2003 Annual Report
Cooperative Bankshares, Inc.
Table of Contents
Selected Financial and Other Data
President's Message
Management's Discussion & Analysis
Independent Auditors' Report
Consolidated Statements of Financial
Condition
Consolidated Statements of Operations
Consolidated Statements of Comprehensive
Income
Consolidated Statements of Stockholders'
Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Directors, Officers, and Financial
Center Locations
Corporate Information
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 (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 and
its subsidiaries.
Cooperative Bank was chartered in 1898. The
Bank's headquarters are located in
Wilmington, North Carolina. Cooperative Bank
operates 21 offices 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") a mortgage banking
firm. Lumina has offices in Wilmington,
North Carolina, North Myrtle Beach, South
Carolina, and Virginia Beach, Virginia. The
Bank's other subsidiary, CS&L Holdings, Inc.
("Holdings") is a Virginia Corporation and a
holding company for CS&L Real Estate Trust,
Inc. (the "REIT"), which is a real estate
investment trust. The Federal Deposit
Insurance Corporation ("FDIC") insures the
Bank's deposit accounts up to applicable
limits.
Through its offices, the Bank provides a
wide range of banking products, including
interest-bearing and noninterest-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. The Bank began offering Online
Banking and Bill Payment on July 1, 2003. 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.
SELECTED FINANCIAL AND OTHER DATA
At December 31, 2003 2002 2001 2000 1999
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Dollars in Thousands
Selected Financial Condition Data:
Assets $ 502,306 $ 504,210 $ 458,114 $ 414,961 $ 410,146
Loans, net 401,242 390,876 373,458 347,486 334,744
Securities 47,419 49,935 47,970 35,027 45,261
FHLB stock 4,154 4,055 4,155 3,755 3,755
Deposits 367,072 357,254 339,830 327,312 304,834
Borrowed funds 89,505 104,678 83,097 55,101 75,106
Stockholders' equity 43,143 38,448 33,618 30,812 29,343
Year Ended December 31, 2003 2002 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------
Dollars in Thousands
Selected Operations Data:
Interest income $ 27,827 $ 29,496 $ 31,117 $ 31,709 $ 28,449
Interest expense 10,686 13,875 18,916 19,305 16,422
Net interest income 17,141 15,621 12,201 12,404 12,027
Provision for loan losses 740 740 460 970 210
Noninterest income 6,634 4,754 2,040 1,670 1,228
Noninterest expenses 15,041 11,888 9,303 10,193 8,885
Income before income taxes 7,994 7,747 4,478 2,911 4,160
Net income 5,404 4,944 2,889 1,932 2,680
- ------------------------------------------------------------------------------------------------------------------
Selected Financial Ratios and Other Data:
Return on average assets 1.07% 1.05% 0.67% 0.47% 0.69%
Return on average equity 13.16% 13.70% 8.91% 6.35% 8.88%
Average stockholders' equity to average assets 8.17% 7.64% 7.57% 7.38% 7.74%
Non-performing assets to total assets 0.05% 0.24% 0.84% 0.22% 0.35%
Allowance for loan losses to total loans 0.84% 0.70% 0.67% 0.62% 0.39%
Dividend payout ratio 10.54% 11.47% 19.49% 28.09% --
Per Share Data:
Earnings per:
Common share - basic $ 1.90 $ 1.74 $ 1.03 $ 0.71 $ 0.95
Common share - diluted $ 1.86 $ 1.73 $ 1.02 $ 0.69 $ 0.90
Cash dividends declared $ 0.20 $ 0.20 $ 0.20 $ 0.20 --
Book value $15.14 $13.56 $11.86 $11.35 $10.92
Number of common shares outstanding 2,849,447 2,835,947 2,835,447 2,714,610 2,687,919
President's Message
The year 2003 was a record setter for our company. The Bank originated
1,833 loans totaling $250.5 million while the bank's subsidiary, Lumina Mortgage
Company, originated 1,486 loans for $205.5 million, giving total originations of
$456.0 million, which is a record that far exceeds any previous year in the
history of the company.
