UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004 Commission File Number 0-22787
FOUR OAKS FINCORP, INC.
-----------------------
(Exact name of registrant as specified in its charter)
North Carolina 56-2028446
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(State or other jurisdiction of (IRS Employer Identification
incorporation or organization) Number)
6114 U.S. 301 South
Four Oaks, North Carolina
(Address of principal executive offices)
27524
(Zip Code)
Registrant's telephone number, including area code: (919) 963-2177
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Securities registered under Section 12(b)
of the Act: NONE Securities registered
under Section 12(g) of the Act:
Common Stock, par value $1.00 per share
(Title of Class)
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: |X| YES [ ] NO
Indicate by check mark whether disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. |X|
Check whether the registrant is an accelerated filer (as defined by Rule
12b-2 of the Act). [ ] YES |X| NO
$51,043,440
-----------
(Aggregate value of voting and non-voting common equity held by non-affiliates
of the registrant based on the price at which the registrant's Common Stock, par
value $1.00 per share was sold on June 30, 2004)
3,454,241
---------
(Number of shares of Common Stock, par value $1.00 per share, outstanding as of
March 7, 2005)
Documents Incorporated by Reference Where Incorporated
(1) Proxy Statement for the 2005 Annual Part III
Meeting of Shareholders to be held April 25, 2005
-1-
FORWARD-LOOKING INFORMATION
Information set forth in this Annual Report on Form 10-K under the
caption "Business" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contains various "forward looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
which statements represent our judgment concerning the future and are subject to
risks and uncertainties that could cause our actual operating results and
financial position to differ materially. Such forward looking statements can be
identified by the use of forward looking terminology, such as "may," "will,"
"expect," "anticipate," "estimate," or "continue" or the negative thereof or
other variations thereof or comparable terminology.
We caution that any such forward looking statements are further
qualified by important factors that could cause our actual operating results to
differ materially from those in the forward looking statements, including,
without limitation, the effects of future economic conditions, governmental
fiscal and monetary policies, legislative and regulatory changes, the risks of
changes in interest rates on the level and composition of deposits, the effects
of competition from other financial institutions, the failure of assumptions
underlying the establishment of the allowance for possible loan losses and the
low trading volume of our common stock.
PART I
ITEM 1 - BUSINESS.
On February 5, 1997, Four Oaks Bank & Trust Company (referred to herein
as the "bank") formed Four Oaks Fincorp, Inc. for the purpose of serving as a
holding company for the bank. Four Oaks Fincorp, Inc. has no significant assets
other than cash and the capital stock of the bank as well as $695,000 in
securities available for sale. Our corporate offices are located at 6114 US 301
South, Four Oaks, North Carolina 27524.
The bank was incorporated under the laws of the State of North Carolina
in 1912. The bank is a state-chartered member of the Federal Reserve System. In
Four Oaks, the main office is located at 6144 US 301 South and an additional
branch is located at 111 North Main Street. The bank also operates a branch
office in Clayton, North Carolina at 102 East Main Street, two in Smithfield,
North Carolina at 128 North Second Street, and 403 South Brightleaf Boulevard,
one in Garner, North Carolina at 200 Glen Road, one in Benson, North Carolina at
200 East Church Street, one in Fuquay-Varina, North Carolina at 325 North Judd
Parkway Northeast, one in Wallace, North Carolina at 406 East Main Street and
one in Holly Springs at 101 Avent Ferry Road, Holly Springs, North Carolina. On
January 10, 2005, the bank opened a new branch office at 590 Tomahawk Highway,
Harrells, North Carolina and a loan production office at 1100 South Horner
Boulevard, Sanford, North Carolina.
The bank is a community bank engaged in the general commercial banking
business in Johnston, Wake, Sampson and Duplin Counties, North Carolina.
Johnston County is contiguous to Wake, Wayne, Wilson, Harnett, Sampson and Nash
counties. Wake County is contiguous to Johnston, Durham, Harnett, Nash,
Franklin, Granville and Chatham counties. Sampson County is contiguous to
Duplin, Pender, Bladen, Harnett, Cumberland, Johnston, and Wayne counties.
Duplin County is contiguous to Pender, Sampson, Wayne, Lenoir, Jones and Onslow
counties.
As of December 31, 2004, we had assets of $398.5 million, net loans
outstanding of $308.8 million and deposits of $315.3 million. We have enjoyed
considerable growth over the past five (5) years as evidenced by the 72%
increase in assets, the 88% increase in net loans outstanding, and the 62%
increase in deposits since December 31, 1999.
The bank provides a full range of banking services, including such
services as checking accounts, savings accounts, individual retirement accounts,
NOW accounts, money market accounts, certificates of deposit, a student checking
and savings program; loans for businesses, agriculture, real estate, personal
uses, home improvement and automobiles; mortgage loans; equity lines of credit;
credit cards; safe deposit boxes; money orders; electronic funds transfer
services, including wire transfers; internet banking and bill pay services;
telephone banking; cashier's checks; traveler's checks; and free notary services
to all bank customers. The bank also provides financial services, offering a
complete line of insurance and investment services, including financial
strategies, mutual funds, annuities, insurance, stock brokerage, IRAs, discount
brokerage services, employee benefit plans, 401(k)'s and SEPs. In addition, the
bank provides worldwide automated teller machine access to its customers for
cash withdrawals through the services of the Star, Cirrus, or Visa networks by
using ATM or Visa check cards. The Visa check cards may also be used at merchant
locations worldwide through the Star, Cirrus, or Visa networks. In 2003, the
bank began issuing stored value cards which are marketed by independent sales
organizations and provide access to funds through the Visa, Plus, Interlink,
Mastercard, Maestro, Cirrus, and Star networks. At present, the bank does not
provide the services of a trust department.
2
The majority of the bank's customers are individuals and small to
medium-size businesses located in Johnston, Wake, and Duplin Counties and
surrounding areas. The deposits and loans are well diversified with no material
concentration in a single industry or group of related industries. There are no
seasonal factors that would have any material adverse effect on the bank's
business, and the bank does not rely on foreign sources of funds or income.
From its headquarters located in Four Oaks and its twelve locations in
Four Oaks, Clayton, Smithfield, Garner, Benson, Fuquay-Varina, Wallace, Holly
Springs, Harrells and a loan production office in Sanford, the bank serves a
major portion of Johnston County, part of Wake, Harnett, Duplin, Sampson and Lee
Counties. Johnston County has a diverse economy and is not dependent on any one
particular industry. The leading industries in the area include retail trade,
manufacturing, pharmaceuticals, government, services, construction, wholesale
trade and agriculture.
In an effort to offer a more diversified and competitive product line
to better serve our customers and community, we have discontinued our provision
of secondary market-type mortgages through the bank and, through a joint venture
with Centex Corporation, formed Four Oaks Mortgage Company, L.P. During 2003,
Four Oaks Mortgage Company, L.P. started providing secondary market-type
mortgages and will be the vehicle through which all of our mortgage and funding
business will be run going forward. Four Oaks Mortgage Company, L.P. is owned
49.99% by our wholly-owned subsidiary, Four Oaks Mortgage Services, L.L.C., and
50.01% by its general partner, CTX Mortgage Ventures, LLC, a wholly-owned
indirect subsidiary of Centex Corporation.
Amounts spent on research activities relating to the development or
improvement of services have been immaterial over the past two years. At
December 31, 2004, the bank employed 131 full time equivalent employees.
The following table sets forth certain of our financial data and ratios
for the years ended December 31, 2004, 2003, and 2002. This information should
be read in conjunction with and is qualified in its entirety by reference to the
more detailed audited financial statements and notes thereto included in this
report:
2004 2003 2002
-------- -------- --------
(In thousands, except ratios)
Net income $ 4,375 $ 2,918 $ 2,916
Average equity capital accounts $ 35,135 $ 32,341 $ 29,931
Ratio of net income to average equity capital accounts 12.45% 9.02% 9.74%
Average daily total deposits $295,524 $255,038 $242,878
Ratio of net income to average daily total deposits 1.48% 1.14% 1.20%
Average daily loans (gross) $298,783 $249,240 $216,620
Ratio of average daily loans to average
daily total deposits 101.10% 97.73% 89.19%
COMPETITION
Commercial banking in North Carolina is extremely competitive due in
large part to statewide branching. The bank competes in its market area with
some of the largest banking organizations in the state and the country and other
financial institutions, such as federally and state-chartered savings and loan
institutions and credit unions, as well as consumer finance companies, mortgage
companies and other lenders engaged in the business of extending credit. Many of
the bank's competitors have broader geographic markets and higher lending limits
than those of the bank and are also able to provide more services and make
greater use of media advertising.
The enactment of legislation authorizing interstate banking has caused
great increases in the size and financial resources of some of the bank's
competitors. In addition, as a result of interstate banking, out-of-state
commercial banks may acquire North Carolina banks and heighten the competition
among banks in North Carolina. See "Holding Company Regulation" below.
3
Despite the competition in its market areas, the bank believes that it
has certain competitive advantages that distinguish it from its competition. The
bank believes that its primary competitive advantages are its strong local
identity, its affiliation with the community and its emphasis on providing
specialized services to small and medium-sized business enterprises, as well as
professional and upper-income individuals. The bank offers customers modern,
high-tech banking without forsaking community values such as prompt, personal
service and friendliness. The bank offers many personalized services and
attracts and retains customers by being responsive and sensitive to their
individualized needs. The bank also relies on goodwill and referrals from our
shareholders and the bank's satisfied customers, as well as traditional media,
to attract new customers. To enhance a positive image in the community, the bank
supports and participates in local events, and its officers and directors serve
on boards of local civic and charitable organizations.
GOVERNMENTAL REGULATION
Holding companies, banks and many of their non-bank affiliates are
extensively regulated under both federal and state law. The following is a brief
summary of certain statutes, rules and regulations affecting us and the bank.
This summary is qualified in its entirety by reference to the particular
statutory and regulatory provisions referred to below and is not intended to be
an exhaustive description of the statutes or regulations applicable to our
business or the business of the bank. Supervision, regulation and examination of
us and the bank by bank regulatory agencies is intended primarily for the
protection of the bank's depositors rather than our shareholders.
HOLDING COMPANY REGULATION
GENERAL. We are a holding company registered with the Board of
Governors of the Federal Reserve System under the Bank Holding Company Act of
1956 (the "BHCA"). As such, we are subject to the supervision, examination and
reporting requirements contained in the BHCA and the regulation of the Federal
Reserve. The bank is also subject to the BHCA. The BHCA requires that a bank
holding company obtain the prior approval of the Federal Reserve before (i)
acquiring direct or indirect ownership or control of more than five percent of
the voting shares of any bank, (ii) taking any action that causes a bank to
become a subsidiary of the bank holding company, (iii) acquiring all or
substantially all of the assets of any bank or (iv) merging or consolidating
with any other bank holding company.
The BHCA generally prohibits a bank holding company, with certain
exceptions, from engaging in activities other than banking, or managing or
controlling banks or other permissible subsidiaries, and from acquiring or
retaining direct or indirect control of any company engaged in any activities
other than those activities determined by the Federal Reserve to be closely
related to banking, or managing or controlling banks, as to be a proper incident
thereto. In determining whether a particular activity is permissible, the
Federal Reserve must consider whether the performance of such an activity can
reasonably be expected to produce benefits to the public, such as greater
convenience, increased competition or gains in efficiency, that outweigh
possible adverse effects, such as undue concentration of resources, decreased or
unfair competition, conflicts of interest or unsound banking practices. For
example, banking, operating a thrift institution, extending credit or servicing
loans, leasing real or personal property, providing securities brokerage
services, providing certain data processing services, acting as agent or broker
in selling credit life insurance and certain other types of insurance
underwriting activities have all been determined by regulations of the Federal
Reserve to be permissible activities.
Pursuant to delegated authority, the Federal Reserve Bank of Richmond
has authority to approve certain activities of holding companies within its
district, including us, provided the nature of the activity has been approved by
the Federal Reserve. Despite prior approval, the Federal Reserve has the power
to order a holding company or its subsidiaries to terminate any activity or to
terminate its ownership or control of any subsidiary when it believes that
continuation of such activity or such ownership or control constitutes a serious
risk to the financial safety, soundness or stability of any bank subsidiary of
that bank holding company.
FINANCIAL HOLDING COMPANIES. The Gramm-Leach-Bliley Modernization Act
of 1999 (the "GLB"), which was enacted on November 12, 1999, allows bank holding
companies that meet certain new regulatory standards regarding management,
capital and the Community Reinvestment Act, to engage in a broader range of
non-banking activities than previously permissible, including insurance
underwriting and making merchant banking investments in commercial and financial
companies; allows insurers and other financial services companies to acquire
banks; removes various restrictions that applied to bank holding company
ownership of securities firms and mutual fund advisory companies; and
establishes the overall regulatory structure applicable to bank holding
companies that also engage in insurance and securities operations.
4
At the present time, we have elected to remain a bank holding company,
and therefore we remain subject to the same regulatory framework as before the
enactment of the GLB. However, the financial holding company structure created
by the GLB permits insurance companies or securities firms operating under the
financial holding company structure to acquire us, and, if we elect to become a
financial holding company in the future, we could acquire insurance companies or
securities firms.
In addition to creating the more flexible financial holding company
structure, the GLB introduced several additional customer privacy protections
that will apply to us and the bank. The GLB's privacy provisions require
financial institutions to, among other things, (i) establish and annually
disclose a privacy policy, (ii) give consumers the right to opt out of
disclosures to nonaffiliated third parties, with certain exceptions, (iii)
refuse to disclose consumer account information to third-party marketers and
(iv) follow regulatory standards to protect the security and confidentiality of
consumer information.
Pursuant to the GLB's rulemaking provisions, the Office of the
Comptroller of the Currency, the Board of Governors of the Federal Reserve
System, the Federal Deposit Insurance Corporation and the Office of Thrift
Supervision adopted regulations, establishing standards for safeguarding
customer information. Such regulations provide financial institutions guidance
in establishing and implementing administrative, technical and physical
safeguards to protect the security, confidentiality and integrity of customer
information.
MERGERS AND ACQUISITIONS. The Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 (the "IBBEA") permits interstate acquisitions
of banks and bank holding companies without geographic limitation, subject to
any state requirement that the bank has been organized for a minimum period of
time, not to exceed five (5) years, and the requirement that the bank holding
company, prior to or following the proposed acquisition, controls no more than
ten percent (10%) of the total amount of deposits of insured depository
institutions in the U.S. and no more than thirty percent (30%) of such deposits
in any state (or such lesser or greater amount set by state law).
In addition, the IBBEA permits a bank to merge with a bank in another
state as long as neither of the states has opted out of the IBBEA prior to May
31, 1997. In 1995, the state of North Carolina "opted in" to such legislation.
In addition, a bank may establish and operate a de novo branch in a state in
which the bank does not maintain a branch if that state expressly permits de
novo interstate branching. As a result of North Carolina having opted-in,
unrestricted interstate de novo branching is permitted in North Carolina.
ADDITIONAL RESTRICTIONS AND OVERSIGHT. Subsidiary banks of a bank
holding company are subject to certain restrictions imposed by the Federal
Reserve on any extensions of credit to the bank holding company or any of its
subsidiaries, investments in the stock or securities thereof and the acceptance
of such stock or securities as collateral for loans to any borrower. A bank
holding company and its subsidiaries are also prevented from engaging in certain
tie-in arrangements in connection with any extension of credit, lease or sale of
property or furnishing of services. An example of a prohibited tie-in would be
any arrangement that would condition the provision or cost of services on a
customer obtaining additional services from the bank holding company or any of
its other subsidiaries.
The Federal Reserve may issue cease and desist orders against bank
holding companies and non-bank subsidiaries to stop actions believed to present
a serious threat to a subsidiary bank. The Federal Reserve also regulates
certain debt obligations, changes in control of bank holding companies and
capital requirements.
Under the provisions of the North Carolina law, we are registered with
and subject to supervision by the North Carolina Commissioner of Banks.
CAPITAL REQUIREMENTS. The Federal Reserve has established risk-based
capital guidelines for bank holding companies and state member banks. The
minimum standard for the ratio of capital to risk-weighted assets (including
certain off balance sheet obligations, such as standby letters of credit) is
eight percent (8%). At least half of this capital must consist of common equity,
retained earnings and a limited amount of perpetual preferred stock and minority
interests in the equity accounts of consolidated subsidiaries, less goodwill
items and certain other items ("Tier 1 capital"). The remainder ("Tier 2
capital") may consist of mandatory convertible debt securities and a limited
amount of other preferred stock, subordinated debt and loan loss reserves.
5
In addition, the Federal Reserve has established minimum leverage ratio
guidelines for bank holding companies. These guidelines provide for a minimum
leverage ratio of Tier 1 capital to adjusted average quarterly assets less
certain amounts ("Leverage Ratio") equal to three percent for bank holding
companies that meet certain specified criteria, including having the highest
regulatory rating. All other bank holding companies will generally be required
to maintain a Leverage Ratio of between four percent and five percent.
The guidelines also provide that bank holding companies experiencing
significant growth, whether through internal expansion or acquisitions, will be
expected to maintain strong capital ratios substantially above the minimum
supervisory levels without significant reliance on intangible assets. The same
heightened requirements apply to bank holding companies with supervisory,
financial, operational or managerial weaknesses, as well as to other banking
institutions if warranted by particular circumstances or the institution's risk
profile. Furthermore, the guidelines indicate that the Federal Reserve will
continue to consider a "tangible Tier 1 Leverage Ratio" (deducting all
intangibles) in evaluating proposals for expansion or new activity. The Federal
Reserve has not advised us of any specific minimum Leverage Ratio or tangible
Tier 1 Leverage Ratio applicable to us.
As of December 31, 2004, we had Tier 1 risk-adjusted, total regulatory
capital and leverage capital of approximately 11.70%, 12.95% and 9.53%,
respectively, all in excess of the minimum requirements to be considered
well-capitalized under prompt corrective action provisions.
USA PATRIOT ACT OF 2001. Title III of the USA Patriot Act of 2001
contains the International Money Laundering Abatement and Financial
Anti-Terrorism Act of 2001 (the "IMLAFA"). The anti-money laundering provisions
of IMLAFA impose affirmative obligations on a broad range of financial
institutions, including banks, brokers, and dealers. Among other requirements,
IMLAFA requires all financial institutions to establish anti-money laundering
programs that include, at minimum, internal policies, procedures, and controls;
specific designation of an anti-money laundering compliance officer; ongoing
employee training programs; and an independent audit function to test the
anti-money laundering program. IMLAFA requires financial institutions that
establish, maintain, administer, or manage private banking accounts for
non-United States persons or their representatives to establish appropriate,
specific, and, where necessary, enhanced due diligence policies, procedures, and
controls designed to detect and report money laundering. Additionally, IMLAFA
provides for the Department of Treasury to issue minimum standards with respect
to customer identification at the time new accounts are opened. As of the date
of this filing, we believe that IMLAFA has not had a material impact on the
bank's operations. The bank has established policies and procedures to ensure
compliance with the IMLAFA, which are overseen by an Anti-Money Laundering
Officer who was appointed by our Board of Directors.
