applies the provisions of Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS No.
142), and Statement of Financial Accounting Standards No. 147, "Acquisition of
Certain Financial Institutions" (SFAS No. 147) effective as of January 1, 2002.
SFAS No. 142 requires the Company to discontinue the amortization of goodwill
associated with acquisitions accounted for under the purchase method of
accounting. SFAS No. 147 requires the Company to cease amortization of
unidentifiable intangible assets associated with certain branch acquisitions.
As a result of applying the provisions of SFAS No.'s 142 and 147, goodwill is
not amortized, but is reviewed for potential impairment on an annual basis. The
Company has performed its annual impairment test and has determined that there
has been no impairment of goodwill.
5
NOTE 7. STOCK OPTIONS. On December 31, 2002, the Financial Accounting Standards
Board (FASB or the "Board") issued FASB Statement No. 148 (FAS 148), Accounting
for Stock-Based Compensation--Transition and Disclosure, which amends FASB
Statement No. 123 (FAS 123), Accounting for Stock-Based Compensation. FAS 148
allows for three methods of transition for those companies that adopt FAS 123's
provisions for fair value recognition. The following are two new transition
alternatives: Modified Prospective Approach and Limited Retrospective Approach.
Under FAS 148, the prospective transition method in FAS 123 resulting in the
"ramp-up" effect will not be available for enterprises that elect to initially
apply the fair value method of accounting for stock-based employee compensation
in fiscal years beginning after December 15, 2003. In addition, the provisions
of FAS 148 require that: the accumulated liability or equity balances accrued
under APB Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees,
would be reversed through additional paid-in-capital as of the beginning of the
period that FAS 123 is adopted if those liabilities or contra-equity balances
would not have been recognized under FAS 123 (e.g., variable stock option awards
under APB 25). Also, companies must disclose for each period for which an income
statement is presented an accounting policy footnote that includes: the method
of accounting for stock options; total stock compensation cost that is
recognized in the income statement and would have been recognized had FAS 123
been adopted for recognition purposes as of its effective date; and pro forma
net income and earnings per share (where applicable) that would have been
reported had FAS 123 been adopted for recognition purposes as of its effective
date.
These disclosures would be required to be made in annual financial statements
and in quarterly information provided to shareholders without regard to whether
the entity has adopted FAS 123 for recognition purposes. The Company implemented
the disclosure provisions of SFAS No. 148 beginning with the December 31, 2002
consolidated financial statements.
For purposes of the proforma disclosures required for the quarter ended March
31, 2003, no stock option grants were made in the quarter ended March 31, 2003.
For the quarter ended March 31, 2003, the following table summarizes the net
income and stock-based compensation expense, as reported, compared to pro forma
amounts had the fair value method been applied:
As Reported Pro Forma
----------- ---------
Net income attributable to common shareholders $2,842,905 $2,810,564
Stock based compensation $ 0 $ 49,001
Net income per share - basic $ .68 $ .68
Net income per share - diluted $ .64 $ .64
NOTE 8. RECLASSIFICATIONS. Certain amounts reported in the quarter ended March
31, 2002 have been reclassified to conform with the presentation for the quarter
period ended March 31, 2003. These reclassifications had no effect on net income
or shareholders' equity for the periods presented, nor did they materially
impact trends in financial information.
NOTE 9. 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.
6
Information concerning the Company's other comprehensive income for the quarter
ended March 31, 2003 and 2002 is as follows:
Quarter Ended
March 31,
2003 2002
------------ ------------
Net income $ 2,842,905 $ 2,178,765
Reclassification of (gains) losses
recognized in net income (168,938) (58,288)
Gains (losses) unrealized,
net of income taxes (139,615) (626,150)
------------ ------------
Other comprehensive income (loss) (308,553) (684,438)
------------ ------------
Comprehensive income $ 2,534,352 $ 1,494,327
============ ============
NOTE 10. FORWARD LOOKING STATEMENTS. The Private Securities Litigation Reform
Act of 1995 states that the disclosure of forward looking information is
desirable for investors and encourages such disclosure by providing a safe
harbor for forward looking statements by corporate management. This Form 10-Q,
including Management's Discussion and Analysis of Financial Condition and
Results of Operations, contains forward looking statements that involve risk and
uncertainty. In order to comply with the terms of the safe harbor, the Company
notes that a variety of risks and uncertainties could cause its actual results
and experience to differ materially from the anticipated results or other
expectations expressed in the Company's forward looking statements. There are
risks and uncertainties that may affect the operations, performance,
development, growth projections and results of the Company's business. They
include, but are not limited to, economic growth, interest rate movements,
timely development of technology enhancements for products, services and
operating systems, the impact of competitive products, services and pricing,
customer requirements, regulatory changes and similar matters. Readers of this
report are cautioned not to place undue reliance on forward looking statements
that are subject to influence by these risk factors and unanticipated events.