Enhancements were made to many of our products including "Online Banking"
which was made available to our customers in July, where customers can now enjoy
the convenience of viewing deposits and loan information, transferring funds
from one account to another, and getting stock quote information. "Online Bill
Pay" allows the customer to schedule bill payments through a personal computer
rather than having to write and mail checks.
In April, 2003, we introduced "Better Than Free Checking". This account is
truly a free checking account, and we have had excellent response to this new
product. We also introduced "Over Draft Privilege", a new service that will
protect customers from the embarrassment and inconvenience of "bouncing" a
check.
Perhaps the biggest record that was set during the year was the opening of
four new financial centers, beginning with the opening in May of a new center at
Monkey Junction in Wilmington. On July 1, our second financial center in
Morehead City opened on Highway 24, and the year ended with a bang during the
month of December when a center was opened in the Landfall Shopping Center in
Wilmington, and our first entry into the rapidly growing Brunswick County area,
when a new facility in Southport was also added.
Net income for the year ended December 31, 2003 was $5,404,226, or $1.86
per diluted share, a 9.3% increase in net income over the same period last year.
Net income for the twelve months ended December 31, 2002 was $4,944,497, or
$1.73 per diluted share. Total assets at December 31, 2003 were $502.3 million.
Stockholders' equity was $43.1 million and represented 8.59% of assets.
Stockholders were handsomely rewarded during the year for this performance as
the price of a share of stock rose from $15.94 on December 31, 2002, to $25.62
on the same day in 2003, or a 60.7% increase during the year.
In summary, the past year has been one of the most exciting in the 105 year
history of the Company. We have experienced dramatic improvements in earnings
and efficiencies while growing our retail and commercial loans, and making our
balance sheet more bank like. The record setting pace of loan originations
favorably affected earnings, and the opening of four new branches, and the
introduction of several new bank products bodes well for the future. Thank you
for your continued support.
Sincerely yours,
/s/ Frederick Willetts, III
Frederick Willetts, III
President
MANAGEMENT'S DISCUSSION AND ANALYSIS
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 21 offices 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. The Bank's other
subsidiary, CS&L Holdings, Inc. ("Holdings"), is a holding company incorporated
in Virginia for CS&L Real Estate Trust, Inc. (the "REIT"), which is a real
estate investment trust. Accordingly, the information set forth in this report,
including financial statements and related data, relates primarily to the Bank
and its subsidiaries.
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 Annual Report.
Critical Accounting Policy
The preparation of our audited consolidated financial statements and the
information included in management's discussion and analysis is governed by
policies that are based on accounting principles generally accepted in the
United States of America and general practices within the banking industry.
Among the more significant policies are those that govern accounting for loans
and allowance for loan losses and goodwill. These policies are discussed in Note
1 of the "Notes to Consolidated Financial Statements" included in this Annual
Report.
A critical accounting policy is one that is both very important to the
portrayal of the Company's financial condition and results, and requires a
difficult, subjective or complex judgment by management. What makes these
judgments difficult, subjective and/or complex is the need to make estimates
about the effects of matters that are inherently uncertain. Estimates and
judgments are integral to our accounting for certain items, and those estimates
and judgments affect the reported amounts of assets, liabilities, revenues,
expenses and related disclosure of contingent assets and liabilities. The
Company periodically evaluates its estimates, including those related to the
reserve for loan losses and goodwill. While we base our estimates on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances, actual results may differ from these estimates under
different assumptions or conditions. Further information regarding the
accounting policies that we consider to be critical is provided below.
Allowance for loan losses. The Company's most significant critical
accounting policy is the determination of its allowance for loan losses. The
allowance for loan losses reflects the estimated losses that will result from
the inability of our customers to make required payments. The allowance for loan
losses results from management's evaluation of the risk characteristics of the
loan portfolio under current economic conditions and considers such factors as
the financial condition of the borrower, fair market value of collateral and
other items that, in our opinion, deserve current recognition in estimating
possible credit losses. Our evaluation process is based on historical evidence
and current trends among delinquencies, defaults and nonperforming assets. Our
estimate of the allowance for loan losses does not include the impact of events
that might occur in the future.
