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ANNUAL REPORT
_________________
COOPERATIVE
BANCSHARES, INC.
_________________
BUILDING ON A TRADITION OF
CUSTOMER SATISFACTION AND TRUST CINE 1898
DECEMBER 31, 2002
PROFILE
Cooperative Bankshares, Inc. (the "Company") is a registered
bank holding company incorporated in North Carolina in 1994.
The Company was formed for the purpose of serving as the
holding company for Cooperative Bank (or the "Bank"); a
North Carolina chartered commercial bank. The Company's
primary activities consist of holding the stock of
Cooperative Bank and operating the business of the Bank and
its subsidiaries. Accordingly, the information set forth in
this report, including financial statements and related
data, relates primarily to Cooperative Bank.
Cooperative Bank was chartered in 1898. The Bank's
headquarters are located in Wilmington, North Carolina.
Cooperative Bank operates 17 financial centers throughout
the coastal and inland communities of eastern North
Carolina. These centers extend from Corolla, located on the
Outer Banks of North Carolina, to Tabor City, located on the
South Carolina border. In addition, the Bank operates a
subsidiary, Lumina Mortgage Company, Inc. ("Lumina") as a
mortgage banking firm. Lumina has offices in Wilmington,
North Carolina; North Myrtle Beach, South Carolina; and
Virginia Beach, Virginia. In October 2002, the Bank changed
the name of its subsidiary from CS&L Services, Inc. to
Lumina Mortgage Company, Inc. The Bank's other subsidiary;
CS&L Holdings, Inc. ("Holdings") is a holding company for
CS&L Real Estate Trust, Inc. (the "REIT"), which is a newly
formed Real Estate Investment Trust. The Federal Deposit
Insurance Corporation ("FDIC") insures the Bank's deposit
accounts up to applicable limits.
Through its financial centers, the Bank provides a wide
range of banking products, including interest bearing and
non-interest bearing checking accounts, certificates of
deposit and individual retirement accounts. It offers an
array of loan products: overdraft protection, commercial,
consumer, agricultural, real estate, residential mortgage
and home equity loans. Also offered are safe deposit boxes
and automated banking services through ATMs and Access24
Phone Banking. In addition, the Bank offers discount
brokerage services, annuity sales and mutual funds through a
third party arrangement with UVEST Investment Services.
The common stock of the Company is traded on the NASDAQ
National Market under the symbol "COOP".
MISSION
It is the mission of Cooperative to provide the maximum in
safety and security for our depositors, an equitable rate of
return for our stockholders, and excellent service for our
customers, and to do so while operating in a fiscally sound
and conservative manner, with fair pricing of our products
and services, good working conditions, outstanding training
and opportunities for our staff, along with a high level of
corporate citizenship.
TABLE OF CONTENTS
Selected Financial and Other Data . . . . . . . . . . . .2
President's Message. . . . . . . . . . . . . . . . . . . .3
Management's Discussion & Analysis . . . . . . . . . . . .4
Independent Auditors' Report . . . . . . . . . . . . . . 15
Consolidated Statements of Financial Condition. . . . . . 16
Consolidated Statements of Operations . . . . . . . . . 17
Consolidated Statements of Comprehensive Income . . . . . 18
Consolidated Statements of Stockholders' Equity . . . . . 19
Consolidated Statements of Cash Flows . . . . . . . . . 20
Notes to Consolidated Financial Statements. . . . . . . . 22
Corporate Information . . . . . . . . . . . . . . . . . 49
Directors, Officers, and Financial Center Locations . . . 50
SELECTED FINANCIAL AND OTHER DATA
AT DECEMBER 31, 2002 2001 2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------
Dollars in Thousands
Selected Financial Condition Data:
Assets $ 504,210 $ 458,114 $ 414,961 $ 410,146 $ 389,773
Loans, net 390,876 373,458 347,486 334,744 321,324
Securities 49,935 47,970 35,027 45,261 44,749
FHLB stock 4,055 4,155 3,755 3,755 2,825
Deposits 357,254 339,830 327,312 304,834 301,656
Borrowed funds 104,678 83,097 55,101 75,106 55,109
Stockholders' equity 38,448 33,618 30,812 29,343 31,613
YEAR ENDED DECEMBER 31, 2002 2001 2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------
Dollars in Thousands
Selected Operations Data:
Interest income $ 29,496 $ 31,117 $ 31,709 $ 28,449 $ 28,411
Interest expense 13,875 18,916 19,305 16,422 17,212
Net interest income 15,621 12,201 12,404 12,027 11,199
Provision for loan losses 740 460 970 210 330
Noninterest income 4,754 2,040 1,670 1,228 1,180
Noninterest expenses 11,888 9,303 10,193 8,885 8,275
Income before income taxes 7,747 4,478 2,911 4,160 3,774
Net income 4,944 2,889 1,932 2,680 2,385
- ------------------------------------------------------------------------------------------------------------------------------
Selected Financial Ratios and Other Data:
Return on average assets 1.05% 0.67% 0.47% 0.69% 0.62%
Return on average equity 13.70% 8.91% 6.35% 8.88% 7.86%
Average stockholders' equity to average assets 7.64% 7.57% 7.38% 7.74% 7.95%
Non-performing assets to total assets 0.24% 0.84% 0.22% 0.35% 1.08%
Allowance for loan losses to total loans 0.75% 0.67% 0.62% 0.39% 0.35%
Dividend payout ratio 11.47% 19.49% 28.09% - -
Per Share Data:
Earnings per:
Common share - basic $ 1.74 $ 1.03 $ 0.71 $ 0.95 $ 0.79
Common share - diluted $ 1.73 $ 1.02 $ 0.69 $ 0.90 $ 0.74
Cash dividends declared $ 0.20 $ 0.20 $ 0.20 - -
Tangible book value $ 13.56 $ 11.86 $ 11.35 $ 10.92 $ 10.38
Number of common shares outstanding 2,835,947 2,835,447 2,714,610 2,687,919 3,046,284
2
Net income for the year ended December 31, 2002 was $4,944,497 or $1.73 per
diluted share, a 71.2% increase over last year. Net income for the year ended
December 31, 2001 was $2,888,943, or $1.02 per diluted share. Total assets at
December 31, 2002 were $504.2 million as compared to $458.1 million at December
31, 2001, a 10.1% increase in assets during the year. Stockholders' equity at
December 31, 2002, was $38.4 million, or $13.56 per share, and represented 7.63%
of assets.
In May 2002, we completed our purchase of Lumina Mortgage Company, a
Wilmington-based mortgage banking firm with additional offices in Virginia
Beach, Virginia, and North Myrtle Beach, South Carolina. This acquisition, in
addition to placing us in our two adjacent states, also increases significantly
the fee income that will be generated going forward as Lumina is a full service
mortgage banking firm, selling its entire product and receiving fee income in
return.
Also, in May 2002, we installed an ATM at Wrightsville Beach providing
additional bank services both to the vacationers from outside of our area as
well as our customer base who find it convenient to bank at Wrightsville Beach.
During 2002, the Company continued paying a quarterly cash dividend of $.05
per share to our stockholders, and it is our hope and intention to continue
paying such dividends in the future.
On December 31, 2002, the Bank completed its previously announced
conversion from a state savings bank to a state commercial bank. This conversion
formalizes the transition that the Bank has been making over the past several
years from a savings institution to a full service community bank. The official
name of the bank is now, Cooperative Bank.
In summary, the past year has been an exciting one for our Company. We have
experienced a dramatic improvement in earnings and efficiencies, and significant
growth in retail and commercial loans, making our balance sheet increasingly
more bank-like. The acquisition of Lumina Mortgage Company will increase the non
interest earnings of the Company as well as provide additional outlets for the
origination of mortgage loans in our two adjacent states. As I look to the
future, I do so with a great deal of confidence in our ability to continue to
provide banking services to the people of Eastern North Carolina, and now to
those in Virginia and South Carolina as well. I thank you for your continued
support.
Sincerely yours,
Frederick Willetts, III
President
3
GENERAL
Cooperative Bankshares, Inc. (the "Company") is a registered bank holding
company incorporated in North Carolina in 1994. The Company is the parent
company of Cooperative Bank (the "Bank"); a North Carolina chartered commercial
bank. Cooperative Bank, headquartered in Wilmington, North Carolina was
chartered in 1898. The Bank provides financial services through 17 financial
centers in Eastern North Carolina. The Bank's subsidiary, Lumina Mortgage
Company, Inc. ("Lumina") is a mortgage banking firm originating and selling
residential mortgage loans through offices in Wilmington, North Carolina; North
Myrtle Beach, South Carolina; and Virginia Beach, Virginia. In October 2002, the
Bank changed the name of its subsidiary from CS&L Services, Inc. to Lumina
Mortgage Company, Inc. The Bank's other subsidiary; CS&L Holdings, Inc.
("Holdings") is a holding company for CS&L Real Estate Trust, Inc. (the "REIT"),
which is a newly formed real estate investment trust. Accordingly, the
information set forth in this report, including financial statements and related
data, relates primarily to Cooperative Bank.
The following is management's discussion and analysis presented to assist
in understanding the Company's financial condition and results of operations.
This discussion should be read in conjunction with the consolidated financial
statements and accompanying notes presented in this report.
CRITICAL ACCOUNTING POLICY
The Bank's most significant critical accounting policy is the determination
of its allowance for loan losses. A critical accounting policy is one that is
both very important to the portrayal of the Bank's financial condition and
results, and requires management's most difficult, subjective or complex
judgments. What makes these judgments difficult, subjective and/or complex is
the need to make estimates about the effects of matters that are inherently
uncertain. For further information on the allowance for loan losses, see the
"Financial Condition" in Management's Discussion and Analysis and Note 3 of the
"Notes to Consolidated Financial Statements" included in this Annual Report.
MANAGEMENT STRATEGY
Cooperative Bank's lending activities have traditionally concentrated on
the origination of loans for the purpose of constructing, financing or
refinancing residential properties. In recent years, however, the Bank has
emphasized origination of nonresidential real estate loans, equity lines of
credit, and secured and unsecured consumer and business loans. As of December
31, 2002 approximately $268 million, or 69%, of the Bank's loan portfolio, which
excludes loans held for sale, consisted of loans secured by residential
properties. This amount includes $32 million of loans classified as construction
and land development. This was down from approximately $273 million, or 73% at
December 31, 2001. The Bank originates adjustable rate and fixed rate loans. As
of December 31, 2002, adjustable rate and fixed rate loans totaled approximately
65% and 35%, respectively, of the Bank's total loan portfolio.
The Bank has chosen to sell a large percentage of its fixed rate mortgage
loan originations in the secondary market and through brokered arrangements.
This enables the Bank to invest its funds in commercial loans, while increasing
fee income. This is part of the continuing effort to restructure the balance
sheet and operations to be more reflective of a commercial bank.
In 2002, the Bank sold $8.8 million in loans in the secondary market where
the Bank retained the servicing of the loans and receives a fee payable monthly
of up to 1/4% per annum of the unpaid balance of each loan. In addition, the
bank sold $6.3 million in the secondary market and $24.5 million through a
brokered arrangement where the bank released the servicing of the loans. Lumina
sold $90.4 million in the secondary market during 2002.
The growth in the loan portfolio has been concentrated in real
estate-backed construction and land development and commercial loans. These
loans generally involve a higher level of credit risk than one-to-four family
residential lending due to the concentration of principal in a limited number of
loans and borrowers, the effects of general economic conditions and the
volatility of the collateral. This increased risk also causes the allowance for
loan losses to increase, which is the primary reason for the increase in the
allowance over the past three years.
The Bank has begun construction to build additional branches in Wilmington
and Morehead City, North Carolina.
INTEREST RATE SENSITIVITY ANALYSIS
Interest rate sensitivity refers to the change in interest spread resulting
from changes in interest rates. To the extent that interest income and interest
expense do not respond equally to changes in interest rates, or that all rates
do not change uniformly, earnings will be affected. Interest rate sensitivity,
at a point in time, can be analyzed using a static gap analysis that measures
the match in balances subject to repricing between interest-earning assets and
interest-bearing liabilities. Gap is considered positive when interest rate
sensitive assets exceed interest rate sensitive liabilities. Gap is considered
negative when interest rate sensitive liabilities exceed interest rate sensitive
4
assets. At December 31, 2002, the Company had a one-year positive gap position
of 4.9%. During a period of rising interest rates, a positive gap would tend to
result in an increase in net interest income, while a negative gap would tend to
adversely affect net interest income. During a period of falling interest rates,
a positive gap would tend to adversely affect net interest income while a
negative gap would tend to result in an increase in net interest income. It is
important to note that certain shortcomings are inherent in static gap analysis.
Although certain assets and liabilities may have similar maturities or periods
of repricing, they may react in different degrees to changes in market interest
rates. For example, part of the Company's adjustable-rate mortgage loans are
indexed to the National Monthly Median Cost of Funds to SAIF-insured
institutions. This index is considered a lagging index that may lag behind
changes in market rates. The one-year or less interest-bearing liabilities also
include checking, savings, and money market deposit accounts. Experience has
shown that the Company sees relatively modest repricing of these accounts.
Management takes this into consideration in determining acceptable levels of
interest rate risk.
The following table indicates the time periods in which interest-earning
assets and interest-bearing liabilities will mature or reprice in accordance
with their contractual terms. The table assumes prepayments and scheduled
principal amortization of fixed-rate loans and mortgage-backed securities, and
assumes that adjustable rate loans will reprice at contractual repricing
intervals.
