U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
| x | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended September 30, 2007
or
| ¨ | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period ended
Commission File Number - 000-49898
NORTH STATE BANCORP
(Exact name of small business issuer as specified in its charter)
| NORTH CAROLINA | 65-1177289 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification Number) |
4270 THE CIRCLE AT NORTH HILLS, RALEIGH, NORTH CAROLINA 27609
(Address of principal executive office)
(919) 787-9696
(Issuer’s telephone number)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act):
Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12 b-2 of the Exchange Act): Yes ¨ No x
As of November 9, 2007, 6,971,926 shares of the registrant’s common stock, no par value per share, were outstanding. The registrant has no other classes of securities outstanding.
| Page No. | ||||
| Part I. | FINANCIAL INFORMATION | |||
| Item 1 - | Financial Statements (Unaudited) | |||
September 30, 2007 and December 31, 2006 | 3 | |||
Consolidated Statements of Operations Three Months and Nine Months Ended September 30, 2007 and 2006 | 4 | |||
Consolidated Statements of Comprehensive Income Three Months and Nine Months Ended September 30, 2007 and 2006 | 5 | |||
Consolidated Statement of Shareholders’ Equity Nine Months Ended September 30, 2007 | 6 | |||
Consolidated Statements of Cash Flows Nine Months Ended September 30, 2007 and 2006 | 7 | |||
| 8 | ||||
| Item 2 - | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 12 | ||
| Item 3 - | Quantitative and Qualitative Disclosures About Market Risk | 19 | ||
| Item 4T - | Controls and Procedures | 19 | ||
| Part II. | OTHER INFORMATION | |||
| Item 6 - | Exhibits | 20 | ||
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CONSOLIDATED BALANCE SHEETS
| September 30, 2007 (Unaudited) | December 31, 2006* | |||||||
| (Amounts in thousands) | ||||||||
ASSETS | ||||||||
Cash and due from banks | $ | 9,931 | $ | 12,189 | ||||
Interest-earning deposits with banks | 1,123 | 1,249 | ||||||
Federal funds sold | 15,533 | 44,059 | ||||||
Investment securities available for sale, at fair value | 37,950 | 41,932 | ||||||
Loans | 412,893 | 345,943 | ||||||
Less allowance for loan losses | (4,358 | ) | (3,983 | ) | ||||
NET LOANS | 408,535 | 341,960 | ||||||
Accrued interest receivable | 1,972 | 1,754 | ||||||
Stock in the Federal Home Loan Bank of Atlanta, at cost | 993 | 939 | ||||||
Premises and equipment, net | 9,956 | 7,810 | ||||||
Other assets | 4,132 | 3,585 | ||||||
TOTAL ASSETS | $ | 490,125 | $ | 455,477 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Deposits: | ||||||||
Demand | $ | 95,206 | $ | 105,228 | ||||
Savings, money market and NOW | 199,115 | 154,400 | ||||||
Time deposits | 139,933 | 142,450 | ||||||
TOTAL DEPOSITS | 434,254 | 402,078 | ||||||
Accrued interest payable | 2,446 | 2,297 | ||||||
Short-term borrowings | 8,388 | 10,670 | ||||||
Long-term debt | 11,181 | 11,196 | ||||||
Accrued expenses and other liabilities | 3,537 | 2,639 | ||||||
TOTAL LIABILITIES | 459,806 | 428,880 | ||||||
Commitments (Note C) | ||||||||
Shareholders’ equity: | ||||||||
Preferred stock, no par value, 1,000,000 shares authorized, none issued | — | — | ||||||
Common stock, no par value as of May 9, 2007; prior to May 9, 2007 $1 par value; 10,000,000 shares authorized 6,971,826 and 4,542,061 shares issued and outstanding at September 30, 2007 and December 31, 2006, respectively | 19,461 | 4,542 | ||||||
Additional paid-in capital | — | 14,002 | ||||||
Retained earnings | 10,830 | 8,344 | ||||||
Accumulated other comprehensive income (loss) | 28 | (291 | ) | |||||
TOTAL SHAREHOLDERS’ EQUITY | 30,319 | 26,597 | ||||||
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | $ | 490,125 | $ | 455,477 | ||||
| * | Derived from audited consolidated financial statements. |
See accompanying notes.
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CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||
| (Amounts in thousands, except share and per share data) | ||||||||||||
INTEREST INCOME | ||||||||||||
Loans | $ | 7,655 | $ | 6,132 | $ | 21,472 | $ | 17,039 | ||||
Investments | 451 | 434 | 1,320 | 1,285 | ||||||||
Federal funds sold and interest-earning deposits | 309 | 342 | 1,088 | 802 | ||||||||
TOTAL INTEREST INCOME | 8,415 | 6,908 | 23,880 | 19,126 | ||||||||
INTEREST EXPENSE | ||||||||||||
Money market, NOW and savings deposits | 1,891 | 1,477 | 5,088 | 3,733 | ||||||||
Time deposits | 1,786 | 1,333 | 5,292 | 3,618 | ||||||||
Short-term borrowings | 51 | 59 | 149 | 221 | ||||||||
Long-term debt | 205 | 203 | 610 | 578 | ||||||||
TOTAL INTEREST EXPENSE | 3,933 | 3,072 | 11,139 | 8,150 | ||||||||
NET INTEREST INCOME | 4,482 | 3,836 | 12,741 | 10,976 | ||||||||
PROVISION FOR LOAN LOSSES | 255 | 85 | 677 | 461 | ||||||||
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES | 4,227 | 3,751 | 12,064 | 10,515 | ||||||||
NON-INTEREST INCOME | ||||||||||||
Fees from mortgage operations | 72 | 59 | 181 | 235 | ||||||||
Service charges and fees on deposit accounts | 174 | 192 | 528 | 566 | ||||||||
Other | 47 | 22 | 137 | 52 | ||||||||
TOTAL NON-INTEREST INCOME | 293 | 273 | 846 | 853 | ||||||||
NON-INTEREST EXPENSE | ||||||||||||
Salaries and employee benefits | 1,765 | 1,330 | 4,859 | 4,046 | ||||||||
Occupancy and equipment | 462 | 414 | 1,398 | 1,166 | ||||||||
Professional fees | 88 | 84 | 207 | 179 | ||||||||
Postage, printing and office supplies | 36 | 41 | 123 | 105 | ||||||||
Data processing and other outsourced services | 191 | 140 | 498 | 392 | ||||||||
Advertising | 62 | 73 | 165 | 170 | ||||||||
Other | 411 | 556 | 1,606 | 1,629 | ||||||||
TOTAL NON-INTEREST EXPENSE | 3,015 | 2,638 | 8,856 | 7,687 | ||||||||
INCOME BEFORE INCOME TAXES | 1,505 | 1,386 | 4,054 | 3,681 | ||||||||
INCOME TAXES | 573 | 516 | 1,568 | 1,369 | ||||||||
NET INCOME | $ | 932 | $ | 870 | $ | 2,486 | $ | 2,312 | ||||
NET INCOME PER COMMON SHARE | ||||||||||||
Basic | $ | .13 | $ | .13 | $ | .36 | $ | .35 | ||||
Diluted | $ | .13 | $ | .12 | $ | .34 | $ | .33 | ||||
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING | ||||||||||||
Basic | 6,960,806 | 6,653,019 | 6,898,691 | 6,551,729 | ||||||||
Diluted | 7,326,126 | 7,171,731 | 7,295,443 | 7,120,946 | ||||||||
See accompanying notes.
