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, 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 November 6, 2003: 4,179,435
CONTENTS
PART I. FINANCIAL INFORMATION PAGE
--------------------- ----
Item 1. Financial Statements
Consolidated Statements of Financial Condition as of
September 30, 2003 (unaudited) and December 31, 2002 1
Consolidated Statements of Operations for the Three and Nine
Months Ended September 30, 2003 and 2002 (unaudited) 2
Consolidated Statements of Stockholders' Equity for the Nine
Months Ended September 30, 2003 (unaudited) 3
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 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 17
ITEM 1. FINANCIAL STATEMENTS
FIRST SOUTH BANCORP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
SEPTEMBER 30 DECEMBER 31
2003 2002
-------------- --------------
ASSETS (UNAUDITED)
Cash and due from banks $ 30,725,717 $ 30,540,790
Interest-bearing deposits in financial institutions 9,747,532 3,931,369
Investment securities - available for sale 50,759,096 55,786,842
Mortgage-backed securities - available for sale 12,716,950 23,526,435
Loans and leases receivable, net:
Held for sale 12,144,445 38,664,967
Held for investment 511,471,736 452,248,942
Premises and equipment, net 7,891,765 7,825,003
Deferred income taxes 632,596 --
Real estate owned 89,194 401,632
Federal Home Loan Bank of Atlanta stock, at cost
which approximates market 2,127,200 2,402,500
Accrued interest receivable 3,210,021 3,403,195
Goodwill 4,218,575 4,218,576
Mortgage servicing rights 1,975,951 1,642,172
Prepaid expenses and other assets 4,726,535 2,544,807
Note receivable 1,276,000 1,336,194
-------------- --------------
Total assets $ 653,713,313 $ 628,473,424
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand $ 218,119,132 $ 199,615,945
Savings 19,902,132 18,950,380
Large denomination certificates of deposit 105,928,722 80,021,790
Other time 231,632,854 227,739,049
-------------- --------------
Total deposits 575,582,840 526,327,164
Borrowed money 5,774,575 38,194,727
Trust preferred securities 10,000,000 --
Other liabilities 9,992,055 13,851,721
-------------- --------------
Total liabilities 601,349,470 578,373,612
Common stock, $.01 par value, 8,000,000 shares authorized,
6,545,848 shares issued 65,458 65,458
Additional paid-in capital 48,297,608 48,466,569
Retained earnings, substantially restricted 41,298,370 35,086,795
Treasury stock at cost, 2,395,818 and 2,341,936 shares (39,999,852) (37,317,469)
Accumulated other comprehensive income, net 2,702,259 3,798,459
-------------- --------------
Total stockholders' equity 52,363,843 50,099,812
-------------- --------------
Total liabilities and stockholders' equity $ 653,713,313 $ 628,473,424
============== ==============
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
============================ ============================
2003 2002 2003 2002
============================ ============================
Interest income:
Interest and fees on loans $ 8,145,992 $ 7,712,229 $ 24,104,360 $ 22,853,529
Interest and dividends on investments and deposits 1,070,908 1,514,140 3,503,417 4,605,337
------------ ------------ ------------ ------------
Total interest income 9,216,900 9,226,369 27,607,777 27,458,866
------------ ------------ ------------ ------------
Interest expense:
Interest on deposits 2,396,706 3,030,039 7,749,619 9,562,124
Interest on borrowings 24,918 12,919 97,764 39,860
Interest trust preferred securities 5,680 0 5,680 0
------------ ------------ ------------ ------------
Total interest expense 2,427,304 3,042,958 7,853,063 9,601,984
------------ ------------ ------------ ------------
Net interest income before provision for possible loan losses 6,789,596 6,183,411 19,754,714 17,856,882
Provision for possible loan losses 395,000 430,000 850,919 1,072,000
------------ ------------ ------------ ------------
Net interest income 6,394,596 5,753,411 18,903,795 16,784,882
------------ ------------ ------------ ------------
Noninterest income:
Loan fees and service charges 1,549,982 1,212,966 4,426,508 3,314,124
Loan servicing fees 198,024 182,816 493,111 541,092
Gain on sale of real estate, net 75,082 346 117,322 75,295
Gain on sale of mortgage loans 800,816 472,781 2,600,907 1,168,568
Gain on sale of mortgage-backed securities 122,800 30,177 291,738 82,843
Other income 208,099 222,347 631,431 654,297
------------ ------------ ------------ ------------
Total noninterest income 2,954,803 2,121,433 8,561,017 5,836,219
------------ ------------ ------------ ------------
Noninterest expenses:
Compensation and fringe benefits 2,663,719 2,389,078 7,941,199 7,022,606
Federal insurance premiums 63,447 21,009 106,577 63,245
Premises and equipment 392,216 348,265 1,132,527 960,717
