U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number: 0-25859
1ST STATE BANCORP, INC.
(Exact Name of Registrant as Specified in Its Charter)
VIRGINIA 56-2130744
- ------------------------------- --------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
445 S. MAIN STREET, BURLINGTON, NORTH CAROLINA 27215
- ------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant' s Telephone Number, Including Area Code (336) 227-8861
--------------
N/A
---------------------------------------------------
Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of April 30, 2003, the issuer had 2,977,789 shares of common stock
issued and outstanding.
1
CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
---------------------
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2003 (unaudited)
and September 30, 2002...........................................3
Consolidated Statements of Income for the Three Months Ended
March 31, 2003 and 2002 (unaudited)..............................4
Consolidated Statements of Income for the Six Months Ended
March 31, 2003 and 2002 (unaudited)............................5
Consolidated Statements of Stockholders' Equity and Comprehensive
Income for the Six Months Ended March 31, 2003 and 2002
(unaudited)....................................................6
Consolidated Statements of Cash Flows for the Six Months Ended
March 31, 2003 and 2002 (unaudited)............................7
Notes to Consolidated Financial Statements...........................9
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.....................................13
Item 3. Quantitative and Qualitative Disclosures About Market Risk..........24
Item 4. Controls and Procedures.............................................24
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings...................................................25
Item 2. Changes in Securities and Use of Proceeds...........................25
Item 3. Defaults Upon Senior Securities.....................................25
Item 4. Submission of Matters to a Vote of Security Holders.................25
Item 5. Other Information...................................................25
Item 6. Exhibits and Reports on Form 8-K....................................25
SIGNATURES...................................................................26
2
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
MARCH 31, 2003 AND SEPTEMBER 30, 2002
(IN THOUSANDS, EXCEPT SHARE DATA)
AT AT
MARCH 31, SEPTEMBER 30,
2003 2002
------------ -------------
(Unaudited)
ASSETS
Cash and cash equivalents $ 31,425 18,865
Investment securities:
Held to maturity (fair value of $13,468 and $11,558
at March 31, 2003 and September 30, 2002, respectively) 13,105 11,114
Available for sale (cost of $58,995 and $77,213
at March 31, 2003 and September 30, 2002, respectively) 59,924 78,572
Loans held for sale, at lower of cost or fair value 4,151 6,798
Loans receivable (net of allowance for loan losses of $3,850
and $3,732 at March 31, 2003 and September 30, 2002,
respectively) 223,903 220,047
Real estate owned 177 183
Federal Home Loan Bank stock, at cost 1,382 1,750
Premises and equipment 8,346 7,972
Accrued interest receivable 1,823 2,272
Other assets 2,771 2,896
----------- ---------
Total assets $ 347,007 350,469
=========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposit accounts 258,806 260,667
Advances from Federal Home Loan Bank 20,000 20,000
Advance payments by borrowers for property taxes and insurance 242 54
Dividend payable 298 241
Other liabilities 5,250 7,938
----------- ---------
Total liabilities 284,596 288,900
----------- ---------
Stockholders' Equity:
Preferred stock, $0.01 par value, 1,000,000 shares authorized;
none issued -- --
Common stock, $0.01 par value, 7,000,000 shares authorized;
2,977,789 and 3,008,682 shares issued and outstanding
at March 31, 2003 and September 30, 2002, respectively 33 33
Additional paid-in capital 35,695 35,623
Unallocated ESOP shares (3,441) (3,739)
Deferred compensation payable in treasury stock 5,466 5,466
Treasury stock (12,642) (11,899)
Retained income - substantially restricted 36,735 35,258
Accumulated other comprehensive income - net unrealized
gain on investment securities available for sale 565 827
----------- ---------
Total stockholders' equity 62,411 61,569
----------- ---------
Total liabilities and stockholders' equity $ 347,007 350,469
=========== =========
See accompanying notes to the consolidated financial statements.
3
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2003 AND 2002
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
FOR THE THREE MONTHS ENDED
MARCH 31,
-----------------------------
2003 2002
--------- --------
Interest income:
Interest and fees on loans $ 3,295 3,527
Interest and dividends on investments 1,060 1,357
Overnight deposits 42 52
--------- --------
Total interest income 4,397 4,936
--------- --------
Interest expense:
Deposit accounts 1,169 1,678
Borrowings 276 286
--------- --------
Total interest expense 1,445 1,964
--------- --------
Net interest income 2,952 2,972
Provision for loan losses 60 60
--------- --------
Net interest income after provision for loan losses 2,892 2,912
--------- --------
Other income:
Customer service fees 214 217
Commissions from sales of annuities and mutual funds 159 98
Mortgage banking income, net 459 357
Securities gains, net -- 47
Other 62 56
--------- --------
Total other income 894 775
--------- --------
Operating expenses:
Compensation and related benefits 1,423 1,584
Occupancy and equipment 384 311
Real estate operations, net 4 (50)
Other expenses 393 404
--------- --------
Total operating expenses 2,204 2,249
--------- --------
Income before income taxes 1,582 1,438
Income taxes 585 513
--------- --------
Net income $ 997 925
========= ========
Earnings per share:
Basic $ 0.35 $ 0.31
Diluted $ 0.34 $ 0.29
See accompanying notes to the consolidated financial statements.
4
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE SIX MONTHS ENDED MARCH 31, 2003 AND 2002
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
FOR THE SIX MONTHS ENDED
MARCH 31,
----------------------------
2003 2002
--------- --------
Interest income:
Interest and fees on loans $ 6,667 7,432
Interest and dividends on investments 2,212 2,579
Overnight deposits 85 142
--------- --------
Total interest income 8,964 10,153
--------- --------
Interest expense:
Deposit accounts 2,460 3,773
Borrowings 552 562
--------- --------
Total interest expense 3,012 4,335
--------- --------
Net interest income 5,952 5,818
Provision for loan losses 120 120
--------- --------
Net interest income after provision for loan losses 5,832 5,698
--------- --------
Other income:
Customer service fees 431 466
Commissions from sales of annuities and mutual funds 246 220
Mortgage banking income, net 893 779
Securities gains, net -- 47
Other 118 106
--------- --------
Total other income 1,688 1,618
--------- --------
Operating expenses:
Compensation and related benefits 2,801 3,148
Occupancy and equipment 735 614
Real estate operations, net 9 (32)
Other expenses 839 776
--------- --------
Total operating expenses 4,384 4,506
--------- --------
Income before income taxes 3,136 2,810
Income taxes 1,156 1,040
--------- --------
Net income $ 1,980 1,770
========= ========
Earnings per share:
Basic $ 0.70 $ 0.59
Diluted $ 0.67 $ 0.56
See accompanying notes to the consolidated financial statements
5
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
FOR THE SIX MONTHS ENDED MARCH 31, 2003 AND 2002 (UNAUDITED)
(IN THOUSANDS)
DEFERRED
COMPENSATION
ADDITIONAL UNALLOCATED UNEARNED PAYABLE IN
COMMON PAID-IN ESOP COMPENSATION TREASURY
STOCK CAPITAL SHARES MRP STOCK
-------- ------- ------- ------------ -----------
Balance at September 30, 2001 $ 33 35,588 (4,373) (518) 4,173
Comprehensive income:
Net income -- -- -- -- --
Other comprehensive loss-unrealized
loss on securities available-for-sale
net of income taxes of $801 -- -- -- -- --
Total comprehensive income
Allocation of ESOP shares -- 13 338 -- --
Deferred compensation -- -- -- -- 270
Acquisition of treasury stock -- -- -- -- --
Vesting of MRP shares -- -- -- 388 --
Cash dividends declared ($0.16 per share) -- -- -- -- --
Cash dividends on unallocated ESOP shares
and unvested MRP shares -- -- -- -- --
-------- ------- ------- ----- ------
Balance at March 31, 2002 $ 33 35,601 (4,035) (130) 4,443
======== ======= ======= ===== ======
Balance at September 30, 2002 $ 33 35,623 (3,739) -- 5,466
Comprehensive income:
Net income -- -- -- -- --
Other comprehensive loss-unrealized
loss on securities available-for-sale
net of income taxes of $169 -- -- -- -- --
Total comprehensive income
Allocation of ESOP shares -- 72 298 -- --
Acquisition of treasury shares -- -- -- -- --
Cash dividends declared ($0.18 per share) -- -- -- -- --
Cash dividends on unallocated ESOP shares -- -- -- -- --
-------- ------- ------- ----- ------
Balance at March 31, 2003 $ 33 35,695 (3,441) -- 5,466
======== ======= ======= ===== ======
ACCUMULATED
OTHER TOTAL
TREASURY RETAINED COMPREHENSIVE STOCKHOLDERS'
STOCK INCOME INCOME (LOSS) EQUITY
-------- -------- ------------- -------------
Balance at September 30, 2001 (4,173) 32,404 510 63,644
Comprehensive income:
Net income -- 1,770 -- 1,770
Other comprehensive loss-unrealized
loss on securities available-for-sale
net of income taxes of $801 -- -- (1,245) (1,245)
------
Total comprehensive income 525
Allocation of ESOP shares -- -- -- 351
Deferred compensation -- -- -- 270
Acquisition of treasury stock (270) -- -- (270)
Vesting of MRP shares -- -- -- 388
Cash dividends declared ($0.16 per share) -- (526) -- (526)
Cash dividends on unallocated ESOP shares
and unvested MRP shares -- 49 -- 49
-------- ------- ------ -------
Balance at March 31, 2002 (4,443) 33,697 (735) 64,431
======== ======= ====== =======
Balance at September 30, 2002 (11,899) 35,258 827 61,569
Comprehensive income:
Net income -- 1,980 -- 1,980
Other comprehensive loss-unrealized
loss on securities available-for-sale
net of income taxes of $169 -- -- (262) (262)
-------
Total comprehensive income 1,718
Allocation of ESOP shares -- -- -- 370
Acquisition of treasury shares (743) -- -- (743)
Cash dividends declared ($0.18 per share) -- (538) -- (538)
Cash dividends on unallocated ESOP shares -- 35 -- 35
-------- ------- ------ -------
Balance at March 31, 2003 (12,642) 36,735 565 62,411
======== ======= ====== =======
See accompanying notes to the consolidated financial statements.