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||||||
| (In thousands) | (In thousands) | |||||||||||||||
Net income | $ | 932 | $ | 870 | $ | 2,486 | $ | 2,312 | ||||||||
Other comprehensive income: | ||||||||||||||||
Securities available for sale: | ||||||||||||||||
Unrealized holding gains on available for sale securities | 482 | 332 | 262 | 119 | ||||||||||||
Tax effect | (186 | ) | (126 | ) | (101 | ) | (45 | ) | ||||||||
Net of tax amount | 296 | 206 | 161 | 74 | ||||||||||||
Cash flow hedging activities: | ||||||||||||||||
Unrealized holding gains | 422 | — | 245 | — | ||||||||||||
Tax effect | (163 | ) | — | (87 | ) | — | ||||||||||
Net of tax amount | 259 | — | 158 | — | ||||||||||||
Total other comprehensive income | 555 | 206 | 319 | 74 | ||||||||||||
Comprehensive income | $ | 1,487 | $ | 1,076 | $ | 2,805 | $ | 2,386 | ||||||||
See accompanying notes.
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CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (Unaudited)
| Common stock | Additional paid-in | Retained | Accumulated Other comprehensive | Total shareholders' | |||||||||||||||
| Shares | Amount | capital | earnings | income (loss) | equity | ||||||||||||||
| (Amounts in thousands, except share data) | |||||||||||||||||||
Balance at December 31, 2006 | 4,542,061 | $ | 4,542 | $ | 14,002 | $ | 8,344 | $ | (291 | ) | $ | 26,597 | |||||||
Net income | — | — | — | 2,486 | — | 2,486 | |||||||||||||
Other comprehensive income, net of tax | — | — | — | — | 319 | 319 | |||||||||||||
Stock based compensation | — | 75 | — | — | — | 75 | |||||||||||||
Stock options exercised for $1 par value common stock including tax benefit of $ 67 | 56,749 | 124 | 175 | — | — | 299 | |||||||||||||
Change in par value of common stock | — | 14,177 | (14,177 | ) | — | — | — | ||||||||||||
Stock options exercised for no par value common stock | 1,000 | 4 | — | — | — | 4 | |||||||||||||
3-for-2 stock split | 2,300,561 | — | — | — | — | — | |||||||||||||
Stock options exercised for no par value post stock split including tax benefit of $ 342 | 71,455 | 539 | — | — | — | 539 | |||||||||||||
Balance at September 30, 2007 | 6,971,826 | $ | 19,461 | $ | — | $ | 10,830 | $ | 28 | $ | 30,319 | ||||||||
See accompanying notes.
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CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
| Nine Months Ended September 30, | ||||||||
| 2007 | 2006 | |||||||
| (In thousands) | ||||||||
CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||
Net income | $ | 2,486 | $ | 2,312 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 467 | 385 | ||||||
Net (accretion) amortization of premiums and discounts on investment securities | (13 | ) | 27 | |||||
Provision for loan losses | 677 | 461 | ||||||
Stock based compensation | 75 | 43 | ||||||
Change in assets and liabilities: | ||||||||
Increase in accrued interest receivable | (218 | ) | (224 | ) | ||||
Increase in other assets | (490 | ) | (390 | ) | ||||
Increase in accrued interest payable | 149 | 448 | ||||||
Increase (decrease) in accrued expenses and other liabilities | 898 | (248 | ) | |||||
NET CASH PROVIDED BY OPERATING ACTIVITIES | 4,031 | 2,814 | ||||||
CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||
Purchase of investment securities available for sale | (7,187 | ) | (8,693 | ) | ||||
Proceeds from maturities and repayments of investment securities available for sale | 11,444 | 8,744 | ||||||
Purchases of premises and equipment | (2,613 | ) | (2,136 | ) | ||||
Net increase in loans | (67,252 | ) | (33,021 | ) | ||||
Purchase of Federal Home Loan Bank Stock | (54 | ) | (295 | ) | ||||
NET CASH USED BY INVESTING ACTIVITIES | (65,662 | ) | (35,401 | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||
Net increase in deposits | 32,176 | 59,431 | ||||||
Net decrease in short-term borrowings | (2,282 | ) | (2,239 | ) | ||||
Exercise of stock options | 433 | 1,128 | ||||||
Excess tax benefits from exercise of stock options | 409 | 845 | ||||||
Net decrease in long-term debt | (15 | ) | (14 | ) | ||||
NET CASH PROVIDED BY FINANCING ACTIVITIES | 30,721 | 59,151 | ||||||
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | (30,910 | ) | 26,564 | |||||
CASH AND CASH EQUIVALENTS, BEGINNING | 57,497 | 40,720 | ||||||
CASH AND CASH EQUIVALENTS, ENDING | $ | 26,587 | $ | 67,284 | ||||
See accompanying notes.
