Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20429
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2007
SEC Commission File No.: 000-52195
BANK OF THE CAROLINAS CORPORATION
(Exact name of registrant as specified in its charter)
NORTH CAROLINA | 20-4989192 | |
(State or other jurisdiction of incorporation) | (IRS Employer Identification No.) |
135 Boxwood Village Drive Mocksville, North Carolina | 27028 | |
(Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code: (336) 751-5755
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a nonaccelerated filer. See definition of accelerated filer and large accelerated filer 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 12b-2 of the Exchange Act). Yes ¨ No x
On November 9, 2007 there were 3,920,752 outstanding shares of the registrant’s common stock.
Table of Contents
BANK OF THE CAROLINAS CORPORATION
FORM 10-Q
September 30, 2007
INDEX
Item 1. | ||||
Consolidated Balance Sheets at September 30, 2007 and December 31, 2006 | 3 | |||
Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2007 and 2006 | 4 | |||
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007 and 2006 | 5 | |||
6 | ||||
7 | ||||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 10 | ||
Item 3. | 15 | |||
Item 4T. | 15 | |||
Item 1. | 16 | |||
Item 1A. | 16 | |||
Item 2. | 16 | |||
Item 3. | 16 | |||
Item 4. | 16 | |||
Item 5. | 16 | |||
Item 6. | 16 | |||
17 | ||||
18 |
2
Table of Contents
Item 1. | Financial Statements |
Bank of the Carolinas Corporation
Consolidated Balance Sheets
(In thousands, except share and per share data)
September 30 2007 | December 31 2006* | |||||||
(Unaudited) | ||||||||
Assets | ||||||||
Cash and due from banks | $ | 6,728 | $ | 5,626 | ||||
Interest-bearing deposits in banks | 165 | 7,777 | ||||||
Federal funds sold | 4,220 | 6,449 | ||||||
Securities available for sale | 63,997 | 55,677 | ||||||
Loans | 376,560 | 354,555 | ||||||
Less, Allowance for loan losses | (3,778 | ) | (3,732 | ) | ||||
Total Loans, net | 372,782 | 350,823 | ||||||
Premises and equipment | 13,284 | 11,142 | ||||||
Accrued interest receivable | 3,206 | 2,449 | ||||||
Other real estate owned | 1,909 | 1,000 | ||||||
Deferred tax assets | 650 | 768 | ||||||
Goodwill | 591 | 591 | ||||||
Bank owned life insurance | 9,194 | 8,937 | ||||||
Other assets | 3,492 | 3,339 | ||||||
Total assets | $ | 480,218 | $ | 454,578 | ||||
Liabilities and Shareholders’ Equity | ||||||||
Deposits: | ||||||||
Non-interest bearing demand deposits | $ | 31,337 | $ | 26,317 | ||||
Interest bearing demand deposits | 67,214 | 67,214 | ||||||
Savings deposits | 14,344 | 10,021 | ||||||
Large denomination time deposits | 160,739 | 153,017 | ||||||
Other time deposits | 136,805 | 126,152 | ||||||
Total deposits | 410,439 | 382,721 | ||||||
Borrowings | 27,000 | 31,000 | ||||||
Other liabilities | 3,133 | 3,143 | ||||||
Total liabilities | 440,572 | 416,864 | ||||||
Commitments and contingencies (Note 3) | ||||||||
Shareholders’ Equity: | ||||||||
Common stock, par value $5 per share: 15,000,000 shares authorized; Issued and outstanding 3,869,062 shares in 2007 and 3,826,792 in 2006 | 19,345 | 19,134 | ||||||
Additional paid-in capital | 11,562 | 11,444 | ||||||
Retained earnings | 8,692 | 7,293 | ||||||
Accumulated other comprehensive income (loss) | 47 | (157 | ) | |||||
Total stockholders’ equity | 39,646 | 37,714 | ||||||
Total liabilities and stockholders’ equity | $ | 480,218 | $ | 454,578 | ||||
* | Derived from audited consolidated financial statements. |
See accompanying notes.