Advertising 69,718 47,956 164,710 163,911
Payroll and other taxes 238,508 214,541 720,746 647,338
Data processing 480,678 460,385 1,429,410 1,330,022
Amortization of mortgage servicing rights 64,768 39,011 174,177 107,653
Other 624,100 564,361 1,852,877 1,522,961
------------ ------------ ------------ ------------
Total noninterest expenses 4,597,154 4,084,606 13,522,223 11,818,453
------------ ------------ ------------ ------------
Income before income taxes 4,752,245 3,790,238 13,942,589 10,802,648
Income taxes 1,786,081 1,335,735 5,246,243 3,816,508
------------ ------------ ------------ ------------
NET INCOME $ 2,966,164 $ 2,454,503 $ 8,696,346 $ 6,986,140
============ ============ ============ ============
Per share data:
Basic earnings per share $ 0.72 $ 0.56 $ 2.10 $ 1.59
Diluted earnings per share $ 0.68 $ 0.53 $ 1.98 $ 1.50
Dividends per share $ 0.20 $ 0.17 $ 0.60 $ 0.51
Weighted average shares Basic 4,138,741 4,355,880 4,144,779 4,403,670
Weighted average shares Diluted 4,392,976 4,647,378 4,396,192 4,654,174
See Notes to Consolidated Financial Statements.
2
FIRST SOUTH BANCORP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 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 8,696,346 8,696,346
Other comprehensive income, net
of taxes (1,096,200) (1,096,200)
Exercise of stock options (168,961) 781,269 612,308
Acquisition of treasury shares (3,463,652) (3,463,652)
Dividends ($.60 per share) (2,484,771) (2,484,771)
------------ ------------ ------------ ------------- ------------ ------------
Balance September 30, 2003 $ 65,458 $ 48,297,608 $ 41,298,370 $(39,999,852) $ 2,702,259 $ 52,363,843
============ ============ ============ ============= ============ ============
See Notes to Consolidated Financial Statements.
3
FIRST SOUTH BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended
September 30
---------------------------------
2003 2002
---------------------------------
Operating activities:
Net Income $ 8,696,346 $ 6,986,140
Adjustments to reconcile net income to net cash provided
in operating activities:
Provision for loan losses 850,919 1,072,000
Depreciation 527,287 464,899
Amortization of discounts on securities, net (126,024) (139,896)
Gain on disposal of premises and equipment and
real estate owned (113,391) (157,403)
Gain on loans held for sale and mortgage-backed securities (2,892,645) (1,251,410)
Originations of loans held for sale, net (108,730,666) (53,547,272)
Proceeds from sale of loans held for sale 128,900,000 56,521,075
Other operating activities (2,322,332) 2,616,751
-------------- --------------
Net cash provided in operating activities 24,789,494 12,564,884
-------------- --------------
Investing activities:
Proceeds from maturities of investments securities available for sale 4,000,000 --
Proceeds from principal repayments and sales of
mortgage-backed securities available for sale 19,439,024 11,322,869
Originations of loans held for investment, net of principal repayments (60,383,622) (52,559,978)
Proceeds from disposal of premises and equipment and
real estate owned 723,598 1,126,313
Redemption of FHLB stock 275,300 --
Purchases of premises and equipment (581,909) (492,143)
Repayment of note receivable 60,194 20,890
-------------- --------------
Net cash used in investing activities (36,467,415) (40,582,049)
-------------- --------------
Financing activities:
Net increase in deposits 49,255,676 48,777,773
Proceeds from FHLB borrowings 168,900,000 19,500,000
Repayments of FHLB borrowings (202,900,000) (20,500,000)
Issuance of trust preferred securities 10,000,000 --
Purchase of treasury shares (7,280,660) (5,265,380)
Cash paid for fractional shares -- (5,812)
Cash dividends paid (2,484,771) (2,232,705)
Proceeds from exercise of stock options 608,919 228,116
Net change in repurchase agreements 1,579,847 (258,461)
-------------- --------------
Net cash provided by financing activities 17,679,011 40,243,531
-------------- --------------
Increase in cash and cash equivalents 6,001,090 12,226,366
Cash and cash equivalents, beginning of period 34,472,159 21,683,082
-------------- --------------
Cash and cash equivalents, end of period $ 40,473,249 $ 33,909,448
============== ==============
Supplemental disclosures:
Real estate acquired in settlement of loans $ 309,909 $ 519,184
Exchange of loans for mortgage-backed securities $ 8,952,095 $ --
Dividends declared, not paid $ 830,006 $ 731,872
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 the state of 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 three and nine month
periods ended September 30, 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 prior
period share and per share data has been adjusted to reflect the stock split.
