UNITED STATES 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 June 30, 2006 | |
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ________ to __________ | |
Commission File Number: 0-19684 |
COASTAL FINANCIAL CORPORATION |
(Exact name of registrant as specified in its charter) |
State of Delaware | 57-0925911 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) | |
2619 OAK STREET, MYRTLE BEACH, S. C. | 29577 | |
(Address of principal executive offices) | (Zip Code) | |
Registrant’s telephone number, including area code (843) 205-2000 | |
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 o |
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or non-accelerated filer. See definition of “accelerated filer and a large accelerated filer” in Rule 12b-2 of the Exchange Act. | |
Large Accelerated Filero Accelerated Filer x Non-accelerated Filero | |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) | |
YES o | NO x |
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of July 31, 2006. | |
Common Stock $.01 Par Value Per Share | 19,679,499 Shares |
(Class) | (Outstanding) |
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2006 |
2 |
PART I. FINANCIAL INFORMATION |
September 30, 2005 | June 30, 2006 | |||||
---|---|---|---|---|---|---|
(Unaudited) (In thousands) | ||||||
ASSETS: | ||||||
Cash and amounts due from banks | $ | 52,592 | $ | 39,888 | ||
Short-term interest-bearing deposits | 33,742 | 3,230 | ||||
Federal funds sold | 5,191 | 1,369 | ||||
Investment securities available for sale | 25,616 | 32,987 | ||||
Mortgage-backed securities available for sale | 399,655 | 398,094 | ||||
Investment securities held to maturity (market value $10,049 at September 30, 2005 and $10,000 at June 30, 2006) | 10,000 | 10,000 | ||||
Loans receivable (net of allowance for loan losses of $11,748 at September 30, 2005 and $12,550 at June 30, 2006) | 924,260 | 1,048,456 | ||||
Loans receivable held for sale | 18,121 | 4,621 | ||||
Real estate acquired through foreclosure, net | 818 | 641 | ||||
Office property and equipment, net | 22,758 | 28,533 | ||||
Federal Home Loan Bank (FHLB) stock, at cost | 15,775 | 19,166 | ||||
Accrued interest receivable on loans | 3,807 | 4,662 | ||||
Accrued interest receivable on securities | 2,351 | 2,820 | ||||
Bank-owned life insurance | 22,574 | 23,293 | ||||
Other assets | 6,199 | 6,321 | ||||
$ | 1,543,459 | $ | 1,624,081 | |||
LIABILITIES AND STOCKHOLDERS’ EQUITY: | ||||||
LIABILITIES: | ||||||
Deposits | $ | 1,070,918 | $ | 1,062,248 | ||
Securities sold under agreements to repurchase | 41,937 | 74,411 | ||||
Advances from FHLB | 289,007 | 355,575 | ||||
Junior subordinated debt | 15,464 | 15,464 | ||||
Drafts outstanding | 12,890 | 3,044 | ||||
Advances by borrowers for property taxes and insurance | 1,221 | 1,033 | ||||
Accrued interest payable | 3,415 | 4,976 | ||||
Other liabilities | 11,386 | 4,753 | ||||
Total Liabilities | 1,446,238 | 1,521,504 | ||||
STOCKHOLDERS’ EQUITY: | ||||||
Serial preferred stock, 1,000,000 shares authorized and unissued | — | — | ||||
Common stock, $.01 par value, 50,000,000 shares authorized; 19,457,492 shares at September 30, 2005 and 19,678,327 shares at June 30, 2006 issued and outstanding | 195 | 197 | ||||
Additional paid-in capital | 11,410 | 12,564 | ||||
Retained earnings, restricted | 86,723 | 97,810 | ||||
Accumulated other comprehensive loss, net of tax | (1,107 | ) | (7,994 | ) | ||
Total stockholders’ equity | 97,221 | 102,577 | ||||
$ | 1,543,459 | $ | 1,624,081 | |||
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
3 |
PART I. FINANCIAL INFORMATION |
2005 | 2006 | |||||
---|---|---|---|---|---|---|
(Unaudited) (In thousands, except per share data) | ||||||
Interest income: | ||||||
Loans receivable | $ | 14,807 | $ | 19,546 | ||
Investment securities | 1,277 | 1,664 | ||||
Mortgage-backed securities | 4,147 | 3,950 | ||||
Other | 106 | 412 | ||||
Total interest income | 20,337 | 25,572 | ||||
Interest expense: | ||||||
Deposits | 3,856 | 7,006 | ||||
Securities sold under agreements to repurchase | 760 | 617 | ||||
Advances from FHLB | 2,981 | 3,733 | ||||
Junior subordinated debt | 234 | 305 | ||||
Total interest expense | 7,831 | 11,661 | ||||
Net interest income | 12,506 | 13,911 | ||||
Provision for loan losses | 550 | 430 | ||||
Net interest income after provision for loan losses | 11,956 | 13,481 | ||||
Other income: | ||||||
Fees and service charges on loan and deposit accounts | 1,611 | 2,445 | ||||
Gain on sales of loans and loans receivable held for sale | 215 | 674 | ||||
Gain on sales of investment securities, net | 15 | 34 | ||||
Loss on sales of mortgage-backed securities, net | (142 | ) | (478 | ) | ||
Gain (loss) from real estate acquired through foreclosure, net | (28 | ) | 120 | |||
Income from sales of non-depository products | 441 | 402 | ||||
FHLB stock dividends | 183 | 264 | ||||
Income from ATM and debit card transactions | 418 | 608 | ||||
Bank-owned life insurance | 235 | 243 | ||||
Other income | 153 | 359 | ||||
Total other income | 3,101 | 4,671 | ||||
General and administrative expenses: | ||||||
Salaries and employee benefits | 4,612 | 5,699 | ||||
Net occupancy, furniture and fixtures and data processing expenses | 1,229 | 1,757 | ||||
Depreciation | 739 | 928 | ||||
FDIC insurance premium | 26 | 37 | ||||
Marketing expenses | 463 | 545 | ||||
Expense from ATM and debit card transactions | 279 | 392 | ||||
Other expense | 1,072 | 1,198 | ||||
Total general and administrative expense | 8,420 | 10,556 | ||||
Income before income taxes | 6,637 | 7,596 | ||||
Income taxes | 2,281 | 2,659 | ||||
Net income | $ | 4,356 | $ | 4,937 | ||
Net income per common share: | ||||||
Basic | $ | 0.22 | $ | 0.25 | ||
Diluted | $ | 0.21 | $ | 0.24 | ||
Dividends declared per common share | $ | 0.04 | $ | 0.05 | ||
Weighted average common shares outstanding: | ||||||
Basic | 19,423,000 | 19,609,000 | ||||
Diluted | 20,497,000 | 20,436,000 | ||||
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
4 |
PART I. FINANCIAL INFORMATION |
2005 | 2006 | |||||
---|---|---|---|---|---|---|
(Unaudited) (In thousands, except per share data) | ||||||
Interest income: | ||||||
Loans receivable | $ | 40,911 | $ | 54,875 | ||
Investment securities | 3,652 | 4,951 | ||||
Mortgage-backed securities | 12,403 | 12,136 | ||||
Other | 229 | 786 | ||||
Total interest income | 57,195 | 72,748 | ||||
Interest expense: | ||||||
Deposits | 9,290 | 19,395 | ||||
Securities sold under agreements to repurchase | 2,074 | 1,534 | ||||
Advances from FHLB | 9,277 | 10,601 | ||||
Junior subordinated debt | 637 | 863 | ||||
Total interest expense | 21,278 | 32,393 | ||||
Net interest income | 35,917 | 40,355 | ||||
Provision for loan losses | 1,525 | 1,160 | ||||
Net interest income after provision for loan losses | 34,392 | 39,195 | ||||
Other income: | ||||||
Fees and service charges on loan and deposit accounts | 4,124 | 6,780 | ||||
Gain on sales of loans and loans receivable held for sale | 769 | 968 | ||||
Gain on sales of investment securities, net | 32 | 52 | ||||
Gain (loss) on sales of mortgage-backed securities, net | 87 | (511 | ) | |||
Gain on investment security held to maturity called by issuer | 160 | — | ||||
Gain (loss) from real estate acquired through foreclosure, net | (73 | ) | 25 | |||
Income from sales of non-depository products | 1,371 | 1,312 | ||||
FHLB stock dividends | 534 | 720 | ||||
Income from ATM and debit card transactions | 1,042 | 1,652 | ||||
Bank-owned life insurance | 709 | 719 | ||||
Other income | 449 | 744 | ||||
Total other income | 9,204 | 12,461 | ||||
General and administrative expenses: | ||||||
Salaries and employee benefits | 13,532 | 16,551 | ||||
Net occupancy, furniture and fixtures and data processing expenses | 3,557 | 4,776 | ||||
Depreciation | 2,010 | 2,574 | ||||
FDIC insurance premium | 79 | 104 | ||||
Marketing expenses | 1,456 | 1,502 | ||||
Expense from ATM and debit card transactions | 744 | 1,074 | ||||
Other expense | 3,142 | 3,581 | ||||
Total general and administrative expense | 24,520 | 30,162 | ||||
Income before income taxes | 19,076 | 21,494 | ||||
Income taxes | 6,541 | 7,469 | ||||
Net income | $ | 12,535 | $ | 14,025 | ||
Net income per common share: | ||||||
Basic | $ | 0.65 | $ | 0.72 | ||
Diluted | $ | 0.61 | $ | 0.69 | ||
Dividends declared per common share | $ | 0.13 | $ | 0.15 | ||
Weighted average common shares outstanding: | ||||||
Basic | 19,314,000 | 19,518,000 | ||||
Diluted | 20,400,000 | 20,404,000 | ||||
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
5 |
Common Stock | Additional Paid-in Capital | Retained Earnings | Treasury Stock | Accumulated Other Compre- hensive Income (Loss) | Total Stockholders’ Equity | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Unaudited) (In thousands) | ||||||||||||||||||
Balance at September 30, 2004 | $ | 192 | $ | 10,607 | $ | 73,533 | $ | (1,182 | ) | $ | 2,198 | $ | 85,348 | |||||
Net income | — | — | 12,535 | — | — | 12,535 | ||||||||||||
Other comprehensive income: | ||||||||||||||||||
Unrealized losses arising during period, net of tax benefit of $392 | — | — | — | — | (640 | ) | — | |||||||||||
Less: reclassification adjustment for gains included in net income net of taxes of $45 | — | — | — | — | (74 | ) | — | |||||||||||
Other comprehensive income | — | — | — | — | (714 | ) | (714 | ) | ||||||||||
Comprehensive income | — | — | — | — | 11,821 | |||||||||||||
Exercise of stock options, including tax benefits of $347 | 2 | 546 | (602 | ) | 1,182 | — | 1,128 | |||||||||||
Cash dividends | — | — | (2,468 | ) | — | — | (2,468 | ) | ||||||||||
Balance at June 30, 2005 | $ | 194 | $ | 11,153 | $ | 82,998 | $ | — | $ | 1,484 | $ | 95,829 | ||||||
Balance at September 30, 2005 | $ | 195 | $ | 11,410 | $ | 86,723 | $ | — | $ | (1,107 | ) | $ | 97,221 | |||||
Net Income | — | — | 14,025 | — | — | 14,025 | ||||||||||||
Other comprehensive income: | ||||||||||||||||||
Unrealized losses arising during period, net of tax benefit of $4,395 | — | — | — | — | (7,172 | ) | — | |||||||||||
Less: reclassification adjustment for losses included in net income net of tax benefit of $174 | — | — | — | — | 285 | — | ||||||||||||
Other comprehensive income | — | — | — | — | (6,887 | ) | (6,887 | ) | ||||||||||
Comprehensive income | — | — | — | — | 7,138 | |||||||||||||
Exercise of stock options, including tax benefit of $326 | 2 | 1,085 | — | — | — | 1,087 | ||||||||||||
Stock compensation expense, net of tax of $42 | — | 69 | — | — | — | 69 | ||||||||||||
Cash dividends | — | — | (2,938 | ) | — | — | (2,938 | ) | ||||||||||
Balance at June 30, 2006 | $ | 197 | $ | 12,564 | $ | 97,810 | $ | — | $ | (7,994 | ) | $ | 102,577 | |||||
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
6 |
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES |
2005 | 2006 | ||||||
(Unaudited) (In thousands) | |||||||
Cash flows from operating activities: | |||||||
Net income | $ | 12,535 | $ | 14,025 | |||
Adjustments to reconcile net income to net cash | |||||||
Provided by operating activities: | |||||||
Depreciation | 2,010 | 2,574 | |||||
Provision for loan losses | 1,525 | 1,160 | |||||
Gain on sale of investment securities available for sale, net | (32 | ) | (52 | ) | |||
(Gain) loss on sale of mortgage-backed securities available for sale, net | (87 | ) | 511 | ||||
Gain on call of investment security called by issuer | (160 | ) | — | ||||
Stock option compensation expense | — | 111 | |||||
Loss on disposal of office properties and equipment | 124 | 9 | |||||
Origination of loans receivable held for sale | (46,843 | ) | (31,065 | ) | |||
Proceeds from sale of loans and loans receivable held for sale, net | 12,306 | 18,604 | |||||
Recovery from write-down of mortgage servicing rights | (223 | ) | — | ||||
Proceeds from securitization and sales of loans receivable held for sale, net | 33,657 | 18,692 | |||||
Tax benefit from the exercise of stock options | (347 | ) | (326 | ) | |||
Increase in: | |||||||
Cash value of life insurance | (709 | ) | (719 | ) | |||
Accrued interest receivable | (562 | ) | (1,324 | ) | |||
Other assets | (5,098 | ) | (122 | ) | |||
Increase (decrease) in: | |||||||
Accrued interest payable | 1,228 | 1,561 | |||||
Other liabilities | 1,661 | (2,128 | ) | ||||
Net cash provided by operating activities | 10,985 | 21,511 | |||||
Cash flows from investing activities: | |||||||
Proceeds from sales of investment securities available for sale | 3,643 | 8,614 | |||||
Proceeds from sales of mortgage-backed securities available for sale | 145,392 | 49,669 | |||||
Proceeds from issuer call of investment securities held to maturity | 8,000 | — | |||||
Proceeds from issuer call of investment securities available for sale | 1,950 | — | |||||
Purchases of investment securities available for sale | (3,659 | ) | (16,936 | ) | |||
Purchases of investment securities held to maturity | (10,000 | ) | — | ||||