3
Table of Contents
Bank of the Carolinas Corporation
Consolidated Statements of Income
(Unaudited)
(In thousands, except per share data)
Three Months Ended September 30 | Nine Months Ended September 30 | |||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||
Interest Income | ||||||||||||
Interest and fees on loans | $ | 7,659 | $ | 7,044 | $ | 22,253 | $ | 19,407 | ||||
Interest on securities | 757 | 577 | 2,070 | 1,598 | ||||||||
Interest on federal funds sold | 22 | 124 | 383 | 293 | ||||||||
Interest on deposits in other banks | 4 | 8 | 9 | 14 | ||||||||
Total interest income | 8,442 | 7,753 | 24,715 | 21,312 | ||||||||
Interest Expense | ||||||||||||
Interest on deposits | 4,296 | 3,607 | 12,857 | 9,276 | ||||||||
Interest on borrowed funds | 333 | 333 | 921 | 978 | ||||||||
Total interest expense | 4,629 | 3,940 | 13,778 | 10,254 | ||||||||
Net Interest Income | 3,813 | 3,813 | 10,937 | 11,058 | ||||||||
Provision for loan losses | 546 | 678 | 1,020 | 975 | ||||||||
Net interest income after provision for loan losses | 3,267 | 3,135 | 9,917 | 10,083 | ||||||||
Non-interest income | ||||||||||||
Customer service fees | 259 | 247 | 761 | 713 | ||||||||
Mortgage loan broker fees | 78 | 54 | 140 | 135 | ||||||||
Investment services | 99 | 66 | 198 | 66 | ||||||||
Income from bank owned life insurance | 89 | 51 | 257 | 151 | ||||||||
Gain on sale of branch | — | 1,755 | — | 1,755 | ||||||||
Other income | 29 | 32 | 99 | 110 | ||||||||
Total non-interest income | 554 | 2,205 | 1,455 | 2,930 | ||||||||
Noninterest Expense | ||||||||||||
Salaries and benefits | 1,543 | 1,773 | 4,478 | 4,590 | ||||||||
Occupancy and equipment | 447 | 357 | 1,286 | 1,029 | ||||||||
Data processing expense | 185 | 182 | 561 | 535 | ||||||||
Other | 794 | 1,232 | 2,210 | 2,507 | ||||||||
Total non-interest expense | 2,969 | 3,544 | 8,535 | 8,661 | ||||||||
Income before income taxes | 852 | 1,796 | 2,837 | 4,352 | ||||||||
Income taxes | 247 | 648 | 860 | 1,559 | ||||||||
Net Income | $ | 605 | $ | 1,148 | $ | 1,977 | $ | 2,793 | ||||
Earnings Per Share | ||||||||||||
Basic | $ | 0.16 | $ | 0.30 | $ | 0.52 | $ | 0.73 | ||||
Diluted | $ | 0.15 | $ | 0.29 | $ | 0.50 | $ | 0.70 | ||||
Dividends Declared | $ | 0.05 | $ | 0.05 | $ | 0.15 | $ | 0.15 | ||||
See accompanying notes.
4
Table of Contents
Bank of the Carolinas Corporation
Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)
Nine Months Ended September 30, 2007 | Nine Months Ended September 30, 2006 | |||||||
Cash Flows from Operating Activities: | ||||||||
Net income | $ | 1,977 | $ | 2,793 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Provision for loan losses | 1,020 | 975 | ||||||
Deferred tax benefit (expense) | (61 | ) | 129 | |||||
Stock based compensation expense | 16 | 12 | ||||||
Depreciation and amortization | 538 | 487 | ||||||
Loss on sale of other real estate owned | 7 | 308 | ||||||
Gain on sale of branch | — | (1,755 | ) | |||||
Loss on disposal of fixed assets | 3 | — | ||||||
Income from bank owned life insurance | (257 | ) | (151 | ) | ||||
Net amortization/accretion of premiums and discounts on investments | 50 | 51 | ||||||
Net change in other assets | (1,240 | ) | (1,251 | ) | ||||
Net change in other liabilities | (12 | ) | 1,376 | |||||
Net cash provided by operating activities | 2,041 | 2,974 | ||||||
Cash Flows from Investing Activities: | ||||||||
Decrease in federal funds sold | 2,229 | 11,446 | ||||||
Purchases of premises and equipment | (2,683 | ) | (564 | ) | ||||
Purchases of securities available-for-sale | (22,057 | ) | (14,160 | ) | ||||
Proceeds from sales, calls, maturities and principal repayments of securities available for sale | 14,070 | 5,226 | ||||||
Sale (purchase) of FHLB stock | 142 | (156 | ) | |||||
Acquisition of other real estate owned | (10 | ) | (249 | ) | ||||
Proceeds from sale of branch | — | 2,134 | ||||||
Proceeds from the sale of other real estate owned | 602 | 186 | ||||||
Proceeds from the sale of premise and equipment | — | 16 | ||||||
Net Increase in loans | (24,299 | ) | (39,519 | ) | ||||
Net cash used in investing activities | (32,006 | ) | (35,640 | ) | ||||
Cash Flows from Financing Activities: | ||||||||
Net Increase in deposits | 27,718 | 37,485 | ||||||
Net advances (repayments) of other borrowings | (4,000 | ) | 100 | |||||
Proceeds from exercise of stock options | 269 | — | ||||||
Tax benefit of stock options exercised | 44 | — | ||||||
Cash dividends paid | (576 | ) | (574 | ) | ||||
Net cash provided by financing activities | 23,455 | 37,011 | ||||||
Net increase (decrease) in cash and cash equivalents | (6,510 | ) | 4,345 | |||||
Cash and cash equivalents at beginning of period | 13,403 | 5,155 | ||||||
Cash and cash equivalents at end of period | $ | 6,893 | $ | 9,500 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Cash paid during the period for interest | $ | 13,834 | $ | 9,274 | ||||
Cash paid during the period for income taxes | $ | 794 | $ | 1,385 | ||||
Noncash investing and financing activities: | ||||||||
Increase in fair value of securities available for sale, net of tax | $ | 204 | $ | 42 | ||||
Dividends declared | 193 | 191 | ||||||
Foreclosed real estate | 1,509 | 575 | ||||||
Transfer from OREO to premise and equipment | — | 1,382 | ||||||
See accompanying notes.