NOTE 4. GOODWILL. The Company applies the provisions of Statement of Financial
Accounting Standards No. 142 (SFAS No. 142), "Goodwill and Other Intangible
Assets", and Statement of Financial Accounting Standards No. 147 (SFAS No. 147),
"Acquisition of Certain Financial Institutions", 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 reviewed for potential impairment on an annual basis. The Company
has performed its annual impairment test and has determined there has been no
impairment of goodwill.
NOTE 5. DIVIDENDS DECLARED. On September 18, 2003, the Company declared a cash
dividend of $0.20 per share, payable on October 24, 2003 to stockholders of
record as of October 3, 2003. This dividend payment represents a payout ratio of
27.8% of the basic earnings per share for the quarter ended September 30, 2003,
and is the Company's twenty-sixth consecutive quarterly cash dividend.
NOTE 6. EARNINGS PER SHARE. Basic and diluted earnings per share for the three
and nine month periods ended September 30, 2003 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 7. STOCK OPTIONS. The Company's 1997 Stock Option Plan (the "Plan")
provides for the issuance of options to purchase shares of the Company's common
stock to selected key employees and Directors of the Company and the Bank. The
options have an original term of ten years with an
5
exercise price equal to the market price of the common stock on the date of
grant, as defined by the Plan. Vesting is determined on the date of grant.
During the three and nine month periods ended September 30, 2003, 4,500 options
were granted under the Plan, respectively. The weighted average remaining
contractual life of currently outstanding options under the Plan is 60 months.
At September 30, 2003, 585,530 options were outstanding and options for 492,592
shares of common stock were reserved for future issuance for the Plan(s). As of
September 30, 2003, 102,900 options had been exercised under the Director Plan.
The Company accounts for the Plan under the provision of SFAS No. 123,
"Accounting for Stock Based Compensation". As permitted by SFAS No. 123, the
Company has chosen to apply APB Opinion No. 25, "Accounting for Stock Issued to
Employees" and related interpretations in accounting for its plans. Accordingly,
no compensation cost had been recognized for options granted under the plans.
Had compensation cost for the Company's plans been determined based on the fair
value at the grant dates for awards under the plans consistent with the method
of SFAS No. 123, the Company's net income and net income per share - basic would
have been decreased to the pro forma amounts indicated below.
