UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2009
or
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to
CAPITAL BANK CORPORATION
(Exact name of registrant as specified in its charter)
North Carolina | 000-30062 | 56-2101930 | ||
(State or other jurisdiction of incorporation) | (Commission File Number) | (IRS Employer Identification No.) |
333 Fayetteville Street, Suite 700
Raleigh, North Carolina 27601
(Address of principal executive offices)
(919) 645-6400
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ | Accelerated filer þ | ||
Non-accelerated filer ¨ (Do not check if a smaller reporting company) | Smaller reporting company ¨ |
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every
Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
As of May 7, 2009 there were 11,300,369 shares outstanding of the registrant’s common stock, no par value.
Form 10-Q for the Quarterly Period Ended March 31, 2009
INDEX
PART I – FINANCIAL INFORMATION | Page No. | |
Financial Statements | ||
Condensed Consolidated Balance Sheets as of March 31, 2009 (Unaudited) and December 31, 2008 | 3 | |
Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2009 and 2008 (Unaudited) | 4 | |
Condensed Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income for the Three Months Ended March 31, 2009 and 2008 (Unaudited) | 5 | |
Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2009 and 2008 (Unaudited) | 6 | |
Notes to Condensed Consolidated Financial Statements (Unaudited) | 7 | |
Management’s Discussion and Analysis of Financial Condition and Results of Operations | 15 | |
Quantitative and Qualitative Disclosures about Market Risk | 26 | |
Controls and Procedures | 26 | |
PART II – OTHER INFORMATION | ||
Legal Proceedings | 27 | |
Risk Factors | 27 | |
Unregistered Sales of Equity Securities and Use of Proceeds | 33 | |
Defaults upon Senior Securities | 33 | |
Submission of Matters to a Vote of Security Holders | 33 | |
Other Information | 33 | |
Exhibits | 34 | |
Signatures |
PART I – FINANCIAL INFORMATION
CAPITAL BANK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, 2009 and December 31, 2008
March 31, 2009 | December 31, 2008 | ||||||
(Dollars in thousands except share data) | (Unaudited) | ||||||
Assets | |||||||
Cash and due from banks: | |||||||
Interest-earning | $ | 378 | $ | 719 | |||
Noninterest-earning | 39,514 | 53,607 | |||||
Federal funds sold and short term investments | 25 | 129 | |||||
Total cash and cash equivalents | 39,917 | 54,455 | |||||
Investment securities – available for sale, at fair value | 281,505 | 272,944 | |||||
Investment securities – held to maturity, at amortized cost | 4,805 | 5,194 | |||||
Loans – net of unearned income and deferred fees | 1,277,064 | 1,254,368 | |||||
Allowance for loan losses | (18,480 | ) | (14,795 | ) | |||
Net loans | 1,258,584 | 1,239,573 | |||||
Premises and equipment, net | 24,810 | 24,640 | |||||
Bank-owned life insurance | 22,646 | 22,368 | |||||
Deposit premium, net | 3,569 | 3,857 | |||||
Deferred income tax | 9,462 | 9,342 | |||||
Accrued interest receivable | 6,114 | 6,225 | |||||
Other assets | 14,199 | 15,634 | |||||
Total assets | $ | 1,665,611 | $ | 1,654,232 | |||
Liabilities | |||||||
Deposits: | |||||||
Demand, noninterest-bearing | $ | 127,062 | $ | 125,281 | |||
Savings and interest-bearing checking | 205,402 | 173,711 | |||||
Money market deposit accounts | 206,194 | 212,780 | |||||
Time deposits less than $100,000 | 499,063 | 509,231 | |||||
Time deposits $100,000 and greater | 303,253 | 294,311 | |||||
Total deposits | 1,340,974 | 1,315,314 | |||||
Repurchase agreements and federal funds purchased | 11,650 | 15,010 | |||||
Borrowings | 127,000 | 132,000 | |||||
Subordinated debentures | 30,930 | 30,930 | |||||
Other liabilities | 12,383 | 12,464 | |||||
Total liabilities | 1,522,937 | 1,505,718 | |||||
Commitments and contingencies | |||||||
Shareholders’ Equity | |||||||
Preferred stock, $1,000 par value; 100,000 shares authorized; 41,279 shares issued and outstanding (liquidation preference of $41,279) | 39,910 | 39,839 | |||||
Common stock, no par value; 20,000,000 shares authorized; 11,300,369 and 11,238,085 shares issued and outstanding | 139,495 | 139,209 | |||||
Retained deficit | (37,373 | ) | (31,420 | ) | |||
Accumulated other comprehensive income | 642 | 886 | |||||
Total shareholders’ equity | 142,674 | 148,514 | |||||
Total liabilities and shareholders’ equity | $ | 1,665,611 | $ | 1,654,232 |
The accompanying notes are an integral part of these condensed consolidated financial statements.
CAPITAL BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months Ended March 31, 2009 and 2008 (Unaudited)
March 31, 2009 | March 31, 2008 | ||||||
(Dollars in thousands except per share data) | |||||||
Interest income: | |||||||
Loans and loan fees | $ | 16,092 | $ | 19,499 | |||
Investment securities: | |||||||
Taxable interest income | 2,799 | 2,218 | |||||
Tax-exempt interest income | 764 | 829 | |||||
Dividends | – | 117 | |||||
Federal funds and other interest income | 13 | 55 | |||||
Total interest income | 19,668 | 22,718 | |||||
Interest expense: | |||||||
Deposits | 7,769 | 9,072 | |||||
Borrowings and repurchase agreements | 1,718 | 2,737 | |||||
Total interest expense | 9,487 | 11,809 | |||||
Net interest income | 10,181 | 10,909 | |||||
Provision for loan losses | 5,986 | 565 | |||||
Net interest income after provision for loan losses | 4,195 | 10,344 | |||||
Noninterest income: | |||||||
Service charges and other fees | 952 | 959 | |||||
Mortgage fees and revenues | 233 | 272 | |||||
Other loan fees | 294 | 113 | |||||
Brokerage fees | 163 | 156 | |||||
Bank card services | 339 | 299 | |||||
Bank-owned life insurance | 258 | 302 | |||||
Net gain (loss) on investment securities | (320 | ) | 71 | ||||
Other | 187 | 68 | |||||
Total noninterest income | 2,106 | 2,240 | |||||
Noninterest expense: | |||||||
Salaries and employee benefits | 6,013 | 5,036 | |||||
Occupancy | 1,373 | 997 | |||||
Furniture and equipment | 830 | 747 | |||||
Data processing and telecommunications | 631 | 432 | |||||
Advertising | 323 | 315 | |||||
Office expenses | 335 | 365 | |||||
Professional fees | 379 | 370 | |||||
Business development and travel | 328 | 333 | |||||
Amortization of deposit premiums | 288 | 257 | |||||
Miscellaneous loan handling costs | 163 | 94 | |||||
Directors fees | 307 | 267 | |||||
Insurance | 104 | 95 | |||||
FDIC deposit insurance | 229 | 47 | |||||
Other | 261 | 263 | |||||
Total noninterest expense | 11,564 | 9,618 | |||||
Net (loss) income before tax (benefit) expense | (5,263 | ) | 2,966 | ||||
Income tax (benefit) expense | (800 | ) | 799 | ||||
Net (loss) income | $ | (4,463 | ) | $ | 2,167 | ||
Dividends and accretion on preferred stock | 587 | – | |||||
Net (loss) income attributable to common shareholders | $ | (5,050 | ) | $ | 2,167 | ||
Earnings (loss) per common share – basic | $ | (0.45 | ) | $ | 0.19 | ||
Earnings (loss) per common share – diluted | $ | (0.45 | ) | $ | 0.19 |
The accompanying notes are an integral part of these condensed consolidated financial statements.
CAPITAL BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
For the Three Months Ended March 31, 2009 and 2008 (Unaudited)
Shares of Common Stock | Common Stock | Preferred Stock | Other Comprehensive Income | Retained Earnings (Deficit) | Total | ||||||||||||||
(Dollars in thousands except per share data) | |||||||||||||||||||
Balance at January 1, 2008 | 11,169,777 | $ | 136,154 | $ | – | $ | 161 | $ | 27,985 | $ | 164,300 | ||||||||
Repurchase of outstanding common stock | (166 | ) | (2 | ) | (2 | ) | |||||||||||||
Issuance of common stock for options exercised | 15,591 | 103 | 103 | ||||||||||||||||
Issuance of common stock for services | 51,883 | 590 | 590 | ||||||||||||||||
Net income | 2,167 | 2,167 | |||||||||||||||||
Net unrealized gain on securities – available for sale, net of tax of $292 | 571 | 571 | |||||||||||||||||
Net unrealized gain related to cash flow hedge, net of tax of $714 | 1,139 | 1,139 | |||||||||||||||||
Comprehensive income | 3,877 | ||||||||||||||||||
Dividends on common stock ($0.08 per share) | (901 | ) | (901 | ) | |||||||||||||||
Balance at March 31, 2008 | 11,237,085 | $ | 136,845 | $ | – | $ | 1,871 | $ | 29,251 | $ | 167,967 | ||||||||
Balance at January 1, 2009 | 11,238,085 | $ | 139,209 | $ | 39,839 | $ | 886 | $ | (31,420 | ) | $ | 148,514 | |||||||
Issuance of common stock for services | 62,284 | 120 | 120 | ||||||||||||||||
Stock option expense | 13 | 13 | |||||||||||||||||
Directors deferred compensation expense | 153 | 153 | |||||||||||||||||
Accretion of preferred stock discount | 71 | (71 | ) | – | |||||||||||||||
Net loss | (4,463 | ) | (4,463 | ) | |||||||||||||||
Net unrealized gain on securities – available for sale, net of tax of $196 | 312 | 312 | |||||||||||||||||
Net unrealized loss related to cash flow hedge, net of tax benefit of $315 | (502 | ) | (502 | ) | |||||||||||||||
Prior service cost recognized on SERP | (54 | ) | (54 | ) | |||||||||||||||
Comprehensive loss | (4,707 | ) | |||||||||||||||||
Dividends on preferred stock | (516 | ) | (516 | ) | |||||||||||||||
Dividends on common stock ($0.08 per share) | (903 | ) | (903 | ) | |||||||||||||||
Balance at March 31, 2009 | 11,300,369 | $ | 139,495 | $ | 39,910 | $ | 642 | $ | (37,373 | ) | $ | 142,674 |
The accompanying notes are an integral part of these condensed consolidated financial statements.
CAPITAL BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 2009 and 2008 (Unaudited)
2009 | 2008 | ||||||
(Dollars in thousands) | |||||||
Cash flows from operating activities: | |||||||
Net (loss) income | $ | (4,463 | ) | $ | 2,167 | ||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||
Provision for loan losses | 5,986 | 565 | |||||
Amortization of deposit premium | 288 | 257 | |||||
Depreciation | 759 | 668 | |||||
Stock-based compensation | 196 | 172 | |||||
Net loss (gain) on investment securities | 320 | (71 | ) | ||||
Net amortization of premium/discount on investment securities | 20 | 26 | |||||
Loss (gain) on disposal of premises, equipment and real estate owned | 8 | (21 | ) | ||||
Deferred income tax (benefit) expense | (18 | ) | 819 | ||||
Increase in cash surrender value of bank-owned life insurance | (278 | ) | (113 | ) | |||
Net decrease (increase) in accrued interest receivable and other assets | 3,105 | (1,447 | ) | ||||
Net (decrease) increase in accrued interest payable and other liabilities | (286 | ) | 679 | ||||
Net cash provided by operating activities | 5,637 | 3,701 | |||||
Cash flows from investing activities: | |||||||
Loan originations, net of principal repayments | (27,321 | ) | (56,054 | ) | |||
Additions to premises and equipment | (961 | ) | (1,412 | ) | |||
Proceeds from sales of premises, equipment and real estate owned | 79 | 84 | |||||
Net purchases of FHLB and Silverton Bank stock | (20 | ) | (798 | ) | |||
Purchase of securities – available for sale | (16,958 | ) | (32,045 | ) | |||
Proceeds from principal repayments/calls/maturities of securities – available for sale | 8,590 | 30,605 | |||||
Proceeds from principal repayments/calls/maturities of securities – held to maturity | 384 | 4,128 | |||||
Net cash used in investing activities | (36,207 | ) | (55,492 | ) | |||
Cash flows from financing activities: | |||||||
Net increase in deposits | 25,660 | 52,199 | |||||
Net decrease in repurchase agreements | (3,360 | ) | (4,138 | ) | |||
Proceeds from borrowings | 30,000 | 65,500 | |||||
Principal repayments of borrowings | (35,000 | ) | (52,500 | ) | |||
Net repayments of federal funds borrowed | – | (5,395 | ) | ||||
Dividends paid | (1,268 | ) | (896 | ) | |||
Issuance of common stock for options exercised | – | 103 | |||||
Repurchase of common stock | – | (2 | ) | ||||
Net cash provided by financing activities | 16,032 | 54,871 | |||||
Net change in cash and cash equivalents | (14,538 | ) | 3,080 | ||||
Cash and cash equivalents at beginning of period | 54,455 | 40,172 | |||||
Cash and cash equivalents at end of period | $ | 39,917 | $ | 43,252 | |||
Supplemental Disclosure of Cash Flow Information | |||||||
Transfer of loans and premises to other real estate owned | $ | 2,324 | $ | 68 | |||
Cash (received) paid for: | |||||||
Income taxes | $ | (4,297 | ) | $ | – | ||
Interest | $ | 9,375 | $ | 11,930 |
The accompanying notes are an integral part of these condensed consolidated financial statements.
