Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005.
|_| 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 |_|
Indicate by check mark whether registrant is an accelerated filer (as defined by
Rule 12b-2 of the Exchange Act).
Yes |X| No |_|
Number of shares of common stock outstanding as of May 2, 2005: 6,324,471
CONTENTS
PART I. FINANCIAL INFORMATION PAGE
--------------------- ----
Item 1. Financial Statements
Consolidated Statements of Financial Condition as of March 31, 2005
(unaudited) and December 31, 2004 1
Consolidated Statements of Operations for the Three Months Ended
March 31, 2005 and 2004 (unaudited) 2
Consolidated Statement of Stockholders' Equity for the Three Months Ended
March 31, 2005 (unaudited) 3
Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2005 and 2004 (unaudited) 4
Notes to Consolidated Financial Statements (unaudited) 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 6
Item 3. Quantitative and Qualitative Disclosures About Market Risk 12
Item 4. Controls and Procedures 12
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 13
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 13
Item 3. Defaults Upon Senior Securities 13
Item 4. Submission of Matters to a Vote of Security Holders 13
Item 5. Other Information 13
Item 6. Exhibits 13
Signatures 14
Exhibits 15
First South Bancorp, Inc. and Subsidiary
Consolidated Statements of Financial Condition
March 31 December 31
2005 2004
-------------- --------------
Assets (unaudited)
Cash and due from banks $ 29,134,703 $ 19,873,210
Interest-bearing deposits in financial institutions 1,135,978 1,065,138
Investment securities - available for sale 28,545,894 32,058,152
Mortgage-backed securities - available for sale 6,088,109 6,639,381
Mortgage-backed securities - held for investment 2,441,252 2,569,358
Loans and leases receivable, net:
Held for sale 5,727,170 5,961,691
Held for investment 669,054,453 625,854,344
Premises and equipment, net 8,255,623 8,402,455
Real estate owned 296,269 89,449
Federal Home Loan Bank of Atlanta stock, at cost
which approximates market 1,891,700 1,825,200
Accrued interest receivable 3,615,392 3,311,187
Goodwill 4,218,576 4,218,576
Mortgage servicing rights 1,649,460 1,698,778
Identifiable intangible assets 282,960 290,820
Prepaid expenses and other assets 6,635,813 6,216,308
Note receivable 1,131,761 1,156,557
-------------- --------------
Total assets $ 770,105,113 $ 721,230,604
============== ==============
Liabilities and Stockholders' Equity
Deposits:
Demand $ 247,683,261 $ 236,319,937
Savings 24,271,580 22,018,388
Large denomination certificates of deposit 128,041,842 120,757,331
Other time 268,840,880 249,441,049
-------------- --------------
Total deposits 668,837,563 628,536,705
Borrowed money 15,724,966 14,791,900
Junior subordinated debentures 10,310,000 10,310,000
Deferred income taxes 1,082,255 1,302,501
Other liabilities 12,275,203 6,594,151
-------------- --------------
Total liabilities 708,229,987 661,535,257
Common stock, $.01 par value, 25,000,000 shares
authorized, 6,321,633 and 6,264,676
shares issued and outstanding, respectively 63,216 62,647
Additional paid-in capital 37,612,329 37,815,715
Retained earnings, substantially restricted 52,441,075 50,597,651
Treasury stock at cost (28,755,274) (29,653,794)
Accumulated other comprehensive income, net 513,780 873,128
-------------- --------------
Total stockholders' equity 61,875,126 59,695,347
-------------- --------------
Total liabilities and stockholders' equity $ 770,105,113 $ 721,230,604
============== ==============
*Derived from audited consolidated financial statements
See Notes to Consolidated Financial Statements.