5
Table of Contents
Bank of the Carolinas Corporation
Consolidated Statements of Changes in Shareholders’ Equity
(Unaudited) (In thousands, except share and per share data)
Common Stock | Additional Capital | Retained Earnings | Accumulated Income (loss) | Total Equity | ||||||||||||||||
Shares | Amount | |||||||||||||||||||
Balance, December 31, 2005 | 3,825,192 | $ | 19,126 | $ | 11,419 | $ | 4,583 | $ | (477 | ) | $ | 34,651 | ||||||||
Stock based compensation expense | 12 | 12 | ||||||||||||||||||
Cash dividends declared ($.15 per share) | (573 | ) | (573 | ) | ||||||||||||||||
Comprehensive income: | ||||||||||||||||||||
Net income | 2793 | 2,793 | ||||||||||||||||||
Other comprehensive income | 42 | 42 | ||||||||||||||||||
Total comprehensive income | 2,835 | |||||||||||||||||||
Balance, September 30, 2006 | 3,825,192 | $ | 19,126 | $ | 11,431 | $ | 6,803 | $ | (435 | ) | $ | 36,925 | ||||||||
Balance, December 31, 2006 | 3,826,792 | $ | 19,134 | $ | 11,444 | $ | 7,293 | $ | (157 | ) | $ | 37,714 | ||||||||
Stock options exercised | 42,270 | 211 | 58 | 269 | ||||||||||||||||
Current Income tax benefit on options exercised | 44 | 44 | ||||||||||||||||||
Stock based compensation expense | 16 | 16 | ||||||||||||||||||
Cash dividends declared ($.15 per share) | (578 | ) | (578 | ) | ||||||||||||||||
Comprehensive income: | ||||||||||||||||||||
Net income | 1,977 | 1,977 | ||||||||||||||||||
Other comprehensive income | 204 | 204 | ||||||||||||||||||
Total comprehensive income | 2,181 | |||||||||||||||||||
Balance, September 30, 2007 | 3,869,062 | $ | 19,345 | $ | 11,562 | $ | 8,692 | $ | 47 | $ | 39,646 | |||||||||
See accompanying notes.
6
Table of Contents
Notes to Consolidated Financial Statements
September 30, 2007 and 2006
(Unaudited)
NOTE 1. BASIS OF PRESENTATION
In the opinion of BankCorp’s management, the financial information included in these unaudited financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the financial information as of September 30, 2007 and December 31, 2006 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 preparation of 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 results presented here are for Bank of the Carolinas Corporation (“BankCorp”), the parent company of Bank of the Carolinas (“the Bank”). The organization and business of BankCorp, accounting policies followed by BankCorp and other relevant information are contained in the notes to the financial statements filed as part of BankCorp’s annual report on Form 10-K for the year ended December 31, 2006. This quarterly report should be read in conjunction with the annual report. Because BankCorp has no separate operations and conducts no business on its own other than owning the Bank, this discussion concerns primarily the business of the Bank. However, because the financial statements are presented on a consolidated basis, BankCorp and the Bank are collectively referred to as the “Company” unless otherwise noted.
NOTE 2. EARNINGS 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. When applicable, the weighted average shares outstanding for the diluted earnings per share computations are adjusted to reflect the assumed conversion of shares available under stock options using the treasury stock method.
Earnings per share have been computed based on the following:
7
Table of Contents
Nine months ended September 30, | ||||
2007 | 2006 | |||
Weighted average number of common shares oustanding used to calculate basic earnings per share | 3,841,070 | 3,825,192 | ||
Additional potential common shares due to stock options | 104,172 | 138,931 | ||
Weighted average number of common shares outstanding used to calculate diluted earnings per share | 3,945,242 | 3,964,123 | ||
Three months ended September 30, | ||||
2007 | 2006 | |||
Weighted average number of common shares oustanding used to calculate basic earnings per share | 3,856,660 | 3,825,192 | ||
Additional potential common shares due to stock options | 83,445 | 138,704 | ||
Weighted average number of common shares outstanding used to calculate diluted earnings per share | 3,940,105 | 3,963,896 | ||
There were 12,500 anti-dilutive options at September 30, 2007. These options were excluded from the calculation of weighted average dilutive shares.
NOTE 3. COMMITMENTS AND CONTINGENCIES
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, lines of credit and standby letters of credit. These instruments involve elements of credit risk in excess of amounts recognized in the accompanying financial statements.
The Company’s risk of loss with the unfunded loans and lines of credit or standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments under such instruments as it does for on-balance sheet instruments. The amount of collateral obtained, if any, is based on management’s credit evaluation of the borrower. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. At September 30, 2007, outstanding financial instruments whose contract amounts represent credit risk were approximately:
(in thousands) | |||
Loan commitments | $ | 64,498 | |
Letters of credit | $ | 1,336 |
8
Table of Contents
NOTE 4. COMPREHENSIVE INCOME
Accounting principles generally require that recognized revenue, expenses, gains, and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component in the equity section of the balance sheet. Such items, along with net income, are considered components of comprehensive income. Accounting principles do not require per share amounts of comprehensive income to be disclosed. The information that follows reconciles net income to comprehensive income.