BANK REGULATION
The bank is subject to numerous state and federal statutes and
regulations that affect its business, activities, and operations, and is
supervised and examined by the North Carolina Commissioner of Banks and the
Federal Reserve. The Federal Reserve and the North Carolina Commissioner of
Banks regularly examine the operations of banks over which they exercise
jurisdiction. They have the authority to approve or disapprove the establishment
of branches, mergers, consolidations, and other similar corporate actions, and
to prevent the continuance or development of unsafe or unsound banking practices
and other violations of law. The Federal Reserve and the North Carolina
Commissioner of Banks regulate and monitor all areas of the operations of banks
and their subsidiaries, including loans, mortgages, issuances of securities,
capital adequacy, loss reserves, and compliance with the Community Reinvestment
Act of 1977 (the "CRA") as well as other laws and regulations. Interest and
certain other charges collected and contracted for by banks are also subject to
state usury laws and certain federal laws concerning interest rates.
The deposit accounts of the bank are insured by the Bank Insurance Fund
(the "BIF") of the Federal Deposit Insurance Corporation (the "FDIC") up to a
maximum of one hundred thousand dollars ($100,000) per insured depositor. Any
insured bank that is not operated in accordance with or does not conform to FDIC
regulations, policies, and directives may be sanctioned for noncompliance. Civil
and criminal proceedings may be instituted against any insured bank or any
director, officer or employee of such bank for the violation of applicable laws
and regulations, breaches of fiduciary duties or engaging in any unsafe or
unsound practice. The FDIC has the authority to terminate insurance of accounts
pursuant to procedures established for that purpose.
Under the North Carolina Business Corporation Act, we may not pay a
dividend or distribution, if after giving it effect, we would not be able to pay
our debts as they become due in the usual course of business or our total assets
would be less than our liabilities. In general, our ability to pay cash
dividends is dependent upon the amount of dividends paid to us by the bank. The
ability of the bank to pay dividends to us is subject to statutory and
regulatory restrictions on the payment of cash dividends, including the
requirement under the North Carolina banking laws that cash dividends be paid
only out of undivided profits and only if the bank has surplus of a specified
level. The Federal Reserve also imposes limits on the bank's payment of
dividends.
6
Like us, the bank is required by federal regulations to maintain
certain minimum capital levels. The levels required of the bank are the same as
those required of us. At December 31, 2004, the bank had Tier 1 risk-adjusted,
total regulatory capital and leverage capital of approximately 10.59%, 11.84%
and 8.63%, respectively, in excess of the minimum requirements to be considered
well-capitalized under prompt corrective action provisions.
The bank is subject to insurance assessments imposed by the FDIC,
including a risk-based assessment schedule providing for annual assessment rates
ranging from 0% to .27% of an institution's average assessment base, applicable
to institutions insured by both the BIF and the Savings Association Insurance
Fund ("SAIF"). The actual assessment to be paid by each insured institution is
based on the institution's assessment risk classification, which focuses on
whether the institution is considered "well capitalized, " "adequately
capitalized" or "under capitalized," as such terms are defined in the applicable
federal regulations. Within each of these three risk classifications, each
institution will be assigned to one of three subgroups based on supervisory risk
factors. In particular, regulators will assess supervisory risk based on whether
the institution is financially sound with only a few minor weaknesses (Subgroup
A), whether it has weaknesses which, if not corrected, could result in an
increased risk of loss to the BIF (Subgroup B) or whether such weaknesses pose a
substantial risk of loss to the BIF unless corrective action is taken (Subgroup
C). The FDIC also is authorized to impose one or more special assessments in an
amount deemed necessary to enable repayment of amounts borrowed by the FDIC from
the United States Treasury Department and, beginning in 1997, all banks are
required to pay additional annual assessments as set by the Financing
Corporation, which was established by the Competitive Equality Banking Act of
1987.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") provides for, among other things, (i) publicly available annual
financial condition and management reports for certain financial institutions,
including audits by independent accountants, (ii) the establishment of uniform
accounting standards by federal banking agencies, (iii) the establishment of a
"prompt corrective action" system of regulatory supervision and intervention,
based on capitalization levels, with greater scrutiny and restrictions placed on
depository institutions with lower levels of capital, (iv) additional grounds
for the appointment of a conservator or receiver and (v) restrictions or
prohibitions on accepting brokered deposits, except for institutions which
significantly exceed minimum capital requirements. FDICIA also provides for
increased funding of the FDIC insurance funds and the implementation of
risk-based premiums.
A central feature of FDICIA is the requirement that the federal banking
agencies take "prompt corrective action" with respect to depository institutions
that do not meet minimum capital requirements. Pursuant to FDICIA, the federal
bank regulatory authorities have adopted regulations setting forth a five-tiered
system for measuring the capital adequacy of the depository institutions that
they supervise. Under these regulations, a depository institution is classified
in one of the following capital categories: "well capitalized, " "adequately
capitalized," "under capitalized," "significantly undercapitalized," and
"critically undercapitalized. "An institution may be deemed by the regulators to
be in a capitalization category that is lower than is indicated by its actual
capital position if, among other things, it receives an unsatisfactory
examination rating with respect to asset quality, management, earnings or
liquidity. FDICIA provides the federal banking agencies with significantly
expanded powers to take enforcement action against institutions which fail to
comply with capital or other standards. Such action may include the termination
of deposit insurance by the FDIC or the appointment of a receiver or conservator
for the institution.
Banks are also subject to the CRA, which requires the appropriate
federal bank regulatory agency, in connection with its examination of a bank, to
assess such bank's record in meeting the credit needs of the community served by
that bank, including low and moderate-income neighborhoods. Each institution is
assigned one of the following four ratings of its record in meeting community
credit needs: "outstanding, " "satisfactory, " "needs to improve" or
"substantial noncompliance. " The regulatory agency's assessment of the bank's
record is made available to the public. Further, such assessment is required of
any bank which has applied to (i) charter a national bank, (ii) obtain deposit
insurance coverage for a newly chartered institution, (iii) establish a new
branch office that will accept deposits, (iv) relocate an office or (v) merge or
consolidate with, or acquire the assets or assume the liabilities of, a
federally regulated financial institution. In the case of a bank holding company
applying for approval to acquire a bank or other bank holding company, the
Federal Reserve will assess the record of each subsidiary bank of the applicant
bank holding company, and such records may be the basis for denying the
application.
7
In addition, the GLB's "CRA Sunshine Requirements" call for financial
institutions to disclose publicly certain written agreements made in fulfillment
of the CRA. Banks that are parties to such agreements also must report to
federal regulators the amount and use of any funds expended under such
agreements on an annual basis, along with such other information as regulators
may require. This annual reporting requirement is effective for any agreements
made after May 12, 2000.
MONETARY POLICY AND ECONOMIC CONTROLS
Both us and the bank are directly affected by governmental policies and
regulatory measures affecting the banking industry in general. Of primary
importance is the Federal Reserve Board, whose actions directly affect the money
supply which, in turn, affects banks' lending abilities by increasing or
decreasing the cost and availability of funds to banks. The Federal Reserve
Board regulates the availability of bank credit in order to combat recession and
curb inflationary pressures in the economy by open market operations in United
States government securities, changes in the discount rate on member bank
borrowings, changes in reserve requirements against bank deposits, and
limitations on interest rates that banks may pay on time and savings deposits.
Deregulation of interest rates paid by banks on deposits and the types
of deposits that may be offered by banks have eliminated minimum balance
requirements and rate ceilings on various types of time deposit accounts. The
effect of these specific actions and, in general, the deregulation of deposit
interest rates has generally increased banks' cost of funds and made them more
sensitive to fluctuations in money market rates. In view of the changing
conditions in the national economy and money markets, as well as the effect of
actions by monetary and fiscal authorities, no prediction can be made as to
possible future changes in interest rates, deposit levels, or loan demand on our
business and earnings or those of the bank. As a result, banks, including the
bank, face a significant challenge to maintain acceptable net interest margins.
OUR EXECUTIVE OFFICERS
The following table sets forth certain information with respect to our
executive officers:
POSITIONS AND OFFICES WITH FOUR OAKS
FINCORP, INC. AND FOUR OAKS BANK & TRUST
YEAR FIRST COMPANY AND BUSINESS EXPERIENCE DURING
NAME AGE EMPLOYED PAST FIVE (5) YEARS
- ---------------------------------------------------------------------------------------------------------------------------
Ayden R. Lee, Jr. 56 1980 Chief Executive Officer, President and Director
of Four Oaks Fincorp, Inc. and Four Oaks Bank
& Trust Company
Clifton L. Painter 55 1986 Senior Executive Vice President, Chief Operating
Officer of Four Oaks Fincorp, Inc. and Four Oaks
Bank & Trust Company
Nancy S. Wise 49 1991 Executive Vice President, Chief Financial Officer of
Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust
Company. Previously, Senior Vice President, Chief
Financial Officer of Four Oaks Fincorp, Inc. and Four
Oaks Bank & Trust Company
W. Leon Hiatt, III 37 1994 Executive Vice President of Four Oaks Fincorp, Inc. and
Four Oaks Bank & Trust Company, Chief Administrative
Officer of Four Oaks Bank & Trust Company.
Previously, Senior Vice President Four Oaks Fincorp,
Inc. and Four Oaks Bank & Trust Company, Loan
Administrator of Four Oaks Bank & Trust Company.
Jeff D. Pope 48 1991 Executive Vice President of Four Oaks Fincorp, Inc. and
Four Oaks Bank & Trust Company, Branch Administrator of
Four Oaks Bank & Trust Company. Previously, Senior
Vice President, Loan Officer and Regional/Branch
Administrator Four Oaks Bank and Trust Company
8
ITEM 2 - PROPERTIES.
The bank owns its main office, which is located at 6144 US 301 South,
Four Oaks, North Carolina. The main office, which was constructed by the bank in
1985, is a 12,000 square foot facility on 1.64 acres of land. The bank leases a
limited-service facility in downtown Four Oaks located at 111 North Main Street
from M.S. Canaday, who is one of our directors as well as a director of the
bank. Under the terms of the lease, which the bank believes to be arms-length,
the bank paid $908 per month in rent in 2004. The lease is month-to-month and we
review its terms on an annual basis. The bank also leases a branch office
located at 101 Avent Ferry Road, Holly Springs, North Carolina. Under the terms
of the lease, the bank will pay $2,166 per month for a period of five years. The
bank's Harrells office located at 590 Tomahawk Highway, Harrells, North Carolina
is under a lease with terms specifying the bank will pay $600 each month for the
period beginning January 1, 2006 and ending December 31, 2009. In addition, the
bank has entered into a yearly lease with an annual option to renew on its
Sanford office located at 1100 South Horner Boulevard, Sanford, North Carolina.
Under the terms of the lease, the bank will pay $1,300 each month. The bank owns
a 5,000 square foot facility renovated in 1992 on 1.15 acres of land located at
5987 US 301 South, Four Oaks, North Carolina which houses its training center.
The bank also owns a 15,000 square foot facility built in 2000 located at 6114
US 301 South, Four Oaks, North Carolina, which houses its administrative
offices, data operations, loan operations and wide area network central link. In
addition, the bank owns the following:
Location Year Built Present Function Square Feet
-------- ---------- ---------------- -----------
102 East Main Street
Clayton, North Carolina 1986 Branch Office 4,700
200 East Church Street
Benson, North Carolina 1987 Branch Office 2,000
128 North Second Street
Smithfield, North Carolina 1991 Branch Office 5,000
403 South Brightleaf Boulevard
Smithfield, North Carolina 1995 Limited-Service Facility 720
200 Glen Road
Garner, North Carolina 1996 Branch Office 3,600
325 North Judd Parkway Northeast
Fuquay-Varina, North Carolina 2002 Branch Office 8,900
406 East Main Street
Wallace, North Carolina 2003 Branch Office (modular) 2,800
Management believes each of the properties referenced above is adequately
covered by insurance.
ITEM 3 - LEGAL PROCEEDINGS.
We are not involved in any material legal proceedings at the present
time.
9
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
Item 5 - Market for Registrant's Common Equity, Related Shareholder Matters and
Issuer Purchases of Equity Securities.
Our common stock trades on the OTC Bulletin Board under the symbol
"FOFN." The range of high and low bid prices of our common stock for each
quarter during the two most recent fiscal years, as published by the OTC
Bulletin Board, is as follows (prices reflect inter-dealer prices, without
retail mark-up, mark-down or commissions and may not necessarily represent
actual transactions):
Fiscal Year Ended December 31,
-----------------------------------------------------------------
2003 2004
------------------------------- -----------------------------
High Low High Low
--------- ------------- ------------- -----------
First quarter $ 15.04 $ 14.11 $ 20.80 $ 16.80
Second quarter 15.36 14.43 19.60 17.60
Third quarter 14.72 14.08 18.40 17.60
Fourth quarter 20.80 14.40 25.00 18.60
As of March 7, 2005, the approximate number of holders of record of our
common stock was 1,400. We have no other class of equity securities. The bank's
ability to declare a dividend to us and our ability to pay dividends are subject
to the restrictions of the North Carolina Business Corporation Act. There also
are state banking laws that require a surplus of at least 50% of paid-in capital
stock be maintained in order for the bank to declare a dividend to us. Subject
to the legal availability of funds to pay dividends, cash dividends paid by us
in 2004 and 2003, after giving effect to the 5-for-4 stock split during 2004,
were $.32 and $.29 per share, respectively.
We did not sell any securities in 2004 that were not registered under
the Securities Act of 1933 as amended. We did not make any purchases of our
equity securities registered pursuant to Section 12 of the Securities Exchange
Act of 1934, as amended during the fourth quarter of 2004.
ITEM 6 - SELECTED FINANCIAL DATA
The following table sets forth our historical consolidated financial
data for the periods indicated. The selected historical annual consolidated
statement of operations and balance sheet data as of and for each of the five
fiscal years presented are derived from, and are qualified in their entirety by,
our consolidated financial statements. Historical results are not necessarily
indicative of the results to be expected in the future. You should read the
following data together with "Item 1. Business," "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
our consolidated financial statements and the related notes appearing in "Item
8. Financial Statements." (Dollars in thousands, except per share data).
10
AS OF AND FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------
2004 2003 2002 2001 2000
------------ ------------ ----------- ------------- -------------
OPERATING DATA:
Total interest income $ 21,748 $ 18,943 $ 19,785 $ 21,462 $ 20,808
Total interest expense 5,811 5,922 7,640 10,167 9,647
------------ ------------ ----------- ------------- -------------
Net interest income 15,937 13,021 12,145 11,295 11,161
Provision for loan losses 1,596 1,373 1,248 834 808
------------ ------------ ----------- ------------- -------------
Net interest income after provision for loan losses 14,341 11,648 10,897 10,461 10,353
Noninterest income 3,849 3,470 2,810 2,284 1,852
Noninterest expense 11,507 10,588 9,485 8,834 7,425
------------ ------------ ----------- ------------- -------------
Income before income taxes 6,683 4,530 4,222 3,911 4,780
Provision for income taxes 2,308 1,612 1,306 1,255 1,664
------------ ------------ ----------- ------------- -------------
Net income $ 4,375 $ 2,918 $ 2,916 $ 2,656 $ 3,116
============ ============ =========== ============= =============
PER SHARE DATA:
Earnings per share - basic $ 1.29 $ 0.87 $ 0.88 $ 0.81 $ 0.97
Earnings per share - diluted 1.28 0.86 0.87 0.81 0.96
Cash dividends declared 0.32 0.29 0.26 0.26 0.23
Market price
High 25.00 20.80 15.04 16.00 17.20
Low 16.80 14.08 13.12 11.52 11.09
Close 22.00 16.80 15.04 13.06 14.72
Book value 10.85 9.83 9.31 8.51 7.81
Weighted average shares outstanding
Basic 3,397,345 3,356,070 3,325,960 3,266,517 3,221,822
Diluted 3,416,680 3,368,041 3,336,866 3,283,683 3,237,491
SELECTED YEAR-END BALANCE SHEET DATA:
Total assets $ 398,500 $ 341,721 $ 318,289 299,970 258,329
Loans 312,815 272,623 229,570 209,822 194,497
Allowance for loan losses 4,055 3,430 2,860 2,650 2,770
Deposits 315,307 272,918 250,573 235,604 216,693
Borrowings 43,160 33,160 33,160 33,173 12,990
Shareholders' equity 37,295 32,880 31,193 28,025 25,348
SELECTED AVERAGE BALANCES:
Total assets $ 376,422 $ 324,222 308,334 274,054 241,165
Loans 298,783 249,240 216,620 202,500 182,874
Total interest-earning assets 349,596 300,672 290,294 256,476 226,191
Deposits 295,524 255,038 242,878 226,476 198,072
Total interest-bearing liabilities 282,743 244,024 236,661 208,381 183,135
Shareholders' Equity 35,135 32,341 29,931 27,306 23,550
SELECTED PERFORMANCE RATIOS:
Return on average assets 1.16% 0.90% 0.95% 0.97% 1.29%
Return on average equity 12.45% 9.02% 9.74% 9.73% 13.23%
Net interest spread 4.16% 3.87% 3.59% 3.49% 3.93%
Net interest margin 4.56% 4.33% 4.18% 4.40% 4.93%
Non-interest income to total revenue 19.45% 21.04% 18.79% 16.82% 14.23%
Non-interest income to average assets 1.02% 1.07% 0.91% 0.83% 0.77%
Non-interest expense to average assets 3.06% 3.27% 3.08% 3.22% 3.08%
Efficiency ratio 58.16% 64.20% 63.42% 65.06% 57.06%
Dividend payout ratio 24.81% 33.33% 29.55% 31.50% 23.84%
ASSET QUALITY RATIOS:
Nonperforming loans to period-end loans 0.30% 0.39% 0.67% 0.97% 0.85%
Allowance for loan losses to period-end loans 1.30% 1.26% 1.25% 1.26% 1.42%
Allowance for loan losses to nonperforming loans 429.56% 323.89% 186.08% 129.65% 167.47%
Nonperforming assets to total assets 0.34% 0.33% 0.62% 0.74% 0.67%
Net loan charge-offs to average loans 0.32% 0.32% 0.48% 0.47% 0.21%
11
AS OF AND FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------
2004 2003 2002 2001 2000
------------ ------------ ----------- ------------- -------------
CAPITAL RATIOS:
Total risk-based capital - Bank 11.80% 12.30% 14.00% 14.10% 12.86%
Tier 1 risk-based capital - Bank 10.60% 11.10% 12.80% 13.90% 13.70%
Leverage ratio - Bank 8.60% 9.00% 9.70% 9.50% 12.40%
Equity to assets ratio 9.33% 9.62% 9.80% 9.34% 9.81%
Equity to assets ratio (averages) 9.33% 9.97% 9.71% 9.96% 9.77%
Average interest-earning assets to average
total assets 92.87% 92.74% 94.15% 93.59% 93.79%
Average loans to average total deposits 101.10% 97.73% 89.19% 89.41% 92.33%
Average interest-bearing liabilities
to average interest-earning assets 80.88% 81.16% 81.52% 81.25% 80.96%
Other Data:
Number of banking offices 10 10 9 8 8
Number of full time equivalent employees 131 126 122 112 100
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis provides information about the
major components of our results of operations and financial condition, liquidity
and capital resources and should be read in conjunction with our Consolidated
Financial Statements and Notes thereto which are contained in this report.
Additional discussion and analysis related to fiscal 2004 is contained in our
Quarterly Reports on Form 10-Q for the fiscal quarters ended March 31, 2004,
June 30, 2004 and September 30, 2004, respectively.
OVERVIEW
We have experienced significant sustained growth in assets and deposits
over the last five years. Our assets have increased from $231.5 million at
December 31, 1999 to $398.5 million at December 31, 2004, while our total
deposits have increased from $194.7 million to $315.3 million over that same
period. In addition, for 69 consecutive years, we have paid dividends (of
course, prior to 1997 when we reorganized into a holding company, it was our
wholly owned subsidiary, Four Oaks Bank & Trust Company, which paid dividends).