6
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED MARCH 31, 2003 AND 2002
(UNAUDITED)
(IN THOUSANDS)
FOR THE SIX MONTHS ENDED
MARCH 31,
-----------------------------
2003 2002
--------- --------
Cash flows from operating activities:
Net income $ 1,980 1,770
Adjustment to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 120 120
Depreciation 394 313
Deferred tax expense 91 305
Amortization of premiums and discounts, net (31) (21)
Deferred compensation 120 164
Release of ESOP shares 370 351
Vesting of MRP shares and dividends on unvested MRP shares -- 520
Loan origination fees and unearned discounts
deferred, net of current amortization (41) (75)
Loss (gain) on sale of other real estate 6 (5)
Securities gains, net -- 47
Net (gain) loss on sale of loans (164) 230
Proceeds from loans held for sale 48,579 41,951
Originations of loans held for sale (45,768) (41,334)
Decrease in other assets 203 27
Decrease (increase) in accrued interest receivable 449 (249)
Decrease in other liabilities (2,809) (1,455)
--------- --------
Net cash provided by operating activities 3,499 2,565
--------- --------
Cash flows provided by (used in) investing activities:
Proceeds from sale of FHLB stock 368 --
Purchases of investment securities held to maturity (2,000) (2,454)
Purchases of investment securities available for sale (48,229) (62,108)
Proceeds from sales of investment securities available for sale -- 1,811
Proceeds from maturities and issuer calls of investment securities
available for sale 66,485 24,208
Proceeds from maturities and issuer calls of investment securities
held to maturity 2 3,003
Net decrease (increase) in loans receivable (3,935) 10,894
Proceeds from disposal of real estate acquired in
settlement of loans -- 81
Purchases of premises and equipment (768) (101)
--------- --------
Net cash provided by (used in) investing activities 11,923 (24,666)
--------- --------
(Continued)
7
1ST STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
FOR THE SIX MONTHS ENDED MARCH 31, 2003 AND 2002
(UNAUDITED)
(IN THOUSANDS)
FOR THE SIX MONTHS ENDED
MARCH 31,
-----------------------------
2003 2002
--------- --------
Cash flows from financing activities:
Net decrease in deposits $ (1,861) $ (1,271)
Advances from the Federal Home Loan Bank 13,000 21,000
Repayments of advances from the Federal Home Loan Bank (13,000) (11,000)
Purchase of treasury stock (743) (270)
Dividends paid on common stock (446) (477)
Increase in advance payments by borrowers for
property taxes and insurance 188 398
---------- ---------
Net cash used in financing activities (2,862) (8,380)
---------- ---------
Net increase (decrease) in cash and cash equivalents 12,560 (13,721)
Cash and cash equivalents at beginning of period 18,865 25,981
---------- ---------
Cash and cash equivalents at end of period $ 31,425 $ 12,260
========== =========
Payments are shown below for the following:
Interest $ 3,021 $ 4,348
========== =========
Income taxes $ 1,133 $ 269
========== =========
Noncash investing and financing activities:
Unrealized losses on investment securities
available for sale $ (431) $ (2,046)
========== =========
Cash dividends declared but not paid $ 279 $ 241
========== =========
Cash dividends on unallocated ESOP shares $ 35 $ 49
========== =========
Transfer from loans to real estate acquired in settlement of loans $ -- $ 347
========== =========
See accompanying notes to consolidated financial statements.
8
1ST STATE BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003 (UNAUDITED) AND SEPTEMBER 30, 2002
NOTE 1. NATURE OF BUSINESS
1st State Bancorp, Inc. (the "Company") was incorporated under the laws of
the Commonwealth of Virginia for the purpose of becoming the holding company for
1st State Bank (the "Bank") in connection with the Bank's conversion from a
North Carolina-chartered mutual savings bank to a North Carolina-chartered stock
savings bank (the "Converted Bank") pursuant to its Plan of Conversion (the
"Stock Conversion"). Upon completion of the Stock Conversion, the Converted Bank
converted from a North Carolina-chartered stock savings bank to a North Carolina
commercial bank (the "Bank Conversion"), retaining the name 1st State Bank (the
"Commercial Bank"), and the Commercial Bank succeeded to all of the assets and
liabilities of the Converted Bank. The Stock Conversion and the Bank Conversion
were consummated on April 23, 1999. The common stock of the Company began
trading on the Nasdaq National Market System under the symbol "FSBC" on April
26, 1999.
NOTE 2. BASIS OF PRESENTATION
The accompanying consolidated financial statements (which are unaudited,
except for the consolidated balance sheet at September 30, 2002, which is
derived from the September 30, 2002 audited consolidated financial statements)
have been prepared in accordance with accounting principles generally accepted
in the United States of America for interim financial information and with the
rules and regulations of the Securities and Exchange Commission. Accordingly,
they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. In the opinion of management, all adjustments (none of
which were other than normal recurring accruals) necessary for a fair
presentation of the financial position and results of operations for the periods
presented have been included.
The results of operations for the three and six month periods ended March
31, 2003 are not necessarily indicative of the results of operations that may be
expected for the year ended September 30, 2003. The preparation of consolidated
financial statements in accordance with accounting principles generally accepted
in the United States of America requires management to make certain estimates.
These amounts may be revised in future periods because of changes in the facts
and circumstances underlying their estimation.
Certain amounts in the March 31, 2002 consolidated financial statements
have been reclassified to conform with the presentation adopted in 2003. Such
reclassifications did not change net income or stockholders' equity as
previously reported.