INTEREST RATE SENSITIVITY ANALYSIS
Over One Over Five
One Year Through Through Over Ten
December 31, 2002 or Less Five Years Ten Years Years Total
- --------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Interest-earning assets:
Securities $ 22,453 $ 18,801 $ 3,699 $ 4,982 $ 49,935
Interest-bearing bank balances - - - - -
Federal Home Loan Bank stock 4,055 - - - 4,055
All Loans 302,572 108,233 7,631 1,037 419,473
--------- --------- --------- -------- ---------
Total $ 329,080 $ 127,034 $ 11,330 $ 6,019 $ 473,463
========= ========= ========= ======== =========
Interest-bearing liabilities:
Deposits $ 237,934 $ 91,321 $ 8,199 $ - $ 337,454
Borrowed funds 66,589 20,010 18,015 64 104,678
--------- --------- --------- -------- ---------
Total $ 304,523 $ 111,331 $ 26,214 $ 64 $ 442,132
========= ========= ========= ======== =========
Interest rate sensitivity gap $ 24,557 $ 15,703 $ (14,884) $ 5,955 $ 31,331
========= ========= ========= ======== =========
Cumulative interest rate sensitivity gap $ 24,557 $ 40,260 $ 25,376 $ 31,331
========= ========= ========= ========
Cumulative ratio of interest-earning
assets to interest-bearing liabilities 108.1% 109.7% 105.7% 107.1%
========= ========= ========= ========
Ratio of cumulative gap to total assets 4.9% 8.0% 5.0% 6.2%
========= ========= ========= ========
MARKET RISK
The Company's primary market risk is interest rate risk. Interest rate risk
is the result of differing maturities or repricing intervals of interest earning
assets and interest bearing liabilities and the fact that rates on these
financial instruments do not change uniformly. These conditions may impact the
earnings generated by the Company's interest earning assets or the cost of its
interest bearing liabilities, thus directly impacting the Company's overall
earnings. The Company's management actively monitors and manages interest rate
risk. One way this is accomplished is through the development of and adherence
to the Company's asset/liability policy. This policy sets forth management's
strategy for matching the risk characteristics of the Company's interest earning
assets and liabilities so as to mitigate the effect of changes in the rate
environment.
5
One way to measure the Company's potential exposure to interest rate risk
is to estimate the effect of a change in rates on the Company's Economic Value
of Equity ("EVE"). At December 31, 2002, the percentage of negative estimated
change in EVE is reduced in the rising rate environments as compared to the
estimated change at December 31, 2001. Changes to EVE in declining rate
environments from December 31, 2001, to December 31, 2002, are negatively
impacted. The following table sets forth information relating to the Company's
EVE and the estimated changes under various interest rate change scenarios as of
December 31, 2002 (in thousands).
- -----------------------------------------------------------------------------
Market Risk Table
December 31, 2002
Change in Economic Estimated Estimated
Interest Rates Value of Equity $ Change % Change
- -----------------------------------------------------------------------------
400 basis point rise $ 31,946 (10,604) -25%
300 basis point rise 34,651 (7,899) -19%
200 basis point rise 37,754 (4,796) -11%
100 basis point rise 41,277 (1,273) -3%
Base Scenario 42,550 -
100 basis point decline 41,745 (805) -2%
200 basis point decline 40,570 (1,980) -5%
300 basis point decline 41,887 (663) -2%
400 basis point decline 45,011 2,461 6%
- ---------------------------------------------------------------------------
Computation of prospective effects of hypothetical interest rate changes,
such as the above computations, are based on numerous assumptions, including
relative levels of market interest rates, loan prepayments and deposit decay,
and should not be relied upon as indicative of actual results. Further, the
computations do not contemplate any actions management could undertake in
response to sudden changes in interest rates.
LIQUIDITY
The Company's goal is to maintain adequate liquidity to meet potential
funding needs of loan and deposit customers, pay operating expenses, and meet
regulatory liquidity requirements. Maturing securities, principal repayments of
loans and securities, deposits, income from operations and borrowings are the
main sources of liquidity. Scheduled loan repayments are a relatively
predictable source of funds, unlike deposits and loan prepayments that are
significantly influenced by general interest rates, economic conditions and
competition.
At December 31, 2002, the estimated market value of liquid assets (cash,
cash equivalents, marketable securities and loans held for sale) was
approximately $87.6 million, representing 19.0% of deposits and borrowed funds
as compared to $60.5 million or 14.3% of deposits and borrowed funds at December
31, 2001. Management maintains a portfolio generally consisting of
mortgage-backed securities and securities with short maturities (within 5 years)
and call dates, consistent with the Bank's focus on liquidity. Investment
securities available for sale are recorded at their fair value, with the
unrealized gain or loss included as a component of shareholders' equity, net of
deferred taxes.
The Company's securities portfolio consists of U.S. Treasury, U.S.
Government agency, mortgage-backed and other permissible securities including
preferred stock from the Federal Home Loan Mortgage Corporation ("FHLMC"), a
Household Finance Corporation note and a Ford Motor Credit Company Note. The
Federal National Mortgage Association (FNMA) and FHLMC guarantee the
mortgage-backed securities. Mortgage-backed securities entitle the Company to
receive a pro rata portion of the cash flows from an identified pool of
mortgages. Although mortgage-backed securities generally offer lesser yields
than the loans for which they are exchanged, they present substantially lower
credit risk by virtue of the guarantees that back them. Mortgage-backed
securities are more liquid than individual mortgage loans, and may be used to
collateralize borrowings or other obligations of the Company.
The mortgage-backed and related securities owned by the Company are subject
to repayment by the mortgagors of the underlying collateral at any time. These
repayments may be affected by a rising or declining
6
interest rate environment. During a rising or declining interest rate
environment, repayments and the interest rate caps may subject the Company's
mortgage-backed and related securities to yield and/or price volatility.
The Company's primary uses of liquidity are to fund loans and to purchase
investments. At December 31, 2002, outstanding off-balance sheet commitments to
extend credit totaled $38.2 million, and the undisbursed portion of construction
loans was $32.7 million. Management considers current liquidity levels adequate
to meet the Company's cash flow requirements.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The Bank enters into agreements that obligate it to make future payments
under contracts, such as debt and lease agreements. In addition, the Bank
commits to lend funds in the future such as credit lines and loan commitments.
Below is a table of such contractual obligations and commitments at December 31,
2002 (in thousands).
Payments Due by Period
-------------------------------------------------------------
Less
than 1 1-3 4-5 Over 5
Contractual Obligations Total year years years years
--------------------------------------------------------------
Borrowed Funds $ 104,678 $ 61,585 $ 15,000 $ 5,000 $ 23,093
Lease Obligations 2,998 285 471 264 1,978
Deposits 357,254 294,339 62,653 181 81
--------------------------------------------------------------
Total Contractual Cash Obligations $ 464,930 $356,209 $ 78,124 $ 5,445 $ 25,152
==============================================================
Amount of Commitment Expiration
Per Period
--------------------------------------------------------------
Total Less
Amounts than 1 1-3 4-5 Over 5
Other Commitments Committed year years years years
--------------------------------------------------------------
Undisbursed portion of home equity
collateralized primarily by junior liens
on 1-4 family properties $ 14,130 $ 633 $ 1,414 $ 411 $ 11,672
Other commitments and credit lines 13,843 3,144 7,631 295 2,773
Undisbursed portion of construction loans 32,667 32,667 - - -
Available for sale mortgage loan commitments 3,729 3,729 - - -
Fixed-rate mortgage loan commitments 879 879 - - -
Adjustable-rate mortgage loan
commitments 5,614 5,614 - - -
--------------------------------------------------------------
Total Commitments $ 70,862 $ 46,666 $ 9,045 $ 706 $ 14,445
==============================================================
CAPITAL
Stockholders' equity at December 31, 2002, was $38.4 million, up $4.8
million, or 14.4%, from $33.6 million at December 31, 2001. The improved capital
position during the year 2002 reflects the impact of earnings retention after
the declaration of cash dividends of $567,163, or $0.20 per share, and the
exercising of 500 stock options. Stockholders' equity at December 31, 2002 and
December 31, 2001 includes unrealized gains net of tax of $635,500 and $188,278,
respectively, on securities available for sale.
Under the capital regulations of the FDIC, the Bank must satisfy minimum
leverage ratio requirements and risk-based capital requirements. Banks
supervised by the FDIC must maintain a minimum leverage ratio of core (Tier I)
capital to average adjusted assets ranging from 3% to 5%. At December 31, 2002,
the Bank's leverage capital ratio was 7.52%. The FDIC's risk-based capital rules
require banks supervised by the FDIC to maintain risk-
7
based capital to risk-weighted assets of at least 8.00%. Risk-based capital for
the Bank is defined as Tier I capital plus the balance of allowance for loan
losses. At December 31, 2002, the Bank had a ratio of qualifying total capital
to risk-weighted assets of 11.00%.
The Company, as a bank holding company, is also subject, on a consolidated
basis, to the capital adequacy guidelines of the Board of Governors of the
Federal Reserve (the "Federal Reserve Board"). The capital requirements of the
Federal Reserve Board are similar to those of the FDIC governing the Bank.
The Company currently exceeds all of its capital requirements. Management
expects the Company to continue to exceed these capital requirements without
altering current operations or strategies. For further information, see Note 7
of Notes to Consolidated Financial Statements.
On December 19, 2002, the Company's Board of Directors approved a quarterly
cash dividend on its common stock of $.05 per share. The dividend was payable
January 17, 2003, to shareholders of record on January 2, 2003. Any future
payment of dividends is dependent on the financial condition and capital needs
of the Company, requirements of regulatory agencies, and economic conditions in
the marketplace.
RELATED PARTY TRANSACTIONS
The Bank has had, and expects to have in the future, banking transactions
in the ordinary course of business with several directors, officers and their
associates ("Related Parties") on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for comparable
transactions with others. Those transactions neither involve more than normal
risk of collectibility, nor present any unfavorable features. The one exception
is officers can participate in the Bank's employee loan program which offers a
six month adjustable rate that is 1% above the Bank's cost of funds rounded up
to the next 1/4%. An employee can only have one property at any given time that
qualifies for the employee rate program. The interest rate is the only favorable
term. Officers do not get preferential treatment in this program over other
employees. For further information, see Note 3 of Notes to Consolidated
Financial Statements included in this Annual Report and the Company's Proxy
Statement for its 2003 Annual Meeting of Stockholders.
8
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
DECEMBER 31, 2002 COMPARED TO DECEMBER 31, 2001
FINANCIAL CONDITION
The Company's total assets increased 10.1% to $504.2 million at December
31, 2002, as compared to $458.1 million at December 31, 2001. The major changes
in the assets are as follows: an increase of $2.9 million (57.2%) in held to
maturity securities, an increase of $17.4 million (4.7%) in net loans
receivable, and a $1.6 million (15.2%) increase in other assets. In addition,
primarily due to the Lumina purchase, loans held for sale were $25.7 million at
December 31, 2002 and there was not a similar asset at December 31, 2001.
Although the Company has historically concentrated its lending activities on the
origination of loans for the purpose of financing or refinancing residential
properties, it is now actively pursuing construction, land development,
consumer, and business lending. The Bank funded the increase in securities,
loans and other assets with a $17.4 million (5.1%) increase in retail deposits,
a $21.6 million (26.0%) increase in borrowed funds and other available liquid
assets. The increase in deposits was primarily in the seven month certificates
due to the customer's desire to stay short in the current rate environment. The
Bank also attracted an additional $7.2 million in internet deposits. Internet
deposits are primarily obtained from other financial institutions in increments
of $99,000 with terms primarily of one or two years. The increase in borrowings
was due to a short term loan from another financial institution, used to fund
the loans held for sale. This loan is collateralized by the loans held for sale.
The increase in other assets was due to an increase in cash surrender value of
bank owned life insurance ("BOLI") of $1.4 million and a $662,000 increase in
Goodwill due to the purchase of Lumina Mortgage Company. Other liabilities
increased $2.2 million (206.5%) primarily due to accounts payable and accrued
expenses.
The Company's nonperforming assets (nonaccrual loans, accruing loans 90
days or more delinquent and foreclosed real estate) were $1.2 million, or 0.24%
of assets, at December 31, 2002, compared to $3.8 million or 0.84% of assets, at
December 31, 2001. The Company usually assumes an aggressive position in
collecting delinquent loans and disposing of foreclosed assets to minimize
balances of nonperforming assets and continues to evaluate the loan and real
estate portfolios to provide loss reserves as considered necessary. While there
can be no guarantee, in the opinion of management, the allowance for loan losses
of $2.9 million at December 31, 2002 is adequate to cover probable losses
inherent in the loan portfolio.
Management considers a variety of factors in establishing the appropriate
levels for the provision and the allowance for loan losses. Consideration is
given to, among other things, the impact of current economic conditions, the
diversification of the loan portfolio, historical loss experience, the review of
loans by the loan review personnel, the individual borrower's financial and
managerial strengths, and the adequacy of underlying collateral.
The process used to allocate the allowance for loan losses considers, among
other factors, whether the borrower is a mortgage, retail or commercial
customer, whether the loan is secured or unsecured, and whether the loan is an
open or closed-end agreement. Generally, loans are reviewed and risk graded
among groups of loans with similar characteristics. An independent third party
annually reviews our risk grades for appropriateness. The probable loss
projections for each risk grade group are the basis for the allowance
allocation. The loss estimates are based on prior experience, general risk
associated with each loan group and current economic conditions. The unallocated
allowance for loan losses primarily represents the impact of certain conditions
that were not considered in allocating the allowance to the specific components
of the loan portfolio.
At December 31, 2002 deposits had increased $17.4 million (5.1%) to $357.3
million as compared to $339.8 million at December 31, 2001. With the focus to
restructure the balance sheet to be more reflective of a commercial bank,
management took an aggressive position in attracting interest and noninterest
bearing demand deposit accounts. Interest and noninterest bearing demand
accounts increased $4.2 million (11.6%) to $40.4 million as compared to $36.2
million at December 31, 2001.