Management considers the established allowance adequate to absorb losses
that relate to loans outstanding at December 31, 2003, although future additions
to the allowance may be necessary based on changes in economic conditions and
other factors. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the allowance for loan losses.
Such agencies may require adjustments to the allowance based on their judgments
of information available to them at the time of their examination. If the
financial condition of our borrowers was to deteriorate, resulting in an
impairment of their ability to make payments, our estimates would be updated,
and additional provisions may be required. For further information on the
allowance for loan losses, see "Financial Condition" in Management's Discussion
and Analysis and Note 3 of the "Notes to Consolidated Financial Statements"
included in this Annual Report.
Goodwill. Goodwill, which represents the excess of the purchase price over
the fair value of net assets acquired in a business combination, is tested at
least annually for impairment. The impairment test is a two-step process that
begins with a comparison of book value and stock price. If the initial
evaluation suggests that an impairment of the asset value exists, the second
step would determine the amount of the impairment, if any. If the tests conclude
that goodwill is impaired, the carrying value would be adjusted, and an
impairment loss would be recorded.
Management Strategy
The 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, 2003
approximately $267 million, or 66%, 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 $268 million, or 68% at December
31, 2002. The Bank originates adjustable rate and fixed rate loans. As of
December 31, 2003, adjustable rate and fixed rate loans totaled approximately
69% and 31%, 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 2003, the Bank sold $19 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 $25 million in the secondary market and $14 million through a brokered
arrangement where the Bank released the servicing of the loans. Lumina sold $228
million in the secondary market during 2003.
The growth in the loan portfolio was concentrated in real estate-backed
commercial loans, including construction 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 opened four financial centers in 2003. The Monkey Junction center
located at 5102 South College Road in Wilmington, North Carolina opened May
2003, and the Morehead City, North Carolina center located at 137 Highway 24,
opened July 2003. The Landfall Center at 1313 Military Cutoff Road in
Wilmington, North Carolina and the 5210 Southport-Supply Road center in
Southport, North Carolina opened December 2003. The Southport office is the
Bank's first financial center in Brunswick County.
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
assets. At December 31, 2003, the Company had a one-year positive gap position
of 0.3%. 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 is
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.
When Lumina gives a rate lock commitment to a customer, there is a
concurrent "lock-in" for the loan with a secondary market investor under a best
efforts delivery mechanism. Therefore, interest rate risk is mitigated because
any commitments to fund a loan available for sale are 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.
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.
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INTEREST RATE SENSITIVITY ANALYSIS
Over One Over Five
One Year Through Through Over Ten
December 31, 2003 or Less Five Years Ten Years Years Total
- -----------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Interest-earning assets:
Securities $ 17,454 $ 21,362 $ 3,887 $ 4,716 $ 47,419
Interest-bearing bank balances 3,993 -- -- -- 3,993
Federal Home Loan Bank stock 4,154 -- -- -- 4,154
All Loans 288,183 112,909 7,880 2,092 411,064
------------- ------------- ------------- ------------- -------------
Total $ 313,784 $ 134,271 $ 11,767 $ 6,808 $ 466,630
============= ============= ============= ============= =============
Interest-bearing liabilities:
Deposits $ 265,966 $ 65,031 $ 9,467 $ -- $ 340,464
Borrowed funds 46,417 25,009 18,014 65 89,505
------------- ------------- ------------- ------------- -------------
Total $ 312,383 $ 90,040 $ 27,481 $ 65 $ 429,969
============= ============= ============= ============= =============
Interest rate sensitivity gap $ 1,401 $ 44,231 $ (15,714) $ 6,743 $ 36,661
============= ============= ============= ============= =============
Cumulative interest rate sensitivity gap $ 1,401 $ 45,632 $ 29,918 $ 36,661
============= ============= ============= =============
Cumulative ratio of interest-earning
assets to interest-bearing liabilities 100.4% 111.3% 107.0% 108.5%
============= ============= ============= =============
Ratio of cumulative gap to total assets 0.3% 9.1% 6.0% 7.3%
============= ============= ============= =============
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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 interest-bearing liabilities so as to mitigate the effect of changes
in the rate environment.