Purchases of mortgage-backed securities available for sale | (243,250 | ) | (118,100 | ) | |||
Principal collected on mortgage-backed securities available for sale | 66,892 | 59,376 | |||||
Origination of loans receivable, net | (587,153 | ) | (559,860 | ) | |||
Purchases of loans receivable | — | (8,656 | ) | ||||
Proceeds from sales of commercial loan participations | 19,456 | 3,083 | |||||
Principal collected on loans receivable, net | 453,382 | 446,417 | |||||
Proceeds from sales of real estate acquired through foreclosure, net | 1,081 | 1,106 | |||||
Purchases of office properties and equipment | (5,118 | ) | (8,358 | ) | |||
Change in FHLB stock, net | 1,373 | (3,391 | ) | ||||
Net cash used in investing activities | (148,011 | ) | (147,036 | ) | |||
(CONTINUED) |
7 |
PART I. FINANCIAL INFORMATION Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED JUNE 30, 2005 AND 2006 (CONTINUED) |
2005 | 2006 | ||||||
(Unaudited) (In thousands) | |||||||
Cash flows from financing activities: | |||||||
Increase (decrease) in deposits, net | $ | 254,227 | $ | (8,670 | ) | ||
Increase (decrease) in securities sold under agreements to repurchase, net | (42,155 | ) | 32,474 | ||||
Proceeds from FHLB advances | 544,400 | 693,360 | |||||
Repayments of FHLB advances | (589,400 | ) | (626,792 | ) | |||
Decrease in advance payments by borrowers for property taxes and insurance, net | (336 | ) | (188 | ) | |||
Increase (decrease) in drafts outstanding, net | 1,370 | (9,846 | ) | ||||
Cash dividends to stockholders | (2,468 | ) | (2,938 | ) | |||
Proceeds from exercise of stock options | 781 | 761 | |||||
Tax benefit from the exercise of stock options | 347 | 326 | |||||
Net cash provided by financing activities | 166,766 | 78,487 | |||||
Net increase (decrease) in cash and cash equivalents | 29,740 | (47,038 | ) | ||||
Cash and cash equivalents at beginning of period | 29,652 | 91,525 | |||||
Cash and cash equivalents at end of period | $ | 59,392 | $ | 44,487 | |||
Supplemental information: | |||||||
Interest paid | $ | 20,050 | $ | 30.832 | |||
Income taxes paid | $ | 5,040 | $ | 7,108 | |||
Supplemental schedule of non-cash investing and financing transactions: | |||||||
Transfer of mortgage loans to real estate acquired through foreclosure | $ | 818 | $ | 929 | |||
Securitization of mortgage loans into mortgage-backed securities | $ | 33,657 | $ | 18,692 | |||
Change in unrealized loss in investment securities and mortgage-backed securities available for sale, net of tax | $ | (714 | ) | $ | (6,887 | ) | |
Transfer of loans held for sale to loans receivable | $ | — | $ | 10,887 | |||
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
8 |
September 30, 2005 | |||||||||||||||||||
Less than 12 Months | 12 Months or Longer | Total | |||||||||||||||||
Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | ||||||||||||||
(Unaudited) (In thousands) | |||||||||||||||||||
Collateralized Mortgage | |||||||||||||||||||
Obligations | $ | 55,560 | (770 | ) | 19,518 | (360 | ) | 75,078 | (1,130 | ) | |||||||||
FNMA | 78,664 | (1,189 | ) | 5,893 | (157 | ) | 84,557 | (1,346 | ) | ||||||||||
GNMA | 32,787 | (416 | ) | — | — | 32,787 | (416 | ) | |||||||||||
FHLMC | 81,540 | (988 | ) | 5,951 | (99 | ) | 87,491 | (1,087 | ) | ||||||||||
$ | 248,551 | (3,363 | ) | 31,362 | (616 | ) | 279,913 | (3,979 | ) | ||||||||||
June 30, 2006 | |||||||||||||||||||
Less than 12 Months | 12 Months or Longer | Total | |||||||||||||||||
Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | ||||||||||||||
(Unaudited) (In thousands) | |||||||||||||||||||
Collateralized Mortgage | |||||||||||||||||||
Obligations | $ | 75,210 | (1,560 | ) | 38,749 | (1,502 | ) | 113,959 | (3,062 | ) | |||||||||
FNMA | 82,320 | (2,646 | ) | 33,250 | (1,937 | ) | 115,570 | (4,583 | ) | ||||||||||
GNMA | 12,639 | (250 | ) | 21,434 | (869 | ) | 34,073 | (1,119 | ) | ||||||||||
FHLMC | 82,600 | (2,812 | ) | 27,861 | (1,265 | ) | 110,461 | (4,077 | ) | ||||||||||
$ | 252,769 | (7,268 | ) | 121,294 | (5,573 | ) | 374,063 | (12,841 | ) | ||||||||||
9 |
PART I. FINANCIAL INFORMATION (3) MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE - CONTINUED The unrealized losses on mortgage-backed securities were attributable to increases in interest rates, rather than credit quality deterioration. The unrealized losses are comprised of 72 securities at September 30, 2005 and 101 securities at June 30, 2006 that have had continuous losses of less than 12 months. There were 10 securities at September 30, 2005 and 41 securities at June 30, 2006 with continuous losses 12 months or longer. None of the individual mortgage-backed securities had an unrealized loss that exceeded 10% of its amortized cost at September 30, 2005. One of the mortgage-backed securities had unrealized losses which exceeded 10% of its amortized cost by an immaterial amount at June 30, 2006. At September 30, 2005 and June 30, 2006, all mortgage-backed securities were rated AAA or higher. At September 30, 2005 and June 30, 2006, none of the Company’s securities were considered impaired. (4) LOANS RECEIVABLE, NET Loans receivable, net, consists of the following: |
September 30, 2005 | June 30, 2006 | |||||||
(Unaudited) (In thousands) | ||||||||
First mortgage loans: | ||||||||
Single family to four family units | $ | 352,893 | $ | 377,854 | ||||
Land and land development | 121,170 | 145,981 | ||||||
Residential lots | 37,112 | 39,777 | ||||||
Other, primarily commercial real estate | 211,432 | 229,206 | ||||||
Construction loans on residential property | 127,970 | 185,299 | ||||||
Construction loans on commercial property | 14,989 | 16,415 | ||||||
Consumer and commercial loans: | ||||||||
Installment consumer loans | 19,115 | 14,576 | ||||||
Mobile home loans | 4,308 | 3,637 | ||||||
Savings account loans | 1,883 | 2,126 | ||||||
Equity lines of credit | 34,019 | 40,112 | ||||||
Commercial and other loans | 38,691 | 38,260 | ||||||
963,582 | 1,093,243 | |||||||
Less: | ||||||||
Allowance for loan losses | 11,748 | 12,550 | ||||||
Deferred loan costs, net | (771 | ) | (339 | ) | ||||
Undisbursed portion of loans in process | 28,345 | 32,576 | ||||||
$ | 924,260 | $ | 1,048,456 | |||||
10 |
PART I. FINANCIAL INFORMATION The changes in the allowance for loan losses consist of the following for the nine months ended: |
Nine Months Ended June 30 | ||||||||
2005 | 2006 | |||||||
(Unaudited) (In thousands) | ||||||||
Allowance at beginning of period | $ | 11,077 | $ | 11,748 | ||||
Provision for loan losses | 1,525 | 1,160 | ||||||
Recoveries: | ||||||||
Residential loans | — | — | ||||||
Commercial loans | 22 | 235 | ||||||
Consumer loans | 66 | 63 | ||||||
Total recoveries | 88 | 298 | ||||||
Charge-offs: | ||||||||
Residential loans | — | — | ||||||
Commercial loans | 504 | 392 | ||||||
Consumer loans | 332 | 264 | ||||||
Total charge-offs | 836 | 656 | ||||||
Net charge-offs | 748 | 358 | ||||||
Allowance at end of period | $ | 11,854 | $ | 12,550 | ||||
Nine Months Ended June 30, | |||||||
2005 | 2006 | ||||||
(Unaudited) | |||||||
Ratio of allowance to total net loans outstanding at the end of the period | 1.30 | % | 1.19 | % | |||
Ratio of net charge-offs to average total loans outstanding during the period | |||||||
(annualized) | 0.12 | % | 0.05 | % | |||
Non-accrual loans, which are primarily loans over ninety days delinquent, totaled approximately $2.6 million and $1.3 million at September 30, 2005 and June 30, 2006, respectively. For the nine months ended June 30, 2005 and 2006, interest income, which would have been recorded, would have been approximately $241,000 and $187,000, respectively, had non-accruing loans been current in accordance with their original terms. At September 30, 2005 and June 30, 2006 impaired loans totaled $2.6 million and $1.9 million, respectively. Included in the allowance for loan losses at September 30, 2005 was $434,000 related to impaired loans compared to $101,000 at June 30, 2006. The average recorded investment in impaired loans for the year ended September 30, 2005 was $3.7 million compared to $2.7 million for the nine months ended June 30, 2006. Interest income of $32,000 and $111,000 was recognized on impaired loans for the quarter and nine months ended June 30, 2006. Interest income of $133,000 and $232,000 was recognized on impaired loans for the quarter and nine months ended June 30, 2005, respectively. |
11 |
PART I. FINANCIAL INFORMATION (5) DEPOSITS Deposits consist of the following: |
September 30, 2005 | June 30, 2006 | |||||||||||
Amount | Weighted Average Rate | Amount | Weighted Average Rate | |||||||||
(Unaudited) (Dollars in thousands) | ||||||||||||
Checking accounts: | ||||||||||||
Noninterest-bearing | $ | 219,080 | — | $ | 249,100 | — | ||||||
Interest-bearing | 139,810 | 0.52 | % | 127,775 | 0.55 | % | ||||||
Total checking accounts | 358,890 | 0.20 | 376,875 | 0.19 | ||||||||
Money market accounts | 213,078 | 2.26 | 212,593 | 3.30 | ||||||||
Statement savings accounts | 71,824 | 1.47 | 74,833 | 2.25 | ||||||||
Certificate accounts | 427,126 | 3.39 | 397,947 | 4.42 | ||||||||
$ | 1,070,918 | 1.97 | % | $ | 1,062,248 | 2.54 | % | |||||
Included in certificate accounts (“CDs”) are $169.9 million of brokered CDs at September 30, 2005 and $135.2 million at June 30, 2006. The average rate and remaining term of brokered CD’s at September 30, 2005 was 3.51% and approximately four months, respectively. The average rate and remaining term of brokered CDs at June 30, 2006 was 4.68% and approximately three months, respectively. (6) ADVANCES FROM FEDERAL HOME LOAN BANK Advances from Federal Home Loan Bank (“FHLB”) consist of the following: |
September 30, 2005 | June 30, 2006 | |||||||||||
Amount | Weighted Average Rate | Amount | Weighted Average Rate | |||||||||
(Unaudited) (Dollars in thousands) | ||||||||||||
Fiscal Year Maturing | ||||||||||||
2006 | $ | 4,177 | 2.79 | % | $ | 20,746 | 5.42 | % | ||||
2007 | 3,560 | 2.83 | 3,560 | 2.83 | ||||||||
2008 | 3,977 | 3.18 | 3,977 | 3.18 | ||||||||
2009 | 31,803 | 2.36 | 6,802 | 3.74 | ||||||||
2010 | 63,651 | 5.74 | 73,651 | 5.58 | ||||||||
After fiscal 2010 | 181,839 | 3.64 | 246,839 | 3.95 | ||||||||
$ | 289,007 | 3.93 | % | $ | 355,575 | 4.35 | % | |||||
At September 30, 2005, and June 30, 2006, the Bank had pledged first mortgage loans and mortgage-backed securities with unpaid balances of approximately $362.5 million and $443.7 million, respectively, as collateral for FHLB advances. At June 30, 2006, the excess first mortgage loans and mortgage-backed securities collateral pledged to FHLB will support additional borrowings of $88.1 million. |
12 |
PART I. FINANCIAL INFORMATION Callable advances at June 30, 2006 are summarized as follows: |
June 30, 2006 | |||||||
Amount | Weighted Average Rate | ||||||
(Unaudited) (Dollars in thousands) | |||||||
Fiscal Year Callable: | |||||||
2006 | $ | 39,000 | 4.93 | % | |||
2007 | 45,000 | 3.17 | |||||
2008 | 37,000 | 2.98 | |||||
2009 | 75,000 | 4.08 | |||||
2010 | — | — | |||||
After fiscal 2010 | 25,000 | 4.86 | |||||
$ | 221,000 | 3.95 | % | ||||
Call provisions are more likely to be exercised by the FHLB when market interest rates rise. If called, the Bank may be required to replace these advances with higher cost funds. (7) EARNINGS PER SHARE Basic earnings per share for the quarter and nine months ended June 30, 2005 and 2006 are computed by dividing net income by the weighted average common shares outstanding during the respective periods. Diluted earnings per share for the quarter and nine months ended June 30, 2005 and 2006 are computed by dividing net earnings by the weighted average dilutive shares outstanding during the respective periods. At June 30, 2006, the Company had antidilutive securities of approximately 477,500 options to purchase shares by Directors and Associates. The average exercise price for these anti-dilutive securities was approximately $14.16 per share. The following is a reconciliation of average shares outstanding used to calculate basic and fully diluted earnings per share. |
For the Quarter Ended June 30, | ||||||||||||
(Unaudited) | ||||||||||||
2005 | 2005 | 2006 | 2006 | |||||||||
Basic | Diluted | Basic | Diluted | |||||||||
Weighted average shares outstanding | 19,423,000 | 19,423,000 | 19,609,000 | 19,609,000 | ||||||||
Effect of dilutive securities- stock options | — | 1,074,000 | — | 827,000 | ||||||||
19,423,000 | 20,497,000 | 19,609,000 | 20,436,000 | |||||||||
For the Nine Months Ended June 30, | ||||||||||||
(Unaudited) | ||||||||||||
2005 | 2005 | 2006 | 2006 | |||||||||
Basic | Diluted | Basic | Diluted | |||||||||
Weighted average shares outstanding | 19,314,000 | 19,314,000 | 19,518,000 | 19,518,000 | ||||||||
Effect of dilutive securities- stock options | — | 1,086,000 | — | 886,000 | ||||||||
19,314,000 | 20,400,000 | 19,518,000 | 20,404,000 | |||||||||
13 |
