U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
| x | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2003
| ¨ | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT |
For the transition period ended
Commission File Number 0-26551
INTEGRITY FINANCIAL CORPORATION
(Exact name of small business issuer as specified in its charter)
| NORTH CAROLINA | 56-2137427 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification Number) |
39 SECOND STREET NW, HICKORY, NC 28601
(Address of principal executive office)
(888) 894-2483
(Issuer’s telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of October 31, 2003, 4,144,592 shares of the issuer’s common stock, $1.00 par value, were outstanding.
This report contains 15 pages.
| Page No. | ||||||
| Item 1 - | Financial Statements (Unaudited) | |||||
| Consolidated Balance Sheets September 30, 2003 and December 31, 2002 | 3 | |||||
| Consolidated Statements of Operations Three Months and Nine Months Ended September 30, 2003 and 2002 | 4 | |||||
| Consolidated Statements of Cash Flows Nine Months Ended September 30, 2003 and 2002 | 5 | |||||
| Notes to Consolidated Financial Statements | 6 | |||||
Item 2 - | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 8 | ||||
Item 3 - | 12 | |||||
Item 4 - | 12 | |||||
Part II. | OTHER INFORMATION | |||||
Item 6 - | 13 | |||||
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Part I. FINANCIAL INFORMATION
Item 1 - Financial Statements
Integrity Financial Corporation
Consolidated Balance Sheets
| 2003 | December 31, | |||||||
| (Unaudited) | 2002* | |||||||
ASSETS | ||||||||
Cash and due from banks | $ | 5,792,811 | $ | 9,000,383 | ||||
Interest-earning deposits in banks | 14,538,063 | 7,518,090 | ||||||
Federal funds sold | 161,856 | 937,494 | ||||||
Investment securities available for sale | 81,464,585 | 75,752,035 | ||||||
Investment securities held to maturity (fair value of $2,979,405 at September 30, 2003 ) | 2,958,418 | — | ||||||
Loans | 444,341,859 | 415,740,668 | ||||||
Less allowance for loan losses | (6,193,433 | ) | (5,721,452 | ) | ||||
Net loans | 438,148,426 | 410,019,216 | ||||||
Factored accounts receivable | 2,604,025 | 3,694,568 | ||||||
Stock in the Federal Home Loan Bank, at cost | 2,105,900 | 2,431,800 | ||||||
Foreclosed real estate | 1,137,758 | 585,697 | ||||||
Bank premises and equipment | 17,947,129 | 14,217,567 | ||||||
Other assets | 4,749,396 | 5,924,613 | ||||||
Bank owned life insurance | 8,260,750 | 4,072,184 | ||||||
Goodwill | 17,017,473 | 17,017,473 | ||||||
Other intangible assets | 2,556,517 | 2,795,901 | ||||||
Total assets | $ | 599,443,107 | $ | 553,967,021 | ||||
Liabilities and Stockholders’ Equity | ||||||||
Deposits: | ||||||||
Non-interest-bearing demand | $ | 43,092,696 | $ | 34,253,286 | ||||
Money market and NOW accounts | 143,168,516 | 121,827,208 | ||||||
Savings | 11,994,472 | 11,692,178 | ||||||
Time, $100,000 and over | 128,201,684 | 118,428,965 | ||||||
Other time | 153,345,943 | 154,330,535 | ||||||
Total deposits | 479,803,311 | 440,532,172 | ||||||
Federal Home Loan Bank advances | 42,114,987 | 36,130,363 | ||||||
Securities sold under agreement to repurchase | 3,937,414 | 3,946,987 | ||||||
Accrued expenses and other liabilities | 2,033,532 | 3,125,684 | ||||||
Trust preferred securities | 10,000,000 | 10,000,000 | ||||||
Total liabilities | 537,889,244 | 493,735,206 | ||||||
Stockholders’ equity: | ||||||||
Preferred stock, no par value, 1,000,000 shares authorized; none issued | — | — | ||||||
Common stock, $1 par value, 9,000,000 shares authorized; 4,306,253 and 4,270,348 shares issued and outstanding in 2003 and 2002, respectively | 4,306,253 | 4,270,348 | ||||||