RESULTS OF OPERATIONS
The net income of the Company depends primarily upon net interest income.
Net interest income is the difference between the interest earned on loans,
securities and interest-bearing deposits in other banks offset by the cost of
funds, consisting principally of the interest paid on deposits and borrowings.
The Company's operations are materially affected by general economic conditions,
the monetary and fiscal policies of the Federal government, and the policies of
regulatory authorities.
NET INCOME
Net income increased 71.2% to $4.9 million for 2002, as compared to $2.9
million in 2001 and $1.9 million in 2000. The following analysis of the
Company's results of operations will explain the changes that had an effect on
net income for the three years under review.
<
9
INTEREST INCOME
Interest income amounted to $29.5 million during 2002, a $1.6 million
(5.2%) decrease from 2001 levels, which decreased $592,000 (1.9%) from the 2000
levels. Interest income reduction during 2002 resulted from lower yields on
earning assets. The average balance of interest-earning assets increased 8.1%
but was more than offset by the yield decreasing 93 basis points as compared to
the same period a year ago. The yield fell because of the action the Federal
Reserve took to reduce interest rates hoping to spur the economy. The Federal
Reserve's actions continue to cause adjustable rate loans to adjust down and new
loans to be made at a lower rate. During 2001, the decrease in interest income
was due to the yield on average interest-earning assets decreasing 37 basis
points because of the interest rate cuts. The average balance of
interest-earning assets increased 3.0% as compared to 2000. The yield on average
interest-earning assets for the year 2002 decreased to 6.62% as compared to
7.55% for 2001 and 7.92% for 2000.
INTEREST EXPENSE
Interest expense amounted to $13.9 million during 2002, a $5.0 million
(26.7%) decrease from 2001 levels, compared to a $388,000 (2.0%) decrease from
2000 to 2001. The decrease in interest expense during 2002 resulted from a lower
cost of interest-bearing liabilities. During 2002, the average balance of
interest-bearing liabilities increased 9.5% but was more than offset by the cost
decreasing 164 basis points as compared to 2001. During 2001 the decrease in
interest expense was due to a 26 basis point drop in the average rate paid
against a 3.2% increase in the average balance of interest-bearing liabilities
as compared to 2000. The average cost on interest-bearing liabilities for the
year 2002 decreased to 3.33% as compared to 4.97% for 2001 and 5.23% for 2000.
NET INTEREST INCOME
Net interest income totaled $15.6 million during 2002, an increase of $3.4
million or 28.0% over 2001, when net interest income was $12.2 million. During
2001, net interest income decreased $203,000 or 1.6% under the $12.4 million
recorded during 2000. The Average Yield/Cost Analysis table analyzes the
interest-earning assets and interest-bearing liabilities for the three years
ending December 31, 2002. The Rate/Volume Analysis table identifies the causes
for changes in interest income and interest expense for 2002 and 2001. The
interest rate spread was 3.29% for 2002, compared to 2.58% for 2001 and 2.69%
for 2000. The increased interest rate spread can be attributed to the fact that
liabilities have repriced more than assets during 2002. The net yield on
interest-earning assets was 3.51% for 2002 compared to 2.96% for 2001 and 3.10%
for 2000.
During 2001, the Bank provided a retirement benefit for its Board of
Directors, President and Executive Vice President. In addition, the Directors
can now defer their Board compensation. These benefits are funded through the
purchase of BOLI, which should enable the Bank to provide these benefits without
a reduction to net income. This transaction will have a negative impact on net
interest income of approximately $350,000 annually because it was funded with
borrowed funds. Noninterest income should be positively affected by
approximately $320,000 annually.
10
AVERAGE YIELD/COST ANALYSIS
The following table contains information relating to the Company's average
balance sheets and reflects the average yield on earning assets and average cost
of interest-bearing liabilities for the periods indicated. Such yields and costs
are derived by dividing income or expense by the average balances of assets or
liabilities, respectively, for the periods presented. The average loan portfolio
balances include nonaccrual loans.
For the year ended
--------------------------------------------------------------------------
DECEMBER 31, 2002 DECEMBER 31, 2001
---------------------------------- ----------------------------------
(DOLLARS IN THOUSANDS) Average Average
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
------------ ------------ --------- ------------ ------------ ---------
ASSETS
Interest-earning assets:
Interest-bearing deposits in other banks $ 2,732 $ 48 1.76% $ 7,648 $ 271 3.54%
Securities:
Available for sale 41,185 2,184 5.30% 36,671 2,212 6.03%
Held to maturity 7,206 433 6.01% 7,452 400 5.37%
FHLB stock 4,141 220 5.31% 3,761 254 6.75%
All loans 390,210 26,611 6.82% 356,540 27,980 7.85%
-------- ------- ------ -------- -------- -------
Total interest-earning assets 445,474 $29,496 6.62% 412,072 31,117 7.55%
------- --------
Non-interest earning assets 27,330 16,676
-------- --------
Total assets $472,804 $428,748
======== ========
LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Deposits 334,980 10,146 3.03% $319,777 $15,353 4.80%
Borrowed funds 81,867 3,729 4.55% 60,943 3,563 5.85%
-------- ------- ------ -------- ------- -------
Total interest-bearing liabilities 416,847 $13,875 3.33% 380,720 18,916 4.97%
------- -------
Non-interest bearing liabilities 19,855 15,588
-------- --------
Total liabilities 436,702 396,308
Stockholders' equity 36,102 32,440
-------- --------
Total liabilities and stockholders' equity $472,804 $428,748
======== ========
Net interest income $15,621 $12,201
======= =======
Interest rate spread 3.29% 2.58%
======= =======
Net yield on interest-earning assets 3.51% 2.96%
======= =======
Percentage of average interest-earning
assets to average interest-bearing
liabilities 106.9% 108.5%
======= =======
For the year ended
-----------------------------------
DECEMBER 31, 2000
-----------------------------------
(DOLLARS IN THOUSANDS) Average
Average Yield/
Balance Interest Cost
---------- ------------ ---------
ASSETS
Interest-earning assets:
Interest-bearing deposits in other banks $ 9,528 $ 390 4.09%
Securities:
Available for sale 21,619 1,267 5.86%
Held to maturity 18,385 1,066 5.80%
FHLB stock 3,755 291 7.75%
All loans 346,848 28,695 8.27%
-------- ------- ------
Total interest-earning assets 400,135 31,709 7.92%
-------
Non-interest earning assets 11,665
--------
Total assets $411,800
========
LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Deposits $303,379 $15,062 4.96%
Borrowed funds 65,470 4,243 6.48%
-------- ------- ------
Total interest-bearing liabilities 368,849 19,305 5.23%
-------
Non-interest bearing liabilities 12,549
--------
Total liabilities 381,398
Stockholders' equity 30,402
--------
Total liabilities and stockholders' equity $411,800
========
Net interest income $12,404
=======
Interest rate spread 2.69%
=======
Net yield on interest-earning assets 3.10%
=======
Percentage of average interest-earning
assets to average interest-bearing
liabilities 108.5%
=======
11
RATE/VOLUME ANALYSIS
The table below provides information regarding changes in interest income
and interest expense for the periods indicated. For each category of
interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to (i) changes in volume (change in volume
multiplied by old rate) and (ii) changes in rates (change in rate multiplied by
old volume). The changes attributable to changes in rate-volume have been
allocated to the other categories based on relative absolute values.
For the year ended For the year ended
December 31, 2001 vs. December 31, 2002 December 31, 2000 vs. December 31, 2001
Increase (Decrease) Increase (Decrease)
Due to Due to
(DOLLARS IN THOUSANDS) ------------------------------------- ---------------------------------------
Volume Rate Total Volume Rate Total
------------------------------------ ---------------------------------------
Interest income:
Interest-bearing deposits in other banks $ (126) $ (97) $ (223) $ (72) $ (47) $ (119)
Securities:
Available for sale 255 (283) (28) 906 39 945
Held to maturity (13) 46 33 (593) (73) (666)
FHLB stock 24 (58) (34) - (37) (37)
All loans 2,497 (3,866) (1,369) 788 (1,503) (715)
------ ------- ------- ------ ------- ------
Total interest-earning assets 2,637 (4,258) (1,621) 1,029 (1,621) (592)
------ ------- ------- ------ ------- ------
Interest expense:
Deposits 699 (5,906) (5,207) 797 (506) 291
Borrowed funds 1,058 (892) 166 (282) (398) (680)
------ ------- ------- ------ ------- ------
Total interest-bearing liabilities 1,757 (6,798) (5,041) 515 (904) (389)
------ ------- ------- ------ ------- ------
Net interest income $ 880 $ 2,540 $ 3,420 $ 514 $ (717) $ (203)
====== ======= ======= ====== ======= ======
PROVISION FOR LOAN LOSSES
The provision for loan losses charged to operations was $740,000 during
2002, compared to $460,000 during 2001 and $970,000 during 2000. The provision
for 2000 included an increase of approximately $670,000 made in response to a
detailed review of the Bank's loan portfolio. Management's decision to increase
the loan loss reserve was considered appropriate in light of the successful
expansion in the commercial loan portfolio and was not in response to any
significant increase in non-performing assets. While commercial loans typically
earn a higher yield than traditional residential mortgage loans, they pose an
incrementally higher level of credit risk to the Company. A review of the
portfolio during the first quarter of 2000 highlighted this trend in the
portfolio and prompted management to make this provision. The commercial loan
portfolio continues to expand which is why the provision for loan losses
continued to increase in 2002 over 2001. Nonperforming assets at December 31,
2002 were $1.2 million compared to $3.8 million at December 31, 2001 and
$925,000 at December 31, 2000. Net charge-offs for 2002 were $326,000 compared
to $97,000 during 2001 and $117,000 during 2000. At December 31, 2002, the
allowance for loan losses was 0.75% of net loans as compared to 0.67% for 2001
and 0.62% for 2000. The allowance for loan losses increased to $2.9 million at
December 31, 2002 compared to $2.5 million at December 31, 2001 and $2.2 million
at December 31, 2000. Management considers this level to be appropriate based on
lending volume, the current level and types of delinquencies and other
nonperforming assets, historical charge off patterns, overall economic
conditions and other factors. Future increases to the allowance may be
necessary, however, due to changes in loan composition or loan volume, changes
in economic or market area conditions and other factors. Additionally, various
regulatory agencies, as an integral part of their examination process,
periodically review the Company's allowance for loan losses. Such agencies may
require the recognition of additions to the allowance based on their judgments
of information available to them at the time of their examination.
12
NONINTEREST INCOME
Total noninterest income increased to $4.8 million during 2002, an increase
of $2.7 million or 133.0% over 2001. This compares to $2.0 million and $1.7
million during 2001 and 2000, respectively. The major component in the year 2002
that had the most impact on noninterest income was the gain on sale of loans
resulting in net gains of $1.9 million versus a gain of $11,000 in 2001. These
gains were realized primarily as a result of the purchase of Lumina. There was
also a gain on sale of real estate of $465,000 in 2002 but no similar
transaction in 2001. Service charges and fees on loans decreased to $649,000
(11.2%) during the year 2002 as compared to $731,000 (63.6%) for 2001 and
$447,000 in 2000. The decrease in service charges and fees on loans for 2002 was
mainly due to a decrease in loan settlement service fees for loans processed for
others and loans serviced for others. The increase in 2001 was due to the fact
that the program for settlement services processed for others began in May 2000.
Bank-owned life insurance earnings increased to $399,000 (298.1%) in 2002 from
$100,000 in 2001. This insurance was purchased in September of 2001. Other
income increased to $223,000 (111.7%) during the year 2002 as compared to
$105,000 (5.6%) for 2001 and $100,000 in 2000. The majority of the increase can
be attributed to the increase in commissions for annuity sales and mutual funds,
through UVEST Investment Services sold in 2002.
NONINTEREST EXPENSE
Total noninterest expense was $11.9 million during the year 2002, an
increase of $2.6 million or 27.8% from 2001. The major increase in noninterest
expense during the year 2002 can be attributed to compensation and related costs
increasing to $7.0 million (36.9%) in 2002 as compared to $5.1 million in 2001
and $6.0 million in 2000. The increase was due to increases in incentive based
pay, costs of benefits, staffing levels and normal increases in salaries as well
as higher personnel costs as a result of the purchase of Lumina. The decrease in
2001 of 15.2% was due to a modification of the defined benefit plan and a
onetime early retirement offering to certain employees. The Bank's occupancy and
equipment expense was $2.3 million during 2002, an increase of 11.7 % as
compared to $2.1 million in 2001 and $2.0 million in 2000. The increase in the
years 2002 and 2001 can be attributed to additional maintenance necessary to
keep the buildings and equipment in good repair, increases in property tax,
increases in the cost of data processing services, and normal increases in
utility expenses as well as the purchase of Lumina in 2002. Advertising cost for
the year 2002 was $358,000, an increase of 28.8% as compared to $278,000 in 2001
and $398,000 in 2000. The reduction in advertising in 2001 can be attributed to
a more conservative advertising policy that year. Other operating expense was
$1.6 million, an increase of 3.0% as compared to $1.6 million in 2001 and $1.4
million in 2000. The majority of the increase in 2001 can be attributed to
credits the Bank received in 2000 for phone lines for data processing. No such
credits were received in 2002 and 2001.
INCOME TAXES
The effective tax rate for the years ended December 31, 2002, 2001 and 2000
was 36.2%, 35.5% and 33.6% respectively. The lower effective tax rate in 2000
was due to higher relative levels of state tax-exempt income.
NOTE REGARDING FORWARD-LOOKING STATEMENTS
In addition to historical information contained herein, the discussion
contains forward-looking statements that involve risks and uncertainties.