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, 2003, the percentage of negative estimated
change in EVE increased in the rising rate environments as compared to the
estimated change at December 31, 2002. Changes to EVE in declining rate
environments from December 31, 2002 to December 31, 2003 are positively
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, 2003 (in thousands).
- --------------------------------------------------------------------------------
Market Risk Table
December 31, 2003
Change in Economic Estimated Estimated
Interest Rates Value of Equity $ Change % Change
- --------------------------------------------------------------------------------
400 basis point rise $ 34,430 (17,751) (34%)
300 basis point rise 38,721 (13,460) (26%)
200 basis point rise 42,643 (9,538) (18%)
100 basis point rise 46,834 (5,347) (10%)
Base Scenario 52,181 --
100 basis point decline 53,386 1,205 2%
200 basis point decline 55,321 3,140 6%
300 basis point decline 57,178 4,997 10%
400 basis point decline 59,609 7,428 14%
- --------------------------------------------------------------------------------
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, selling loans held for sale, deposits, income from
operations and borrowings are the main sources of liquidity. The Bank has been
granted a line of credit by the Federal Home Loan Bank of Atlanta ("FHLB") in an
amount of up to 25% of the Bank's total assets. At December 31, 2003, the Bank's
borrowed funds from the FHLB equaled 17% of its total assets. 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, 2003, the estimated market value of liquid assets (cash,
cash equivalents, marketable securities and loans held for sale) was
approximately $72 million, representing 16% of deposits and borrowed funds as
compared to $88 million or 19% of deposits and borrowed funds at December 31,
2002. The decrease in liquid assets was primarily due to a decrease in loans
held for sale. Management maintains a portfolio generally consisting of
mortgage-backed securities and securities with short maturities (within 6 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 stockholders' 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") and a
Household Finance Corporation 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 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, 2003, outstanding off-balance sheet commitments to
extend credit totaled $41 million, and the undisbursed portion of construction
loans was $45 million. Management considers current liquidity levels adequate to
meet the Company's cash flow requirements.
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements that have or
are reasonably likely to have a current or future effect of the Company's
financial condition, changes in financial condition, revenues or expenses,
results of operations, liquidity, capital expenditures or capital resources that
are material to investors except as disclosed in Note 3 of "Notes to
Consolidated Financial Statements."
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,
2003 (in thousands).
- ---------------------------------------------------------------------------------------------------------------------------
Payments Due by Period
-------------------------------------------------------------------
Less
than 1 1-3 4-5 Over 5
Contractual Obligations Total year years years years
-------------------------------------------------------------------
Borrowed Funds $ 89,505 $ 41,417 $20,000 $ 5,000 $23,088
Lease Obligations 4,992 487 681 493 3,331
Lumina Mortgage Company Purchase 400 400 -- -- --
Deposits 367,072 334,154 32,815 82 21
-------------------------------------------------------------------
Total Contractual Cash Obligations $ 461,969 $ 376,458 $53,496 $ 5,575 $26,440
===================================================================
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 $ 15,431 $ 220 $ 1,707 $ 549 $12,955
Other commitments and credit lines 15,275 1,614 10,288 400 2,973
Undisbursed portion of construction loans 45,311 45,311 -- -- --
Available for sale mortgage loan commitments 2,954 2,954 -- -- --
Fixed-rate mortgage loan commitments 1,031 1,031 -- -- --
Adjustable-rate mortgage loan
commitments 5,815 5,815 -- -- --
-------------------------------------------------------------------
Total Commitments $ 85,817 $ 56,945 $11,995 $ 949 $15,928
===================================================================
- ---------------------------------------------------------------------------------------------------------------------------
In the normal course of business, the Company may enter into purchase
agreements for goods or services. In management's opinion, the dollar amount of
such agreements at December 31, 2003 is immaterial and has not been included in
the previous table.