Three-months ended September 30, | Nine-months ended September 30, | ||||||||||
2007 | 2006 | 2007 | 2006 | ||||||||
(In thousands) | |||||||||||
Net Income | $ | 605 | $ | 1,148 | 1,977 | $ | 2,793 | ||||
Net unrealized gain on AFS securities, net of taxes 405 | 405 | 163 | 204 | 42 | |||||||
Comprehensive income | $ | 1,010 | $ | 1,311 | 2,181 | $ | 2,835 | ||||
NOTE 5. INCOME TAXES
Effective January 1, 2007, the Company adopted Financial Accounting Standards Board Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes”, an interpretation of FASB Statement 109 (FIN 48). FIN 48 provides guidance on financial statement recognition and measurements of tax positions taken, or expected to be taken, in tax returns. The initial adoption of FIN 48 had no impact on the Company’s financial statements. As of January 1, 2007, there were no unrecognized tax benefits.
The amount of unrecognized tax benefits may increase or decrease for various reasons including adding amounts for current tax positions, expiration of open income tax returns due to statute of limitations, changes in management’s judgment about the level of uncertainty, status of examinations, litigation and legislative activity and the addition or elimination of uncertain tax positions.
The Company’s policy is to report interest and penalties, if any, related to unrecognized tax benefits in tax expense in the Consolidated Statements of Income.
The Company’s federal and state income tax returns are open and subject to examination from the 2003 tax return year and forward.
NOTE 6. RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued FASB Statement No. 157 “Fair Value Measurements.” This pronouncement creates a framework for consistently measuring fair value of financial assets and liabilities. SFAS 157 also requires increased disclosure of the assumptions used to determine fair values. This pronouncement is effective for fiscal years beginning after November 15, 2007, however early adoption is permitted. Management has not yet determined the impact of adopting FAS 157 on the consolidated financial statements.
In February 2007, the FASB issued FASB Statement No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities.” FASB 159 allows companies to measure financial instruments at fair value. The statement will be effective as of the beginning of each fiscal year that begins after November 15, 2007. FASB has allowed companies the choice to adopt the standard early but the Bank has chosen not to take that option. Management has not yet determined the impact of adopting FAS 157 on the consolidated financial statements.
NOTE 7. SUBSEQUENT EVENTS
The Company and Randolph Bank & Trust Company (“Randolph”), each has chosen to terminate their merger agreement dated April 12, 2007, after Randolph’s shareholders did not approve the merger at Randolph’s meeting of shareholders. The holders of over 60% of Randolph’s outstanding shares voted in favor of the merger, but the merger did not receive the favorable vote of the holders of two-thirds of the outstanding shares as required by North Carolina banking law. The Company’s shareholders previously had approved the merger.
As a result of termination of the merger, expenses incurred in connection with the transaction will be charged against the Company’s earnings during the fourth quarter of 2007. After adjustment for taxes, the Company currently expects that charge to reduce its consolidated earnings for the fourth quarter by approximately $430,000, or $0.11 per diluted share.
9
Table of Contents
Item 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
GENERAL
Introduction
Bank of the Carolinas Corporation (“BankCorp”) is the parent holding company of Bank of the Carolinas (“the Bank”). Because BankCorp has no separate operations and conducts no business on its own other than owning the Bank, the discussion contained in this Management’s Discussion and Analysis concerns primarily the business of the Bank. However, because the financial statements are presented on a consolidated basis, BankCorp and the Bank are collectively referred to herein as the “Company” unless otherwise noted.
The Bank began in December 1998 as a state chartered bank and currently has ten offices in the Piedmont region. The Bank competes for loans and deposits throughout the markets it serves. The Bank, like other financial institutions, derives most of its revenue from net interest income which is the difference between the income it earns from loans and securities minus the interest expense it incurs on deposits and borrowings.
Recent Developments
The Company and Randolph Bank & Trust Company (“Randolph”), each has chosen to terminate their merger agreement dated April 12, 2007, after Randolph’s shareholders did not approve the merger at Randolph’s meeting of shareholders. The holders of over 60% of Randolph’s outstanding shares voted in favor of the merger, but the merger did not receive the favorable vote of the holders of two-thirds of the outstanding shares as required by North Carolina banking law. The Company’s shareholders previously had approved the merger.
As a result of termination of the merger, expenses incurred in connection with the transaction will be charged against the Company’s earnings during the fourth quarter of 2007. After adjustment for taxes, the Company currently expects that charge to reduce its consolidated earnings for the fourth quarter by approximately $430,000, or $0.11 per diluted share.
On September 26, 2007, the Company declared a cash dividend of $.05 per share on its common stock, payable October 24, 2007 to shareholders of record on October 10, 2007.