Economic circumstances, the Company's operations, and the Company's actual
results could differ significantly from those discussed in the forward-looking
statements. Some of the factors that could cause or contribute to such
differences are discussed herein, but also include changes in the economy and
interest rates in the nation, changes in the Company's regulatory environment
and the Company's market area generally.
13
SELECTED QUARTERLY DATA
The following table contains selected financial data for the Company on a
quarterly basis for the previous eight quarters.
2002
Fourth Third Second First
- ----------------------------------------------------------------------------------------------
Dollars in Thousands
Selected Quarter-End Balances:
Assets $ 504,210 $ 498,035 $ 479,435 $ 462,846
Loans, net 390,876 386,940 384,871 375,125
Securities 49,935 51,298 48,438 47,354
FHLB stock 4,055 4,155 4,155 4,155
Deposits 357,254 359,873 360,536 352,083
Borrowed funds 104,679 96,133 80,929 74,295
Stockholders' equity 38,448 37,065 35,776 34,142
- ----------------------------------------------------------------------------------------------
Dollars in Thousands
Selected Operations Data:
Interest income $ 7,374 $ 7,366 $ 7,393 $ 7,362
Interest expense 3,234 3,380 3,502 3,758
Net interest income 4,140 3,986 3,891 3,604
Provision for loan losses 220 120 120 280
Noninterest income 1,666 1,274 604 1,210
Noninterest expenses 3,450 3,277 2,611 2,550
Income before income taxes 2,136 1,863 1,764 1,984
Net income 1,305 1,220 1,131 1,288
- ----------------------------------------------------------------------------------------------
Selected Financial Ratios and Other Data:
Return on average assets 1.06% 1.02% 0.98% 1.13%
Return on average equity 13.65% 13.29% 12.91% 14.99%
Average stockholders' equity to average assets 7.74% 7.69% 7.57% 7.53%
Per Share Data:
Earnings per:
Common share - basic $ 0.46 $ 0.43 $ 0.40 $ 0.45
Common share - diluted $ 0.46 $ 0.43 $ 0.40 $ 0.45
Cash dividends declared $ 0.05 $ 0.05 $ 0.05 $ 0.05
Tangible book value $ 13.56 $ 13.07 $ 12.62 $ 11.86
Number of common shares outstanding 2,835,947 2,835,947 2,835,947 2,835,447
2001
Fourth Third Second First
- --------------------------------------------------------------------------------------------------
Dollars in Thousands
Selected Quarter-End Balances:
Assets $ 458,114 $ 443,781 $ 427,992 $ 417,408
Loans, net 373,458 364,306 351,104 349,136
Securities 47,970 47,441 51,650 42,767
FHLB stock 4,155 3,755 3,755 3,755
Deposits 339,830 340,615 338,985 328,566
Borrowed funds 83,097 68,098 55,099 55,100
Stockholders' equity 33,618 33,010 31,873 31,375
- --------------------------------------------------------------------------------------------------
Dollars in Thousands
Selected Operations Data:
Interest income $ 7,505 $ 7,870 $ 7,825 $ 7,918
Interest expense 4,375 4,747 4,823 4,972
Net interest income 3,130 3,123 3,002 2,946
Provision for loan losses 160 120 90 90
Noninterest income 630 533 462 415
Noninterest expenses 2,362 2,292 2,275 2,374
Income before income taxes 1,238 1,244 1,099 897
Net income 806 805 703 574
- --------------------------------------------------------------------------------------------------
Selected Financial Ratios and Other Data:
Return on average assets 0.72% 0.74% 0.67% 0.56%
Return on average equity 9.59% 9.87% 8.77% 7.31%
Average stockholders' equity to average assets 7.52% 7.53% 7.63% 7.59%
Per Share Data:
Earnings per:
Common share - basic $ 0.29 $ 0.29 $ 0.25 $ 0.21
Common share - diluted $ 0.28 $ 0.28 $ 0.25 $ 0.20
Cash dividends declared $ 0.05 $ 0.05 $ 0.05 $ 0.05
Tangible book value $ 11.86 $ 11.69 $ 11.38 $ 11.20
Number of common shares outstanding 2,835,447 2,823,271 2,800,975 2,800,975
14
[KPMG LETTERHEAD]
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Cooperative Bankshares, Inc.:
We have audited the accompanying consolidated statements of financial condition
of Cooperative Bankshares, Inc. and subsidiary as of December 31, 2002 and 2001,
and the related consolidated statements of operations, comprehensive income,
stockholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 2002. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Cooperative
Bankshares, Inc. and subsidiary as of December 31, 2002 and 2001, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States of America.
/s/ KPMG LLP
Raleigh, North Carolina
January 24, 2003
15
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Financial Condition
December 31, 2002 and 2001
ASSETS 2002 2001
------------ ------------
Cash and due from banks, noninterest-bearing $ 11,858,603 10,709,799
Interest-bearing deposits in other banks -- 1,585,779
------------ ------------
Total cash and cash equivalents 11,858,603 12,295,578
Securities:
Available for sale (amortized cost of $41,033,409 in 2002
and $42,661,527 in 2001) 42,075,212 42,970,180
Held to maturity (estimated market value of $8,009,087
in 2002 and $5,282,815 in 2001) 7,859,955 5,000,000
FHLB stock 4,054,700 4,154,900
Loans held for sale 25,659,935 --
Loans 393,812,940 375,980,628
Less allowance for loan losses 2,936,795 2,522,737
------------ ------------
Net loans 390,876,145 373,457,891
Other real estate owned 619,163 759,272
Accrued interest receivable 2,239,826 2,637,367
Premises and equipment, net 7,019,219 6,471,715
Prepaid expenses and other assets 11,946,819 10,367,162
------------ ------------
Total assets $504,209,577 458,114,065
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $357,254,096 339,830,052
Short-term borrowings 61,585,827 35,000,000
Escrow deposits 223,604 220,944
Accrued interest payable 284,568 264,391
Accrued expenses and other liabilities 3,320,629 1,083,242
Long-term obligations 43,092,592 48,097,156
------------ ------------
Total liabilities 465,761,316 424,495,785
------------ ------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $1 par value: 3,000,000 shares authorized,
no shares issued and outstanding -- --
Common stock, $1 par value: 7,000,000 shares authorized,
2,835,947 and 2,835,447 issued and outstanding 2,835,947 2,835,447
Additional paid-in capital 2,440,645 2,435,720
Accumulated other comprehensive income 635,500 188,278
Retained earnings 32,536,169 28,158,835
------------ ------------
Total stockholders' equity 38,448,261 33,618,280
------------ ------------
Total liabilities and stockholders' equity $504,209,577 458,114,065
============ ============
See accompanying notes to consolidated financial statements.
16
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Operations
Years ended December 31, 2002, 2001 and 2000
2002 2001 2000
----------- ----------- -----------
Interest income:
Loans $26,611,364 27,980,414 28,694,889
Securities 2,613,110 2,611,299 2,332,743
Other 51,633 271,767 390,285
Dividends on FHLB stock 219,730 253,918 291,036
----------- ----------- -----------
Total interest income 29,495,837 31,117,398 31,708,953
----------- ----------- -----------
Interest expense:
Deposits 10,148,866 15,352,845 15,061,870
Borrowed funds 3,726,021 3,563,469 4,242,721
----------- ----------- -----------
Total interest expense 13,874,887 18,916,314 19,304,591
----------- ----------- -----------
Net interest income 15,620,950 12,201,084 12,404,362
Provision for loan losses 740,000 460,000 970,000
----------- ----------- -----------
Net interest income after provision for
loan losses 14,880,950 11,741,084 11,434,362
----------- ----------- -----------
Noninterest income:
Gain on sale of loans 1,852,388 11,150 245
Net gain (loss) on sale of securities 135,182 125,172 (287,282)
Service charges and fees on loans 649,074 731,338 446,922
Deposit-related fees 1,030,429 967,171 827,432
Gain on sale of real estate 464,977 -- 582,583
Bank-owned life insurance earnings 398,528 100,104 --
Other income, net 223,008 105,324 99,694
----------- ----------- -----------
Total noninterest income 4,753,586 2,040,259 1,669,594
----------- ----------- -----------
Noninterest expenses:
Compensation and fringe benefits 7,016,029 5,124,945 6,046,774
Occupancy and equipment 2,317,141 2,073,635 1,994,560
Professional and examination fees 570,229 238,681 310,363
Advertising 357,775 277,758 397,662
Real estate owned 14,300 22,053 36,031
Other 1,612,495 1,566,080 1,407,797
----------- ----------- -----------
Total other operating expenses 11,887,969 9,303,152 10,193,187
----------- ----------- -----------
Income before income taxes 7,746,567 4,478,191 2,910,679
Income tax expense 2,802,070 1,589,248 979,004
----------- ----------- -----------
Net income $ 4,944,497 2,888,943 1,931,675
=========== =========== ===========
Net income per share:
Basic $ 1.74 1.03 .71
=========== =========== ===========
Diluted 1.73 1.02 .69
=========== =========== ===========
Weighted average common shares outstanding:
Basic 2,835,712 2,797,317 2,714,216
=========== =========== ===========
Diluted 2,859,014 2,823,191 2,805,611
=========== =========== ===========
See accompanying notes to consolidated financial statements
17
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Comprehensive Income
Years ended December 31, 2002, 2001 and 2000
2002 2001 2000
----------- ---------- ----------
Net income $ 4,944,497 2,888,943 1,931,675
Other comprehensive income:
Unrealized gain arising during the year 868,332 385,127 286,808
Tax expense (338,649) (150,201) (111,855)
Reclassification to realized (gain) loss (135,182) (125,172) 287,282
Tax expense (benefit) 52,721 48,817 (112,040)
----------- ---------- ----------
Other comprehensive income 447,222 158,571 350,195
----------- ---------- ----------
Comprehensive income $ 5,391,719 3,047,514 2,281,870
=========== ========== ==========
See accompanying notes to consolidated financial statements.
18
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Stockholders' Equity
Years ended December 31, 2002, 2001 and 2000
ACCUMULATED
OTHER
ADDITIONAL COMPREHENSIVE TOTAL
COMMON PAID-IN INCOME (LOSS), RETAINED STOCKHOLDERS'
STOCK CAPITAL NET EARNINGS EQUITY
---------- ---------- -------- ----------- -----------
Balance, December 31, 1999 $2,687,919 2,531,998 (320,488) 24,443,871 29,343,300
Exercise of stock options 73,076 132,959 -- -- 206,035
Tax benefit of stock option exercise -- 4,251 -- -- 4,251
Repurchase of stock (46,385 shares) (46,385) (434,272) -- -- (480,657)
Other comprehensive income, net of taxes -- -- 350,195 -- 350,195
Net income for year -- -- -- 1,931,675 1,931,675
Cash dividends ($.20 per share) -- -- -- (542,620) (542,620)
---------- ---------- -------- ----------- -----------
Balance, December 31, 2000 2,714,610 2,234,936 29,707 25,832,926 30,812,179
Exercise of stock options 141,537 392,364 -- -- 533,901
Tax benefit of stock option exercise -- 60,372 -- -- 60,372
Stock traded to exercise options
(20,700 shares) (20,700) (251,952) -- -- (272,652)
Other comprehensive income, net of taxes -- -- 158,571 -- 158,571
Net income for year -- -- -- 2,888,943 2,888,943
Cash dividends ($.20 per share) -- -- -- (563,034) (563,034)
---------- ---------- -------- ----------- -----------
Balance, December 31, 2001 2,835,447 2,435,720 188,278 28,158,835 33,618,280
Exercise of stock options 500 4,925 -- -- 5,425
Other comprehensive income, net of taxes -- -- 447,222 -- 447,222
Net income for year -- -- -- 4,944,497 4,944,497
Cash dividends ($.20 per share) -- -- -- (567,163) (567,163)
---------- ---------- -------- ----------- -----------
Balance, December 31, 2002 $2,835,947 2,440,645 635,500 32,536,169 38,448,261
========== ========== ======== =========== ===========
See accompanying notes to consolidated financial statements.