1
First South Bancorp, Inc. and Subsidiary
Consolidated Statements of Operations
(unaudited)
Three Months Ended
March 31
---------------------------
2005 2004
------------ ------------
Interest income:
Interest and fees on loans $ 11,113,597 $ 8,386,121
Interest and dividends on investments and deposits 618,004 974,924
------------ ------------
Total interest income 11,731,601 9,361,045
Interest expense:
Interest on deposits 2,738,273 2,120,735
Interest on borrowings 89,370 38,821
Interest on junior subordinated notes 137,500 104,145
------------ ------------
Total interest expense 2,965,143 2,263,701
Net interest income before provision for loan losses 8,766,458 7,097,344
Provision for loan losses 638,000 --
------------ ------------
Net interest income 8,128,458 7,097,344
------------ ------------
Non-interest income:
Fees and service charges 1,382,381 1,513,423
Loan servicing fees 177,236 179,353
Gain on sale of real estate, net 19,063 1,501
Gain on sale of mortgage loans 93,653 146,838
Gain on sale of mortgage-backed securities -- 45,916
Other income 228,253 269,326
------------ ------------
Total non-interest income 1,900,586 2,156,357
------------ ------------
Non-interest expense:
Compensation and fringe benefits 2,954,538 2,976,149
Federal insurance premiums 22,025 21,655
Premises and equipment 426,459 402,280
Advertising 49,048 38,706
Payroll and other taxes 295,143 275,155
Data processing 520,212 529,960
Amortization of intangible assets 81,424 65,751
Other 623,837 555,671
------------ ------------
Total non-interest expense 4,972,686 4,865,327
------------ ------------
Income before income taxes 5,056,358 4,388,374
Income taxes 1,948,607 1,612,600
------------ ------------
Net income $ 3,107,751 $ 2,775,774
============ ============
Per share data:
Basic earnings per share $ 0.49 $ 0.44 *
Diluted earnings per share $ 0.47 $ 0.42 *
Dividends per share $ 0.20 $ 0.17 *
Weighted average shares Basic 6,308,746 6,281,980 *
Weighted average shares Diluted 6,604,422 6,625,951 *
(*) Adjusted for April 23, 2004 three-for-two stock split.
See Notes to Consolidated Financial Statements.
2
First South Bancorp, Inc. and Subsidiary
Consolidated Statement of Stockholders' Equity
Three Months Ended March 31, 2005
(unaudited)
Accumulated
Retained Other
Additional Earnings, Comprehensive
Common Paid-in Substantially Treasury Income,
Stock Capital Restricted Stock Net Total
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 2004 $ 62,647 $ 37,815,715 $ 50,597,651 $(29,653,794) $ 873,128 $ 59,695,347
Net income 3,107,751 3,107,751
Other comprehensive loss, net
of taxes (359,348) (359,348)
Exercise of stock options 655 (752,471) 1,119,972 368,156
Acquisition of treasury shares (3) (6,974) (6,977)
Shares traded to exercise options (83) 549,085 (214,478) 334,524
Dividends ($ .20 per share) (1,264,327) (1,264,327)
------------ ------------ ------------ ------------ ------------ ------------
Balance, March 31, 2005 $ 63,216 $ 37,612,329 $ 52,441,075 $(28,755,274) $ 513,780 $ 61,875,126
------------ ------------ ------------ ------------ ------------ ------------
See Notes to Consolidated Financial Statements.
3
First South Bancorp, Inc. and Subsidiary
Consolidated Statements of Cash Flows
(unaudited)
Three Months Ended
March 31
----------------------------
2005 2004
------------ ------------
Operating activities
Net income $ 3,107,751 $ 2,775,774
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for loan losses 638,000 --
Depreciation 205,076 173,443
Amortization of intangibles 81,424 42,338
Accretion of discounts on securities, net (14,317) (34,573)
Gain on disposal of premises and equipment and real estate owned (20,020) (1,501)
Gain on loans held for sale and mortgage-backed securities (93,653) (192,754)
Originations of loans held for sale, net (6,407,491) (8,240,038)
Proceeds from sale of loans held for sale 6,735,665 9,641,568
Other operating activities 4,739,254 1,648,036
------------ ------------
Net cash provided in operating activities 8,971,689 5,812,293
------------ ------------
Investing activities:
Proceeds from maturities of investment securities available for sale 6,000,000 --
Purchase of investment securities available for sale (2,948,438) --
Proceeds from principal repayments and sales of mortgage-backed
securities available for sale 446,690 2,177,704
Proceeds from principal repayments of mortgage-backed held for investment 128,106 --
Originations of loans held for investment, net of principal repayments (44,071,053) (25,228,201)
Proceeds from disposal of premises and equipment and real estate owned 55,230 11,662
(Purchase) sales of FHLB stock (66,500) 134,700
Purchases of premises and equipment (67,331) (178,076)
Repayment of note receivable 24,796 23,588
Net cash received in branch acquisition -- 15,771,621
------------ ------------
Net cash used in investing activities (40,498,500) (7,287,002)
------------ ------------
Financing activities:
Net increase in deposit accounts 40,300,858 298,480
Proceeds from FHLB borrowings 66,500,000 71,000,000
Repayments of FHLB borrowings (67,000,000) (60,000,000)
Purchase of treasury shares (6,977) (163,874)
Proceeds from exercise of stock options 702,680 56,650
Cash paid for dividends and fractional shares (1,070,483) (838,067)
Net change in repurchase agreements 1,433,066 602,755
------------ ------------
Net cash provided by financing activities 40,859,144 10,955,944
------------ ------------
Increase in cash and cash equivalents 9,332,333 9,481,235
Cash and cash equivalents, beginning of period 20,938,348 34,924,604
------------ ------------
Cash and cash equivalents, end of period $ 30,270,681 $ 44,405,839
============ ============
Supplemental disclosures:
Real estate acquired in settlement of loans $ 232,944 $ --
Dividends declared, not paid $ 1,264,327 $ 1,074,799
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 Company's common stock is traded on The Nasdaq National Market
under the symbol "FSBK".