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Notes to Consolidated Financial Statements
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, 2007 and for the three and nine-month periods ended September 30, 2007 and 2006, in conformity with accounting principles generally accepted in the United States of America. The consolidated financial statements include the accounts of North State Bancorp (the “Company”) and its wholly-owned subsidiary, North State Bank (the “Bank”). All significant intercompany transactions and balances have been eliminated in consolidation.
The preparation of consolidated financial statements requires management to make estimates and assumptions that affect reported amounts of assets and liabilities at the date of the financial statements, as well as the amounts of income and expense during the reporting period. Actual results could differ from those estimates. Operating results for the three and nine-month periods ended September 30, 2007 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2007.
The organization and business of the Company, accounting policies followed by the Company and other relevant information are contained in the notes to the consolidated financial statements filed as part of the Company’s 2006 Annual Report on Form 10-KSB for the year ended December 31, 2006. This quarterly report should be read in conjunction with the Annual Report.
At our annual meeting on May 3, 2007, shareholders approved the amendment of our Articles of Incorporation to decrease the par value of our common stock from $1.00 per share to no par value per share, which amendment was effective on May 9, 2007.
NOTE B – RECENT ACCOUNTING PRONOUNCEMENTS
The Company and its wholly-owned subsidiary the Bank are subject to U.S. federal income tax and North Carolina income tax. The Company’s primary business is the ownership and operation of the Bank. The Company’s 2003 through 2006 U.S. federal income tax returns remain open for examination by the Internal Revenue Service. The Company’s North Carolina state income tax returns remain open for the tax years 2003 through 2006 for examination by the North Carolina Department of Revenue. As of September 30, 2007, no authorities had commenced income tax examinations.
In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes” (“SFAS 109”). This Interpretation prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted the provisions of FIN 48 on January 1, 2007. Management has evaluated the Company’s tax positions and has concluded that the Company has no uncertain tax positions for which the Company should not recognize a tax benefit. The adoption of this statement had no material effect on the Company’s financial position or results of operations.
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NOTE B - RECENT ACCOUNTING PRONOUNCEMENTS (Continued)
The Company adopted the provisions of FASB Statement No. 155, “Accounting for Certain Hybrid Financial Instruments” (“SFAS 155”), effective January 1, 2007. The adoption of the provisions of SFAS 155 had no effect on the Company’s consolidated financial position or results of operations.
The provisions of FASB Statement No. 156, “Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140” (“SFAS 156”), were effective beginning January 1, 2007. The adoption of the provisions of SFAS 156 had no effect on the Company’s consolidated financial position or results of operations.
FASB Statement 157, “Fair Value Measurements” (“SFAS 157”), defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Company is in the process of evaluating the impact of the adoption of SFAS 157 on its consolidated financial position and results of operations.
FASB Statement 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”), permits an entity to choose to measure many financial instruments and certain other items at fair value. The fair value option permits companies to choose to measure eligible items at fair value at specified election dates. Companies will report unrealized gains and losses on items for which the fair value option has been elected in earnings after adoption. SFAS 159 requires additional disclosures related to the fair value measurements included in the companies financial statements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. Early adoption is permitted; however, the Company will adopt SFAS 159 effective January 1, 2008. The Company is evaluating the impact of SFAS 159 on its consolidated financial position and results of operations.
NOTE C - COMMITMENTS
At September 30, 2007, loan commitments were as follows (in thousands):
Commitments to extend credit | $ | 64,053 | |
Undisbursed lines of credit | 27,474 | ||
Letters of credit | 2,238 |
NOTE D - NET INCOME PER SHARE
Basic earnings per share represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate to outstanding stock options. Basic and diluted net income per common share have been computed based upon net income as presented in the accompanying consolidated statements of operations divided by the weighted average number of common shares outstanding or assumed to be outstanding as summarized below.
The Company effected 3-for-2 stock splits in both 2006 and the second quarter of 2007. All references in these financial statements to per share results and weighted average common and potential common shares outstanding have been adjusted for the effects of these stock splits.
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NOTE D - NET INCOME PER SHARE (Continued)
The weighted average number of shares outstanding or assumed to be outstanding are summarized below:
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||
| 2007 | 2006 | 2007 | 2006 | |||||
Weighted average number of common shares used in computing basic net income per share | 6,960,806 | 6,653,019 | 6,898,691 | 6,551,729 | ||||
Effect of dilutive stock options | 365,320 | 518,712 | 396,752 | 569,217 | ||||
Weighted average number of common shares and dilutive potential common shares used in computing diluted net income per share | 7,326,126 | 7,171,731 | 7,295,443 | 7,120,946 | ||||
For the three and nine-month periods ended September 30, 2007 and 2006, there were no anti-dilutive stock options.
NOTE E - STOCK OPTION PLANS
During 2000, the Bank adopted, with shareholder approval, an Employee Stock Option Plan and a Non-Employee Director Stock Option Plan. The Company assumed these plans in July 2002 as part of the Bank’s holding company reorganization. In 2003, the Company adopted, with shareholder approval, the 2003 Stock Plan. The 2003 Stock Plan replaced the two prior plans. All shares available for issuance under the prior plans, plus any shares covered by outstanding options that are forfeited under the prior plans, were transferred to the 2003 Plan. An aggregate of 1,239,827 shares of the Company’s common stock was initially reserved for options under the stock option plans. Certain of the options granted to directors in 2000 vested immediately at the time of grant. All other options granted vest 20% annually. All unexercised options expire ten years after the date of grant.
The fair market value of each option award is estimated on the date of grant using the Black-Scholes option pricing model. In valuing options under Black-Scholes, the risk-free interest rate is based upon a U.S. Treasury instrument with a life that is similar to the expected life of the option grant. Expected volatility is based on the Company’s stock price. The expected term of the options is based upon the average life of previously issued stock options. The expected dividend yield is based upon current yield on date of grant. No post-vesting restrictions exist for these options.