19
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years ended December 31, 2002, 2001 and 2000
2002 2001 2000
------------- ----------- -----------
Net income $ 4,944,497 2,888,943 1,931,675
Adjustments to reconcile net income to net cash
provided by operating activities:
Net accretion and amortization 300,135 45,494 15,085
Depreciation 801,173 669,842 639,291
Net (gain) loss on sale of securities (135,182) (125,172) 287,282
Gain on sale of loans (1,777,314) (11,150) (245)
Deferred tax benefit (3,990) (276,589) (695,383)
Loss (gain) on sales of premises and equipment (464,977) 8,621 (130)
Gain on sale of branch office -- -- (582,583)
Loss (gain) on sales of foreclosed real estate (6,855) 3,793 22,681
Valuation losses on foreclosed real estate 108,738 36,330 --
Provision for loan losses 740,000 460,000 970,000
Proceeds from sales of loans 106,027,979 506,245 44,560
Loan originations held for sale (129,910,600) -- --
Changes in assets and liabilities:
Accrued interest receivable 397,541 139,037 (309,675)
Prepaid expenses and other assets (148,324) (843,020) 890,265
Accrued interest payable 20,177 (36,005) (169,702)
Accrued expenses and other liabilities 2,225,719 269,985 496,507
------------- ----------- -----------
Net cash provided (used) by operating activities (16,881,283) 3,736,354 3,539,628
------------- ----------- -----------
Purchases of securities available for sale (29,203,805) (82,123,753) (10,000,000)
Purchases of securities held to maturity (4,165,348) -- (986,604)
Purchase of Lumina Mortgage Company (773,188) -- --
Proceeds from maturity of securities available for sale -- 16,000,000 5,000,000
Proceeds from sale of securities available for sale 24,058,015 43,107,351 16,277,957
Proceeds from maturities of securities held to maturity -- 8,000,000 --
Repayments of mortgage-backed securities available for sale 6,721,816 2,413,006 213,783
Repayments of mortgage-backed securities held to maturity 1,192,533 -- --
Loan originations, net of principal repayments (18,229,406) (28,078,369) (15,451,318)
Proceeds from disposals of foreclosed real estate 221,207 643,413 353,420
Purchases of premises and equipment (1,311,187) (902,513) (789,299)
Proceeds from sales of premises and equipment 499,071 3,518 68,154
Net cash paid related to sale of branch office -- -- (5,156,761)
Net expenditures on foreclosed real estate (111,829) (35,352) (14,985)
Purchases of FHLB stock (350,000) (399,600) --
Proceeds from sale of FHLB stock 450,200 -- --
Purchases of life insurance (1,000,000) (8,088,704) --
------------- ----------- -----------
Net cash used in investing activities (22,001,921) (49,461,003) (10,485,653)
------------- ----------- -----------
Net increase in deposits 17,424,044 12,517,728 29,576,608
Net proceeds (repayments) on short-term borrowings 6,585,827 5,000,000 (40,000,000)
Repayments on long-term obligations (4,564) (4,321) (4,090)
Proceeds received on long-term obligations 15,000,000 23,000,000 20,000,000
Proceeds from issuance of common stock, net 5,425 261,249 206,035
Purchase and retirement of common stock -- -- (480,657)
Dividends paid (567,163) (563,034) (406,890)
Net change in escrow deposits 2,660 (339,831) 218,071
------------- ----------- -----------
Net cash provided by financing activities 38,446,229 39,871,791 9,109,077
------------- ----------- -----------
Increase (decrease) in cash and
cash equivalents (436,975) (5,852,858) 2,163,052
Cash and cash equivalents:
Beginning of year 12,295,578 18,148,436 15,985,384
------------- ----------- -----------
End of year $ 11,858,603 12,295,578 18,148,436
============= =========== ===========
(Continued)
20
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years ended December 31, 2002, 2001 and 2000
2002 2001 2000
----------- ---------- ----------
Cash paid for:
Interest $13,854,710 18,952,319 19,305,008
Income taxes 2,597,763 1,699,583 1,739,500
Summary of noncash investing and financing activities:
Transfer from loans to other real estate owned 989,602 1,151,318 351,201
Transfer of premises and equipment to other real
real estate owned -- 21,427 --
Loans to facilitate the sale of foreclosed
real estate 918,450 -- --
Unrealized gains (losses) on securities available
for sale, net of taxes 447,222 158,571 350,195
Transfer of securities from held to maturity to
available for sale at fair value -- 5,946,000 --
Long-term obligations reclassified to short-term
borrowings 20,000,000 15,000,000 15,000,000
See accompanying notes to consolidated financial statements.
21
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
(1) BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts and transactions
of Cooperative Bankshares, Inc. (the Company), a bank holding company
incorporated under the laws of the State of North Carolina, and its wholly
owned subsidiary, Cooperative Bank (the Bank), and the Bank's wholly owned
subsidiaries, Lumina Mortgage Company, Inc. (Lumina) and CS&L Holdings,
Inc. (Holdings) and Holdings' wholly owned subsidiary, CS&L Real Estate
Trust, Inc. (REIT). All significant intercompany transactions have been
eliminated.
NATURE OF OPERATIONS
The Company operates 20 offices (including 16 full service branches) in
Eastern North Carolina and North Myrtle Beach, South Carolina and Virginia
Beach, Virginia and offers a wide range of banking services including
deposits, bankcards, and alternative investment products. The funds are
used for the extension of credit through home loans, commercial loans,
consumer loans, and other installment credit such as home equity loans,
auto and boat loans, and check reserves. The Company's primary source of
revenue is interest income from its loan and securities portfolios.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities in the financial statements and accompanying notes. Actual
results could differ from those estimates. The most significant estimates
made by the Company in the preparation of the consolidated financial
statements are the determination of the reserve for loan losses and fair
value estimates.
RECLASSIFICATIONS
Certain items included in prior years' consolidated financial statements
have been reclassified to conform to the current year presentation. These
reclassifications have no effect on the net income or stockholders' equity
as previously reported.
SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies of the Company are summarized below:
(a) CASH AND CASH EQUIVALENTS
Cash and cash equivalents include demand and time deposits (with
original maturities of ninety days or less) at other institutions.
Federal regulations require institutions to set aside specified
amounts of cash as reserves against transaction and time deposits. As
of December 31, 2002, the daily average gross reserve requirement was
$823,000.
22
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
(b) SECURITIES
Investments in certain securities are classified into three categories
and accounted for as follows: (1) debt securities that the entity has
the positive intent and the ability to hold to maturity are classified
as held to maturity and reported at amortized cost; (2) debt and
equity securities that are bought and held principally for the purpose
of selling them in the near term are classified as trading securities
and reported at fair value, with unrealized gains and losses included
in earnings; (3) debt and equity securities not classified as either
held to maturity securities or trading securities are classified as
available for sale securities and reported at fair value, with
unrealized gains and losses excluded from net income and reported as
other comprehensive income and included as a separate component of
stockholders' equity.
Premiums are amortized and discounts are accreted using the effective
interest method over the remaining terms of the related securities.
Gains and losses on the sales of securities are determined using the
specific-identification method and are included in noninterest income
at the time of sale.
(c) FHLB STOCK
The Company, as a member of the Federal Home Loan Bank (FHLB) System,
is required to maintain an investment in capital stock of the FHLB of
Atlanta in an amount equal to the greater of 1% of its outstanding
home loans or 5% of its outstanding FHLB advances. No ready market
exists for FHLB stock, and it has no quoted market value. The FHLB
stock is carried at cost.
(d) LOANS HELD FOR SALE
As a part of its normal business operations, the Company originates
mortgage loans that have been approved by secondary investors. The
Company issues a rate lock commitment to a customer and concurrently
"locks in" with a secondary market investor under a best efforts
delivery mechanism. The terms of the loan are set by the secondary
investors and are transferred within several weeks of the Company
initially funding the loan. The Company receives origination fees from
borrowers and servicing release premiums from the investors that are
recognized on the Statement of Operations in the line item "gain on
sale of loans". Between the initial funding of the loans by the
Company and the subsequent purchase by the investor, the Company
carries the loans on its balance sheet at cost.
(e) LOANS AND ALLOWANCE FOR LOAN LOSSES
Loans are stated at the amount of unpaid principal, reduced by an
allowance for loan losses, unearned discounts and net deferred loan
origination fees and costs. Interest income on loans is recorded on
the accrual basis based upon the principal amount outstanding.
Deferred loan fees and costs and unearned discounts are amortized to
interest income over the contractual life of the loan using the
interest method. If a loan is sold, the remaining deferred loan fees
and costs are included in gain on sale of loans in the period the loan
is sold.
23
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
The Company evaluates its loan portfolio in accordance with Statement
of Financial Accounting Standards (SFAS) No. 114, "Accounting by
Creditors for Impairment of a Loan" as amended by SFAS No. 118,
"Accounting by Creditors for Impairment of a Loan - Income Recognition
and Disclosure". Under these standards, a loan is considered impaired,
based on current information and events, if it is probable that the
Company will be unable to collect the scheduled payments of principal
and interest when due according to the contractual terms of the loan
agreement. Uncollateralized loans are measured for impairment based on
the present value of expected future cash flows discounted at the
original contractual interest rate, while all collateral-dependent
loans are measured for impairment based on the fair value of the
collateral. As permitted by the Statement, smaller-balance homogeneous
loans which consist primarily of residential mortgages and consumer
loans are evaluated collectively and reserves are established based on
historical loss experience.
The Company uses several factors in determining if a loan is impaired.
The internal asset classification procedures include a thorough review
of significant loans and lending relationships and the accumulation of
related data. This data includes loan payment status, borrowers'
financial data and borrowers' operating factors such as cash flows and
operating income or loss.
The allowance for loan losses is established through a provision
charged to income. The allowance is an amount that management believes
will be adequate to absorb probable losses on existing loans, based on
the evaluations of the collectibility of loans and prior loan loss
experience. The evaluations take into consideration such factors as
changes in the nature and volume of the loan portfolio quality, review
of specific problem loans, and current economic conditions and trends
that may affect the borrowers' ability to pay. It is possible that
such factors in management's evaluations of the adequacy of the
allowance for loan losses will change. Thus, future additions to the
allowance may be necessary based on the impact of changes in economic
conditions.
Additionally, various regulatory agencies, as an integral part of
their examination process, periodically review the Company's allowance
for loan losses. Such agencies may require the recognition of
additions to the allowance based on their judgments of information
available to them at the time of their examination.
(f) INCOME RECOGNITION ON IMPAIRED AND NONACCRUAL LOANS
Loans, including impaired loans, are generally classified as
nonaccrual if they are past due for a payment of principal or interest
for a period of more than 90 days, unless such loans are well-secured
and in the process of collection. Loans that are on a current payment
status or past due less than 90 days may also be classified as
nonaccrual if repayment in full of principal and/or interest is in
doubt. When interest accrual is discontinued, all unpaid accrued
interest is reversed. Interest income is subsequently recognized only
to the extent cash payments are received.
Loans may be returned to accrual status when all principal and
interest amounts contractually due (including arrearages) are
reasonably assured of repayment within an acceptable period of time,
and there is a sustained period of repayment performance (generally a
minimum of six months) by the borrower, in accordance with the
contractual terms of interest and principal.
24
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
When the future collectibility of the recorded loan balance is
expected, interest income may be recognized on a cash basis. In the
case where a nonaccrual loan had been partially charged-off,
recognition of interest on a cash basis is limited to that which would
have been recognized on the recorded loan balance at the contractual
interest rate. Receipts in excess of that amount are recorded as
recoveries to the allowance for loan losses until prior charge-offs
have been fully recovered.
(g) TRANSFERS AND SERVICING OF FINANCIAL ASSETS
There were $8,832,200 and $470,400 in loans sold in 2002 and 2001,
respectively, with retained servicing rights. The recorded balance of
the rights to service mortgage loans for others was $73,240 at
December 31, 2002 as compared to $3,898 at December 31, 2001 and is
included in other assets. There were no loan sales in 2000 with
retained servicing rights.
Servicing loans for others generally consists of collecting mortgage
payments, maintaining escrow accounts, disbursing payments to
investors and foreclosure processing. Loan servicing income is
recorded on the cash basis less the amortized amount for retained
servicing rights and includes servicing fees from investors and
certain charges collected from borrowers, such as late payment fees.
(h) OTHER REAL ESTATE OWNED
Other real estate owned is recorded initially at the lower of the loan
balance or estimated fair value of the property less estimated costs
to sell at the date of foreclosure and subsequently reduced by
additional allowances which are charged to earnings if the estimated
fair value declines below its initial value plus any capitalized
costs. Costs related to the improvement of the property are
capitalized, whereas those related to holding the property are
expensed.
(i) PREMISES AND EQUIPMENT
Premises and equipment are carried at cost less accumulated
depreciation and amortization. The provision for depreciation is
computed using the straight-line method over the estimated useful
lives of the various classes of assets. Useful lives range from 15 to
40 years for buildings and 5 to 10 years for furniture and equipment.
The cost of leasehold improvements is amortized on the straight-line
method over the lesser of the lives of the improvements or the terms
of the leases. Repairs and maintenance are charged to expense as
incurred.
(j) INCOME TAXES
Deferred tax asset and liability balances are determined by
application to temporary differences of the tax rate expected to be in
effect when taxes become payable or receivable. Temporary differences
are differences between the tax basis of assets and liabilities and
their reported amounts in the consolidated financial statements that
will result in taxable or deductible amounts in future years.
25
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
(k) STOCK-BASED COMPENSATION
On January 1, 1996 the Company adopted SFAS No. 123, "Accounting for
Stock-Based Compensation". As permitted by SFAS No. 123, the Company
has chosen to continue to apply APB Opinion No. 25, "Accounting for
Stock Issued to Employees" and related interpretations. The option
exercise price is the market price of the common stock on the date the
option is granted. Accordingly, no compensation cost has been
recognized for options granted under the Option Plan. Had compensation
cost for the Company's Option Plan been determined based on the fair
value at the grant dates for awards under the Option Plan consistent
with the method of SFAS No. 123, the Company's net income and net
income per share would have been reduced to the pro forma amounts
indicated below.
YEAR ENDED DECEMBER 31,
--------------------------------------------
2002 2001 2000
------------- ------------ -----------
Net income, as reported $ 4,944,497 2,888,943 1,931,675
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects (60,543) (29,097) (46,905)
------------- ------------ -----------
Proforma net income $ 4,883,954 2,859,846 1,884,770
============= ============ ===========
Earnings per share:
Basic - as reported $ 1.74 1.03 0.71
============= ============ ===========
Basic - proforma $ 1.72 1.02 0.69
============= ============ ===========
Diluted- as reported $ 1.73 1.02 0.69
============= ============ ===========
Diluted - proforma $ 1.71 1.01 0.67
============= ============ ===========
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for grants in 2002, 2001 and 2000.
The weighted average fair values of options granted in 2002, 2001 and
2000 were $3.60, $2.65 and $1.85, respectively.
2002 2001 2000
----- ------ ------
Risk-free interest rate 4.79% 4.86% 6.00%
Dividend yield 1.45% 1.85% 2.00%
Expected volatility 25% 20% 20%
Expected lives (in years) 8 8 5
(Continued)
26
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
(l) COMPREHENSIVE INCOME
The Company reports as comprehensive income all changes in
stockholders' equity during the year from nonowner sources. Other
comprehensive income refers to all components (revenues, expenses,
gains, and losses) of comprehensive income that are excluded from net
income. The Company's only component of other comprehensive income is
unrealized gains and losses on securities available for sale.
