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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------------
FORM 10-Q
Quarterly report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2004
Commission File Number 0-23971
Citizens South Banking Corporation
(Exact name of registrant as specified in its charter)
Delaware 54-2069979
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
519 South New Hope Road, Gastonia, North Carolina 28054-4040
(Address of principal executive offices)
Registrant's telephone number, including area code: (704)-868-5200
Indicate by check |X| whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check whether the Registrant is an accelerated filer. Yes |X|
No |_|
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
Common stock, $0.01 par value
7,484,544 shares outstanding as of August 5, 2004.
Citizens South Banking Corporation
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements............................ 1
Consolidated Statements of Financial Condition
June 30, 2004 and December 31, 2003 ......................... 1
Consolidated Statements of Operations
three months and six months ended June 30, 2004 and 2003 ....... 2
Consolidated Statements of Comprehensive Income
six months ended June 30, 2004 and 2003......................... 3
Consolidated Statements of Changes in Stockholders' Equity
six months ended June 30, 2004 and 2003......................... 4
Consolidated Statements of Cash Flows
six months ended June 30, 2004 and 2003......................... 5
Notes to Consolidated Financial Statements.......................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk..... 16
Item 4. Controls and Procedures....................................... 16
PART II. OTHER INFORMATION.................................................. 16
SIGNATURES.................................................................. 19
Exhibit 31.1 Certification of Chief Executive Officer Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002............. 20
Exhibit 31.2 Certification of Chief Financial Officer Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002............. 21
Exhibit 32.1 Statement of Chief Executive Officer Furnished Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002............. 22
Exhibit 32.2 Statement of Chief Financial Officer Furnished Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002............. 23
PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements
Citizens South Banking Corporation
Consolidated Statements of Financial Condition
(dollars in thousands, except per share data)
June 30, December 31,
2004 2003
----------- ------------
(unaudited)
Assets:
Cash and due from banks ..................................................... $ 6,455 $ 5,374
Interest-earning bank balances .............................................. 19,675 2,840
--------- ---------
Cash and cash equivalents ................................................ 26,130 8,214
Investment securities available-for-sale, at fair value ..................... 54,646 56,233
Mortgage-backed and related securities available-for-sale, at fair value .... 73,524 89,168
Loans receivable, net of unearned income .................................... 300,247 297,995
Allowance for loan losses ................................................... (2,902) (2,969)
--------- ---------
Loans, net ............................................................... 297,345 295,026
Real estate owned ........................................................... 79 145
Accrued interest receivable ................................................. 1,557 1,943
Premises and equipment, net ................................................. 17,390 14,939
Federal Home Loan Bank stock ................................................ 2,550 2,915
Cash value of bank-owned life insurance policies ............................ 12,639 12,317
Intangible assets ........................................................... 7,763 7,985
Other assets ................................................................ 6,963 6,866
--------- ---------
Total assets ............................................................. $ 500,586 $ 495,751
========= =========
Liabilities and Stockholders' Equity:
Demand deposit accounts ..................................................... $ 48,027 $ 43,686
Money market deposit accounts ............................................... 60,112 48,189
Savings accounts ............................................................ 32,420 36,754
Time deposits ............................................................... 230,141 213,817
--------- ---------
Total deposits ........................................................... 370,700 342,446
Borrowed money .............................................................. 51,772 58,981
Deferred compensation ....................................................... 5,651 6,165
Other liabilities ........................................................... 736 490
--------- ---------
Total liabilities ........................................................ 428,859 408,082
Common stock, $0.01 par value, 20,000,000 shares authorized, 9,062,727
shares issued and outstanding at June 30, 2004 and December 31, 2003 ..... 91 91
Additional paid-in-capital .................................................. 68,280 68,280
Unallocated common stock held by Employee Stock Ownership Plan .............. (1,887) (1,979)
Retained earnings, substantially restricted ................................. 29,679 28,824
Accumulated unrealized loss on securities available-for-sale, net of tax .... (1,955) (40)
Unearned compensation related to Recognition and Retention Plan ............. (1,712) (1,979)
Treasury stock of 1,540,683 shares at June 30, 2004, and 392,414 shares
at December 31, 2003, at cost ............................................. (20,769) (5,528)
--------- ---------
Total stockholders' equity ............................................... 71,727 87,669
--------- ---------
Total liabilities and stockholders' equity ............................... $ 500,586 $ 495,751
========= =========
See accompanying notes to consolidated financial statements.