Accordingly, actual results may differ materially from management's
expectations.
7
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 MARCH 31, 2003 AND DECEMBER 31, 2002
Total assets increased to $634.0 million at March 31, 2003 from $628.5 million
at December 31, 2002. Earning assets increased to $581.8 million at March 31,
2003 from $576.6 million at December 31, 2002, reflecting growth of the
commercial and consumer loan portfolio, as further discussed below. Earning
assets were 91.8% of total assets at March 31, 2003 and December 31, 2002,
respectively.
Interest-bearing overnight deposits in financial institutions were $1.3 million
at March 31, 2003, compared to $3.9 million at December 31, 2002. Overnight
funds are available to fund loan originations, liquidity management activities
and daily operations of the Bank.
The Bank has implemented strategies to sell certain securities and loans during
favorable interest rate windows, to maintain its regulatory liquidity at
required levels, and to securitize certain mortgage loans held for sale into
mortgage-backed securities. During the quarter ended March 31, 2003, the Bank
sold $3.0 million of mortgage-backed securities, compared to $1.5 million of
mortgage-backed securities sales during the quarter ended March 31, 2002. $3.6
million of loans were securitized into mortgage-backed securities during the
quarter ended March 31, 2003, compared to no loans securitized during the
quarter ended March 31, 2002. The mortgage-backed securities portfolio declined
to $20.1 million at March 31, 2003, compared to $23.5 million at December 31,
2002.
Loans held for sale declined to $29.1 million at March 31, 2003 from $38.7
million at December 31, 2002. During the quarter ended March 31, 2003 the Bank
sold $39.4 million of mortgage loans, compared to $24.4 million of sales during
the quarter ended March 31, 2002. Net loans and leases held for investment
increased to $473.3 million at March 31, 2003 from $452.3 million at December
31, 2002, reflecting an 18.7% annualized growth rate during the current quarter.
This growth reflects the Bank's emphasis placed on structuring itself as a
commercial banking entity. To support the risk associated with its commercial
and consumer loan portfolio growth, the Bank increased its reserves for
potential loan losses to $7.3 million at March 31, 2003 from $7.0 million at
December 31, 2002. The ratio of reserves for loan losses to loans outstanding,
net of loans in process and deferred loan fees, was 1.4% at March 31, 2003 and
December 31, 2002, respectively.
Total deposits and borrowings increased to $572.9 million at March 31, 2003 from
$564.5 million at December 31, 2002. Deposits increased to $561.8 million at
March 31, 2003 from $526.3 million at December 31, 2002. Checking accounts
increased 5.5% to $210.6 million at March 31, 2003 from $199.6 million at
December 31, 2002, and represent 37.5% of total deposits at March 31, 2003, as a
result of the Bank's efforts to attract more lower costing core checking
accounts. Time deposits increased 7.7% to $331.5 million at March 31, 2003 from
$307.8 million at December 31, 2002.
FHLB advances used primarily to fund loan originations were $7.0 million at
March 31, 2003, compared to $34.0 million at December 31, 2002. Borrowings, in
the form of repurchase agreements, were $4.0 million at March 31, 2003 compared
to $4.2 million at December 31, 2002. These borrowings represent funds in cash
management accounts for commercial banking customers.
8
Stockholders' equity was $49.6 million at March 31, 2003, compared to $50.1
million at December 31, 2002. See "Consolidated Statements of Stockholders'
Equity" for additional information. At March 31, 2003, the Company's equity to
assets ratio was 7.8%, compared to 8.0% at December 31, 2002. Accumulated other
comprehensive income declined to $3.5 million at March 31, 2003 from $3.8
million at December 31, 2002, reflecting the impact of the mortgage-backed
securities sales as previously discussed.
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 $49.5 million at March 31, 2003, 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 split, payable April 19, 2002 to stockholders of record as of
April 8, 2002. All share and per share data for the quarter ended March 31, 2002
were adjusted to reflect the stock split, and issued shares increased to
6,545,848.