The Company opened a branch in Concord on July 16, 2007. This is the Company’s tenth full service branch.
CHANGES IN FINANCIAL CONDITION
Total Assets
At September 30, 2007, total assets were $480.2 million compared to $454.6 million at December 31, 2006, and $431.4 million at September 30, 2006 representing an 11.3 percent year over year increase.
Investment Securities
Investment securities totaled $64.0 million at September 30, 2007, compared to $55.7 million at December 31, 2006 and $56.3 million at September 30, 2006. Total investments increased $8.3 million or 14.9 percent from December 31, 2006 and $7.7 million or 13.8 percent from September 30, 2006.
At September 30, 2007, BankCorp held 42,642 shares of Randolph Bank and Trust Company stock.
The investment portfolio includes U.S. Government Agency bonds, mortgage-backed securities, corporate bonds, municipal bonds, treasuries and equity securities all classified as available-for-sale and carried at fair value.
Loans and Allowance for Loan Losses
At September 30, 2007, the loan portfolio totaled $376.6 million and represented 78.4 percent of total assets compared to $354.6 million or 78.0 percent of total assets at December 31, 2006 and $338.7 million or 78.5 percent of total assets at September 30, 2006. Total loans increased $22.0 million from December 31, 2006 and $37.9 million or 11.2 percent from September 30, 2006. Real estate loans and commercial loans constituted approximately 68.6 percent and 28.6 percent, respectively, of the total loan portfolio at September 30, 2007.
10
Table of Contents
The allowance for loan losses is created by direct charges to income. Losses on loans are charged against the allowance in the period in which such loans, in management’s opinion, become uncollectible. Recoveries during the period are credited to this allowance. The factors that influence management’s judgment in determining the amount charged to operating expense include past loan experience, composition of the loan portfolio, current economic conditions and probable losses.
The appropriateness of the allowance for loan losses is measured on a quarterly basis using an allocation model that assigns reserves to various components of the loan portfolio in order to provide for probable inherent losses. It must be emphasized, however, that the determination of the reserve using the Company’s procedures and methods rests upon various judgments and assumptions about current economic conditions and other factors affecting loans. No assurance can be given that the Company will not in any particular period sustain loan losses that are sizable in relation to their amounts reserved or that subsequent evaluations of the loan portfolio, in light of conditions and factors then prevailing, will not require significant changes in the allowance for loan losses or future charges to earnings. In addition, various regulatory agencies, as an integral part of their routine examination process, periodically review the Company’s allowance. Such agencies may require the Company to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examinations. The Company believes the allowance is appropriate based on management’s current analysis.
The following table describes the activity in our allowance for loan losses for the nine-month periods ended September 30, 2007 and 2006.
Nine-months ended September 30, | ||||||||
2007 | 2006 | |||||||
(dollars in thousands) | ||||||||
Balance at beginning of period | $ | 3,732 | $ | 3,315 | ||||
Provision for loan losses | 1,020 | 975 | ||||||
Charge-offs | (1,006 | ) | (501 | ) | ||||
Recoveries of loans previously charged-off | 32 | 13 | ||||||
Balance at end of period | $ | 3,778 | $ | 3,802 | ||||
Ratio of allowance for loan losses to total loans at end of period | 1.00 | % | 1.12 | % |
The decline in the ratio of allowance for loan losses to total loans as of September 30, 2007 versus the prior year was due to a decrease in the amount of impaired loans and their related reserves. Impaired loans at September 30, 2007 were $580,000 compared to $3,671,000 at September 30, 2006. The reserves related to these impaired loans were $306,000 at September 30, 2007 versus $842,000 at September 30, 2006. The ratio of annualized net charge-offs to average loans was 0.36% for the nine months ended September 30, 2007 versus .20% for same period in 2006. A significant portion of this increase was due to a charge-off on a credit involving a piece of multi-family real estate sold at foreclosure in the second quarter. Excluding the charge-off related to this one problem credit, the Company’s annualized net charge-off ratio would have been .18% as opposed to .36%.
Certain credit risks are inherent in making loans, particularly commercial and consumer loans. Management prudently assesses these risks and attempts to manage them effectively. The Company also attempts to reduce repayment risks by adhering to internal credit underwriting policies and procedures. These policies and procedures include officer and customer limits, periodic loan documentation review and follow up on exceptions to credit policies. A loan is placed in nonaccrual status when, in management’s judgment, the collection of interest appears doubtful. Nonperforming assets are defined as foreclosed properties, nonaccrual loans and accruing loans that are contractually past due 90 days or more.
The following table summarizes information regarding our nonaccrual loans, other real estate owned, and certain other repossessed assets and loans, as of September 30, 2007 and December 31, 2006. On those dates, we had no loans categorized as troubled debt restructuring within the meaning of SFAS 15.