1
Citizens South Banking Corporation
Consolidated Statements of Operations (unaudited)
(in thousands, except per share data)
Three Months Six Months
Ended June 30, Ended June 30,
2004 2003 2004 2003
---------- ---------- ---------- ----------
Interest Income:
Loans ....................................................... $ 3,836 $ 4,364 $ 7,722 $ 8,833
Investment securities ....................................... 472 272 957 689
Interest-bearing deposits ................................... 46 73 66 162
Mortgage-backed and related securities ...................... 641 936 1,419 1,864
---------- ---------- ---------- ----------
Total interest income ..................................... 4,995 5,645 10,164 11,548
Interest Expense:
Deposits .................................................... 1,461 1,693 2,887 3,434
Borrowed funds .............................................. 450 593 895 1,180
---------- ---------- ---------- ----------
Total interest expense .................................... 1,911 2,286 3,782 4,614
---------- ---------- ---------- ----------
Net interest income ......................................... 3,084 3,359 6,382 6,934
Provision for loan losses ................................... 30 15 60 30
---------- ---------- ---------- ----------
Net interest income after provision for loan losses ....... 3,054 3,344 6,322 6,904
Noninterest Income:
Fee income on deposit accounts .............................. 553 525 1,183 1,008
Income on mortgage banking and other lending activities ..... 185 287 279 553
Dividends on FHLB stock ..................................... 22 27 46 58
Gain on sale of assets ...................................... 180 45 470 60
Fair value adjustment on deferred compensation assets ...... (37) 156 35 187
Other noninterest income .................................... 262 242 498 447
---------- ---------- ---------- ----------
Total noninterest income .................................. 1,165 1,282 2,511 2,313
Noninterest Expense:
Compensation and benefits ................................... 1,539 1,498 3,096 2,986
Vesting expense for Recognition and Retention Plan .......... 81 0 267 0
Fair value adjustment on deferred compensation assets ....... (37) 156 35 187
Occupancy and equipment expense ............................. 400 318 782 643
Professional services ....................................... 125 211 236 332
Amortization of intangible assets ........................... 104 126 221 272
Loss on sale of assets ...................................... 0 3 0 13
Other noninterest expense ................................... 650 743 1,456 1,331
---------- ---------- ---------- ----------
Total noninterest expense ................................. 2,862 3,055 6,093 5,764
Income before income taxes .................................. 1,357 1,571 2,740 3,453
Provision for income taxes .................................. 409 447 831 1,122
---------- ---------- ---------- ----------
Net income .................................................. $ 948 $ 1,124 $ 1,909 $ 2,331
========== ========== ========== ==========
Basic earnings per share .................................... $ 0.12 $ 0.13 $ 0.24 $ 0.27
Diluted earnings per share .................................. $ 0.12 $ 0.13 $ 0.24 $ 0.26
Basic average common shares outstanding ..................... 7,780,751 8,660,195 8,024,668 8,708,740
Diluted average common shares outstanding ................... 7,891,635 8,808,915 8,117,736 8,840,222
See accompanying notes to consolidated financial statements.
2
Citizens South Banking Corporation
Consolidated Statements of Comprehensive Income (unaudited)
(dollars in thousands)
Six Months Ended
June 30,
2004 2003
-------- --------
Net income ................................................................ $ 1,909 $ 2,331
Other comprehensive income, net of tax:
Unrealized gains on securities available for sale:
Unrealized holding gains (losses) arising during period ........... (1,625) 152
Reclassification adjustment for (gains) included in net income .... (290) (27)
-------- --------
Other comprehensive income ............................................ (1,915) 125
-------- --------
Comprehensive income (loss) ............................................... $ (6) $ 2,456
-------- --------
See accompanying notes to consolidated financial statements.
3
Citizens South Banking Corporation
Consolidated Statements of Changes in Stockholders' Equity (unaudited)
(dollars in thousands)
Six Months Ended
June 30,
2004 2003
-------- --------
Common stock:
At beginning of period ........................................................ $ 91 $ 91
Issuance of common stock ...................................................... 0 0
-------- --------
At end of period .............................................................. 91 91
-------- --------
Additional paid-in-capital:
At beginning of period ........................................................ 68,280 68,176
Allocation from shares purchased with loan from ESOP .......................... 0 3
Exercise of options ........................................................... 0 125
-------- --------
At end of period .............................................................. 68,280 68,304
-------- --------
Unallocated common stock held by ESOP:
At beginning of period ........................................................ (1,979) (2,161)
Allocation from shares purchased with loan from ESOP .......................... 92 91
-------- --------
At end of period .............................................................. (1,887) (2,070)
-------- --------
Retained earnings, substantially restricted:
At beginning of period ........................................................ 28,824 28,739
Net income .................................................................... 1,909 2,331
Cash dividends declared on common stock ....................................... (1,054) (1,079)
-------- --------
At end of period .............................................................. 29,679 29,991
-------- --------
Accumulated unrealized gain on securities available for sale, net of tax:
At beginning of period ........................................................ (40) 1,538
Other comprehensive results, net of tax ....................................... (1,915) 125
-------- --------
At end of period .............................................................. (1,955) 1,663
-------- --------
Unearned compensation related to Recognition and Retention Plan:
At beginning of period ........................................................ (1,979) 0
Vesting of shares for plan .................................................... 267 0
-------- --------
At end of period .............................................................. (1,712) 0
-------- --------
Treasury Stock:
At beginning of period ........................................................ (5,528) 0
Repurchase of common stock .................................................... (15,241) (2,723)
-------- --------
At end of period .............................................................. (20,769) (2,723)
-------- --------
See accompanying notes to consolidated financial statements.
4
Citizens South Banking Corporation
Consolidated Statements of Cash Flows (unaudited)
(dollars in thousands)
Six Months Ended
June 30,
2004 2003
-------- --------
Cash flows from operating activities:
Net income .......................................................................... $ 1,909 $ 2,331
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses ....................................................... 60 30
Depreciation .................................................................... 446 322
Gain on sale of investments, available for sale ................................. (454) (42)
Gain on sale of other assets .................................................... (16) (5)
Purchase of bank-owned life insurance ........................................... 0 (3,000)
Deferred loan origination fees .................................................. (16) (83)
Allocation of shares to the ESOP ................................................ 92 91
Vesting of shares for the Recognition and Retention Plan ........................ 267 0
(Increase) decrease in accrued interest receivable .............................. 386 84
Amortization of intangible assets ............................................... 221 272
Decrease in other assets ........................................................ 878 (314)
Decrease in other liabilities ................................................... (746) 313
-------- --------
Net cash provided by (used for) operating activities .......................... 3,027 (1)
Cash flows from investing activities:
Net (increase) decrease in loans receivable ......................................... (2,362) 1,202
Proceeds from the sale of investment securities ..................................... 2,266 7,000
Proceeds from the sale of mortgage-backed securities ................................ 6,432 525
Proceeds from the sale of other assets .............................................. 25 1,040
Maturities and prepayments of investment securities ................................. 12,184 10,008
Maturities and prepayments of mortgage-backed securities ............................ 11,948 12,037
Purchases of investments ............................................................ (14,292) (6,850)
Purchases of mortgage-backed securities ............................................. (4,000) (37,779)
(Purchase) sale of FHLB stock ....................................................... 365 65
Capital expenditures for premises and equipment ..................................... (2,906) (4,428)
-------- --------
Net cash provided by (used for) investment activities ......................... 9,660 (17,180)
Cash flows from financing activities:
Net increase in deposits ............................................................ 28,255 4,152
Exercise of options ................................................................. 0 125
Dividends paid to stockholders ...................................................... (1,054) (1,079)
Repurchase of common stock .......................................................... (15,241) (2,723)
Net increase (decrease) in borrowed money ........................................... (7,244) 5,096
Increase in advances from borrowers for insurance and taxes ......................... 513 469
-------- --------
Net cash provided by (used for) financing activities .......................... 5,229 6,040
Net increase (decrease) in cash and cash equivalents .................................. 17,916 (11,141)
Cash and cash equivalents at beginning of period ...................................... 8,214 46,999
-------- --------
Cash and cash equivalents at end of period ............................................ $ 26,130 $ 35,858
======== ========
See accompanying notes to consolidated financial statements.