Note 2. Basis of Presentation. The accompanying unaudited consolidated financial
statements have been prepared in accordance with accounting principles generally
accepted in the United States of America 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 accounting principles generally accepted in the United
States of America for complete financial statements and should be read in
conjunction with the consolidated financial statements and notes thereto in the
Company's Annual Report on Form 10-K for the year ended December 31, 2004. 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 month periods ended
March 31, 2005 are not necessarily indicative of the results of operations that
may be expected for the year ended December 31, 2005.
Note 3. Stock Split. On March 18, 2004 the Company declared a three-for-two
stock split, in the form of a 50% stock dividend, payable April 23, 2004 to
stockholders of record as of April 2, 2004. Stockholders received one additional
share of stock for every two shares held on the record date. Share and per share
data for the three months ended March 31, 2004 have been adjusted to reflect the
stock split.
Note 4. Allowance for Loan Losses. As of March 31, 2005 and December 31, 2004,
the Bank maintained an allowance for loan losses totaling $8.9 million and $8.3
million, respectively, representing a ratio of allowance for loan losses to
loans outstanding of 1.3% at each respective period end date.
Note 5. Earnings Per Share. Basic and diluted earnings per share for the three
month periods ended March 31, 2005 and 2004 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 6. 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 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 quarter ended March 31,
2005, 4,000 options were granted under the Plan. The weighted average remaining
contractual life of currently outstanding options under the Plan is 46 months.
At March 31, 2005, 711,209 options were outstanding, including 4,000 options
that were anti-dilutive, and 698,018 options were reserved for future issuance.
In addition, 365,306 options had been exercised under the 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
5
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 adjusted to the pro forma amounts indicated below.
Three Months Ended March 31, 2005 As Reported Pro Forma
- --------------------------------- ----------- ---------
Net income attributable to common shareholders $ 3,107,751 $ 3,088,125
Stock based compensation, before tax effect $ 0 $ 29,737
Net income per share - basic $ .49 $ .49
Net income per share - diluted $ .47 $ .47
Three Months Ended March 31, 2004 As Reported Pro Forma
- --------------------------------- ----------- ---------
Net income attributable to common shareholders $ 2,775,774 $ 2,753,811
Stock based compensation, before tax effect $ 0 $ 33,184
Net income per share - basic $ .44 $ .44
Net income per share - diluted $ .42 $ .42
Note 7. 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.
Unrealized gains and losses on available for sale securities is primarily
impacted by purchases and sales of available for sale securities and changes in
interest rates between the respective reporting periods. Information concerning
the Company's other comprehensive income for the three month periods ended March
31, 2005 and 2004 is as follows:
Three Months Ended
March 31,
2005 2004
------------ ------------
Net income $ 3,107,751 $ 2,775,774
Reclassify gain on sale of securities 0 (45,916)
Losses unrealized, net of taxes (359,348) (96,240)
------------ ------------
Other comprehensive loss (359,348) (142,156)
------------ ------------
Comprehensive income $ 2,748,403 $ 2,633,618
============ ============
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, 2005 and December 31, 2004
Total assets increased to $770.1 million at March 31, 2005 from $721.2 million
at December 31, 2004, reflecting a 27.1% annualized internal growth rate.
Earning assets increased to $714.9 million at March 31, 2005 from $676.0 million
at December 31, 2004, reflecting growth of the commercial and consumer loan
portfolio, as further discussed below. Earning assets were 93.8% of total assets
at March 31, 2005 compared to 93.7% at December 31, 2004.