Additional paid-capital | 51,391,790 | 51,016,222 | ||||||
Treasury stock (161,661 shares) | (2,691,777 | ) | (1,192,728 | ) | ||||
Retained earnings | 7,938,293 | 4,906,988 | ||||||
Accumulated other comprehensive income | 609,304 | 1,230,985 | ||||||
Total stockholders’ equity | 61,553,863 | 60,231,815 | ||||||
Total liabilities and stockholders’ equity | $ | 599,443,108 | $ | 553,967,021 | ||||
* Derived from audited financial statements
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Integrity Financial Corporation
Consolidated Statements of Operations (Unaudited)
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||
| 2003 | 2002 | 2003 | 2002 | |||||||||
Interest and dividend Income | ||||||||||||
Loans, including fees | $ | 6,518,172 | $ | 4,648,099 | $ | 19,769,831 | $ | 13,007,392 | ||||
Taxable investment securities | 598,246 | 591,750 | 1,669,360 | 2,056,460 | ||||||||
Tax-exempt investment securities | 125,391 | 213,686 | 431,897 | 453,938 | ||||||||
Other interest and dividends | 43,518 | 75,424 | 158,685 | 181,883 | ||||||||
Total Interest and dividend income | 7,285,327 | 5,528,959 | 22,029,773 | 15,699,673 | ||||||||
Interest expense | ||||||||||||
Time deposits, $100,000 and over | 832,434 | 789,062 | 2,487,604 | 2,201,433 | ||||||||
Other deposits | 1,576,236 | 1,226,026 | 4,894,876 | 3,794,221 | ||||||||
Federal Home Loan Bank Advances | 523,757 | 284,054 | 1,525,551 | 827,409 | ||||||||
Total interest expense | 2,932,427 | 2,299,142 | 8,908,031 | 6,823,063 | ||||||||
Net interest income | 4,352,900 | 3,229,817 | 13,121,742 | 8,876,610 | ||||||||
Provision for loan losses | 262,000 | 419,220 | 772,000 | 854,220 | ||||||||
Net interest income after provision for loan losses | 4,090,900 | 2,810,597 | 12,349,742 | 8,022,390 | ||||||||
Non-interest income | ||||||||||||
Service charges on deposit accounts | 734,246 | 513,976 | 2,055,204 | 1,306,593 | ||||||||
Factoring operations | 186,571 | 96,706 | 407,090 | 310,560 | ||||||||
Mortgage operations | 598,469 | 658,607 | 2,032,326 | 1,545,589 | ||||||||
Gain on sale of investment securities | 69,666 | 148,488 | 80,847 | 157,330 | ||||||||
Other | 223,886 | 141,317 | 647,443 | 393,341 | ||||||||
Total non-interest income | 1,812,838 | 1,559,094 | 5,222,910 | 3,713,413 | ||||||||
Non-interest expenses | ||||||||||||
Compensation and employee benefits | 2,210,113 | 1,439,169 | 6,371,499 | 4,090,062 | ||||||||
Occupancy and equipment | 620,930 | 294,507 | 1,590,993 | 813,361 | ||||||||
Professional fees | 187,385 | 125,757 | 349,357 | 242,852 | ||||||||
Stationery, printing and supplies | 126,515 | 64,420 | 302,842 | 180,013 | ||||||||
Advertising and business promotion | 125,473 | 76,363 | 266,794 | 183,361 | ||||||||
Data processing | 356,069 | 179,989 | 964,191 | 536,912 | ||||||||
Other | 505,328 | 489,457 | 2,056,658 | 1,312,176 | ||||||||
Total non-interest expenses | 4,131,813 | 2,669,662 | 11,902,334 | 7,358,737 | ||||||||
Income before taxes | 1,771,925 | 1,700,029 | 5,670,318 | 4,377,066 | ||||||||
Income taxes | 610,812 | 607,647 | 1,977,186 | 1,532,123 | ||||||||
Net income | $ | 1,161,113 | $ | 1,092,382 | $ | 3,693,132 | $ | 2,844,943 | ||||
Net income per common share | ||||||||||||
Basic | $ | 0.25 | $ | 0.36 | $ | 0.84 | $ | 0.94 | ||||
Diluted | $ | 0.25 | $ | 0.35 | $ | 0.81 | $ | 0.90 | ||||
Dividends declared per common share | $ | 0.07 | $ | - | $ | 0.14 | $ | 0.06 | ||||
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Integrity Financial Corporation
Consolidated Statements of Cash Flows (Unaudited)