NOTE 3. EARNINGS PER SHARE
For purposes of computing basic and diluted earnings per share, weighted
average shares outstanding excludes unallocated ESOP shares that have not been
committed to be released. The deferred compensation obligation discussed in note
5 that is fully funded with shares of the Company's common stock has no net
impact on the Company's earnings per share computations. Diluted earnings per
share includes the potentially dilutive effects of the Company's stock-based
benefit plans. There were no antidilutive stock options for the three and six
months ended March 31, 2003 and 2002. A reconciliation of the denominators of
the basic and diluted earnings per share computations is as follows:
9
THREE MONTHS ENDED
MARCH 31,
-----------------------------
2003 2002
---------- ---------
Average shares issued and outstanding 2,995,606 3,289,607
Less: Unvested MRP shares -- (42,156)
Less: Unallocated ESOP shares (179,585) (223,522)
---------- ---------
Average basic shares for earnings per share 2,816,021 3,023,929
Add: Unvested MRP shares -- 42,156
Add: Potential common stock pursuant to stock option plan 122,277 86,763
---------- ---------
Average dilutive shares for earnings per share 2,938,298 3,152,848
========== =========
SIX MONTHS ENDED
MARCH 31,
-----------------------------
2003 2002
---------- ---------
Average shares issued and outstanding 2,999,280 3,289,607
Less: Unvested MRP shares issued -- (42,156)
Less: Unallocated ESOP shares (183,449) (227,870)
---------- ---------
Average basic shares for earnings per share 2,815,831 3,019,581
Add: Unvested MRP shares -- 42,156
Add: Potential common stock pursuant to stock option plan 124,438 87,666
---------- ---------
Average dilutive shares for earnings per share 2,940,269 3,149,403
========== =========
NOTE 4. EMPLOYEE STOCK OWNERSHIP PLAN ("ESOP")
The Company sponsors an employee stock ownership plan (the "ESOP") whereby
an aggregate number of shares amounting to 253,050 or 8% of the stock issued in
the conversion was purchased for future allocation to employees. The ESOP was
funded by an 11 year term loan from the Company in the amount of $4,899,000. The
loan is secured by the shares of stock purchased by the ESOP. During the three
and six months ended March 31, 2003 and 2002, 7,560 and 8,507 and 15,288 and
17,203 shares of stock were committed to be released and approximately $181,000
and $172,000 and $371,000 and $350,000 of compensation expense was recognized,
respectively.
NOTE 5. DEFERRED COMPENSATION
Directors and certain executive officers participate in a deferred
compensation plan, which was approved by the Board of Directors on September 24,
1997. This plan generally provides for fixed payments beginning after the
participant retires. Each participant is fully vested in his account balance
under the plan. Directors may elect to defer their directors' fees and executive
officers may elect to defer 25% of their salary and 100% of bonus compensation.
Prior to the Conversion, amounts deferred by each participant accumulated
interest at a rate equal to the highest rate of interest paid on the Bank's
one-year certificates of deposit. In connection with the Conversion,
participants in the plan were given the opportunity to prospectively elect to
have their deferred compensation balance earn a rate of return equal to the
total return of the Company's stock. All participants elected this option
concurrent with the Conversion, so the Company purchases its common stock to
fund this obligation. Refer to the Company's notes to consolidated financial
statements, incorporated by reference in the Company's 2002 Annual Report on
Form 10-K for a discussion of the Company's accounting policy with respect to
this deferred compensation plan and the related treasury stock purchased by the
Company to fund this obligation.
The expense related to this plan for the three and six months ended March
31, 2003 and 2002 was $60,000 and $72,000 and $120,000 and $164,000,
respectively. This expense is included in compensation expense.
10
NOTE 6. MANAGEMENT RECOGNITION PLAN
The Company has a Management Recognition Plan ("MRP") which serves as a
means of providing existing directors and officers of the Bank with an ownership
interest in the Company. On June 6, 2000, restricted stock awards of 126,482
shares were granted. The shares awarded under the MRP were issued from
authorized but unissued shares of common stock at no cost to the recipients. The
shares vest at a rate of 33 1/3% per year with a one-third immediate vest on the
date of the grant and annually thereafter. The Company recorded no compensation
expense associated with the MRP during the three and six months ended March 31,
2003 as all shares became fully vested in June 2002. Compensation expense of
$260,000 and $520,000 associated with the MRP was recorded during the three and
six months ended March 31, 2002, respectively.
NOTE 7. STOCK OPTION AND INCENTIVE PLAN
On June 6, 2000 the Company's stockholders approved the 1st State Bancorp,
Inc. 2000 Stock Option and Incentive Plan (the "Plan"). The purpose of this plan
is to advance the interests of the Company through providing select key
employees and directors of the Bank with the opportunity to acquire shares. By
encouraging such stock ownership, the Company seeks to attract, retain and
motivate the best available personnel for positions of substantial
responsibility and to provide incentives to the key employees and directors.
Under the Plan, the Company granted 316,312 options to purchase its $0.01 par
value common stock in fiscal year 2000. The exercise price per share is equal to
the fair market value per share on the date of the grant of the stock. Options
granted under the Stock Option Plan are 100% vested on the date of the grant,
and all options expire 10 years from the date of the grant. As a result of the
one-time cash dividend of $5.17 paid on October 2, 2000, the exercise price for
the options repriced from $18.44 to $14.71. No options were exercised or granted
during the three and six months ended March 31, 2003 and 2002. At March 31,
2003, 316,312 options are outstanding, all of which are exercisable.
In December 2002, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 148 "Accounting for Stock-Based
Compensation - Transition and Disclosure" (SFAS 148) an amendment of FASB
Statement No. 123, "Accounting for Stock-Based Compensation" (SFAS 123), which
provides alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require
prominent disclosure in both annual and interim financial statements about the
method of accounting for stock-based compensation and the effect of the method
on reported results. The Company does not have any plans to change its method of
accounting for stock-based employee compensation. There is no pro forma impact
for any of the periods presented or for either of the two prior fiscal years.
NOTE 8. MORTGAGE SERVICING RIGHTS
The rights to service mortgage loans for others are included in other
assets on the consolidated balance sheet. Mortgage servicing rights ("MSRs") are
capitalized based on the allocated cost which is determined when the underlying
loans are sold. MSRs are amortized over a period which approximates the life of
the underlying loans as an adjustment of income. Impairment reviews of MSRs are
performed on a quarterly basis. As of March 31, 2003 and September 30, 2002 MSRs
totaled $484,000 and $370,000, respectively, and no valuation allowance was
required.
Amortization expense totaled $71,000 and $30,000 for the six months ended
March 31, 2003 and 2002, respectively.
11
The estimated amortization expense for the mortgage servicing rights for
the years ended September 30, 2003, 2004, 2005, 2006 and 2007 and thereafter is
as follows:
ESTIMATED AMORTIZATION EXPENSE
(In Thousands)
2003 40,000
2004 40,000
2005 40,000
2006 40,000
2007 40,000
2008 and thereafter 170,000
--------
$370,000
========
The estimation of future amortization expense presented above is based on
assumptions (such as estimate of prepayment of loans) subject to change in
future periods. Accordingly, the amortization expense in future periods may be
different from the amounts disclosed above to the extent that any of these
assumptions are modified due to a change in the underlying estimations.
NOTE 9. STANDBY LETTERS OF CREDIT
In November 2002, the FASB issued Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others", which addressed the disclosure
to be made by a guarantor in its interim and annual financial statements about
its obligations under guarantees. FIN 45 requires the guarantor to recognize a
liability for the non-contingent component of the guarantee, such as the
obligation to stand ready to perform in the event that specified triggering
events or conditions occur. The initial measurement of this liability is the
fair value of the guarantee at inception. The recognition of the liability is
required even if it is not probable that payments will be required under the
guarantee or if the guarantee was issued with a premium payment or as part of a
transaction with multiple events. The initial recognition and measurement
provisions are effective for all guarantees within the scope of FIN 45 issued or
modified after December 31, 2002. The Company issues standby letters of credit
whereby the Company guarantees performance if a specified triggering event or
condition occurs (primarily nonperformance under construction contracts entered
into by construction customers). The guarantees generally expire within one year
and may be automatically renewed depending on the terms of the guarantee. The
maximum potential amount of undiscounted future payments related to standby
letters of credit at March 31, 2003 is $265,000. At March 31, 2003 the Company
has recorded no liability for the current carrying amount of the obligation to
perform as a guarantor and no contingent liability is considered necessary as
such amounts are deemed immaterial. Substantially all standby letters of credit
are secured by real estate and/or guaranteed by third parties in the event the
Company had to advance funds to fulfill the guarantee.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
When used in this Form 10-Q, the words or phrases "will likely result,"
"are expected to," "will continue," "is anticipated," "estimate," "project" or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties including changes in
economic conditions in our market area, changes in policies by regulatory
agencies, fluctuations in interest rates, demand for loans in our market area,
and competition that could cause actual results to differ materially from
historical earnings and those presently anticipated or projected. We wish to
caution you not to place undue reliance on any such forward-looking statements,
which speak only as of the date made. We wish to advise you that the factors
listed above could affect our financial performance and could cause our actual
results for future periods to differ materially from any opinions or statements
expressed with respect to future periods in any current statements.