Estimated fair value of options granted during the three-month period ended September 30, 2007 | $ | 10.74 | ||
Assumptions in estimating option values: | ||||
Risk-free interest rate | 4.45 | % | ||
Dividend yield | 0.00 | % | ||
Volatility | 41.67 | % | ||
Expected life | 10.01years | |||
A summary of option activity under the stock option plans as of September 30, 2007 and changes during the nine-month period ended September 30, 2007 is presented below:
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NOTE E - STOCK OPTION PLANS (Continued)
Shares | Weighted Average | Aggregate Intrinsic Value | ||||||||
| Exercise Price | Remaining Contractual Term | |||||||||
| (In thousands) | ||||||||||
Outstanding at December 31, 2006 | 724,314 | $ | 3.35 | 4.24 years | $ | 9,165 | ||||
Granted | 35,500 | 17.87 | ||||||||
Exercised | 158,079 | 2.74 | ||||||||
Forfeited | 1,180 | 5.15 | ||||||||
Expired | — | — | ||||||||
Outstanding at September 30, 2007 | 600,555 | $ | 4.36 | 4.02 years | $ | 7,501 | ||||
Exercisable at September 30, 2007 | 498,029 | $ | 2.97 | $ | 6,913 | |||||
For the nine-month period ended September 30, 2007 the intrinsic value of options exercised was approximately $1.2 million. During the three-month period ended September 30, 2007, 35,500 shares were granted, and no shares were granted during the first six months of 2007. The fair value of options vested during the nine month period was approximately $75,000. As of September 30, 2007, approximately $575,000 of share-based compensation expense remained to be recognized over a weighted average period of 2.97 years.
Cash received from option exercises under share-based payment arrangements for the nine-month period ended September 30, 2007 was approximately $433,000. A tax benefit of approximately $409,000 was realized for tax deductions from option exercise of the share-based payment arrangements during the nine-month period ended September 30, 2007.
NOTE F - DERIVATIVE FINANCIAL INSTRUMENTS
To mitigate exposure to variability in expected future cash flows resulting from changes in interest rates the Company utilizes a stand-alone derivative financial instrument, in the form of an interest rate floor (a purchased option), in its asset/liability management program. The transaction involves both credit and market risk and provides payments to the Company in the event interest rates decrease below levels provided in the agreement. The effective portion of change in the fair value of the derivative instrument is reflected on the Company’s consolidated balance sheets as a derivative asset and other comprehensive income. On a quarterly basis, the Company performs prospective and retrospective effectiveness assessments and measure ineffectiveness by comparing the actual option with a hypothetically perfect option. Hedge ineffectiveness at September 30, 2007 was insignificant. The cash flow hedge is consistent with the Company’s risk management objective and strategy to reduce its exposure to decreases in cash flows relating to interest receipts on its prime-based variable-rate loans.
At September 30, 2007 the information pertaining to the outstanding interest rate floor (purchased option) agreement is as follows:
| September 30, 2007 | |||
| (Amounts in thousands) | |||
Notional amount | $ | 50,000 | |
Fair Value | 531 | ||
Unrealized gain relating to interest rate floor, net of tax | 121 | ||
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This report contains forward-looking statements intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements can generally be identified as such because the context of the statement will include words such as we “believe,” “anticipate,” “expect” or words of similar meaning. Similarly, statements that describe our future plans, objectives or goals are also forward-looking statements. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those currently anticipated, including: changes in interest rates, deposit flows, loan demand, real estate values and competition; our ability to manage growth; general and local economic conditions; changes in accounting principles, policies or guidelines; changes in legislation or regulation; and other competitive, technological, governmental and regulatory factors affecting our operations, pricing, products, and services.
Management’s discussion and analysis is intended to assist readers in the understanding and evaluation of our financial condition and results of operations. You should read this discussion in conjunction with our consolidated financial statements and notes thereto included in our Annual Report on Form 10-KSB for the year ended December 31, 2006.
Overview
We are a commercial bank holding company that was incorporated on June 5, 2002. Effective June 28, 2002, North State Bank became our wholly owned subsidiary. In March 2004, we formed North State Statutory Trust I, and in December 2005 we formed North State Statutory Trust II, both of which issued trust preferred securities to provide additional capital for general corporate purposes, including current and future expansion of North State Bank. Our primary business is the ownership and operation of North State Bank.
North State Bank is a commercial bank that was incorporated under the laws of the State of North Carolina on May 25, 2000 and began operations on June 1, 2000. The Bank is a full service community bank providing banking services through six locations: its main office in the North Hills section of Raleigh, North Carolina; one office in North Raleigh; one office in West Raleigh; one office in Garner, North Carolina; one office serving the Wake Forest area of North Carolina; and one loan production office in Wilmington, North Carolina. Construction is currently underway to open a full service office in Wilmington, North Carolina and an office in downtown Raleigh.
Comparison of Financial Condition at September 30, 2007 and December 31, 2006
Total assets at September 30, 2007 were $490.1 million compared to $455.5 million at December 31, 2006, an increase of $34.6 million or 7.6%.
Loan production was up a total of $67.0 million or 19.4% over December 31, 2006. The growth was primarily in commercial real estate and construction loans reflecting favorable market conditions in our markets during the period. Our loan production office in the Wilmington market, which opened in the second quarter of 2006, provided approximately 40% of the growth in commercial real estate loans and construction loans from December 31, 2006 to September 30, 2007. The Company has no exposure in sub-prime mortgages. Investments decreased $4.0 million or 9.5% from $41.9 million at December 31, 2006 as maturing investments were redeployed into the loan portfolio. Federal funds sold decreased $28.5 million, also declining as a result of loan growth. Cash and due from banks decreased $2.3 million from December 31, 2006.