6
Interest-bearing overnight deposits in financial institutions were $1.1 million
at March 31, 2005 and December 31, 2004, respectively. 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 $34.6 million
at March 31, 2005 and $38.7 million at December 31, 2004. The Bank's strategy is
to sell certain securities during favorable interest rate windows, and
securitize certain mortgage loans held for sale into mortgage-backed securities
in order to maintain its liquidity levels. The Bank sold no securities during
the three months ended March 31, 2005, compared to $1.5 million of securities
sold during the three months ended March 31, 2004. The Bank securitized no
mortgage loans into mortgage-backed securities during either the three months
ended March 31, 2005 or 2004. The mortgage-backed securities portfolio was $8.5
million at March 31, 2005 and to $9.2 million at December 31, 2004.
Loans held for sale were $5.7 million at March 31, 2005 and $6.0 million at
December 31, 2004. The sale of loans held for sale declined to $6.7 million
during the three months ended March 31, 2005, from $9.6 million sold during the
three months ended March 31, 2004, reflecting a slow down in origination and
refinancing volumes due to an increase in interest rates.
Net loans and leases held for investment increased to $669.1 million at March
31, 2005 from $625.9 million at December 31, 2004, reflecting a 27.6% annualized
net growth rate during the period. This growth reflects the Bank's continued
emphasis on structuring its loan portfolio as a commercial banking entity.
Deposits increased to $668.8 million at March 31, 2005 from $628.5 million at
December 31, 2004, primarily reflecting internal deposit growth. Checking
accounts increased to $247.7 million at March 31, 2005 from $236.3 million at
December 31, 2004, resulting from efforts to attract lower costing core checking
accounts. Time deposits increased to $396.9 million at March 31, 2005 from
$370.2 million at December 31, 2004, reflecting a successful deposit marketing
campaign.
FHLB advances and junior subordinated debentures used primarily to fund loan
originations and general banking operations were $20.3 million at March 31, 2005
and $20.8 million at December 31, 2004. Borrowings in the form of repurchase
agreements were $5.7 million at March 31, 2005 and $4.3 million at December 31,
2004. These borrowings represent funds held in cash management accounts for
commercial banking customers.
Stockholders' equity was $61.9 million at March 31, 2005, compared to $59.7
million at December 31, 2004. See "Consolidated Statement of Stockholders'
Equity" for additional information. At March 31, 2005, the Company's equity to
assets ratio was 8.0%, compared to 8.3% at December 31, 2004, primarily
reflecting the correlation of earnings growth generated by the growth in earning
assets as previously discussed and an increase in the quarterly cash dividend
discussed below.
Accumulated other comprehensive income declined to $514,000 at March 31, 2005
from $873,000 at December 31, 2004, reflecting a decline in the net market value
of the investment portfolio caused by a nominal rise in interest rates, as
previously discussed. See "Note 7. Comprehensive Income" of "Notes to
Consolidated Financial Statements (Unaudited)" above for additional information.
As a North Carolina chartered commercial bank, the Bank must meet various
capital standards required by federal and state banking regulatory agencies. The
Bank's stand-alone capital was $69.5 million at March 31, 2005, substantially in
excess of all regulatory capital requirements. See "Liquidity and Capital
Resources" below for additional information.
7
On March 24, 2005, the Company declared a cash dividend of $0.20 per share,
payable April 22, 2005 to stockholders of record as of April 4, 2005,
representing a 17.7% payment rate increase over the previous quarterly cash
dividend. This dividend payment represents a payout ratio of 40.8% of the basic
earnings per share for the quarter ended March 31, 2005, and is the Company's
thirty-second consecutive quarterly cash dividend.
During the three months ended March 31, 2005, the Company acquired 286 shares of
its common stock through private purchases pursuant to a stock repurchase plan
adopted by the board of directors. Shares acquired via the stock repurchase plan
are held as treasury stock, at cost. At March 31, 2005, the Company had
1,678,367 treasury shares held totaling $28.8 million, compared to 1,735,324
shares totaling $29.7 million held at December 31, 2004.
The Company believes the repurchase of its outstanding common stock will
decrease the potential dilutive effect caused by the exercise of stock options.
During the three months ended March 31, 2005, 65,515 shares were issued as a
result of the exercise of stock options, compared to 3,155 shares issued during
the three months ended March 31, 2004, adjusted to reflect the stock split.