Nine Months Ended September 30, | ||||||||
| 2003 | 2002 | |||||||
Cash flows from operating activities | ||||||||
Net income | $ | 3,693,132 | $ | 2,844,943 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation, amortization and accretion, net | 1,757,707 | 442,803 | ||||||
Amortization of intangibles | 239,384 | 374,621 | ||||||
Provision for loan losses | 772,000 | 854,220 | ||||||
Provision for losses on foreclosed assets | — | 31,200 | ||||||
Deferred compensation | 12,525 | 23,040 | ||||||
Net gains on sales of investment securities | (80,847 | ) | (157,330 | ) | ||||
Net gains on sales of assets | 16,091 | 27,594 | ||||||
Change in assets and liabilities: | ||||||||
(Increase) decrease in other assets | 2,145,049 | (754,757 | ) | |||||
Decrease (increase) in other liabilities | (1,104,677 | ) | 359,109 | |||||
Net cash provided by operating activities | 7,450,364 | 4,045,443 | ||||||
Cash flows from investing activities | ||||||||
Purchase of investment securities available for sale | (43,529,657 | ) | (17,734,540 | ) | ||||
Redemption (purchase) of Federal Home Loan Bank stock | 325,900 | (525,000 | ) | |||||
Proceeds from sales, maturities and calls of investment securities | 32,433,814 | 15,647,159 | ||||||
Net increase in loans | (30,916,422 | ) | (52,789,973 | ) | ||||
Net (increase) decrease in factored accounts receivable | 1,090,543 | (400,868 | ) | |||||
Purchases of bank owned life insurance | (4,188,566 | ) | (4,018,046 | ) | ||||
Purchases of premises and equipment | (4,304,331 | ) | (1,965,446 | ) | ||||
Proceeds from sale of foreclosed real estate | 1,178,330 | 1,134,300 | ||||||
Net cash used in investing activities | (47,910,389 | ) | (60,652,414 | ) | ||||
Cash flows from financing activities | ||||||||
Net increase in noninterest-bearing deposits | 8,839,410 | 3,660,795 | ||||||
Net increase in interest-bearing deposits | 30,431,729 | 46,146,630 | ||||||
Net decrease in securities sold under agreements to repurchase | (9,573 | ) | (1,745,877 | ) | ||||
Net decrease in federal funds purchased | — | (1,775,000 | ) | |||||
Net increase in Federal Home Loan Bank advances | 5,984,624 | 10,500,000 | ||||||
Cash paid for dividends | (661,826 | ) | (193,611 | ) | ||||
Purchase of treasury stock | (1,499,049 | ) | (971,090 | ) | ||||
Proceeds from issuance of common stock | 411,473 | 65,542 | ||||||
Net cash provided by financing activities | 43,496,788 | 55,687,389 | ||||||
Net decrease in cash and cash equivalents | 3,036,763 | (919,582 | ) | |||||
Cash and cash equivalents, beginning of period | 17,455,967 | 10,463,968 | ||||||
Cash and cash equivalents, end of period | $ | 20,492,730 | $ | 9,544,386 | ||||
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Integrity Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)
NOTE A - BASIS OF PRESENTATION
In management’s opinion, the financial information, which is unaudited, reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of September 30, 2003 and for the three and nine month periods ended September 30, 2003 and 2002, in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements include the accounts of Integrity Financial Corporation and its wholly-owned subsidiaries: Catawba Valley Bank, First Gaston Bank, Valley Financial Services, Inc., Community Mortgage Corporation, Catawba Valley Capital Trust I, and Catawba Valley Capital Trust II, collectively referred to as the “Company.” All significant intercompany transactions and balances have been eliminated. Operating results for the nine month period ended September 30, 2003 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2003.