I. FINANCIAL INFORMATION (8) STOCK BASED COMPENSATION In December 2004, the FASB issued SFAS No. 123 (revised), “Share-Based Payment” (“SFAS 123(R)”). SFAS 123(R) replaces SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). SFAS 123(R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements over the period that an employee provides service in exchange for the award. Public companies are required to adopt, and the Company has adopted effective October 1, 2005, the new standard using a modified prospective method. Under the modified prospective method, companies are allowed to record compensation cost for new and modified awards over the related vesting period of such awards prospectively and record compensation cost prospectively on the nonvested portion, at the date of adoption, of previously issued and outstanding awards over the remaining vesting period of such awards. No change to prior periods presented is permitted under the modified prospective method. At June 30, 2006, the Company had one stock-based payment plan for directors, officers and other key Associates, which is described below. Prior to October 1, 2005, the Company, as permitted under SFAS 123, applied the intrinsic value method under APB 25, and related interpretations in accounting for its stock-based compensation plan. Effective October 1, 2005, the Company adopted the provisions of SFAS 123(R) thereby expensing employee stock-based compensation using the fair value method prospectively for all awards granted, modified, or settled on or after October 1, 2005. The fair value at the date of grant of the stock option is estimated using the Black-Scholes option-pricing model based on assumptions noted in a table below. The dividend yield is based on estimated future dividend yields. The risk-free rate for periods within the contractual term of the share option is based on the U.S. Treasury yield curve in effect at the time of grant. Expected volatilities are generally based on historical volatilities. The expected term of share options granted is generally derived from historical experience. Compensation expense is recognized on a straight-line basis over the stock option vesting period. The impact of adoption of the fair value based method for expense recognition of employee awards resulting in expense of approximately $69,000, net of tax benefit of approximately $42,000, during the nine months ended June 30, 2006. The Company’s stock option plan (“the Plan”), which is stockholder approved, provides for stock options to be granted primarily to directors, officers and other key Associates. Options granted under the stock option plan may be incentive stock options or non-incentive stock options. Share option awards are generally granted with an exercise price equal to, or higher than, the market price of the Company’s shares at the date of grant. Options vest ratably over a five-year period and expire after ten years from the date of grant, except as discussed below. Share options awards provide for accelerated vesting if there is a change in control, as defined in the Plan. The remaining shares of stock reserved for the stock option plan at June 30, 2006 amounted to approximately 111,000 shares. Options awarded prior to September 21, 2005 vest ratably over a five-year period. Effective September 21, 2005, the vesting period for approximately 731,000 options awarded during the fiscal 2003, 2004 and 2005 through September 20, 2005 that would have otherwise vested at various times through fiscal 2010 was accelerated, as more fully described in note 1(p) of the 2005 Annual Report to Stockholders. All other terms and conditions of the accelerated options remain unchanged as a result of the acceleration. In addition, in September 2005, the Company granted options to employees, officers and directors of approximately 390,000 shares, without a vesting requirement. All options expire ten years after the date of grant. The weighted average fair value of all of the options granted during the nine months ended June 30 have been estimated using the Black-Scholes option-pricing model with the following assumptions (unaudited): |
2005 | 2006 | ||||||
Dividend yield | 1.11 | % | 1.52 | % | |||
Weighted average risk-free interest rate | 4.20 | % | 4.92 | % | |||
Weighted average expected volatility | 35.25 | % | 29.00 | % | |||
Weighted average expected life in years | 7.50 | 5.00 |
14 |
PART I. FINANCIAL INFORMATION (8) STOCK BASED COMPENSATION (continued) A summary of share option activity for the nine months ended June 30, 2006 follows: |
Number Of Shares | Weighted Average Exercise Price | Weighted Average Remaining Contractual Life (Years) | Aggregate Intrinsic Value | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
(Unaudited) | |||||||||||
Outstanding at September 30, 2005 | 2,811,609 | $ | 8.52 | ||||||||
Granted | 4,000 | $ | 13.15 | ||||||||
Exercised | (252,574 | ) | $ | 4.94 | |||||||
Forfeited or expired | (8,193 | ) | $ | 11.11 | |||||||
Outstanding at June 30, 2006 | 2,554,842 | $ | 8.88 | 5.9 | $ | 11,294,000 | |||||
Exercisable at June 30, 2006 | 2,503,763 | $ | 8.94 | 5.9 | $ | 10,926,000 | |||||
The weighted average grant-date fair value of options granted during the nine months ended June 30, 2005 and 2006 was $5.51 per share and $3.87 per share, respectively. The total intrinsic value of options exercised during the nine months ended June 30, 2005 and 2006 was $2,045,000 and $2,190,000, respectively. A summary of the status of the Company’s nonvested options as of June 30, 2006, and changes during the nine months then ended, is presented below (unaudited): |
Number Of Shares | Weighted Average Grant-Date Fair Value | |||||||
---|---|---|---|---|---|---|---|---|
Nonvested at September 30, 2005 | 145,389 | $ | 2.09 | |||||
Granted | 4,000 | $ | 3.87 | |||||
Vested | (97,191 | ) | $ | 1.81 | ||||
Forfeited | (1,119 | ) | $ | 2.59 | ||||
Nonvested at June 30, 2006 | 51,079 | $ | 2.78 | |||||
Fair values have been retroactively restated for all stock dividends since the date the option was granted. As of June 30, 2006, there was approximately $47,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements. That cost is expected to be recognized over a weighted average period of approximately one year. The Company generally issues authorized but previously unissued shares to satisfy option exercises. |
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Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES (8) STOCK BASED COMPENSATION (continued) Had the compensation cost for the Company’s stock-based compensation plan been determined under the fair value-based method, the Company’s net income and earnings per share would have been adjusted to the pro forma amounts below for the quarters ended June 30 (Dollars in thousands, except per share data): |
2005 | 2006 | ||||||
---|---|---|---|---|---|---|---|
(Unaudited) | |||||||
Information as reported in the Financial Statements: | |||||||
Net income | $ | 4,356 | $ | 4,937 | |||
Basic earnings per share | $ | 0.22 | $ | 0.25 | |||
Diluted earnings per share | $ | 0.21 | $ | 0.24 | |||
Share-based compensation cost, net of related tax effects | $ | 201 | $ | 22 | |||
Information calculated as if fair value method had been applied to all awards: | |||||||
Net income, as reported | $ | 4,356 | $ | 4,937 | |||
Add: Stock-based compensation expense recognized during the period, net of related tax effects | — | 22 | |||||
Less: Stock-based compensation expense determined under the fair value-based method, net of related tax effects | (201 | ) | (22 | ) | |||
Pro forma net income | $ | 4,155 | $ | 4,937 | |||
Pro forma basic earnings per share | $ | 0.21 | $ | 0.25 | |||
Pro forma diluted earnings per share | $ | 0.20 | $ | 0.24 | |||
Had the compensation cost for the Company’s stock-based compensation plan been determined under the fair value-based method, the Company’s net income and earnings per share would have been adjusted to the pro forma amounts below for the nine months ended June 30 (Dollars in thousands, except per share data): |
2005 | 2006 | ||||||
---|---|---|---|---|---|---|---|
(Unaudited) | |||||||
Information as reported in the Financial Statements: | |||||||
Net income | $ | 12,535 | $ | 14,025 | |||
Basic earnings per share | $ | 0.65 | $ | 0.72 | |||
Diluted earnings per share | $ | 0.61 | $ | 0.69 | |||
Share-based compensation cost, net of related tax effects | $ | 577 | $ | 69 | |||
Information calculated as if fair value method had been applied to all awards: | |||||||
Net income, as reported | $ | 12,535 | $ | 14,025 | |||
Add: Stock-based compensation expense recognized during the period, net of related tax effects | — | 69 | |||||
Less: Stock-based compensation expense determined under the fair value-based method, net of related tax effects | (577 | ) | (69 | ) | |||
Pro forma net income | $ | 11,958 | $ | 14,025 | |||
Pro forma basic earnings per share | $ | 0.62 | $ | 0.72 | |||
Pro forma diluted earnings per share | $ | 0.59 | $ | 0.69 | |||
16 |
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES (9) COMMON STOCK DIVIDEND On December 15, 2004 and October 26, 2005, the Company declared 10% stock dividends, aggregating approximately 1,594,000 and 1,770,000 shares, respectively. All share and per share data have been retroactively restated for the stock dividends. (10) GUARANTEES Standby letters of credit obligate the Company to meet certain financial obligations of its customers, if, under the contractual terms of the agreement, the customers are unable to do so. Payment is only guaranteed under these letters of credit upon the borrower’s failure to perform its obligations to the beneficiary. The Company can seek recovery of the amounts paid from the borrower. These standby letters of credit are generally collateralized. Commitments under standby letters of credit are usually one year or less. At June 30, 2006, the Company has recorded no liability for the current carrying amount of the obligation to perform as a guarantor. The maximum potential amount of undiscounted future payments related to standby letters of credit at September 30, 2005 and June 30, 2006 was $5.8 million and $6.2 million, respectively. (11) DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES The Bank originates certain fixed rate residential loans with the intention of selling these loans in the secondary market. Between the time that the Bank enters into an interest rate lock or a commitment to originate a fixed rate residential loan with a potential borrower and the time the closed loan is sold, the Company is subject to variability in the market prices related to these commitments due to potential changes in interest rates. The Company believes that it is prudent to limit the variability of expected proceeds from the sales through forward sales of “to be issued” mortgage-backed securities and loans (“forward sales commitments”). The commitment to originate fixed rate residential loans and forward sales commitments are freestanding derivative instruments. Since such instruments do not qualify for hedge accounting treatment, their fair value adjustments are recorded through the income statement in net gains on sales of loans held for sale. The commitments to originate fixed rate conforming loans totaled $5.0 million at June 30, 2006. The fair value of the loan commitments was an asset of approximately $14,000 at June 30, 2006. As of June 30, 2006, the Company had sold $5.0 million in forward commitments to deliver fixed rate mortgage-backed securities, which were recorded as a derivative asset of $17,000. |
17 |
18 |