11
Table of Contents
September 30, 2007 | December 31, 2006 | |||||||
(dollars in thousands) | ||||||||
Loans accounted for on a nonaccrual basis: | ||||||||
Real estate loans: | ||||||||
Land | $ | 294 | $ | — | ||||
Mortgage | — | 102 | ||||||
Commercial | — | 2,596 | ||||||
Construction | 55 | — | ||||||
Home Equity | — | — | ||||||
Commercial business and consumers | 524 | 82 | ||||||
Installment | — | — | ||||||
Total nonaccrual loans | 873 | 2,780 | ||||||
Accruing loans, which are contractually past due 90 days or more 1,202 | 1,202 | 1,882 | ||||||
Total non-performing loans | 2,075 | 4,662 | ||||||
Other real estate owned, net | 1,909 | 1,000 | ||||||
Total non-performing assets | $ | 3,984 | $ | 5,662 | ||||
Non-performing loans as a percentage of net loans | 0.56 | % | 1.33 | % | ||||
Total non-performing assets as a percentage of total assets | 0.83 | % | 1.25 | % |
Although non–performing assets were higher at December 31, 2006 than in prior years, they decreased after year end in total dollar amount and as a percentage of total assets. The amount at December 31, 2006 included a loan in the amount of $1.9 million that was placed on non-accrual in the fourth quarter of 2006 and subsequently was restored to an accruing status during the first quarter, and was paid off during the second quarter of 2007.
Deposits
The Company’s deposit services include business and individual checking accounts, savings accounts, NOW accounts, certificates of deposit and money market checking accounts. At September 30, 2007, total deposits were $410.4 million compared to $382.7 million at December 31, 2006 and $364.1 million at September 30, 2006. These figures represent increases of 7.2 percent over December 31, 2006 and 12.8 percent over September 30, 2006. At September 30, 2007, time deposits of $100,000 and over made up approximately 39.1 percent of total deposits versus 40.0 percent at December 31, 2006 and 37.2 percent at September 30, 2006. A majority of the Company’s deposits are generated primarily from within its banking market. The Company has continued to shift its focus on outsourced funds from institutional CD’s (which are solicited on the Internet through Express Data Corporation’s Quick-Rate CD Clearinghouse) to brokered deposits. At September 30, 2007, the Company had $89.2 million in brokered deposits amounting to approximately 21.7 percent of total deposits and $1.4 million in institutional certificates of deposits, amounting to approximately 0.3 percent of the Company’s total deposits. At December 31, 2006 and September 30, 2006, the Company’s deposits solicited on the Internet amounted to approximately 1.0 percent and 1.3 percent, respectively, of total deposits.
Liquidity
Liquidity management is the process of managing assets and liabilities and their maturities to insure adequate funding for loan and deposit activity and continued growth of the Company. Sources of funding come from both the asset and liability side of the balance sheet. Asset side sources include cash and cash equivalents, federal funds sold and unpledged available for sale securities. These totaled $57.3 million at September 30, 2007 and $51.4 million at December 31, 2006. Liquidity sources from liabilities include deposits and lines of credit with other institutions. These sources are largely affected by our ability to attract and maintain deposits. Our deposits, together with equity capital, funded 93.7 percent of total assets at September 30, 2007. The Company has borrowing lines available from various correspondent banks and the Federal Home Loan Bank of Atlanta (FHLB) for short-term or long-term funding. At September 30, 2007, the Company had total borrowings of $27.0 million from the FHLB, with maturity dates on these borrowings extending through 2012. A lien on loans secured by residential 1-4 family dwellings and qualifying non-residential loans is in place with the FHLB to secure these advances. The Company closely monitors and evaluates its overall liquidity position. The Company believes its liquidity position at September 30, 2007 is adequate to meet its operating needs.
12
Table of Contents
Interest Rate Sensitivity
Fluctuating interest rates, increased competition and changes in the regulatory environment continue to significantly affect the importance of interest-rate sensitivity management. Rate sensitivity arises when interest rates on assets change in a different period of time or in a different proportion to interest rates on liabilities. The primary objective of interest-rate sensitivity management is to prudently structure the balance sheet so that movements of interest rates on assets and liabilities are highly correlated and produce a reasonable net interest margin even in periods of volatile interest rates. The Company uses an asset/liability simulation model to project potential changes to the Company’s net interest margin, net income, and economic value of equity based on simulated changes to market interest rates, namely the prime rate. The Company is slightly liability sensitive over the next twelve months, which means that interest-earning liabilities could re-price more quickly than interest bearing assets. Theoretically, the Company’s net interest margin will decline if market interest rates rise or improve if market interest rates fall.
Capital Adequacy
Regulatory guidelines require banks to hold minimum levels of capital based upon the risk weighting of certain categories of assets as well as any off-balance sheet contingencies. Federal regulators have adopted risk-based capital and leverage capital guidelines for measuring the adequacy of a bank’s capital, and all applicable capital standards must be satisfied for us to be considered in compliance with regulatory requirements. On September 30, 2007, the Bank’s Total Capital Ratio and Tier 1 Capital Ratio were 10.26 percent and 9.33 percent, respectively, which were well above the minimum levels required by regulatory guidelines. At September 30, 2007, the Bank’s Leverage Capital Ratio was 8.16 percent, which was also well above the minimum level required by the regulatory guidelines. Banks are placed into one of four capital categories based on the above three separate capital ratios. The four categories are “well-capitalized”, “adequately capitalized”, “under-capitalized”, and “critically under-capitalized.” The Company is considered “well-capitalized” as of September 30, 2007.