Three Months Ended September 30, 2003 As Reported Pro Forma
- ------------------------------------- ----------- ---------
Net income attributable to common shareholders $2,966,164 $2,935,393
Stock based compensation $ 0 $ 46,623
Net income per share - basic $ .72 $ .71
Net income per share - diluted $ .68 $ .67
Nine Months Ended September 30, 2003 As Reported Pro Forma
- ------------------------------------ ----------- ---------
Net income attributable to common shareholders $8,696,346 $8,604,032
Stock based compensation $ 0 $ 139,869
Net income per share - basic $ 2.10 $ 2.08
Net income per share - diluted $ 1.98 $ 1.96
NOTE 8. 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, 2003 and 2002 is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
---- ---- ---- ----
Net income $ 2,966,164 $ 2,454,503 $ 8,696,346 $ 6,986,140
Reclassification of (gains) losses
recognized in net income (122,800) (30,176) (291,738) (82,842)
Gains (losses) unrealized,
net of income taxes (538,336) 803,901 (804,462) 1,296,700
------------ ------------ ------------ ------------
Other comprehensive income (loss) (661,136) 773,725 (1,096,200) 1,213,858
------------ ------------ ------------ ------------
Comprehensive income $ 2,305,028 $ 3,228,228 $ 7,600,146 $ 8,199,998
============ ============ ============ ============
6
NOTE 9. RECLASSIFICATIONS. Certain amounts reported in the three and nine months
ended September 30, 2002 have been reclassified to conform to the presentation
for the three and nine months ended September 30, 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 10. TRUST PREFERRED SECURITIES. On September 26, 2003, the Company
completed the private placement in a pooled offering of $10,000,000 of trust
preferred securities, issued by its Delaware statutory trust, First South
Preferred Trust I. The trust preferred securities bear interest at a rate of
2.95% over three-month LIBOR, payable quarterly. The trust preferred securities
have a 30 year maturity and are redeemable after 5 years with certain
exceptions. For regulatory purposes, the $10.0 million total of trust preferred
securities qualifies as Tier 1 capital in accordance with regulatory reporting
requirements. The Company intends to use the proceeds to support future growth
and for general corporate purposes.
NOTE 11. 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.
NOTE 12. SIGNIFICANT ACTIVITIES AND SUBSEQUENT EVENTS. On October 29, 2003, the
Bank signed a Purchase and Assumption Agreement (the "Agreement") with Central
Carolina Bank ("CCB"), a Division of National Bank of Commerce, to acquire two
of CCB's branch offices located in Greenville, North Carolina and New Bern,
North Carolina, subject to regulatory approval and certain other conditions.
Under terms of the Agreement, the Bank will assume the deposits of the two CCB
offices for a premium of approximately 1.5% of the assumed deposits, and
purchase loans, fixed assets and certain other assets associated with the branch
offices. At September 30, 2003, the deposits of these branch offices totaled
approximately $17.0 million. Both branch offices will become branch offices of
the Bank, and the transaction is expected to be completed in the first quarter
of 2004.
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 SEPTEMBER 30, 2003 AND DECEMBER 31, 2002
Total assets increased to $653.7 million at September 30, 2003 from $628.5
million at December 31, 2002, reflecting a 5.4% annualized internal growth rate.
Earning assets increased to $599.0 million at September 30, 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 91.6% of total
assets at September 30, 2003 compared to 91.8% at December 31, 2002.
Interest-bearing overnight deposits in financial institutions were $9.7 million
at September 30, 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.
Investment and mortgage-backed securities available for sale were $63.5 million
at September 30, 2002 and $79.3 million at December 31, 2002. The Bank has
implemented strategies to sell certain securities during favorable interest rate
windows, and securitize certain mortgage loans previously held for sale into
mortgage-backed securities, to maintain its regulatory liquidity at required
levels. The Bank sold $7.1 million and $10.1 million of securities during the
three and nine months ended September 30, 2003, compared to no sales during the
three months and $1.5 million sold during the nine months ended September 30,
2002. The Bank securitized no mortgage loans during the three months and $9.0
million into mortgage-backed securities during the nine months ended September
30, 2003, compared to no mortgage loans securitized into mortgage-backed
securities during the three and nine months ended September 30, 2002.
Loans held for sale declined to $12.1 million at September 30, 2003 from $38.7
million at December 31, 2002. The Bank sold $49.9 million and $128.9 million of
loans during the three and nine months ended September 30, 2003 compared to
$15.3 million and $56.4 million sold during the three and nine months ended
September 30, 2002, taking advantage of refinancing volumes, current prices and
protecting itself from the risk of rising interest rates.