Certain amounts in the 2002 consolidated financial statements have been reclassified to conform to the 2003 presentation. The reclassifications had no effect on net income or stockholders’ equity as previously reported.
The organization and business of the Company, accounting policies followed by the Company and other information are contained in the notes to the consolidated financial statements filed as part of the Company’s 2002 annual report on Form 10-KSB. This quarterly report should be read in conjunction with such annual report.
On April 29, 2003, at the Company’s Annual Meeting of Shareholders, the shareholders approved a name change for the Company. The name United Community Bancorp was changed to Integrity Financial Corporation. The new symbol is IFCB. The change went into effect on May 30, 2003.
NOTE B - NET INCOME PER SHARE
Basic and diluted net income per common share is computed based on the weighted average number of shares outstanding during each period after retroactively adjusting for stock dividends. Diluted net income per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the net income of the Company. Shares, earnings per share and dividends declared per share have been adjusted to reflect the 10% stock dividend paid November 15, 2003.
Basic and diluted net income per common share has been computed based upon net income as presented in the accompanying consolidated statements of operations divided by the weighted average number of common shares outstanding or assumed to be outstanding as summarized below:
| Three months ended September 30, | Nine months ended September 30, | |||||||
| 2003 | 2002 | 2003 | 2002 | |||||
Weighted average number of common shares used in computing basic net income per share | 4,558,672 | 3,004,015 | 4,411,706 | 3,026,555 | ||||
Effect of dilutive stock options | 146,926 | 130,405 | 137,341 | 121,670 | ||||
Weighted average number of common shares and dilutive potential common shares used in computing diluted net income per share | 4,705,598 | 3,134,420 | 4,549,047 | 3,148,225 | ||||
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NOTE C - COMPREHENSIVE INCOME
For the three months ended September 30, 2003 and 2002, total comprehensive income, consisting of net income and unrealized gains and losses on available for sale securities, net of taxes, was $151,469 and $1,593,735, respectively.
For the nine months ended September 30, 2003 and 2002, total comprehensive income, consisting of net income and unrealized gains and losses on available for sale securities, net of taxes, was $3,071,451 and $3,876,993 respectively.
NOTE D - STOCK COMPENSATION PLANS
Statement of Financial Accounting Standards (“SFAS”) No. 123,Accounting for Stock-Based Compensation, encourages all entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25,Accounting for Stock Issued to Employees,whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued under the Company’s stock option plans have no intrinsic value at the grant date and, under APB Opinion No. 25, no compensation cost is recognized for them. The Company has elected to continue with the accounting methodology in APB Opinion No. 25. Presented below are the pro forma disclosures of net income and earnings per share and other disclosures as if the fair value based method of accounting had been applied.
| Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
| 2003 | 2002 | 2003 | 2002 | |||||||||||||
Net income as reported | $ | 1,161,113 | $ | 1,092,382 | $ | 3,693,132 | $ | 2,844,943 | ||||||||
Deduct: Total stock-based employee Compensation expense determined under fair value method for all awards, net of related tax effects | (7,749 | ) | (6,208 | ) | (23,248 | ) | (18,624 | ) | ||||||||
Net income pro forma | $ | 1,153,364 | $ | 1,086,174 | $ | 3,669,884 | $ | 2,826,319 | ||||||||
Basic net income per common share: | ||||||||||||||||
As reported | $ | 0.25 | $ | 0.36 | $ | 0.84 | $ | 0.94 | ||||||||
Pro forma | 0.25 | 0.35 | 0.83 | 0.93 | ||||||||||||
Diluted net income per common share: | ||||||||||||||||
As reported | 0.25 | 0.35 | 0.81 | 0.90 | ||||||||||||
Pro forma | 0.25 | 0.35 | 0.78 | 0.90 | ||||||||||||
NOTE E - GUARANTEES
The Company has issued guarantees under standby letters of credit, which require the Company to fund the guarantee in part or in entirety, in the event the customer fails to perform under an obligating agreement. These standby letters of credit typically have terms ranging from 10 to 156 months.