Our loan growth was funded with increased deposit funds, up $32.2 million or 8.0% from December 31, 2006 as well as by reducing and redeploying Federal funds sold and investment securities. After strong growth in noninterest-bearing deposits during the first half of the year, compared to December 31, 2006,
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noninterest-bearing demand deposits decreased $10.0 million or 9.5% to $95.2 million. Since June 30, 2007 the decline in these core deposits reflects the slow down in real estate closings due to an easing of property sales with our attorney customers. Interest-bearing savings, money market and interest checking deposits grew $44.7 million or 29.0% to $199.1 million at September 30, 2007 from December 31, 2006, primarily in money market deposits. Our growth in these deposits is a result of our continuous efforts to emphasize relationship banking with our customers. Time deposits declined slightly, $2.5 million, from December 31, 2006 to $139.9 million.
We also use borrowings to support balance sheet management and growth. Total borrowings were down $2.3 million or 10.5% to $19.6 million at September 30, 2007 from $21.9 million at December 31, 2006. This decrease was almost entirely in short-term customer repurchase agreements.
Effective May 1, 2007, we extended the lease term on our operations center from September 2007 to April 2017 and also added square footage to expand the operations center. Beginning May 1, 2007, the space was increased by 1,421 square feet and beginning May 1, 2008 we will add another 1,765 square feet. The effect of the revised lease term and additional rental space increased our total future operating lease payments to approximately $6.4 million from $3.7 million at December 31, 2006. Also, in May 2007 we purchased 1.73 acres of land for $2.2 million to build a new banking office at our 6200 Falls of Neuse Road location. Construction for the proposed multi-story full-service banking office is expected to begin in the second quarter of 2008.
Total shareholders’ equity increased $3.7 million or 14.0% from $26.6 million at December 31, 2006 to $30.3 million at September 30, 2007. The increase was provided by net income of $2.5 million and the conversion of 158,079 stock options held by directors and employees into common stock. The exercise of these options contributed $842,000 to our total shareholders’ equity while stock based compensation added $75,000. Other comprehensive income components increased shareholders’ equity at September 30, 2007 by $319,000.
Comparison of Results of Operations for the Three-Month Periods Ended September 30, 2007 and 2006
Net Income. For the three-month period ended September 30, 2007, net income was $932,000 compared to $870,000 for the corresponding three-month period of 2006, representing a 7.1% increase. On a diluted share basis, earnings were $.13 and $.12 per share, respectively, for the three-month periods ended September 30, 2007 and 2006.
The increase in earnings was provided primarily by net interest income, which grew $646,000 in the three-month period ended September 30, 2007 compared to the prior year period, driven primarily by higher average loan volumes. The additional net interest income absorbed increased costs for loan loss provision, up $170,000 and increased noninterest expense up $377,000, primarily in additional personnel costs.
Net Interest Income. Interest income for the three-month period ended September 30, 2007 increased $1.5 million or 21.8% over the prior year period. The increase in interest income was provided substantially by higher levels of average earning assets. Average earning asset volumes increased $69.0 million, providing additional interest income of approximately $1.4 million, almost entirely attributable to loan growth.
Correspondingly, the $861,000 increase in interest expense was primarily due to increased volumes of average interest-bearing deposits and flat growth in average noninterest-bearing deposits. Most of the growth in average interest-bearing deposits occurred in money market and time deposits over $100,000, increasing $43.0 million and $23.0 million, respectively, resulting in increased interest expense of approximately $426,000 and $291,000, respectively. Repricing of our interest-bearing deposits to reflect
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market conditions and provide competitive rates increased our interest expense by approximately $148,000. Although our average noninterest-bearing demand deposits were flat at $90.5 million for the third quarter, these deposits provided low cost funding of our earning assets. Overall, net interest income for the three-month period ended September 30, 2007 increased $646,000 or 16.8%, with a net interest margin of 3.88% compared to a net interest margin of 3.91% for the prior year period.
The following table contains information relating to our average balance sheet and reflects the average yield on assets and cost of liabilities for the periods indicated. Such annualized yields and costs are derived by dividing annualized income or expense by the average balances of assets or liabilities, respectively, for the periods presented.
| Three Months Ended September 30, 2007 | Three Months Ended September 30, 2006 | |||||||||||||||||
| Average Balance | Interest | Average Rate | Average Balance | Interest | Average Rate | |||||||||||||
| (Amounts in thousands) | (Amounts in thousands) | |||||||||||||||||
Interest-earning assets: | ||||||||||||||||||
Loans | $ | 398,135 | $ | 7,655 | 7.63 | % | $ | 323,796 | $ | 6,132 | 7.51 | % | ||||||
Investments available for sale | 38,637 | 451 | 4.63 | % | 41,497 | 434 | 4.15 | % | ||||||||||
Fed funds sold | 18,963 | 249 | 5.21 | % | 21,562 | 297 | 5.46 | % | ||||||||||
Other interest-earning assets | 2,192 | 60 | 10.86 | % | 2,088 | 45 | 8.55 | % | ||||||||||
Total interest-earning assets | 457,927 | 8,415 | 7.29 | % | 388,943 | 6,908 | 7.05 | % | ||||||||||
Other assets | 19,888 | 16,356 | ||||||||||||||||
Total assets | $ | 477,815 | $ | 405,299 | ||||||||||||||
Interest-bearing liabilities: | ||||||||||||||||||
Deposits: | ||||||||||||||||||
NOW & money market | $ | 191,124 | 1,888 | 3.92 | % | $ | 148,128 | 1,475 | 3.95 | % | ||||||||
Savings | 1,431 | 3 | 0.83 | % | 1,042 | 2 | 0.76 | % | ||||||||||
Time deposits over $100,000 | 78,355 | 1,037 | 5.25 | % | 55,387 | 669 | 4.79 | % | ||||||||||
Other time deposits | 61,013 | 749 | 4.87 | % | 60,721 | 664 | 4.34 | % | ||||||||||
Short-term borrowings | 8,806 | 51 | 2.30 | % | 10,142 | 59 | 2.31 | % | ||||||||||
Long-term debt | 11,182 | 205 | 7.27 | % | 11,204 | 203 | 7.19 | % | ||||||||||
Total interest-bearing liabilities | 351,911 | 3,933 | 4.43 | % | 286,624 | 3,072 | 4.25 | % | ||||||||||
Demand deposits | 90,500 | 90,841 | ||||||||||||||||
Other liabilities | 5,740 | 3,494 | ||||||||||||||||
Shareholders’ equity | 29,664 | 24,340 | ||||||||||||||||
Total liabilities and shareholders’ equity | $ | 477,815 | $ | 405,299 | ||||||||||||||
Net interest income and interest rate spread | $ | 4,482 | 2.86 | % | $ | 3,836 | 2.79 | % | ||||||||||
Net yield on average interest-earning assets | 3.88 | % | 3.91 | % | ||||||||||||||
Ratio of average interest-earning assets to average interest-bearing liabilities | 130.13 | % | 135.70 | % | ||||||||||||||
Provision for Loan Losses. The provision for loan losses was $255,000 during the three-month period ended September 30, 2007 as compared with $85,000 for the same period in 2006. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level considered appropriate by our management. There were no significant charge-offs or recoveries recorded during the three-month periods ended September 30, 2007 or 2006. Nonaccrual loans were $141,000 and $397,000 respectively, representing .03% and .11% of period end loans as of September 30, 2007 and December 31, 2006. There were no loans on nonaccrual status as of September 30, 2006. We had no restructured loans or other real estate owned at September 30, 2007, December 31, 2006 or September 30, 2006. The
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allowance for loan losses was $4.4 million at September 30, 2007, $4.0 million at December 31, 2006, and $4.2 million at September 30, 2006 representing 1.06%, 1.15% and 1.30%, respectively, of loans outstanding at each date. The decrease in the level of the allowance relative to gross loans to 1.06% at September 30, 2007 is largely due to the elimination of the specific allowance related to loans charged off during the first six months of 2007, approximately $194,000. The allowance for loan losses is maintained at a level management considers adequate to provide for probable loan losses based on our assessment of our loan portfolio at September 30, 2007.