Checking account balances at June 30, 2006 grew approximately 12.3% when compared to the same period a year ago. This rate of growth necessitated the hiring of additional Associates to open and service these accounts. The Associates hired for these two initiatives are expected to have total compensation averaging between $28,000 and $35,000 per Associate. In the latter part of fiscal 2005, the Company began preparations to increase lending production in mortgage originations. The Company has hired leadership and support staff as well as additional mortgage lending officers. The nine month average of the number of support staff increased by eight and residential lending officers by nine when comparing June 30, 2005 and 2006. Increased lending volumes from these lending personnel have been slow to materialize, and are not expected to increase until the fourth quarter of fiscal 2006 and the first quarter of fiscal 2007. Further, the amount of increased revenues in relation to the increased expense cannot be accurately predicted at this time. During the first quarter of fiscal 2006, the Bank opened two branches; in Oak Island, North Carolina and at Stephens Crossroads in Longs, South Carolina. In April 2006, a new branch was opened in North Conway, South Carolina, and in July 2006 a new branch was opened in Conway, South Carolina. The Bank anticipates that it will open one additional branch during the remainder of fiscal 2006. The opening of these branches will increase compensation, occupancy and other expenses as well as related marketing expenditures. Generally, the Bank will hire personnel three to nine months in advance of a branch opening to ensure that they are properly trained. The Bank expects its total investment in the branch opened in July 2006 and the branch to be opened by the end of fiscal 2006 to be approximately $3.5 million in land, buildings and equipment costs as well as increased lease expenses of approximately $85,000. CRITICAL ACCOUNTING POLICIES The Company’s accounting policies are in accordance with accounting principles generally accepted in the United States of America and with general practice within the banking industry. In order to understand the Company’s financial condition and results of operations, it is important to understand the more critical accounting policies and the extent to which judgment and estimates are used in applying those policies. The Company considers its policies regarding the allowance for loan losses and income taxes to be its most critical accounting policies due to the significant degree of the levels of subjectivity and management judgment necessary to account for these matters. Different assumptions in the application of these policies could result in material changes in the Company’s consolidated financial statements. The Company’s accounting policies are set forth in Note 1 of the Notes to Consolidated Financial Statements in the Company’s 2005 Annual Report to Stockholders. For additional discussion concerning the Company’s allowance for loan losses and related matters, see “Allowance for Loan Losses.” See “Income Taxes” for additional discussion concerning income taxes in the Company’s 2005 Annual Report to Stockholders. OFF-BALANCE SHEET ARRANGEMENTS In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with generally accepted accounting principles, are recorded in amounts that differ from the notional amounts. These transactions involve, to varying degrees, elements of credit risk, interest rate, and liquidity risk. Such transactions are used by the Company for general corporate purposes or to satisfy customer needs. Corporate purpose transactions are used to help manage customers’ requests for funding. The Bank’s off-balance sheet arrangements, which principally include lending commitments and derivatives, are described below. Lending Commitments: Lending Commitments include loan commitments, standby letters of credit, and unused business and personal lines of credit. These instruments are not recorded in the consolidated balance sheet until funds are advanced under the commitments. The Bank provides these lending commitments to customers in the normal course of business. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company applies essentially the same credit policies and standards as it does in the lending process when making these loan commitments. For business customers, commercial loan commitments generally consist of financing real estate and construction and land development or take the form of revolving credit arrangements to finance customers’ working capital requirements. For personal customers, loan commitments are generally lines of credit that are unsecured or are secured by residential property. Standby letters of credit obligate the Company to meet certain financial obligations of its customers, if, under the contractual terms of the agreement, the customers are unable to do so. Payment is only guaranteed under these letters of credit upon the borrower’s failure to perform its obligations to the beneficiary. The Company can seek recovery of the amounts paid from the borrower. Standby letters of credit are generally collateralized and are usually one year or less. Effective May 31, 2006, the Bank sold its entire credit card portfolio. Accordingly, there are no unused business or consumer credit card commitments outstanding at June 30, 2006. See additional disclosures regarding the sale of the credit card portfolio hereafter. At June 30, 2006, the Company recorded no liability for the current carrying amount of the obligation to perform as a guarantor, as such amounts are not considered material. The maximum potential amount of undiscounted future payments related to standby letters of credit at September 30, 2005 and June 30, 2006 was $5.8 million and $6.2 million, respectively. |
19 |
A summary of loans receivable with undisbursed commitments to extend credit at September 30, 2005 and June 30, 2006 follows: |
September 30, 2005 | June 30, 2006 | ||||||
---|---|---|---|---|---|---|---|
(Unaudited) ( In thousands) | |||||||
Residential mortgage loans in process | $ | 28,345 | $ | 32,576 | |||
Business and consumer credit card lines | 14,065 | — | |||||
Consumer home equity lines | 41,117 | 46,411 | |||||
Other consumer lines of credit | 6,818 | 6,937 | |||||
Standby letters of credit | 5,777 | 6,245 | |||||
Commercial real estate and construction and land development | 107,731 | 123,465 | |||||
Other commercial lines of credit | 10,527 | 9,052 | |||||
Total loans receivable with undisbursed commitments | $ | 214,380 | $ | 224,686 | |||
Derivatives and Hedging Activities: See Note 11 “Derivative Instruments and Hedging Activities” in the accompanying Coastal Financial Corporation and Subsidiaries Consolidated Financial Statements as of, and for the period ended June 30, 2006, for disclosure. DISCUSSION OF FINANCIAL CONDITION CHANGES FROM SEPTEMBER 30, 2005 TO JUNE 30, 2006 LIQUIDITY AND CAPITAL RESOURCES Historically, the Company has maintained its liquidity at levels believed by management to be adequate to meet the requirements of normal operations, potential deposit out-flows and strong loan demand and still allow for optimal investment of funds and return on assets. The principal sources of funds for the Company are cash flows from operations, consisting mainly of loan payments, Customer deposits, advances from the FHLB, securitization of loans and subsequent sales, and loan sales. The principal use of cash flows is the origination of loans receivable and purchase of investment securities. The Company originated loans receivable of $634.0 million for the nine months ended June 30, 2005, compared to $590.9 million for the nine months ended June 30, 2006. Loan principal repayments amounted to $453.4 million in the first nine months of 2005 compared to $446.4 million for the nine months ended June 30, 2006. In addition, the Company sells certain loans in the secondary market to finance future loan originations. In the first nine months of fiscal 2005, the Company sold mortgage loans or securitized and sold mortgage loans totaling $46.0 million that compares to $33.7 million for the nine months ended June 30, 2006. The Bank also sold $19.5 million of commercial loan participations in the nine months ended June 30, 2005 compared to $3.1 million for the same period in 2006. During the nine month period ended June 30, 2006, the Company securitized $18.7 million of mortgage loans and concurrently sold these mortgage-backed securities to outside third parties and recognized a net gain on sale of $238,000. The related mortgage servicing rights associated with the loans are $277,000. The gain is included in gains on sales of loans and loans receivable held for sale in the consolidated statement of operations. The Company has no retained interest in the securities that were sold other than servicing rights. Effective May 31, 2006, the Company sold its entire credit card portfolio to an unrelated third party for approximately $3.6 million, realizing a gain of approximately $507,000 that is included in gains on sales of loans and loans receivable held for sale in the consolidated statement of operations. The Company has retained no interest in the credit card portfolio other than short-term servicing until the purchaser converts the portfolio to its system. The Company will continue to issue branded credit cards through a third party bank. In connection with the sale, the Company also recorded approximately $100,000 of other expense to reflect de-conversion costs and the termination of the credit card awards program that is reflected in other expense in the consolidated statement of operations. For the nine months ended June 30, 2006, the Company purchased $135.0 million in investment and mortgage-backed securities. For the nine months ended June 2005, the Company purchased $256.9 million in investment and mortgage-backed securities. These purchases during the nine months ended June 30, 2006 were primarily funded by borrowings, repayments of $59.4 million within the securities portfolio and proceeds from sales of investments and mortgage-backed securities of $58.3 million. Total Customer Deposits, defined as total deposits excluding certificates of deposits (“CD’s”) obtained through brokers, increased $26.0 million between September 30, 2005 and June 30, 2006. Money market and checking accounts increased from approximately $572.0 million at September 30, 2005 to $589.5 million at June 30, 2006, an increase of $17.5 million or 3.1%. Core Deposits (defined as money market accounts, checking accounts and statement savings accounts) increased from $643.8 million at September 30, 2005 to $664.3 million at June 30, 2006, an increase of 3.2%. Customer Deposits at June 30, 2006 and June 30, 2005, are $927.1 million and $876.6 million, respectively, an increase of 5.8%. In addition, Core Deposits at June 30, 2006 and June 30, 2005 are $664.3 million and $633.7 million, respectively, a 4.8% increase. |
20 |
At June 30, 2006, the Company had $366.0 million of CD’s that were due to mature within one year. Included in these CDs were brokered CDs totaling $135.2 million. Based on past experience, the Company believes that the majority of the non-brokered certificates of deposits will renew with the Company. At June 30, 2006, the Company had commitments to originate $26.3 million in residential mortgage loans, $62.4 million in undisbursed business and retail lines of credit, and $123.5 million in commercial real estate and construction and land development which the Company expects to fund from normal operations. At June 30, 2006, the Company had approximately $88.1 million available in FHLB advances. In addition, the Company had unpledged collateral that would support approximately $91.2 million in additional borrowings. At June 30, 2006, the Company also had an outstanding available line for federal funds of $20.0 million. As a result of $14.0 million in net income, less the cash dividends paid to stockholders of approximately $2.9 million, proceeds of approximately $1.1 million from the exercise of stock options, and the net increase in unrealized loss on securities available for sale, net of income tax of $6.9 million, stockholders’ equity increased from $97.2 million at September 30, 2005 to $102.6 million at June 30, 2006. OTS regulations require that the Bank calculate and maintain a minimum regulatory capital requirement on a quarterly basis and satisfy such requirement as of the calculation date and throughout the quarter. The Bank’s capital, as calculated under OTS regulations, is approximately $124.4 million at June 30, 2006, exceeding the core capital requirement by $59.0 million. At June 30, 2006, the Bank’s risk-based capital of approximately $135.1 million exceeded its current risk-based capital requirement by $59.6 million. (For further information see Regulatory Capital Matters.) The table below summarizes future contractual obligations as of June 30, 2006 (In thousands)(unaudited): |
Payments Due by Period | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Total | 1 Year and Less | 2-3 Years | 4-5 Years | After 5 Years | |||||||||||
Time deposits | $ | 397,947 | $ | 365,969 | $ | 27,866 | $ | 3,517 | $ | 595 | |||||
Short-term borrowings | 75,157 | 75,157 | — | — | — | ||||||||||
Long-term debt | 370,293 | — | 7,537 | 80,453 | 282,303 | ||||||||||
Construction contracts | 645 | 645 | — | — | — | ||||||||||
Operating leases | 4,757 | 498 | 663 | 448 | 3,148 | ||||||||||
Total contractual cash obligations | $ | 848,799 | $ | 442,269 | $ | 36,066 | $ | 84,418 | $ | 286,046 | |||||
Purchase commitments.The Company has signed contracts to purchase four parcels of land for branches in Brunswick and New Hanover Counties in North Carolina. The purchase commitments total approximately $4.1 million. After due diligence, the Company expects these four sales to close around the end of the fiscal year. Because these contracts are subject to due diligence, they are not included in the table of future contractual obligations above. Lease commitments.The Bank executed a lease in the first quarter of fiscal 2006 for 5.48 acres of land and a building, which includes an option to purchase after one year of the lease for approximately $2.8 million. Rent during the year prior to the purchase option is approximately $200,000 and is included in the operating leases line of the above schedule of future contractual obligations. |