Capital Bank Corporation – Notes to Condensed Consolidated Financial Statements (Unaudited)
1. Significant Accounting Policies and Interim Reporting
The accompanying unaudited condensed consolidated financial statements include the accounts of Capital Bank Corporation (the “Company”) and its wholly owned subsidiary, Capital Bank (the “Bank”). In addition, the Company has interests in three trusts, Capital Bank Statutory Trust I, II, and III (hereinafter collectively referred to as the “Trusts”). The Trusts have not been consolidated with the financial statements of the Company pursuant to the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 46R, Consolidation of Variable Interest Entities. The interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). They do not include all of the information and footnotes required by such accounting principles for complete financial statements, and therefore should be read in conjunction with the audited consolidated financial statements and accompanying footnotes in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. The more significant estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, valuation of goodwill and intangible assets, valuation of investments, and tax assets, liabilities and expense. Actual results could differ from those estimates.
In the opinion of management, all adjustments necessary for a fair presentation of the financial position and results of operations for the periods presented have been included, and all significant intercompany transactions have been eliminated in consolidation. Certain amounts reported in prior periods have been reclassified to conform to the current presentation. Such reclassifications have no effect on total assets, net income or shareholders’ equity as previously reported. The results of operations for the three months ended March 31, 2009 are not necessarily indicative of the results of operations that may be expected for the year ended December 31, 2009.
The condensed consolidated balance sheet at December 31, 2008 has been derived from the audited consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.
The accounting policies followed by the Company are as set forth in Note 1 of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.
In April 2009, the FASB issued three related Staff Positions to (1) clarify the application of Statement of Financial Accounting Standards No. 157 (“SFAS No. 157”) to fair value measurements in the current economic environment, (2) modify the recognition of other-than-temporary impairments of debt securities, and (3) require companies to disclose the fair values of financial instruments in interim periods. The final Staff Positions are effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009, if all three Staff Positions or both the fair value measurements and other-than-temporary impairment Staff Positions are adopted simultaneously. The Company will adopt these Staff Positions effective for the quarterly period ending June 30, 2009. None of the Staff Positions are expected to have a significant impact on financial condition or results of operations, but each is described in more detail below.
FASB Staff Position (“FSP”) FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, provides additional guidance for estimating fair value in accordance with SFAS No. 157 when the volume and level of activity for the asset or liability have significantly decreased and also provides guidance on identifying circumstances that indicate a transaction is not orderly. The FSP emphasizes that even if there has been a significant decrease in the volume and level of activity for the asset or liability and regardless of the valuation technique used, the objective of a fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale), between market participants at the measurement date under current market conditions.
FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments, amends the other-than-temporary impairment guidance in U.S. GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. The FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities.
Capital Bank Corporation – Notes to Condensed Consolidated Financial Statements (Unaudited)
FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments, amends SFAS No. 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. The FSP also amends Accounting Principles Bulletin Opinion No. 28, Interim Financial Reporting, to require those disclosures in summarized information in interim reporting periods.
In October 2008, the FASB issued FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active (“FSP FAS 157-3”). The FSP clarifies the application of SFAS No. 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. FSP FAS 157-3 was effective upon issuance, including prior periods for which financial statements had not been issued. The adoption of this FSP did not have a material impact on the Company’s consolidated financial condition or results of operations.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133 (“SFAS No. 161”). The new statement is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial condition, financial performance, and cash flows. Effective January 1, 2009, the Company adopted SFAS No. 161. The adoption of this statement impacts disclosures only and had no impact on the Company’s financial condition or results of operations. See Note 6, Derivative Instruments, for disclosures required upon adoption of this statement.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS No. 141R”), which replaced SFAS No. 141, Business Combinations (“SFAS No. 141”) issued in 2001. Whereas its predecessor applied only to business combinations in which control was obtained by transferring consideration, the revised standard applies to all transactions or other events in which one entity obtains control over another. SFAS No. 141R defines the acquirer as the entity that obtains control over one or more other businesses and defines the acquisition date as the date the acquirer achieves control. SFAS No. 141R requires the acquirer to recognize assets acquired, liabilities assumed and any noncontrolling interest in the acquiree at their respective fair values as of the acquisition date. The revised standard changes the treatment of acquisition-related costs, restructuring costs related to an acquisition that the acquirer expects but is not obligated to incur, contingent consideration associated with the purchase price and pre-acquisition contingencies associated with acquired assets and liabilities. SFAS No. 141R retains the guidance in SFAS No. 141 for identifying and recognizing intangible assets apart from goodwill. Effective January 1, 2009, the Company adopted this statement and will apply its provisions to any business combination which occurs on or after that date.
Also in December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51 (“SFAS No. 160”). This statement amends Accounting Research Bulletin No. 51, Consolidated Financial Statements, to establish accounting and reporting standards for the noncontrolling interests in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. The Company adopted SFAS No. 160 effective January 1, 2009, and its adoption had no impact on the Company’s consolidated financial condition or results of operations.
2. Earnings Per Share
The Company follows SFAS No. 128, Earnings per Share. In accordance with this statement, the Company has presented both basic and diluted earnings per share (“EPS”) on the face of the Condensed Consolidated Statements of Operations. Basic EPS excludes dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS assumes the conversion, exercise or issuance of all potential common stock instruments, such as stock options and warrants, unless the effect is to reduce a loss or increase earnings per share. EPS is adjusted for outstanding stock options and warrants using the treasury stock method in order to compute diluted EPS. The weighted average number of shares outstanding for the three month periods ended March 31, 2009 and 2008 (unaudited) were as follows:
Capital Bank Corporation – Notes to Condensed Consolidated Financial Statements (Unaudited)
2009 | 2008 | ||||||
(Dollars in thousands) | |||||||
Earnings (loss) attributable to common shareholders – basic and diluted | $ | (5,050 | ) | $ | 2,167 | ||
Shares used in the computation of earnings per share: | |||||||
Weighted average number of shares outstanding – basic | 11,293,480 | 11,289,453 | |||||
Incremental shares from assumed exercise of stock options | – | 16,643 | |||||
Weighted average number of shares outstanding – diluted | 11,293,480 | 11,306,096 |
Due to the net loss attributable to common shareholders for the three month period ended March 31, 2009, the Company excluded potential shares in its EPS calculations, as required by SFAS No. 128, since the effect of including those potential shares would have been antidilutive to the per share amounts. For the three month period ended March 31, 2008, options to purchase approximately 108,411 shares of common stock were used in the diluted calculation and options to purchase 263,573 shares of common stock were not included in the diluted calculation because the option price exceeded the average fair market value of the associated shares of common stock.
3. Comprehensive Income
The Company follows SFAS No. 130, Reporting Comprehensive Income, which establishes standards for reporting and displaying comprehensive income and its components (revenues, expenses, gains, and losses) in general-purpose financial statements. Comprehensive income is the change in the Company’s equity during the period from transactions and other events and circumstances from non-owner sources. Total comprehensive income consists of net income and other comprehensive income. The Company’s other comprehensive income and accumulated other comprehensive income are comprised of unrealized gains and losses on certain investments in debt securities and derivatives that qualify as cash flow hedges to the extent that the hedge is effective. Information concerning the Company’s other comprehensive (loss) income for the three month periods ended March 31, 2009 and 2008 (unaudited) is as follows:
2009 | 2008 | ||||||
(Dollars in thousands) | |||||||
Unrealized gain on available-for-sale investment securities | $ | 508 | $ | 863 | |||
Unrealized (loss) gain on change in fair value of cash flow hedge | (817 | ) | 1,853 | ||||
Prior service cost recognized on SERP | (54 | ) | – | ||||
Income tax benefit (expense) | 119 | (1,006 | ) | ||||
Other comprehensive (loss) income | $ | (244 | ) | $ | 1,710 |
4. Investment Securities
The following table shows the gross unrealized losses and fair value of the Company’s marketable securities with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of March 31, 2009.
Less than 12 Months | 12 Months or Greater | Total | |||||||||||||||||
(Dollars in thousands) | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||
Available for sale: | |||||||||||||||||||
Municipal bonds | $ | 42,155 | $ | 2,840 | $ | 19,235 | $ | 2,295 | $ | 61,390 | $ | 5,135 | |||||||
Mortgage-backed securities | 15,359 | 1,238 | 6,431 | 575 | 21,790 | 1,813 | |||||||||||||
Other securities | – | – | 1,057 | 193 | 1,057 | 193 | |||||||||||||
57,514 | 4,078 | 26,723 | 3,063 | 84,237 | 7,141 | ||||||||||||||
Held to maturity: | |||||||||||||||||||
Mortgage-backed securities | – | – | 1,930 | 655 | 1,930 | 655 | |||||||||||||
Total at March 31, 2009 | $ | 57,514 | $ | 4,078 | $ | 28,653 | $ | 3,718 | $ | 86,167 | $ | 7,796 |
Capital Bank Corporation – Notes to Condensed Consolidated Financial Statements (Unaudited)
Unrealized losses on the Company’s investments in mortgage-backed securities are primarily the result of interest rate changes. Mortgage-backed securities include securities issued by government agencies and corporate entities. The mortgage-backed securities issued by government agencies, such as Fannie Mae, Freddie Mac and Ginnie Mae, are backed by the full faith and credit of the U.S. government and do not receive credit ratings from rating agencies. The mortgage-backed securities issued by corporate entities have all received the highest possible credit rating by either Moody’s or S&P. Unrealized losses on the Company’s investments in municipal bonds are partially related to interest rate changes but are primarily related to concerns in the marketplace regarding credit quality of issuers and the viability of certain bond insurers. Municipal bonds in an unrealized loss position, however, are investment grade securities without considering bond insurance backing the issuer.
Each quarter, the Company makes an assessment to determine whether there have been any events or economic circumstances to indicate that a marketable security on which there is an unrealized loss is impaired on an other-than-temporary basis. The Company considers many factors, including the severity and duration of the impairment; the intent and ability of the Company to hold the security for a period of time sufficient for a recovery in value, which may be maturity; and recent events specific to the issuer or industry, including any changes in credit ratings. The marketable securities in an unrealized loss position as of March 31, 2009 are all still performing and are expected to perform through maturity, have not experienced recent credit rating downgrades, and the issuers have not experienced significant adverse events that would call into question their ability to repay these debt obligations. Further, the Company has the intent and ability to hold these securities for a period of time sufficient for a recovery in value or until maturity. The Company’s ability to hold securities for this period of time is based on an analysis of liquidity and capital levels. Based on this detailed portfolio review, the Company does not consider any of its marketable securities to be other-than-temporarily impaired as of March 31, 2009.
During the three months ended March 31, 2009, the Company recorded an impairment charge of $320 thousand on an equity investment in Silverton Bank, a correspondent financial institution. The impairment charge represents the full amount of the Company’s investment in Silverton Bank and is recorded as a reduction to noninterest income on the Condensed Consolidated Statements of Operations. Because of restrictions on the ability to sell this investment, it does not have a readily determinable fair value and was recorded at cost when purchased. Management believes that due to significant deterioration in Silverton Bank’s capital ratios and overall financial strength as well as the departure of key members of the management team in recent months, minimal value remains in this equity investment, thus requiring the impairment charge.