(m) SEGMENT INFORMATION
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", requires that public business enterprises report certain
information about operating segments. It also requires that the public
business enterprises report related disclosures and descriptive
information about products and services provided by significant
segments, geographic areas, and major customers, differences between
the measurements used in reporting segments and those used in the
enterprise's general-purpose financial statements, and changes in the
measurement of segment amounts from period to period.
The Company has determined that it operates primarily in one operating
segment, the providing of general commercial financial services to
customers located in the single geographic area of Eastern North
Carolina, Southeastern Virginia and Northeastern South Carolina. The
various products are those generally offered by community banks, and
the allocation of resources is based on the overall performance of the
institution, versus the individual branches or products.
(n) NEW ACCOUNTING PRONOUNCEMENTS
On January 1, 2001, the Company adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities". The statement is
effective for fiscal years beginning after June 15, 2000, with earlier
adoption permitted, as amended by SFAS No. 137. SFAS No. 133
establishes accounting and reporting standards for derivative
instruments and for hedging activities. The statement requires an
entity to recognize all derivatives as either assets or liabilities in
the statement of financial position and measure those instruments at
fair value. On January 1, 2001, the Company transferred
held-to-maturity investment securities with an amortized cost of
approximately $5,978,000 to the available-for-sale category at fair
value as allowed by SFAS No. 133. The unrealized loss at the time of
transfer was approximately $32,000 before tax. Such transfers from the
held-to-maturity category at the date of initial adoption shall not
call into question the Company's intent to hold other debt securities
to maturity in the future.
The Company does not engage in hedging activities except for the buy
and sell commitments for loans held for sale, which are deemed
immaterial due to the fact the Company issues a rate lock commitment
to a customer and concurrently "locks in" the loan with a secondary
market investor under a best efforts delivery mechanism. Therefore,
market risk is mitigated because any commitments to fund a loan
available for sale is concurrently hedged by a commitment from an
investor to purchase the loan under the same terms. Loans are usually
sold within 60 days after closing. Other than the aforementioned
transfer of securities, the adoption of the Statement had no material
impact on the Company.
(Continued)
27
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
On July 1, 2001, the Company adopted SFAS No. 141, "Business
Combinations". This Statement improves the transparency of the
accounting and reporting for business combinations by requiring that
all business combinations be accounted for under a single method - the
purchase method. Use of the pooling-of-interests method is no longer
permitted. SFAS No. 141 requires that the purchase method be used for
business combinations initiated after June 30, 2001. The purchase
method was used in recording the acquisition of Lumina Mortgage
Company.
On January 1, 2002, the Company adopted SFAS No. 142 "Goodwill and
Other Intangible Assets". This Statement requires that goodwill no
longer be amortized to earnings, but instead be reviewed for
impairment. The Company did not have any goodwill until the purchase
of Lumina Mortgage Company on May 31, 2002. This purchase created
goodwill in the amount of $661,543. In accordance with Statement No.
142, this goodwill will not be amortized but instead will be tested
for impairment annually.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS No. 143 requires the Company to record
the fair value of an asset retirement obligation as a liability in the
period in which it incurs a legal obligation associated with the
retirement of tangible long-lived assets that result from the
acquisition, construction, development, and/or normal use of the
assets. The Company also records a corresponding asset that is
depreciated over the life of the asset. Subsequent to the initial
measurement of the asset retirement obligation, the obligation will be
adjusted at the end of each period to reflect the passage of time and
changes in the estimated future cash flows underlying the obligation.
The Company is required to adopt SFAS No. 143 on January 1, 2003. The
adoption of SFAS No. 143 is not expected to have a material effect on
the Company's consolidated financial statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", which supersedes SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of", and the accounting and reporting
provisions of APB Opinion No. 30, "Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events
and Transactions". SFAS No. 144 establishes a single accounting model
for long-lived assets to be disposed of by a sale. The Company adopted
the provisions of SFAS No. 144 on January 1, 2002. The implementation
did not have a material impact on the Company's consolidated financial
statements.
(Continued)
28
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and
Technical Corrections". SFAS No. 145 amends existing guidance on
reporting gains and losses on the extinguishment of debt to prohibit
the classification of the gain or loss as extraordinary, as the use of
such extinguishments have become part of the risk management strategy
of many companies. SFAS No. 145 also amends SFAS No. 13 to require
sale-leaseback accounting for certain lease modifications that have
economic effects similar to sale-leaseback transactions. The
provisions of the Statement related to the rescission of Statement No.
4 is applied in fiscal years beginning after May 15, 2002. Earlier
application of these provisions is encouraged. The provisions of the
Statement related to Statement No. 13 were effective for transactions
occurring after May 15, 2002, with early application encouraged. The
adoption of SFAS No. 145 is not expected to have a material effect on
the Company's consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS No. 146 addresses
financial accounting and reporting for costs associated with exit or
disposal activities and nullifies Emerging Issues Task Force (EITF)
Issue 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity". The provisions of this
Statement are effective for exit or disposal activities that are
initiated after December 31, 2002, with early application encouraged.
The adoption of SFAS No. 146 is not expected to have a material effect
on the Company's consolidated financial statements.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of
Certain Financial Institutions". This Statement requires financial
institutions to subject all of their goodwill, including amounts
previously recorded as intangible assets relating to transactions now
determined to be business combinations under SFAS No. 147, to an
annual impairment test instead of amortizing the asset over its
estimated useful life. The adoption of SFAS No. 147 on October 1, 2002
did not have a material effect on the Company's consolidated financial
statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness to Others, an interpretation of
FASB Statements No. 5, 57 and 107 and a rescission of FASB
Interpretation No. 34". This Interpretation elaborates on the
disclosures to be made by a guarantor in its interim and annual
financial statements about its obligations under guarantees issued.
The Interpretation also clarifies that a guarantor is required to
recognize, at inception of a guarantee, a liability for the fair value
of the obligation undertaken. The initial recognition and measurement
provisions of the Interpretation are applicable to guarantees issued
or modified after December 31, 2002 and are not expected to have a
material effect on the Company's consolidated financial statements.
The disclosure requirements are effective for financial statements of
interim and annual periods ending after December 15, 2002.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of
FASB Statement No. 123. This Statement amends FASB Statement No. 123,
Accounting for Stock-Based Compensation", to provide alternative
methods of transition for a voluntary change to the fair value method
of accounting for stock-based employee compensation. In addition, this
Statement amends the disclosure requirements of Statement No. 123 to
require prominent disclosures in both annual and interim financial
statements.
(Continued)
29
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
Certain of the disclosure modifications are required for fiscal years
ending after December 15, 2002 and are included in the notes to these
consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities, an interpretation of ARB No. 51". This
Interpretation addresses the consolidation by business enterprises of
variable interest entities as defined in the Interpretation. The
Interpretation applies immediately to variable interests in variable
interest entities created after January 31, 2003, and to variable
interests in variable interest entities obtained after January 31,
2003. For public enterprises with a variable interest in a variable
interest equity created before February 1, 2003, the interpretation
applies to that enterprise no later than the beginning of the first
interim or annual reporting period beginning after June 15, 2003. The
application of this Interpretation is not expected to have a material
effect on the Company's consolidated financial statements. The
Interpretation requires certain disclosures in financial statements
issued after January 31, 2003 if it is reasonably possible that the
Company will consolidate or disclose information about variable
interest entities when the Interpretation becomes effective.
(2) SECURITIES
Securities as of December 31, 2002 and 2001 are summarized as follows:
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
AMORTIZED COST GAINS LOSSES MARKET VALUE
-------------- ---------- ---------- ------------
2002:
SECURITIES AVAILABLE FOR SALE:
U.S. Government and agency
securities $ 19,104,121 558,725 -- 19,662,846
Mortgage-backed securities 14,457,784 348,228 -- 14,806,012
Marketable equity securities 4,975,000 99,500 -- 5,074,500
Corporate bonds 2,496,504 59,743 24,393 2,531,854
------------ ----------- --------- ------------
Total $ 41,033,409 1,066,196 24,393 42,075,212
============ =========== ========= ============
SECURITIES HELD TO MATURITY:
U.S. Government and agency
securities $ 5,000,000 122,600 -- 5,122,600
Mortgage-backed securities 2,859,955 26,532 -- 2,886,487
------------ ----------- --------- ------------
$ 7,859,955 149,132 -- 8,009,087
============ =========== ========= ============
(Continued)
30
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
AMORTIZED COST GAINS LOSSES MARKET VALUE
-------------- ---------- ---------- ------------
2001:
SECURITIES AVAILABLE FOR SALE:
U.S. Government and agency
securities $ 25,600,964 268,987 112,134 25,757,817
Mortgage-backed securities 11,070,696 120,060 67,456 11,123,300
Marketable equity securities 4,984,950 114,425 -- 5,099,375
Corporate bonds 1,004,917 -- 15,229 989,688
--------------- ----------- ----------- -----------
Total $ 42,661,527 503,472 194,819 42,970,180
=============== =========== =========== ===========
SECURITIES HELD TO MATURITY:
U.S. Government and agency
securities $ 5,000,000 282,815 -- 5,282,815
=============== =========== =========== ===========
The maturities of securities at December 31, 2002 are summarized as
follows:
ESTIMATED
AMORTIZED MARKET
COST VALUE
----------- -----------
Held to maturity:
Within 1 year $ 5,000,000 5,122,600
Mortgage-backed securities 2,859,955 2,886,487
----------- -----------
$ 7,859,955 8,009,087
=========== ===========
Available for sale:
Within 1 year $ 300,516 306,000
After 1 year through 5 years 12,697,765 12,983,166
After 5 years through 10 years 8,602,344 8,905,534
Marketable equity securities 4,975,000 5,074,500
Mortgage-backed securities 14,457,784 14,806,012
----------- -----------
$41,033,409 42,075,212
=========== ===========
Expected maturities for mortgage-backed securities will differ from
contractual maturities because borrowers have the right to prepay
obligations without prepayment penalties.
For the three years ended December 31, 2002, sales of investment securities
resulted in gross realized gains of $135,182 in 2002, gross realized gains
of $125,172 in 2001, gross realized gains of $4,697 and gross realized
losses of $291,979 in 2000.
(Continued)
31
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
Investment securities having an aggregate carrying value of $13,905,534 at
December 31, 2002 were pledged to secure public funds on deposit.
Investment securities having an aggregate carrying value of $511,312 at
December 31, 2002 were pledged to secure repurchase agreements. Investment
securities having an aggregate carrying value of $987,720 at December 31,
2002 were pledged to secure the Treasury tax and loan account with the
Federal Reserve Bank.
(3) LOANS
Loans at December 31, 2002 and 2001 are summarized as follows (in
thousands):
2002 2001
--------- ---------
Real estate:
Construction and land development $ 51,431 62,142
Mortgage:
1-4 family residential 204,395 209,622
Multi-family residential 17,044 15,626
Commercial 87,257 55,664
Equity line 14,541 13,131
Other 363 254
--------- ---------
Total real estate loans 375,031 356,439
Commercial, industrial and agricultural 13,717 13,430
Consumer 6,396 7,285
--------- ---------
Total gross loans 395,144 377,154
Unamortized net deferred fees (1,331) (1,173)
--------- ---------
Loans $ 393,813 375,981
========= =========
In the normal course of business, the Company originates loans to related
parties. Related parties include directors, executive officers, principal
shareholders of equity securities, or any associate of such persons. The
activity with respect to related party loans is summarized below for the
year ending December 31, 2002 (in thousands):
Balance at beginning of year $ 6,380
New loans 2,503
Repayments (1,076)
-------
Balance at end of year $ 7,807
=======
(Continued)
32
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
Activity in the allowance for loan losses for the years ended December 31,
2002, 2001 and 2000 is summarized as follows (in thousands):
2002 2001 2000
------- ------- -------
Balance at beginning of year $ 2,523 2,160 1,306
Provision for loan losses 740 460 970
Loans charged-off (360) (106) (146)
Recoveries 34 9 30
------- ------- -------
Balance at end of year $ 2,937 2,523 2,160
======= ======= =======
The following is a summary of nonperforming assets at December 31, 2002 and
2001 (in thousands):
2002 2001
------ ------
Loans 90 days past due and still accruing interest $ 249 2,563
Nonaccrual loans 335 505
Other real estate owned 619 759
------ ------
Total $1,203 3,827
====== ======
At December 31, 2002, 2001 and 2000, the recorded investment in loans
considered impaired in accordance with SFAS No. 114 totaled $334,289,
$505,378 and $332,779, respectively, with no corresponding valuation
allowances. For the years ended December 31, 2002, 2001 and 2000, the
average recorded investment in impaired loans was approximately $254,000,
$513,000 and $204,000, respectively. The amount of interest recognized on
impaired loans during the portion of the year that they were impaired was
not material.
In the normal course of business, the Company enters into off-balance sheet
commitments to extend credit. The Company maintains the same credit
policies in making off-balance sheet commitments as it does for its
on-balance sheet instruments. Commitments to extend credit are agreements
to lend which generally have fixed expiration dates or other termination
clauses and may require a fee.
The following table summarizes the Company's outstanding off-balance sheet
commitments to extend credit at December 31, 2002 and 2001 (in thousands):
2002 2001
------- -------
Undisbursed portion of home equity lines of credit
collateralized primarily by junior liens on 1-4
family properties $14,130 12,031
Other commitments and credit lines 13,843 15,755
Undisbursed portion of construction loans 32,667 33,728
Fixed-rate mortgage loan commitments 879 618
Adjustable-rate mortgage loan commitments 5,614 1,881
Available-for-sale mortgage loan commitments 3,729 --
------- -------
Total $70,862 64,013
======= =======
(Continued)
33
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
As commitments may expire unused, the total commitment amount does not
necessarily represent future cash requirements.