The maximum amount of the Company’s guarantees under these standby letters of credit are as follows (in thousands):
| September 30, 2003 | December 31, 2002 | |||||
Undisbursed standby letters of credit | $ | 1,538 | $ | 1,448 | ||
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Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q may contain certain forward-looking statements consisting of estimates with respect to the financial condition, results of operations and business of the Company that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, but are not limited to, general economic conditions, changes in interest rates, deposit flows, loan demand, real estate values, and competition; changes in accounting principles, policies, or guidelines; changes in legislation or regulation; and other economic, competitive, governmental, regulatory, and technological factors affecting the Company’s operations, pricing, products and services.
Overview
On December 31, 2002, the Company acquired Community Bancshares, Inc. headquartered in Wilkesboro, North Carolina, the holding company for Northwestern National Bank (“Northwestern”) and Community Mortgage Corporation. The branches of Northwestern were merged into the Company’s wholly owned subsidiary, Catawba Valley Bank, and are now doing business as “Northwestern Bank, a division of Catawba Valley Bank.” Community Mortgage became a wholly owned subsidiary of the Company. This business combination was appropriately accounted for under the purchase method, therefore the results of operations for the three and nine month periods ended September 30, 2003 do not include the consolidated results of operations for Community Bancshares, Inc.
Comparison of Financial Condition at September 30, 2003 and December 31, 2002
During the nine months ended September 30, 2003, total consolidated assets increased $45.5 million or 8.2% from $553.9 million at December 31, 2002 to $599.4 million. This increase in the Company’s assets during the period resulted primarily from an increase in our net loan portfolio of $28.1 million or 6.9%. This increase in our loans was attributable to the continued growth in our commercial loan portfolio. Also during the period, our liquid assets, consisting of cash and cash equivalents and investment securities, increased $11.7 million. The primary factor contributing to this increase was the purchase of investment securities during the period. Our investment securities portfolio increased $8.7 million or 11.4% during the first nine months of 2003.
The $3.7 million or 26.2% increase in bank premises and equipment during the first nine months of 2003 resulted from the ongoing construction of new branches by the Company’s subsidiary Catawba Valley Bank. In June 2003, Catawba Valley Bank opened a new full service branch in Boone, North Carolina. There are also two additional branches under current construction, which are scheduled to be completed early in the fourth quarter of this year in Statesville and Mooresville. The Company also purchased a building in downtown Hickory to serve as the its new corporate headquarters, and opened a full service brokerage securities office, doing business as Integrity Securities, in August.
We also utilized available liquidity during the period to fund an additional $4.2 million investment in bank owned life insurance. These increases in our consolidated assets were partially offset by a $1.1 million decrease in factored accounts receivable and a $1.2 million decrease in our other assets during the period.
The aforementioned growth in our assets was funded principally by an increase of $39.3 million or 8.9% in deposits from our customers during the period from $440.5 million at December 31, 2002 to $479.8 million at September 30, 2003, and from a net increase in our borrowings of $6.0 million during the same period. Noninterest bearing deposits increased $8.8 million during the period, while interest bearing deposits increased $30.4 million. Management is continuing to make a conscious effort to attract lower cost core deposits and reduce the dependency on certificates of deposit. Our borrowings consist of Federal Home Loan Bank advances, securities sold under agreements to repurchase, federal funds purchased, and trust preferred securities.
Earning assets represented 92.8% of total assets on September 30, 2003. The allowance for loan losses was $6.2 million at September 30, 2003, representing 1.39% of total loans. Management believes that the allowance is adequate at this time.
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Other liabilities decreased from $3.1 million at December 31, 2002 to $2.0 million at September 30, 2003, a decrease of $1.1 million or 34.9%. The decrease resulted from the payment of accrued merger expenses of $500,000 during the first quarter and from the payment of accrued income taxes during the period.
The Banks now operate fifteen full service branches and continue to actively solicit loans and deposits.
Total stockholders’ equity increased $1.3 million during the nine months ended September 30, 2003. The increase resulted principally from our comprehensive income during the period of $3.1 million. During the nine months ended September 30, 2003, the Company repurchased 86,417 of its common shares totaling $1.5 million under its stock repurchase plan. At September 30, 2003, the Company and the Banks continued to exceed all applicable regulatory capital requirements.