RESULTS OF OPERATIONS
Three-Month Periods Ended September 30, 2007 and September 30, 2006
The Company had net income of $605,000 or $.15 per diluted share for the three-month period ended September 30, 2007 and $1,148,000 or $.29 per diluted share for the three-month period ended September 30, 2006.
Net interest income, or the difference between income generated by earning assets (primarily loans, investment securities, and interest-bearing balances) and the expense incurred on interest bearing liabilities (primarily deposits and borrowed funds used to fund earning assets), is the Company’s primary source of earnings. The Company’s net interest income was $3.8 million for both three-month periods ended September 30, 2007 and 2006.
The loan loss provision decreased $132,000 in the third quarter of 2007 from the same period in the previous year which was primarily the result of a decrease in the amount of impaired loans and their related reserves.
Interest expense for the three-month period ending September 30, 2007 was $4.6 million compared to $3.9 million during the same period in 2006. This was an increase of $689,000 or 17.5%. The majority of this increase was due to deposit growth during the period as well as rising interest rates in the market, particularly for time deposit products.
Non-interest income was $554,000 for the three-months compared to $2,205,000 for the three-month period ended September 30, 2006. Excluding the one time gain on the sale of our Carthage branch in the third quarter of 2006, non-interest income for the quarter would have been $450,000. Excluding that gain, the 2007 quarter had an increase of $104,000 or 23.1%. As compared to the third quarter of 2006, non-interest income reflects increases of $12,000 in service charges on deposit accounts, $33,000 in income from the Bank’s investment services division (which was started in the second quarter of 2006), $38,000 in income from bank owned life insurance (BOLI) and $24,000 in mortgage loan broker fees. The Bank acquired additional BOLI at the end of 2006 which resulted in the period over period increase in that component of non-interest income.
13
Table of Contents
Non-interest expense was $2.9 million for the three-months ended September 30, 2007, compared to $3.5 million for the same period in 2006, a decrease of $575,000 or 16.2 percent. Salary expense decreased $230,000 over the same quarter in the previous year. This was primarily due to $172,000 in incentive accruals that were included in the September 2006 expense and the remainder was a result of employee attrition. Occupancy expense increased $90,000 which was primarily due to increased expenses from the opening of our Winston-Salem and Concord offices. The effective tax rate for the three-month period ended September 30, 2007 was 29.0 % compared to 36.1 % for the three-months ended September 30, 2006. The decrease in the effective tax rate is primarily due to greater percentage of the Company’s income being derived from tax exempt sources such as municipal bonds and bank owned life insurance (BOLI).
Nine-Month Periods Ended September 30, 2007 and September 30, 2006
The Company had net income of $1,977,000 or $.50 per diluted share for the nine-month period ended September 30, 2007 and $2,793,000 or $.70 per diluted share for the nine-month period ended September 30, 2006.
Net interest income, or the difference between income generated by earning assets (primarily loans, investment securities, and interest-bearing balances) and the expense incurred on interest bearing liabilities (primarily deposits and borrowed funds used to fund earning assets), is the Company’s primary source of earnings. The Company’s net interest income for the nine-month period ended September 30, 2007 and 2006 was $10.9 million and $11.0 million, respectively.
Interest expense for the nine-month period ending September 30, 2007 was $13.8 million compared to $10.2 million during the same period in 2006. This was an increase of $3.5 million or 34.4%. The majority of this increase was due to deposit growth during the period as well as rising interest rates in the market, particularly for time deposit products.
The net interest margin decreased to 3.40% at September 30, 2007 compared to 3.87% at September 30, 2006. While the yield on earning assets increased by 23 basis points that was more than offset by a 72 basis point increase in the cost of funds.
Non-interest income was $1,455,000 for the nine-months compared to $2,930,000 for the nine-month period ended September 30, 2006. Excluding the one time gain on the sale of the Carthage branch, non-interest income would have been $1,175,000 for the year to date period in 2006. The $280,000 year over year increase, excluding the gain on sale of branch, was largely a result of a $132,000 increase in income from our investment services division which was started in the second quarter of 2006 and a $106,000 increase in income from bank owned life insurance (BOLI). The Bank acquired additional BOLI at the end of 2006 which resulted in the year over year increase in that component of non-interest income.
Non-interest expense was $8.5 million for the nine-months ended September 30, 2007, compared to $8.7 million for the same period in 2006, an increase of $126,000 or 1.5 percent. Salary expense decreased $112,000 over the same period in the previous year which was primarily a result of $172,000 in incentive accruals that were included in the September 2006 expense. Occupancy expense increased $257,000 which was primarily due to increased expenses from the opening of our Winston-Salem and Concord offices. The effective tax rate for the nine-month period ended September 30, 2007 was 30.3 % compared to 35.8 % for the nine-months ended September 30, 2006. The decrease in the effective tax rate is primarily due to greater percentage of the Company’s income being derived from tax exempt sources such as municipal bonds and bank owned life insurance (BOLI).