For the past five years, dividends have averaged 25.6% of our average net
income.
We set interest rates on deposits and loans at competitive rates while
maintaining spreads of 4.16% and 3.87% in 2004 and 2003, respectively, between
interest earned on average loans and investments and interest paid on average
interest-bearing deposits and borrowings. Our gross loans have increased from
$166.6 million at December 31, 1999 to $312.8 million at December 31, 2004,
while our average net annual charge-offs over the same period were $831,000. The
sustained growth provided by operations resulted in increases in total assets of
16.6%, 7.4% and 6.1% for 2004, 2003 and 2002, respectively.
Our gross loans grew 14.7% and 18.8% in 2004 and 2003, respectively.
Our total investments (including interest-earning deposits and FHLB stock)
increased 29.0% in 2004 following a decrease of 31.9% in 2003, which the decline
was primarily due to the decision to build the portfolio as interest rates began
to rise. We closely monitor changes in the financial markets in order to
maximize the yield on our assets. The growth in loans for 2004 and 2003 was
funded by deposit growth of 15.5% and 8.9% in 2004 and 2003, net income of $4.4
million in 2004 and $2.9 million in 2003 and for the year 2003, a reduction of
lower yielding investments. Net income for 2004 was $4.4 million, an increase of
49.9% over 2003's net income of $2.9 million. This increase was primarily due to
an increase in net interest income. Strategic pricing of both loans and deposits
provided improvement in our net interest margin for 2004. Reduced overhead costs
resulting from the effects of cost containment initiatives begun in prior years
also improved net income in 2004.
During 2004 and 2003, Four Oaks Mortgage Company, L.P. provided
secondary market-type mortgages. Four Oaks Mortgage Company, L.P. is owned
49.99% by our wholly owned subsidiary, Four Oaks Mortgage Services, L.L.C., and
50.01% by its general partner, CTX Mortgage Ventures, LLC, a wholly owned
indirect subsidiary of Centex Corporation.
12
In December 2004, we added the Retail Real Estate Lending division
which will work with individuals, developers and contractors involved in real
estate acquisition and development.
Management historically has monitored and controlled increases in
overhead expenses while being committed to developing the skills and enhancing
the professionalism of our employees. Employee turnover has been minimal, while
the number of full-time equivalent employees has increased from 100 at December
31, 1999 to 131 at December 31, 2004.
RESULTS OF OPERATIONS
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2004 AND 2003
During 2004, our total assets increased by $56.8 million, or 16.6%,
from $341.7 million at December 31, 2003 to $398.5 million at December 31, 2004.
This increase in our total assets resulted primarily from growth in our net
loans, which increased from $269.2 million at December 31, 2003 to $308.8
million at December 31, 2004, an increase of $39.6 million. Additionally, our
securities portfolio increased $14.1 million to $52.3 million at December 31,
2004, and other assets increased $4.1 million in 2004 due to our investment in
bank-owned life insurance during the year of $3.2 million. The funding for our
loan growth, increases in our securities portfolio and investment in bank-owned
life insurance was primarily funded by considerable deposit growth of $42.4
million, or 15.5% during 2004 to $315.3 million at December 31, 2004 compared
with $272.9 million at December 31, 2003.
Shareholders' equity increased by $4.4 million during 2004. This
increase resulted from our net income of $4.4 million, dividend reinvestment
plan proceeds of $506,000 and proceeds from the exercise of stock options of
$924,000, net of repurchases of stock totaling $65,000, and dividends paid of
$1.1 million.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2003 AND 2002
During 2003, our total assets increased by $23.4 million, or 7.4%, from
$318.3 million at December 31, 2002 to $341.7 million at December 31, 2003. This
increase in our total assets resulted primarily from growth in our net loans,
which increased from $226.7 million at December 31, 2002 to $269.2 million at
the end of 2003, an increase of $42.5 million. Additionally, our other assets
increased $3.1 million in 2003 due to our investment in bank-owned life
insurance during the year of $2.9 million. These increases in our assets were
partially offset by the decrease during 2003 in our liquid assets, which
consists of cash and cash equivalents and investment securities, of $22.4
million. This decrease in our liquid assets resulted principally from the net
decrease in our securities portfolio during the year of $18.6 million. In
addition to the aforementioned use of our liquid assets, the funding for our
loan growth and investment in bank-owned life insurance came from deposits,
which increased by $22.3 million during 2003 to $272.9 million at December 31,
2003 compared with $250.6 million at December 31, 2002.
Shareholders' equity increased by $1.7 million during 2003 compared to
2002. This increase resulted from our net income of $2.9 million, dividend
reinvestment plan proceeds of $469,000 and proceeds from the exercise of stock
options of $300,000, net of repurchases of stock totaling $993,000, and
dividends paid of $952,000.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003
NET INCOME
We earned net income of $4.4 million or $1.29 basic net income per
share for 2004, which was a 49.9% increase over net income of $2.9 million, or
$.87 basic net income per share for 2003. We believe strategic pricing of both
our loans and deposits improved our net interest margin by lowering our overall
cost of funds and allowing us to attract the higher balance, higher quality
loans in our markets. Cost containment initiatives that began in prior years
continue to positively impact our overhead levels. We incurred only a moderate
increase in non-interest expense of 8.7% in 2004 over the prior year despite
expenses incurred in preparation of the opening of two new offices in January
2005. Non-interest expense increased 11.6% for the year 2003 over the prior year
when one new branch was opened and one branch was permanently relocated from
temporary quarters.
13
NET INTEREST INCOME
Like most financial institutions, the primary component of earnings for
the bank is net interest income. Net interest income is the difference between
interest income, principally from loan and investment securities, and interest
expense, principally on customer deposits and borrowings. Changes in net
interest income result from changes in volume, spread and margin. For this
purpose, volume refers to the average dollar level of interest-earning assets
and interest-bearing liabilities, spread refers to the difference between the
average yield on interest-earning assets and the average cost of
interest-bearing liabilities, and margin refers to net interest income divided
by average interest-earning assets. Margin is influenced by the level and
relative mix of interest-earning assets and interest-bearing liabilities, as
well as by levels of non-interest-bearing liabilities and capital.
Net interest income increased to $15.9 million in 2004, with a net
yield of 4.56%, compared to $13.0 million and a net yield of 4.33% in 2003,
which was an increase of $2.9 million or 23 basis points from 2003. Our level of
average interest-earning assets increased from $300.7 million for 2003 to $349.6
million for 2004. Although the average rate we earned on these assets dropped 8
basis points from 6.30% in 2003 to 6.22% in 2004, the average growth in volume
of earning assets, primarily loans, provided additional interest income of $3.4
million offsetting the $546,000 decrease due to decline in yields. Interest paid
on interest-bearing liabilities declined $111,000 for 2004 due to declines in
rates paid on interest-bearing funds. Our average interest-bearing liabilities,
primarily time deposits, grew 15.9% to $282.7 million for the year 2004
resulting in an increase in interest expense of $828,000. However, declines in
rates paid on interest-bearing funds provided a decrease in interest expense of
$939,000 primarily in time deposits where the average rates paid for time
deposits greater than $100,000 declined 56 basis points and other time deposits
declined 32 basis points. The growth in our non-interest-bearing demand deposits
of 22.9% also contributed to our increase in net interest income.
PROVISION FOR LOAN LOSSES AND ASSET QUALITY
Our provision for loan losses was $1.6 million during 2004 and $1.4
million during 2003. Net charge-offs in 2004 were $971,000 compared to $803,000
in 2003. This increase resulted primarily from the growth in our loan portfolio
during the year. The allowance for loan losses is maintained at a level deemed
adequate to absorb probable losses inherent in the loan portfolio and results
from management's consideration of such factors as the financial condition of
borrowers, past and expected loss experience, current economic conditions, and
other factors management feels deserve recognition in establishing an
appropriate reserve. Although management attempts to maintain the allowance at a
level deemed adequate, future additions to the allowance may be necessary based
upon changes in market conditions or the status of the loans included in the
loan portfolio. In addition, various regulatory agencies periodically review our
allowance for loan losses. These agencies may require us to make adjustments
based upon their judgments about information available to them at the time of
their examination.
Our non-performing assets, which consist of loans past due 90 days or
more, real estate acquired in the settlement of loans, and loans in nonaccrual
status, decreased from $1.8 million at December 31, 2003 to $1.6 million at
December 31, 2004. Our allowance for loan losses, expressed as a percentage of
gross loans, was 1.30% and 1.26% at December 31, 2004 and 2003, respectively. At
December 31, 2004, the allowance for loan losses amounted to $4.1 million, which
management believes is adequate to absorb losses inherent in its loan portfolio.
NON-INTEREST INCOME
Non-interest income increased 10.9% from $3.5 million during 2003 to
$3.8 million in 2004. Our non-interest income is comprised primarily of service
charges on deposit accounts, insurance commissions, gain or loss on sale of
investment securities, gain on sale of loans, merchant fees, bank-owned life
insurance income and various other sources of miscellaneous operating income.
The $379,000 increase in non-interest income from 2003 to 2004 primarily
resulted from increases in service charges on deposits accounts of $74,000,
merchant fees of $23,000, other service charges of $389,000 as well as increases
in income from bank-owned life insurance of $235,000 all of which were in part
offset by declines in net gains from sales of securities and loans. Our net
gains on sales of loans declined $140,000 in 2004 compared to the previous year.
The decline in loan sales was attributable to a slow down in funding of
government-backed loans, which generated net gains of $212,000 during 2003.
NON-INTEREST EXPENSE
Our non-interest expense increased from $10.6 million in 2003 to $11.5
million in 2004, an increase of $919,000. Approximately 48.9% of this increase
was due to increases in salaries and benefits. In addition to normal salary
increases and increased benefits costs, we opened two new offices in January
2005, incurring additional expense during the fourth quarter of 2004 in
preparation for these two new locations. Professional fees increased due to our
preparation for compliance with Section 404 of the Sarbanes-Oxley Act of 2002.
14
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002
NET INCOME
We earned net income of $2.9 million or $.87 basic net income per share
for 2003, as compared with net income of $2.9 million or $.88 basic net income
per share for 2002. We were able to maintain the level of our earnings despite
the challenges presented by the historically low rates during the year, which
fell to their lowest level in June 2003. We believe strategic pricing of both
our loans and deposits improved our net interest margin by lowering our overall
cost of funds and allowing us to attract the higher balance, higher quality
loans in our market. Cost containment initiatives that began in prior years
continue to positively impact our overhead levels. Despite opening one new
branch and permanently locating a branch opened in temporary quarters late in
2002, our non-interest expenses only increased 11.6% in 2003 as compared to
2002.
NET INTEREST INCOME
Net interest income increased to $13.0 million in 2003, compared to the
$12.1 million earned in 2002, an increase of $876,000. During 2003, our level of
average interest-earning assets increased from $290.3 million in 2002 to $300.7
million, but the average rate we earned on those assets dropped 52 basis points
from 6.82% in 2002 to 6.30% in 2003. This decrease in the average rate we earned
on our assets more than offset the effect of the increase in our average
interest earning assets during the year and resulted in the decrease in our
interest income of $842,000 in 2003. This decrease in our interest income,
however, was negated by the decrease in our interest expense during 2003. While
our average interest-bearing liabilities increased from $236.7 million in 2002
to $244.0 million in 2003, it is important to note that 16.1% of the increase in
deposits occurred in our money market and interest-bearing demand deposit
accounts, which have rates significantly less than our other types of
interest-bearing liabilities. The average rate we paid for our interest-bearing
liabilities during the year dropped 80 basis points during 2003 from 3.23% in
2002 to 2.43% in 2003, resulting in a decrease of $1.7 million in our total
interest expense in 2003. We also grew noninterest-bearing demand deposit
accounts by 18.7% in 2003 compared to 2002.
PROVISION FOR LOAN LOSSES AND ASSET QUALITY
Our provision for loan losses was $1.4 million during 2003 and $1.2
million in 2002. Loan charge-offs in 2003 and 2002 were $1.1 million and $1.2
million, respectively. This increase resulted primarily from the growth in our
loan portfolio during the year.
Our non-performing assets decreased from $2.1 million at December 31,
2002 to $1.8 million at December 31, 2003. Our allowance for loan losses,
expressed as a percentage of gross loans, was 1.26% and 1.25% at December 31,
2003 and 2002, respectively. At December 31, 2003, the allowance for loan losses
amounted to $3.4 million, which management believes is adequate to absorb losses
inherent in its loan portfolio.
NON-INTEREST INCOME
Non-interest income increased 23.5% from $2.8 million during 2002 to
$3.5 million in 2003. The $660,000 increase in non-interest income from 2002 to
2003 primarily resulted from increases in the net gains on sale of securities of
$281,000 and merchant fees of $115,000, as well as increases in income from
bank-owned life insurance of $159,000.
NON-INTEREST EXPENSE
Our non-interest expense increased from $9.5 million in 2002 to $10.6
million in 2003, an increase of $1.1 million. Approximately 64.5% of this
increase was due to salaries and benefits expenses. We opened one new office in
June of 2003. Another office which opened in temporary quarters late in 2002,
relocated to their permanent location in January 2003. These new locations
contributed to the increase in salaries and benefits and to the increase in our
occupancy and equipment expenses during 2003.
15
LIQUIDITY AND CAPITAL RESOURCES
Our liquidity position is primarily dependent upon the bank's need to
respond to loan demand, the short-term demand for funds caused by withdrawals
from deposit accounts (other than time deposits) and the liquidity of its
assets. The bank's primary liquidity sources include cash and amounts due from
other banks, federal funds sold, and U.S. Government Agency and other short-term
investment securities. In addition, the bank has the ability to borrow funds
from the Federal Reserve Bank and the Federal Home Loan Bank of Atlanta, to
purchase federal funds from other financial institutions and to obtain wholesale
deposits. Our management believes that our liquidity sources are adequate to
meet our operating needs and the operating needs of the bank for the next
eighteen months. Total shareholders' equity was $37.3 million or 9.4% of total
assets at December 31, 2004 and $32.9 million or 9.6% of total assets at
December 31, 2003.
INTEREST RATE SENSITIVITY ANALYSIS
As a part of our interest rate risk management policy, we periodically
perform an interest rate sensitivity analysis. Interest rate sensitivity
analysis is a common, though imperfect, measure of interest rate risk, which
measures the relative dollar amounts of interest-earning assets and
interest-bearing liabilities that reprice within a specific time period, either
through maturity or rate adjustment. Any resulting interest rate "gap" is the
difference between the amounts of such assets and liabilities that are subject
to repricing. A positive gap for a given period means that the amount of
interest-earning assets maturing or otherwise repricing within that period
exceeds the amount of interest-bearing liabilities maturing or otherwise
repricing within the same period. Accordingly, in a declining interest rate
environment, an institution with a positive gap would generally be expected,
absent the effects of other factors, to experience a decrease in the yield on
its assets greater than the decrease in the cost of its liabilities, and its net
interest income should be negatively affected. Conversely, the yield on its
assets for an institution with a positive gap would generally be expected to
increase more quickly than the cost of funds in a rising interest rate
environment, and such institution's net interest income generally would be
expected to be positively affected by rising interest rates. Changes in interest
rates generally have the opposite effect on an institution with a negative gap.
The table below sets forth the amounts of our interest-earning assets
and interest-bearing liabilities outstanding as of December 31, 2004 that are
projected to reprice or mature in each of the future time periods shown. Except
as stated below, the amounts of assets and liabilities shown which reprice or
mature within a particular period were determined in accordance with the
contractual terms of the assets or liabilities. Loans with adjustable rates are
shown as being due at the end of the next upcoming adjustment period. Money
market deposit accounts and negotiable order of withdrawal or other transaction
accounts are assumed to be subject to immediate repricing and depositor
availability and have been placed in the shortest period. In making the gap
computations, none of the traditional assumptions regarding prepayment rates and
deposit decay rates have been used for any interest-earning assets or
interest-bearing liabilities. In addition, the table does not reflect scheduled
principal payments that will be received throughout the lives of the loans or
investments. The interest rate sensitivity of our assets and liabilities
illustrated in the following table would vary substantially if different
assumptions were used or if actual experience differs from that indicated by
such assumptions. (Dollars in thousands).
16
INTEREST RATE SENSITIVITY AS OF DECEMBER 31, 2004
---------------------------------------------------------------
OVER
3 MONTHS 3 MONTHS TOTAL WITHIN OVER 12
OR LESS TO 12 MONTHS 12 MONTHS MONTHS TOTAL
--------- ------------- ----------- ---------- ----------
INTEREST-EARNING ASSETS:
Loans $227,741 $ 9,456 $237,197 $ 75,618 $312,815
Securities available for sale -- 926 926 51,416 52,342
Other earning assets 3,615 -- 3,615 2,621 6,236
-------- -------- -------- -------- --------
Total interest-earning assets $231,356 $ 10,382 $241,738 $129,655 $371,393
======== ======== ======== ======== ========
Percent of total interest-earning assets 62.74% 2.82% 65.55% 34.91% 100.00%
Cumulative percent of total interest-
earning assets 62.74% 65.55% 65.55% 100.00% 100.00%
INTEREST-BEARING LIABILITIES:
Fixed maturity deposits $ 54,684 $ 66,256 $120,940 $ 64,472 $185,412
All other deposits 70,367 -- 70,367 -- 70,367
Borrowings -- -- -- 43,160 43,160
-------- -------- -------- -------- --------
Total interest-bearing liabilities $125,051 $ 66,256 $191,307 $107,632 $298,939
======== ======== ======== ======== ========
Percent of total interest-bearing liabilities 41.83% 22.16% 64.00% 36.00% 100.00%
Cumulative percent of total interest-
bearing liabilities 41.83% 64.00% 64.00% 100.00% 100.00%
Interest sensitivity gap $106,305 $(55,874) $ 50,431 $ 22,023 $ 72,454
Cumulative interest sensitivity gap 106,305 50,431 50,431 72,454 72,454
Cumulative interest sensitivity gap as a
percent of total interest-earning assets 28.83% 13.68% 13.68% 19.51% 19.51%
Cumulative ratio of interest-sensitive assets
to interest-sensitive liabilities 185.01% 126.36% 126.36% 124.24% 124.24%
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
In the normal course of business there are various outstanding
contractual obligations that require future cash outflows. The following table
shows our expected contractual obligations and future operating lease
commitments as of December 31, 2004 (in thousands):
PAYMENTS DUE BY PERIOD
-------------------------------------------------------------------------
LESS THAN MORE THAN
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
------------ ------------ ------------ ------------- -------------
Borrowings $ 43,160 $ - $ 10,160 $ - $ 33,000
Operating leases 130 42 66 22 -
Deposits 185,412 120,940 33,453 5,017 26,002
Purchase obligations 650 650 - - -
------------ ------------ ------------ ------------- ------------
Total $ 229,352 $ 121,632 $ 43,679 $ 5,039 $ 59,002
============ ============ ============ ============= ============
The following table shows our undisbursed lines of credit, other
commitments to extend, undisbursed portion of construction loans and stand-by
letters of credit as of December 31, 2004 (in thousands):
AMOUNT OF COMMITMENT EXPIRATION PER PERIOD
-------------------------------------------------------------------------
LESS THAN MORE THAN
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
------------ ------------ ------------ ------------- -------------
Undisbursed lines of credit $ 21,221 $ 34 $ 6,851 $ 278 $ 14,058
Other commitments to extend 49,003 39,107 8,481 900 515
Undisbursed portion of construction loans 19,153 15,542 1,911 1,700 -
Stand-by letters of credit 1,726 823 870 33 -
------------ ------------ ------------ ------------- ------------
Total $ 91,103 $ 55,506 $ 18,113 $ 2,911 $ 14,573
============ ============ ============ ============= ============
17
INFLATION
The effect of inflation on financial institutions differs somewhat from
the effect it has on other businesses. The performances of banks, with assets
and liabilities that are primarily monetary in nature, are affected more by
changes in interest rates than by inflation. Interest rates generally increase
as the rate of inflation increases, but the magnitude of the change in rates may
not be the same. During periods of high inflation, there are normally
corresponding increases in the money supply, and banks will normally experience
above average growth in assets, loans and deposits. Also, general increases in
the price of goods and services will generally result in increased operating
expenses.