5. Loans
The composition of the loan portfolio by loan classification as of March 31, 2009 and December 31, 2008 is as follows:
March 31, 2009 | December 31, 2008 | ||||||
(Dollars in thousands) | (Unaudited) | ||||||
Commercial | $ | 740,553 | $ | 726,522 | |||
Construction | 372,977 | 366,376 | |||||
Consumer | 47,106 | 46,019 | |||||
Home equity | 94,862 | 92,722 | |||||
Residential mortgage | 21,744 | 22,652 | |||||
1,277,242 | 1,254,291 | ||||||
Deferred loan fees and origination costs, net | (178 | ) | 77 | ||||
$ | 1,277,064 | $ | 1,254,368 |
6. Derivative Instruments
The Company maintains positions in derivative financial instruments to manage interest rate risk, to facilitate asset/liability management strategies, and to manage other risk exposures. Effective January 1, 2009, the Company adopted SFAS No. 161, which is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial condition, financial performance, and cash flows. The disclosure requirements from the adoption of this statement are reflected within this footnote.
Capital Bank Corporation – Notes to Condensed Consolidated Financial Statements (Unaudited)
In October 2006, the Company entered into a $100.0 million (notional) three-year interest rate swap agreement to convert a portion of its prime-based loan portfolio to a fixed rate of 7.81%. The Company accounts for this swap as a cash flow hedge of the volatility in cash flows resulting from changes in interest rates. For cash flow hedges, changes in the fair value of the derivative are, to the extent that the hedging relationship is effective, recorded as other comprehensive income and are subsequently recognized in earnings at the same time that the hedged item is recognized in earnings. Any portion of the change in fair value of a cash flow hedge related to hedge ineffectiveness is recognized immediately as other noninterest income. The fair value of this cash flow hedge was $2.3 million and $3.2 million as of March 31, 2009 and December 31, 2008, respectively, and was recorded in other assets on the Condensed Consolidated Balance Sheets. No portion of the cash flow hedge was considered to be ineffective, and no portion of the change in fair value of the cash flow hedge was charged to other noninterest income during the three months ended March 31, 2009 and 2008.
In July 2003, the Company entered into $25.0 million (notional) interest rate swap agreements to convert portions of its fixed-rate FHLB advances to variable interest rates. In February 2009, $15.0 million (notional) of interest rate swaps were unwound prior to maturity of the underlying FHLB advances for net proceeds of $500 thousand. The proceeds received from the swap counterparty will be amortized as a reduction to interest expense over the remaining term of the underlying advances. The Company continues to account for the remaining $10.0 million (notional) interest rate swaps as a hedge of the fair value of the designated FHLB advances. For fair value hedges, the change in the fair value of the derivative and the corresponding change in fair value of the hedged risk in the underlying item being hedged are accounted for in earnings. Because of the effectiveness of the remaining swap agreements against the related debt instruments, the adjustments needed to record the swaps at fair value were offset by the adjustments needed to record the related debt instruments at fair value, and the net difference between those amounts was not material for the three months ended March 31, 2009 and 2008.
7. Stock-Based Compensation
The Company uses stock-based compensation as an incentive for certain employees and non-employee directors and accounts for stock-based compensation in accordance with SFAS No. 123R, Share-Based Payments. Stock-based grants currently take one of three forms: stock options, restricted stock, and stock issued through a deferred compensation plan for non-employee directors.
Stock Options. The Company has stock option plans providing for the issuance of up to 650,000 options to purchase shares of the Company’s stock to officers and directors. As of March 31, 2009, options for 315,850 shares of common stock were outstanding and options for 75,559 shares of common stock remained available for future issuance. In addition, there were 566,071 options that were assumed under various plans from previously acquired financial institutions, of which 61,233 remain outstanding. Grants of options are made by the Board of Directors or the Compensation/Human Resources Committee. All grants must be at no less than fair market value on the date of grant, must be exercised no later than 10 years from the date of grant, and may be subject to some vesting provisions.
The following is a summary of stock option information and the weighted average exercise price (“WAEP”) for the three months ended March 31, 2009.
Number of Shares | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term in Years | Aggregate Intrinsic Value | ||||||||||
Outstanding at January 1, 2009 | 377,083 | $ | 11.71 | ||||||||||
Granted | – | – | |||||||||||
Exercised | – | – | |||||||||||
Forfeited and expired | – | – | |||||||||||
Outstanding at March 31, 2009 | 377,083 | $ | 11.71 | 4.98 | $ | – | |||||||
Options exercisable at March 31, 2009 | 274,283 | $ | 12.40 | 3.41 | $ | – |
Capital Bank Corporation – Notes to Condensed Consolidated Financial Statements (Unaudited)
The following table summarizes information about the Company’s stock options as of March 31, 2009.
Exercise Price | Number Outstanding | Weighted Average Remaining Contractual Life in Years | Number Exercisable | |||
$6.00 – $9.00 | 129,631 | 5.10 | 69,631 | |||
$9.01 – $12.00 | 90,202 | 2.59 | 88,202 | |||
$12.01 – $15.00 | 20,000 | 7.38 | 7,200 | |||
$15.01 – $18.00 | 83,000 | 6.30 | 55,000 | |||
$18.01 – $18.37 | 54,250 | 5.74 | 54,250 | |||
377,083 | 4.98 | 274,283 |
The fair values of the options were estimated on the date of grant using the Black-Scholes option-pricing model. Option pricing models require the use of highly subjective assumptions, including expected stock volatility, which, if changed, can materially affect fair value estimates. The expected life of the options used in this calculation was the period the options are expected to be outstanding. Expected stock price volatility was based on the historical volatility of the Company’s common stock for a period approximating the expected life; the expected dividend yield was based on the Company’s historical annual dividend payout; and the risk-free rate was based on the implied yield available on U.S. Treasury issues.
As of March 31, 2009, the Company had unamortized compensation expense related to unvested stock options of $177,000, which is expected to be amortized over 5 years. For the three months ended March 31, 2009 and 2008, the Company recorded compensation expense of $13,000 and $10,000, respectively, related to stock options.
Restricted Stock. Outstanding restricted stock represents 20,000 shares with a vesting period of five years granted by the Board of Directors to certain employees in December 2008, and 24,000 shares with a vesting period of three years granted by the Board of Directors to certain key executives in December 2007. Unvested shares are subject to forfeiture if employment terminates prior to the vesting dates. The Company expenses the cost of the stock awards, determined to be the fair value of the shares at the date of grant, ratably over the period of the vesting. Total compensation expense recognized in the three month periods ended March 31, 2009 and 2008 related to these restricted stock awards was $30,000 and $24,000, respectively. As of March 31, 2009, the Company had 36,000 shares of unvested restricted stock grants, which represents unrecognized compensation expense of $285,000 to be recognized over the remaining vesting periods of the respective grants.
Deferred Compensation for Non-employee Directors. The Company administers the Capital Bank Corporation Deferred Compensation Plan for Outside Directors (“Deferred Compensation Plan”). Eligible directors may elect to participate in the Deferred Compensation Plan by deferring all or part of their directors’ fees for at least one calendar year, in exchange for common stock of the Company. If a director does not elect to defer all or part of his fees, then he is not considered a participant in the Deferred Compensation Plan. The amount deferred is equal to 125 percent of total director fees. Each participant is fully vested in his account balance. The Deferred Compensation Plan provides for payment of share units in shares of common stock of the Company after the participant ceases to serve as a director for any reason.
Prior to amendment and restatement in November 2008, the Deferred Compensation Plan was classified as a liability-based plan in accordance with SFAS No. 123R due to certain plan provisions which would have allowed payments to have been made in either cash or shares of common stock. The Deferred Compensation Plan was reclassified to an equity-based plan in accordance with SFAS No. 123R when amended and restated on November 20, 2008. Among other changes to the plan provisions, the Deferred Compensation Plan was modified to only allow payment in shares of common stock of the Company. As required for equity-based plans under SFAS No. 123R, the Company recognizes fixed expense and a corresponding increase to equity as the compensation is earned by eligible directors. For the three month periods ended March 31, 2009 and 2008, the Company recognized $153,000 and $138,000, respectively, of expense related to the Deferred Compensation Plan.
8. Financial Instruments with Off-Balance-Sheet Risk
To meet the financial needs of its customers, the Company is party to financial instruments with off-balance-sheet risk in the normal course of business. These financial instruments are comprised of unused lines of credit, overdraft lines and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet.
Capital Bank Corporation – Notes to Condensed Consolidated Financial Statements (Unaudited)
The Company’s exposure to credit loss in the event of nonperformance by the other party is represented by the contractual amount of those instruments. The Company uses the same credit policies in making these commitments as it does for on-balance-sheet instruments. The amount of collateral obtained, if deemed necessary by the Company, upon extension of credit is based on management’s credit evaluation of the borrower. Collateral held varies but may include trade accounts receivable, property, plant and equipment, and income-producing commercial properties. Since many unused lines of credit expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
The Company’s exposure to off-balance-sheet credit risk as of March 31, 2009 and December 31, 2008 is as follows:
March 31, 2009 | December 31, 2008 | ||||||
(Dollars in thousands) | (Unaudited) | ||||||
Unused lines of credit and overdraft lines | $ | 250,460 | $ | 263,663 | |||
Standby letters of credit | 9,047 | 4,233 | |||||
Total commitments | $ | 259,507 | $ | 267,896 |
9. Fair Value Measurement
The Company follows SFAS No. 157, Fair Value Measurements, which defines fair value and establishes a framework for measuring fair value under U.S. GAAP, and enhances disclosures about fair value measurements. The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Available-for-sale investment securities and derivatives are recorded at fair value on a recurring basis. Additionally, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets. The following is a description of valuation methodologies used for assets and liabilities recorded at fair value. The determination of where an asset or liability falls in the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosures each quarter and based on various factors, it is possible that an asset or liability may be classified differently from quarter to quarter. However, the Company expects changes in classifications between levels will be rare.
Investment Securities. Available-for-sale investment securities are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets. Held-to-maturity investment securities are recorded at amortized cost, not at fair value.
As a member of the FHLB system, the Company is required to maintain an investment in capital stock of the FHLB. The carrying value of the Company’s investment in FHLB stock was $6.0 million as of March 31, 2009 and was classified as part of investment securities on the Condensed Consolidated Balance Sheets. Because of membership requirements to hold stock in this institution and restrictions on the Company’s ability to sell such stock, this investment does not have a readily determinable market value and is accounted for using the cost method. Thus, the Company’s investment in FHLB stock is not subject to SFAS No. 157 and has been excluded from the tables below.
Derivative Assets and Liabilities. Derivative instruments held or issued by the Company for risk management purposes are traded in over-the-counter markets where quoted market prices are not readily available. For those derivatives, the Company measures fair value using models that use primarily market observable inputs, such as yield curves and option volatilities, and include the value associated with counterparty credit risk. The Company classifies derivatives instruments held or issued for risk management purposes as Level 2. At March 31, 2009, the Company’s derivative instruments consisted solely of a cash flow interest rate swap on a portion of the Company’s variable-rate commercial loan portfolio and fair value interest rate swaps on certain fixed-rate FHLB advances. For effective fair value hedges, the change in the fair value of the derivative is offset by a corresponding change in fair value of the hedged risk in the underlying item being hedged. Thus, the adjusted value of the underlying FHLB advances ($10.0 million notional) being hedged is also classified as Level 2.
Capital Bank Corporation – Notes to Condensed Consolidated Financial Statements (Unaudited)
Loans Held for Sale. Loans held for sale are carried at the lower of cost or market value. The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company classifies loans subjected to nonrecurring fair value adjustments as Level 2. The Company had no loans held for sale as of March 31, 2009.
Loans. The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired, and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. In accordance with SFAS No. 157, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.
Foreclosed Assets. Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.
Assets and liabilities measured at fair value on a recurring basis are summarized below:
Fair Value Measurements at March 31, 2009 | |||||||||||||
Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total | ||||||||||
(Dollars in thousands) | |||||||||||||
Investment securities | $ | 993 | $ | 272,524 | $ | 2,000 | $ | 275,517 | |||||
Cash flow interest rate swap | – | 2,334 | – | 2,334 | |||||||||
Borrowings | – | (10,026 | ) | – | (10,026 | ) | |||||||
Fair value interest rate swaps | – | 26 | – | 26 |
Assets and liabilities measured at fair value on a nonrecurring basis are summarized below:
Fair Value Measurements at March 31, 2009 | |||||||||||||
Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total | ||||||||||
(Dollars in thousands) | |||||||||||||
Impaired loans | $ | – | $ | – | $ | 26,714 | $ | 26,714 | |||||
Foreclosed assets | – | – | 3,616 | 3,616 |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion presents an overview of the unaudited financial statements for the three months ended March 31, 2009 and 2008 for Capital Bank Corporation (the “Company”) and its wholly owned subsidiary, Capital Bank (the “Bank”). This discussion and analysis is intended to provide pertinent information concerning financial condition, results of operations, liquidity, and capital resources for the periods covered and should be read in conjunction with the unaudited financial statements and related footnotes contained in Part I, Item 1 of this report.