5
CITIZENS SOUTH BANKING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Basis of Presentation
In management's opinion, the accompanying consolidated financial
statements, which are unaudited, reflect all adjustments, consisting solely of
normal recurring accruals, necessary for a fair presentation of the financial
information as of and for the three- and six-month periods ended June 30, 2004
and 2003, in conformity with accounting principles generally accepted in the
United States of America. Results for the three and six months ended June 30,
2004, are not necessarily indicative of the results that may be expected for the
year ending December 31, 2004.
The consolidated financial statements include the accounts of Citizens
South Banking Corporation (the "Company") and the Company's wholly-owned
subsidiary, Citizens South Bank (the "Bank").
The organization and business of the Company, accounting policies
followed, and other related information are contained in the notes to the
consolidated financial statements of the Company as of December 31, 2003 and
2002, and for the years ended December 31, 2003, 2002, and 2001, filed as part
of the Company's annual report on Form 10-K. These consolidated financial
statements should be read in conjunction with the annual consolidated financial
statements.
The Company's critical accounting policy relates to the evaluation of the
allowance for loan losses, which is based on management's opinion of losses in
the Company's existing portfolio. The allowance for loan losses is established
through a provision for loan losses based on available information including the
composition of the loan portfolio, historical loan losses, specific impaired
loans, availability and quality of collateral, age of the various portfolios,
changes in local economic conditions, and loan performance and quality of the
portfolio. Different assumptions used in establishing the Company's allowance
for loan losses could result in material changes in the Company's consolidated
financial condition or consolidated results of operations. The Company's
policies with respect to the methodology for determining the allowance for loan
losses involve a higher degree of complexity and require management to make
subjective judgments that often require assumptions or estimates about uncertain
matters. These critical policies and their assumptions are periodically reviewed
with the Board of Directors.
In accordance with the Statement of Financial Accounting Standards
("SFAS") No. 123, Accounting for Stock-Based Compensation, as amended by SFAS
No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure -
An Amendment of FASB Statement No. 123, the Company has adopted the
disclosure-only option and elected to apply the provisions of APB No. 25 for
financial statement purposes. As such, no stock-based employee compensation cost
is reflected in net income for the Company's stock option plans.
Pro forma information regarding net income and earnings per share have
been determined as if the Company had accounted for its employee stock options
using the fair value method, and is presented in the following table.
6
Three months ended Six months ended
June 30, June 30,
-------------------- --------------------
2004 2003 2004 2003
---- ---- ---- ----
Net income (in thousands):
As reported $ 948 $ 1,124 $ 1,909 $ 2,331
Deduct: Total stock-based employee
compensation cost determined under
the fair value method, net of tax 16 (85) 28 (117)
-------- -------- -------- --------
Pro forma $ 932 $ 1,039 $ 1,881 $ 2,214
-------- -------- -------- --------
Basic earnings per share:
As reported $ 0.12 $ 0.13 $ 0.24 $ 0.27
Pro forma $ 0.12 $ 0.12 $ 0.23 $ 0.25
Diluted earnings per share:
As reported $ 0.12 $ 0.13 $ 0.24 $ 0.26
Pro forma $ 0.12 $ 0.12 $ 0.23 $ 0.25
The fair value of each option grant is estimated on the date of the grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions used for the six-month periods ended June 30, 2004 and 2003:
dividend yield of 2.0%, expected volatility of 30%, risk-free investment rate of
3.5%, and expected lives of seven years.
Note 2 - Use of Estimates
The financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America which require
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
Note 3 - Earnings per Share
Earnings per share has been determined under the provisions of SFAS No.
128, Earnings Per Share. The only potential stock of the Company, as defined in
SFAS No. 128, Earnings Per Share, is stock options granted to various directors
and officers of the Bank. The following is a summary of the diluted earnings per
share calculation for the six months ended June 30, 2004 and 2003 (dollars in
thousands, except per share data):
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ ------------------------
2004 2003 2004 2003
---- ---- ---- ----
Net income ............................. $ 948 $ 1,124 $ 1,909 $ 2,331
Weighted average outstanding shares .... 7,780,751 8,660,195 8,024,668 8,708,740
Dilutive effect of stock options ....... 110,884 148,720 93,068 131,482
---------- ---------- ---------- ----------
Weighted average diluted shares ........ 7,891,635 8,808,915 8,117,736 8,840,222
Diluted earnings per share ............. $ 0.12 $ 0.13 $ 0.24 $ 0.26
7
Note 4 - Dividend Declaration
On July 19, 2004, the Board of Directors of the Company approved and
declared a regular cash dividend of six and one-half cents per share of common
stock to stockholders of record as of August 1, 2004, and payable on August 15,
2004.