We do not undertake, and specifically disclaim any obligation, to publicly
release the result of any revisions which may be made to any forward-looking
statements to reflect events or circumstances after the date of such statements
or to reflect the occurrence of anticipated or unanticipated events.
GENERAL
1st State Bancorp, Inc. was formed in November 1998 and became the holding
company for 1st State Bank on April 23, 1999. As a result, portions of this
discussion (as of dates and for periods prior to April 23, 1999) relate to the
financial condition and results of operations of 1st State Bank.
Our business consists principally of attracting deposits from the general
public and investing these funds in loans secured by single-family residential
and commercial real estate, secured and unsecured commercial loans and consumer
loans. Our profitability depends primarily on our net interest income, which is
the difference between the income we receive on our loan and investment
securities portfolios and our cost of funds, which consists of interest paid on
deposits and borrowed funds. Net interest income also is affected by the
relative amounts of interest-earning assets and interest-bearing liabilities.
When interest-earning assets approximate or exceed interest-bearing liabilities,
any positive interest rate spread will generate net interest income. Our
profitability is also affected by the level of other income and operating
expenses. Other income consists of miscellaneous fees related to our loans and
deposits, mortgage banking income and commissions from sales of annuities and
mutual funds. Operating expenses consist of compensation and benefits, occupancy
related expenses, federal deposit insurance premiums, data processing,
advertising and other expenses.
Our operations are influenced significantly by local economic conditions
and by policies of financial institution regulatory authorities. Our cost of
funds is influenced by interest rates on competing investments and by rates
offered on similar investments by competing financial institutions in our market
area, as well as general market interest rates. These factors can cause
fluctuations in our net interest income and other income. Lending activities are
affected by the demand for financing of real estate and other types of loans,
which in turn is affected by the interest rates at which such financing may be
offered. In addition, local economic conditions can impact the credit risk of
our loan portfolio, in that local employers may be required to eliminate
employment positions of many of our borrowers, and small businesses and other
commercial borrowers may experience a downturn in their operating performance
and become unable to make timely payments on their loans. Management evaluates
these factors in estimating its allowance for loan losses, and changes in these
economic conditions could result in increases or decreases to the provision for
loan losses.
Our business emphasis has been to operate as a well-capitalized, profitable
and independent community-oriented financial institution dedicated to providing
quality customer service. We are committed to meeting the financial needs of the
communities in which we operate. We believe that we can be more effective in
servicing our customers than many of our nonlocal competitors because of our
ability to quickly and effectively provide senior management responses to
customer needs and inquiries. Our ability to provide these services is enhanced
by the stability of our senior management team.
13
Beginning in the late 1980's, we have sought to gradually increase the
percentage of our assets invested in commercial real estate loans, commercial
loans and consumer loans, which have shorter terms and adjust more frequently to
changes in interest rates than single-family residential mortgage loans. These
loans generally carry added risk when compared to a single family residential
mortgage loan, so we have concurrently increased our allowance for loan losses
as we have originated these loans.
CRITICAL ACCOUNTING POLICIES
The Company's significant accounting policies are set forth in note 1 of the
consolidated financial statements as of September 30, 2002 which was filed on
Form 10-K. Of these significant accounting policies, the company considers its
policy regarding the allowance for loan losses to be its most critical
accounting policy, because it requires management's most subjective and complex
judgments. In addition, changes in economic conditions can have a significant
impact on the allowance for loan losses and therefore the provision for loan
losses and results of operations. The Company has developed appropriate policies
and procedures for assessing the adequacy of the allowance for loan losses,
recognizing that this process requires a number of assumptions and estimates
with respect to its loan portfolio. The Company's assessments may be impacted in
future periods by changes in economic conditions, the impact of regulatory
examinations, and the discovery of information with respect to borrowers which
is not known to management at the time of the issuance of the consolidated
financial statements.
COMPARISON OF FINANCIAL CONDITION AT MARCH 31, 2003 AND SEPTEMBER 30, 2002
Total assets decreased by $3.5 million or 1.0% from $350.5 million at
September 30, 2002 to $347.0 million at March 31, 2003. As market rates remained
low during the six months ended March 31, 2003, many of the Company's callable
investments were called by the issuers. The proceeds from investment maturities
and calls totaled $66.5 million for the six months ended March 31, 2003 compared
with investment purchases of $50.2 million; therefore, total investment
securities decreased from September 30, 2002. Cash and cash equivalents
increased $12.6 million or 66.6% from $18.9 million at September 30, 2002 to
$31.4 million at March 31, 2003 as a result of the decrease in investment
securities. Loans receivable, net increased while loans held for sale decreased.
Deposits decreased by $1.9 million or 0.7% from $260.7 million at September 30,
2002 to $258.8 million at March 31, 2003. This decrease resulted from the runoff
of $4.7 million of certificates of deposits held by municipalities as part of
the Company's asset liability strategy. This decrease in certificates of deposit
was offset partially by growth in transaction accounts.
Investment securities available for sale decreased $18.6 million from $78.6
million at September 30, 2002 to $59.9 million at March 31, 2003. During the six
months ended March 31, 2003, we purchased $48.2 million of securities available
for sale and received $66.5 million in proceeds from maturities and issuer calls
of investment securities available for sale. Investment securities held to
maturity increased from $11.1 million at September 30, 2002 to $13.1 million at
March 31, 2003 as $2.0 million of investment securities held to maturity were
purchased during this period.
Loans held for sale decreased by $2.6 million from $6.8 million at
September 30, 2002 to $4.2 million at March 31, 2003. Loans receivable, net
increased $3.9 million from $220.0 million at September 30, 2002 to $223.9
million at March 31, 2003. The decrease in loans held for sale resulted from
timing differences in the funding of loan sales. During the six months ended
March 31, 2003 our mortgage originations and prepayments continued at record
levels. Mortgage rates declined to record low levels during this period, and
many borrowers took advantage of this opportunity to refinance their existing
mortgage loans. Mortgage loans secured by single family dwellings decreased by
$10.1 million during this period as a result of the tremendous refinancing
activity. During this same period, increases in commercial and home equity line
loans more than offset this single family mortgage loan decrease.
Stockholders' equity increased by $842,000 from $61.6 million at September
30, 2002 to $62.4 million at March 31, 2003 as a result of net income of
$1,980,000 and release of ESOP shares of $370,000. These increases were offset
by cash dividends to stockholders declared of $503,000, purchases of treasury
stock of $743,000 and a decrease in unrealized gain on available for sale
securities of $262,000.
14
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED MARCH 31, 2003 AND
2002
Net Income. We recorded net income of $997,000 for the quarter ended March
31, 2003, as compared to $925,000 for the quarter ended March 31, 2002,
representing an increase of $72,000, or 7.8%. For the three months ended March
31, 2003, basic and diluted earnings per share were $0.35 and $0.34,
respectively, compared to the basic and diluted earnings per share for the
quarter ended March 31, 2002 of $0.31 and $0.29, respectively. The increase in
net income resulted primarily from increased other income and decreased
operating expenses that were offset partially by decreased net interest income
and increased income tax expense. The decrease in net interest income resulted
from lower net interest margins. The average prime interest rate for the quarter
ended March 31, 2003 was 4.25%, a decrease of 50 basis points from 4.75% which
was the average prime for the quarter ended March 31, 2002. The repricing of
certificates of deposits, savings and money market investment accounts decreased
the Company's cost of funds to partially offset the decrease in asset yield
which resulted from the lower prevailing interest rates during the quarter ended
March 31, 2003.