Information set forth below 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 (the “Exchange Act”), which statements represent the Company’s judgment concerning the future and are subject to risks and uncertainties that could cause the Company’s actual operating results to differ materially. Such forward-looking statements can be identified by the use of forward-looking terminology, such as “may,” “will,” “expect,” “anticipate,” “estimate,” “believe,” or “continue,” or the negative thereof or other variations thereof or comparable terminology. The Company cautions that such forward-looking statements are further qualified by important factors that could cause the Company’s actual operating results to differ materially from those in the forward-looking statements, as well as the factors set forth in Part II, Item 1A of this report, and the Company’s periodic reports and other filings with the Securities and Exchange Commission (“SEC”).
Overview
Capital Bank is a full-service state chartered community bank conducting business throughout North Carolina. The Bank operates through four North Carolina regions: Triangle, Sandhills, Triad and Western. The Bank was incorporated on May 30, 1997 and opened its first branch in June of that same year in Raleigh. In 1999, the shareholders of the Bank approved the reorganization of the Bank into a bank holding company. In 2001, the Company received approval to become a financial holding company. As of March 31, 2009, the Company conducted no business other than holding stock in the Bank and its three trusts, Capital Bank Statutory Trust I, II, and III.
The Bank’s business consists principally of attracting deposits from the general public and investing these funds in loans secured by commercial real estate, secured and unsecured commercial and consumer loans, single-family residential mortgage loans and home equity lines. As a community bank, the Bank’s profitability depends primarily upon its levels of net interest income, which is the difference between interest income from interest-earning assets and interest expense on interest-bearing liabilities. When interest-earning assets approximate or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income.
The Bank’s profitability is also affected by its provision for loan losses, noninterest income and other operating expenses. Noninterest income primarily consists of service charges and ATM fees, fees generated from originating mortgage loans, commission income generated from brokerage activity, and the increase in cash surrender value of bank-owned life insurance. Operating expenses primarily consist of compensation and benefits, occupancy related expenses, advertising, data processing, professional fees, telecommunication and other noninterest expenses.
The Bank’s operations are influenced significantly by local economic conditions and by policies of financial institution regulatory authorities. The Bank’s cost of funds is influenced by interest rates on competing investments and by rates offered on similar investments by competing financial institutions in our market area, as well as general market interest rates. Lending activities are affected by the demand for financing, which in turn is affected by the prevailing interest rates.
Impact of Recent Developments on the Banking Industry
The banking industry, including the Company, is operating in a challenging and volatile economic environment. The effects of the downturn in the housing market have adversely impacted credit markets, consumer confidence and the broader economy. Along with other financial institutions, the Company’s stock price has suffered as a result. Management cannot predict when these market difficulties will subside. While the current economic downturn and the difficulties it presents for the Company and others in the banking industry are unprecedented, management believes that the business is cyclical and must be viewed and measured over time. The Company’s primary focus at this time is to manage the business safely during the economic downturn and be poised to take advantage of any market opportunities that may arise.
Because of the current economic situation, U.S. and foreign governments have acted in attempt to stabilize the financial system. For example, the U.S. government enacted the Emergency Economic and Stabilization Act of 2008 (“EESA”), which, among other things, authorized the U.S. Treasury Department (“Treasury”) to establish the Troubled Asset Relief Program (“TARP”), of which the Capital Purchase Program (“CPP”) is a part. Under the CPP, certain U.S. financial institutions may sell senior preferred stock and issue warrants to purchase an institution’s common stock to the Treasury in exchange for a capital infusion. See the “Liquidity and Capital Resources” section below for a more detailed discussion of the Company’s participation in the CPP. It is not clear at this time what impact these measures will have on the Company or the financial markets as a whole. Management will continue to monitor the effects of these programs as they relate to the Company and its financial operations.
Additionally, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was enacted on February 17, 2009. The ARRA includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs. The ARRA imposes certain new executive compensation and corporate governance obligations on all current and future TARP recipients, including the Company, until the institution has redeemed the preferred stock, which TARP recipients are now permitted to do under the ARRA without regard to the three year holding period and without the need to raise new capital, subject to approval of its primary federal regulator.
The Bank is subject to insurance assessments imposed by the FDIC. On December 16, 2008, the FDIC adopted a final rule increasing risk-based assessment rates uniformly by 7 basis points, on an annual basis, for the first quarter of 2009. On February 27, 2009, the FDIC adopted an interim rule, with request for comment, which would institute a one-time special assessment of 20 cents per $100 of domestic deposits on FDIC insured institutions. If approved, the Bank estimates that the assessment would total approximately $2.4 million. The assessment would be payable on September 30, 2009. On March 5, 2009, the chairman of the FDIC indicated that the FDIC intended to lower the special assessment to 10 cents per $100 of insured deposits contingent upon Congress increasing the FDIC’s line of credit with the Treasury to $100 billion. On May 6, 2009, the U.S. Senate passed legislation that would increase the FDIC’s line of credit with the Treasury to $100 billion. The U.S. House of Representatives passed similar legislation in March 2009. The legislation has not yet been reconciled and enacted into law. Even though both the U.S. Senate and the U.S. House of Representatives have approved the increase in the FDIC’s line of credit, the assessment rates, including the special assessment, are subject to change at the discretion of the Board of Directors of the FDIC.
Critical Accounting Policies and Estimates
The Company’s critical accounting policies are described in Note 1 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. These policies are important in understanding management’s discussion and analysis. Some of the Company’s accounting policies require the Company to make estimates and judgments regarding uncertainties that may affect the reported amounts of assets, liabilities, revenues and expenses.
The Company has identified four accounting policies as being critical in terms of significant judgments and the extent to which estimates are used: allowance for loan losses, investment impairment, income tax valuation allowances and impairment of long-lived assets, including other intangible assets. In many cases, there are several alternative judgments that could be used in the estimation process. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. For more information on the Company’s critical accounting policies, refer to Part II, Item 7 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.
Executive Summary
As discussed in more detail below, the following is a summary of our significant results for the three months ended March 31, 2009.
• | The Company reported a net loss of $4.5 million, or $0.45 per diluted share, for the quarter ended March 31, 2009 compared to net income of $2.2 million, or $0.19 per diluted share, for the quarter ended March 31, 2008. Net income decreased by $6.6 million, primarily due to a $5.4 million increase in provision for loan losses. Additionally, net interest income decreased by $728 thousand over the quarters under comparison, reflecting a lower net interest margin. Noninterest income decreased by $134 thousand primarily due to an impairment charge taken on an equity investment in a financial institution while noninterest expense increased $1.9 million over the quarters under comparison primarily due to higher salaries and benefits as well as occupancy expenses from the purchase of four branches in Fayetteville and the opening of a Clayton branch in December 2008. Taxes declined from expense of $799 thousand for the quarter ended March 31, 2008 to a benefit of $800 thousand for the quarter ended March 31, 2009, reflecting the decline in net income before taxes over the same quarters. | |
• | Net interest income decreased $728 thousand, or 6.7%, from $10.9 million for the quarter ended March 31, 2008 to $10.2 million for the quarter ended March 31, 2009. This decrease was primarily due to a decline in the Company’s net interest margin from 3.23% for the quarter ended March 31, 2008 to 2.76% for the quarter ended March 31, 2009. The decline in the net interest margin was primarily a result of the 2.0% reduction in the prime rate over the last twelve months and competitive pressures in the Company’s primary markets for retail deposits. The majority of the Company’s loans are prime-based, while the Company’s interest-bearing deposits are impacted more by competitive rates in the marketplace offered for time deposits. The margin compression was partially offset by 10.6% growth in average earning assets over the same period. | |
• | Provision for loan losses was $6.0 million for the quarter ended March 31, 2009 compared to $565 thousand for the quarter ended March 31, 2008. The significant increase in the provision was primarily driven by deteriorating economic conditions and weaknesses in the local real estate markets which resulted in downgrades to the credit ratings of certain loans in the portfolio and a significant increase in the balances of nonperforming loans and was also partially due to loan growth of $126.6 million from March 31, 2008. Additionally, the decline in real estate values securing certain nonperforming loans required increased provision during the quarter. Net charge-offs for the quarter ended March 31, 2009 were $2.3 million, or 0.73% of average loans (annualized), compared to net charge-offs of $573 thousand, or 0.20% of average loans (annualized), for the quarter ended March 31, 2008. Nonperforming loans and past due loans increased from $4.3 million and $9.4 million, respectively, as of March 31, 2008 to $17.0 million and $17.1 million, respectively, as of March 31, 2009. | |
• | Noninterest income decreased from $2.2 million for the quarter ended March 31, 2008 to $2.1 million for the quarter ended March 31, 2009, a decline of $134 thousand, or 6.0%. The primary reason for the overall decline in noninterest income was an impairment charge of $320 thousand recorded on an equity investment in a correspondent financial institution during the quarter ended March 31, 2009 compared to a gain of $71 thousand on the sale of certain debt securities during the quarter ended March 31, 2008. The impairment charge this quarter represents the full amount of the Company’s investment in that institution. Partially offsetting the impact of the impairment charge, mortgage and other loan fees increased a net of $142 thousand, or 36.9%, compared to the same quarter last year primarily as a result of management’s emphasis on increasing loan-related fee income as well as favorable interest rates for the refinancing of residential and commercial loans. | |
• | Noninterest expense increased from $9.6 million for the quarter ended March 31, 2008 to $11.6 million for the quarter ended March 31, 2009, an increase of $1.9 million, or 20.2%. Salaries and employee benefits, occupancy, furniture and equipment, and data processing and telecommunications expenses increased a combined $1.6 million primarily due additional costs incurred as new branches were opened during the past year in Asheville (May 2008) and Clayton (December 2008) in addition to four branches purchased in the Fayetteville market (December 2008). FDIC deposit insurance costs rose by $182 thousand as the regulatory agency continued to increase premiums to cover higher monitoring costs and claims. |
Results of Operations
Quarter ended March 31, 2009 compared to quarter ended March 31, 2008
The Company reported a net loss of $4.5 million, or $0.45 per diluted share, for the quarter ended March 31, 2009 compared to net income of $2.2 million, or $0.19 per diluted share, for the quarter ended March 31, 2008. Net income decreased by $6.6 million, primarily due to a $5.4 million increase in provision for loan losses. Additionally, net interest income decreased by $728 thousand over the quarters under comparison, reflecting a lower net interest margin. Noninterest income decreased by $134 thousand primarily due to an impairment charge taken on an equity investment in a financial institution while noninterest expense increased $1.9 million over the quarters under comparison primarily due to higher salaries and benefits as well as occupancy expenses from the purchase of four branches in Fayetteville and the opening of a Clayton branch in December 2008. Taxes declined from expense of $799 thousand for the quarter ended March 31, 2008 to a benefit of $800 thousand for the quarter ended March 31, 2009, reflecting the decline in net income before taxes over the same quarters.
Net Interest Income. Net interest income decreased $728 thousand, or 6.7%, from $10.9 million for the quarter ended March 31, 2008 to $10.2 million for the quarter ended March 31, 2008. Average earning assets increased $148.9 million to $1.56 billion for the quarter ended March 31, 2009 from $1.41 billion for the quarter ended March 31, 2008. Average interest-bearing liabilities increased $114.7 million to $1.37 billion for the quarter ended March 31, 2009 from $1.26 billion for the quarter ended March 31, 2008. The net interest margin on a fully tax equivalent basis decreased by 47 basis points (“bps”) to 2.76% for the quarter ended March 31, 2009 from 3.23% for the quarter ended March 31, 2008. The earned yield on average interest-earning assets was 5.23% and 6.60% for the quarters ended March 31, 2009 and 2008, respectively, while the interest rate on average interest-bearing liabilities for those periods was 2.80% and 3.76%, respectively. The decline in the net interest margin was primarily a result of the 2.0% reduction in the prime rate over the last twelve months and competitive pressures in the Company’s primary markets for retail deposits. The majority of the Company’s loans are prime-based, while the Company’s interest-bearing deposits are impacted more by competitive rates in the marketplace offered for time deposits.
The following table shows the Company’s effective yield on earning assets and cost of funds. Yields and costs are computed by dividing income or expense for the year by the respective daily average asset or liability balance.