The Company, through its normal lending activity, originates and maintains
loans which are substantially concentrated in Eastern North Carolina, where
its offices are located. The Company's policy calls for collateral or other
forms of repayment assurance to be received from the borrower at the time
of loan origination. Such collateral or other form of repayment assurance
is subject to changes in economic value due to various factors beyond the
control of the Company and such changes could be significant.
The Company originates both adjustable and fixed interest rate loans. The
adjustable-rate loans have interest rate adjustment limitations and are
indexed to various nationally recognized indexes or financial instruments.
Future market factors may affect the correlation of the interest rate
adjustment with rates the Company pays on the short term deposits that have
been primarily utilized to fund these loans.
Mortgage loans serviced for others approximated $44,809,000, $56,041,000
and $74,140,000 at December 31, 2002, 2001 and 2000, respectively.
(4) PREMISES AND EQUIPMENT
Premises and equipment at December 31, 2002 and 2001 are summarized as
follows (in thousands):
2002 2001
-------- --------
Land $ 2,526 1,984
Buildings 5,539 5,524
Leasehold improvements 369 308
Furniture and equipment 6,516 5,786
-------- --------
14,950 13,602
Less accumulated depreciation and amortization (7,931) (7,130)
-------- --------
Premises and equipment, net $ 7,019 6,472
======== ========
(5) DEPOSITS
Deposits at December 31, 2002 and 2001, are summarized as follows (in
thousands):
2002 2001
-------- --------
Demand $ 19,800 17,716
Checking with interest 20,630 18,523
Money market accounts 24,213 24,862
Savings 20,345 20,175
Time deposits of $100 or more 85,831 74,610
Other time deposits 186,435 183,944
-------- --------
Total $357,254 339,830
======== ========
(Continued)
34
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
At December 31, 2002, the scheduled maturities of time deposits were (in
thousands):
2003 $209,351
2004 59,689
2005 2,964
2006 100
2007 81
Thereafter 81
--------
Total time deposits $272,266
========
(6) BORROWED FUNDS
Borrowed funds and the corresponding weighted average rates (WAR) at
December 31, 2002 and 2001 are summarized as follows:
2002 WAR 2001 WAR
--------------- ------- ------------ ----------
Advances from FHLB $ 81,000,000 3.84% $ 83,000,000 4.59%
Affordable Housing Program
Advances from FHLB 92,592 3.50% 97,156 3.50%
Advances for loans held
for sale 23,485,233 4.09% -- --
Repurchase agreements 100,594 0.70% -- --
--------------- ------------
Total $ 104,678,419 $ 83,097,156
=============== ============
Pursuant to a collateral agreement with the FHLB, advances are
collateralized by all the Company's FHLB stock and qualifying first
mortgage loans. The balance of qualifying first mortgage loans as of
December 31, 2002 was approximately $115,762,000. This agreement with the
FHLB provides for a line of credit up to 25% of the Bank's assets. The
maximum month end balances were $83 million, $83 million and $75 million
during the years ended December 31, 2002, 2001 and 2000, respectively.
Annual principal maturities of Federal Home Bank advances for the years
subsequent to December 31, 2002 are as follows:
2003 $ 38,000,000
2004 15,000,000
2006 5,000,000
2010 10,000,000
2011 13,000,000
----------------
$ 81,000,000
================
(Continued)
35
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
The Affordable Housing Program advances are funds advanced by the FHLB for
the Company to lend to borrowers who might not otherwise qualify for a home
mortgage. These advances have an interest rate of 3.50% and mature at
various times between November 2015 and January 2016.
Lumina borrows money on a short-term basis principally from another
financial institution to fund its loans that are held for sale. At December
31, 2002, the balance of this borrowing was $23.5 million. Borrowings for
loans that were funded from this line of credit within 60 days were at a
rate of 3.63% and borrowings for loans that were funded more than 60 days
($2.3 million) were at a rate of 8.25%. This borrowing is collateralized by
mortgage loans held for sale. When a loan is sold, the proceeds are used to
repay the borrowing. Loans are usually sold within 60 days. This borrowing
agreement provides for a maximum line of credit up to $10 million, but the
financial institution continues to supply sufficient funds for loans
originated by Lumina during the large volume increase caused by the current
low interest rate environment.
Cooperative enters into agreements with customers to transfer excess funds
in a demand account into a repurchase agreement. Under the repurchase
agreement, the Bank sells the customer an interest in securities that are
direct obligations of the United States Government. The customer's interest
in the underlying security shall be repurchased by the Bank at the opening
of the next banking day. The rate fluctuates weekly and is tiered, with the
highest rate being .50% below the 90-day Treasury Bill.
(7) REGULATORY MATTERS AND CAPITAL REQUIREMENTS
The Company is subject to various regulatory capital requirements
administered by federal and state banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory, and possibly
additional discretionary actions by regulators that, if undertaken, could
have a direct material effect on the Company's consolidated financial
statements. Quantitative measures established by regulation to ensure
capital adequacy require the Company to maintain minimum amounts and
ratios, as set forth in the table below. Management believes, as of
December 31, 2002, that the Company meets all capital adequacy requirements
to which it is subject. The Company's only significant asset is its
investment in Cooperative Bank. Consequently, the information concerning
capital ratios is essentially the same for the Company and the Bank.
As of December 31, 2002 and 2001, the most recent notification from the
FDIC categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well
capitalized the Bank must maintain minimum amounts and ratios, as set forth
in the table below. There are no conditions or events since that
notification that management believes have changed the Bank's category.
(Continued)
36
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
The Bank's actual capital amounts and ratios are also presented in the
table below (dollars in thousands) as of December 31:
MINIMUM RATIO TO MAINTAIN
WELL-CAPITALIZED STATUS
------------------------------
2002 2001 2002 2001
---------- --------- --------- ---------
Risk-based capital:
Tier I capital $ 37,193 33,428
Total capital 40,130 35,951
Risk-adjusted assets 364,763 326,820
Quarterly average
tangible assets 494,455 447,214
Tier I capital ratio 10.20% 10.23% 6.00% 6.00%
Total capital ratio 11.00% 11.00% 10.00% 10.00%
Leverage capital ratio 7.52% 7.47% 5.00% 5.00%
A liquidation account was established at the time of conversion to a stock
institution in an amount equal to the total net worth of the Bank as of
March 31, 1991. Each eligible deposit account holder is entitled to a
proportionate share of this account in the event of a complete liquidation
of the Bank, and only in such an event. This share will be reduced if the
account holder's eligible deposits fall below the amount on the date of
record and will cease to exist if the account is closed. The liquidation
account will never be increased despite any increase after the conversion
in the related eligible deposit of an account holder. The liquidation
account was approximately $2,219,170 at December 31, 2002.
The Bank may not declare or pay a cash dividend, or repurchase any of its
capital stock, if the effect would cause the regulatory net worth of the
Bank to fall below the amount required for the liquidation account
established in connection with the conversion, or to an amount which is
less than the minimum required by the FDIC and the North Carolina Office of
the Commissioner of Banks.
(8) BENEFIT PLANS
The Company participates in a qualified, noncontributory, defined-benefit,
multi-employer retirement plan (the Plan) covering substantially all of its
employees. The benefits are based on each employee's years of service and
the employee's compensation during the last five years of employment.
Under the multi-employer plan, the Company is required to contribute its
share of the Plan's total pension liability as determined by the plan
administrator. Expenses related to this Plan were $164,618, $34,537 and
$303,803 for the years 2002, 2001 and 2000, respectively.
During 2000, the Company made certain changes to its defined benefit plan.
As a result of these changes, three executives of the Company decided to
take early retirement. The Company established a deferred compensation plan
for these executives, which resulted in a pre-tax charge of approximately
$686,000.
(Continued)
37
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
The Bank maintains a Supplemental Retirement 401(k) Plan (the 401(k)).
Employees are able to contribute up to 15% of their eligible annual
compensation to the 401(k) subject to Internal Revenue Service limitations.
The Bank matches employee contributions up to a limit determined annually
by the Board of Directors. The Board established the match at 50% up to the
first 6% of the employee contribution for 2002, 2001 and 2000.
The compensation expense incurred by the Company for the 401(k) was
$90,098, $78,585 and $107,784 for the years ended December 31, 2002, 2001
and 2000, respectively.
Lumina also maintains a 401(k) plan for its employees. Participants are
able to contribute up to 20% of their eligible annual compensation to this
plan subject to Internal Revenue Service limitations. The Company does not
match employee contributions.
(9) EARNINGS PER SHARE
The following table provides a reconciliation of income available to common
stockholders and the average number of shares outstanding for the years
ended December 31, 2002, 2001 and 2000:
2002 2001 2000
---------- ---------- ----------
Net income (numerator) $4,944,497 2,888,943 1,931,675
========== ========== ==========
Shares for basic EPS (denominator) 2,835,712 2,797,317 2,714,216
Dilutive effect of stock options 23,302 25,874 91,395
---------- ---------- ----------
Shares for diluted EPS (denominator) 2,859,014 2,823,191 2,805,611
========== ========== ==========
For the years ended December 31, 2002, 2001 and 2000, there were 14,204,
14,204 and 114,043, respectively, of options outstanding that were
antidilutive since the exercise price exceeds the average market price for
the year. These options have been omitted from the 2002, 2001 and 2000
calculations of the dilutive effect of stock options.
(Continued)
38
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
(10) INCOME TAXES
Income tax expense consists of the following components for the years ended
December 31, 2002, 2001 and 2000:
2002 2001 2000
----------- ----------- -----------
Current tax expense:
Federal $ 2,379,444 1,651,815 1,525,540
State 426,616 214,022 148,847
----------- ----------- -----------
Total current tax expense 2,806,060 1,865,837 1,674,387
----------- ----------- -----------
Deferred tax expense (benefit):
Federal (113,579) (227,083) (570,120)
State 109,589 (49,506) (125,263)
----------- ----------- -----------
Total deferred tax benefit (3,990) (276,589) (695,383)
----------- ----------- -----------
Total tax expense $ 2,802,070 1,589,248 979,004
=========== =========== ===========
The components of the net deferred tax asset at December 31, 2002 and 2001
are as follows:
2002 2001
----------- -----------
Deferred tax assets:
Allowance for loan losses $ 1,132,134 972,515
Deferred compensation 226,150 207,118
----------- -----------
Total gross deferred tax assets 1,358,284 1,179,633
Valuation allowance (82,469) --
----------- -----------
Total net deferred tax assets 1,275,815 1,179,633
----------- -----------
Deferred tax liabilities:
Deferred loan fees 120,264 167,046
FHLB stock 169,829 190,467
Excess of book over tax basis of equipment 186,755 204,231
Unrealized gain on securities available for sale 406,303 120,376
Like kind exchange of real estate 179,249 --
Other 3,456 5,618
----------- -----------
Total 1,065,856 687,738
----------- -----------
Net deferred tax asset $ 209,959 491,895
=========== ===========
The Company has established a valuation allowance at December 31, 2002
because management has determined that it is more likely than not that some
of the deferred tax assets will not be realized. For the year ended
December 31, 2002, the valuation allowance increased $82,469.
(Continued)
39
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
Reconciliations of income taxes computed at the statutory federal income
tax rate (34%) to the provisions for income tax for the years ended
December 31, 2002, 2001 and 2000 are as follows:
2002 2001 2000
----------- ----------- -----------
Income taxes at federal tax rate $ 2,633,833 1,522,585 989,631
Increase (decrease) resulting from:
State income taxes, net of federal income
tax benefit 353,895 108,581 15,565
Cash surrender value of bank owned
life insurance (135,500) (34,035) --
Tax exempt securities (72,701) (36,350) --
Other 22,543 28,467 (26,192)
----------- ----------- -----------
Total $ 2,802,070 1,589,248 979,004
=========== =========== ===========
Retained earnings at December 31, 2002 and 2001 includes approximately
$5,170,000 representing pre-1988 tax bad debt reserve base year amounts for
which no deferred income tax liability has been provided since these
reserves are not expected to reverse and may never reverse. Circumstances
that would require an accrual of a portion or all of this unrecorded tax
liability are a reduction in qualifying loan levels relative to the end of
1987, failure to meet the definition of a bank, dividend payments in excess
of accumulated tax earnings and profits, or other distributions,
dissolution, liquidation or redemption of the Bank's stock.
(11) STOCK OPTION PLAN
The Company has a Stock Option Plan (the Option Plan) for selected
employees of the Company and for nonemployee directors. The purpose of the
Option Plan is to attract and retain the best available personnel for
positions of substantial responsibility and to provide additional incentive
to key employees and directors by facilitating their purchase of a stock
interest in the Company.
The Option Plan provides for a term of ten years, after which no awards may
be made, unless earlier terminated by the Board of Directors pursuant to
the Option Plan. The option exercise price is the market price of the
common stock on the date the option is granted. Options are fully vested
and exercisable upon being granted.