Comparison of Operating Results - Three Months Ended March 31, 2005 and 2004
General. Net income for the three months ended March 31, 2005 and 2004 was $3.1
million and $2.8 million, respectively. Basic earnings per share were $0.49 for
the three months ended March 31, 2005, compared to $0.44 per share for the three
months ended March 31, 2004, adjusted for the stock split. Diluted earnings per
share were $0.47 for three month periods ended March 31, 2005 compared to $0.42
for three month periods ended March 31, 2004, adjusted for the stock split.
Core earnings during the three months ended March 31, 2005 were supported by
sustained growth in net interest income, reflecting growth in both the
commercial and consumer loan and leases receivable portfolio, and in lower
costing core checking accounts. During the three months ended March 31, 2005 the
Company had less dependence on gains from mortgage loan sales, as compared to
the three months ended March 31, 2004, which was an advantageous period for
selling loans due to a more favorable interest rate environment.
Interest Income. Interest income increased to $11.7 million for the three months
ended March 31, 2005, from $9.4 million for the three months ended March 31,
2004. This increase is due to the increase in the volume of average
interest-earning assets between the respective periods. Average interest-earning
assets were $693.0 million for the three months ended March 31, 2005, compared
to $624.4 million for the three months ended March 31, 2004, reflecting the
growth in loans and leases held for investment as previously discussed. The
yield on average interest-earning assets was 6.8% for the three months ended
March 31, 2005, compared to 6.0% for the three months ended March 31, 2004,
primarily impacted by an increase in interest rates between the respective
periods.
Interest Expense. Interest expense on deposits and borrowings was $3.0 million
for the three months ended March 31, 2005, compared to $2.3 million for the
three months ended March 31, 2004, reflecting the impact of changing interest
rates and the change in the core deposit mix as previously discussed. Average
deposits and borrowings were $674.2 million for the three months ended March 31,
2005, compared to $612.6 million for the three months ended March 31, 2004. The
effective cost of average deposits and borrowings was 1.8% for the three months
ended March 31, 2005, compared to 1.5% for the three months ended March 31,
2004.
8
Net Interest Income. Net interest income was $8.8 million for the three months
ended March 31, 2005, compared to $7.1 million for the three months ended March
31, 2004. The interest rate spread (the difference between the effective yield
on average earning assets and the effective cost of average deposits and
borrowings) was 5.0% for the three months ended March 31, 2005, compared to 4.5%
for the three months ended March 31, 2004. The net yield on interest-earning
assets (net interest income divided by average interest-earning assets) was 5.1%
for the three months ended March 31, 2005, compared to 4.6% for the three months
ended March 31, 2004.
Provision for Loan Losses. The Bank recorded $300,000 of general and $338,000 of
specific provisions for loan losses in the three months ended March 31, 2005,
compared to no provisions recorded in the three months ended March 31, 2004.
Provisions were necessary to support inherent losses and risk associated with
the growth in the Bank's loan portfolio. Provisions are charged to current
operations and the Bank believes the resulting reserve for loan losses is
adequate to absorb probable losses on loans. Additions to the reserve 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.
To support the risk associated with its loan portfolio, the Bank maintained
general and specific reserves for loan losses totaling $8.9 million at March 31,
2005, compared to $8.3 million at December 31, 2004. The ratio of reserves for
loan losses to loans outstanding, net of loans in process and deferred loan
fees, was 1.3% at March 31, 2005 and December 31, 2004, respectively.
Non-performing assets were $2.6 million at March 31, 2005 and $2.5 million at
December 31, 2004, as total loans and leases increased significantly between the
respective periods as previously discussed. Based on the credit quality of the
loan and lease portfolio, the Bank believes the current level of its reserves
for loan losses is adequate. However, future additions to the reserve for loan
losses may be necessary based on changes in economic conditions and other
economic factors.
Noninterest Income. Noninterest income declined to $1.9 million for the three
months ended March 31, 2005, from $2.2 million for the three months ended March
31, 2004. Noninterest income consists of fees, service charges and servicing
fees earned on loans, service charges on deposit accounts, gains from sales of
loans and mortgage-backed securities and other miscellaneous income. Fees and
service charges were $1.6 million for the three months ended March 31, 2005,
compared to $1.7 million for the three months ended March 31, 2004. The
collection of fees and service charges during the respective periods is
attributable to the volume of loan and deposit account transactions processed
during each period. The Bank recorded $94,000 of gains from sales of loans
during the three months ended March 31, 2005, compared to $147,000 during the
three months ended March 31, 2004, reflecting the general slow down in
origination and refinancing volumes due to a nominal rise in interest rates.