INCOME TAXES
Income taxes, as a percentage of income before income taxes, for 2004
and 2003 were 34.54% and 35.58%, respectively. The decrease was the result of
management's redirection of funds between loans and different types of taxable
and tax exempt interest-bearing assets in response to economic conditions and
the bank's liquidity requirements.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY;
INTEREST RATES AND INTEREST DIFFERENTIAL
The following schedule presents average balance sheet information for
the years 2004, 2003 and 2002, along with related interest earned and average
yields for interest-earning assets and the interest paid and average rates for
interest-bearing liabilities:
AVERAGE DAILY BALANCES, INTEREST INCOME/EXPENSE, AVERAGE YIELD/RATE
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------------------------
2004 2003 2002
------------------------ ------------------------------ ----------------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
-------- -------- ------ --------- -------- -------- -------- --------- -------
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Loans $298,783 $19,968 6.68% $249,240 $17,318 6.95% $216,620 $16,746 7.73%
Investment securities - taxable 40,729 1,470 3.61% 40,691 1,272 3.13% 52,348 2,482 4.74%
Investment securities - tax-exempt 4,278 162 3.79% 4,968 212 4.27% 4,716 213 4.52%
Other 5,806 148 2.55% 5,773 141 2.44% 16,610 344 2.07%
-------- ------- -------- ------- -------- -------
Total interest-earning assets 349,596 21,748 6.22% 300,672 18,943 6.30% 290,294 19,785 6.82%
------- ---- ------- ------- ------- ------
Other assets 26,826 23,550 18,040
-------- -------- --------
Total assets $376,422 $324,222 $308,334
======== ======== ========
Interest-bearing liabilities:
Deposits:
NOW and money market $ 52,677 361 .69% $39,313 238 .61% $ 32,431 302 .93%
Savings 13,967 59 .42% 12,659 63 .50% 11,427 124 1.09%
Time deposits greater
than $100,000 94,313 1,978 2.10% 70,567 1,878 2.66% 70,543 2,541 3.60%
Other time deposits 78,987 1,725 2.18% 87,285 2,186 2.50% 89,100 3,136 3.52%
Borrowings 42,799 1,688 3.94% 34,200 1,557 4.55% 33,160 1,537 4.64%
-------- ------- -------- ------- -------- -------
Total interest-bearing
liabilities 282,743 5,811 2.06% 244,024 5,922 2.43% 236,661 7,640 3.23%
------- ---- ------- ------- ------- ------
Non-interest-bearing deposits 55,580 45,214 39,377
Other liabilities 2,964 2,643 2,365
Shareholders' equity 35,135 32,341 29,931
-------- -------- --------
Total liabilities and
shareholders' equity $376,422 $324,222 $308,334
======== ======== ========
Net interest income and
interest rate spread $ 15,937 4.16% $13,021 3.87% $12,145 3.59%
========= ==== ======= ======= ======= ======
Net yield on average interest-
earning assets 4.56% 4.33% 4.18%
==== ======= ======
Ratio of average interest-earning
assets to average interest-bearing
liabilities 123.64% 123.21% 122.66%
======== ======== ========
18
The following table shows changes in interest income and expense by
category and rate/volume variances for the years ended December 31, 2004 and
2003. The changes due to rate and volume were allocated on their absolute
values:
YEAR ENDED YEAR ENDED
DECEMBER 31, 2004 VS. 2003 DECEMBER 31, 2003 VS. 2002
----------------------------- ------------------------------
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
----------------------------- ------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------- ---- ------ ------ ---- -----
(IN THOUSANDS)
Interest income:
Loans $ 3,377 $(727) $ 2,650 $ 2,394 $(1,822) $ 572
Investment securities - taxable 1 197 198 (459) (751) (1,210)
Investment securities - tax-exempt (28) (22) (50) 11 (12) (1)
Other 1 6 7 (245) 42 (203)
------- ----- ------- ------- ------- --------
Total interest income 3,351 (546) 2,805 1,701 (2,543) (842)
------- ----- ------- ------- ------- --------
Interest expense:
Deposits:
NOW and money market 86 37 123 53 (117) (64)
Savings 6 (10) (4) 10 (71) (61)
Time deposits greater
than $100,000 566 (466) 100 1 (664) (663)
Other time deposits (195) (266) (461) (55) (895) (950)
Borrowings 365 (234) 131 48 (28) 20
------- ----- ------- ------- ------- --------
Total interest expense 828 (939) (111) 57 (1,775) (1,718)
------- ----- ------- ------- ------- --------
Net interest income increase
(decrease) $ 2,523 $ 393 $ 2,916 $ 1,644 $ (768) $ 876
======= ===== ======= ======= ======= ========
Market Risk
Like most financial institutions, our most significant market risk
exposure is the risk of economic loss resulting from adverse changes in market
price and interest rates. This risk of loss can be reflected in diminished
current market values and/or reduced potential net interest income in future
periods. Our market risk arises primarily from interest rate risk inherent in
our lending and deposit-taking activities. The structure of our loan and deposit
portfolios is such that a significant decline in interest rates may adversely
impact net market values and net interest income. We do not maintain a trading
account nor are we subject to currency exchange risk or commodity price risk.
Interest rate risk is monitored as part of the bank's asset/liability management
function. The following table presents information about the contractual
maturities, average interest rates and estimated fair values of our financial
instruments we considered market risk sensitive as of December 31, 2004.
(Dollars in thousands).
AVERAGE
BEYOND INTEREST ESTIMATED
2005 2006 2007 2008 2009 FIVE YEARS TOTAL RATE FAIR VALUE
--------- -------- -------- -------- -------- ---------- --------- -------- ----------
Financial assets:
Loans:
Fixed rate $ 18,372 $ 10,396 $ 15,232 $ 20,398 $ 16,081 $ 13,511 $ 93,990 7.35% $ 93,976
Variable Rate 218,825 - - - - - 218,825 5.79% 218,792
Securities available
for sale 926 - 5,963 10,973 5,840 28,640 52,342 3.89% 52,342
Other earning assets 3,615 - - - - - 3,615 2.10% 3,615
--------- -------- -------- -------- -------- -------- --------- ---------
Total $ 241,738 $ 10,396 $ 21,195 $ 31,371 $ 21,921 $ 42,151 $ 368,772 5.88% $ 368,725
========= ======== ======== ======== ======== ======== ========= =========
Financial liabilities:
Money market, NOW and
savings deposits $ 70,367 - - - - - $ 70,367 0.39% $ 63,959
Time deposits 120,940 $ 13,490 $ 13,754 $ 6,209 $ 20,019 $ 11,000 185,412 2.54% 186,314
Borrowings - 10,160 - - - 33,000 43,160 3.87% 41,651
--------- -------- -------- -------- -------- -------- --------- ---------
Total $ 191,307 $ 23,650 $ 13,754 $ 6,209 $ 20,019 $ 44,000 $ 298,939 2.23% $ 291,924
========= ======== ======== ======== ======== ======== ========= =========
19
Derivative Financial Instruments
A derivative is a financial instrument that derives its cash flows, and
therefore its value, by reference to an underlying instrument, index or
reference rate. These instruments primarily consist of interest rate swaps,
caps, floors, financial forward and futures contracts and options written or
purchased. Derivative contracts are written in amounts referred to as notional
amounts. Notional amounts only provide the basis for calculating payments
between counterparties and do not represent amounts to be exchanged between
parties and are not a measure of financial risks. Credit risk arises when
amounts receivable from a counterparty exceed amounts payable. We control our
risk of loss on derivative contracts by subjecting counterparties to credit
reviews and approvals similar to those used in making loans and other extensions
of credit.
We have used interest rate swaps in the management of interest rate
risk. Interest rate swaps are contractual agreements between two parties to
exchange a series of cash flows representing interest payments. A swap allows
both parties to alter the repricing characteristics of assets or liabilities
without affecting the underlying principal positions. Through the use of a swap,
assets and liabilities may be transformed from fixed to floating rates, from
floating rates to fixed rates, or from one type of floating rate to another. At
December 31, 2004, swap derivatives with a total notional value of $51.0
million, with terms ranging up to six years, were outstanding.
Although off-balance sheet derivative financial instruments do not
expose us to credit risk equal to the notional amount, such agreements generate
credit risk to the extent of the fair value gain in an off-balance sheet
derivative financial instrument if the counterparty fails to perform. We
minimize such risk by evaluating the creditworthiness of the counterparties and
consistently monitoring these agreements. The counterparties to these
arrangements are primarily large commercial banks and investment banks. Where
appropriate, master netting agreements are arranged or collateral is obtained in
the form of rights to securities. At December 31, 2004, our interest rate swaps
reflected a net unrealized loss of $213,000.
Other risks associated with interest-sensitive derivatives include the
effect on fixed rate positions during periods of changing interest rates.
Indexed amortizing swaps' notional amounts and maturities change based on
certain interest rate indices. Generally, as rates fall the notional amounts
decline more rapidly, and as rates increase notional amounts decline more
slowly. As of December 31, 2004, we had no indexed amortizing swaps outstanding.
Under unusual circumstances, financial derivatives also increase liquidity risk,
which could result from an environment of rising interest rates in which
derivatives produce negative cash flows while being offset by increased cash
flows from variable rate loans. We consider such risk to be insignificant due to
the relatively small derivative positions we hold.
A discussion of derivatives is presented in Note I to our consolidated
financial statements, which are presented under Item 8 in this Form 10-K.
QUARTERLY FINANCIAL INFORMATION
The following table, sets forth, for the periods indicated, certain of
our consolidated quarterly financial information. This information is derived
from our unaudited financial statements, which include, in the opinion of
management, all normal recurring adjustments which management considers
necessary for a fair presentation of the results for such periods. This
information should be read in conjunction with our consolidated financial
statements included elsewhere in this report. The results for any quarter are
not necessarily indicative of results for any future period. (Dollars in
thousands, except per share data).
20
YEAR ENDED DECEMBER 31, 2004 YEAR ENDED DECEMBER 31, 2003
-------------------------------------- -------------------------------------
FOURTH THIRD SECOND FIRST FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- ------- ------- ------- ------- -------
OPERATING DATA:
Total interest income $5,856 $5,609 $5,215 $5,068 $4,954 $4,685 $4,690 $4,614
Total interest expense 1,567 1,505 1,401 1,338 1,345 1,411 1,511 1,655
-------- -------- -------- ------- ------- ------- ------- -------
Net interest income 4,289 4,104 3,814 3,730 3,609 3,274 3,179 2,959
Provision for loan losses 205 401 422 568 322 285 423 343
-------- -------- -------- ------- ------- ------- ------- -------
Net interest income after provision 4,084 3,703 3,392 3,162 3,287 2,989 2,756 2,616
Non-interest income 938 1,071 982 858 798 951 860 861
Non-interest expense 3,068 2,789 2,860 2,790 2,628 2,661 2,753 2,546
-------- -------- -------- ------- ------- ------- ------- -------
Income before income taxes 1,954 1,985 1,514 1,230 1,457 1,279 863 931
Provision for income taxes 691 654 532 431 547 517 245 303
-------- -------- -------- ------- ------- ------- ------- -------
Net income $1,263 $1,331 $ 982 $ 799 $ 910 $ 762 $ 618 $ 628
======== ======== ======== ======= ======= ======= ======= =======
PER SHARE DATA:
Net income:
Basic $ 0.37 $ 0.39 $ 0.29 $ 0.24 $ 0.27 $ 0.23 $ 0.18 $ 0.19
Diluted 0.37 0.39 0.28 0.24 $ 0.27 $ 0.22 $ 0.18 $ 0.19
Cash dividends declared 0.08 0.08 0.08 0.08 0.08 0.07 0.07 0.07
Common stock price:
High $25.00 $18.40 $19.60 $20.80 $20.80 $14.72 $15.36 $15.04
Low 18.60 17.60 17.60 16.80 14.40 14.08 14.43 14.11
INVESTMENT PORTFOLIO
The valuations of investment securities at December 31, 2004, 2003 and
2002, respectively, were as follows (in thousands):
AVAILABLE FOR SALE
--------------------------------------------------------------------------------
2004 2003 2002
------------------------ ------------------------- --------------------------
AMORTIZED ESTIMATED AMORTIZED ESTIMATED AMORTIZED ESTIMATED
COST FAIR VALUE COST FAIR VALUE COST FAIR VALUE
----------- ---------- ----------- ----------- ----------- ------------
U.S. Government and agency
securities $ 34,991 $ 34,958 $ 15,866 $ 15,914 $ 27,147 $ 27,361
State and municipal securities 3,573 3,632 4,664 4,955 4,616 4,860
Mortgage-backed securities 12,759 12,775 16,535 16,502 23,671 23,933
Other 628 977 567 832 552 635
----------- ---------- ----------- ----------- ----------- ------------
Total securities $ 51,951 $ 52,342 $ 37,632 $ 38,203 $ 55,986 $ 56,789
=========== ========== =========== =========== =========== ============
Pledged securities $ 33,408 $ 12,329 $ 15,339
========== =========== ============
The following table sets forth the carrying value of our available for
sale investment portfolio at December 31, 2004 (in thousands):
CARRYING VALUE
-----------------------------------------------------------------------
AFTER 1 YEAR AFTER 5 YEARS
THROUGH THROUGH AFTER
1 YEAR 5 YEARS 10 YEARS 10 YEARS TOTAL
--------- ------------ --------------- ----------- ---------
U.S. Government and Agency
securities $ - $ 20,251 $ 14,707 $ - $34,958
State and municipal securities - 134 2,390 1,108 3,632
Mortgage-backed securities - 2,388 7,968 2,419 12,775
Other - - - 977 977
--------- -------- -------- ------- -------
Total $ - $ 22,773 $ 25,065 $ 4,504 $52,342
========= ======== ======== ======= =======
21
The following table sets forth the weighted average yield by maturity
of our available for sale investment portfolio at December 31, 2004:
WEIGHTED AVERAGE YIELDS
-----------------------------------------------------------------------
AFTER 1 YEAR AFTER 5 YEARS
THROUGH THROUGH AFTER
1 YEAR 5 YEARS 10 YEARS 10 YEARS TOTAL
--------- ------------ --------------- ----------- ---------
U.S. Government and agency
securities - 3.66% 3.90% - 3.76%
State and municipal securities - 4.76% 3.65% 3.94% 3.78%
Mortgage-backed securities - 3.51% 3.76% 4.57% 3.87%
Other - - - 3.48% 3.48%
--------- -------- --------------- ----------- ---------
Total weighted average yields - 3.65% 3.83% 4.18% 3.78%
========= ======== =============== =========== =========
LOAN PORTFOLIO
Loans consisted of the following, as extracted from the Call Reports of
December 31, 2004, 2003, 2002, 2001 and 2000 (in thousands):
2004 2003 2002 2001 2000
--------- --------- --------- ------- -------
Loans receivable:
Loans secured by real estate:
Construction and land development $ 90,742 $ 66,242 $ 56,780 $44,770 $35,751
Secured by farmland 15,203 13,384 8,290 7,171 7,576
Secured by 1-4 family residential
properties:
Revolving open-end loans & lines
of credit 23,295 18,879 16,569 14,603 12,394
All other 58,158 55,113 43,821 48,190 48,589
Secured by multifamily residential
properties 5,088 3,634 3,265 2,621 1,170
Secured by nonfarm nonresidential
properties 72,611 63,372 42,941 38,446 31,300
Loans to finance agricultural production
and other loans to farmers 4,020 5,084 6,277 6,329 5,954
Commercial and industrial loans 26,005 27,872 29,908 26,420 30,344
Loans to individuals for household,
family and other personal expenditures:
Credit cards and related plans 3,807 3,574 3,527 2,917 2,354
Other 13,400 14,458 17,177 17,169 18,120
Obligations of states and political
subdivisions in the U.S.:
Tax exempt obligations 225 332 -- 202 280
All other loans 628 836 921 953 712
Lease financing receivables 12 13 14 20 33
Deferred cost (unearned income) on loans 379 170 (80) (11) 80
--------- --------- --------- ---------- ---------
Total loans 312,815 272,623 229,570 209,822 194,497
Allowance for loan losses (4,055) (3,430) (2,860) (2,650) (2,770)
--------- --------- --------- ---------- ---------
Net loans $ 308,760 $ 269,193 $ 226,710 $207,172 $ 191,727
========= ========= ========= ========== =========
Commitments and contingencies:
Commitments to make loans $ 89,377 $ 68,731 $ 44,525 $ 45,510 $ 35,810
Standby letters of credit $ 1,726 $ 1,003 $ 2,408 $ 653 $ 1,473
22
CERTAIN LOAN MATURITIES
The maturities and carrying amounts of certain loans as of December 31,
2004 are summarized as follows (in thousands):
REAL ESTATE
COMMERCIAL CONSTRUCTION
FINANCIAL AND AND LAND
AGRICULTURAL DEVELOPMENT TOTAL
-------------- ------------- ---------
Due within one year $ 30,424 $67,898 $98,322
Due after one year to five years:
Fixed rate 19,570 4,938 24,508
Variable rate 60,521 12,497 73,018
Due after five years:
Fixed rate 771 370 1,141
Variable rate 6,156 5,039 11,195
-------- ------- --------
Total $117,442 $90,742 $208,184
======== ======= ========
RISK ELEMENTS
Past due and nonaccrual loans, as extracted from the Call Reports of
December 31, 2004, 2003, 2002, 2001 and 2000 were as follows (in thousands):
2004 2003 2002 2001 2000
------ ------ ------ ------ ------
Nonaccrual loans:
Real estate loans $ 614 $ 739 $1,059 $1,651 $1,150
Installment loans 80 96 191 62 445
Commercial and all other loans 250 224 287 331 59
------ ------ ------ ------ ------
Total $ 944 $1,059 $1,537 $2,044 $1,654
====== ====== ====== ====== ======
Agricultural loans included above $ 197 $ 110 $ 163 $ 82 $ 10
====== ====== ====== ====== ======
Past due 90 days or more and
still accruing:
Real estate loans $ 188 $ 597 $ -- $ 24 $ 367
Installment loans 1 5 36 19 21
Credit cards and related plans 11 18 17 9 22
Commercial and all other loans 26 15 30 65 --
------ ------ ------ ------ ------
Total $ 226 $ 635 $ 83 $ 117 $ 410
====== ====== ====== ====== ======
Agricultural loans included above $ 26 $ -- $ 17 $ 65 $ --
====== ====== ====== ====== ======
Foreclosed assets (included in other assets) were $404,000, $75,000,
$442,000, $170,000, and $85,000 at December 31, 2004, 2003, 2002, 2001 and 2000,
respectively.
Allowance for Loan Losses and Summary of Loan Loss Experience
As a matter of policy, the bank maintains an allowance for loan losses.