Note 5 - Stock Repurchase Program
On May 17, 2004, the Board of Directors of the Company authorized the
repurchase of up to 815,000 shares, or approximately 10% of the Company's
outstanding shares of common stock. The stock repurchase program may be carried
out through open market purchases, block trades, and negotiated private
transactions. The stock may be repurchased on an ongoing basis and will be
subject to the availability of stock, general market conditions, the trading
price of the stock, alternative uses for capital, and the Company's financial
performance. As of June 30, 2004, management had repurchased a total of 636,000
shares at an average price of $13.03 per share and had 179,000 shares remaining
to be repurchased under this plan. Management will consider repurchasing
additional shares of common stock of the Company at prices that are considered
to be attractive and in the best interests of both the Company and its
stockholders. Any repurchased shares will be held as treasury stock and will be
available for general corporate purposes.
In October 2003, the Company authorized the repurchase of up to 879,900
shares, or approximately 10% of the outstanding shares. This repurchase program
was completed in May 2004, with the repurchase of 877,235 shares at an average
price of $13.80. Also, in March 2003 the Company authorized the repurchase of up
to 343,027 shares, or approximately 3.8% of the outstanding shares. This program
was completed in September 2003, with the repurchase of 342,200 shares at an
average price of $13.66.
Note 6 - Impact of Recently Issued Accounting Standards
In March 2004, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 105, Application of Accounting Principles to Loan
Commitments. This Staff Accounting Bulletin summarizes the views of the staff
regarding the application of accounting principles generally accepted in the
United States of America to loan commitments accounted for as derivative
instruments. The provisions of this Staff Accounting Bulletin are effective
after March 31, 2004. The adoption of this Staff Accounting Bulletin did not
have a material impact on the consolidated financial statements of the Company.
8
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward Looking Statements
From time to time, the Company may publish forward looking statements
relating to such matters as anticipated financial performance, business
prospects, technological developments, new products, and similar matters. The
Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward looking statements provided that the Company notes that a variety of
factors could cause the Company's actual results to differ materially from the
anticipated results expressed in the Company's forward looking statements.
Factors that may cause actual results to differ materially from those projected
in the forward looking statements include, but are not limited to, general
economic conditions that are less favorable than expected, changes in market
interest rates that result in reduced interest margins, risks in the loan
portfolio, including prepayments, are greater than expected, legislation or
regulatory changes that have a less than favorable impact on the business of the
Company are enacted, and competitive pressures increase significantly.
Statements included in this report should be read in conjunction with the
Company's Annual Report on Form 10-K, which is incorporated into this discussion
by this reference. Forward looking statements speak only as of the date they are
made and the Company does not undertake to update forward looking statements to
reflect circumstances or events that occur after the date of the forward looking
statements or to reflect the occurrence of unanticipated events. Accordingly,
past results and trends should not be used by investors to anticipate future
results or trends.
Comparison of Financial Condition
Assets. Total assets of the Company increased by $4.8 million, or 1.0%,
from $495.8 million as of December 31, 2003, to $500.6 million as of June 30,
2004. This increase in assets was primarily funded from a $28.3 million increase
in deposits, the effects of which were offset by the repayment of $7.2 million
in borrowed funds and the repurchase of 1.1 million shares of the Company's
common stock for $15.2 million. During the six-month period cash and cash
equivalents increased by $17.9 million, or 218.1%, to $26.1 million. Management
expects to use this excess liquidity to repurchase common stock, to increase the
origination of loans for portfolio, and to purchase short-term investment and
mortgage-backed securities. Also during the period, mortgage-backed securities
decreased $15.6 million, or 17.5%, to $73.5 million and investment securities
decreased by $1.6 million, or 2.8%, to $54.6 million. During the six-month
period, the Company sold $6.4 million in mortgage-backed securities and $2.3
million in investment securities in order to reduce the Company's level of
interest rate risk and to generate gains to offset the expense from the vesting
of a portion of the shares of stock issued by the Company's Recognition and
Retention Plan approved by shareholders in 2003. Also, during the period, the
Company had $12.1 million in investments that either matured or were called, the
effects of which were offset by purchases of $14.3 million. The Company also
purchased $4.0 million in mortgage-backed securities and received an additional
$11.9 million in principal payments on mortgage-backed securities.
Outstanding loans increased by $2.3 million, or 0.8%, to $297.3 million at
June 30, 2004, as the origination of commercial and consumer loans began to
outpace prepayments of residential mortgage loans. From December 31, 2003, to
June 30, 2004, the percentage of residential mortgage loans to gross loans
decreased from 38.3% to 31.8%. Management will seek to continue to grow the
commercial and consumer loan portfolios in a safe and sound manner with an
emphasis on adjustable-rate loans or shorter-term fixed rate loans. Management
believes that these short-term and adjustable-rate commercial and consumer loans
will have a positive impact on the Company's net interest margin as interest
rates begin to increase.