Comparison of Results of Operations for the Three Months Ended September 30, 2003 and 2002
Net Income. Net income for the quarter ended September 30, 2003 was $1.2 million or $.25 per basic share, as compared with net income of $1.1 million or $.36 per basic share for the three months ended September 30, 2002, an increase of $69,000 in net income and a decrease of $.11 per share. The decrease in earnings per share was attributable to the increase in our weighted average common shares outstanding in the 2003 quarter, which resulted from the additional shares issued to effect our business combination. Increases in net interest income of $1.1 million and non-interest income of $254,000 were offset by an increase in our non-interest expenses of $1.5 million. In addition, the provision for loan losses decreased by $157,000 during the period.
Net Interest Income. Like most financial institutions, the primary component of earnings for our banks, Catawba Valley and First Gaston, is net interest income. Net interest income is the difference between interest income, principally from loan and investment securities portfolios, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earnings assets and the average cost of interest-bearing liabilities and margin refers to net interest income divided by average interest-earnings assets. Margin is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as by levels of noninterest-bearing liabilities and capital.
Net interest income for the quarter ended September 30, 2003 was $4.3 million as compared with $3.2 million during the quarter ended September 30, 2002 an increase of $1.1 million. This increase resulted largely from the increased level of net interest earning assets during 2003. This increase in the level of our net interest earning assets offset the continued decline in interest rates during the period. Although after the rapid rate decline in 2002, rates had begun to stabilize, the Federal Reserve lowered rates late in second quarter of 2003. The Company’s net interest margin decreased from 3.52% for the three-month period ending September 30, 2002 to 3.16% for the same period in 2003.
Asset Quality. Our allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. We increase our allowance for loan losses by provisions charged to operations and by recoveries of amounts previously charged off, and we reduce our allowance by loans charged off. We evaluate the adequacy of the allowance at least quarterly. In evaluating the adequacy of the allowance, we consider the growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors deriving from our history of operations.
We follow a loan review program designed to evaluate the credit risk in our loan portfolio. Through this loan review process, we maintain an internally classified watch list that helps management assess the overall quality of the loan portfolio and the adequacy of the allowance for loan losses. In establishing the appropriate classification for specific assets, management considers, among other factors, the estimated value of the underlying collateral, the borrower’s ability to repay, the borrower’s payment history, and the current delinquent status. As a result of this process, certain loans are categorized as substandard, doubtful, or loss and reserves are allocated based on management’s judgment and historical experience. Testing by our internal auditors and by other independent third parties contracted with to perform reviews of our loans helps to validate this process. In addition, regulatory agencies, as an integral part of their examinations process, periodically review our allowance for loan losses and may require us to make adjustments based upon information available to them at the time of their examination.
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The provision for loan losses was $262,000 and $419,000 for the quarters ended September 30, 2003 and 2002, respectively, a decrease of $157,000. Likewise, our net loan charge offs decreased to $97,000 during the quarter ended September 30, 2003 as compared with net charge offs of $157,000 during the quarter ended September 30, 2002. Although our provision decreased, the allowance for loan losses expressed as a percentage of gross loans increased slightly from 1.38% at December 31, 2002 to 1.39% at September 30, 2003. Management determined that although the level of charge-offs has continued to decrease even as the level of the loan portfolio has increased, that it was necessary to maintain the overall level of the allowance relative to gross loans due to the increase in the level of loans on nonaccrual status and loans past due ninety days or more. Management believes that as of September 30, 2003, the allowance for loan losses is adequate to absorb probable losses inherent in the loan portfolio.