Net Interest Income. Net interest income, the difference between interest
earned on loans and investments and interest paid on interest-bearing
liabilities, decreased by $20,000 or 0.7% for the three months ended March 31,
2003, compared to the same quarter in the prior year. This decrease results from
a $539,000 decrease in interest income that was offset in part by the $519,000
decrease in total interest expense. The average net interest income as a
percentage of average earning assets decreased 5 basis points from 3.67% for the
three months ended March 31, 2002 to 3.62% for the quarter ended March 31, 2003.
Interest Income. The decrease in interest income for the three months ended
March 31, 2003 was the result of a decrease in yield on interest-earning assets
of 71 basis points from 6.10% for the three months ended March 31, 2002 to 5.39%
for the three months ended March 31, 2003 which was partially offset by a $2.7
million increase in interest earning assets. Average loans receivable increased
$13.7 million from $215.1 million for the quarter ended March 31, 2002 to $228.8
million for the quarter ended March 31, 2003. Average investment securities
decreased $13.9 million for the quarter compared to the prior year. Average
interest-bearing overnight funds increased $2.9 million for the quarter compared
to the prior year. The decrease in asset yield resulted from the lower rates
prevailing in the marketplace. The increase in average interest earning assets
increased interest income by approximately $43,000 and the decrease in the
average yield on interest earning assets decreased interest income by
approximately $582,000.
Interest Expense. Interest expense decreased in the three months ended
March 31, 2003 due to a decrease in the cost of interest-bearing liabilities of
79 basis points from 2.97% for the three months ended March 31, 2002 to 2.18%
for the three months ended March 31, 2003. Average interest-bearing deposits
increased by $2.8 million while average FHLB advances decreased $1.5 million for
the three months ended March 31, 2003 compared to the same quarter in the prior
year. The decrease in the average cost of interest-bearing liabilities accounted
for the decrease in interest expense.
15
The following table presents average balances and average rates earned/paid
by the Company for the quarter ended March 31, 2003 compared to the quarter
ended March 31, 2002.
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 2003 MARCH 31, 2002
DOLLARS IN THOUSANDS
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST YIELD/COST BALANCE INTEREST YIELD/COST
Assets:
Loans receivable (1) $228,764 $3,295 5.76% $215,058 $3,527 6.56%
Investment securities (2) 82,921 1,060 5.11 96,821 1,357 5.61
Interest-bearing overnight deposits 14,669 42 1.15 11,762 52 1.77
-------- ------ ------ -------- ------ ------
Total interest-earning assets (4) 326,354 4,397 5.39 323,641 4,936 6.10
Non interest-earning assets 21,001 22,414
-------- --------
Total assets $347,355 $346,055
======== ========
Liabilities and stockholders' equity
Interest-bearing checking 33,018 36 0.44 31,320 36 0.46
Money market investment accounts 22,485 54 0.96 27,465 86 1.25
Passbook and statement savings 29,321 80 1.09 27,060 102 1.51
Certificates of deposit 158,776 999 2.52 154,984 1,454 3.75
FHLB advances 21,900 276 5.05 23,444 286 4.88
-------- ------ ------ -------- ------ ------
Total interest-bearing liabilities 265,500 1,445 2.18 264,273 1,964 2.97
Non interest-bearing liabilities 19,356 17,321
-------- --------
Total liabilities 284,856 281,594
Stockholders' equity 62,499 64,461
-------- --------
Total liabilities and stockholders' equity $347,355 $346,055
======== ========
Net interest income $2,952 $2,972
====== ======
Interest rate spread 3.21% 3.13%
Net interest margin (3) 3.62% 3.67%
Ratio of average interest-earning assets to
average interest-bearing liabilities 122.92% 122.46%
<FN>
________
(1) Includes nonaccrual loans and loans held for sale, net of discounts and
allowance for loan losses.
(2) Includes FHLB of Atlanta stock.
(3) Represents net interest income divided by the average balance of
interest-earning assets.
(4) Due to immateriality, the interest income and yields related to certain tax
exempt assets have not been adjusted to reflect a fully taxable equivalent
yield.
</FN>
Provision for Loan Losses. We charge provisions for loan losses to earnings
to maintain the total allowance for loan losses at a level we consider adequate
to provide for probable loan losses, based on existing loan levels and types of
loans outstanding, nonperforming loans, prior loss experience, general economic
conditions and other factors. We estimate the allowance using an allowance for
loan losses model which takes into consideration all of these factors. Our
policies require the review of assets on a regular basis, and we assign risk
grades to loans based on the relative risk of the credit, considering such
factors as repayment experience, value of collateral, guarantors, etc. Our
credit management systems have resulted in low loss experience; however, there
can be no assurances that such experience will continue. We believe we use the
best information available to make a determination with respect to the allowance
for loan losses, recognizing that future adjustments may be necessary depending
upon a change in economic conditions. The provision for loan losses was $60,000
and net charge-offs were $0 for the quarter ended March 31, 2003 compared with a
provision of $60,000, and net charge-offs of $7,000 for the quarter ended March
31, 2002. Nonperforming loans were $4.4 million at both March 31, 2003 and
September 30, 2002. The majority of the non-performing loans resulted from two
unrelated, unique credits which are not necessarily indicative of the credit
quality of the entire portfolio. There was no significant impact on the
provision as these loans are well secured by property and equipment. The
provision for the quarter ended March 31, 2003 was positively
16
impacted by the decrease in charge-offs which was offset by the shift in the
loan portfolio to commercial loans which receive higher allocations in the
allowance for loan losses model. The Company made no significant changes to the
allowance for loan losses methodology during the period which impacted the
provision for loan losses.
During the quarter ended March 31, 2003 commercial and home equity loans
continued to increase as well as the percentages of these loans to the total
portfolio. Although these loans normally have a relatively short maturity
management believes that there is greater risk inherent in these loans than the
typical one-to-four family residential mortgage loan. Therefore, management
assigns these types of loans a higher risk weighting in the analysis of the loan
loss reserve. The commercial loans that have been originated are loans made to
businesses to either produce a product, sell a product or provide a service.
Many of these loans are asset-based loans which are loans where repayment is
based primarily on the cash flow from operations and secondarily on, the
liquidation of assets such as inventory and accounts receivable.
Other Income. Other income increased $119,000, or 15.4%, from $775,000 for
the quarter ended March 31, 2002 to $894,000 for the quarter ended March 31,
2003. Commissions from sales of annuities and mutual funds increased $61,000, or
62.2% from $98,000 for the quarter ended March 31, 2002 to $159,000 for the
quarter ended March 31, 2003. This increase results from higher sales of
annuities and mutual funds. Mortgage banking income, net increased $102,000 from
$357,000 for the quarter ended March 31, 2002 to $459,000 for the quarter ended
March 31, 2003 as a result of higher loan sales. Proceeds from the sale of
mortgage loans totaled $23.7 million for the quarter ended March 31, 2003 as
compared to $16.7 million for the quarter ended March 31, 2002. The increased
loan activity resulted from heavy mortgage loan refinancing activity which
resulted from the attractive mortgage loan rates available in the marketplace.
The Company recorded gains on the sale of investments of $47,000 for the quarter
ended March 31, 2002 which were not present in the current quarter.
Operating Expenses. Total operating expenses were $2.2 million for both the
quarters ended March 31, 2003 and 2002. Compensation and related benefits
expense decreased $161,000 from $1.6 million for the quarter ended March 31,
2002 to $1.4 million for the quarter ended March 31, 2003. Compensation and
related benefits expense for the quarter ended March 31, 2002 included $260,000
of MRP expense which was not present in 2003 as the final vesting date for the
MRPs was June 6, 2002. Partially offsetting this decrease was increased
personnel expense related to increased number of employees and increased salary
and benefit costs. Occupancy and equipment expense increased $73,000, or 23.4%
from $311,000 for the quarter ended March 31, 2002 to $384,000 for the quarter
ended March 31, 2003. This increase was primarily the result of increased
depreciation on new equipment. Expenses incurred in operating real estate owned
were $4,000 for the three months ended March 31, 2003 compared to income of
$50,000 for the quarter ended March 31, 2002. During the quarter ended March 31,
2002, the rent receipts on real estate owned properties exceeded operating
expenses by $50,000.