Allowance for loan losses and nonperforming assets. The Company has
established a systematic methodology for determining the adequacy of the
allowance for loan losses. This methodology is set forth in a formal policy and
considers all loans in the portfolio. Specific allowances are established for
certain individual
9
loans that management considers impaired. The remainder of the portfolio is
segmented into groups of loans with similar risk characteristics for evaluation
and analysis. Management's periodic evaluation of the allowance is consistently
applied and based on inherent losses in the portfolio, past loan loss
experience, risks inherent in the different types of loans, the estimated value
of any underlying collateral, current economic conditions, the borrower's
financial position, and other relevant internal and external factors that may
affect loan collectibility. The allowance for loan losses is increased by
charging provisions for loan losses against income. As of June 30, 2004, the
allowance for loan losses amounted to $2.9 million. Management believes that
this amount meets the requirement for losses on loans that management considers
to be impaired, for known losses, and for incurred losses inherent in the
remaining loan portfolio. Although management believes that it uses the best
information available to make such determinations, future adjustments to the
allowance for loan losses may be necessary and results of operations could be
significantly adversely affected if circumstances differ substantially from the
assumptions used in making the determinations. The following table presents an
analysis of changes in the allowance for loan losses for the periods and
information with respect to nonperforming assets at the dates indicated.
At and For the Three At and For the Six
Months Ended June 30, Months Ended June 30,
--------------------- ---------------------
2004 2003 2004 2003
---- ---- ---- ----
(dollars in thousands) (dollars in thousands)
Allowance for loan losses:
Beginning of period ................. $ 2,998 $ 3,000 $ 2,969 $ 2,995
Add:
Provision for loan losses ....... 30 15 60 30
Recoveries ...................... 0 0 1 2
Less:
Charge-offs ..................... 126 13 128 25
-------- -------- -------- --------
End of period ....................... $ 2,902 $ 3,002 $ 2,902 $ 3,002
Nonaccrual loans .................... $ 928 $ 802 $ 928 $ 802
Real estate owned ................... 79 146 79 146
-------- -------- -------- --------
Nonperforming assets ................ $ 1,007 $ 948 $ 1,007 $ 948
Allowance for loan losses as a
percentage of total loans ...... 0.97% 0.98% 0.97% 0.98%
Nonperforming loans to
total loans .................... 0.31% 0.26% 0.31% 0.26%
Nonperforming assets to
total assets .................. 0.20% 0.19% 0.20% 0.19%
Liabilities. Total liabilities increased by $20.8 million, or 5.1%, from
$408.1 million as of December 31, 2003, to $428.9 million as of June 30, 2004.
This increase was primarily due to a $28.3 million, or 8.3%, increase in total
deposits, the effects of which were partly offset by a $7.2 million, or 12.2%,
decrease in borrowed funds. Growth in core deposits (checking accounts, savings
accounts, and money market accounts) was strong during the six-month period,
with such accounts increasing by $11.9 million, or 9.3%, to $140.6 million. This
was primarily due to an aggressive marketing campaign directed at increasing the
Company's number of checking account customers. Management will continue to
focus on increasing the Company's core deposits in both the retail and
commercial sectors. Time deposits increased during the six-month period by $16.3
million, or 7.6%, to $230.1 million. This increase was largely due to a
marketing campaign commemorating the Company's 100th anniversary, which was used
to secure deposits for one to two years at the current interest rates in
anticipation of
10
higher interest rates in the near future. During the six-month period, the
Company reduced its outstanding borrowed funds by $7.2 million. This reduction
was primarily due to the repayment of Federal Home Loan Bank daily rate advances
that were used to fund an increase in loan demand at the end of 2003. These
Federal Home Loan Bank advances were repaid from proceeds received from the
increase in local deposits.
Stockholders' Equity. Total stockholders' equity decreased by $15.9
million, or 18.2%, from $87.6 million as of December 31, 2003, to $71.7 million
as of June 30, 2004. The decrease in stockholders' equity was primarily due to
the repurchase of 1,160,000 shares of common stock for $15.3 million, at an
average cost of $13.14 per share. In October 2003, the Company authorized the
repurchase of up to 879,900 shares, or approximately 10% of the outstanding
shares of common stock. This repurchase program was completed in May 2004 and
the Board of Directors of the Company subsequently authorized the repurchase of
an additional 815,000 shares, or approximately 10% of the Company's outstanding
shares of common stock. As of June 30, 2004, management had repurchased a total
of 636,000 shares under the current program at an average price of $13.03 per
share and had 179,000 shares remaining to be repurchased. Management will
consider repurchasing additional shares of common stock of the Company at prices
that are considered to be attractive and in the best interests of both the
Company and its stockholders. Any repurchased shares will be held as treasury
stock and will be available for general corporate purposes. In addition, the
Company paid cash dividends totaling $1.1 million during the six-month period,
representing $0.13 per share, and posted a $1.9 million increase in unrealized
losses on available for sale securities due to an increase in market interest
rates. These decreases in equity were partially offset by $1.9 million in
earnings during the period.
Comparison of Results of Operations for the Three Months Ended June 30, 2004 and
2003
General. Net income for the Company for the three months ended June 30,
2004, amounted to $948,000, or $0.12 per diluted share, as compared to $1.1
million, or $0.13 per diluted share, for the three months ended June 30, 2003.
Net interest income. Net interest income decreased by $275,000, or 8.2%,
to $3.1 million for the three months ended June 30, 2004. Interest income
decreased by $650,000, or 11.5%, primarily as a result of a 50 basis point, or
9.9%, decrease in the average yield on earning assets to 4.55%. The decrease in
yield was primarily due to a 50 basis point decrease in the prime lending rate
at the end of the second quarter of 2003. In addition, the average outstanding
balance of interest earning assets decreased by $8.7 million, or 1.9%, to $446.0
million. This decrease in average interest earning assets related to the
Company's funding of the repurchase of $22.3 million shares of the Company's
common stock. Interest expense decreased by $375,000, or 16.4%, between the
periods. This reduction in interest expense was due to a 46 basis point, or
19.2%, reduction in the average cost of funds to 1.93%. This decrease in the
cost of funds was partially offset by a $12.2 million, or 3.2%, increase in the
average balance of interest-bearing liabilities to $395.6 million. Average
interest-bearing liabilities increased primarily as a result of a $10.7 million
increase in average core deposits (checking accounts, savings accounts, and
money market accounts). The net interest margin for the Company was 2.47% for
the quarter ended June 30, 2004, compared to 2.69% for the quarter ended June
30, 2003. This decrease was primarily the result of an increased level of
mortgage loan refinancings and decreases in the yield on prime-based consumer
and commercial loans.