The allowance for loan losses is created by direct charges to income, and losses
on loans are charged against the allowance when realized. The amount of the
allowance is based on management's evaluation of the portfolio, the financial
condition of borrowers, current economic conditions, past and expected loan loss
experience, and other factors management deems appropriate. The bank's
management believes its allowance for loan losses is adequate under existing
economic conditions to absorb loan losses inherent in its loan portfolio.
23
The following table summarizes the bank's loan loss experience for the
years ending December 31, 2004, 2003, 2002, 2001 and 2000 (in thousands, except
ratios):
2004 2003 2002 2001 2000
------- ------- ------ ------- ------
Balance at beginning of period $3,430 $2,860 $2,650 $2,770 $2,350
Charge-offs:
Commercial and other 417 311 604 668 192
Real estate 395 342 240 174 39
Installment loans to individuals 237 396 283 176 240
Credit cards and related plans 297 88 72 60 75
------- ------- ------ ------- ------
1,346 1,137 1,199 1,078 546
------- ------- ------ ------- ------
Recoveries:
Commercial and other 206 31 74 38 32
Real estate 27 134 13 24 12
Installment loans 56 159 62 53 97
Credit cards and related plans 86 10 12 9 17
------- ------- ------ ------- ------
375 334 161 124 158
------- ------- ------ ------- ------
Net charge-offs 971 803 1,038 954 388
------- ------- ------ ------- ------
Additions charged to operations 1,596 1,373 1,248 834 808
------- ------- ------ ------- ------
Balance at end of year $4,055 $3,430 $2,860 $2,650 $2,770
======= ======= ====== ======= ======
Ratio of net charge-offs during
the year to average gross loans
outstanding during the year .32% .32% .48% .47% .21%
The following table summarizes the bank's allocation of allowance for
loan losses for the years ending December 31, 2004, 2003, 2002, 2001 and 2000
(in thousands, except ratios):
AT DECEMBER 31,
---------------------------------------------------------------------------
2004 2003 2002
----------------------- -------------------------- -----------------------
% OF TOTAL % OF TOTAL % OF TOTAL
AMOUNT LOANS (1) AMOUNT LOANS (1) AMOUNT LOANS (1)
---------- ----------- ----------- ----------- ---------- -------------
Real estate loans $ 3,432 84% $ 2,773 81% $ 2,139 75%
Commercial and industrial loans 389 10% 415 12% 451 16%
Installment loans 223 6% 227 7% 258 9%
Unallocated 11 -% 15 -% 12 -%
---------- ----------- ----------- --------- ---------- ------------
Total $ 4,055 100% $ 3,430 100% $ 2,860 100%
========== =========== =========== ========= ========== ============
AT DECEMBER 31,
------------------------------------------------
2001 2000
----------------------- -----------------------
% OF TOTAL % OF TOTAL
AMOUNT LOANS (1) AMOUNT LOANS (1)
---------- ---------- ---------- ----------
Real estate loans $ 1,967 74% $ 1,946 70%
Commercial and industrial loans 414 16% 517 19%
Installment loans 254 10% 292 11%
Unallocated 15 -% 15 -%
---------- ----------- ---------- ----------
Total $ 2,650 100% $ 2,770 100%
========== =========== ========== ==========
- --------------------------------------------
(1) Represents total of all outstanding loans in each category as a percentage
of total loans outstanding.
24
DEPOSITS
Time certificates in amounts of $100,000 or more outstanding at
December 31, 2004 by maturity were as follows (in thousands):
Three months or less $ 36,122
Over three months through twelve months 28,076
Over twelve months through three years 16,765
Over three years 27,692
--------
Total $108,655
========
BORROWINGS
The bank borrows funds principally from the Federal Home Loan Bank of
Atlanta. Information regarding such borrowings is as follows (in thousands,
except rates):
2004 2003 2002
------------ ------------ -------------
Balance outstanding at December 31 $ 43,160 $ 33,160 $ 33,160
Weighted average rate at December 31 3.86% 4.58% 4.60%
Maximum borrowings during the year $ 43,160 $ 35,760 $ 33,160
Average amounts outstanding during year $ 42,799 $ 34,200 $ 33,160
Weighted average rate during year 3.94% 4.55% 4.64%
CRITICAL ACCOUNTING ESTIMATES AND POLICIES
We prepare our consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America. The
preparation of these financial statements requires us to make estimates and
assumptions that 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 amount of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Critical accounting estimates and policies are those we believe are
both most important to the portrayal of our financial condition and results, and
require our most difficult, subjective or complex judgments, often as a result
of the need to make estimates about the effect of matters that are inherently
uncertain. Judgments and uncertainties affecting the application of those
policies may result in materially different amounts being reported under
different conditions or using different assumptions. We believe that the
allowance for loan losses represents a particularly sensitive accounting
estimate. The amount of the allowance is based on management's evaluation of the
collectibility of the loan portfolio, including the maturity of the loan
portfolio, credit concentration, trends in historical loss experience, specific
impaired loans and general economic conditions. See Note A to the consolidated
financial statements for a comprehensive discussion of our accounting policy for
the allowance for loan losses.
NEW ACCOUNTING STANDARDS
In December 2004, the FASB issued SFAS 123 (revised 2004), Share-Based
Payment, ("SFAS No. 123(R)"), which is a revision of SFAS No. 123, Accounting
for Stock-Based Compensation. SFAS No. 123(R) supersedes Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"),
and amends SFAS No. 95 Statement of Cash Flows. 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. The provisions of
this Statement are effective for the first interim reporting period that begins
after June 15, 2005. Accordingly, we will adopt SFAS No. 123(R) commencing with
the quarter ending September 30, 2005. If we had included the cost of employee
stock option compensation in our consolidated financial statements, our net
income for the fiscal years ended December 31, 2004, 2003 and 2002 would have
decreased by approximately $64,000, $68,000, and $52,000, respectively.
Accordingly, the adoption of SFAS No. 123(R) is not expected to have a material
effect on our consolidated financial statements.
25
Item 7A - Quantitative and Qualitative Disclosures About Market Risk.
This information is included under Item 7 of this report under the
captions "Interest Rate Sensitivity," "Market Risk," and "Derivative Financial
Instruments."
Item 8 - Financial Statements.
26
[LOGO]
DIXON HUGHES PLLC
CERTIFIED PUBLIC ACCOUNTANTS AND ADVISORS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
Four Oaks Fincorp, Inc.
Four Oaks, North Carolina
We have audited the accompanying consolidated balance sheets of Four Oaks
Fincorp, Inc. and Subsidiaries as of December 31, 2004 and 2003 and the related
consolidated statements of operations, comprehensive income, shareholders'
equity and cash flows for each of the years in the three-year period ended
December 31, 2004. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Four Oaks Fincorp,
Inc. and Subsidiaries as of December 31, 2004 and 2003, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2004 in conformity with accounting principles generally
accepted in the United States of America.
/s/ Dixon Hughes PLLC
Sanford, North Carolina
March 18, 2005
27
FOUR OAKS FINCORP, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2004 AND 2003
- ----------------------------------------------------------------------------------------------------
2004 2003
----------------------- -------------------
(AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
ASSETS
Cash and due from banks $ 10,634 $ 10,548
Interest-earning deposits 3,615 5,277
Investment securities available for sale 52,342 38,203
Loans 312,815 272,623
Allowance for loan losses (4,055) (3,430)
--------- ---------
Net loans 308,760 269,193
Accrued interest receivable 2,210 1,893
Bank premises and equipment, net 10,149 10,582
FHLB stock 2,621 1,923
Investment in life insurance 6,054 2,896
Other assets 2,115 1,206
--------- ---------
Total assets $ 398,500 $ 341,721
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Non-interest-bearing demand $ 59,528 $ 50,829
Money market and NOW accounts 55,467 43,927
Savings 14,900 13,038
Time deposits, $100,000 and over 108,655 85,100
Other time deposits 76,757 80,024
--------- ---------
Total deposits 315,307 272,918
Borrowings 43,160 33,160
Accrued interest payable 1,201 1,284
Other liabilities 1,537 1,479
--------- ---------
Total liabilities 361,205 308,841
--------- ---------
Shareholders' equity:
Common stock; $1.00 par value, 10,000,000
shares authorized; 3,438,107 and 2,676,263 shares issued
and outstanding at December 31, 2004 and 2003, respectively 3,438 2,676
Additional paid-in capital 8,788 8,029
Retained earnings 25,091 21,867
Accumulated other comprehensive income (loss) (22) 308
--------- ---------
Total shareholders' equity 37,295 32,880
--------- ---------
Total liabilities and shareholders' equity $ 398,500 $ 341,721
========= =========
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements
28
FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------------------------------------
2004 2003 2002
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
Interest and dividend income:
Loans, including fees $ 19,968 $ 17,318 $ 16,746
Investment securities:
Taxable 1,470 1,272 2,482
Tax-exempt 162 212 213
Dividends 109 88 114
Interest-earning deposits 39 53 230
-------- -------- --------
Total interest and dividend income 21,748 18,943 19,785
-------- -------- --------
Interest expense:
Deposits 4,123 4,365 6,103
Borrowings 1,688 1,557 1,537
-------- -------- --------
Total interest expense 5,811 5,922 7,640
-------- -------- --------
Net interest income 15,937 13,021 12,145
Provision for loan losses 1,596 1,373 1,248
-------- -------- --------
Net interest income after provision for loan losses 14,341 11,648 10,897
-------- -------- --------
Non-interest income:
Service charges on deposit accounts 1,941 1,867 1,827
Other service charges, commissions and fees 1,024 635 618
Gains (loss) on sale of investment securities 71 273 (8)
Gains on sale of loans 72 212 175
Merchant fees 347 324 198
Income from investment in bank-owned life insurance 394 159 --
-------- -------- --------
Total non-interest income 3,849 3,470 2,810
-------- -------- --------
Non-interest expenses:
Salaries 5,354 4,934 4,320
Employee benefits 1,037 1,008 910
Occupancy expenses 508 493 397
Equipment expenses 1,223 1,124 983
Professional and consulting fees 747 664 730
Other taxes and licenses 251 251 164
Merchant processing expenses 304 277 192
Other operating expenses 2,083 1,837 1,789
-------- -------- --------
Total non-interest expenses 11,507 10,588 9,485
-------- -------- --------
Income before income taxes 6,683 4,530 4,222
Provision for income taxes 2,308 1,612 1,306
-------- -------- --------
Net income $ 4,375 $ 2,918 $ 2,916
======== ======== ========
Basic net income per common share $ 1.29 $ .87 $ .88
======== ======== ========
Diluted net income per common share $ 1.28 $ .86 $ .87
======== ======== ========
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements
29
FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
- -------------------------------------------------------------------------------------
2004 2003 2002
-------- -------- --------
(AMOUNTS IN THOUSANDS)
Net income $ 4,375 $ 2,918 $ 2,916
------- ------- -------
Other comprehensive income:
Securities available for sale:
Unrealized holding gains (losses) on
available for sale securities (109) 40 699
Tax effect 44 (17) (280)
Reclassification of (gains) losses recognized in (71) (273) 8
net income
Tax effect 28 109 (3)
------- ------- -------
Net of tax amount (108) (141) 424
------- ------- -------
Cash flow hedging activities:
Unrealized holding losses on cash flow
hedging activities (370) (56) --
Tax effect 148 22 --
------- ------- -------
Net of tax amount (222) (34) --
------- ------- -------
Total other comprehensive income (loss) (330) (175) 424
------- ------- -------
Comprehensive income $ 4,045 $ 2,743 $ 3,340
======= ======= =======
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements
30
FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------------------------------------------
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER TOTAL
------------ PAID-IN RETAINED COMPREHENSIVE SHAREHOLDERS'
SHARES AMOUNT CAPITAL EARNINGS INCOME (LOSS) EQUITY
----------- ---------- ---------- ---------- -------------- -------------
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
BALANCE, DECEMBER 31, 2001 2,106,477 $ 2,106 $ 6,706 $ 19,154 $ 59 $ 28,025
Net income -- -- -- 2,916 -- 2,916
Other comprehensive income -- -- -- -- 424 424
Issuance of common stock 54,655 55 957 -- -- 1,012
Current income tax benefit -- -- 53 -- -- 53
Purchases and retirement
of common stock (16,921) (17) -- (368) -- (385)
Cash dividends of $.26 per share -- -- -- (852) -- (852)
--------- ---------- ---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 2002 2,144,211 2,144 7,716 20,850 483 31,193
Net income -- -- -- 2,918 -- 2,918
Other comprehensive loss -- -- -- -- (175) (175)
Effect of 5-for-4 stock split 533,706 534 (542) -- -- (8)
Issuance of common stock 42,014 42 837 -- -- 879
Current income tax benefit -- -- 18 -- -- 18
Purchases and retirement
of common stock (43,668) (44) -- (949) -- (993)
Cash dividends of $.29 per share -- -- -- (952) -- (952)
--------- ---------- ---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 2003 2,676,263 2,676 8,029 21,867 308 32,880
Net income -- -- -- 4,375 -- 4,375
Other comprehensive loss -- -- -- -- (330) (330)
Effect of 5-for-4 stock split 682,474 683 (683) -- -- --
Issuance of common stock 82,170 82 1,348 -- -- 1,430
Current income tax benefit -- -- 94 -- -- 94
Purchases and retirement
of common stock (2,800) (3) -- (62) -- (65)
Cash dividends of $.32 per share -- -- -- (1,089) -- (1,089)
--------- ---------- ---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 2004 3,438,107 $ 3,438 $ 8,788 $ 25,091 $ (22) $ 37,295
========= ========== ========== ========== ========== ==========
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements
31
FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
- -------------------------------------------------------------------------------------------------
2004 2003 2002
--------- --------- -----------
(AMOUNTS IN THOUSANDS)
Cash flows from operating activities:
Net income $ 4,375 $ 2,918 $ 2,916
Adjustments to reconcile net income to net cash
provided by operations:
Provision for loan losses 1,596 1,373 1,248
Provision for depreciation and amortization 1,008 946 824
Deferred income tax expense (benefit) (188) (129) 32
Net amortization of bond premiums and discounts 109 595 290
Gain on sale of loans (72) (212) (175)
(Gain) loss on sale of investment securities (71) (273) 8
Loss on sale of foreclosed assets 25 15 26
(Gain) loss on disposition of premises and equipment 7 -- (5)
Increase in cash surrender value of life insurance (394) (159) --
Changes in assets and liabilities:
Other assets 545 (130) 349
Loans held for sale -- -- 1,483
Interest receivable (317) (122) 339
Other liabilities 52 (155) 1,357
Interest payable (83) (501) (946)
--------- --------- ---------
Net cash provided by operating activities 6,592 4,166 7,746
--------- --------- ---------
Cash flows from investing activities:
Proceeds from sales and calls of investment
securities available for sale 41,422 44,835 100,678
Proceeds from maturities of investment
securities available for sale -- 10,516 2,739
Purchase of investment securities available for sale (55,779) (37,320) (97,595)
Purchase of FHLB stock (698) (273) --
Net increase in loans (42,305) (43,811) (22,679)
Additions to premises and equipment (568) (848) (1,867)
Purchases of bank-owned life insurance (3,552) (2,896) --
Proceeds from sale of foreclosed assets 860 521 302
Expenditures on foreclosed assets -- (2) (15)
--------- --------- ---------
Net cash used by investing activities (60,620) (29,278) (18,437)
--------- --------- ---------
Cash flows from financing activities:
Net proceeds from borrowings 10,000 -- (13)
Net increase in deposit accounts 42,176 22,345 14,877
Proceeds from issuance of common stock 1,430 879 1,012
Purchases and retirement of common stock (65) (993) (385)
Cash dividends paid (1,089) (960) (852)
--------- --------- ---------
Net cash provided by financing activities 52,452 21,271 14,639
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents (1,576) (3,841) 3,948
Cash and cash equivalents at beginning of year 15,825 19,666 15,718
--------- --------- ---------
Cash and cash equivalents at end of year $ 14,249 $ 15,825 $ 19,666
========= ========= =========
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements
32
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements include the accounts and transactions of
Four Oaks Fincorp, Inc. (the "Company"), a bank holding company incorporated
under the laws of the State of North Carolina, and its wholly owned
subsidiaries, Four Oaks Bank & Trust Company, Inc. (the "Bank") and Four Oaks
Mortgage Services, LLC, the Company's mortgage origination subsidiary. All
significant intercompany transactions have been eliminated.
NATURE OF OPERATIONS
The Company was incorporated under the laws of the State of North Carolina on
February 5, 1997. The Company's primary function is to serve as the holding
company for its wholly owned subsidiary, the Bank. The Bank operates ten offices
in eastern and central North Carolina, and its primary source of revenue is
derived from loans to customers and from its securities portfolio. The loan
portfolio is comprised mainly of real estate, commercial and consumer loans.
These loans are primarily collateralized by residential and commercial
properties, commercial equipment, and personal property.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
In preparing consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the 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. Material estimates that are particularly susceptible to significant
change relate to the determination of the allowance for loan losses.
CASH AND CASH EQUIVALENTS
For the purpose of presentation in the consolidated statements of cash flows,
cash and cash equivalents are defined as those amounts included in the balance
sheet captions cash and due from banks and interest-earning deposits.
Federal regulations require institutions to set aside specified amounts of cash
as reserves against transactions and time deposits. As of December 31, 2004, the
daily average gross reserve requirement was $5 million.
INVESTMENT SECURITIES
Investment securities are classified into three categories:
(1) Held to Maturity - Debt securities that the Company has the positive intent
and the ability to hold to maturity are classified as held to maturity and
reported at amortized cost;
(2) Trading - Debt and equity securities that are bought and held principally
for the purpose of selling them in the near term are classified as trading
securities and reported at fair value, with unrealized gains and losses included
in earnings; and
- --------------------------------------------------------------------------------
33
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
Investment Securities (Continued)
(3) Available for Sale - Debt and equity securities not classified as either
securities held to maturity or trading securities are reported at fair value,
with unrealized gains and losses excluded from earnings and reported, net of
income taxes, as other comprehensive income, a separate component of
shareholders' equity.
The Company has historically classified all securities as available for sale.
Gains and losses on sales of securities, computed based on specific
identification of adjusted cost of each security, are included in income at the
time of the sale. Premiums and discounts are amortized into interest income
using a method that approximates the interest method over the period to
maturity.
LOANS AND ALLOWANCE FOR LOAN LOSSES
Loans are stated at the amount of unpaid principal, reduced by an allowance for
loan losses. Interest on loans is calculated by using the simple interest method
on daily balances of the principal amount outstanding.
Loan origination fees are deferred, as well as certain direct loan origination
costs. Such costs and fees are recognized as an adjustment to yield over the
contractual lives of the related loans utilizing the interest method.
The Company evaluates its loan portfolio in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 114, Accounting by Creditors for
Impairment of a Loan, as amended by SFAS No. 118, Accounting by Creditors for
Impairment of a Loan - Income Recognition and Disclosure. Under these standards,
a loan is considered impaired, based on current information and events, if it is
probable that the Company will be unable to collect the scheduled payments of
principal and 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 allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to earnings. Loans are
charged against the allowance for loan losses when management believes that the
uncollectibility of a loan balance is confirmed. The provision for loan losses
is based upon such factors as changes in the nature and volume of the loan
portfolio, overall portfolio quality, review of specific problem loans, and
current economic conditions and trends that may affect the borrowers' ability to
pay. Because these factors may change, it is possible that management's
assessment of the allowance may change. In addition, regulatory examiners may
require the Bank to recognize changes to the allowance for loan losses based on
their judgments about information available to them at the time of their
examination.