Loans and leases held for investment increased to $511.5 million at September
30, 2003 from $452.2 million at December 31, 2002, reflecting a 17.5% annualized
growth rate during the nine month period. To support the risk associated with
its commercial loan portfolio, the Bank maintained reserves for potential loan
losses of $7.5 million at September 30, 2003, compared to $7.0 million at
December 31, 2002. The ratio of reserves for loan losses to total loans
outstanding, net of loans in process and deferred loan fees, was 1.4%, at both
September 30, 2003 and December 31, 2002.
Deposits increased to $575.6 million at September 30, 2003 from $526.3 million
at December 31, 2002. Checking accounts increased at an annualized growth rate
of 12.4% to $218.1 million at September 30, 2003 from $199.6 million at December
31, 2002, resulting from the Bank's efforts to attract more lower cost core
checking accounts. Time deposits increased at an annualized growth rate of 12.9%
to $337.6 million at September 30, 2003 from $307.8 million at December 31,
2002.
8
The Bank had no outstanding FHLB advances at September 30, 2003, compared to
$34.0 million at December 31, 2002. A portion of the above referenced loan sale
proceeds were applied to the repayment of FHLB advances. Borrowings in the form
of repurchase agreements were $5.5 million at September 30, 2003 and $4.2
million at December 31, 2002. These borrowings represent funds held in cash
management accounts for commercial banking customers.
On September 26, 2003, the Company completed the private placement in a pooled
offering of $10.0 million of trust preferred securities. For regulatory
purposes, the $10.0 million total of trust preferred securities qualifies as
Tier 1 capital in accordance with regulatory reporting requirements. The Company
intends to use the proceeds to support future growth and for general corporate
purposes. See Note 10 of "Notes to Consolidated Financial Statements" for
additional information.
Stockholders' equity was $52.4 million at September 30, 2003, compared to $50.1
million at December 31, 2002. See "Consolidated Statements of Stockholders'
Equity" for additional information. The Company's equity to assets ratio was
8.0% at both September 30, 2003 and December 31, 2002. Accumulated other
comprehensive income declined to $2.7 million at September 30, 2003 from $3.8
million at December 31, 2002, reflecting the impact of current market rates and
the 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 $61.7 million at September 30, 2003, compared to
$50.0 million at December 31, 2002, reflecting the infusion of the net proceeds
from the trust preferred securities discussed above. The Bank's regulatory
capital is substantially in excess of all regulatory capital requirements. See
"Liquidity and Capital Resources" below for additional information.
During the quarter ended September 30, 2003, the Company purchased 100 shares of
its common stock through a private purchase transaction. Purchased shares are
being held as treasury stock, at cost. At September 30, 2003, treasury shares
held were 2,395,818 totaling $40.0 million, compared to 2,341,936 shares
totaling $37.3 million at December 31, 2002. During the three and nine months
ended September 30, 2003, 16,600 and 47,100 shares, respectively, were issued as
a result of the exercise of stock options, compared to 11,700 and 18,075 shares
issued during the three and nine months ended September 30, 2002.
On September 18, 2003, the Company declared a quarterly cash dividend of $0.20
per share, payable October 24, 2003 to stockholders of record as of October 3,
2003. This dividend payment represents a payout ratio of 27.8% of the basic
earnings for the quarter ended September 30, 2003, and is the Company's
twenty-sixth consecutive quarterly cash dividend.
COMPARISON OF OPERATING RESULTS - THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003
AND 2002
GENERAL. Net income for the three and nine months ended September 30, 2003 was
$3.0 million and $8.7 million, compared to $2.5 million and $7.0 million for the
three and nine months ended September 30, 2002. Basic earnings per share was
$0.72 and $2.10 per share for the three and nine months ended September 30,
2003, compared to $0.56 and $1.59 per share for the three and nine months ended
September 30, 2002, adjusted for the stock split. Diluted earnings per share was
$0.68 and $1.98 per share for the three and nine months ended September 30,
2003, compared to $0.53 and $1.50 per share for the three and nine months ended
September 30, 2002, adjusted for the stock split.
9
INTEREST INCOME. Interest income was $9.2 million and $27.6 million for the
three and nine months ended September 30, 2003, compared to $9.2 million and
$27.5 million for the three and nine months ended September 30, 2002.