Provision for loan losses. The provision for loan losses amounted to
$30,000 for the three months ended June 30, 2004, compared to $15,000 for the
three months ended June 30, 2003. The allowance for loan losses has remained
relatively stable at $2.9 million, or 0.97% of total loans, as of June 30, 2004,
compared to $3.0 million, or 0.98% as of June 30, 2003. While the Company
continued to emphasize commercial and consumer loans, in addition to residential
mortgage loans, the Company's ratio of nonperforming loans to total loans
remains below our peer group average, at 0.31% of total loans on June 30, 2004,
compared to 0.26% of total loans on June 30, 2003.
11
Noninterest income. Noninterest income decreased to $1.1 million for the
three months ended June 30, 2004, as compared to $1.3 million for the three
months ended June 30, 2003. This represented a decrease of $117,000, or 9.1%.
This decrease was primarily due to a $193,000 fair value adjustment on deferred
compensation assets, the effects of which are offset by a corresponding decrease
in compensation expense. Also, the Company experienced a $102,000, or 35.5 %,
decrease in fees generated from mortgage brokerage and other lending activities.
Mortgage banking activity has decreased due to higher interest rates resulting
in fewer residential loan originations. Management expects that the level of
residential loan originations in 2004 will continue to be significantly less
than the 2003 level. The decreases in noninterest income were partly offset by a
$28,000, or 5.3%, increase in fee income on deposit accounts and a $20,000, or
8.3%, increase in other income. Fee income on deposits improved due to an
increased number of deposit customers. Management has focused on growing the
number of deposit customers and increasing the number of banking products used
by existing customers. The increase in other income was primarily due to a
$28,000 increase in the cash value of bank-owned life insurance, resulting from
the purchase of an additional $3.0 million in bank-owned life insurance in 2003
During the quarter ended June 30, 2004, the Company recognized a gain of
$180,000 on the sale of $1.0 million in investment securities and a small parcel
of real estate owned. The purpose of the sales was to generate sufficient gains
to offset the $81,000 expense from the vesting of shares of stock issued to a
retiring Director through the Company's Recognition and Retention Plan approved
by stockholders in 2003. During the quarter ended June 30, 2003, the Company
recognized a gain of $45,000 on the sale of $5.0 million in investment
securities.
Noninterest expense. Noninterest expense decreased from $3.1 million for
the quarter ended June 30, 2003, to $2.9 million for the quarter ended June 30,
2004. This represents a decrease of $193,000, or 6.3%. This decrease was partly
due to a $193,000 reduction in the fair value adjustment on deferred
compensation assets, the effects of which were offset by a corresponding
decrease in noninterest income. In addition, the Company experienced an $86,000,
or 40.8%, decrease in professional services, a $22,000, or 17.5%, decrease in
the amortization of intangible assets, and a $93,000, or 12.5%, reduction in
other noninterest expenses. These decreases were partly offset by an $81,000
expense from the vesting of a portion of the stock issued to a retiring Director
through the Company's Recognition and Retention Plan. Also, the Company
experienced increases of $41,000, or 2.7%, in compensation and benefits and
$82,000, or 25.8%, in occupancy and equipment expense. These expenses increased
due, in part, to the opening of the Company's tenth full-service office in the
second quarter of 2003, and the relocation of an existing office in the second
quarter of 2004.
Income taxes. Income taxes amounted to $409,000, or 30.1% of taxable
income, for the quarter ended June 30, 2004, as compared to $447,000, or 28.5%
of taxable income, for the quarter ended June 30, 2003. This reduction in income
taxes is primarily due to a $214,000 decrease in net income before taxes.
12
Comparison of Results of Operations for the Six Months Ended June 30, 2004 and
2003
General. Net income for the Company for the six months ended June 30,
2004, amounted to $1.9 million, or $0.24 per diluted share, as compared to $2.3
million, or $0.26 per diluted share, for the six months ended June 30, 2003.
Net interest income. Net interest income decreased by $552,000, or 8.0% to
$6.4 million for the six months ended June 30, 2004. Interest income decreased
by $1.4 million, or 12.0%, primarily as a result of a 52 basis point, or 10.1%,
decrease in the average yield on earning assets to 4.65%. The decrease in yield
was primarily due to a 50 basis point decrease in the prime lending rate during
the second quarter of 2003. In addition, the average outstanding balance of
interest earning assets decreased by $11.1 million, or 2.4%, to $442.9 million.
This decrease in average interest earning assets related to the Company's
funding of the repurchase of $22.3 million of shares of common stock. Interest
expense decreased by $833,000, or 18.1%, during the period. This reduction in
interest expense was due to a 51 basis point, or 20.7%, reduction in the average
cost of funds to 1.95%. This decrease in the cost of funds was partially offset
by a $10.2 million, or 2.7%, increase in the average balance of interest-bearing
liabilities to $389.3 million. Average interest-bearing liabilities increased
primarily as a result of an $11.1 million increase in average core deposits
(checking accounts, savings accounts, and money market accounts). The net
interest margin for the Company was 2.58% for the six months ended June 30,
2004, compared to 2.79% for the six months ended June 30, 2003. This decrease
was primarily the result of an increased level of mortgage loan refinancings and
decreases in the yield on prime-based consumer and commercial loans.