CAPITAL BANK CORPORATION
Average Balances, Interest Earned or Paid, and Interest Yields/Rates
For the Three Months Ended March 31, 2009, December 31, 2008 and March 31, 2008 (Unaudited)
Tax Equivalent Basis (1)
March 31, 2009 | December 31, 2008 | March 31, 2008 | ||||||||||||||||||||||||||
(Dollars in thousands) | Average Balance | Amount Earned | Average Rate | Average Balance | Amount Earned | Average Rate | Average Balance | Amount Earned | Average Rate | |||||||||||||||||||
Assets | ||||||||||||||||||||||||||||
Loans receivable: (2) | ||||||||||||||||||||||||||||
Commercial | $ | 1,095,804 | $ | 13,942 | 5.16 | % | $ | 1,052,172 | $ | 14,719 | 5.55 | % | $ | 986,205 | $ | 16,777 | 6.82 | % | ||||||||||
Consumer | 52,873 | 910 | 6.98 | 47,537 | 888 | 7.41 | 46,700 | 910 | 7.82 | |||||||||||||||||||
Home equity | 93,861 | 966 | 4.17 | 89,125 | 1,047 | 4.66 | 79,564 | 1,321 | 6.66 | |||||||||||||||||||
Residential mortgages | 22,900 | 274 | 4.79 | 24,193 | 355 | 5.87 | 30,259 | 491 | 6.49 | |||||||||||||||||||
Total loans | 1,265,438 | 16,092 | 5.16 | 1,213,027 | 17,009 | 5.56 | 1,142,728 | 19,499 | 6.84 | |||||||||||||||||||
Investment securities (3) | 289,368 | 3,957 | 5.47 | 246,658 | 3,430 | 5.56 | 256,538 | 3,590 | 5.60 | |||||||||||||||||||
Federal funds sold and other interest on short-term investments | 1,437 | 13 | 3.67 | 13,737 | 25 | 0.72 | 8,079 | 55 | 2.73 | |||||||||||||||||||
Total interest-earning assets | 1,556,243 | $ | 20,062 | 5.23 | % | 1,473,422 | $ | 20,464 | 5.51 | % | 1,407,345 | $ | 23,144 | 6.60 | % | |||||||||||||
Cash and due from banks | 40,578 | 25,018 | 26,232 | |||||||||||||||||||||||||
Other assets | 78,126 | 136,387 | 136,071 | |||||||||||||||||||||||||
Allowance for loan losses | (15,180 | ) | (14,010 | ) | (13,662 | ) | ||||||||||||||||||||||
Total assets | $ | 1,659,767 | $ | 1,620,817 | $ | 1,555,986 | ||||||||||||||||||||||
Liabilities and Equity | ||||||||||||||||||||||||||||
Savings deposits | $ | 28,793 | $ | 13 | 0.18 | % | $ | 27,948 | $ | 11 | 0.16 | % | $ | 30,382 | $ | 46 | 0.61 | % | ||||||||||
Interest-bearing demand deposits | 353,262 | 1,205 | 1.38 | 336,011 | 1,363 | 1.61 | 333,108 | 1,855 | 2.23 | |||||||||||||||||||
Time deposits | 800,879 | 6,551 | 3.32 | 758,491 | 6,733 | 3.52 | 657,609 | 7,171 | 4.37 | |||||||||||||||||||
Total interest-bearing deposits | 1,182,934 | 7,769 | 2.66 | 1,122,450 | 8,107 | 2.87 | 1,021,099 | 9,072 | 3.56 | |||||||||||||||||||
Borrowed funds | 146,233 | 1,389 | 3.85 | 145,962 | 1,605 | 4.36 | 171,645 | 2,022 | 4.72 | |||||||||||||||||||
Subordinated debt | 30,930 | 322 | 4.22 | 30,930 | 424 | 5.44 | 30,930 | 526 | 6.82 | |||||||||||||||||||
Repurchase agreements and fed funds purchased | 13,849 | 7 | 0.20 | 22,050 | 20 | 0.36 | 35,563 | 189 | 2.13 | |||||||||||||||||||
Total interest-bearing liabilities | 1,373,946 | $ | 9,487 | 2.80 | % | 1,321,392 | $ | 10,156 | 3.05 | % | 1,259,237 | $ | 11,809 | 3.76 | % | |||||||||||||
Noninterest-bearing deposits | 124,893 | 115,893 | 118,007 | |||||||||||||||||||||||||
Other liabilities | 11,643 | 12,305 | 11,132 | |||||||||||||||||||||||||
Total liabilities | 1,510,482 | 1,449,590 | 1,388,376 | |||||||||||||||||||||||||
Shareholders’ equity | 149,285 | 171,227 | 167,610 | |||||||||||||||||||||||||
Total liabilities and shareholders’ equity | $ | 1,659,767 | $ | 1,620,817 | $ | 1,555,986 | ||||||||||||||||||||||
Net interest spread (4) | 2.43 | % | 2.46 | % | 2.83 | % | ||||||||||||||||||||||
Tax equivalent adjustment | $ | 394 | $ | 376 | $ | 426 | ||||||||||||||||||||||
Net interest income and net interest margin (5) | $ | 10,575 | 2.76 | % | $ | 10,308 | 2.78 | % | $ | 11,335 | 3.23 | % |
(1) | The tax equivalent basis is computed using a blended federal and state tax rate of approximately 34%. |
(2) | Loans receivable include nonaccrual loans for which accrual of interest has not been recorded. |
(3) | The average balance for investment securities excludes the effect of their mark-to-market adjustment, if any. |
(4) | Net interest spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. |
(5) | Net interest margin represents net interest income divided by average interest-earning assets. |
Interest income on loans decreased from $19.5 million for the quarter ended March 31, 2008 to $16.1 million for the quarter ended March 31, 2009, a decline of $3.4 million, or 17.5%. This decrease is primarily due to declining loan yields, which decreased from 6.84% in the quarter ended March 31, 2008 to 5.16% in the quarter ended March 31, 2009, the effect of which was partially offset by higher average loan balances, which increased by $122.7 million. The declining loan yields are largely due to the drop in the prime rate from 5.25% at March 31, 2008 to 3.25% by March 31, 2009. In November 2006, the Company entered into a $100 million (notional) interest rate swap to help mitigate its exposure to interest rate volatility in the prime-based portion of the loan portfolio. This swap increased loan interest income by $1.1 million and $0.4 million for the quarters ended March 31, 2009 and 2008, respectively.
Interest income on investment securities increased from $3.2 million in for the quarter ended March 31, 2008 to $3.6 million for the quarter ended March 31, 2009, an increase of $399 thousand, or 12.6%. This increase is due to growth in the investment portfolio, partially offset by slightly lower investment yields. Average investment balances increased from $256.5 million for the quarter ended March 31, 2008 to $289.4 million for the quarter ended March 31, 2009, and the tax equivalent yield on investment securities decreased from 5.60% to 5.47% over the same period. The increase in average investment balances largely reflects management’s efforts to quickly deploy the $41.3 million of capital received from the CPP in December 2008 and net cash received from the purchase of four Fayetteville branch offices from Omni National Bank, also in December 2008.
Interest expense on deposits decreased from $9.1 million for the quarter ended March 31, 2008 to $7.8 million for the quarter ended March 31, 2009. The decrease is primarily due to a decrease in average deposit rates from 3.56% for the quarter ended March 31, 2008 to 2.66% for the quarter ended March 31, 2009. For time deposits, which represented 67.7% and 64.4% of total average interest-bearing deposits for the quarters ended March 31, 2009 and 2008, respectively, the average rate decreased from 4.37% for the quarter ended March 31, 2008 to 3.32% for the quarter ended March 31, 2009, reflecting the declining interest rate environment over the past year and some recent easing in competitor pricing for time deposits in part from government programs to ensure liquidity remains available in the financial system.
Interest expense on borrowings decreased from $2.7 million for the quarter ended March 31, 2008 to $1.7 million for the quarter ended March 31, 2009, partially due to declines in interest rates as well as a $47.1 million decrease in average borrowings over the two periods. The rate on average borrowings, including subordinated debt and repurchase agreements, for the quarter ended March 31, 2008 was 4.29% compared to 3.65% for the quarter ended March 31, 2009. In July 2003, the Company entered into interest rate swap agreements on $25.0 million of its outstanding Federal Home Loan Bank advances to swap fixed rate borrowings to a variable rate. In February 2009, swaps on $15.0 million of advances were unwound, and the proceeds received from the swap counterparty will be amortized as a reduction to interest expense over the remaining term of the underlying advances. The net effect of the swaps, including amortization of swap terminations, was a decrease to interest expense of $87 thousand and an increase to interest expense of $43 thousand for the quarters ended March 31, 2009 and 2008, respectively.
Provision for Loan Losses. Provision for loan losses was $6.0 million for the quarter ended March 31, 2009 compared to $565 thousand for the quarter ended March 31, 2008. The significant increase in the provision was primarily driven by deteriorating economic conditions and weaknesses in the local real estate markets which resulted in downgrades to the credit ratings of certain loans in the portfolio and a significant increase in the balances of nonperforming loans and was also partially due to loan growth of $126.6 million from March 31, 2008. Additionally, the decline in real estate values securing certain nonperforming loans required increased provision during the quarter. Net charge-offs for the quarter ended March 31, 2009 were $2.3 million, or 0.73% of average loans (annualized), compared to net charge-offs of $573 thousand, or 0.20% of average loans (annualized), for the quarter ended March 31, 2008. Nonperforming loans and past due loans increased from $4.3 million and $9.4 million, respectively, as of March 31, 2008 to $17.0 million and $17.1 million, respectively, as of March 31, 2009.
Noninterest Income. Noninterest income decreased from $2.2 million for the quarter ended March 31, 2008 to $2.1 million for the quarter ended March 31, 2009, a decline of $134 thousand, or 6.0%. Management continues to focus on noninterest income improvement strategies, which are based on core deposit growth, expanded mortgage origination staff, fee collection efforts, restructured pricing and innovative product enhancements. The following table presents the detail of noninterest income and related changes for the quarters ended March 31, 2009 and 2008.
2009 | 2008 | Variance | ||||||||
(Dollars in thousands) | ||||||||||
Noninterest income: | ||||||||||
Service charges and other fees | $ | 952 | $ | 959 | $ | (7 | ) | |||
Bank card services | 339 | 299 | 40 | |||||||
Mortgage fees and revenues | 233 | 272 | (39 | ) | ||||||
Other loan fees | 294 | 113 | 181 | |||||||
Brokerage fees | 163 | 156 | 7 | |||||||
Bank-owned life insurance | 258 | 302 | (44 | ) | ||||||
Net gain (loss) on investment securities | (320 | ) | 71 | (391 | ) | |||||
Other | 187 | 68 | 119 | |||||||
Total noninterest income | $ | 2,106 | $ | 2,240 | $ | (134 | ) |
The primary reason for the overall decline in noninterest income was an impairment charge of $320 thousand recorded on an equity investment in Silverton Bank, a correspondent financial institution during the quarter ended March 31, 2009 compared to a gain of $71 thousand on the sale of certain debt securities during the quarter ended March 31, 2008. The impairment charge this quarter represents the full amount of the Company’s investment in Silverton Bank. Management believes that due to significant deterioration in Silverton Bank’s capital ratios and overall financial strength as well as the departure of key members of the management team in recent months, minimal value remains in this equity investment.
Although the Company grew core deposits over the past year, service charges and other fees, which also includes overdraft and non-sufficient funds charges, remained relatively flat due to a decline in consumer spending during the current economic recession. Bank card services, which includes income received from debit card transactions, increased slightly from an increase in demand deposit accounts offset by a decline in overall consumer spending. Mortgage and other loan fees increased a net of $142 thousand, or 36.9%, compared to the same quarter last year primarily as a result of management’s emphasis on increasing loan-related fee income as well as favorable interest rates for the refinancing of residential and commercial loans. Brokerage fees remained relatively flat over the periods under comparison. Bank-owned life insurance income declined as the Company recorded a non-recurring gain during the quarter ended March 31, 2008 from the receipt of insurance proceeds upon the death of a former director. Other noninterest income increased primarily due to a reclassification of certain sublease receipts.
Noninterest Expense. Noninterest expense represents the costs of operating the Company. Management regularly monitors all categories of noninterest expense in an effort to improve productivity and operating performance. Noninterest expense increased from $9.6 million for the quarter ended March 31, 2008 to $11.6 million for the quarter ended March 31, 2009, an increase of $1.9 million, or 20.2%. The following table presents the detail of noninterest expense and related changes for the quarters ended March 31, 2009 and 2008.