Maintaining consistent interest income is due to the increase in the volume of
average interest earning assets, although a decline in average yield on
interest-earning assets occurred between the respective periods. Average
interest-earning assets were $601.9 million and $590.2 million for the three and
nine months ended September 30, 2003, compared to $543.0 million and $526.5
million for the three and nine months ended September 30, 2002, reflecting the
growth loans and leases held for sale as discussed above. The yield on average
interest-earning assets was 6.1% and 6.2% for the three and nine months ended
September 30, 2003, compared to 6.8% and 7.0% for the three and nine months
ended September 30, 2002.
INTEREST EXPENSE. Interest expense on deposits and borrowings was $2.4 million
and $7.9 million for the three and nine months ended September 30, 2003,
compared to $3.0 million and $9.6 million for the three and nine months ended
September 30, 2002, reflecting the decline in interest rates and the change in
the deposit mix as discussed above. Average deposits and borrowings were $591.2
million and $579.7 million for the three and nine months ended September 30,
2003, compared to $520.4 million and $502.9 million for the three and nine
months ended September 30, 2002. The effective cost of average deposits and
borrowings was 1.6% and 1.8% for the three and nine months ended September 30,
2003, compared to 2.3% and 2.6% for the three and nine months ended September
30, 2002.
NET INTEREST INCOME. Net interest income was $6.8 million and $19.8 million for
the three and nine months ended September 30, 2003, compared to $6.2 million and
$17.9 million for the three and nine months ended September 30, 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
4.5% and 4.4% for both the three and nine month periods ended September 30, 2003
and September 30, 2002. The net yield on interest-earning assets (net interest
income divided by average interest-earning assets) was 4.5% for both the three
and nine months ended September 30, 2003, compared to 4.6% and 4.5% for the
three and nine months ended September 30, 2002.
PROVISION FOR LOAN LOSSES. The Bank recorded approximately $395,000 and $851,000
of provisions for loan losses during the three and nine months ended September
30, 2003, compared to $430,000 and $1.1 million recorded in the three and nine
months ended September 30, 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 future losses, if any, will not exceed estimated amounts.
NONINTEREST INCOME. Noninterest income was $3.0 million and $8.6 million for the
three and nine months ended September 30, 2003, compared $2.1 million and $5.8
million for the three and nine months ended September 30, 2002. Noninterest
income consists of fees and service charges earned on loans, service charges on
deposit accounts, gains from sales of loans and securities, and other
miscellaneous income. Fees and service charges were $1.7 million and $4.9
million for the three and nine months ended September 30, 2003, compared to $1.4
million and $3.9 million for the three and
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nine months ended September 30, 2002. The increase in fees and service charges
during the current periods is attributable to a greater volume of loans and
checking deposits as discussed above. In addition, the Bank recorded $924,000
and $2.9 million of gains from sales of loans and securities during the three
and nine months ended September 30, 2003, compared to $503,000 and $1.3 million
during the three and nine months ended September 30, 2002.
NONINTEREST EXPENSE. Noninterest expenses were $4.6 million and $13.5 million
for the three and nine months ended September 30, 2003, compared to $4.1 million
and $11.8 million for the three and nine months ended September 30, 2002. The
largest component of these expenses, compensation and fringe benefits, was $2.7
million and $7.9 million for the three and nine months ended September 30, 2003,
compared to $2.4 million and $7.0 million for the three and nine months ended
September 30, 2002. The Bank's fulltime equivalent employees increased by 8.4%
to 244 at September 30, 2003 from 225 at September 30, 2002. The growth is due
to additional personnel resulting from opening two new full-service branch
offices, and administrative staff required to support the 8.8% growth in assets
between the periods.
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 new offices opened. Other noninterest expenses including
premises and equipment, repairs, printing, advertising, and office supplies have
also grown proportionately with the growth in earning assets, deposits and
branch office locations.