Income Tax Expense. Income tax expense increased $72,000 from tax expense
of $513,000 for the quarter ended March 31, 2002 to $585,000 for the quarter
ended March 31, 2003. The effective tax rates were 37.0% and 35.7% for the
quarters ended March 31, 2003 and 2002, respectively. The increase in the
effective rate was primarily due to an increase in non-deductible expenses over
the prior period.
COMPARISON OF OPERATING RESULTS FOR THE SIX MONTHS ENDED MARCH 31, 2003 AND 2002
Net Income. We recorded net income of $2.0 million for the six months ended
March 31, 2003, an increase of $210,000, or 11.9% over the $1.8 million reported
in the six months ended March 31, 2002. For the six months ended March 31, 2003,
basic and diluted earnings per share were $0.70 and $0.67, respectively. The
Company reported basic and diluted earnings per share for the six months ended
March 31, 2002 of $0.59 and $0.56, respectively. The increase in net income
resulted primarily from increased net interest income, increased other income
and decreased operating expenses. These increases in income were partially
offset by increased income taxes. The increase in the net interest income
resulted from higher net interest margins. The average prime interest rate for
the six months ended March 31, 2003 was 4.35%, a decrease of 61 basis points
from 4.96% which was the average prime for the six months ended March 31, 2002.
The rate decrease caused a greater reduction in the average rate paid on
interest-bearing liabilities than the average yield on earning assets.
Net Interest Income. Net interest income, the difference between interest
earned on loans and investments and interest paid on interest-bearing
liabilities, increased by $134,000 or 2.3% for the six months ended March 31,
2003,
17
compared to the same six months in the prior year. This increase reflects a $1.2
million decrease in interest income that was more than offset by the $1.3
million decrease in total interest expense. The average net interest margin
increased 8 basis points from 3.58% for the six months ended March 31, 2002 to
3.66% for the six months ended March 31, 2003.
Interest Income. The decrease in interest income for the six months ended
March 31, 2003 was due a decrease in yield on interest-earning assets of 73
basis points from 6.24% for the six months ended March 31, 2002 to 5.51% for the
six months ended March 31, 2003 that was partially offset by an increase of
$225,000 in average interest-earning assets compared to the same period in the
prior year. The increased volume of average interest-earning assets increased
interest income by approximately $66,000 and the decreased yield decreased
interest income by approximately $1.3 million. Average loans receivable
increased $8.1 million for the six months ended March 31, 2003 compared with the
prior year. This increase was offset in part by a decrease in average investment
securities of $7.0 million and a decrease of $845,000 in average interest
bearing overnight funds.
Interest Expense. Interest expense decreased in the six months ended March
31, 2003 due to a decrease in average interest-bearing liabilities of $1.2
million and a decrease in the cost of interest-bearing liabilities of 99 basis
points from 3.28% for the six months ended March 31, 2002 to 2.29% for the six
months ended March 31, 2003. Average deposits decreased by $628,000 while
average FHLB advances decreased $562,000 for the six months ended March 31, 2003
compared to the same six months in the prior year. The decrease in average
interest-bearing liabilities decreased interest expense by approximately $24,000
and the decrease in the average cost of interest-bearing liabilities decreased
interest expense by approximately $1.3 million.
18
The following table presents average balances and average rates earned/paid
by the Company for the six months ended March 31, 2003 compared to the six
months ended March 31, 2002.
SIX MONTHS ENDED SIX MONTHS ENDED
MARCH 31, 2003 MARCH 31, 2002
DOLLARS IN THOUSANDS
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST YIELD/COST BALANCE INTEREST YIELD/COST
Assets:
Loans receivable (5) $227,857 $6,667 5.85% $219,783 $7,432 6.76%
Investment securities (6) 83,906 2,212 5.27 90,909 2,579 5.67
Interest-bearing overnight deposits 13,789 85 1.24 14,634 142 1.94
-------- ------ ------ -------- ------ ------
Total interest-earning assets (8) 325,552 8,964 5.51 325,326 10,153 6.24
Non interest-earning assets 19,996 22,119
-------- --------
Total assets $345,548 $347,445
======== ========
Liabilities and stockholders' equity
Interest-bearing checking 33,369 74 0.45 31,060 77 0.49
Money market investment accounts 21,945 112 1.02 28,167 205 1.45
Passbook and statement savings 29,264 161 1.10 26,619 213 1.60
Certificates of deposit 157,639 2,112 2.68 156,999 3,278 4.18
FHLB advances 21,077 553 5.25 21,639 562 5.19
-------- ------ ------ -------- ------ ------
Total interest-earning liabilities 263,294 3,012 2.29 264,484 4,335 3.28
Non interest-earning liabilities 20,055 18,736
-------- --------
Total liabilities 283,349 283,220
Stockholders' equity 62,199 64,225
-------- --------
Total liabilities and stockholders' equity $345,548 $347,445
======== ========
Net interest income $5,952 $5,818
====== ======
Interest rate spread 3.22% 2.96%
Net interest margin (7) 3.66% 3.58%
Ratio of average interest-earning assets 123.65% 123.00%
<FN>
_________
(5) Includes nonaccrual loans and loans held for sale, net of discounts and
allowance for loan losses.
(6) Includes FHLB of Atlanta stock.
(7) Represents net interest income divided by the average balance of
interest-earning assets.
(8) Due to immateriality, the interest income and yields related to certain tax
exempt assets have not been adjusted to reflect a fully taxable equivalent
yield.
</FN>
Provision for Loan Losses. The provision for loan losses is charged to
earnings to maintain the total allowance for loan losses at a level considered
adequate to absorb estimated probable losses inherent in the loan portfolio
based on existing loan levels and types of loans outstanding, nonperforming
loans, prior loan loss experience, general economic conditions and other
factors. Provisions for loan losses totaled $120,000 for both the six months
ended March 31, 2003 and 2002. The provision for loan losses was impacted by the
continued shift in the portfolio to commercial loans which require a larger
allocation of allowance for loan losses. The effects of this continued shift in
the portfolio were offset to a certain degree in 2003 by a decrease in net loan
charge-offs.
Other Income. Other income increased $70,000, or 4.3%, from $1.6 million
for the six months ended March 31, 2002 to $1.7 million for the six months ended
March 31, 2003. Mortgage banking income, net increased $114,000 from $779,000
for the six months ended March 31, 2002 to $893,000 for the six months ended
March 31, 2003. During the six months ended March 31, 2003, we sold fixed-rate
mortgage loans held for sale of $48.6 compared with loan sales of $42.0 million
for the six months ended March 31, 2002. Gains on sales of investment securities
of $47,000 were recognized during
19
the six months ended March 31, 2002 that were not present in the current year.
Operating Expenses. Total operating expenses were $4.4 million for the six
months ended March 31, 2003, a decrease of $122,000, or 2.7% over the $4.5
million recorded for the six months ended March 31, 2002. Compensation and
related benefits expense decreased $347,000, or 11.0% from $3.1 million for the
six months ended March 31, 2002 to $2.8 million for the six months ended March
31, 2003. Compensation and benefits expense for the six months ended March 31,
2002 included $520,000 of MRP expense which was not present in 2003 as the final
vesting date for the MRPs was June 6, 2002. Partially offsetting this decrease
was increased personnel expense related to the increased number of employees and
increased salary and benefit costs. The Company recognized income from real
estate operations of $32,000 during the six months ended March 31, 2002 compared
to expenses of $9,000 in the six months ended March 31, 2003.
Income Tax Expense. Income tax expense increased $116,000 from tax expense
of $1.0 million for the six months ended March 31, 2002 to $1.2 million for the
six months ended March 31, 2003. The increase resulted from a $326,000 increase
in income before income taxes. The effective tax rates were 36.9% and 37.0% for
the six months ended March 31, 2003 and 2002, respectively.