(Continued)
40
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
A summary of the status of the Option Plan as of December 31, 2002, 2001
and 2000, and changes during the years then ended is presented below:
2002 2001 2000
----------------------------- ----------------------------- -----------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER OPTION PRICE NUMBER OPTION PRICE NUMBER OPTION PRICE
------------- ------------- ------------- ------------- ------------- -------------
Options
outstanding,
beginning of
year 117,943 $ 11.37 246,457 $ 6.85 281,118 $ 5.03
Granted 25,500 10.85 18,000 13.38 38,415 10.58
Exercised (500) 10.85 (141,537) 3.77 (73,076) 2.82
Forfeited (1,000) 11.00 (4,977) 10.86 -- --
--------- ------------ --------- ------------ --------- ------------
Options
outstanding,
end of year 141,943 $ 11.28 117,943 $ 11.37 246,457 $ 6.85
========= ============ ========= ============ ========= ============
The following table summarizes additional information about the Option Plan
at December 31, 2002:
Remaining
Exercise Price Number Contractual Number
Exercise Price Outstanding Life Exercisable
-------------- ----------- -------------- -----------
$ 7.50 10,000 1.25 years 10,000
10.50 5,424 4.25 years 5,424
10.85 2,000 .90 years 2,000
10.85 23,000 9.00 years 23,000
10.94 9,000 6.70 years 9,000
11.00 10,315 7.00 years 10,315
11.06 60,000 6.50 years 60,000
11.50 8,000 9.00 years 8,000
14.88 10,000 8.10 years 10,000
19.50 4,204 5.00 years 4,204
--------- -------------- -----------
141,943 6.63 years 141,943
========= ============== ===========
(Continued)
41
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
(12) PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information of Cooperative Bankshares, Inc., the parent
company, at December 31, 2002 and 2001 and for the years ended December 31,
2002, 2001 and 2000 is presented below:
CONDENSED STATEMENTS OF FINANCIAL CONDITION
2002 2001
----------- -----------
Assets:
Cash $ 1,913 1,753
Equity investment in subsidiary 38,490,495 33,616,593
Other assets 141,797 141,772
----------- -----------
$38,634,205 33,760,118
=========== ===========
Liabilities and stockholders' equity:
Other liabilities $ 185,944 141,838
Stockholders' equity 38,448,261 33,618,280
----------- -----------
$38,634,205 33,760,118
=========== ===========
CONDENSED STATEMENTS OF OPERATIONS
2002 2001 2000
----------- ----------- -----------
Dividends from subsidiary $ 575,739 347,309 825,242
Equity in undistributed net income of subsidiary 4,426,679 2,586,569 1,114,286
Miscellaneous expenses (57,921) (44,935) (7,853)
----------- ----------- -----------
$ 4,944,497 2,888,943 1,931,675
=========== =========== ===========
(Continued)
42
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
CONDENSED STATEMENTS OF CASH FLOWS
2002 2001 2000
----------- ----------- -----------
Operating activities:
Net income $ 4,944,497 2,888,943 1,931,675
Equity in undistributed net income of
subsidiary (4,426,680) (2,586,569) (1,114,286)
Change in other assets (25) (6,042) (135,730)
Change in other liabilities 44,106 6,036 72
----------- ----------- -----------
Net cash provided by operating
activities 561,898 302,368 681,731
Financing activities:
Proceeds from issuance of common stock, net 5,425 261,249 206,035
Purchase and retirement of common stock -- -- (480,657)
Cash dividends paid (567,163) (563,034) (406,890)
----------- ----------- -----------
Net cash used in financing activities (561,738) (301,785) (681,512)
----------- ----------- -----------
Increase in cash and cash equivalents 160 583 219
Cash and cash equivalents, beginning of year 1,753 1,170 951
----------- ----------- -----------
Cash and cash equivalents, end of year $ 1,913 1,753 1,170
=========== =========== ===========
(Continued)
43
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
(13) ACQUISITION
On May 31, 2002, the Bank acquired the operating assets of Wilmington-based
Lumina Mortgage Company. The combined resources of these two companies
enable the Bank to offer a wider range of products to a larger customer
base. Lumina has offices in Wilmington, North Carolina, North Myrtle Beach,
South Carolina and Virginia Beach, Virginia. Their 2001 loan originations
totaled $118 million. The purchase price was $740,061 in cash with two
future contingent payments based on loan origination volume and meeting
certain profitability goals of Lumina in the two subsequent years after the
purchase. Due to the uncertainties surrounding the determination of the
contingent payments, such payments have not been recorded. The two
contingent payments are estimated to be approximately $650,000 each and, if
made, will be recorded as additional purchase price. The goodwill created
by this transaction was $661,543.
The following table summarizes the estimated fair value of assets acquired
and liabilities assumed at May 31, 2002, excluding $33,127 of professional
fees that were included in goodwill as part of this transaction:
Property and equipment $ 71,584
Goodwill 628,416
Other assets 51,729
--------
Total assets acquired 751,729
--------
Accrued expenses and other liabilities 11,668
--------
Total liabilities assumed 11,668
--------
Net assets acquired $740,061
========
Presented below are the unaudited proforma consolidated condensed
statements of operations for the Company and Lumina Mortgage Company, for
the years ended December 31, 2002 and 2001, assuming the acquisition was
completed at the beginning of all periods presented. The unaudited proforma
information presented below is not necessarily indicative of the results of
operations that would have resulted had the merger been completed at the
beginning of the applicable periods presented, nor is it necessarily
indicative of the results of operations in future periods.
(Continued)
44
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
YEARS ENDED
2002 2001
----------- -----------
Interest income $29,648,777 31,569,610
Interest expense 13,973,200 19,334,494
----------- -----------
Net interest income 15,675,577 12,235,116
Provision for loan losses 740,000 460,000
----------- -----------
Net interest income after provision for loan losses 14,935,577 11,775,116
----------- -----------
Noninterest income 6,167,688 5,394,986
Noninterest expense 13,235,876 12,324,831
Income before income taxes 7,867,389 4,845,271
Income tax expense 2,849,191 1,732,409
----------- -----------
Net income $ 5,018,198 3,112,862
=========== ===========
Net income per share:
Basic $ 1.77 1.11
=========== ===========
Diluted 1.76 1.10
=========== ===========
(14) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS No. 107,
"Disclosures About Fair Value of Financial Instruments". The estimated fair
value amounts have been determined by the Company using the methods and
assumptions described below. However, considerable judgment is required to
interpret market data to develop the estimates of fair value. Accordingly,
the estimates presented herein are not necessarily indicative of the
amounts the Company could realize in a current market exchange. The use of
different market assumptions and/or estimation methodologies may have a
material effect on the estimated fair value amounts.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to
estimate that value.
CASH AND CASH EQUIVALENTS
The carrying amount is a reasonable estimate of fair value.
SECURITIES
For investments in debt securities, fair values are based on quoted
market prices or dealer quotes. For other securities, fair value
equals quoted market price, if available. If a quoted market price is
not available, fair value is estimated using quoted market prices for
similar securities.
(Continued)
45
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
FHLB STOCK
The carrying amount is a reasonable estimate of fair value.
LOANS HELD FOR SALE
The carrying amount is a reasonable estimate of fair value since they
will be sold in a short period.
LOANS
The fair value of loans is estimated by discounting the future cash
flows using the current rates at which similar loans would be made to
borrowers with similar credit ratings and for the same remaining
maturities.
ACCRUED INTEREST
The carrying amount is a reasonable estimate of fair value.
DEPOSITS
The fair value of NOW, savings, and money market deposit accounts is
the amount payable on demand at the reporting date. The fair value of
fixed-maturity certificates of deposit is estimated using the rates
currently offered for deposits of similar remaining maturities.
BORROWED FUNDS
Borrowed funds consist of short-term loans and FHLB borrowings with
varying maturities. The fair values of these liabilities are estimated
using the discounted values of the contractual cash flows. The
discount rate is estimated using the rates currently in effect for
similar borrowings.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
The fair value of off-balance sheet financial instruments is
considered immaterial. As discussed in note 3, these off-balance sheet
financial instruments are commitments to extend credit and are either
short term in nature or subject to immediate repricing.
(Continued)
46
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
The carrying amounts and estimated fair values of the Company's financial
instruments at December 31, 2002 and 2001 are as follows (in thousands):
2002 2001
----------------------------- -----------------------------
CARRYING ESTIMATED FAIR CARRYING ESTIMATED FAIR
AMOUNT VALUE AMOUNT VALUE
--------- -------------- ---------- --------------
Financial assets:
Cash and cash
equivalents 11,859 11,859 12,296 12,296
Securities:
Available for sale 42,075 42,075 42,970 42,970
Held to maturity 7,860 8,009 5,000 5,283
Loans held
for sale 25,660 25,660 -- --
Loans, net 390,876 397,001 373,458 376,503
FHLB stock 4,055 4,055 4,155 4,155
Accrued interest
receivable 2,240 2,240 2,637 2,637
Financial liabilities:
Deposits 357,254 357,915 339,830 340,320
Borrowed funds 104,678 106,089 83,097 86,451
Accrued interest
payable 285 285 264 264
(15) STOCK REPURCHASE PLAN
On October 21, 1999 the Company's Board of Directors approved a Stock
Repurchase Program authorizing the Company to repurchase up to 138,000
shares, or approximately 5% of the then outstanding shares of common stock.
The Company did not purchase any shares pursuant to the program during 2002
and 2001. During 2000, the Company purchased 46,385 shares at an average
cost of $10.36 per share pursuant to the program.
(16) ASSET SALE
During February 2002, the Company sold a parking lot for $500,000. A gain
of $464,977 was realized on the sale.
During February 2000, the Company sold the Robersonville, N.C. branch with
$7.1 million in deposits to Southern Bank & Trust Company. A gain of
$582,583 was realized on the sale.
(Continued)
47
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
(17) LEASES
The Company has several noncancelable operating leases, primarily for
office space that expire over the next twenty years. These leases generally
contain renewal options for periods ranging from two to five years and
require the Company to pay all executory costs such as maintenance and
insurance. Rental expense for operating leases was approximately $200,000,
$98,000 and $62,000 during 2002, 2001 and 2000, respectively.
Future minimum lease payments under noncancelable operating leases as of
December 31, 2002 are (in thousands):
YEAR ENDING DECEMBER 31:
-----------------------
2003 $ 285
2004 263
2005 208
2006 138
2007 126
After 2007 1,978
---------
Total minimum lease payments $ 2,998
=========
48
CORPORATE HEADQUARTERS
Cooperative Bankshares, Inc.
201 Market Street
P.O. Box 600
Wilmington, North Carolina 28402
(910) 343-0181
www.coop-bank.com
TRANSFER AGENT SPECIAL COUNSEL
First Citizens Bank Stradley Ronon Stevens & Young, LLP
Corporate Trust Department, DAC61 1220 19th Street, NW Suite 600
P.O. Box 29522 Washington, DC 20036
Raleigh, North Carolina 27626-0522
ANNUAL MEETING FORM 10-K
The Annual Meeting of Stockholders of Cooperative
Bankshares, Inc. will be held: Copies of Form 10-K may be obtained without
HILTON WILMINGTON RIVERSIDE charge by writing to Linda B. Garland at the
301 NORTH WATER STREET, WILMINGTON, NC 28401 Corporate Headquarters address.
APRIL 25, 2003 AT 11:00 A.M.
All stockholders are cordially invited to attend.
ADDITIONAL INFORMATION
For additional information, please contact
Linda B. Garland or Todd Sammons at (910) 343-0181
ANNUAL DISCLOSURE STATEMENT
"This information has not been reviewed or confirmed for accuracy or relevancy
by Federal Deposit Insurance Corporation (FDIC)."
Cooperative Bankshares, Inc. stock is traded on the NASDAQ National Market under
the symbol "COOP". As of December 31, 2002, there were 2,835,947 shares
outstanding, which were held by 530 stockholders of record. A $0.05 per share
dividend was declared each quarter in 2002 and 2001. Stock performance for 2002
and 2001 is given in the following table
QUARTERLY COMMON STOCK DATA
2002 2001
--------------------------------------------------------------------------------------
HIGH LOW HIGH LOW
QUARTERS ENDED
--------------------------------------------------------------------------------------
December 17.000 13.850 12.400 9.500
September 15.000 13.000 13.500 9.500
June 16.000 12.040 12.500 10.800
March 12.394 10.401 15.750 9.750
--------------------------------------------------------------------------------------
49
BOARD OF DIRECTORS
Cooperative Bankshares, Inc.
Cooperative Bank
Frederick Willetts, III James D. Hundley, M.D.
Chairman, President & Chief Executive Officer President, Wilmington Orthopaedic Group P.A.
Paul G. Burton H. T. King, III
President, Burton Steel Company President, Hanover Iron Works, Inc.
Russell M. Carter R. Allen Rippy
President, Atlantic Corporation Vice President, Rippy Automotive Company
F. Peter Fensel, Jr. O. Richard Wright, Jr.
President, F. P. Fensel Supply Company Attorney, McGougan, Wright, Worley, Harper & Bullard
OFFICERS OF COOPERATIVE BANK
Frederick Willetts, III Chairman, President-Chief Executive Officer
O. C. Burrell, Jr. Executive Vice President-Chief Operating Officer
Dickson B. Bridger Senior Vice President-Mortgage Lending
Todd L. Sammons, CPA Senior Vice President-Chief Financial Officer
Sandra B. Carr Vice President-Retail Banking Operations
George B. Church Vice President-Business Banking
Linda B. Garland Vice President-Marketing/ Corporate Secretary
Raymond A. Martin Vice President-Information Services
Donna H. Mitchell Vice President-Mortgage Operations
John P. Payne, CPA General Auditor
Susie K. Register Vice President-Mortgage Servicing/Processing
Dare C. Rhodes Vice President-Human Resources
COOPERATIVE BANK FINANCIAL CENTER LOCATIONS
Beaufort Tabor City
Belhaven Wallace
Elizabethtown Washington (2)
Jacksonville (2) Whiteville
Kill Devil Hills Wilmington (4)
Morehead City
Corolla -Loan Production Office
LUMINA MORTGAGE COMPANY LOCATIONS
Wilmington, North Carolina; North Myrtle Beach, South Carolina; Virginia Beach; Virginia
50