Management determines the adequacy of our allowance for loan losses based on a number of factors including reviewing and evaluating our loan portfolio in order to identify potential problem loans, credit concentrations and other risk factors connected to the loan portfolio as well as current and projected economic conditions locally and nationally. As discussed in our Annual Report on Form 10-KSB for the year ended December 31, 2006, during the second half of 2006, management re-evaluated and implemented improvements to its methodology used to estimate the allowance for loan losses. In evaluating the allowance for loan losses, we prepare a statistically-based analysis of our current loan portfolio through the use of peer statistics utililizing key loan portfolio quality measures such as net losses to average loans, allowance for loan losses to nonaccrual loans and the percentage of loans over 30 days past due. Commercial loans grouped by risk rating and consumer loans grouped by general loan types are assigned risk factors based on estimated risk of inherent loss and on their respective risk ratings. We utilize a system of nine possible risk ratings. All loans risk rated “doubtful” and “loss” are removed from their loan group and individually analyzed for impairment as detailed in Statement of Financial Accounting Standards No. 114. Other groups of loans based on loan size may be selected for impairment review. We have identified seven qualitative factors that are considered indicators of changes in the level of risk of loss inherent in our loan portfolio. These factors include and consider the risk of payment performance, overall portfolio quality (utilizing weighted average risk rating), general economic factors such as unemployment, inflation, delinquency and charge-off rates, regulatory examination results, interest rate environment, levels of highly leveraged transactions (as defined in Section 365.2 of the FDIC regulations) and levels of construction, development and non-owner occupied commercial real estate lending.
The following is a summary of nonperforming assets at the dates presented:
| September 30, 2007 | December 31, 2006 | September 30, 2006 | ||||||||||
| (Amounts in thousands) | ||||||||||||
Nonaccrual loans | $ | 141 | $ | 397 | $ | — | ||||||
Restructured loans | — | — | — | |||||||||
Total nonperforming loans | 141 | 397 | — | |||||||||
Other real estate owned | — | — | — | |||||||||
Total nonperforming assets | $ | 141 | $ | 397 | $ | — | ||||||
Other impaired loans | $ | 257 | $ | 242 | $ | — | ||||||
Accruing loans past due 90 days or more | 580 | — | — | |||||||||
Allowance for loan losses | 4,358 | 3,983 | 4,247 | |||||||||
Nonperforming loans to period end loans | 0.03 | % | 0.11 | % | 0.00 | % | ||||||
Allowance for loan losses to period end loans | 1.06 | % | 1.15 | % | 1.30 | % | ||||||
Nonperforming assets to loans and other real estate owned | 0.03 | % | 0.11 | % | 0.00 | % | ||||||
Nonperforming assets to total assets | 0.03 | % | 0.09 | % | 0.00 | % | ||||||
Ratio of allowance for loan losses to nonperforming loans | 30.91 | x | 10.03 | x | n/a | x | ||||||
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Noninterest Income. For the three-month period ended September 30, 2007, non-interest income increased $20,000 to $293,000 from $273,000 for the same period in the prior year. Deposit fees and other fees decreased $18,000 for the three-month period ended September 30, 2007 compared to the prior year period due to lower rates resulting from increased competition. Fees from mortgage operations increased $13,000 as overall mortgage loan production increased compared to the prior year period due to market conditions and changes in performance standards for our mortgage loan originators. Other non-interest income grew $25,000 to $47,000 primarily through annuity sales fees and other fees generated from wealth management services.
Noninterest Expense. Total non-interest expense for the three-month period ended September 30, 2007 was $3.0 million, with salaries and benefits representing the largest expense category at $1.8 million. This compares to total non-interest expense for the three-month period ended September 30, 2006 of $2.6 million with salaries and benefits of $1.3 million. The $435,000 increase in salaries and benefits for the three-month period ended September 30, 2007 is attributable to an overall increase of 14 full time equivalent employees. We hired additional staff in 2007 for our new full service office in Wilmington and our new loan production office in downtown Raleigh, both anticipated opening in late in 2007. Other management and support staff also were added throughout the Bank during 2007 compared to the prior year period.