21 |
EARNINGS SUMMARY Net income increased from $12.5 million, or $.61 per diluted share, for the nine months ended June 30, 2005 to $14.0 million, or $.69 per diluted share for the nine months ended June 30, 2006. This 11.9% increase in net income resulted from increased net interest income of $4.4 million, or 12.4%, an increase in other income of $3.3 million, and a decrease in the provision for loan losses of $365,000, which were offset by increased general and administrative expenses of $5.6 million, and increased income taxes of $928,000. Net interest income increased 12.4% as a result of growth in loans receivable and investments despite a slight decrease in net interest margin from 3.69% for the nine months ended June 30, 2005 to 3.65% for the nine months ended June 30, 2006. The increase in net interest income is primarily attributable to an increase in average earning assets of $177.1 million, or 13.6%. Average loans receivable increased $143.2 million for the nine months ended June 30, 2006 compared to June 30, 2005. The average balance of Customer Deposits increased from $790.1 million for the nine months ended June 30, 2005 to $889.8 million for the nine months ended June 30, 2006, which exclude brokered CD average balances of $182.4 million and $51.5 million for the nine months ended June 30, 2006 and 2005, respectively. The provision for loan losses decreased $365,000 for the nine months ended June 30, 2006 when compared to the prior year primarily due to a reduction in individually significant special mention, substandard and impaired loans which carry higher risk allocations when computing the allowance for loan losses and the sale of the credit card portfolio which consisted of higher risk loans. Several of the special mention, substandard and impaired loans were either paid off or there was a significant improvement in the Company’s collateral position. The allowance for loan losses as a percentage of loans was 1.19% at June 30, 2006 as compared to 1.30% at June 30, 2005. Other income increased from $9.2 million for the nine months ended June 30, 2005 to $12.5 million for the nine months ended June 30, 2006. This was a result of an increase in fees and service charges on loan and deposit accounts of $2.7 million primarily as a result of the Company’s “FANtastic! Customer Service” and “Totally Free Checking with a Gift” initiatives. ATM and debit card income increased $610,000, and gains on sales of loans and loans receivable held for sale increased $199,000, which includes a $507,000 gain from the sale of the credit card portfolio. The Company had a net loss on sales of mortgage-backed securities available for sale of $511,000 for the nine months ended June 30, 2006, compared to net gains of $87,000 for the nine months ended June 30, 2005. General and administrative expenses increased from $24.5 million for the nine months ended June 30, 2005 to $30.2 million for the nine months ended June 30, 2006. Compensation and benefits increased from $13.5 million for the first nine months of fiscal 2005 to $16.6 million in the first nine months of fiscal 2006, primarily due to an increase in the number of banking Associates in business and residential banking, Associates in the Company’s expanded hours call center, Associates in new branches and normal salary increases. Marketing expenses were $1.5 million for the nine months ended June 30, 2006 and 2005. Expenses for ATM and debit card transactions increased $330,000 when comparing the two periods. In addition, other expense was $3.1 million for the nine months ended June 30, 2005, compared to $3.6 million for the nine months ended June 30, 2006. MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2005 AND 2006 INTEREST INCOME Interest income for the three months ended June 30, 2006, increased to $25.6 million as compared to $20.3 million for the three months ended June 30, 2005. The earning asset yield for the three months ended June 30, 2006, was 6.75% compared to 6.00% for the three months ended June 30, 2005. The average yield on loans receivable for the three months ended June 30, 2006, was 7.57% compared to 6.64% for three months ended June 30, 2005. The increased yield on loans is primarily due to the increased yield on commercial loans with interest rates tied to the prime lending rate. The prime rate was 8.25% at June 30, 2006, compared to 6.25% at June 30, 2005. The yield on investments increased to 5.00% for the three months ended June 30, 2006, from 4.77% for the three months ended June 30, 2005. Long-term interest rates have remained relatively constant during the last year despite rising short-term rates, resulting in a flat yield curve. Consequently, most of the cash flows received from the investment portfolio have been reinvested at approximately the same interest rate. Should short-term rates continue to rise more quickly than long-term rates, it is possible that the yield curve would become inverted. A flat yield curve or inverted yield curve would likely cause the Bank’s net interest margin to decline and reduce opportunities for using securities to leverage capital. Total average interest-earning assets were $1.5 billion for the quarter ended June 30, 2006 as compared to $1.4 billion for the quarter ended June 30, 2005, an increase of 11.8%. The increase in average interest-earning assets is primarily due to an increase in average loans receivable of approximately $140.8 million, an increase of 15.8%, resulting primarily from growth in the commercial loan portfolio. |
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INTEREST EXPENSE Interest expense on interest-bearing liabilities was $11.7 million for the three months ended June 30, 2006, as compared to $7.8 million for the three months ended June 30, 2005. The average cost of Customer Deposits for the three months ended June 30, 2006, was 2.21% compared to 1.47% for the three months ended June 30, 2005. The cost of interest-bearing liabilities was 3.07% for the three months ended June 30, 2006 compared to 2.29% for the three months ended June 30, 2005. The increased cost of funds is due to the increased short-term interest rates. At June 30, 2006, the federal funds rate was 5.05% compared to 3.35% at June 30, 2005. Total average interest-bearing liabilities increased from $1.4 billion at June 30, 2005 to $1.5 billion at June 30, 2006. The increase in average interest-bearing liabilities is due to an increase in average Customer Deposits of approximately $84.7 million, increased average FHLB advances of $48.6 million and increased average customer repurchase agreements of $19.0 million. This was partially offset by a decrease in average broker reverse repurchase agreements of $63.5 million. Brokered CD’s increased by $62.9 million in average balances when comparing the two periods and were used to fund loan and investment securities growth. NET INTEREST INCOME Net interest income was $13.9 million for the three months ended June 30, 2006, as compared to $12.5 million for the three months ended June 30, 2005. The net interest margin was 3.68% for the three months ended June 30, 2006, compared to 3.71% for the three months ended June 30, 2005. The following table summarizes the average balance sheet and the related yields on interest-earning assets and deposits and borrowings for the three months ended June 30, 2005 and 2006: |
Three Months Ended June 30, | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
2005 | 2006 | |||||||||||||||||
Average Balance (1) | Income/ Expense | Yield/ Rate | Average Balance (1) | Income/ Expense | Yield/ Rate | |||||||||||||
(Unaudited) (Dollars in thousands) | ||||||||||||||||||
Assets | ||||||||||||||||||
Earning assets Loans (2) | $ | 892,027 | $ | 14,807 | 6.64 | % | $ | 1,032,872 | $ | 19,546 | 7.57 | % | ||||||
Investment Securities, MBS Securities and Other (3) | 463,320 | 5,530 | 4.77 | % | 481,876 | 6,026 | 5.00 | % | ||||||||||
Total earning assets | $ | 1,355,347 | 20,337 | 6.00 | % | $ | 1,514,748 | 25,572 | 6.75 | % | ||||||||
Liabilities | ||||||||||||||||||
Customer Deposits | $ | 832,420 | 3,053 | 1.47 | % | $ | 917,144 | 5,062 | 2.21 | % | ||||||||
Brokered CD’s | 107,214 | 803 | 3.00 | % | 170,152 | 1,944 | 4.57 | % | ||||||||||
FHLB Advances | 301,406 | 2,981 | 3.96 | % | 350,036 | 3,733 | 4.27 | % | ||||||||||
Customer Repurchase Agreements | 26,574 | 175 | 2.63 | % | 45,590 | 438 | 3.84 | % | ||||||||||
Junior Subordinated Debt | 15,000 | 234 | 6.24 | % | 15,000 | 305 | 8.13 | % | ||||||||||
Reverse Repurchase Agreements | 83,457 | 585 | 2.80 | % | 20,000 | 179 | 3.58 | % | ||||||||||
Total interest-bearing Liabilities | $ | 1,366,071 | 7,831 | 2.29 | % | $ | 1,517,922 | 11,661 | 3.07 | % | ||||||||
Net interest income (4) | $ | 12,506 | $ | 13,911 | ||||||||||||||
Net interest margin | 3.71 | % | 3.68 | % | ||||||||||||||
Net yield on earning assets | 3.69 | % | 3.67 | % | ||||||||||||||
(1) | The average balances are derived from monthly balances. | |
(2) | Nonaccrual loans are included in average balances for yield computations. | |
(3) | Investment securities include taxable and tax-exempt securities. | |
(4) | Net interest income has not been adjusted to produce a tax-equivalent yield. |
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PROVISION FOR LOAN LOSSES The provision for loan losses decreased from $550,000 for the three months ended June 30, 2005, to $430,000 for the three months ended June 30, 2006 primarily due to a reduction in individually significant special mention, substandard and impaired loans that carry increased risk allocations and the sale of the credit card portfolio, when computing the allowance for loan loss. Several of the special mention, substandard and impaired loans were either paid off or there was a significant improvement in the Company’s collateral position at June 30, 2006. The allowance for loan losses as a percentage of loans was 1.19% at June 30, 2006 as compared to 1.30% at June 30, 2005. Loans delinquent 90 days or more were $1.3 million or .12% of total loans at June 30, 2006, compared to $3.8 million or .41% of total loans at June 30, 2005 and $2.6 million or .28% of total loans at September 30, 2005. The allowance for loan losses was 973% of loans delinquent more than 90 days at June 30, 2006, compared to 314% at June 30, 2005 and 445% at September 30, 2005. Net charge-offs for the three months ended June 30, 2006 were $88,000 compared to $464,000 for the three months ended June 30, 2005. Management believes the level of the allowance for loan losses at June 30, 2006 is adequate considering the composition of the loan portfolio, the portfolio’s loss experience, delinquency trends, current regional and local economic conditions and other factors at that date. OTHER INCOME For the three months ended June 30, 2006, other income was $4.7 million compared to $3.1 million for the three months ended June 30, 2005. Fees and service charges from deposit accounts increased $834,000 or 51.8% to $2.4 million for the three months ended June 30, 2006, compared to $1.6 million for the three months ended June 30, 2005. The majority of this increase is due to fee income from increased number of personal and business checking accounts. The number of checking accounts increased 24% from June 30, 2005 to June 30, 2006. During the quarter ended June 30, 2006, the Company securitized mortgage loans into mortgaged backed securities (“MBS”), and then sold MBS and sold loans aggregating $16.4 million, compared to $17.5 million for the quarter ended June 30, 2005. Included in the $16.4 million of MBS and loans sold were proceeds of $3.6 million related to the sale of the credit card portfolio. Gain on sale of loans and loans receivable held for sale was $674,000 for the quarter ended June 30, 2006, compared to $215,000 for the quarter ended June 30, 2005. The gain on sale of loans and loans receivable held for sale for the quarter ended June 30, 2006 included a gain on the sale of the Company’s credit card portfolio totaling $507,000. Margins on sales of conforming mortgage loans declined in fiscal 2006 due to rising interest rates. Losses on sales of securities available for sale, net of gains, were $444,000 for the quarter ended June 30, 2006, compared to $127,000 for the quarter ended June 30, 2005. Income from Federal Home Loan Bank Stock dividends increased from $183,000 to $264,000 due to increased dividends resulting from higher interest rates. In