Provision for loan losses. The provision for loan losses amounted to
$60,000 for the six months ended June 30, 2004, compared to $30,000 for the six
months ended June 30, 2003. The allowance for loan losses has remained
relatively stable at $2.9 million, or 0.97% of total loans, as of June 30, 2004,
compared to $3.0 million, or 0.98% as of June 30, 2003. While the Company
continued to emphasize commercial and consumer loans, in addition to residential
mortgage loans, the Company's ratio of nonperforming loans to total loans
remains below our peer group average, at 0.31% of total loans on June 30, 2004,
compared to 0.26% of total loans on June 30, 2003.
Noninterest income. Noninterest income increased to $2.5 million for the
six months ended June 30, 2004, as compared to $2.3 million for the six months
ended June 30, 2003. This represented an increase of $198,000, or 8.6%. This
increase was partly due to a $175,000, or 17.4%, increase in fee income on
deposit accounts and a $51,000, or 11.4%, increase in other noninterest income.
Fee income on deposits improved due to an increased number of deposit customers.
Management has focused on growing the number of deposit customers and increasing
the number of banking products used by existing customers. The increase in other
noninterest income was primarily due to a $73,000, or 28.6%, increase in the
cash value of bank-owned life insurance policies as a result of the purchase of
an additional $3.0 million in such policies during 2003. Fee income from
mortgage brokerage and other lending activities decreased by $274,000, or 49.6 %
due to lower levels of residential loan originations during 2004. Management
expects that the level of residential loan originations in 2004 will continue to
be significantly less than the 2003 level. Also, during the period, the fair
value adjustment on deferred compensation assets decreased by $152,000, the
effects of which were offset by a corresponding decrease in compensation
expense.
During the six months ended June 30, 2004, the Company recognized a gain
of $470,000 on the sale of $2.3 million in investment securities and $6.4
million in mortgage-backed securities. The purpose of the sale was to offset the
expense from the vesting of a portion of the shares of stock issued by the
Company's Recognition and Retention Plan approved by the shareholders in 2003
and to reduce the Company's level of interest rate risk. During the six months
ended June 30, 2003, the Company recognized a gain of $60,000 resulting from the
sale of $5.0 million in investment securities.
13
Noninterest expense. Noninterest expense amounted to $6.1 million for the
six months ended June 30, 2004, compared to $5.8 million for the six months
ended June 30, 2003, representing an increase of $329,000, or 5.7%. This
increase was partly due to the $267,000 expense from the vesting of a portion of
the stock issued through the Company's Recognition and Retention Plan. Also,
compensation increased by $110,000, or 3.7%, and occupancy and equipment expense
increased by $139,000, or 21.6%, due in part to the opening of the Company's
tenth full-service office in the second quarter of 2003, and the relocation of
an existing office in the second quarter of 2004. These increases were offset,
in part, by a $96,000, or 28.9%, decrease in professional services and a
$51,000, or 18.8%, reduction in amortization of core deposit intangible. Also,
the fair value adjustment on deferred compensation assets was $152,000 lower
during the six months ended June 30, 2004, compared to the same period in 2003.
The effects of this reduction were offset by a corresponding decrease of
noninterest income.
Income taxes. Income taxes amounted to $831,000, or 30.3% of taxable
income, for the six months ended June 30, 2004, as compared to $1.1 million, or
32.5% of taxable income, for the six months ended June 30, 2003. This reduction
in income taxes is primarily due to a $713,000 decrease in net income before
taxes. The reduction in the estimated effective rate was due to an increase in
earnings from tax-advantaged assets.
Liquidity, Market Risk, and Capital Resources
The objectives of the Company's liquidity management policy include
providing adequate funds to meet the cash needs of both borrowers and
depositors, to provide for the on-going operations of the Company, and to
capitalize on opportunities for expansion. Liquidity management addresses the
Company's ability to meet deposit withdrawals on demand or at contractual
maturity, to repay borrowings as they mature, and to fund new loans and
investments as opportunities arise. The primary sources of internally generated
funds are principal and interest payments on loans receivable, increases in
local deposits, cash flows generated from operations, and cash flows generated
by investments. If the Company requires funds beyond its internal funding
capabilities, it may rely upon external sources of funds such in brokered
deposits and Federal Home Loan Bank of Atlanta ("FHLB") advances. The Company
has $73.6 million in additional advances available from its line of credit from
the FHLB. The FHLB functions as a central reserve bank providing credit for
member financial institutions. As a member of the FHLB, we are required to own
capital stock in the FHLB and we are authorized to apply for advances on the
security of such stock and certain of our mortgage loans and other assets
(principally securities that are obligations of, or guaranteed by, the U.S.
Government) provided certain creditworthiness standards have been met. Advances
are made pursuant to several different credit programs. Each credit program has
its own interest rate and range of maturities. Depending on the program,
limitations on the amount of advances are based on the financial condition of
the member institution and the adequacy of collateral pledged to secure the
credit. The Company may also solicit brokered deposits for providing funds for
asset growth; however, to date, the Company has not used such deposits to
supplement its liquidity position.
In the normal course of business, various commitments are outstanding that
are not reflected in the consolidated financial statements. Commitments to
extend credit and undisbursed advances on customer lines of credit are
agreements to lend to a customer as long as there is no violation of any
condition established in the contract. The funding of these commitments and
previously approved undisbursed lines of credit could effect the Company's
liquidity position. At June 30, 2004, the Company had loan commitments of $7.2
million and unused lines of credit of $73.2 million. The Company believes that
it has adequate resources to fund loan commitments and lines of credit as they
arise. The Company does not have any special purpose entities or other similar
forms of off-balance sheet financing.