COMMITMENTS, CONTINGENCIES AND OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet risk
including commitments to extend credit under existing lines of credit and
commitments to sell loans. These instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the consolidated balance sheets.
Off-balance sheet financial instruments whose contract amount represents credit
and interest rate risk are summarized as follows:
March 31, 2003 September 30, 2002
-------------- ------------------
(dollars in thousands)
Commitments to originate new loans $1,787 $1,435
Commitments to originate new loans held for sale -- --
Unfunded commitments to extend credit under existing
equity line and commercial lines of credit 64,409 56,200
Commercial letters of credit 265 266
Commitments to sell loans held for sale 4,710 16,371
The Company does not have any special purpose entities or other similar forms of
off-balance sheet financing arrangements.
Commitments to originate new loans or to extend credit are agreements to lend to
a customer as long as there is no violation of any condition established in the
contract. Loan commitments generally expire within 30 to 45 days. Most equity
line commitments are for a term of 15 years, and commercial lines of credit are
generally renewable on an annual basis. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee.
Since many of the commitments are expected to expire without being drawn upon,
the total commitment amounts do not necessarily represent future cash
requirements. The Company evaluates each customer's creditworthiness on a
case-by-case basis. The amounts of collateral obtained, if deemed necessary by
the Company upon extension of credit, is based on management's credit evaluation
of the borrower.
Commitments to sell loans held for sale are agreements to sell loans to a third
party at an agreed upon price. At March 31, 2003, the agreed-upon price of these
commitments exceeded the book value of the loans to be sold.
20
CONTRACTUAL OBLIGATIONS
As of March 31, 2003
Payments due by period
----------------------
(Dollars in thousands)
----------------------
Less than
1 year 1-3 years 4-5 years Over 5 years Total
---------- --------- --------- ------------ ----
Deposits $230,882 19,920 8,004 -- 258,806
Long-term borrowings -- -- 20,000 -- 20,000
Lease obligations 19 56 42 38 155
-------- ------ ------ --- -------
Total contractual cash
obligations $230,901 19,976 28,046 38 278,961
======== ====== ====== === =======
ASSET QUALITY
At March 31, 2003, we had approximately $4.6 million in non-performing
assets (nonaccrual loans and real estate owned) or 1.32% of total assets. At
September 30, 2002, non-performing assets were $4.4 million or 1.25% of total
assets. At March 31, 2003 and September 30, 2002, impaired loans totaled $3.8
million and $3.7 million, respectively, as defined by Statement of Financial
Accounting Standards No. 114, "Accounting by Creditors for Impairment of a
Loan." The impaired loans at March 31, 2003 result from three unrelated
commercial loan customers, all of which have loans secured by commercial real
estate and business assets in Alamance County. At March 31, 2003, the entire
$3.8 million of the impaired loans were on non-accrual status, and their related
reserve for loan losses totaled $210,000. The average carrying value of impaired
loans was $3.7 million during the three and six months ended March 31, 2003,
respectively. Interest income of $75,000 and $117,000 has been recorded on
impaired loans on a cash basis in the three and six months ended March 31, 2003,
respectively. The Bank's net charge-offs for the three and six months ended
March 31, 2003 were $0 and $2,000, respectively. The Bank's allowance for loan
losses was $3.8 million at March 31, 2003 compared with $3.7 million at
September 30, 2002 and $3.6 million at March 31, 2002. As a result of our
continued , gradual shift toward commercial, construction, consumer and home
equity loans, the recent decrease in residential mortgage loans, the modest
increase in non-performing loans as a percentage of total loans as well as the
continued decline in the local and regional economy, the ratio of the allowance
for loan losses to total loans, net of loans in process and deferred loan fees
increased to 1.69% at March 31, 2003 compared to 1.67% at September 30, 2002.
The following table presents an analysis of our nonperforming assets:
At At At
March 31, September 30, March 31,
2003 2002 2002
---- ---- ----
Nonperforming loans:
Nonaccrual loans $ 4,414 $ 4,204 $ 1,747
Loans 90 days past due and accruing -- -- --
Restructured loans -- -- --
-------- ------- -------
Total nonperforming loans 4,414 4,204 1,747
Other real estate 177 183 2,252
-------- ------- -------
Total nonperforming assets $ 4,591 $ 4,387 $ 3,999
======== ======= =======
Nonperforming loans to loans receivable, net 1.97% 1.91% 0.83%
Nonperforming assets as a percentage
of loans and other real estate owned 2.05% 1.99% 1.88%
Nonperforming assets to total assets 1.32% 1.25% 1.16%
Regulations require that we classify our assets on a regular basis. There are
three classifications for problem assets:
21
substandard, doubtful and loss. We regularly review our assets to determine
whether any assets require classification or re-classification. At March 31,
2003, we had $5.1 million in classified assets consisting of $5.0 million in
substandard and loss loans and $177,000 in real estate owned. At September 30,
2002, we had $5.1 million in substandard assets consisting of $4.9 million in
loans and $183,000 million in real estate owned.
In addition to regulatory classifications, we also classify as "special mention"
and "watch" assets that are currently performing in accordance with their
contractual terms but may become classified or nonperforming assets in the
future. At March 31, 2003, we have identified approximately $1.1 million in
assets classified as special mention and $30.7 million as watch.
LIQUIDITY AND CAPITAL RESOURCES
The Bank must meet certain liquidity requirements established by the State
of North Carolina Office of the Commissioner of Banks (the "Commissioner"). At
March 31, 2003, the Bank's liquidity ratio exceeded such requirements. Liquidity
generally refers to the Bank's ability to generate adequate amounts of funds to
meet its cash needs. Adequate liquidity guarantees that sufficient funds are
available to meet deposit withdrawals, fund loan commitments, maintain adequate
reserve requirements, pay operating expenses, provide funds for debt service,
pay dividends to stockholders and meet other general commitments.
Our primary sources of funds are deposits, principal and interest payments
on loans, proceeds from the sale of loans, and to a lesser extent, advances from
the FHLB of Atlanta. While maturities and scheduled amortization of loans are
predictable sources of funds, deposit flows and mortgage prepayments are greatly
influenced by general interest rates, economic conditions and local competition.
Our most liquid assets are cash and cash equivalents. The levels of these
assets are dependent on our operating, financing, lending and investing
activities during any given period. At March 31, 2003, cash and cash equivalents
totaled $31.4 million. We have other sources of liquidity should we need
additional funds. During the three and six months ended March 31, 2003, we sold
loans totaling $23.7 million and $48.6 million, respectively. Additional sources
of funds include FHLB of Atlanta advances. Other sources of liquidity include
loans and investment securities designated as available for sale, which totaled
$64.1 million at March 31, 2003.
We anticipate that we will have sufficient funds available to meet our
current commitments. At March 31, 2003, we had $1.8 million in commitments to
originate new loans, $64.4 million in unfunded commitments to extend credit
under existing equity lines and commercial lines of credit and $265,000 in
standby letters of credit. At March 31, 2003, certificates of deposit, which are
scheduled to mature within one year, totaled $127.4 million. We believe that a
significant portion of such deposits will remain with us.
The FDIC requires the Bank to meet a minimum leverage capital requirement
of Tier I capital to assets ratio of 4%. The FDIC also requires the Bank to meet
a ratio of total capital to risk-weighted assets of 8%, of which 4% must be in
the form of Tier I capital. The Commissioner requires the Bank at all times to
maintain certain minimum capital levels. The Bank was in compliance with all
capital requirements of the FDIC and the Commissioner at March 31, 2003 and is
deemed to be "well capitalized."
The Federal Reserve also mandates capital requirements on all bank holding
companies, including 1st State Bancorp, Inc. These capital requirements are
similar to those imposed by the FDIC on the Bank. At March 31, 2003, the Company
was in compliance with the capital requirements of the Federal Reserve.