- --------------------------------------------------------------------------------
34
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
INCOME RECOGNITION ON IMPAIRED AND NONACCRUAL LOANS
Loans, including impaired loans, are generally classified as nonaccrual if they
are past due as to maturity or payment of principal or interest for a period of
more than 90 days, unless such loans are well-secured and in the process of
collection. If a loan or a portion of a loan is classified as doubtful or is
partially charged-off, the loan is generally classified as nonaccrual. Loans
that are on a current payment status or past due less than 90 days may also be
classified as nonaccrual if repayment in full of principal and/or interest is in
doubt.
Loans may be returned to accrual status when all principal and interest amounts
contractually due (including arrearages) are reasonably assured of repayment
within an acceptable period of time and there is a sustained period of repayment
performance (generally a minimum of six months) by the borrower, in accordance
with the contractual terms.
While a loan is classified as nonaccrual and the future collectibility of the
recorded loan balance is doubtful, collections of interest and principal are
generally applied as a reduction to the principal outstanding, except in the
case of loans with scheduled amortizations where the payment is generally
applied to the oldest payment due. When the future collectibility of the
recorded loan balance is expected, interest income may be recognized on a cash
basis. In the case where a nonaccrual loan had been partially charged-off,
recognition of interest on a cash basis is limited to that which would have been
recognized on the recorded loan balance at the contractual interest rate.
Receipts in excess of that amount are recorded as recoveries to the allowance
for loan losses until prior charge-offs have been fully recovered.
FORECLOSED ASSETS
Assets acquired as a result of foreclosure are valued at fair value at the date
of foreclosure establishing a new cost basis. After foreclosure, valuations of
the property are periodically performed by management and the assets are carried
at the lower of cost or fair value minus estimated costs to sell. Losses from
the acquisition of property in full or partial satisfaction of debt are treated
as credit losses. Routine holding costs, subsequent declines in value, and gains
or losses on disposition are included in other income and expense.
BANK PREMISES AND EQUIPMENT
Land is carried at cost. Bank premises and equipment are stated at cost less
accumulated depreciation. Depreciation is computed using the straight-line
method based on the estimated useful lives of assets. Useful lives range from 5
to 10 years for furniture and equipment and 40 years for premises. Expenditures
for repairs and maintenance are charged to expense as incurred.
- --------------------------------------------------------------------------------
35
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
INCOME TAXES
Deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the tax bases of assets and
liabilities and their carrying amounts for financial reporting purposes.
Deferred tax assets are also recognized for operating loss carryforwards.
Deferred tax assets and liabilities are measured using enacted tax rates in
effect for the year in which the temporary differences are expected to be
recovered or settled. Deferred tax assets are reduced by a valuation allowance
if it is more likely than not that the tax benefits will not be realized.
STOCK IN FEDERAL HOME LOAN BANK OF ATLANTA
As a requirement for membership, the Company invests in stock of the Federal
Home Loan Bank of Atlanta ("FHLB"). This investment is carried at cost. Due to
the redemptive provisions of the FHLB, the Company estimated that fair value
equals cost and that this investment was not impaired as of December 31, 2004.
COMPREHENSIVE INCOME
Comprehensive income is defined as the change in equity during a period for
non-owner transactions and is divided into net income and other comprehensive
income. Other comprehensive income includes revenues, expenses, gains, and
losses that are excluded from earnings under current accounting standards.
Components of other comprehensive income for the Company consist of the
unrealized gains and losses, net of taxes, in the Company's available for sale
securities portfolio and unrealized gains and losses, net of taxes, in the
Company's cash flow hedge instruments.
Accumulated other comprehensive income at December 31, 2004, 2003 and 2002
consists of the following:
2004 2003 2002
------ ------ -------
(AMOUNTS IN THOUSANDS)
Unrealized holding gains - investment securities
available for sale $ 391 $ 571 $ 803
Deferred income taxes (157) (229) (320)
------ ------ ------
Net unrealized holding gains - investment securities
available for sale 234 342 483
----- ------ ------
Unrealized holding losses - cash flow hedge instruments (426) (56) --
Deferred income taxes 170 22 --
----- ------ ------
Net unrealized holding losses - cash flow hedge
instruments (256) (34) --
----- ------ ------
Total accumulated other comprehensive income (loss) $ (22) $ 308 $ 483
===== ====== ======
- --------------------------------------------------------------------------------
36
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
Stock Compensation Plans
SFAS No. 123, Accounting for Stock-Based Compensation, encourages all entities
to adopt a fair value based method of accounting for employee stock compensation
plans, whereby compensation cost is measured at the grant date based on the
value of the award and is recognized over the service period, which is usually
the vesting period. However, it also allows an entity to continue to measure
compensation cost for those plans using the intrinsic value based method of
accounting prescribed by Accounting Principles Board ("APB") Opinion No. 25,
Accounting for Stock Issued to Employees, whereby compensation cost is the
excess, if any, of the quoted market price of the stock at the grant date (or
other measurement date) over the amount an employee must pay to acquire the
stock. Stock options issued under the Company's stock option plans have no
intrinsic value at the grant date and, under APB Opinion No. 25, no compensation
cost is recognized for them. The Company has elected to continue with the
accounting methodology in APB No. 25 and, as a result, has provided pro forma
disclosures of net income and earnings per share and other disclosures as if the
fair value based method of accounting had been applied.
2004 2003 2002
----------- ---------- ----------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income:
As reported $ 4,375 $ 2,918 $ 2,916
Deduct: Total stock-based employee compensation
expense determined under fair value method
for all awards, net of related tax effects (64) (68) (52)
--------- ---------- --------
Pro forma $ 4,311 $ 2,850 $ 2,864
========= ========== ========
Basic earnings per share:
As reported $ 1.29 $ .87 $ .88
Pro forma 1.27 .85 .86
Diluted earnings per share:
As reported $ 1.28 $ .86 $ .87
Pro forma 1.26 .85 .86
Net Income Per Common Share and Common Shares Outstanding
Basic earnings per share represents income available to common shareholders
divided by the weighted average number of common shares outstanding during the
period. Diluted earnings per share reflect additional common shares that would
have been outstanding if dilutive potential common shares had been issued, as
well as any adjustment to income that would result from the assumed issuance.
The weighted average number of shares outstanding during each period have been
retroactively adjusted for a 25% stock split distributed October 29, 2004 and
November 10, 2003. Potential common shares that may be issued by the Company
relate solely to outstanding stock options.
- --------------------------------------------------------------------------------
37
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
Net Income Per Common Share and Common Shares Outstanding (Continued)
Basic and diluted net income per common share have been computed based upon net
income as presented in the accompanying consolidated statements of operations
divided by the weighted average number of common shares outstanding or assumed
to be outstanding as summarized below:
2004 2003 2002
---------- --------- ----------
Weighted average number of common shares used
in computing basic net income per common share 3,397,345 3,356,070 3,325,960
Effect of dilutive stock options 19,335 11,971 10,906
---------- --------- ----------
Weighted average number of common shares and
dilutive potential common shares used in computing
diluted net income per common share 3,416,680 3,368,041 3,336,866
========= ========= =========
There were no antidilutive shares outstanding for the years ended December 31,
2004, 2003 and 2002. .
DERIVATIVE INSTRUMENTS
The Company utilizes interest rate swaps in the management of interest rate
risk. Interest rate swaps are contractual agreements between two parties to
exchange a series of cash flows representing interest payments. A swap allows
both parties to alter the repricing characteristics of assets or liabilities
without affecting the underlying principal positions. Through the use of a swap,
assets and liabilities may be transformed from fixed to floating rates, from
floating rates to fixed rates, or from one type of floating rate to another.
Swap terms generally range from one year to ten years depending on the need.
The net interest payable or receivable on interest rate swaps that are
designated as hedges is accrued and recognized as an adjustment to the interest
income or expense of the related asset or liability. Gains and losses from early
terminations of derivatives are deferred and amortized as yield adjustments over
the shorter of the remaining term of the hedged asset or liability or the
remaining term of the derivative instrument. Upon disposition or settlement of
the asset or liability being hedged, deferral accounting is discontinued and any
gains or losses are recognized in income. Unrealized holding gains and losses on
derivatives designated as cash flow hedges are reported, net of applicable
income tax effect, in accumulated other comprehensive income.
Derivative financial instruments that fail to qualify as a hedge are carried at
fair value with gains and losses recognized in current earnings.
- --------------------------------------------------------------------------------
38
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
New Accounting Standards
On March 9, 2004, the SEC Staff issued Staff Accounting Bulletin No. 105,
Application of Accounting Principles to Loan Commitments ("SAB 105"). SAB 105
clarifies existing accounting practices relating to the valuation of issued loan
commitments, including interest rate lock commitments ("IRLC"), subject to SFAS
No. 149 and Derivative Implementation Group Issue C13, Scope Exceptions: When a
Loan Commitment is included in the Scope of Statement 133. Furthermore, SAB 105
disallows the inclusion of the values of a servicing component and other
internally developed intangible assets in the initial and subsequent IRLC
valuation. The provisions of SAB 105 were effective for loan commitments entered
into after March 31, 2004. The adoption of SAB 105 did not have a material
impact on the Company's consolidated financial statements.
In March 2004, the ("EITF") released EITF Issue 03-01, The Meaning of
Other-Than-Temporary Impairment and its Application to Certain Investments. The
Issue provides guidance for determining whether an investment is
other-than-temporarily impaired and requires certain disclosures with respect to
these investments. The recognition and measurement guidance for
other-than-temporary impairment has been delayed by the issuance of FASB Staff
Position EITF 03-1-1 on September 30, 2004. The adoption of Issue 03-1 did not
result in any other-than-temporary impairment.
In December 2003, the American Institute of Certified Public Accountants (AICPA)
issued Statement of Position (SOP) 03-3, Accounting for Loans or Certain Debt
Securities Acquired in a Transfer. The SOP addresses accounting for differences
between contractual cash flows and cash flows expected to be collected from an
investor's initial investment in loans or debt securities acquired in a transfer
if those differences relate to a deterioration of credit quality. The SOP also
prohibits companies from "carrying over" or creating a valuation allowance in
the initial accounting for loans acquired that meet the scope criteria of the
SOP. The SOP is effective for loans acquired in fiscal years beginning after
December 15, 2004. The adoption of this SOP is not expected to have a material
impact on the Company's financial position or results of operations.
In December 2004, the FASB issued SFAS 123 (revised 2004), Share-Based Payment,
("SFAS No. 123(R)"), which is a revision of SFAS No. 123, Accounting for
Stock-Based Compensation. SFAS No. 123(R) supersedes Accounting Principles Board
(APB) Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"), and
amends SFAS No. 95 Statement of Cash Flows. 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. The provisions of
this Statement are effective for the first interim reporting period that begins
after June 15, 2005. Accordingly, we will adopt SFAS No. 123(R) commencing with
the quarter ending September 30, 2005. If we had included the cost of employee
stock option compensation in our consolidated financial statements, our net
income for the fiscal years ended December 31, 2004, 2003 and 2002 would have
decreased by approximately $64,000, $68,000, and $52,000, respectively.
Accordingly, the adoption of SFAS No. 123(R) is not expected to have a material
effect on our consolidated financial statements.
- --------------------------------------------------------------------------------
39
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
Reclassifications
Certain items included in the 2003 and 2002 consolidated financial statements
have been reclassified to conform to the 2004 presentation. These
reclassifications have no effect on the net income or shareholders' equity
previously reported.
NOTE B - INVESTMENT SECURITIES
The amortized cost, gross unrealized gains, gross unrealized losses and fair
values of securities available for sale as of December 31, 2004 and 2003 are as
follows:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
------- -------- -------- ----------
(AMOUNTS IN THOUSANDS)
2004:
U.S. Government and agency securities $34,991 $ 57 $ 90 $34,958
State and municipal securities 3,573 72 13 3,632
Mortgage-backed securities 12,759 53 37 12,775
Other 628 349 -- 977
------- ------- ------- -------
$51,951 $ 531 $ 140 $52,342
======= ======= ======= =======
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
------- -------- -------- ----------
(AMOUNTS IN THOUSANDS)
2003:
U.S. Government and agency securities $15,866 $ 54 $ 6 $15,914
State and municipal securities 4,664 291 -- 4,955
Mortgage-backed securities 16,535 41 74 16,502
Other 567 265 -- 832
------- ------- ------- -------
$37,632 $ 651 $ 80 $38,203
======= ======= ======= =======
The following table shows gross unrealized losses and fair values of investment
securities, aggregated by investment category and length of time that the
individual securities have been in a continuous unrealized loss position, at
December 31, 2004 and 2003. As of December 31, 2004, the unrealized losses
relate to eleven U.S. government agency securities and four mortgage-backed
securities, of which none and two such securities, respectively, had continuous
unrealized losses for more than twelve months. The unrealized losses relate to
debt securities that have incurred fair value reductions due to higher market
interest rates since the securities were purchased. The unrealized losses are
not likely to reverse unless and until market interest rates decline to the
levels that existed when the securities were purchased. Since none of the
unrealized losses relate to the marketability of the securities or the issuer's
ability to honor redemption obligations, none of the securities are deemed to be
other than temporarily impaired. (Amounts in thousands)
- --------------------------------------------------------------------------------
40
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE B - INVESTMENT SECURITIES (Continued)
2004
---------------------------------------------------------------------------------------
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL
------------------------- ----------------------- ---------------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES VALUE LOSSES
------- --------- ------- ---------- -------- -----------
Securities available for sale:
U.S. government and
agency securities $18,892 $ 90 $ -- $ -- $18,892 $ 90
State and municipal securities 1,968 13 -- -- 1,968 13
Mortgage-backed securities 2,056 15 2,924 22 4,980 37
------- ------- ------- ------- -------- -------
Total temporarily impaired
securities $22,916 $ 118 $ 2,924 $ 22 $25,840 $ 140
======= ======= ======== ======== ======== =======
2003
---------------------------------------------------------------------------------------
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL
------------------------- ----------------------- ---------------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES VALUE LOSSES
------- --------- ------- ---------- -------- -----------
Securities available for sale:
U.S. government and
agency securities $ 750 $ 6 $ -- $ -- $ 750 $ 6
Mortgage-backed securities 8,938 74 -- -- 8,938 74
------- ------- ------- ------- -------- -------
Total temporarily impaired
securities $ 9,688 $ 80 $ -- $ -- $ 9,688 $ 80
======= ======= ======== ======== ======== =======
The amortized cost and fair value of debt securities at December 31, 2004 by
contractual maturities are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
AMORTIZED
COST FAIR VALUE
------- --------
(AMOUNTS IN THOUSANDS)
Due after one year through five years $22,761 $22,773
Due after five years through ten years 25,051 25,065
Due after ten years 4,139 4,504
------- -------
$51,951 $52,342
======= =======
Securities with a carrying value of approximately $33.4 million and $12.3
million at December 31, 2004 and 2003, respectively, were pledged to secure
public deposits and for other purposes required or permitted by law.
Sales and calls of securities available for sale during 2004 and 2003 generated
gross realized gains of $224,000 and $295,000, respectively. Gross realized
losses amounted to $153,000 and $22,000, respectively.
- --------------------------------------------------------------------------------
41
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE C - LOANS AND ALLOWANCE FOR LOAN LOSSES
Major classifications of loans as of December 31, 2004 and 2003 are summarized
as follows:
2004 2003
--------- ----------
(AMOUNTS IN THOUSANDS)
Real estate - residential and other $ 159,152 $ 140,998
Real estate - agricultural 15,203 13,384
Construction and land development 90,742 66,242
Other agricultural 4,020 5,084
Consumer loans 17,207 16,475
Commercial loans 26,005 27,872
Other loans 865 2,738
--------- ----------
313,194 272,793
Less:
Net deferred loan costs (379) (170)
Allowance for loan losses (4,055) (3,430)
--------- ----------
$ 308,760 $ 269,193
========= ==========
Nonperforming assets at December 31, 2004 and 2003 consist of the following:
2004 2003
-------- -------
(AMOUNTS IN THOUSANDS)
Loans past due ninety days or more $ 226 $ 635
Nonaccrual loans 944 1,059
Foreclosed assets (included in other assets) 404 75
-------- -------
$1,574 $1,769
======== =======
At December 31, 2004 and 2003, the recorded investment in loans considered
impaired in accordance with SFAS No. 114 totaled $944,000 and $1.1 million,
respectively, and consisted entirely of nonaccrual loans. Impaired loans of
$944,000 and $1.1 million had related allowances for loan losses of $151,000 and
$165,000 at December 31, 2004 and 2003, respectively. For the years ended
December 31, 2004 and 2003, the average recorded investment in impaired loans
was approximately $1.5 million and $1.2 million, respectively. The amount of
interest recognized on impaired loans during the portion of the year that they
were impaired was not material.
A summary of the allowance for loan losses for the years ended December 31,
2004, 2003 and 2002 is as follows:
2004 2003 2002
------- ------- -------
(AMOUNTS IN THOUSANDS)
Balance, beginning $ 3,430 $ 2,860 $ 2,650
Provision for loan losses 1,596 1,373 1,248
Loans charged-off (1,346) (1,137) (1,199)
Recoveries of loans previously charged-off 375 334 161
------- ------- -------
Balance, ending $ 4,055 $ 3,430 $ 2,860
======= ======= =======
- --------------------------------------------------------------------------------
42
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE C - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
The Bank had loan and deposit relationships with most of its directors and
executive officers and with companies with which certain directors and executive
officers are associated. The following is a reconciliation of loans directly
outstanding to executive officers, directors, and their affiliates (amounts in
thousands):
Balance at December 31, 2003 $ 5,053
New loans 3,760
Principal repayments (4,103)
-------
Balance at December 31, 2004 $ 4,710
=======
As a matter of policy, these loans and credit lines are approved by the
Company's Board of Directors and are made with interest rates, terms, and
collateral requirements comparable to those required of other borrowers. In the
opinion of management, these loans do not involve more than the normal risk of
collectibility. At December 31, 2004, the Company had pre-approved but unused
lines of credit totaling $135,000 to executive officers, directors and their
affiliates.
NOTE D - BANK PREMISES AND EQUIPMENT
Bank premises and equipment at December 31, 2004 and 2003 are as follows:
2004 2003
-------- --------
(AMOUNTS IN THOUSANDS)
Land $ 2,237 $ 2,237
Building 7,042 6,957
Furniture and equipment 6,952 6,522
-------- ---------
16,231 15,716
Less accumulated depreciation (6,082) (5,134)
-------- ---------
$ 10,149 $ 10,582
======== =========
Depreciation expense for the years ended December 31, 2004 and 2003 amounted to
$994,000 and $932,000, respectively.
NOTE E - DEPOSITS
At December 31, 2004, the scheduled maturities of time deposits are as follows
(amounts in thousands):
LESS THAN $100,000
$100,000 OR MORE TOTAL
---------- --------- --------
Within one year $ 56,742 $ 64,198 $120,940
Over one year through three years 16,688 16,765 33,453
Over three years 3,327 27,692 31,019
-------- -------- --------
$ 76,757 $108,655 $185,412
======== ======== ========
- --------------------------------------------------------------------------------
43
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE F - BORROWINGS
At December 31, 2004 and 2003, borrowed funds consisted of the following FHLB
advances (amounts in thousands):
Maturity Interest Rate 2004 2003
----------------- ---------------- ------- --------
March 2006 2.52% - Variable $10,000 $ -
July 2010 5.75% - Fixed 10,000 10,000
July 2011 4.44% - Fixed 5,000 5,000
September 2011 4.38% - Fixed 3,000 3,000
October 2011 4.30% - Fixed 7,000 7,000
November 2011 2.31% - Variable 8,000 -
November 2011 3.54% - Fixed - 8,000
------- --------
$43,000 $ 33,000
======= ========
The above advances are secured by a floating lien covering the Company's loan
portfolio of qualifying residential (1-4 units) first mortgage loans. At
December 31, 2004, the Company had available lines of credit totaling $111.5
million at various financial institutions for borrowing, dependent on adequate
collateralization. The weighted average rates for the above borrowings at
December 31, 2004 and 2003 were 3.86% and 4.58%, respectively.