addition, income from ATM and debit card transactions increased 45.5% to $608,000 during the third quarter of fiscal 2006, primarily due to increased personal checking accounts. In addition, other income increased approximately $206,000 to $359,000 for the quarter ended June 30, 2006 over the quarter ended June 30, 2005, primarily due to the recovery of certain litigation costs from the Company’s insurance carrier of $143,000. GENERAL AND ADMINISTRATIVE EXPENSES General and administrative expenses were $8.4 million for the quarter ended June 30, 2005 compared to $10.6 million for the quarter ended June 30, 2006. Salaries and employee benefits were $4.6 million for the three months ended June 30, 2005, as compared to $5.7 million for the three months ended June 30, 2006, an increase of 23.6%. Increased compensation is due to the increased number of Associates in (i) the Company’s expanded hours call center, (ii) four new branches opened since September 30, 2005 and, (iii) residential and business banking. In the latter part of fiscal 2005, the Company began preparations to increase lending production in mortgage originations. The Company has hired leadership and support staff as well as additional mortgage lending officers. As a result of these plans, the Company has increased the average number of support staff by approximately eight and residential lending officers by approximately nine for the nine month period ended June 30, 2006 as compared to the comparable prior year period. Increased lending volumes from these lending personnel have been slow to materialize and are not expected to increase until the fourth quarter of fiscal 2006 and the first quarter of fiscal 2007. Over the past year, the Company also added several Associates in a Banking Group that is focused on growing small to medium sized business banking relationships. As a result of new branches, equipment purchased to improve Customer convenience and increased checking activity, net occupancy, furniture and fixtures and data processing expenses increased by $528,000, and depreciation increased $189,000, when comparing the two periods. Marketing expenses were $463,000 for the three months ended June 30, 2005, compared to $545,000 for the three months ended June 30, 2006. Other expenses were $1.1 million for the quarter ended June 30, 2005 compared to $1.2 million for the quarter ended June 30, 2006. INCOME TAXES Income taxes were $2.7 million for the three months ended June 30, 2006 compared to $2.3 million for the three months ended June 30, 2005. The effective income tax rate as a percentage of pretax income was 35.0% and 34.4% for the quarters ended June 30, 2006 and 2005, respectively. The effective income tax rate differs from the statutory rate primarily due to income generated by bank-owned life insurance, municipal securities that are exempt from federal and certain state taxes. The Company’s effective income tax rates take into consideration certain assumptions and estimates made by management. No assurance can be given that either the tax returns submitted by management or the income tax reported on the consolidated financial statements will not be adjusted by either adverse rulings by the U.S. Tax court, changes in the tax code, or assessments made by the Internal Revenue Service. |
24 |
The Company is subject to potential adverse adjustments, including but not limited to: an increase in the statutory federal or state income tax rates, the permanent non-deductibility of amounts currently considered deductible either now or in future periods, and the dependency on the generation of the future taxable income, in order to ultimately realize deferred income tax assets. MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE NINE MONTHS ENDED JUNE 30, 2005 AND 2006 INTEREST INCOME Interest income for the nine months ended June 30, 2006, increased to $72.7 million as compared to $57.2 million for the nine months ended June 30, 2005. The earning asset yield for the nine months ended June 30, 2006, was 6.56% compared to a yield of 5.86% for the nine months ended June 30, 2005. The average yield on loans receivable for the nine months ended June 30, 2006, was 7.33% compared to 6.38% for the nine months ended June 30, 2005. The increased yield on loans is primarily due to the increased yield on commercial loans with interest rates tied to the prime lending rate. The prime rate was 8.25% at June 30, 2006, compared to 6.25% at June 30, 2005. The yield on investments increased to 4.95% for the nine months ended June 30, 2006, from 4.85% for the nine months ended June 30, 2005. Total average interest-earning assets were $1.5 billion for the nine months ended June 30, 2006 as compared to $1.3 billion for the nine months ended June 30, 2005. The increase in average interest-earning assets is primarily due to an increase in average loans receivable of approximately $143.1 million resulting primarily from growth in the commercial loan portfolio and an increase in investment securities of approximately $33.9 million, primarily funded by brokered CD’s. INTEREST EXPENSE Interest expense on interest-bearing liabilities was $32.4 million for the nine months ended June 30, 2006, as compared to $21.3 million for the nine months ended June 30, 2005. The average cost of Customer Deposits for the nine months ended June 30, 2006, was 2.05% compared to 1.38% for the nine months ended June 30, 2005. The cost of interest-bearing liabilities was 2.91% for the nine months ended June 30, 2006 compared to 2.17% for the nine months ended June 30, 2005. The increased cost of funds on other borrowings is due to increased short-term interest rates. At June 30, 2006, the federal funds rate was 5.05% compared to 3.35% at June 30, 2005. Total average interest-bearing liabilities increased from $1.3 billion at June 30, 2005 to $1.5 billion at June 30, 2006. The increase in average interest-bearing liabilities is due to an increase in average Customer Deposits of approximately $99.7 million as a result of the Company’s focus on checking growth, increased average brokered CD’s of $130.9 million and increased average customer repurchase agreements of $13.1 million. This increase was partially offset by a decrease in average reverse broker repurchase agreements of $76.0 million. NET INTEREST INCOME Net interest income was $40.4 million for the nine months ended June 30, 2006, as compared to $35.9 million for the nine months ended June 30, 2005. The net interest margin was 3.65% for the nine months ended June 30, 2006, compared to 3.69% for the nine months ended June 30, 2005. |
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The following table summarizes the average balance sheet and the related yields on interest-earning assets and deposits and borrowings for the nine months ended June 30, 2006 and 2005: |
Nine months Ended June 30, | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
2005 | 2006 | |||||||||||||||||
Average Balance (1) | Income/ Expense | Yield/ Rate | Average Balance (1) | Income/ Expense | Yield/ Rate | |||||||||||||
(Unaudited) (Dollars in thousands) | ||||||||||||||||||
Assets | ||||||||||||||||||
Earning assets Loans (2) | $ | 854,556 | $ | 40,911 | 6.38 | % | $ | 997,702 | $ | 54,875 | 7.33 | % | ||||||
Investment Securities, MBS Securities and Other (3) | 447,630 | 16,284 | 4.85 | % | 481,570 | 17,873 | 4.95 | % | ||||||||||
Total earning assets | $ | 1,302,186 | 57,195 | 5.86 | % | $ | 1,479,272 | 72,748 | 6.56 | % | ||||||||
Liabilities | ||||||||||||||||||
Customer Deposits | $ | 790,148 | 8,174 | 1.38 | % | $ | 889,830 | 13,649 | 2.05 | % | ||||||||
Brokered CD’s | 51,487 | 1,116 | 2.89 | % | 182,400 | 5,746 | 4.20 | % | ||||||||||
FHLB Advances | 328,634 | 9,277 | 3.76 | % | 342,765 | 10,601 | 4.12 | % | ||||||||||
Customer Repurchase Agreements | 25,313 | 421 | 2.22 | % | 38,398 | 1,057 | 3.67 | % | ||||||||||
Junior Subordinated Debt | 15,000 | 637 | 5.66 | % | 15,000 | 863 | 7.67 | % | ||||||||||
Reverse Repurchase Agreements | 94,109 | 1,653 | 2.34 | % | 18,111 | 477 | 3.51 | % | ||||||||||
Total interest-bearing Liabilities | $ | 1,304,691 | 21,278 | 2.17 | % | $ | 1,486,504 | 32,393 | 2.91 | % | ||||||||
Net interest income | $ | 35,917 | $ | 40,355 | ||||||||||||||
Net interest margin | 3.69 | % | 3.65 | % | ||||||||||||||
Net yield on earning assets | 3.68 | % | 3.64 | % | ||||||||||||||
(1) | The average balances are derived from monthly balances. | |
(2) | Nonaccrual loans are included in average balances for yield computations. | |
(3) | Investment securities include taxable and tax-exempt securities. | |
(4) | Net interest income has not been adjusted to produce a tax-equivalent yield. |
PROVISION FOR LOAN LOSSES The provision for loan losses decreased $365,000 from $1.5 million for the nine months ended June 30, 2005, to $1.2 million for the nine months ended June 30, 2006 primarily due to a reduction in individually significant special mention, substandard and impaired loans that carry increased risk allocations and the sale of the credit card portfolio, when computing the allowance for loan loss. Several of the special mention, substandard and impaired loans were either paid off or there was a significant improvement in the Company’s collateral position. The allowance for loan losses as a percentage of loans was 1.19% at June 30, 2006 as compared to 1.30% at June 30, 2005. Loans delinquent 90 days or more were $1.3 million or .12% of total loans at June 30, 2006 as compared to $3.8 million or ..41% of total loans at June 30, 2005 and $2.6 million or .28% at September 30, 2005. The allowance for loan losses was 973% of loans delinquent more than 90 days at June 30, 2006, compared to 314% at June 30, 2005 and 445% at September 30, 2005. Net charge-offs for the nine months ended June 30, 2006 were $358,000 compared to $748,000 for the nine months ended June 30, 2005. Management believes that the level of the allowance for loan losses at June 30, 2006 is adequate considering the composition of the loan portfolio, the portfolio’s loss experience, delinquency trends, current regional and local economic conditions and other factors at that date. OTHER INCOME For the nine months ended June 30, 2006, other income was $12.5 million compared to $9.2 million for the nine months ended June 30, 2005. Fees and service charges from deposit accounts increased $2.7 million or 64.4% to $6.8 million for the nine months ended June 30, 2006, compared to $4.1 million for the nine months ended June 30, 2005. The majority of this increase is due to fee income resulting from an increase in the number of personal and business checking accounts. The number of checking accounts increased 24% from June 30, 2005 to June 30, 2006. During the nine months ended June 30, 2006, the Company securitized mortgage loans into mortgage-backed securities (“MBS”) and then sold the MBS and sold loans aggregating $37.3 million of loans held for sale compared to $46.0 million for the nine months ended June 30, 2005. |
26 |