During the quarter ended March 31, 2003, the Company acquired $2.4 million of
its common stock through open market and private purchases, pursuant to a stock
repurchase plan previously adopted by the board of directors. Shares acquired
via the stock repurchase plan are held as treasury stock, at cost. At March 31,
2003, treasury shares held were 2,395,247 totaling $39.5 million, compared to
2,099,561 shares totaling $37.3 million at December 31, 2002. The Company
believes the repurchase of its outstanding common stock will increase per share
earnings and return on average equity, and decrease the potential dilutive
effect caused by the exercise of stock options. During the quarter ended March
31, 2003, 16,150 shares were issued as a result of the exercise of stock options
compared to and 6,375 shares (adjusted for the stock split) during the quarter
ended March 31, 2002.
COMPARISON OF OPERATING RESULTS FOR THE QUARTER ENDED MARCH 31, 2003 AND 2002
GENERAL. Net income for the quarter ended March 31, 2003 was $2.8 million,
compared to $2.2 million for the quarter ended March 31, 2002. Basic earnings
per share for the quarter ended March 31, 2003 was $0.68, compared to $0.49 per
share for the quarter ended March 31, 2002, adjusted for the stock split.
Diluted earnings per share for the quarter ended March 31, 2003 was $0.64 per
share, compared to $0.47 per share for the quarter March 31, 2002, adjusted for
the stock split.
INTEREST INCOME. Interest income was $9.1 million for the quarter ended March
31, 2003, compared to $9.0 million for the quarter ended March 31, 2002. This
increase is due to the increase in the volume of average interest-earning assets
between the respective periods. Average interest-earning assets were $575.3
million for the quarter ended March 31, 2003, compared to $511.9 million for the
quarter ended March 31, 2002, reflecting the growth of loans and leases held for
sale as discussed above. The yield on average interest-earning assets was 6.4%
for the quarter ended March 31, 2003, compared to 7.1% for 2002, due to a
general decline in interest rates between the periods.
INTEREST EXPENSE. Interest expense on deposits and borrowings declined to $2.7
million for the quarter ended March 31, 2003, from $3.4 million for the quarter
ended March 31, 2002, reflecting the general decline in interest rates and the
change in the deposit mix as previously discussed. Average deposits and
borrowings were $566.3 million for the quarter ended March 31, 2003,
9
compared to $484.4 million for the quarter ended March 31, 2002. The effective
cost of average deposits and borrowings was 1.9% for the quarter ended March 31,
2003, compared to 2.8% for the quarter ended March 31, 2002.
NET INTEREST INCOME. Net interest income increased to $6.4 million for the
quarter ended March 31, 2003, from $5.7 million for the quarter ended March 31,
2002. 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 the quarter ended March 31, 2003, compared to 4.3% for
the quarter ended March 31, 2002. The net yield on interest-earning assets (net
interest income divided by average interest-earning assets) was 4.5% for the
quarter ended March 31, 2003, compared to 4.4% for the quarter ended March 31,
2002.
PROVISION FOR LOAN LOSSES. During the quarter ended March 31, 2003, the Bank
recorded provisions for loan losses of $334,000 compared to $309,000 recorded
during the quarter ended March 31, 2002. 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 probable future losses, if any, will not exceed estimated
amounts.
NONINTEREST INCOME. Noninterest income was $2.9 million for the quarter ended
March 31, 2003, compared to $1.8 million for the quarter ended March 31, 2002.
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. The increase in fees and services
charges to $1.3 million during the quarter ended March 31, 2003 from $1.0
million during the quarter ended March 31, 2002 is attributable to the greater
volume of loans and checking account deposits as previously discussed. In
addition, the Bank recorded $1.2 million of gains from the sales of loans and
mortgage-backed securities during the quarter ended March 31, 2003, compared to
$364,000 during the quarter ended March 31, 2002.
NONINTEREST EXPENSE. Noninterest expense was $4.4 million for the quarter ended
March 31, 2003, compared to $3.7 million for the quarter ended March 31, 2002.
The largest component of these expenses, compensation and fringe benefits, was
$2.6 million for the quarter ended March 31, 2003, compared to $2.2 million for
the quarter ended March 31, 2002. Full-time equivalent employees increased to
238 at March 31, 2003 from 212 at March 31, 2002. This growth is due to
additional personnel resulting from opening a new full-service branch office, a
new loan production office and administrative staff required to support the
12.7% growth in assets between the periods.
Premises and equipment and data processing expenses have grown proportionately
with the growth in the number of customer accounts and transaction activity,
primarily attributable to both internal growth and the new offices opened since
March 31, 2002. Other noninterest expenses including premises and equipment,
repairs, printing, advertising, and office supplies have also grown
proportionately with the growth in full-service branch office locations.