On October 2, 2000, the Company paid a one-time special cash distribution
of $5.17 per share to its stockholders. The distribution was made to manage the
Company's capital and enhance shareholder value. Returning capital to the
stockholders reduced the Company's equity to asset ratio from 21.2% to 17.2%.
The Company's equity to asset ratio at March 31, 2003 was 18.0%. The Company's
capital level is sufficient to support future growth.
The Company has declared cash dividends per common share of $0.10, $0.08
and $0.08 for each of the three months ended March 31, 2003, September 30, 2002
and March 31, 2002, respectively. The Company's ability to pay
22
dividends is dependent upon earnings. The Company's dividend payout ratio for
the three months ended March 31, 2003, September 30, 2002 and March 31, 2002 was
29.4%, 26.4% and 27.6%, respectively.
ACCOUNTING MATTERS
On October 3, 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS
No. 144), which addresses financial accounting and reporting for the impairment
or disposal of long-lived assets. While SFAS No. 144 supercedes SFAS No. 121
(Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of), it retains many of the fundamental provisions of SFAS No. 121.
SFAS No. 144 also supersedes the accounting and reporting provisions of
Accounting Principles Board 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) for
the disposal of a segment of a business. However, it retains the requirement in
Opinion No. 30 to report separately discontinued operations and extends the
reporting to a component of an entity that either has been disposed of (by sale,
abandonment, or in a distribution to owners) or is classified as held for sale.
By broadening the presentation of discontinued operations to include more
disposal transactions, the FASB has enhanced management's ability to provide
information that helps financial statement users to assess the effects of
disposal transactions on the ongoing operations of an entity. The provisions of
SFAS No. 144 are effective for financial statements issued for fiscal years
beginning after December 15, 2001, and interim periods within those fiscal
years. Adoption of SFAS No. 144 on October 1, 2002 did not have a material
impact on the Company's consolidated financial statements.
In June 2002, the FASB issued Statement of Financial Accounting Standards No.
146 (SFAS No. 146), "Accounting for Costs Associated with Exit or Disposal
Activities," which addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." This Statement applies to costs associated
with an exit activity that does not involve an entity newly acquired in a
business combination or with a disposal activity covered by SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets." Those costs
include, but are not limited to, the following: a) termination benefits provided
to current employees that are involuntarily terminated under the terms of a
benefit arrangement that, in substance, is not an ongoing benefit arrangement or
an individual deferred compensation contract (hereinafter referred to as
one-time termination benefits), b) costs to terminate a contract that is not a
capital lease and c) costs to consolidate facilities or relocate employees. This
Statement does not apply to costs associated with the retirement of a long-lived
asset covered by FASB Statement No. 143, "Accounting for Asset Retirement
Obligations." A liability for a cost associated with an exit or disposal
activity shall be recognized and measured initially at its fair value in the
period in which the liability is incurred. A liability for a cost associated
with an exit or disposal activity is incurred when the definition of a liability
is met. The provisions of this Statement are effective for exit or disposal
activities that are initiated after December 31, 2002, with early application
encouraged. This statement will impact the Company to the extent it engages in
exit or disposal activities in future periods.
In November 2002, the FASB issued Interpretation No. 45 (FIN 45), "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others", which addresses the disclosure to be made
by a guarantor in its interim and annual financial statements about its
obligations under guarantees. FIN 45 requires the guarantor to recognize a
liability for the non-contingent component of the guarantee, such as the
obligation to stand ready to perform in the event that specified triggering
events or conditions occur. The initial measurement of this liability is the
fair value of the guarantee at inception. The recognition of the liability is
required even if it is not probable that payments will be required under the
guarantee or if the guarantee was issued with a premium payment or as part of a
transaction with multiple events. The disclosure requirements are effective for
interim and annual financial statements ending after December 15, 2002. The
initial recognition and measurement provisions are effective for all guarantees
within the scope of FIN 45 issued or modified after December 31, 2002. The
Company issues standby letters of credit whereby the Company guarantees
performance if a specified triggering event or condition occurs (primarily
nonperformance under construction contracts entered into by construction
customers.) The guarantees generally expire within one year and may be
automatically renewed depending on the terms of the guarantee. The maximum
potential amount of undiscounted future payments related to standby letters of
credit at March 31, 2003 is $265,000. At March 31, 2003, the Company has
recorded no liability for the current carrying amount of the obligation to
perform as a guarantor and no contingent liability is considered necessary, as
such amounts are deemed immaterial. Substantially all standby
23
letters of credit are secured by real estate and/or guaranteed by third parties
in the event the Company had to advance funds to fulfill the guarantee.
In December 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation
- - Transition and Disclosure' (SFAS 148) an amendment of FASB Statement No. 123,
Accounting for Stock-Based Compensation (SFAS 123), which provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, SFAS 148 amends
the disclosure requirements of SFAS 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The transition provisions of the statement are effective for financial
statements for fiscal years ending after December 15, 2002 while the disclosure
requirements are effective for interim periods beginning after December 15,
2002, with early application encouraged. The adoption of SFAS 148 have resulted
in enhanced disclosures for the Company's stock-based employee compensation plan
effective January 1, 2003.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the possible chance of loss from unfavorable changes in
market prices and rates. These changes may result in a reduction of current and
future period net interest income, which is the favorable spread earned from the
excess of interest income on interest-earning assets over interest expense on
interest-bearing liabilities.
The Company considers interest rate risk to be its most significant market
risk, which could potentially have the greatest impact on operating earnings.
The structure of the Company's loan and deposit portfolios is such that a
significant decline in interest rates may adversely impact net market values and
net interest income.
The Company monitors whether material changes in market risk have occurred
since September 30, 2002. The Company does not believe that any material adverse
changes in market risk exposures occurred since September 30, 2002.
ITEM 4. CONTROLS AND PROCEDURES
(a) Within 90 days prior to the date of this report, we carried out an
evaluation, under the supervision and with the participation of our principal
executive officer and principal financial officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based on this
evaluation, our principal executive officer and principal financial officer
concluded that our disclosure controls and procedures are effective in timely
alerting them to material information required to be included in our periodic
SEC reports.
(b) In addition, there have been no significant changes in our internal
controls or in other factors that could significantly affect those controls
subsequent to the date of their last evaluation.
24
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Stockholders was held on January 28, 2003. At
this meeting 2,574,001 shares of the Company's common stock were represented in
person or by proxy.
Stockholders voted in favor of the election of three nominees for director. The
voting results for each nominee were as follows:
Votes in Favor Votes
Nominee of Election Withheld
Bernie C. Bean 2,571,002 2,999
James C. McGill 2,561,735 12,226
Virgil L. Stadler 2,570,478 3,523
There were no broker nonvotes on the matter.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a.) Exhibits.
--------
99 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
(b.) Reports on Form 8-K.
-------------------
On March 20, 2003, the Company filed a report on Form 8-K regarding its
March 19, 2003 news release in which it announced an increase in its cash
dividend to $0.10 per share. The full text news release dated March 19,
2003 was attached as Exhibit 99(a) to this Form 8-K filing.
25
SIGNATURES
Pursuant to the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
1ST STATE BANCORP, INC.
/s/ James C. McGill
Date: May 14, 2003 --------------------------------------------
James C. McGill
President and Chief Executive Officer
(Principal Executive Officer)
/s/ A. Christine Baker
Date: May 14, 2003 --------------------------------------------
A. Christine Baker
Executive Vice President
Treasurer and Secretary
(Principal Financial and Accounting Officer)
26
CERTIFICATION
I, James C. McGill, President and Chief Executive Officer of 1st State Bancorp,
Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of 1st State Bancorp,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) All significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003
By: /s/ James C. McGill
--------------------------------------------
Name: James C. McGill
Title: President and Chief Executive Officer
27
CERTIFICATION
I, A. Christine Baker, Secretary, Treasurer and Chief Financial Officer of 1st
State Bancorp, Inc,, certify that:
1. I have reviewed this quarterly report on Form 10-Q of 1st State Bancorp,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) All significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003
By: /s/ A. Christine Baker
------------------------------------
Name: A. Christine Baker
Title: Secretary, Treasurer and
Chief Financial Officer
28