Occupancy and equipment costs increased $48,000 to $462,000 for the three-month period ended September 30, 2007 compared to the same period last year. These costs include the additional lease expense for our planned new loan production office in downtown Raleigh as well as additional lease expense due to expansion in our operations area. Overall, lease expense increased approximately $43,000 over the prior year three-month period. Other non-interest expenses decreased $106,000 during the three-month period ended September 30, 2007 when compared to the prior year period in 2006. A decision by our board of directors to waive their equity compensation for fiscal 2007 was approved during September 2007, resulting in a decrease in directors fees of $227,000 for the three-month period ended September 30, 2007 compared to the prior year period. Outsourced data processing fees were up $51,000 due to an increase in the volume of accounts. FDIC insurance increased $63,500 due to higher regulatory rates initiated in 2007.
Provision for Income Taxes. The effective tax rate for the three-month period ended September 30, 2007 was 38.1% compared to 37.2% for the same period ended September 30, 2006.
Comparison of Results of Operations for the Nine-Month Periods Ended September 30, 2007 and 2006
Net Income. For the nine-month period ended September 30, 2007, net income was $2.5 million compared to $2.3 million for the corresponding period in 2006, representing a 7.5% increase. On a diluted share basis, earnings were $.34 and $.33 per share, respectively, for the nine-month period ended September 30, 2007 and 2006.
The increase in earnings was provided by net interest income, which grew $1.8 million in the nine-month period ended September 30, 2007 compared to the prior year period, driven primarily by higher average loan volumes. The increase in net interest income absorbed increases in provision for loan losses of $216,000, noninterest expense of $1.2 million, income taxes of $199,000, as well as a decrease of $7,000 in noninterest income.
Net Interest Income. Interest income for the nine-month period ended September 30, 2007 increased $4.8 million over the prior year period. Most of the increase in interest income is attributable to higher average loan volume. Average loan volume increased $64.9 million providing additional interest income of approximately $3.6 million. Additionally, higher loan yields provided approximately $800,000 of
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interest income. The average prime lending rate for the nine-month period ended September 30, 2007 was approximately 36 basis points higher than the average of 7.86% for the prior year period. The increase in interest rates produced higher loan and other earning asset yields providing overall additional interest income of approximately $1.1 million over the prior year nine-month period.
Higher interest rates also increased our cost of funds. Repricing of our interest-bearing deposits to reflect market conditions and provide competitive rates increased our interest expense by approximately $1.1 million while our $58.5 million increase in volume of average interest-bearing deposits contributed additional interest expense of approximately $1.9 million. Our noninterest-bearing demand deposits grew an average of $4.2 million for the nine-month period ended September 30, 2007 compared to the prior year period. Overall, net interest income for the first nine-month period of 2007 increased $1.8 million or 16.1% with a net interest margin of 3.87% compared to a net interest margin of 3.93% for the prior year period.
The following table contains information relating to our average balance sheet and reflects the average yield on assets and cost of liabilities for the periods indicated. Such annualized yields and costs are derived by dividing annualized income or expense by the average balances of assets or liabilities, respectively, for the periods presented.
Nine Months Ended September 30, 2007 | Nine Months Ended September 30, 2006 | |||||||||||||||||
| Average Balance | Interest | Average Rate | Average Balance | Interest | Average Rate | |||||||||||||
| (Dollars in thousands) | (Dollars in thousands) | |||||||||||||||||
Interest-earning assets: | ||||||||||||||||||
Loans | $ | 376,114 | $ | 21,472 | 7.63 | % | $ | 311,199 | $ | 17,039 | 7.32 | % | ||||||
Investments available for sale | 39,113 | 1,320 | 4.51 | % | 42,921 | 1,285 | 4.00 | % | ||||||||||
Fed funds sold | 22,943 | 919 | 5.36 | % | 16,132 | 616 | 5.11 | % | ||||||||||
Other interest-earning assets | 2,310 | 169 | 9.78 | % | 3,617 | 186 | 6.88 | % | ||||||||||
Total interest-earning assets | 440,480 | 23,880 | 7.25 | % | 373,869 | 19,126 | 6.84 | % | ||||||||||
Other assets | 18,174 | 14,635 | ||||||||||||||||
Total assets | $ | 458,654 | $ | 388,504 | ||||||||||||||
Interest-bearing liabilities: | ||||||||||||||||||
Deposits: | ||||||||||||||||||
NOW & money market | $ | 174,830 | 5,082 | 3.89 | % | $ | 139,511 | 3,727 | 3.57 | % | ||||||||
Savings | 1,254 | 6 | 0.64 | % | 1,095 | 6 | 0.73 | % | ||||||||||
Time deposits over $100,000 | 76,187 | 2,982 | 5.23 | % | 52,892 | 1,782 | 4.50 | % | ||||||||||
Other time deposits | 63,110 | 2,310 | 4.89 | % | 60,896 | 1,836 | 4.03 | % | ||||||||||
Short-term borrowings | 8,769 | 149 | 2.27 | % | 11,269 | 221 | 2.62 | % | ||||||||||
Long-term debt | 11,188 | 610 | 7.29 | % | 11,208 | 578 | 6.89 | % | ||||||||||
Total interest-bearing liabilities | 335,338 | 11,139 | 4.44 | % | 276,871 | 8,150 | 3.94 | % | ||||||||||
Demand deposits | 89,756 | 85,541 | ||||||||||||||||
Other liabilities | 5,021 | 2,968 | ||||||||||||||||
Shareholders’ equity | 28,539 | 23,124 | ||||||||||||||||
Total liabilities and shareholders’ equity | $ | 458,654 | $ | 388,504 | ||||||||||||||
Net interest income and interest rate spread | $ | 12,741 | 2.81 | % | $ | 10,976 | 2.90 | % | ||||||||||
Net yield on average interest-earning assets | 3.87 | % | 3.93 | % | ||||||||||||||
Ratio of average interest-earning assets to average interest-bearing liabilities | 131.35 | % | 135.03 | % | ||||||||||||||
Provision for Loan Losses. The provision for loan losses was $677,000 during the nine-month period ended September 30, 2007 as compared with $461,000 for the same period in 2006. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level considered appropriate by
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our management. Loans of $299,000, $2,500 and $300 were charged-off during the first nine-months of 2007. Due to the level of the allowance specific to these charged off loans of approximately $194,000, these charge-offs were the primary factor resulting in the decrease in the level of the allowance relative to gross loans to 1.06% as of September 30, 2007 compared to 1.30% as of September 30, 2006 and 1.15% as of December 31, 2006. By comparison, recoveries of $113,000 and charge-offs of $5,000 were recorded during the nine-month period ended September 30, 2006.