Included in the $37.3 million of MBS and sold loans were proceeds of $3.6 million related to the sale of the credit card portfolio. Gain on sale of loans and loans receivable held for sale was $968,000 for the nine months ended June 30, 2006, compared to $769,000 for the nine months ended June 30, 2005. Gain on sale of loans and loans receivable held for sale for the nine months ended June 30, 2006 included a gain on the sale of the Company’s credit card portfolio totaling $507,000. Loss on sales of securities, net of gains, was $459,000 for the nine months ended June 30, 2006, compared to net gains of $119,000 for the nine months ended June 30, 2005. In addition, the Company had gain on investment security held to maturity called by issuer of $160,000 for the nine months ended June 30, 2005 and none for the nine months ended June 30, 2006. Other income increased $295,000 to $744,000 for the nine months ended June 30, 2006, as compared to the nine months ended June 30, 2005 primarily due to the recovery of litigation costs from the Company’s insurance carrier of $143,000. ATM and debit card income increased $610,000 for the nine months ended June 30, 2006 to $1.7 million over the similar period in fiscal 2005 primarily due to the increased number of personal checking accounts. GENERAL AND ADMINISTRATIVE EXPENSES General and administrative expenses were $24.5 million for the nine months ended June 30, 2005 compared to $30.2 million for the nine months ended June 30, 2006. Salaries and employee benefits were $13.5 million for the nine months ended June 30, 2005, as compared to $16.6 million for the nine months ended June 30, 2006, an increase of 22.3%, primarily due to an increase in the number of Associates in (i) the Company’s expanded hours call center, (ii) the four new branches opened since September 30, 2005, and (iii) residential and business banking. In the latter part of fiscal 2005, the Company began preparations to increase production in mortgage originations. As a result of these plans, the Company has increased the average number of support staff by approximately eight and residential lending officers by approximately nine when comparing the nine month averages for the periods ended June 30, 2006 and June 30, 2005. Increased lending volumes have been slow to materialize from these lending personnel and are not expected to increase until the fourth quarter of fiscal 2006 and the first quarter of fiscal 2007. The Company also added several Associates in a Banking Group that is focused on growing small to medium sized business banking relationships. As a result of new branches, equipment purchased to improve Customer convenience and increased checking activity, net occupancy, furniture and fixtures and data processing expenses increased $1.2 million and depreciation increased by $564,000, when comparing the two periods. Marketing expenses were $1.5 million for the nine months ended June 30, 2005 and 2006. ATM and debit card expenses increased $330,000 from $744,000 for the nine months ended June 30, 2005 to $1.1 million for the nine months ended June 30, 2006 primarily as a result of an increased number of personal checking accounts. Other expenses were $3.1 million for the nine months ended June 30, 2005 compared to $3.6 million for the nine months ended June 30, 2006. INCOME TAXES Income taxes were $6.5 million for the nine months ended June 30, 2005 compared to $7.5 million for the nine months ended June 30, 2006. The effective income tax rate as a percentage of pretax income was 34.3% and 34.8% for the nine months ended June 30, 2005 and 2006, respectively. The effective income tax rate differs from the statutory rate primarily due to income generated by bank-owned life insurance, municipal securities that are exempt from federal and certain state taxes. The Company’s effective income tax rates take into consideration certain assumptions and estimates made by management. No assurance can be given that either the tax returns submitted by management or the income tax reported on the consolidated financial statements will not be adjusted by either adverse rulings by the U.S. Tax court, changes in the tax code, or assessments made by the Internal Revenue Service. The Company is subject to potential adverse adjustments, including but not limited to: an increase in the statutory federal or state income tax rates, the permanent non-deductibility of amounts currently considered deductible either now or in future periods, and the dependency on the generation of the future taxable income, in order to ultimately realize deferred income tax assets. |
27 |
REGULATORY CAPITAL MATTERS To be categorized as “Well Capitalized” under the prompt corrective action regulations adopted by the Federal Banking Agencies, the Bank must maintain a total risk-based capital ratio as set forth in the following table and not be subject to a capital directive order. |
Actual | For Capital Adequacy Purposes | Categorized as “Well Capitalized” under Prompt Corrective Action Provision | ||||||||||||||||
Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||
As of June 30, 2006 | ||||||||||||||||||
Total Capital: | $ | 135,120 | 14.32 | % | $ | 75,512 | 8.00 | % | $ | 94,389 | 10.00 | % | ||||||
(To Risk Weighted Assets) | ||||||||||||||||||
Tier 1 Capital: | $ | 124,361 | 13.18 | % | $ | N/A | N/A | $ | 56,634 | 6.00 | % | |||||||
(To Risk Weighted Assets) | ||||||||||||||||||
Tier 1 Capital: | $ | 124,361 | 7.61 | % | $ | 48,770 | 3.00 | % | $ | 81,283 | 5.00 | % | ||||||
(To Total Assets) | ||||||||||||||||||
Tangible Capital: | $ | 124,361 | 7.61 | % | $ | 24,385 | 1.50 | % | $ | N/A | N/A | |||||||
(To Total Assets) |
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In May 2005, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 154, “Accounting for Changes and Error Corrections – a replacement of Accounting Principles Board Opinion No. 20 and FASB Statement No. 3 (FAS 154),” which eliminates the requirement to reflect changes in accounting principles as cumulative adjustments to net income in the period of change and requires retrospective application to prior periods’ financial statements for voluntary changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. If it is impracticable to determine the cumulative effect of the change to all prior periods, FAS 154 requires the new accounting principle to be adopted prospectively. For new accounting pronouncements, the transition guidance in the pronouncement should be followed. Retrospective application refers to the application of a different accounting principle to previously issued financial statements as if that principle had always been used. FAS 154 did not change the guidance for reporting corrections of errors, changes in estimates or for justification of a change in accounting principle on the basis of preferability. FAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005 (October 1, 2006 for the Company). The Company does not expect the adoption of FAS 154 to have a material effect on the results of operations or statement of condition. In February 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (SFAS) No. 155, “Accounting for Certain Hybrid Financial Instruments” an amendment of FASB Statements No. 133 and 140 (FAS 155). FAS 155 permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest only-strips and principal-only strips are not subject to the requirements of Statement 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends Statement 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. FAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006 (October 1, 2006 for the Company). The Company does not expect the adoption of FAS 155 to have a material effect on the results of operations or statement of condition. In March 2006, FASB issued Statement of Financial Accounting Standards No. 156 “Accounting for Servicing of Financials Assets” an amendment of FASB Statement No. 140 (FAS 140 and FAS 156). FAS 140 establishes, among other things, the accounting for all separately recognized servicing assets and servicing liabilities. This Statement amends FAS 140 to require that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. This Statement permits, but does not require, the subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value. Under this Statement, an entity can elect subsequent fair value measurement to account for its separately recognized servicing assets and servicing liabilities. Adoption of this Statement is required as of the beginning of the first fiscal year that begins after September 15, 2006. Upon adoption, the Company will apply the requirements for recognition and initial measurement of servicing assets and servicing liabilities prospectively to all transactions. The Company will adopt FAS 156 for the fiscal year beginning October 1, 2006 and currently has not determined if it will adopt FAS 156 using the fair value election. |
28 |
Change in interest rates | Board Limit Minimum NPV Ratio | Board Limit Maximum Decline in NPV | Market Value Of Assets 6/30/06 | Market Value Portfolio Equity 6/30/06 | NPV Ratio | ||||||||||
300 basis point rise | 5.00 | % | 400 BPS | $ | 1,626,177 | $ | 163,307 | 10.04 | % | ||||||
200 basis point rise | 6.00 | % | 300 BPS | $ | 1,647,693 | $ | 175,849 | 10.67 | % | ||||||
100 basis point rise | 6.00 | % | 250 BPS | $ | 1,669,345 | $ | 188,152 | 11.27 | % | ||||||
No change | 6.00 | % | $ | 1,688,941 | $ | 197,978 | 11.72 | % | |||||||
100 basis point decline | 6.00 | % | 250 BPS | $ | 1,705,282 | $ | 203,981 | 11.96 | % | ||||||
200 basis point decline | 6.00 | % | 300 BPS | $ | 1,716,400 | $ | 203,938 | 11.88 | % | ||||||
300 basis point decline | 6.00 | % | 350 BPS | N/A | N/A | N/A |
29 |
• | We are geographically concentrated along the coastlines of South Carolina and North Carolina. Changes in local economic conditions and catastrophic weather could have a significantly adverse impact on our profitability. | |
We operate primarily along the coastlines of South Carolina and North Carolina and substantially all of our loan customers and most of our deposits and other customers live or have operations in these areas. Accordingly, our success significantly depends upon the growth in population, income levels, deposits and housing starts in the region, along with continued attraction of business ventures to the area. Our profitability is impacted by changes in economic conditions, particularly changes in the real estate and tourism industries. Exposure to changes in tourism or the real estate market, whether due to changing economic conditions or catastrophic weather, could reduce our growth rate, affect the ability of our customers to repay their loans to us, and generally affect our financial condition and results of operations. | |
• | If our loan customers do not pay us as they have contracted to, we may experience losses. | |
Our principal revenue producing business is making loans. If our customers do not repay the loans, we will suffer losses. Even though we maintain an allowance for loan losses, the amount of the allowance may not be adequate to cover the losses we experience. We attempt to mitigate this risk by a thorough review of creditworthiness of loan customers. Nevertheless, there is risk that our credit evaluation will prove to be inaccurate due to changed circumstances or otherwise. | |
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• | Fluctuations in interest rates could reduce our profitability. |
Changes in interest rates may affect our level of interest income, the primary component of our gross revenue, as well as the level of our interest expense. Interest rate fluctuations are caused by many factors which, for the most part, are not under our direct control. For example, national monetary policy plays a significant role in the determination of interest rates. Additionally, competitor pricing and the resulting negotiations that occur with customers also impact the rates we collect on loans and the rates we pay on deposits. | |
As interest rates change, we expect we will periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market rates should move contrary to our position, this “gap” may work against us, and our earnings may be negatively affected. | |
Changes in the level of interest rates also may negatively affect our ability to originate real estate loans, the value of our assets and our ability to realize gains from the sale of our assets, all ultimately affect our earnings. A decline in the market value of our assets may limit our ability to borrow additional funds. As a result, we could be required to sell some of our loans and investments under adverse market conditions, upon terms that are not favorable to us, in order to maintain our liquidity. If those sales are made at prices lower than the amortized cost of the investments, we will incur losses. | |
• | The banking industry is highly competitive. | |
The banking industry in our market area is highly competitive. We compete with many different financial and financial services institutions. A substantial number of the banks in our market area are branches or subsidiaries of much larger organizations affiliated with statewide, regional, or national banking companies, and as a result, may have greater resources and lower costs of funds. These competitors aggressively solicit customers within their market area by advertising through direct mail, electronic media and other means. These competitors may offer services, such as international banking services, that we can offer only through correspondents, if at all. Additionally, larger competitors have greater capital resources and, consequently, higher lending limits. | |
• | We are dependent on key personnel and the loss of one or more of those key personnel may materially and adversely affect our prospects. | |
Competition for qualified employees and personnel in the banking industry is intense and there are a limited number of qualified persons with knowledge and experience in the South Carolina banking industry. The process of recruiting personnel with a combination of skills and attributes required to carryout our strategies is often lengthy. Our success depends, to a significant degree, upon our ability to attract and retain qualified management, loan origination, finance, administrative, marketing and technical personnel. We are dependent upon a number of key executives who are integral to implementing our business plan. The loss of the services of any one of our senior executive management team or other key executives could have a material adverse effect on our business, financial condition, results of operations and cash flows. | |