The following is a summary of the principal balances of loans on nonaccrual status and loans past due ninety days or more:
| September 30, 2003 | December 31, 2002 | |||||
Loans contractually past due 90 days or more and/or on nonaccrual status: | ||||||
Nonaccrual loans | $ | 3,745,000 | $ | 3,142,000 | ||
Past due loans 90 days or more and still accruing | 2,013,000 | 997,000 | ||||
| $ | 5,758,000 | $ | 4,139,000 | |||
Non-Interest Income. Non-interest income was $1.8 million for the quarter ended September 30, 2003 compared to $1.6 million for the quarter ended September 30, 2002, an increase of $254,000. Service charges on deposit accounts accounted for most of the increase, increasing from $514,000 during the 2002 quarter to $734,000 during the 2003 quarter, an increase of $220,000. Fees charged for non-sufficient funds, a major component of service charges on deposit accounts, increased from $409,000 to $572,000 for the same period an increase of $163,000. The business combination discussed earlier in this section had a direct impact on service charges. A decrease in the volume of loan refinances resulted in a decrease in revenue from our mortgage operations of $60,000 for the three-month period. During the fourth quarter of 2002, the Company invested in bank owned life insurance. An additional investment was made in July of this year. The income generated during the third quarter of 2003 from this investment was $80,000 and is included in other non-interest income.
Non-Interest Expense. Non-interest expenses increased $1.5 million, from $2.7 million at September 30, 2002 to $4.1 million at September 30, 2003. This increase is due largely to the business combination discussed previously. Catawba Valley Bank added six full service branches with the acquisition on December 31, 2002. The increases in the categories under non-interest expense were all affected by this. Also, First Gaston Bank opened their fourth full service office in July 2002 and purchased a fifth full service office from RBC Centura in Dallas, North Carolina in October 2002.
Income Tax Expense. Income before income tax provision totaled $1.8 million and $1.7 million for the quarters ended September 30, 2003 and 2002, respectively. Income tax provision totaled $611,000 and $608,000 for the quarters ended September 30, 2003 and 2002, respectively, which equated to effective tax rates of 34.47% and 35.74%.
Comparison of Results of Operations for the Nine Months Ended September 30, 2003 and 2002
Net Income. Net income for the nine months ended September 30, 2003 was $3.7 million or $.84 per basic share, as compared with net income of $2.8 million or $.94 per basic share for the same period of 2002, an increase of $848,000 in net income. As was the case for the third quarter of the current year, the decrease in earnings per share during the nine month period was attributable to the increase in our weighted average common shares outstanding resulting from the additional shares issued to effect our business combination. Increases in net interest income of $4.2 million and in non-interest income of $1.5 million were partially offset by increases in non-operating expenses of $4.5 million. In addition, the provision for loan losses decreased $82,000 during the period.
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Net interest income for the nine months ended September 30, 2003 was $13.1 million as compared with $8.9 million during the nine months ended September 30, 2002, an increase of $4.2 million. As discussed in our analysis of the results of operations for the three-month periods, the increase in our net interest income for the first nine months of 2003 resulted from an increase in the level of our net interest earning assets during the period which offset the effects of the lower interest rates during the period.
Asset Quality. The provision for loan losses was $772,000 and $854,000 for the nine months ended September 30, 2003 and 2002, respectively, while our net loan charge offs were $300,000 for the nine months ended September 30, 2003 as compared with charge offs of $352,000 during the nine months ended September 30, 2002. See the Asset Quality section in theComparison of Results of Operations for the Three Months Ended September 30, 2003 and 2002for an expanded discussion of the Company’s allowance for loan losses.
Non-Interest Income. Non-interest income was $5.2 million for the nine months ended September 30, 2003 as compared to $3.7 million for the nine months ended September 30, 2002, an increase of $1.5 million. Service charges on deposit accounts increased $749,000 or 57.3% during the nine-month period ending September 30, 2003 as compared to the same period in 2002. Fees charged on non-sufficient funds increased from $994,000 for the nine-month period ending September 30, 2002 to $1.6 million for the same period in 2003. The aforementioned business combination had a direct impact on service charges. Income from mortgage operations was $2.0 million for the period ending September 30, 2003 compared to $1.5 million for the same period in 2002. Other noninterest income increased $254,000 for the period due primarily to income from bank owned life insurance of $189,000.
Non-Interest Expense. Non-interest expense increased $4.5 million from $7.4 million at September 30, 2002 to $11.9 million at September 30, 2003. The acquisition and new branches discussed previously resulted in increases in all categories of our non-interest expenses.
Income Tax Expense. Income before income tax provision totaled $5.7 million and $4.4 million for the nine months ended September 30, 2003 and 2002, respectively. Income tax provision totaled $2.0 million and $1.5 million for the nine months ended September 30, 2003 and 2002, respectively, which equated to effective tax rates of 34.87% and 35.00%.