The Company's most significant form of market risk is interest rate risk,
as the Company's assets and liabilities are sensitive to changes in interest
rates. The Company's Asset / Liability Committee ("ALCO") is responsible for
monitoring its level of interest rate risk and ensuring compliance with
Board-adopted limits. There were no changes in the Company's asset or liability
composition that could result in a material change in
14
the Company's analysis of interest rate sensitivity as discussed in the
Company's Annual Report on Form 10-K for the year ended December 31, 2003.
The Bank is subject to various regulatory capital requirements
administered by the banking regulatory agencies. As of June 30, 2004, Citizens
South Bank's level of capital exceeded all applicable regulatory requirements.
Citizens South Bank's Tier I capital was $61.1 million, or 12.4% of adjusted
total assets. The minimum Tier I capital ratio is 4.00%. Failure to meet minimum
capital requirements can initiate certain mandatory and possibly discretionary
actions by the regulators that, if undertaken, could have a direct material
effect on the Bank's financial statements. Under capital adequacy guidelines and
the regulatory framework for prompt corrective action, the Bank must meet
specific capital guidelines that involve quantitative measures of the Bank's
assets, liabilities, and certain off-balance sheet items as calculated under
regulatory accounting practices. The Bank's capital amounts and classifications
are subject to qualitative judgments by the regulators about components,
risk-weightings, and other factors.
15
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
The information required by this item is included above in Item 2,
Management's Discussion and Analysis of Financial Condition and Results of
Operations, under the caption "Liquidity, Market Risk, and Capital Resources."
ITEM 4. Controls and Procedures
Under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief Financial
Officer, the Company has evaluated the effectiveness of the design and operation
of its disclosure controls and procedures (as defined in Rule 13a-15(e) and
15d-15(e) under the Exchange Act) as of the end of the period covered by this
report. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that, as of the end of the period covered by this
report, the Company's disclosure controls and procedures were effective to
ensure that information required to be disclosed in the reports that the Company
files or submits under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the SEC's rules and forms and in
timely alerting them to material information relating to the Company (or its
consolidated subsidiaries) required to be filed in its periodic SEC filings.
There has been no change in the Company's internal control over financial
reporting identified in connection with the quarterly evaluation that occurred
during the Company's last fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
PART II. OTHER INFORMATION
Legal Proceedings
There are various claims and lawsuits in which the Bank is periodically
involved incidental to the Company's business. In the opinion of management, no
material loss is expected from any of such pending claims or lawsuits.
16
Changes in Securities and Use of Proceeds
During the six-month period ended June 30, 2004, the Company
repurchased 1,160,000 shares of common stock for $15.2 million, at an average
cost of $13.14 per share as detailed in the following table:
- ----------------------------------------------------------------------------------------------------------
Total Number of Shares Maximum Number of Shares
Total Number of Average Price Purchased as Part of the that May be Purchased Under
Period Shares Purchased Paid per Share Current Repurchase Plan Current Repurchase Plan
- ----------------------------------------------------------------------------------------------------------
January 102,500 $13.62 0 0
- ----------------------------------------------------------------------------------------------------------
February 64,500 $13.66 0 0
- ----------------------------------------------------------------------------------------------------------
March 75,000 $13.64 0 0
- ----------------------------------------------------------------------------------------------------------
April 40,000 $13.22 0 0
- ----------------------------------------------------------------------------------------------------------
May 470,500 $12.99 228,500 586,500
- ----------------------------------------------------------------------------------------------------------
June 407,500 $13.07 636,000 179,000
- ----------------------------------------------------------------------------------------------------------
Total 1,160,000 $13.14 636,000 179,000
- ----------------------------------------------------------------------------------------------------------
On May 17, 2004, the Board of Directors of the Company authorized the
repurchase of up to 815,000 shares, or approximately 10% of the Company's
outstanding shares of common stock. The stock repurchase program may be carried
out through open market purchases, block trades, and negotiated private
transactions. The stock may be repurchased on an ongoing basis and will be
subject to the availability of stock, general market conditions, the trading
price of the stock, alternative uses for capital, and the Company's financial
performance. As of June 30, 2004, management had repurchased a total of 636,000
shares at an average price of $13.03 per share and had 179,000 shares remaining
to be repurchased under this plan.
Defaults Upon Senior Securities
Not applicable.
Submission of Matters to a Vote of Security Holders
The following proposals were considered and acted upon at the Annual
Meeting of Stockholders of the Company held on May 10, 2004:
Proposal 1: To consider the election of two Directors to the Board of Directors.
Kim S. Price For 6,945,400 Withheld 46,306
Eugene R. Matthews, II For 6,889,265 Withheld 102,441
Proposal 2: To consider the ratification of the appointment of Cherry, Bekaert,
& Holland, L.L.P. as auditors for the Company for the fiscal year ending
December 31, 2004.
For 6,878,738 Against 91,010 Abstain 21,958
17
Exhibits and Report on Form 8-K.
(a) Exhibits:
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Written statement of Chief Executive Officer furnished pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Written statement of Chief Financial Officer furnished pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) The Company filed the following reports on Form 8-K with the SEC during
the quarter ended June 30, 2004:
(1) April 19, 2004: The Company reported that it had issued two press
releases regarding 1) earnings for the quarter ended March 31, 2004,
and 2) the declaration of a $0.065 dividend for shareholders of
record on May 1, 2004.
18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed by the undersigned thereunto
duly authorized.
Citizens South Banking Corporation
Date: August 9, 2004 By: /s/ Kim S. Price
-------------------------------------
Kim S. Price
President and Chief Executive Officer
Date: August 9, 2004 By: /s/ Gary F. Hoskins
-------------------------------------
Gary F. Hoskins
Executive Vice President,
Chief Financial Officer and Treasurer
19