At December 31, 2004 and 2003, the Company was obligated under an outstanding
promissory note for $160,000 for the purchase of property. The note calls for
set monthly interest only payments, with a balloon payment at maturity on June
2006. The note bears interest at 7.50%.
NOTE G - INCOME TAXES
Allocation of income tax expense between current and deferred portions is as
follows:
YEARS ENDED DECEMBER 31,
----------------------------------------
2004 2003 2002
-------- ------- --------
(AMOUNTS IN THOUSANDS)
Current tax expense:
Federal $ 2,086 $ 1,470 $ 1,085
State 410 271 189
-------- ------- --------
2,496 1,741 1,274
-------- ------- --------
Deferred tax expense:
Federal (161) (106) 26
State (27) (23) 6
-------- ------- --------
(188) (129) 32
-------- ------- --------
$ 2,308 $ 1,612 $ 1,306
======== ======= ========
- --------------------------------------------------------------------------------
44
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE G - INCOME TAXES (Continued)
The reconciliation of expected income tax at the statutory federal rate of 34%
with income tax expense is as follows:
YEARS ENDED DECEMBER 31,
-----------------------------------------
2004 2003 2002
------- --------- --------
(AMOUNTS IN THOUSANDS)
Expense computed at statutory rate of 34% $ 2,272 $ 1,540 $ 1,435
Effect of state income taxes, net of federal benefit 304 164 129
Tax exempt income (101) (123) (203)
Bank owned life insurance income (152) (61) --
Other, net (15) 92 (55)
------- ------- -------
$ 2,308 $ 1,612 $ 1,306
======= ======= =======
Deferred income taxes consist of the following:
YEARS ENDED DECEMBER 31,
-----------------------------------------
2004 2003 2002
------- --------- --------
(AMOUNTS IN THOUSANDS)
Deferred tax assets:
Allowance for loan losses $ 1,518 $ 1,277 $ 1,058
Unamortized investment premiums 49 44 135
Net deferred loan fees 146 66 --
Other 38 31 53
------- ------- -------
Total deferred tax assets 1,751 1,418 1,246
------- ------- -------
Deferred tax liabilities:
Property and equipment 857 818 744
Other comprehensive income (13) 207 320
Net deferred loan costs 93 -- 31
Unaccreted investment discounts 13 -- --
------- ------- -------
Total deferred tax liabilities 950 1,025 1,095
------- ------- -------
Net deferred tax assets $ 801 $ 393 $ 151
======= ======= =======
NOTE H - REGULATORY RESTRICTIONS
The Bank, as a North Carolina banking corporation, may pay dividends to the
Company only out of undivided profits as determined pursuant to North Carolina
General Statutes Section 53-87. However, regulatory authorities may limit
payment of dividends by any bank when it is determined that such a limitation is
in the public interest and is necessary to ensure the financial soundness of the
bank.
Current Federal regulations require that the Bank maintain a minimum ratio of
total capital to risk weighted assets of 8%, with at least 4% being in the form
of Tier 1 capital, as defined in the regulations. In addition, the Bank must
maintain a leverage ratio of 4%. As of December 31, 2004, the Bank's capital
exceeded the current capital requirements. The Bank currently expects to
continue to exceed these minimums without altering current operations or
strategy.
- --------------------------------------------------------------------------------
45
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE H - REGULATORY RESTRICTIONS (Continued)
The Bank is subject to various regulatory capital requirements administered by
the federal and state banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory, and possibly additional
discretionary, actions by regulators that, if undertaken, could have a direct
material effect on the Bank's financial statements. Quantitative measures
established by regulation to ensure capital adequacy require the Bank to
maintain minimum amounts and ratios, as set forth in the table below. Management
believes, as of December 31, 2004, that the Bank meets all capital adequacy
requirements to which it is subject.
As of December 31, 2004, the most recent notification from the FDIC categorized
the Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, the Bank must maintain
minimum amounts and ratios as set forth in the table below. There are no
conditions or events since that notification that management believes have
changed the Bank's category.
The Bank's actual capital amounts and ratios are also presented in the table
below (amounts in thousands, except ratios):
MINIMUM
TO BE WELL
MINIMUM CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
----------------------- ------------------------ -----------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- -------- ----- ------- -----
As of December 31, 2004:
- ------------------------
Total Capital (to Risk Weighted Assets) $37,642 11.8% $25,427 8.0% $31,784 10.0%
Tier I Capital (to Risk Weighted Assets) 33,668 10.6% 12,714 4.0% 19,071 6.0%
Tier I Capital (to Average Assets) 33,668 8.6% 15,605 4.0% 19,506 5.0%
As of December 31, 2003:
- ------------------------
Total Capital (to Risk Weighted Assets) $33,792 12.3% $21,973 8.0% $27,467 10.0%
Tier I Capital (to Risk Weighted Assets) 30,362 11.1% 10,987 4.0% 16,480 6.0%
Tier I Capital (to Average Assets) 30,362 9.0% 13,421 4.0% 16,776 5.0%
The Company is also subject to these capital requirements. At December 31, 2004
and 2003, the Company's total capital to risk weighted assets, Tier 1 capital to
risk weighted assets and Tier 1 capital to average assets were 13.0% and 13.1%,
11.7% and 11.8%, and 9.5% and 9.7%, respectively.
NOTE I - DERIVATIVES
DERIVATIVE FINANCIAL INSTRUMENTS
The Company has stand-alone derivative financial instruments in the form of
interest rate swap agreements, which derive their value from underlying interest
rates. These transactions involve both credit and market risk. The notional
amounts are amounts on which calculations, payments, and the value of the
derivative are based. Notional amounts do not represent direct credit exposures.
Direct credit exposure is limited to the net difference between the calculated
amounts to be received and paid, if any. Such difference, which
- --------------------------------------------------------------------------------
46
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE I - DERIVATIVES (Continued)
represents the fair value of the derivative instruments, is reflected on the
Company's consolidated balance sheets as derivative assets and derivative
liabilities.
The Company is exposed to credit-related losses in the event of nonperformance
by the counterparties to these agreements. The Company controls the credit risk
of its financial contracts through credit approvals, limits and monitoring
procedures, and does not expect any counterparties to fail their obligations.
The Company deals only with primary dealers.
Derivative instruments are generally either negotiated over-the-counter ("OTC")
contracts or standardized contracts executed on a recognized exchange.
Negotiated OTC derivative contracts are generally entered into between two
counterparties that negotiate specific agreements terms, including the
underlying instruments, amount, exercise prices and maturity.
RISK MANAGEMENT POLICIES - HEDGING INSTRUMENTS
The primary focus of the Company's asset/liability management program is to
monitor the sensitivity of the Company's net portfolio value and net income
under varying interest rate scenarios to take steps to control its risks. On a
quarterly basis, the Company simulates the net portfolio value and net income
expected to be earned over a twelve-month period following the date of
simulation. The simulation is based on a projection of market interest rates at
varying levels and estimates the impact of such market rates on the levels of
interest-earning assets and interest-bearing liabilities during the measurement
period. Based upon the outcome of the simulation analysis, the Company considers
the use of derivatives as a means of reducing the volatility of net portfolio
value and projected net income within certain ranges of projected changes in
interest rates. The Company evaluates the effectiveness of entering into any
derivative instrument agreement by measuring the cost of such an agreement in
relation to the reduction in net portfolio value and net income volatility
within an assumed range of interest rates.
INTEREST RATE RISK MANAGEMENT - CASH FLOW HEDGING INSTRUMENTS
The Company originates variable rate loans for its loan portfolio. These loans
expose the Company to variability in interest receipts due to changes to
interest rates. If interest rates increase, interest income increases.
Conversely, if interest rates decrease, interest income decreases. Management
believes it is prudent to limit the variability of a portion of its interest
receipts therefore, generally hedges a portion of its variable-rate interest
receipts. To meet this objective, management enters into interest rate swap
agreements whereby the Company receives fixed rate payments and makes variable
interest rate payments during the contract period.
At December 31, 2004 and 2003, the information pertaining to an outstanding
interest rate swap agreement used to hedge variable rate loans is as follows
(amounts in thousands):
2004 2003
------------ -----------
Notional amount $ 25,000 $ 25,000
Weighted average pay rate 4.38% 4.00%
Weighted average receive rate 5.85% 5.85%
Weighted average maturity in years 2.7 3.7
Unrealized loss relating to interest rate swaps $ (426) $ (56)
This agreement requires the Company to make payments at a variable rate
determined by a specified index (prime) in exchange for receiving payments at a
fixed rate.
- --------------------------------------------------------------------------------
47
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE I - DERIVATIVES (Continued)
At December 31, 2004 and 2003, the Company's interest rate swaps used to hedge
variable rate loans reflected an unrealized loss of $426,000 and $56,000,
respectively. The unrealized losses are included in other comprehensive income,
net of tax, in the accompanying consolidated balance sheet.
Risk management results for the year ended December 31, 2004 related to the
balance sheet hedging of variable rate loans indicate that the hedges were 100%
effective and that there was no component of the derivative instruments' gain or
loss which was excluded from the assessment of hedge effectiveness.
At December 31, 2004, the unrealized loss relating to use of interest rate swaps
was recorded in derivative liabilities in accordance with SFAS No. 133. Changes
in the fair value of interest rate swaps designated as hedging instruments of
the variability of cash flows associated with variable rate loans are reported
in other comprehensive income.
INTEREST RATE RISK MANAGEMENT - FAIR VALUE HEDGING INSTRUMENTS
The Company uses fixed rate time deposits for use in its lending and investment
activities and other general purposes. These debt obligations expose the Company
to variability in their fair value due to changes in the level of interest
rates. Management believes that it is prudent to limit the variability in the
fair value of a portion of its fixed-rate funding. It is the Company's objective
to hedge the change in fair value of fixed-rate funding coverage levels that are
appropriate, given anticipated or existing interest rate levels and other market
considerations, as well as the relationship of change in this liability to other
liabilities of the Company. To meet this objective, on December 31, 2004, the
Company utilized interest rate swaps as an asset/liability management strategy
to hedge the change in value of the funding due to changes in expected interest
rate assumptions. These interest rate swap agreements are contracts to make a
series of floating rate payments in exchange for receiving a series of fixed
rate payments.
At December 31, 2004 and 2003, the information pertaining to outstanding
interest rate swap agreements used to hedge fixed-rate funding is as follows
(amounts in thousands):
2004 2003
---------- -----------
Notional amount $ 26,000 $ 5,000
Weighted average pay rate 2.30% 1.17%
Weighted average receive rate 3.66% 3.25%
Weighted average maturity in years 5.6 5.5
Unrealized gain relating to interest rate swaps $ 213 $ --
These agreements require the Company to make payments at variable-rate
determined by a specified index (LIBOR) in exchange for receiving payments at a
fixed-rate.
During 2004, an interest rate swap was called at par, with no corresponding gain
or loss recognized. No interest rate swaps were terminated during 2004. At
December 31, 2004, the Company's interest rate swaps used to hedge fixed-rate
funding reflected an unrealized gain of $213,000 which is recorded in other
liabilities in the accompanying consolidated balance sheet.
- --------------------------------------------------------------------------------
48
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE J - COMMITMENTS AND CONTINGENCIES
The Bank is a party to financial instruments with off-balance sheet credit risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and letters of
credit. Those instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the balance sheet. The
contract or notional amounts of those instruments reflect the extent of
involvement the Bank has in particular classes of financial instruments. The
Bank uses the same credit policies in making commitments and conditional
obligations as it does for on-balance-sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of conditions established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since some of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Bank, upon extension of credit is based on management's
credit evaluation of the borrower. Collateral obtained varies but may include
real estate, stocks, bonds, and certificates of deposit.
Unfunded commitments under lines of credit are commitments for possible future
extensions of credit to existing customers. These lines of credit usually do not
contain a specified maturity date and may not be drawn upon to the total extent
to which the Bank is committed.
Stand-by letters of credit are conditional lending commitments issued by the
Bank to guarantee the performance of a customer to a third party. Those letters
of credit are primarily issued to support public and private borrowing
arrangements. Essentially all letters of credit issued have expiration dates
within one year. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
A summary of the contract amount of the Bank's exposure to off-balance sheet
credit risk as of December 31, 2004 is as follows (amounts in thousands):
Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit $ 68,156
Undisbursed lines of credit 21,221
Financial stand-by letters of credit 159
Performance stand-by letters of credit 1,567
NOTE K - STOCK OPTION PLAN
The Company has a non-qualified stock option plan for certain key employees
under which it is authorized to issue options for up to 781,250 shares of common
stock. Options are granted at the discretion of the Company's Board of Directors
at a price approximating market, as determined by a committee of Board members.
All options granted subsequent to a 1997 amendment will be 100% vested one year
from the grant date and will expire after such a period as is determined by the
Board at the time of grant. Options granted prior to the amendment have ten year
lives and a five year level vesting provision.
- --------------------------------------------------------------------------------
49
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE K - STOCK OPTION PLAN (Continued)
A summary of the status of the Company's stock options, after giving retroactive
effect to stock splits, as of December 31, 2004, 2003 and 2002, and changes
during the years ending on those dates is presented below:
OPTIONS OPTION PRICE
OUTSTANDING PER SHARE
----------- ---------------
Balance December 31, 2001 149,285 $7.39 - 13.23
Granted 38,375 $12.80
Exercised (44,910) $9.10 - 13.23
Forfeited (10,501) $12.37 - 13.23
-----------
Balance December 31, 2002 132,249 $7.39 - 13.23
Granted 45,079 $14.40
Exercised (24,456) $12.37
Forfeited - -
Expired (153) $12.37
-----------
Balance December 31, 2003 152,719 $7.39 - 14.08
Granted 33,875 $17.60
Exercised (61,862) $13.11
Forfeited (1) $12.80
Expired (7) $13.23
-----------
Balance December 31, 2004 124,724 $14.42
===========
The weighted average exercise price of all exercisable options at December 31,
2004 is $13.24. There were 326,477 shares reserved for future issuance at
December 31, 2004.
Additional information concerning the Company's stock options at December 31,
2004 is as follows:
REMAINING
NUMBER CONTRACTUAL NUMBER
EXERCISE PRICE OUTSTANDING LIFE EXERCISABLE
---------------- ---------------- ----------- -----------------
$7.40 5,274 2.19 years 5,274
$12.80 42,841 .83 years 42,841
$14.40 42,734 2.16 years 42,734
$17.60 33,875 3.15 years -
------- ------
124,724 90,849
======= ======
- --------------------------------------------------------------------------------
50
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE K - STOCK OPTION PLAN (Continued)
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions used for
grants in 2004, 2003 and 2002:
2004 2003 2002
-------- -------- -------
Dividend yield 2.06% 1.69% 1.77%
Expected volatility 21.92% 21.65% 22.04%
Risk free interest rate 3.00% 2.82% 3.00%
Expected life 4 years 4 years 4 years
The weighted average fair value of options granted during 2004, 2003 and 2002
was $3.07, $3.21, and $2.91, respectively.
NOTE L - OTHER EMPLOYEE BENEFITS
SUPPLEMENTAL RETIREMENT
In 1998, the Company's subsidiary, Four Oaks Bank & Trust Company, adopted a
Supplemental Executive Retirement Plan ("SERP") for its president. The Company
has purchased life insurance policies in order to provide future funding of
benefit payments. Plan benefits will accrue and vest during the period of
employment and will be paid in annual benefit payments over the officer's
remaining life commencing with the officer's retirement. The liability accrued
under the plan amounts to $99,000 and $79,000 at December 31, 2004 and 2003,
respectively. During 2004, 2003 and 2002, the expense attributable to this plan
amounted to $20,000, $18,000 and $16,000, respectively.
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with certain of its executive
officers to ensure a stable and competent management base. The agreements
provide for benefits as spelled out in the contracts and cannot be terminated by
the Company's Board of Directors, except for cause, without prejudicing the
officers' rights to receive certain vested rights, including compensation. In
addition, the Company has entered into severance compensation agreements with
certain of its executive officers to provide them with severance pay benefits in
the event of a change in control of the Company, as outlined in the agreements,
the acquirer will be bound to the terms of the contracts.
DEFINED CONTRIBUTION PLAN
The Company sponsors a contributory profit-sharing plan in effect for
substantially all employees. Participants may make voluntary contributions
resulting in salary deferrals in accordance with Section 401(k) of the Internal
Revenue Code. The plans provide for employee contributions up to $13,000 of the
participant's annual salary and an employer contribution of 25% matching of the
first 6% of pre-tax salary contributed by each participant. Expenses related to
these plans for the years ended December 31, 2004, 2003 and 2002 were $47,000,
$56,000 and $92,000, respectively. Contributions under the plan are made at the
discretion of the Company's Board of Directors.
- --------------------------------------------------------------------------------
51
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE L - OTHER EMPLOYEE BENEFITS (CONTINUED)
EMPLOYEE STOCK OWNERSHIP PLAN
The Company sponsors an employee stock ownership plan (ESOP) which makes the
employees of a company, owners of stock in the company. The Four Oaks Bank &
Trust Company's Employee Stock Ownership Trust is available to full-time
employees at least 21 years of age after six months of service. Contributions
are voluntary by the Company and employees cannot contribute. Stock issued is
purchased on the open market and the Company does not issue new shares in
conjunction with this plan. Voluntary contributions are determined by the
Company's Board of Directors annually based on Company performance and are
allocated to employees based on annual compensation. Contribution expenses for
this plan for 2004, 2003, and 2002 were $180,000, 189,000, and 150,000,
respectively.
EMPLOYEE STOCK PURCHASE AND BONUS PLAN
The Employee Stock Purchase and Bonus Plan (the "Purchase Plan") is a voluntary
plan that enables full-time employees of the Company and its subsidiaries to
purchase shares of our common stock. The Purchase Plan is administered by a
committee of the Board of Directors, which has broad discretionary authority to
administer the Purchase Plan. The Company's Board of Directors may amend or
terminate the Purchase Plan at any time. The Purchase Plan is not intended to be
qualified as an employee stock purchase plan under Section 423 of the Internal
Revenue Code of 1986, as amended.
Once a year, participants in the Purchase Plan purchase the Company's common
stock at fair market value. Participants are permitted to purchase shares under
the Purchase Plan up to (5%) of their compensation, with a maximum purchase
amount of $1,000 per year. The Company matches, in cash, fifty percent (50%) of
the amount of each participant's purchase, up to $500. After withholding for
income and employment taxes, participants use the balance of our matching grant
to purchase shares of our common stock.
As of December 31, 2004, 156,250 shares of our common stock had been reserved
for issuance under the Purchase Plan, and 85,294 shares had been purchased.
During 2004, 6,578 shares were purchased under the Purchase Plan.
NOTE M - LEASES
The Bank has entered into non-cancelable operating leases for three branch
facilities. Future minimum lease payments under the leases for year ending
December 31, 2004 is as follows (amounts in thousands):
2005 $ 42
2006 33
2007 33
2008 15
2009 7
------
$ 130
======
In addition, the Bank has leased a building from one of its directors for $908
and $891 per month in 2004 and 2003, respectively under an operating lease on a
month-to-month basis.