Liquidity and Capital Resources
Maintaining adequate liquidity while managing interest rate risk is the primary goal of the Company’s asset and liability management strategy. Liquidity is the ability to fund the needs of the Company’s borrowers and depositors, pay operating expenses, and meet regulatory liquidity requirements. Maturing investments, loan and mortgage-backed security principal repayments, deposit growth, and borrowings are presently the main sources of the Company’s liquidity. The Company’s primary uses of liquidity are to fund loans and to make investments.
As of September 30, 2003, liquid assets, consisting of cash and cash equivalents and investment securities were approximately $104.9 million, which represents 17.5% of total assets and 19.9% of total deposits and borrowings. Supplementing this liquidity, the Company, through its bank subsidiaries, had $68.1 million of credit available from the Federal Home Loan Bank and available lines of credit from correspondent banks totaling $27.0 million. At September 30, 2003, outstanding commitments to extend credit were $1.5 million and undisbursed line of credit balances totaled $62.3 million. The Company also has commitments to complete two new branches in 2003 of $400,000. Management believes that the combined aggregate liquidity position of the Company is sufficient to meet the funding requirements of loan demand and deposit maturities and withdrawals in the near term.
Certificates of deposit represented 58.7% of the Company’s total deposits at September 30, 2003. The Company’s growth strategy will include efforts focused at increasing the relative volume of transaction deposit accounts. Certificates of deposit of $100,000 or more represented 26.7% of the Company’s total deposits at September 30, 2003. These deposits are generally considered rate sensitive, but management believes many of them are relationship-oriented. While the Company will need to pay competitive rates to retain these deposits at maturity, there are other subjective factors that will determine the Company’s continued retention of those deposits.
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Banks and bank holding companies, as regulated institutions, must meet required levels of capital. The FDIC, the primary regulator of Catawba Valley Bank and First Gaston Bank, and the Federal Reserve, the primary regulator of Integrity Financial Corporation, have adopted minimum capital regulations or guidelines that categorize components and the level of risk associated with various types of assets. Financial institutions are expected to maintain a level of capital commensurate with the risk profile assigned to its assets in accordance with these guidelines.
At September 30, 2003, both Integrity Financial and each of its bank subsidiaries maintained capital levels exceeding the minimum levels for “well capitalized” bank holding companies and banks.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
The Company’s primary market risk is interest rate risk. Interest rate risk is the result of differing maturities or repricing intervals of interest earning assets and interest bearing liabilities and the fact that rates on these financial instruments do not change uniformly. These conditions may impact the earnings generated by the Company’s interest earning assets or the cost of its interest bearing liabilities, thus directly impacting the Company’s overall earnings. The Company’s management actively monitors and manages interest rate risk. One way this is accomplished is through the development of and adherence to the Company’s asset/liability policy. This policy sets forth management’s strategy for matching the risk characteristics of the Company’s interest earning assets and liabilities so as to mitigate the effect of changes in the rate environment. The Company’s market risk profile has not changed significantly since December 31, 2002.
Item 4. Controls and Procedures
As of the end of the period covered by this Report, the Company’s management carried out an evaluation, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 of the Securities and Exchange Commission (the “SEC”). Based upon that evaluation, the Company’s management, including its Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s SEC filings.
There have been no significant changes in internal control over financial reporting 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.
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Part II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
| (a) | Exhibits. |
| 31.1 | Certification of Principal Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002 | |
| 31.2 | Certification of Principal Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002 | |
| 32 | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
| (b) | Reports on Form 8-K. |
A Form 8-K was filed on July 23, 2003 releasing second quarter earnings.
A Form 8-K was filed on September 11, 2003 announcing cash and stock dividends.
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| INTEGRITY FINANCIAL CORPORATION | ||||
Date: November 12, 2003 | By: | /s/ R. Steve Aaron | ||
R. Steve Aaron | ||||
President and Chief Executive Officer | ||||
Date: November 12, 2003 | By: | /s/ Susan B. Mikels | ||
Susan B. Mikels | ||||
Chief Financial Officer | ||||
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