2009 | 2008 | Variance | ||||||||
(Dollars in thousands) | ||||||||||
Noninterest expense: | ||||||||||
Salaries and employee benefits | $ | 6,013 | $ | 5,036 | $ | 977 | ||||
Occupancy | 1,373 | 997 | 376 | |||||||
Furniture and equipment | 830 | 747 | 83 | |||||||
Data processing and telecommunications | 631 | 432 | 199 | |||||||
Advertising | 323 | 315 | 8 | |||||||
Office expenses | 335 | 365 | (30 | ) | ||||||
Professional fees | 379 | 370 | 9 | |||||||
Business development and travel | 328 | 333 | (5 | ) | ||||||
Amortization of deposit premiums | 288 | 257 | 31 | |||||||
Miscellaneous loan handling costs | 163 | 94 | 69 | |||||||
Directors fees | 307 | 267 | 40 | |||||||
Insurance | 104 | 95 | 9 | |||||||
FDIC deposit insurance | 229 | 47 | 182 | |||||||
Other | 261 | 263 | (2 | ) | ||||||
Total noninterest expense | $ | 11,564 | $ | 9,618 | $ | 1,946 |
Salaries and employee benefits, occupancy, furniture and equipment, and data processing and telecommunications expenses increased a combined $1.6 million primarily due to additional costs incurred as new branches were opened during the past year in Asheville (May 2008) and Clayton (December 2008) in addition to four branches purchased in the Fayetteville market (December 2008). Additionally, salaries and employee benefits increased from normal compensation increases as well as from lower levels of cost deferrals from loan originations. Occupancy expenses increased from higher rent due to sale-leaseback agreements signed for three existing branch facilities in September 2008. Data processing and telecommunications costs rose from increased transaction volume due to growth in the Company’s business lines since much of the data processing costs are volume based.
Office expenses declined due to lower printing costs. Amortization of deposit premiums increased from additional amortization required on the core deposit intangible recognized as part of the acquisition of four Fayetteville branches from Omni National Bank in December 2008. Miscellaneous loan handling costs increased partially due to loan growth but primarily due to higher levels of loan collection costs. Directors fees increased as expense was reduced during the quarter ended March 31, 2008 to reflect a slight decline in the Company’s stock price during the quarter. The Deferred Compensation Plan for Outside Directors, which is a stock-based plan, was modified in November 2008, and since the modified terms of the Deferred Compensation Plan required a change from variable to fixed accounting in accordance with SFAS No. 123R, no market value adjustment was recorded during the quarter ended March 31, 2009. FDIC deposit insurance costs rose as the regulatory agency continued to increase premiums to cover higher monitoring costs and claims. Advertising, professional fees, business development and travel, insurance, and other noninterest expenses remained relatively flat over the periods under comparison.
Income Taxes. Income taxes represented a benefit of $800 thousand for the quarter ended March 31, 2009 compared to tax expense of $799 thousand for the quarter ended March 31, 2008. The significant decrease in tax expense (benefit) is due to the change in pretax income (loss) recorded for both periods. The decline in the effective tax rate from 26.9% for the quarter ended March 31, 2008 to 15.2% for the quarter ended March 31, 2009 is primarily due a change in projected annual taxable income used in the intraperiod tax allocation. Taxable income and book income can vary significantly due to nontaxable income such as municipal bond interest and bank-owned life insurance income.
Financial Condition
Total assets as of March 31, 2009 were $1.67 billion, an increase of $11.4 million, or 0.7%, from $1.65 billion as of December 31, 2008. The increase in total assets for the three months ended March 31, 2009 is primarily due to a $19.0 million increase in the Company’s loan portfolio, net of allowance for loan losses, since December 31, 2008. Total earning assets were $1.56 billion as of March 31, 2009 compared to $1.53 billion as of December 31, 2008. Earning assets represented 93.9% and 92.7% of total assets as of March 31, 2009 and December 31, 2008, respectively. As of March 31, 2009, investment securities were $286.3 million compared to $278.1 million as of December 31, 2008. Interest-earning cash, federal funds sold and short term investments were $403 thousand as of March 31, 2009 compared to $848 thousand as of December 31, 2008. Allowance for loan losses was $18.5 million as of March 31, 2009 compared to $14.8 million as of December 31, 2008, representing approximately 1.45% and 1.18%, respectively, of total loans as of both dates. Management believes that the allowance balance is adequate to absorb estimated losses inherent in the current loan portfolio. See “Asset Quality” section below for further discussion of the allowance for loan losses.
Total deposits as of March 31, 2009 were $1.34 billion, an increase of $25.7 million, or 2.0%, from $1.32 billion as of December 31, 2008. The increase was primarily due to a $33.5 million increase in demand deposit accounts, partially offset by a $1.2 million decrease in time deposits and a $6.6 million decrease in money market deposits. Time deposits represented 59.8% of total deposits at March 31, 2009 compared to 61.1% at December 31, 2008.
Total shareholders’ equity decreased from $148.5 million as of December 31, 2008 to $142.7 million as of March 31, 2009. Retained earnings declined by $5.9 million, reflecting a $4.5 million net loss for the quarter ended March 31, 2009 in addition to $1.4 million of dividends declared during the quarter on common and preferred shares. Accumulated other comprehensive income, which represents the unrealized gains and losses on available-for-sale securities and derivatives accounted for as cash flow hedges, net of related tax benefits, declined from $886 thousand as of December 31, 2008 to $642 thousand as of March 31, 2009. The decrease in accumulated other comprehensive income was primarily due to a decline in fair value of the cash flow hedge, partially offset by an increase in the fair value of available-for-sale securities. See the Condensed Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income for additional information regarding fluctuations in equity accounts during the quarter ended March 31, 2009.
Asset Quality
Determining the allowance for loan losses is based on a number of factors, many of which are subject to judgments made by management. At the origination of each commercial loan, management assesses the relative risk of the loan and assigns a corresponding risk grade. To ascertain that the credit quality is maintained after the loan is booked, a loan review officer performs an annual review of all unsecured loans over a predetermined loan amount, a sampling of loans within a lender’s authority, and a sampling of the entire loan pool. Loans are reviewed for credit quality, sufficiency of credit and collateral documentation, proper loan approval, covenant, policy and procedure adherence, and continuing accuracy of the loan grade. The Loan Review Manager reports directly to the Chief Credit Officer and the Audit Committee of the Company’s Board of Directors.
The allowance for loan losses is an amount that management believes will be adequate to absorb losses estimated inherent in existing loans, based on evaluations of the collectability of loans and prior loan loss experience. The evaluations take into consideration 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. The allowance calculation consists of two primary components: (1) a component for individual impairment as recognized and measured in accordance with SFAS No. 114, Accounting By Creditors for Impairment of a Loan, and (2) components for collective reserve as recognized in accordance with SFAS No. 5, Accounting for Contingencies, including a qualitative portion.
The Company maintains specific reserves for individually impaired loans pursuant to SFAS No. 114. 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 Company uses several factors in determining if a loan is impaired. The internal asset classification procedures include a thorough review of significant loans and lending relationships and include the accumulation of related data. This data includes loan payment status, borrowers’ financial data and borrowers’ operating factors such as cash flows, operating income or loss, etc. As of March 31, 2009 and December 31, 2008 impaired loans on relationships over $750 thousand totaled $22.4 million and $9.7 million, respectively, with specific reserves of $1.5 million and $0.3 million, respectively. These loans were evaluated individually based on the present value of expected future cash flows or the fair value of the collateral. As of March 31, 2009 and December 31, 2008, impaired loans on relationships less than $750 thousand, totaled $6.9 million and $6.0 million, respectively, with associated reserves of $1.1 million and $0.6 million, respectively. These loans were evaluated on the pooled method as allowed by SFAS No. 114 and were assigned reserves based on each loan’s risk grading.
For loans not considered impaired, the Company estimates the amount of allowance needed to cover losses inherent in the portfolio, in accordance with SFAS No. 5, by applying a loss allowance factor to each risk grade. Unless identified as an at-risk loan, consumer loans and mortgages are not risk graded, but a loss allocation factor is utilized for these loans based on historical losses. The loss allocation factors have been developed based on the Company’s historical losses and industry trends. Further, for commercial loans rated special mention and/or classified with outstanding relationship balances greater than $750 thousand, management determines the level of reserves based on the facts and circumstances of each borrower relationship, including among other factors, payment history, collateral values, guarantor liquidity, and net worth. In addition to this quantitative analysis, a qualitative assessment of the general economic trends, portfolio concentration, interest rate movements and the trend of delinquencies are taken into consideration. The loan loss allowance is adjusted to an amount that management believes is adequate to absorb losses inherent in the loan portfolio as of the balance sheet date presented.
The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely. Based on this allowance calculation, management recorded a provision of $6.0 million for the quarter ended March 31, 2009 compared to $565 thousand for the quarter ended March 31, 2008. The significant increase in the provision was partially due to loan growth of $126.6 million from March 31, 2008, but the increase was primarily driven by deteriorating economic conditions and weaknesses in the local real estate markets which resulted in downgrades to the credit ratings of certain loans in the portfolio and a significant increase in the balances of nonperforming loans. Additionally, the decline in real estate values securing certain nonperforming loans required increased provision during the quarter. Net charge-offs for the quarter ended March 31, 2009 were $2.3 million, or 0.73% of average loans (annualized), compared to net charge-offs of $573 thousand, or 0.20% of average loans (annualized), for the quarter ended March 31, 2008.
The following table presents an analysis of changes in the allowance for loan losses for the three months ended March 31, 2009 and 2008, respectively.
Three Months Ended March 31, | |||||||
2009 | 2008 | ||||||
(Dollars in thousands) | |||||||
Allowance for loan losses, beginning of period | $ | 14,795 | $ | 13,571 | |||
Net charge-offs: | |||||||
Loans charged off: | |||||||
Commercial | 680 | 346 | |||||
Construction | 1,332 | 332 | |||||
Consumer | 73 | 593 | |||||
Home equity | 123 | – | |||||
Residential mortgages | 165 | – | |||||
Total charge-offs | 2,373 | 1,271 | |||||
Recoveries of loans previously charged off: | |||||||
Commercial | 61 | 386 | |||||
Construction | – | 275 | |||||
Consumer | 10 | 35 | |||||
Home equity | 1 | 1 | |||||
Residential mortgages | – | 1 | |||||
Total recoveries | 72 | 698 | |||||
Total net charge-offs | 2,301 | 573 | |||||
Loss provision charged to operations | 5,986 | 565 | |||||
Allowance for loan losses, end of period | $ | 18,480 | $ | 13,563 | |||
Net charge-offs to average loans during the period (annualized) | 0.73 | % | 0.20 | % | |||
Allowance as a percent of gross loans | 1.45 | % | 1.18 | % |
The evaluation of the allowance for loan losses is inherently subjective, and management uses the best information available to establish this estimate. However, if factors such as economic conditions differ substantially from assumptions, or if amounts and timing of future cash flows expected to be received on impaired loans vary substantially from the estimates, future adjustments to the allowance for loan losses may be necessary. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance for loan losses based on their judgments about all relevant information available to them at the time of their examination. Any adjustments to original estimates are made in the period in which the factors and other considerations indicate that adjustments to the allowance for loan losses are necessary.
The following table presents an analysis of nonperforming assets as of March 31, 2009 and December 31, 2008.
March 31, 2009 | December 31, 2008 | ||||||
(Dollars in thousands) | (Unaudited) | ||||||
Nonperforming loans: | |||||||
Commercial | $ | 6,231 | $ | 4,682 | |||
Construction | 10,259 | 3,843 | |||||
Consumer | 33 | 92 | |||||
Home equity | 96 | 275 | |||||
Residential mortgages | 389 | 223 | |||||
Total nonperforming loans | 17,008 | 9,115 | |||||
Foreclosed property held | 3,616 | 1,347 | |||||
Total nonperforming assets | $ | 20,624 | $ | 10,462 | |||
Nonperforming loans to total loans | 1.33 | % | 0.73 | % | |||
Nonperforming assets to total assets | 1.24 | % | 0.63 | % | |||
Allowance coverage of nonperforming loans | 109 | % | 162 | % |
Of the $29.3 million of loans considered impaired in accordance with SFAS No. 114, loan relationships totaling $8.5 million are still accruing interest and are not included in nonperforming loans as of March 31, 2009. The largest of these is a builder/developer relationship located in Central North Carolina and an automobile dealership/real estate relationship located in Central North Carolina, with outstanding loan balances of $5.6 million and $1.6 million, respectively, as of March 31, 2009. Such loans are classified as troubled debt restructurings by the Company when certain modifications are made to the loan terms due to financial difficulty experienced by the debtors. These loans were not placed in nonaccrual status prior to the restructuring, and since the Company expects the borrowers to perform after the restructuring (based on modified note terms), the loans continue to accrue interest at the restructured rate. The Company will continue to closely monitor these loans and will cease accruing interest on them if management believes that the borrowers may not continue performing based on the restructured note terms. Since these loans were classified as troubled debt restructurings, they were considered to be impaired and were evaluated for impairment in accordance with SFAS No. 114. As of March 31, 2009, specific reserves recorded on impaired loans still accruing interest totaled $1.0 million.