10
INCOME TAXES. Income tax expense was $1.7 million for the quarter ended March
31, 2003, compared to $1.3 million for the quarter ended March 31, 2002. The
changes in the amounts of income tax provisions reflect 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 March 31, 2003, 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 March 31, 2003, the Bank had cash, deposits
in banks, investment securities, mortgage-backed securities, FHLB stock and
loans held for sale totaling $137.5 million, or 21.7% of total assets, compared
to $154.9 million at December 31, 2002, or 24.6% 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 Federal Home Loan
Bank 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. In
addition, the Bank 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 March 31, 2003 and December 31, 2002.
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.
11
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.
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.
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.
12
NEW ACCOUNTING PRONOUNCEMENTS
In June 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No.
146, "Accounting for Costs Associated with Exit or Disposal Activities". This
statement addresses financial accounting and reporting for costs associated with
exit or disposal activities and nullifies Emerging Issues Task Force (EITF)
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)". The provisions of SFAS No. 146 are effective for exit or
disposal activities initiated after December 31, 2002. The application of this
statement is not expected to have a material impact on the Company's
consolidated financial statements.
In November 2002, the FASB issued FIN 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others". This interpretation elaborates on the disclosures to be made by a
guarantor in its interim and annual financial statements about its obligations
under certain guarantees it has issued. It also clarifies that a guarantor is
required to recognize, at the inception of a guarantee, a liability for the fair
value of the obligation undertaken in issuing the guarantee. The application of
this interpretation is not expected to have a material impact on the Company's
consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure". SFAS No. 148 amends FASB Statement No.
123, "Accounting for Stock-Based Compensation", to provide alternative methods
of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, SFAS No. 148
amends the disclosure requirements of Statement 123 to require prominent
disclosures in both interim and annual financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results The application of this statement is not expected to
have a material impact on the Company's consolidated financial statements.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities-an Interpretation of ARB No. 51". This interpretation addresses
consolidation by business enterprises of variable interest entities, which have
the following characteristics: (1) The equity investment at risk is not
sufficient to permit the entity to finance its activities without additional
subordinated financial support from other parties, which is provided through
other interests that will absorb some or all of the expected losses of the
entity, and (2) The equity investors lack one or more of the following essential
characteristics of a controlling financial interest: (a) The direct or indirect
ability to make decisions about the entity's activities through voting rights or
similar rights, (b) The obligation to absorb the expected losses of the entity
if they occur, which makes it possible for the entity to finance its activities,
or (c) The right to receive the expected residual returns of the entity if they
occur, which is the compensation for the risk of absorbing the expected losses.
The application of this interpretation is not expected to have a material impact
on the Company's consolidated financial statements.
In April 2003, FASB issued Statement of Financial Accounting Standards No. 149
"Amendment of Statement 133 on Derivative Instruments and Hedging Activities".
FASB Statements No. 133 "Accounting for Derivative Instruments and Hedging
Activities" and No. 138, "Accounting for Certain Derivative Instruments and
Certain Hedging Activities", establish accounting and reporting standards for
derivative instruments including derivatives embedded in other contracts
(collectively referred to as derivatives) and for hedging activities. Statement
149 amends Statement 133 for certain decisions made by the Board as part of the
Derivatives Implementation Group (DIG) process.
13
This Statement contains amendments relating to FASB Concepts Statement No. 7,
"Using Cash Flow Information and Present Value in Accounting Measurements", and
FASB Statements No. 65, "Accounting for Certain Mortgage Banking Activities",
No. 91 "Accounting for Nonrefundable Fees and Costs Associated with Originating
or Acquiring Loans and Initial Direct Costs of Leases", No. 95, "Statement of
Cash Flows", and No. 126, "Exemption from Certain Required Disclosures about
Financial Instruments for Certain Nonpublic Entities". The Company is presently
evaluating the effect of this pronouncement.
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, 2002. The Company does not believe
that any material adverse changes in market risk exposures occurred since
December 31, 2002.
The current period earnings growth reflects the Company's success in 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.
14
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
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. A Form 8-K was filed on January 7, 2003 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 209,465 shares.
15
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: May 13, 2003
16
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: May 13, 2003 /s/ Thomas A. Vann
------------------
Thomas A. Vann
President and Chief Executive Officer
17
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: May 13, 2003 /s/ William L. Wall
-------------------
William L. Wall
Executive Vice President and
Chief Financial Officer
18