Noninterest Expense. Noninterest expenses were $5.0 million for the three months
ended March 31, 2005, compared to $4.9 million for the three months ended March
31, 2004. The largest component of these expenses, compensation and fringe
benefits, was $3.0 million for the three months ended March 31, 2005 and 2004,
respectively. This reflects efforts placed on controlling operating expenses
while the volume of loans and deposits accounts have increased, as previously
discussed.
Other noninterest expenses including premises and equipment, data processing,
repairs, advertising, payroll and other taxes and office supplies have grown
9
proportionately with the growth in earning assets, the number of customer
accounts and transaction activity, primarily attributable to internal growth
during the current period.
Income Taxes. Income tax expense was $1.9 million for the three months ended
March 31, 2005, compared to $1.6 million for the three months ended March 31,
2004. The changes in the amounts of income tax provisions reflect the changes in
pretax income at the estimated income tax rates in effect during the respective
periods.
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, as
actual results may differ materially from management's expectations.
Liquidity and Capital Resources. 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. The Bank must
maintain certain regulatory liquidity requirements of liquid assets to deposits
and short-term borrowings. At March 31, 2005, the Bank had cash, deposits in
banks, investment securities, mortgage-backed securities, FHLB stock and loans
held for sale totaling $75.0 million, compared to $70.0 million at December 31,
2004, representing 11.0% and 10.9% of deposits and short-term borrowings for the
respective periods. 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. In
addition, the Bank manages 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 North Carolina Office of the
Commissioner of Banks 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 regulatory capital requirements at March 31, 2005 and December 31,
2004.
10
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.
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 adjustments to 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 Arrangements. 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.
11
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.
Recent Accounting Pronouncements. In December 2004, the FASB issued SFAS No.
123(R), "Accounting for Stock-Based Compensation (SFAS No. 123(R))." SFAS No.
123(R) establishes standards for the accounting for transactions in which an
entity exchanges its equity instruments for goods or services. This Statement
focuses primarily on accounting for transactions in which an entity obtains
employee services in share-based payment transactions. SFAS No. 123(R) requires
that the fair value of such equity instruments be recognized as an expense in
the historical financial statements as services are performed. Prior to SFAS No.
123(R), only certain pro forma disclosures of fair value were required. This
Statement was amended on April 14, 2005 to make the provisions of this Statement
effective at the beginning of the next fiscal year that begins after June 15,
2005. Accordingly, we will adopt SFAS No. 123(R) on January 1, 2006. The
adoption of SFAS No. 123(R) is expected to have a material effect on the
Company's consolidated financial statements on an annualized basis.
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, 2004. The Company does not believe
that any material changes in market risk exposures occurred since December 31,
2004.
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 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.
12
In addition, there have been no changes in the Company's internal control over
financial reporting 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 l. 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. Unregistered Sales of Equity Securities and Use of Proceeds: The
following table sets forth information regarding the Company's repurchases of
its Common Stock during the quarter ended March 31, 2005.
Total Number
of Shares
Purchased Maximum
as Part of Number of Shares
Total Publicly that May Yet Be
Number of Average Announced Purchased Under
Shares Price Paid Plans or the Plans or
Period Purchased per Share Programs (1) Programs (1)
------ --------- --------- ------------ ------------
January 2005
Beginning date: January 1 0 0 0 150,000
Ending date: January 31
February 2005
Beginning date: February 1 286 $24.39 286 149,714
Ending date: February 28
March 2005
Beginning date: March 1 0 0 149,714
Ending date: March 31
--------------------
(1) Shares were purchased pursuant to a stock repurchase program
announced on January 10, 2005. This repurchase program will
expire on January 10, 2006
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: The following exhibits are filed herewith:
Exhibit
Number Title
- ------ -----
10.14 Change-in-Control Protective Agreement between First South Bank, First
South Bancorp, Inc. and Larry W. Mallard dated April 4, 2005
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
32 Section 1350 Certification
13
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FIRST SOUTH BANCORP, INC.
/s/ William L. Wall /s/ Kristie W. Hawkins
----------------------------- ----------------------
William L. Wall Kristie W. Hawkins
Executive Vice President Controller
Chief Financial Officer Treasurer
(Principal Financial Officer) (Principal Accounting Officer)
Date: May 9, 2005 Date: May 9, 2005
14