Foreclosed property increased to $3.6 million at March 31, 2009 from $1.3 million at December 31, 2008. The increase was primarily due to the repossession during the quarter of certain commercial and residential real estate. The Company is actively marketing all of its foreclosed property. Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value.
Liquidity and Capital Resources
Liquidity. Liquidity management involves the ability to meet the cash flow requirements of depositors desiring to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. To ensure the Company is positioned to meet immediate and future cash demands, management relies on internal analysis of its liquidity, knowledge of current economic and market trends and forecasts of future conditions. Regulatory agencies set certain minimum liquidity standards, including the setting of a reserve requirement by the Federal Reserve. The Company must submit weekly reports to the Federal Reserve to ensure that it meets those requirements. As of March 31, 2009, the Company met all of its regulatory liquidity requirements.
The Company had $39.9 million in its most liquid assets, cash and cash equivalents, as of March 31, 2009. The Company’s principal sources of funds are loan repayments, deposits, short-term borrowings, capital and, to a lesser extent, investment repayments. Core deposits (total deposits less certificates of deposits in the amount of $100 thousand or more), one of the most stable sources of liquidity, together with equity capital funded $1.18 billion, or 70.9%, of total assets as of March 31, 2009 compared to $1.17 billion, or 70.7%, of total assets as of December 31, 2008. Additional sources of liquidity are available to the Company through the Federal Reserve and through membership in the FHLB system as well as access to funding through various brokered deposit programs, federal funds lines and security repurchase agreements.
Capital Resources. The management of equity is a critical aspect of capital management in any business. The determination of the appropriate amount of equity is affected by a wide number of factors. The primary factor for a regulated financial institution is the amount of capital needed to meet regulatory requirements, although other factors, such as the “risk equity” the business requires and balance sheet leverage, also affect the determination.
To be categorized as well capitalized, the Company and the Bank each must maintain minimum amounts and ratios. The Company’s and the Bank’s actual capital amounts and ratios as of March 31, 2009 and the minimum requirements are presented in the following table.
Actual | Minimum Requirements To Be Well Capitalized | ||||||||||||
(Dollars in thousands) | Amount | Ratio | Amount | Ratio | |||||||||
Capital Bank Corporation: | |||||||||||||
Total capital (to risk-weighted assets) | $ | 183,990 | 13.07 | % | $ | 140,779 | 10.00 | % | |||||
Tier I capital (to risk-weighted assets) | 166,386 | 11.82 | 84,467 | 6.00 | |||||||||
Tier I capital (to average assets) | 166,386 | 10.01 | 83,100 | 5.00 | |||||||||
Capital Bank: | |||||||||||||
Total capital (to risk-weighted assets) | $ | 181,557 | 12.90 | % | $ | 140,718 | 10.00 | % | |||||
Tier I capital (to risk-weighted assets) | 163,953 | 11.65 | 84,431 | 6.00 | |||||||||
Tier I capital (to average assets) | 163,953 | 9.93 | 82,584 | 5.00 |
Total shareholders’ equity was $142.7 million as of March 31, 2009. Management believes this level of shareholders’ equity provides adequate capital to support the Company’s growth and to maintain a well capitalized position.
On October 3, 2008, the EESA was enacted, which authorized the Treasury to establish the TARP, of which the CPP is a part. Under the CPP, certain U.S. financial institutions sold senior preferred stock and issue warrants to purchase an institution’s common stock to the Treasury in exchange for a capital infusion. Eligible institutions applied to issue preferred stock to the Treasury in aggregate amounts between 1% and 3% of the institution’s risk-weighted assets, along with warrants covering shares of common stock. In order to participate in the CPP, the Company’s shareholders approved an amendment to the Company’s articles of incorporation to authorize 100,000 shares of preferred stock.
In December 2008, the Company entered into a Securities Purchase Agreement—Standard Terms with the Treasury (the “Stock Purchase Agreement”) pursuant to which, among other things, the Company sold to the Treasury for an aggregate purchase price of $41.3 million, 41,279 shares of Series A Fixed Rate Cumulative Perpetual Preferred Stock of the Company (“Series A Preferred Stock”) and warrants to purchase up to 749,619 shares of common stock (the “Warrants”) of the Company. As a condition under the CPP, the Company’s share repurchases are currently limited to purchases in connection with the administration of any employee benefit plan, consistent with past practices, including purchases to offset share dilution in connection with any such plans. This restriction is effective until December 2011 or until the Treasury no longer owns any of the Series A Preferred Stock.
The Series A Preferred Stock ranks senior to the Company’s common shares and pays a compounding cumulative dividend, in cash, at a rate of 5% per annum for the first five years, and 9% per annum thereafter on the liquidation preference of $1,000 per share. The Company is prohibited from paying any dividend with respect to shares of common stock or repurchasing or redeeming any shares of the Company’s common shares unless all accrued and unpaid dividends are paid on the Series A Preferred Stock for all past dividend periods (including the latest completed dividend period). The Series A Preferred Stock is non-voting, other than class voting rights on matters that could adversely affect the Series A Preferred Stock. The Series A Preferred Stock is callable at par after three years. Prior to the end of three years, the Series A Preferred Stock may be redeemed with the proceeds from one or more qualified equity offerings of any Tier 1 perpetual preferred or common stock of at least $10.3 million (each a “Qualified Equity Offering”). The Treasury may also transfer the Series A Preferred Stock to a third party at any time. The Company made its first scheduled dividend payment to the Treasury for approximately $361,000 during the quarter ended March 31, 2009.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
As described in more detail in Part II, Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2008, asset/liability management involves the evaluation, monitoring and management of interest rate risk, liquidity and funding. While the Board of Directors has overall responsibility for the Company’s asset/liability management policies, the Bank’s Asset and Liability Committee monitors loan, investment, and liability portfolios to ensure comprehensive management of interest rate risk and adherence to the Bank’s policies. The Company has not experienced any material change in the risk of its portfolios of interest-earning assets and interest-bearing liabilities from December 31, 2008 to March 31, 2009.
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports it files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures, which, by their nature, can provide only reasonable assurance regarding management’s control objectives.
As required by paragraph (b) of Rule 13a-15 under the Exchange Act, an evaluation was carried out under the supervision and with the participation of the Company’s management, including the CEO and CFO, of the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. During the course of their evaluation, management discovered that, as a result of human error, the Company failed to file a Form 8-K pursuant to Item 5.02 in connection with the award of certain discretionary bonuses under the Company’s Annual Incentive Plan. As a result, management has implemented further training of relevant Company personnel and Board members regarding Form 8-K triggers and the timing related thereto. Based upon that evaluation, the CEO and CFO concluded that, as of the period covered by the report, the Company’s disclosure controls and procedures are effective in that they provide reasonable assurances that the information the Company is required to disclose in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods required by the SEC’s rules and forms.
Changes in Internal Control over Financial Reporting
There were no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the period covered by this report that have materially affected or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Management has implemented changes in internal control over financial reporting as a result of remediation of matters identified through its review of internal control over financial reporting as required under Section 404 of the Sarbanes-Oxley Act; however, it does not believe any of the changes implemented were material in nature.
PART II – OTHER INFORMATION
There are no material pending legal proceedings to which the Company or its subsidiaries is a party or to which any of the Company’s or its subsidiaries’ property is subject. In addition, the Company is not aware of any threatened litigation, unasserted claims or assessments that could have a material adverse effect on the Company’s business, operating results or condition.
You should consider the following material risk factors carefully before deciding to invest in the Company’s securities. Additional risks and uncertainties not presently known to us, that we may currently deem to be immaterial or that are similar to those faced by other companies in our industry or business in general, such as competitive conditions, may also impact our business operations. If any of the events described below occur, the Company’s business, financial condition, or results of operations could be materially adversely affected. In that event, the trading price of the Company’s common stock may decline, in which case the value of your investment may decline as well. References herein to “we”, “us”, and “our” refer to Capital Bank Corporation, a North Carolina corporation, and its subsidiaries, unless the context otherwise requires.
Legislative and regulatory actions taken now or in the future to address the current liquidity and credit crisis in the financial industry may significantly affect our liquidity or financial condition.
The EESA, which established the TARP, was enacted on October 3, 2008. As part of the TARP, the Treasury created the CPP, under which the Treasury will invest up to $250 billion in senior preferred stock of U.S. banks and savings associations or their holding companies for the purpose of stabilizing and providing liquidity to the U.S. financial markets. On February 17, 2009, the ARRA was enacted as a sweeping economic recovery package intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs. There can be no assurance as to the actual impact that EESA or its programs, including the CPP, and ARRA or its programs, will have on the national economy or financial markets. The failure of these significant legislative measures to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect the Company’s financial condition, results of operation, liquidity or stock price.
U.S. and international credit markets and economic conditions could adversely affect our liquidity and financial condition.
Global market and economic conditions continue to be disruptive and volatile and the disruption has particularly had a negative impact on the financial sector. The possible duration and severity of this adverse economic cycle is unknown. Although the Company remains well capitalized and has not suffered any liquidity issues as a result of these recent events, the cost and availability of funds may be adversely affected by illiquid credit markets. Continued turbulence in U.S. and international markets and economies may adversely affect our liquidity, financial condition and profitability.
In addition, federal and state governments could pass additional legislation responsive to current credit conditions. We could experience higher credit losses because of legislation or regulatory action that reduces the amounts borrowers are contractually required to pay under existing loan contracts or that limits our ability to foreclose on property or other collateral or makes foreclosure less economically feasible.
Changes in local economic conditions could lead to higher loan charge-offs and reduce our net income and growth.
Our business is subject to periodic fluctuations based on local economic conditions in Central and Western North Carolina. These fluctuations are not predictable, cannot be controlled, and may have a material adverse impact on our operations and financial condition even if other favorable events occur. Our operations are locally oriented and community-based. Accordingly, we expect to continue to be dependent upon local business conditions as well as conditions in the local residential and commercial real estate markets we serve. For example, an increase in unemployment, a decrease in real estate values or increases in interest rates, as well as other factors, could weaken the economies of the communities we serve.
Weakness in our market areas could depress our earnings and consequently our financial condition because:
• | customers may not want or need our products or services; | |
• | borrowers may not be able to repay their loans; | |
• | the value of the collateral securing loans to borrowers may decline; and | |
• | the quality of our loan portfolio may decline. |
Any of the latter three scenarios could require us to charge off a higher percentage of loans and/or increase provisions for credit losses, which would reduce our net income. For an analysis of our recent charge-off experience, please refer to the “Asset Quality” section in Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Because the majority of our borrowers are individuals and businesses located and doing business in Wake, Granville, Lee, Cumberland, Johnston, Chatham, Alamance, Buncombe and Catawba Counties, North Carolina, our success will depend significantly upon the economic conditions in those and the surrounding counties. Unfavorable economic conditions in those and the surrounding counties may result in, among other things, a deterioration in credit quality or a reduced demand for credit and may harm the financial stability of our customers. Due to our limited market areas, these negative conditions may have a more noticeable effect on us than would be experienced by a larger institution that is able to spread these risks of unfavorable local economic conditions across a large number of diversified economies.
Weakness in the markets for residential or commercial real estate could reduce our net income and profitability.
Recently, the financial markets have experienced volatility associated with subprime mortgages, including adverse impacts on credit quality and liquidity within the financial markets. The volatility has been exacerbated by a general decline in the real estate and housing market along with significant mortgage loan related losses reported by many other financial institutions. Our financial results may be adversely affected by changes in real estate values. Decreases in real estate values could adversely affect the value of property used as collateral for loans and investments. If poor economic conditions result in decreased demand for real estate loans, our net income and profits may decline.
The declines in home prices in the markets we serve, along with the reduced availability of mortgage credit, also may result in increases in delinquencies and losses in our portfolio of loans related to residential real estate construction and development. We significantly increased our provision for loan losses in the quarter ended March 31, 2009 primarily due to deteriorating economic conditions and weakness in local real estate markets. Further declines in home prices coupled with a deepened economic recession and continued rises in unemployment levels could drive losses beyond that which is provided for in our allowance for loan losses. In that event, our earnings could be adversely affected.