INCOME TAXES. Income tax expense was $1.8 million and $5.2 million for the three
and nine months ended September 30, 2003, compared to $1.3 million and $3.8
million for the three and nine months ended September 30, 2002. 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, 2003
exceeded the requirements under such guidelines. 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,
2003, the Bank had cash, deposits in banks, investment securities,
mortgage-backed securities, FHLB stock and loans held for sale totaling $118.2
million, or 20.3% of deposits and borrowings, compared to $154.9 million, or
27.4% of deposits and borrowings at December 31, 2002.
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.
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The Company has completed the private placement in a pooled offering of $10.0
million of trust preferred securities. For regulatory purposes, the $10.0
million of trust preferred securities qualifies as Tier 1 capital in accordance
with regulatory reporting requirements.
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, 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 is reflected in the cost and prices the Company 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.
LOAN 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.
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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.
NEW ACCOUNTING PRONOUNCEMENTS
In January 2003 the Financial Accounting Standards Board (the "FASB") issued
FASB Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest
Entities (an interpretation of ARB No. 51)." FIN 46 addresses the consolidation
by business enterprises of certain variable interest entities. Management does
not anticipate the implementation of FIN 46 to have a material impact on the
Company's consolidated financial position or consolidated results of operations.
In April 2003, the 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. 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.
13
In May 2003, the FASB issued Statement of Financial Accounting Standards No.
150, "Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity". Statement 150 establishes standards for classification
and measurement of certain financial instruments with characteristics of both
liabilities and equity. It requires the classification of a financial instrument
that is within its scope as a liability (or an asset in some circumstances).
Many of those instruments were previously classified as equity. Some of the
provisions of Statement 150 are consistent with the current definition of
liabilities in FASB Concepts Statement No. 6, "Elements of Financial
Statements". The remaining provisions of Statement 150 are consistent with the
FASB's proposal to revise that definition to encompass certain obligations that
a reporting entity can or must settle by issuing its own equity shares,
depending on the nature of the relationship established between the holder and
the issuer. While the FASB plans to revise that definition through an amendment
to Concepts Statement 6, it decided to defer issuing that amendment until it has
concluded its deliberations on the next phase of this project. That next phase
will deal with certain compound financial instruments including puttable shares,
convertible bonds, and dual-indexed financial instruments. This Statement is
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003, except for mandatory redeemable financial
instruments of nonpublic entities. It is to be implemented by reporting the
cumulative effect of a change in an accounting principle for financial
instruments created before the issuance date of the Statement and still existing
at the beginning of the interim period of adoption. Restatement is not
permitted. Management does not anticipate the implementation of this statement
to have a material impact on the Company's consolidated financial position or
consolidated results of operations.
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 June 30, 2003. The Company does not believe that
any material adverse changes in market risk exposures occurred since June 30,
2003.
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
As of the end of the period covered by this report, management of the Company
carried out an evaluation, under the supervision and with the participation of
the Company's principal executive
14
officer and principal financial officer, of the effectiveness of the Company's
disclosure controls and procedures. Based on this evaluation, the Company's
principal executive officer and principal financial officer concluded that the
Company's disclosure controls and procedures are effective in ensuring that
information required to be disclosed by the Company in reports that it files or
submits under the Securities Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported, within the time periods specified in the
Securities and Exchange Commission's rules and forms. It should be noted that
the design of the Company's disclosure controls and procedures is based in part
upon certain reasonable assumptions about the likelihood of future events, and
there can be no reasonable assurance that any design of disclosure controls and
procedures will succeed in achieving its stated goals under all potential future
conditions, regardless of how remote, but the Company's principal executive and
financial officers have concluded that the Company's disclosure controls and
procedures are, in fact, effective at a reasonable assurance level.
In addition, there have been no changes in the Company's internal control over
financial reporting (to the extent that elements of internal control over
financial reporting are subsumed within disclosure controls and procedures)
identified in connection with the evaluation described in the above paragraph
that occurred during the Company's last fiscal quarter, that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
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 exhibits are filed herewith:
Exhibit
Number Title
------ -----
31 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
15
32 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 July 18, 2003 under Item
7., Financial Statements, Pro Forma Financial Information and
Exhibits, and under Item 9., Regulation FD Disclosure, reporting the
Company issued a press release announcing its unaudited financial
results for the three and nine months ended September 30, 2003.
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 12, 2003
16