Total rental expense under operating leases for the years ended December 31,
2004, 2003 and 2002 amounted to $45,000 and $31,000 and $14,000, respectively.
- --------------------------------------------------------------------------------
52
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE N - PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information of Four Oaks Fincorp, Inc., the parent company,
at December 31, 2004 and 2003 and for the years ended December 31, 2004, 2003
and 2002 is presented below:
2004 2003
--------- ---------
(AMOUNTS IN THOUSANDS)
CONDENSED BALANCE SHEETS
Assets:
Cash and cash equivalents $ 3,074 $ 1,709
Equity investment in subsidiaries 33,665 30,681
Securities available for sale 695 595
Other assets -- --
------- -------
Total assets $37,434 $32,985
======= =======
Liabilities and Shareholders' Equity:
Liabilities:
Other liabilities $ 139 $ 105
Shareholders' equity 37,295 32,880
------- -------
Total liabilities and shareholders' equity $37,434 $32,985
======= =======
2004 2003 2002
-------- -------- --------
(AMOUNTS IN THOUSANDS)
CONDENSED STATEMENTS OF OPERATIONS
Equity in earnings of subsidiaries $ 4,361 $ 2,897 $ 2,922
Interest income 30 22 34
Other investment income 15 17 9
Miscellaneous expenses (31) (18) (49)
-------- ------- -------
Net income $ 4,375 $ 2,918 $ 2,916
======== ======= =======
- --------------------------------------------------------------------------------
53
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE N - PARENT COMPANY FINANCIAL INFORMATION (Continued)
2004 2003 2002
------- --------- ---------
(AMOUNTS IN THOUSANDS)
CONDENSED STATEMENTS OF CASH FLOWS
Operating activities:
Net income $ 4,375 $ 2,918 $ 2,916
Equity in undistributed earnings of subsidiaries (4,361) (2,897) (2,922)
Amortization -- -- 10
Decrease in other assets -- -- 67
------- ------- -------
Cash flows provided by operating activities 14 21 71
------- ------- -------
Investing activities:
Purchase of securities available for sale (14) (16) (9)
Investment in subsidiaries -- -- (31)
Upstream dividend received from subsidiary 1,089 1,166 584
------- ------- -------
Cash flows provided by investing activities 1,075 1,150 544
------- ------- -------
Financing activities:
Proceeds from issuance of common stock 1,430 879 1,012
Purchases and retirements of common stock (65) (993) (385)
Dividends paid (1,089) (960) (852)
------- ------- -------
Cash flows used by financing activities 276 (1,074) (225)
------- ------- -------
Net increase in cash and cash equivalents 1,365 97 390
Cash and cash equivalents, beginning of year 1,709 1,612 1,222
------- ------- -------
Cash and cash equivalents, end of year $ 3,074 $ 1,709 $ 1,612
======= ======= =======
NOTE O - FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires
the disclosure of estimated fair values for financial instruments. Quoted market
prices, if available, are utilized as an estimate of the fair value of financial
instruments. Because no quoted market prices exist for a significant part of the
Company's financial instruments, the fair value of such instruments has been
derived based on management's assumptions with respect to future economic
conditions, the amount and timing of future cash flows and estimated discount
rates. Different assumptions could significantly affect these estimates.
Accordingly, the net realizable value could be materially different from the
estimates presented below. In addition, the estimates are only indicative of
individual financial instruments' values and should not be considered an
indication of the fair value of the Company taken as a whole. The following
methods and assumptions were used to estimate the fair value of each class of
financial instrument.
- --------------------------------------------------------------------------------
54
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE O - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
CASH AND CASH EQUIVALENTS
The carrying amounts of cash and cash equivalents are equal to the fair value
due to the liquid nature of the financial instruments.
INVESTMENT SECURITIES AVAILABLE FOR SALE
Fair values of investment securities available for sale are based on quoted
market prices. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities.
LOANS
Fair values have been estimated by type of loan: residential real estate loans,
consumer loans, and commercial and other loans. For variable-rate loans that
reprice frequently and with no significant credit risk, fair values are based on
carrying values. The fair values of fixed rate loans are estimated by
discounting the future cash flows using the current rates at which loans with
similar terms would be made to borrowers with similar credit ratings and for the
same remaining maturities. The Company has assigned no fair value to off-balance
sheet financial instruments since they are either short term in nature or
subject to immediate repricing.
FHLB STOCK
The carrying amount of FHLB stock approximates fair value.
INVESTMENT IN LIFE INSURANCE
The carrying value of life insurance approximates fair value because this
investment is carried at cash surrender value, as determined by the insurer.
DEPOSITS
The fair value of demand deposits, savings accounts and money market deposits is
the amount payable on demand at year-end. Fair value of time deposits is
estimated by discounting the future cash flows using the current rate offered
for similar deposits with the same maturities.
BORROWINGS
The fair values are based on discounting expected cash flows at the interest
rate for debt with the same or similar remaining maturities and collection
requirements.
ACCRUED INTEREST RECEIVABLE AND PAYABLE
The carrying amounts of accrued interest approximate fair value.
DERIVATIVE FINANCIAL INSTRUMENTS
Fair values for interest rate swap agreements are based upon the amounts
required to settle the contracts.
- --------------------------------------------------------------------------------
55
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE O - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
The following table presents information for financial assets and liabilities as
of December 31, 2004 and 2003 (amounts in thousands):
2004 2003
--------------------------- ----------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
VALUE FAIR VALUE VALUE FAIR VALUE
--------- ----------- ---------- -----------
FINANCIAL ASSETS:
Cash and cash equivalents $ 14,249 $ 14,249 $ 15,825 $ 15,825
Securities available for sale 52,342 52,342 38,203 38,203
Loans, net 308,760 308,713 269,193 271,566
FHLB stock 2,621 2,621 1,923 1,923
Investment in life insurance 6,054 6,054 2,896 2,896
Accrued interest receivable 2,210 2,210 1,893 1,893
FINANCIAL LIABILITIES:
Deposits $ 315,307 $ 309,801 $ 272,918 $ 270,127
Borrowings 43,160 41,651 33,160 30,665
Accrued interest payable 1,201 1,201 1,284 1,284
DERIVATIVE FINANCIAL INSTRUMENTS:
Interest rate swap agreements:
Liabilities, net (213) (213) 56 56
NOTE P - CASH FLOW SUPPLEMENTAL DISCLOSURES
The following information is supplemental information regarding the cash flows
for the years ended December 31, 2004, 2003 and 2002:
2004 2003 2002
-------- -------- --------
(AMOUNTS IN THOUSANDS)
Cash paid for:
Interest on deposits and borrowings $ 5,895 $ 4,365 $ 8,586
Income taxes 2,192 1,637 997
Summary of noncash investing and financing activities:
Transfer from loans to foreclosed assets 1,214 167 585
Loans to facilitate the sale of foreclosed assets 393 111 137
Tax benefit from the exercise of non-qualified
stock options 94 18 53
Increase (decrease) in fair value of securities
available for sale, net of tax (108) (141) 424
Decrease in fair value of cash flow hedge, net of tax (222) (34) --
- --------------------------------------------------------------------------------
56
FOUR OAKS FINCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
NOTE Q - STOCK PURCHASE PLAN
On December 10, 2001, the Company's Board of Directors approved a Stock Purchase
Program authorizing the Company to purchase up to 100,000 shares, or
approximately 4.7% of the then outstanding shares of common stock. During 2003,
the Company purchased 43,668 shares at an average cost of $21.73 per share.
During 2004, the Company purchased 2,800 shares at an average cost of $23.25 per
share. Neither 2004 nor 2003 purchase amounts reflect of the 5-for-4 stock split
during 2004 to shareholders of record as of October 15, 2004, payable on or
after October 29, 2004. In December 2004, the Company's Board of Directors
extended this stock purchase plan until December 31, 2005.
- --------------------------------------------------------------------------------
57
Item 9 - Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not Applicable.
Item 9A - Controls and Procedures
As required by paragraph (b) of Rule 13a-15 under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), our Chief Executive
Officer and our Chief Financial Officer have evaluated the effectiveness of our
disclosure controls and procedures (as such term is defined in Rules 13a-15(e)
and 15d-15(e) under the Exchange Act) as of the end of the period covered by
this report. Based on such evaluation, our Chief Executive Officer and our Chief
Financial Officer conclude that, as of the end of the period covered by this
report, our disclosure controls and procedures are effective, in that they
provide reasonable assurance that the information we are required to disclose in
the reports that we file or submit under the Exchange Act is recorded,
processed, summarized, and reported within the time periods required by the
United States Securities and Exchange Commission's rules and forms.
There have been no changes in our internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) during the fourth quarter of fiscal 2004 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
Item 9B - Other Information
Not Applicable.
PART III
Item 10 - Directors and Executive Officers of the Registrant.
Director information is incorporated by reference from the sections
entitled "Information about Our Board of Directors," "Election of Directors,"
and under the section entitled "Section 16(a) Beneficial Ownership Reporting
Compliance," in our Proxy Statement for the 2005 Annual Meeting of Shareholders.
Information on our executive officers is included under the caption "Our
Executive Officers" on Page 8 and 9 of this report. Information about our Code
of Ethics is incorporated by reference from the section entitled "Code of
Ethics," in our Proxy Statement for the 2005 Annual Meeting of Shareholders.
Item 11 - Executive Compensation.
This information is incorporated by reference from the sections
entitled "Executive Compensation," "Board Compensation Committee Report on
Executive Compensation," "Compensation Committee Interlocks and Insider
Participation" and "Comparison of Cumulative Total Return" in our Proxy
Statement for the 2005 Annual Meeting of Shareholders.
Item 12 - Security Ownership of Certain Beneficial Owners and Management and
Related Shareholder Matters.
This information is incorporated by reference from the section entitled
"Security Ownership of Management and Certain Beneficial Owners" and the
sections entitled "Equity Compensation Plan Information," "Nonqualified Stock
Option Plan" and "Employee Stock Purchases and Bonus Plan" in our Proxy
Statement for the 2005 Annual Meeting of Shareholders.
Item 13 - Certain Relationships and Related Transactions.
This information is incorporated by reference from the section entitled
"Certain Transactions" in our Proxy Statement for the 2005 Annual Meeting of
Shareholders.
Item 14 - Principal Accountant Fees and Services
Information regarding principal accountant fees and services is
incorporated by reference from the section entitled "Audit Firm Fee Summary" in
our Proxy Statement for the 2005 Annual Meeting of Shareholders.
58
Item 15 - Exhibits, Financial Statement Schedules .
(a)(1) Financial Statements. The following financial statements and
supplementary data are included in Item 8 of this annual report.
Form 10-K Page
--------------
Financial Statements
Report of Independent Public Auditors, Dixon Hughes PLLC, dated March 18, 2005 27
Consolidated Balance Sheets as of December 31, 2004 and 2003 28
Consolidated Statements of Operations for the years ended December 31, 2004, 29
2003 and 2002
Consolidated Statements of Comprehensive Income for the years ended December 31, 30
2004, 2003 and 2002
Consolidated Statements of Shareholders' Equity for the years ended December 31, 31
2004, 2003 and 2002
Consolidated Statements of Cash Flows for the years ended December 31, 2004, 32
2003 and 2002
Notes to Consolidated Financial Statements 33
(a)(2) Financial Statement Schedules. All applicable financial
statement schedules required under Regulation S-X have been included in the
Notes to Consolidated Financial Statements.
(a)(3) Exhibits. The following exhibits are filed as part of this
annual report.
Exhibit No. Description of Exhibit
----------- ---------------------------------------------------------------------------------
2(1) Agreement and Plan of Reorganization
and Merger by and between Four Oaks
Bank & Trust Company and Four Oaks
Fincorp, Inc. dated February 24, 1997
3.1 Articles of Incorporation of Four Oaks Fincorp, Inc. including Articles of
Amendment to Articles of Incorporation
3.2(1) Bylaws of Four Oaks Fincorp, Inc.
4(1) Specimen of Certificate for Four Oaks Fincorp, Inc. Common Stock
10.1(2)* Employment Agreement with Ayden R. Lee, Jr.
10.2(2)* Severance Compensation Agreement with Ayden R. Lee, Jr.
10.3(3)* Amended and Restated Nonqualified Stock Option Plan
10.4(3)* Amended and Restated Employee Stock Purchase and Bonus Plan
10.5(4)* Amended and Restated Dividend Reinvestment and Stock Purchase Plan
10.6(5)* Four Oaks Bank & Trust Company Supplemental Executive
Retirement Plan
10.7(6)* Employment Agreement with Clifton L. Painter
10.8(7)* Severance Compensation Agreement with Clifton L. Painter
10.9(8)* Executive Employment Agreement with W. Leon Hiatt, III
10.10(8)* Severance Compensation Agreement with W.Leon Hiatt, III
10.11(8)* Executive Employment Agreement with Nancy S. Wise
10.12(8)* Severance Compensation Agreement with Nancy S. Wise
10.13(9)* Form of Stock Option Agreement (Non-Employee Director)
10.14(9)* Form of Stock Option Agreement (Employee)
10.15* Executive Employment Agreement with Jeff D. Pope
10.16* Severance Compensation Agreement with Jeff D. Pope
21 Subsidiaries of Four Oaks Fincorp, Inc.
23 Consent of Dixon Hughes PLLC
31.1 Certification of Chief Executive Officer Pursuant to Rule 13a-14/15d-14 as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer Pursuant to Rule 13a-14/15d-14 as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
-----------------------
*Management Contract or Compensatory Plan
(1) Filed as an exhibit to the Current Report on Form 8-K12G3 filed with the SEC on July 2, 1997
and incorporated herein by reference.
(2) Filed as an exhibit to the Quarterly Report on Form 10-Q for the period ended June 30, 1997
and incorporated herein by reference.
(3) Filed as an exhibit to the Quarterly Report on Form 10-Q for the period ended June 30, 2004
and incorporated herein by reference.
(4) Filed as an exhibit to the Current Report on Form 8-K filed with the SEC on September 9, 2004 and
incorporated herein by reference.
(5) Filed as an exhibit to the Annual Report on Form 10-KSB for the period ended December 31, 1998 and
incorporated herein by reference.
(6) Filed as an exhibit to the Annual Report on Form 10-KSB for the period ended December 31, 2001 and
incorporated herein by reference.
(7) Filed as an exhibit to the Annual Report on Form 10-KSB for the period ended December 31, 2002 and
incorporated herein by reference.
(8) Filed as an exhibit to the Annual Report on Form 10-KSB for the period ended December 31, 2003 and
incorporated herein by reference.
(9) Filed as an exhibit to the Current Report on Form 8-K filed with the SEC on March 1, 2005 and
incorporated herein by reference.
(b) See (a)(3) above.
(c) See (a)(2) above.
- --------------------------------------------------------------------------------
59
61
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
FOUR OAKS FINCORP, INC.
Date: March 29, 2005 By: /s/ Ayden R. Lee, Jr.
-------------------------------------
Ayden R. Lee, Jr.
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
Date: March 29, 2005 /s/ Ayden R. Lee, Jr.
----------------------------------------
Ayden R. Lee, Jr.
President, Chief Executive Officer
and Director
Date: March 29, 2005 /s/ Nancy S. Wise
----------------------------------------
Nancy S. Wise
Executive Vice President and Chief
Financial Officer
Date: March 29, 2005 /s/ William J. Edwards
----------------------------------------
William J. Edwards
Director
Date: March 29, 2005 /s/ Warren L. Grimes
----------------------------------------
Warren L. Grimes
Director
Date: March 29, 2005 /s/ Dr. R. Max Raynor, Jr.
----------------------------------------
Dr. R. Max Raynor, Jr.
Director
Date: March 29, 2005 /s/ Percy Y. Lee
----------------------------------------
Percy Y. Lee
Director
Date: March 29, 2005 /s/ Merwin S. Canaday
----------------------------------------
Merwin S. Canaday
Director
Date: March 29, 2005 /s/ Paula C. Bowman
----------------------------------------
Paula C. Bowman
Director
Date: March 29, 2005 /s/ William Ashley Turner
----------------------------------------
William Ashley Turner
Director
60
EXHIBIT INDEX
Exhibit No. Description of Exhibit
----------- ---------------------------------------------------------------------------------
2(1) Agreement and Plan of Reorganization
and Merger by and between Four Oaks
Bank & Trust Company and Four Oaks
Fincorp, Inc. dated February 24, 1997
3.1 Articles of Incorporation of Four Oaks Fincorp, Inc. including Articles of
Amendment to Articles of Incorporation
3.2(1) Bylaws of Four Oaks Fincorp, Inc.
4(1) Specimen of Certificate for Four Oaks Fincorp, Inc. Common Stock
10.1(2)* Employment Agreement with Ayden R. Lee, Jr.
10.2(2)* Severance Compensation Agreement with Ayden R. Lee, Jr.
10.3(3)* Amended and Restated Nonqualified Stock Option Plan
10.4(3)* Amended and Restated Employee Stock Purchase and Bonus Plan
10.5(4)* Amended and Restated Dividend Reinvestment and Stock Purchase Plan
10.6(5)* Four Oaks Bank & Trust Company Supplemental Executive
Retirement Plan
10.7(6)* Employment Agreement with Clifton L. Painter
10.8(7)* Severance Compensation Agreement with Clifton L. Painter
10.9(8)* Executive Employment Agreement with W. Leon Hiatt, III
10.10(8)* Severance Compensation Agreement with W.Leon Hiatt, III
10.11(8)* Executive Employment Agreement with Nancy S. Wise
10.12(8)* Severance Compensation Agreement with Nancy S. Wise
10.13(9)* Form of Stock Option Agreement (Non-Employee Director)
10.14(9)* Form of Stock Option Agreement (Employee)
10.15* Executive Employment Agreement with Jeff D. Pope
10.16* Severance Compensation Agreement with Jeff D. Pope
21 Subsidiaries of Four Oaks Fincorp, Inc.
23 Consent of Dixon Hughes PLLC
31.1 Certification of Chief Executive Officer Pursuant to Rule 13a-14/15d-14 as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer Pursuant to Rule 13a-14/15d-14 as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
-----------------------
*Management Contract or Compensatory Plan
(1) Filed as an exhibit to the Current Report on Form 8-K12G3 filed with the SEC on July 2, 1997
and incorporated herein by reference.
(2) Filed as an exhibit to the Quarterly Report on Form 10-Q for the period ended June 30, 1997
and incorporated herein by reference.
(3) Filed as an exhibit to the Quarterly Report on Form 10-Q for the period ended June 30, 2004
and incorporated herein by reference.
(4) Filed as an exhibit to the Current Report on Form 8-K filed with the SEC on September 9, 2004 and
incorporated herein by reference.
(5) Filed as an exhibit to the Annual Report on Form 10-KSB for the period ended December 31, 1998 and
incorporated herein by reference.
(6) Filed as an exhibit to the Annual Report on Form 10-KSB for the period ended December 31, 2001 and
incorporated herein by reference.
(7) Filed as an exhibit to the Annual Report on Form 10-KSB for the period ended December 31, 2002 and
incorporated herein by reference.
(8) Filed as an exhibit to the Annual Report on Form 10-KSB for the period ended December 31, 2003 and
incorporated herein by reference.
(9) Filed as an exhibit to the Current Report on Form 8-K filed with the SEC on March 1, 2005 and
incorporated herein by reference.
(b) See (a)(3) above.
(c) See (a)(2) above.
61