Additionally, recent weakness in the secondary market for residential lending could have an adverse impact upon our profitability. Significant ongoing disruptions in the secondary market for residential mortgage loans have limited the market for and liquidity of most mortgage loans other than conforming Fannie Mae and Freddie Mac loans. The effects of ongoing mortgage market challenges, combined with the ongoing correction in residential real estate market prices and reduced levels of home sales, could result in further price reductions in single family home values, adversely affecting the value of collateral securing mortgage loans held, mortgage loan originations and gains on sale of mortgage loans. Continued declines in real estate values and home sales volumes, and financial stress on borrowers as a result of job losses, or other factors, could have further adverse effects on borrowers that result in higher delinquencies and greater charge-offs in future periods, which would adversely affect our financial condition or results of operations.
Changes in interest rates may have an adverse effect on our profitability.
Our earnings and financial condition are dependent to a large degree upon net interest income, which is the difference between interest earned from loans and investments and interest paid on deposits and borrowings. The narrowing of interest rate spreads, meaning the difference between interest rates earned on loans and investments and the interest rates paid on deposits and borrowings, could adversely affect our earnings and financial condition. We cannot predict with certainty or control changes in interest rates. Regional and local economic conditions and the policies of regulatory authorities, including monetary policies of the Federal Reserve Board, affect interest income and interest expense. We have ongoing policies and procedures designed to manage the risks associated with changes in market interest rates. However, changes in interest rates still may have an adverse effect on our profitability.
We are exposed to risks in connection with the loans we make.
A significant source of risk for us arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans. We have underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for loan losses, that we believe are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying our loan portfolio. Such policies and procedures, however, may not prevent unexpected losses that could adversely affect our results of operations. Loan defaults result in a decrease in interest income resulting from a loan default or defaults may be for a prolonged period of time as we seek to recover, primarily through legal proceedings, the outstanding principal balance, accrued interest and default interest due on a defaulted loan plus the legal costs incurred in pursuing our legal remedies. No assurance can be given that recent market conditions will not result in our need to increase loan loss reserves or charge off a higher percentage of loans, thereby reducing net income.
We compete with larger companies for business.
The banking and financial services business in our market areas continues to be a competitive field and is becoming more competitive as a result of:
• | changes in regulations; | |
• | changes in technology and product delivery systems; and | |
• | the accelerating pace of consolidation among financial services providers. |
We may not be able to compete effectively in our markets, and our results of operations could be adversely affected by the nature or pace of change in competition. We compete for loans, deposits and customers with various bank and nonbank financial services providers, many of which have substantially greater resources, including higher total assets and capitalization, greater access to capital markets and a broader offering of financial services.
Our trading volume has been low compared with larger banks.
The trading volume in the Company’s common stock on the NASDAQ Global Select Market has been comparable to other similarly-sized banks. Nevertheless, this trading is relatively low when compared with more seasoned companies listed on the NASDAQ Global Select Market or other consolidated reporting systems or stock exchanges. Thus, the market in the Company’s common stock may be limited in scope relative to other companies.
We depend heavily on our key management personnel.
The Company’s success depends in part on its ability to retain key executives and to attract and retain additional qualified management personnel who have experience both in sophisticated banking matters and in operating a small- to mid-size bank. Competition for such personnel is strong in the banking industry, and we may not be successful in attracting or retaining the personnel we require. We expect to effectively compete in this area by offering financial packages that include incentive-based compensation and the opportunity to join in the rewarding work of building a growing bank.
Participation in the TARP imposes several restrictions on compensation paid to our executives.
Pursuant to the terms of the Stock Purchase Agreement, we adopted certain standards for executive compensation and corporate governance for the period during which the Treasury holds the equity issued pursuant to the Stock Purchase Agreement, including the common stock which may be issued pursuant to the Warrants. These standards generally apply to our Chief Executive Officer, Chief Financial Officer and our senior executive officers (“SEOs”). The standards include (1) ensuring that bonus incentive compensation arrangements for SEOs do not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) requiring clawback of any bonus or incentive compensation paid to a SEOs based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibiting certain parachute payments to SEOs; and (4) agreeing not to deduct for tax purposes executive compensation in excess of $500,000 for each SEO. In particular, the change to the deductibility limit on executive compensation will likely increase the overall cost of our compensation programs in future periods. Since the Warrants have a ten year term, we could potentially be subject to the executive compensation and corporate governance restrictions for a ten year time period.
Additionally, the ARRA amends Section 111 of the EESA to require the Treasury to adopt additional standards with respect to executive compensation and corporate governance for TARP recipients (including the Company). The standards required to be established by the Treasury include, in part, (1) prohibitions on making golden parachute payments to SEOs and the next 5 most highly-compensated employees during such time as any obligation arising from financial assistance provided under the TARP remains outstanding (the “Restricted Period”), (2) prohibitions on paying or accruing bonuses or other incentive awards for certain SEOs and employees, except for awards of long-term restricted stock with a value equal to no greater than 1/3 of an individual’s annual compensation that do not fully vest during the Restricted Period or unless such compensation is pursuant to a valid written employment contract prior to February 11, 2009, (3) requirements that CPP participants provide for the recovery of any bonus or incentive compensation paid to SEOs and the next 20 most highly-compensated employees based on statements of earnings, revenues, gains or other criteria later found to be materially inaccurate, with the Treasury having authority to negotiate for reimbursement, and (4) a review by the Treasury of all bonuses and other compensation paid by TARP participants to senior executive employees and the next 20 most highly-compensated employees before the date of enactment of the ARRA to determine whether such payments were inconsistent with the purposes of the EESA.
Technological advances impact our business.
The banking industry is undergoing technological changes with frequent introductions of new technology-driven products and services. In addition to improving customer services, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, on our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources than we do to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or successfully market such products and services to our customers.
Government regulations may prevent or impact our ability to pay dividends, engage in acquisitions or operate in other ways.
Current and future legislation and the policies established by federal and state regulatory authorities will affect our operations. We are subject to supervision and periodic examination by the Federal Deposit Insurance Corporation and the North Carolina State Banking Commission. Banking regulations, designed primarily for the protection of depositors, may limit our growth and the return to you, our investors, by restricting certain of our activities, such as:
• | the payment of dividends to our shareholders; | |
• | possible mergers with, or acquisitions of or by, other institutions; | |
• | our desired investments; | |
• | loans and interest rates on loans; | |
• | interest rates paid on our deposits; | |
• | the possible expansion of our branch offices; and/or | |
• | our ability to provide securities or trust services. |
We also are subject to capitalization guidelines set forth in federal legislation, and could be subject to enforcement actions to the extent that we are found by regulatory examiners to be undercapitalized. We cannot predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that such changes may have on our future business and earnings prospects. The cost of compliance with regulatory requirements including those imposed by the SEC may adversely affect our ability to operate profitably.
The Treasury’s investment in us imposes restrictions and obligations limiting our ability to increase dividends and repurchase common stock.
In December 2008, the Company issued preferred stock and Warrants to the Treasury. Prior to December 12, 2011, unless the Company has redeemed all of the preferred stock, or the Treasury has transferred all of the preferred stock to a third party, the consent of the Treasury will be required for the Company to, among other things, increase common stock dividends or effect repurchases of common stock (with certain exceptions, including the repurchase of the Company’s common stock to offset share dilution from equity-based employee compensation awards).
There are potential risks associated with future acquisitions and expansions.
We intend to continue to explore expanding our branch system through selective acquisitions of existing banks or bank branches in the Research Triangle area and other North Carolina markets. We cannot say with any certainty that we will be able to consummate, or if consummated, successfully integrate, future acquisitions, or that we will not incur disruptions or unexpected expenses in integrating such acquisitions. In the ordinary course of business, we evaluate potential acquisitions that would bolster our ability to cater to the small business, individual and residential lending markets in North Carolina. In attempting to make such acquisitions, we anticipate competing with other financial institutions, many of which have greater financial and operational resources. In addition, since the consideration for an acquired bank or branch may involve cash, notes or the issuance of shares of common stock, existing shareholders could experience dilution in the value of their shares of our common stock in connection with such acquisitions. Any given acquisition, if and when consummated, may adversely affect our results of operations or overall financial condition. In addition, we may expand our branch network through de novo branches in existing or new markets. These de novo branches will have expenses in excess of revenues for varying periods after opening, which could decrease our reported earnings.
Compliance with changing regulation of corporate governance and public disclosure may result in additional risks and expenses.
Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002 and new SEC regulations, are creating uncertainty for companies such as ours. These laws, regulations and standards are subject to varying interpretations in many cases, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, our efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased expenses and a diversion of management time and attention. In particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding management’s required assessment of our internal control over financial reporting and our external auditors’ audit of that assessment has required the commitment of significant financial and managerial resources.
We expect these efforts to require the continued commitment of significant resources. Further, the members of our Board of Directors, members of the Audit or Compensation/Human Resources Committees, our CEO, our CFO and certain other of our executive officers could face an increased risk of personal liability in connection with the performance of their duties. As a result, our ability to attract and retain executive officers and qualified Board and committee members could be more difficult. In addition, it may become more difficult and more expensive to obtain director and officer liability insurance.
We are subject to environmental liability risk associated with lending activities.
A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures to perform an environmental review before initiating any foreclosure action on nonresidential real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations. Loan defaults result in a decrease in interest income and may require the establishment of or an increase in loan loss reserves. Furthermore, the decrease in interest income resulting from a loan default or defaults may be for a prolonged period of time as we seek to recover, primarily through legal proceedings, the outstanding principal balance, accrued interest and default interest due on a defaulted loan plus the legal costs incurred in pursuing our legal remedies. No assurance can be given that recent market conditions will not result in our need to increase loan loss reserves or charge-off a higher percentage of loans, thereby reducing net income.
Our controls and procedures may fail or be circumvented.
Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition.
The holders of our subordinated debentures have rights that are senior to those of our shareholders.
We have issued $30.9 million of subordinated debentures in connection with three trust preferred securities issuances by our subsidiaries, Trust I, II and III. We conditionally guarantee payments of the principal and interest on the trust preferred securities. Our subordinated debentures are senior to our shares of common stock. As a result, we must make payments on the subordinated debentures (and the related trust preferred securities) before any dividends can be paid on our common stock and, in the event of bankruptcy, dissolution or liquidation, the holders of the debentures must be satisfied before any distributions can be made to the holders of common stock.
Our information systems may experience an interruption or breach in security.
We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that we can prevent any such failures, interruptions or security breaches or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
An investment in our common stock is not an insured deposit.
Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire our common stock, you may lose some or all of your investment.
Consumers may decide not to use banks to complete their financial transactions.
Technology and other changes are allowing parties to complete financial transactions that historically have involved banks through alternative methods. For example, consumers can now maintain funds in brokerage accounts or mutual funds that would have historically been held as bank deposits. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
There were no repurchases (both open market and private transactions) during the three months ended March 31, 2009 of any of the Company���s securities registered under Section 12 of the Exchange Act, by or on behalf of the Company, or any affiliated purchaser of the Company.
None
Item 4. Submission of Matters to a Vote of Security Holders
None
None
Exhibit No. | Description | |
Exhibit 4.1 | In accordance with Item 601(b)(4)(iii)(A) of Regulation S-K, certain instruments respecting long-term debt of the registrant have been omitted but will be furnished to the Commission upon request. | |
Exhibit 31.1 | Certification of B. Grant Yarber pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
Exhibit 31.2 | Certification of Michael R. Moore pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
Exhibit 32.1 | Certification of B. Grant Yarber pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by that Act, be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the case may be.] | |
Exhibit 32.2 | Certification of Michael R. Moore pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by that Act, be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the case may be.] |
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in Raleigh, North Carolina, on the 8th day of May 2009.
CAPITAL BANK CORPORATION | ||
By: /s/ Michael R. Moore | ||
Michael R. Moore | ||
Chief Financial Officer | ||
(Authorized Officer and Principal Financial Officer) |
Exhibit Index
Exhibit No. | Description | |
Exhibit 4.1 | In accordance with Item 601(b)(4)(iii)(A) of Regulation S-K, certain instruments respecting long-term debt of the registrant have been omitted but will be furnished to the Commission upon request. | |
Exhibit 31.1 | Certification of B. Grant Yarber pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
Exhibit 31.2 | Certification of Michael R. Moore pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
Exhibit 32.1 | Certification of B. Grant Yarber pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by that Act, be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the case may be.] | |
Exhibit 32.2 | Certification of Michael R. Moore pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by that Act, be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the case may be.] |
- 36 - -