• | Provisions in our articles of incorporation and Delaware law may discourage or prevent takeover attempts, and these provisions may have the effect of reducing the market price of our stock. | |
Our articles of incorporation include several provisions that may have the effect of discouraging or preventing hostile takeover attempts, and therefore, making the removal of incumbent management difficult. The provisions include staggered terms for our board of directors and requirements of supermajority votes to approve certain business transactions. In addition, Delaware law contains several provisions that may make it more difficult for a third party to acquire control of us without the approval of the board of directors, and may make it more difficult or expensive for a third party to acquire a majority of our outstanding stock. To the extent that these provisions are effective in discouraging or preventing takeover attempts, they may tend to reduce the market price for our stock. | |
• | We are subject to governmental regulations which could change and increase our cost of doing business or have an adverse effect on our business. | |
We operate in a highly regulated industry and are subject to examination, supervision and comprehensive regulation by various federal and state agencies. Our compliance with the requirements of these agencies is costly and may limit our growth and restrict certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged and location of offices. We are also subject to capitalization guidelines established by federal authorities and our failure to meet those guidelines could result, in an extreme case, in our bank being placed in receivership. Supervision, regulation and examination of banks and bank holding companies by financial institution regulatory agencies are intended for the protection of depositors and our other customers rather than the holders of our common stock. |
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• | Changes in accounting standards could impact reported earnings. | |
The accounting standard setters, including FASB, SEC and other regulatory bodies, periodically change financial accounting and reporting standards that govern the preparation of our consolidated statements. These changes can be hard to predict and can materially impact how the Company records and reports its financial condition and results of operations. In some cases, we could be required to apply a new or revised accounting standard retroactively, resulting in the restatement of prior period financial statements. | |
• | We are susceptible to changes in monetary policy and other economic factors which may adversely affect our ability to operate profitably. | |
Changes in governmental, economic and monetary policies may affect the ability of our bank to attract deposits and make loans. The rates of interest payable on deposits and chargeable on loans are affected by governmental regulation and fiscal policy as well as by national, state and local economic conditions. All of these matters are outside of our control and affect our ability to operate profitably. | |
• | The preparation of financial statements requires the use of estimates that may vary from actual results. | |
Preparation of consolidated financial statements in conformity with accounting principles accepted in the United States of America requires management to make significant estimates that affect the financial statements. One of our most critical estimates is the level of the allowance for loan losses. Due to the inherent nature of this estimate, we cannot provide absolute assurance that we will not significantly increase allowances for losses that are significantly higher than the provided allowance. | |
• | We rely on communications, information, operating and financial control systems, and technology from third-party service providers, and we may suffer an interruption in those systems that may result in lost business. Further, we may not be able to substitute providers on terms that are as favorable if our relationships with our existing service providers are interrupted. | |
We rely heavily on third-party service providers for much of our communications, information, operating and financial controls systems, and technology. Any failure or interruption or breach in security of these systems could result in failures or interruptions in our customer relationships management, general ledger, deposit, servicing and/or loan origination systems. We cannot assure you that such failures or interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third parties on which we rely. The occurrence of any failure or interruption could have a material adverse effect on our business, financial condition, results of operations and cash flows. If any of our third-party service providers experience financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to locate alternative sources of such services, and we cannot assure you that we could negotiate terms that are as favorable to us, or could obtain services with similar functionality as found in our existing systems, without the need to expend substantial resources, if at all. Any of these circumstances could have a material adverse effect on our business, financial condition, results of operations and cash flows. | |
• | If the business continuity and disaster recovery plans that we have in place are not adequate to continue our operations in the event of a disaster, the business disruption can adversely impact our operations. | |
External events, including terrorist or military actions, or an outbreak of disease, such as Asian Influenza, or “bird flu” and resulting political and social turmoil could cause unforeseen damage to our physical facilities or could cause delays or disruptions to operational functions, including information processing and financial market settlement functions. Additionally, our customers, vendors and counterparties could suffer from such events. Should these events affect us, or our customers, or vendors or counterparties with which we conduct business, our results of operations could be adversely affected. | |
• | From time to time, we are subject to claims and litigation from customers and other individuals. | |
Whether such claims and legal actions are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to us, they may result in significant financial liability and/or adversely affect the market perception of us and our products and services. Any financial liability or reputation damage could have a material adverse effect on our business and financial performance. | |
• | Even though our common stock is currently traded on the Nasdaq Stock Market, it has less liquidity than the average stock quoted on national stock exchanges. | |
The trading volume in our common stock on the Nasdaq Stock Market has been relatively low when compared with larger companies on the Nasdaq National Market or national stock exchanges. As a result, it may be more difficult for stockholders to sell a substantial number of shares for the same price at which stockholders could sell a small number of shares. We also |
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cannot predict the effect, if any, that future sales of our common stock in the market, or the availability of shares of common stock for sale in the market, will have on the market price of our common stock. We can give no assurance that sales of substantial amounts of common stock in the market, or the potential for large of amounts of sales in the market, would not cause the price of our common stock to decline or impair our future ability to raise capital through sales of common stock. The market price of our common stock may fluctuate in the future, and these fluctuations may be unrelated to our performance. General market price declines or overall stock market volatility in the future could adversely affect the price of our common stock. Further, the current market price of our stock may not be indicative of future market prices. | |
• | Decline in home values in the Company’s markets could adversely impact results from operations. | |
Like all banks, the Company is subject to the effects of any economic downturn, and in particular, a significant decline in home values in the Company’s markets could have a negative effect on the results of operations A significant decline in home values would likely lead to a decrease in new home equity loan originations and increased delinquencies and defaults in both the consumer home equity loan and the residential real estate loan portfolios and result in increased losses in these portfolios. | |
• | The Company is subject to federal and state income tax regulations. | |
Income tax regulations are often complex and require interpretation. Changes in income tax regulations could negatively impact the Company’s results of operations. If the Company’s REIT affiliate fails to qualify as a REIT, or should states enact legislation taxing these or related entities, the Company will be subject to a higher consolidated effective tax rate. The REIT and related companies must meet specific provisions of the Internal Revenue Code (“IRC”) and state tax laws. If these companies fail to meet any of the required provisions of the federal and state tax laws, tax expense could increase. Use of these companies is and has been subject of federal and state audits. See “Management’s Discussion and Analysis of Operations-Income Taxes” for additional information. | |
• | The Company is subject to the USA Patriot and Bank Secrecy Acts. | |
The USA Patriot and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury Department’s Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions. During the past year, several banking institutions have received large fines for non-compliance with these laws and regulations. The Company has developed policies and procedures designed to ensure compliance. | |
• | Our common stock is not insured, so you could lose your total investment. | |
Our common stock is not a deposit or savings account, and will not be insured by the Federal Deposit Insurance Corporation any other government agency. Should our business decline or fail, you could lose your total investment. |
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3 | (a) | Certificate of Incorporation of Coastal Financial Corporation (1) | |
(b) | Certificate of Amendment to Certification of Incorporation of Coastal Financial Corporation (4) | ||
(c) | Certificate of Amendment dated February 1, 2006 to the Certificate of Incorporation of Coastal Financial Corporation (7) | ||
(d) | Bylaws of Coastal Financial Corporation (1) | ||
10 | (a) | Employment Agreement with Michael C. Gerald (6) | |
(b) | Employment Agreement with Jerry L. Rexroad (6) | ||
(c) | Employment Agreement with Philip G. Stalvey (6) | ||
(d) | Employment Agreement with Jimmy R. Graham (6) | ||
(e) | Employment Agreement with Steven J. Sherry (6) | ||
(f) | 1990 Stock Option Plan (2) | ||
(g) | Directors Performance Plan (3) | ||
(h) | Coastal Financial Corporation 2000 Stock Option Plan (5) | ||
31 | (a) | Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer) | |
(b) | Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer) | ||
32 | (a) | Section 1350 Certification (Chief Executive Officer) | |
(b) | Section 1350 Certification (Chief Financial Officer) |
___________________________________________ |
(1) | Incorporated by reference to Registration Statement on Form S-4 filed with the Securities and Exchange Commission on November 26, 1990. | |
(2) | Incorporated by reference to 1995 Form 10-K filed with the Securities and Exchange Commission on December 29, 1995. |
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(3) | Incorporated by reference to the definitive proxy statement for the 1996 Annual Meeting of Stockholders. | |
(4) | Incorporated by reference to December 31, 1998 Form 10-Q filed with Securities and Exchange Commission on May 15, 1998. | |
(5) | Incorporated by reference to the definitive proxy statement for the 2000 Annual Meeting of Stockholders filed December 22, 1999. | |
(6) | Incorporated by reference to 2003 Form 10-K filed with Securities and Exchange Commission on December 22, 2003. | |
(7) | Incorporated by reference to March 31, 2006 Form 10-Q filed with the Securities and Exchange Commission on May 10, 2006. |
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Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. |
COASTAL FINANCIAL CORPORATION | ||||
August 9, 2006 | /s/ Michael C. Gerald | |||
Michael C. Gerald | ||||
President and Chief Executive Officer | ||||
August 9, 2006 | /s/ Jerry L. Rexroad | |||
Date | ||||
Jerry L. Rexroad | ||||
Executive Vice President and | ||||
Chief Financial Officer |
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