DISCLOSURES ABOUT FORWARD LOOKING STATEMENTS
This Report and its exhibits contain statements relating to our financial condition, results of operations, plans, strategies, trends, projections of results of specific activities or investments, expectations or beliefs about future events or results, and other statements that are not descriptions of historical facts. Those statements may be forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may be identified by terms such as “may”, “will”, “should”, “could”, “expects”, “plans”, “intends”, “anticipates”, “believes”, “estimates”, “predicts”, “forecasts”, “potential” or “continue,” or similar terms or the negative of these terms, or other statements concerning opinions or judgments of the Company’s management about future events. Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, risk factors discussed in the Company’s Annual Report on Form 10-K and in other documents the Company files with the Securities and Exchange Commission from time to time. Copies of those reports are available directly through the Commission’s website atwww.sec.gov. Other factors that could influence the accuracy of such forward-looking statements include, but are not limited to, (a) changes in competitive pressures among depository and other financial institutions or in the Company’s ability to compete successfully against the larger financial institutions in its banking markets; (b) the financial success or changing strategies of the Company’s customers; (c) actions of government regulators, or changes in laws,
14
Table of Contents
regulations or accounting standards, that adversely affect the Company’s business; (d) changes in the interest rate environment and the level of market interest rates that reduce the Company’s net interest margins and/or the volumes and values of loans it makes and securities it holds; (e) changes in general economic or business conditions and real estate values in the Company’s banking markets (particularly changes that affect the Company’s loan portfolio, the abilities of its borrowers to repay their loans, and the values of loan collateral); (f) the Company’s ability to successfully integrate the business of merger partners into its business without unexpected costs or difficulty, disruption, deposit attrition, or loss of revenue, or its inability to fully realize expected costs savings of any acquisition; and (g) other developments or changes in our business that the Company does not expect. Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, it cannot guarantee future results, levels of activity, performance or achievements. All forward-looking statements attributable to the Company are expressly qualified in their entirety by the cautionary statements in this paragraph. The Company has no obligation, and do not intend, to update these forward-looking statements.
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 rate risks. Interest rate risk is the result of differing maturities or re-pricing intervals of interest-earning assets and interest-bearing liabilities and the fact that rates on these financial instruments do not change uniformly. These changes can have a direct impact on the Company’s overall earnings. The current structure of the Company’s balance sheet is such that a significant increase in interest rates may negatively impact net interest income.
Management of the Company actively monitors interest rate risk through the development of and adherence to the Company’s asset/liability management policy. The Company has also established an Asset Liability Management Committee (“ALCO”) which monitors interest rate risk exposure, liquidity and funding strategies to ensure that their potential impact is within standards. There has been no significant change in market risk since December 31, 2006.
Item 4T. | CONTROLS AND PROCEDURES |
The Company’s management, with participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures in accordance with Rule 13a-15 of the Securities Exchange Act (“the Exchange Act”). Based on that evaluation, those officers concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective to provide reasonable assurance that it is able to record, process, summarize and report in a timely manner the information required to be disclosed in reports it files under the Exchange Act.
In connection with the above evaluation of the effectiveness of the Company’s disclosure controls and procedures, no changes in the Company’s internal control over financial reporting was identified that occurred during the most recent fiscal quarter and that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
15
Table of Contents
Item 1. | Legal Proceedings |
From time to time, the Company may be a party to various legal proceedings incident to its business. At September 30, 2007 there were no legal proceedings to which the Company was a party, or to which any of its property was subject, which were expected by management to result in a material loss.
Item 1A. | Risk Factors |
Along with other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, which could materially affect the Company’s business, financial condition or future results. In addition to the risks described in the Annual Report on Form 10-K and investment risks that apply in the case of any financial institution, the Company’s business, financial condition and operating results could be harmed by other risks, including risks not yet identified or that the Company believes are immaterial or unlikely.
Item 2. | Unregistered Sales of Equity 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 |
The following exhibits are being furnished or filed with this report.
31.01 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) (furnished herewith) | |
31.02 | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) (furnished herewith) | |
32.01 | Certification of our Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (furnished herewith) |
16
Table of Contents
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
BANK OF THE CAROLINAS CORPORATION | ||||||
Date: November 13, 2007 | By: | /s/ Robert E. Marziano | ||||
Robert E. Marziano | ||||||
President and Chief Executive Officer | ||||||
Date: November 13, 2007 | By: | /s/ Eric E. Rhodes | ||||
Eric E. Rhodes | ||||||
Vice President and Chief Financial Officer |
17
Table of Contents
Exhibit | Description | |
31.01 | Certification of our Chief Executive Officer pursuant to Rule 13a-14(a) (furnished herewith) | |
31.02 | Certification of our Chief Financial Officer pursuant to Rule 13a-14(a) (furnished herewith) | |
32.01 | Certifications of our Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (furnished herewith) |
18