Noninterest Income. For the nine-month period ended September 30, 2007, non-interest income decreased $7,000 to $846,000 from $853,000 for the same period in the prior year. Deposit and other fees and fees from mortgage operations continued to trend downward, decreasing $38,000 and $54,000, respectively, for the nine-month period ended September 30, 2007 compared to the prior year period. Lower rates due to increased competition have resulted in lower deposit fees and credit card fees. Fees from mortgage operations fell year-to-date as a result of an overall decline in mortgage loan production due to fewer loan originators compared to the prior year period, however, loan production and corresponding fees improved for the three-month period ended September 30, 2007. Other non-interest income grew $85,000 to $137,000 primarily through annuity sales fees and other fees generated from wealth management services.
Noninterest Expense. Total non-interest expense for the nine-month period ended September 30, 2007 was $8.9 million, an increase of $1.2 million or 15.2% over the prior year period. Salaries and benefits of $4.9 million, representing the largest expense category, were up $813,000 or 20.1% for the same period. Salaries and benefits were up due to an overall increase of 14 full time equivalent employees. During 2007 we hired staff for the anticipated opening of our full service office in Wilmington and our loan production office in downtown Raleigh, both anticipated to open in late 2007. Other management and support also were added throughout the Bank, compared to the prior year period.
Expenses related to the anticipated openings of our full service office in Wilmington and loan production office in downtown Raleigh also contributed to the increase in occupancy and equipment and other general operating costs. In total, occupancy and equipment expense increased $232,000 or 19.9% to $1.4 million for the nine-month period ended September 30, 2007 compared to the same period last year. Building lease expense increased approximately $122,000 of which approximately $70,000 was for our planned downtown office. We also incurred increased expenses as we changed our credit processing to centralized document preparation, which required the purchase of credit software. In addition to overall higher operating costs due to the planned opening of new offices, the other noninterest expenses were higher due to costs associated with outsourced data processing fees, up $106,000, due to increased volume in accounts, and to FDIC insurance and state regulatory assessments which increased $184,000 due to higher regulatory rate requirements. In September 2007, our board of directors waived their equity compensation for fiscal 2007 resulting in a decrease in directors fees of $231,000 for the nine-month period ended September 30, 2007 compared to the prior year period. In total, other non-interest expense increased $124,000 during the nine-month period ended September 30, 2007 compared to the prior year period in 2006.
Provision for Income Taxes. The effective tax rate for nine-month period ended September 30, 2007 was 38.7% compared to 37.2% for the same period ended September 30, 2006.
Liquidity and Capital Resources
To ensure that sufficient funds are available for loan growth and deposit withdrawals, as well as to provide for general needs, we must maintain an adequate level of liquidity. Both assets and liabilities provide sources of liquidity. Asset liquidity comes from our ability to convert short-term investments into cash and from the maturity and repayment of loans and investment securities. We had $64.5 million in liquid assets, consisting of cash and cash equivalents and investment securities, at September 30, 2007, compared with $99.4 million at December 31, 2006. Liability liquidity is provided by our ability to
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attract and retain deposits and from lines of credit with correspondent banks. The primary source of liquidity is our customer base, which provides our core deposits. Our deposits, together with our equity capital, represented 94.8% of total assets at September 30, 2007. We closely monitor and evaluate our overall liquidity position on a monthly basis and adjust our position as management deems appropriate. We believe our liquidity position at September 30, 2007 is adequate to meet our operating needs.
At September 30, 2007, our equity to assets ratio was 6.2%. The Bank’s leverage and risk based capital ratios and its total risk based capital ratio were 8.14%, 9.28% and 10.32%, respectively. At September 30, 2007, the Bank exceeded the minimum requirements of a “well capitalized” institution as defined by federal banking regulations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods.
The largest component of our earnings is net interest income which can fluctuate widely, directly impacting our overall earnings. Significant interest rate movements occur due to differing maturities or repricing intervals of our interest-earning assets and interest-bearing liabilities and the fact that rates on these financial instruments do not change uniformly. Management is responsible for minimizing our exposure to interest rate risk. This is accomplished by developing objectives, goals and strategies designed to enhance profitability and performance while minimizing our overall interest rate risk.
We use several modeling techniques to measure interest rate risk. Our primary method is the simulation of net interest income under varying interest rate scenarios. We believe this methodology is preferable in that it takes into account the pricing strategies we would undertake in response to rate changes, whereas other methods such as interest rate shock or balance sheet gap analysis do not take these into consideration. Our balance sheet remains asset-sensitive, which means that more assets than liabilities are subject to immediate repricing as market rates change. During periods of rising rates, this should result in increased interest income. The opposite would be expected during periods of declining rates. Our market risk has not changed significantly since December 31, 2006.
The Company’s hedging strategy is generally intended to take advantage of opportunities to reduce, to the extent possible, unpredictable cash flows. The Company may use a variety of commonly used derivative products that are instruments used by financial institutions to manage interest rate risk. The products that may be used as part of a hedging strategy include swaps, caps, floors and collars.
Item 4T. Controls and Procedures
| (a) | As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e)) pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective. |
| (b) | No change in our internal control over financial reporting occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. |
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| Exhibit # | Description | |
| 31.1 | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) | |
| 31.2 | Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) | |
| 32.1 | Certification by the Chief Executive Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
| 32.2 | Certification by the Chief Financial Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
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SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| NORTH STATE BANCORP | ||||||
| Date: November 14, 2007 | By: | /s/ Larry D. Barbour | ||||
| Larry D. Barbour | ||||||
| President and Chief Executive Officer | ||||||
| Date: November 14, 2007 | By: | /s/ Kirk A. Whorf | ||||
| Kirk A. Whorf | ||||||
| Executive Vice President and Chief Financial Officer | ||||||
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