Capital
Stockholders' equity at December 31, 2003, was $43.1 million, up $4.7
million, or 12.2%, from $38.4 million at December 31, 2002. The improved capital
position during the year 2003 reflects the impact of earnings retention after
the declaration of cash dividends of $570,000, or $0.20 per share, and the
exercising of 13,500 stock options. Stockholders' equity at December 31, 2003
and December 31, 2002 includes unrealized gains net of tax of $285,000 and
$636,000, respectively, on securities available for sale.
Under the capital regulations of the Federal Deposit Insurance Corporation
("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, 2003, the Bank's leverage capital ratio
was 8.41%. The FDIC's risk-based capital rules require banks supervised by the
FDIC to maintain risk-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, 2003, the Bank had a ratio of
qualifying total capital to risk-weighted assets of 12.11%.
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 17, 2003, 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, 2004, to shareholders of record on January 2, 2004. 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 2004 Annual Meeting of Stockholders.
FINANCIAL CONDITION
The Company's total assets decreased 0.4% to $502.3 million at December 31,
2003, as compared to $504.2 million at December 31, 2002. The major change in
assets is a decrease of $19.3 million (75.2%) in loans held for sale due to the
decrease in mortgage volume caused by a reduction in mortgage loan refinancing
and an increase in mortgage rates at December 31, 2003. This reduction allowed
the Bank to reduce short-term borrowings $20.2 million (32.7%). In addition,
there is an increase of $6.5 million (55.1%) in cash and cash equivalents, which
was caused by an increase in deposits of $9.8 million (2.7%). The increase in
deposits was mainly due to checking accounts. The Bank continues to emphasize
obtaining business accounts, which is part of the reason for this increase. The
Bank also attracted an additional $6.9 million in internet deposits because the
rates are competitive with the Bank's local markets. Internet deposits are
usually obtained from other financial institutions with terms primarily of one
or two years. The increase in deposits along with the maturing of a held to
maturity bond helped
fund the increase of $10.9 million (2.8%) in loans. The increase of $1.6 million
(23.5%) in premises and equipment was primarily due to the building and
furnishing of new branches. Other assets increased $1.5 million (12.9 %) largely
due to an increase of $448,000 in deferred income taxes and a receivable of
$734,000 for the sale of a building. The additional goodwill of $800,000 was
generated by amending the purchase agreement of Lumina Mortgage Company from two
contingent payments into two payments of $400,000 each, payable on July 31, 2003
and 2004. A reduction in accounts payable caused the decrease of $1.1 million
(33.5%) in accrued expenses and other liabilities.
The Company's nonperforming assets (nonaccrual loans, accruing loans 90
days or more delinquent and foreclosed real estate) were $267,000, or 0.05% of
assets, at December 31, 2003, compared to $1.2 million, or 0.24% of assets, at
December 31, 2002. The Company 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
$3.4 million at December 31, 2003 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 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, 2003 deposits had increased $9.8 million (2.7%) to $367.1
million as compared to $357.3 million at December 31, 2002. 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 $12.1 million (29.9%) to $52.5 million as compared to
$40.4 million at December 31, 2002.
RESULTS OF OPERATION
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 9.3% to $5.4 million for 2003, as compared to $4.9
million for 2002 and $2.9 million in 2001. 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.
Interest Income
Interest income amounted to $27.8 million during 2003, a $1.7 million
(5.7%) decrease from 2002 levels, which decreased $1.6 million (5.2%) from 2001
levels. Interest income reduction during 2003 resulted from lower yields on
earning assets. The average balance of interest-earning assets increased 6.0%
but was more than offset by the yield decreasing 73 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 2002, the decrease in interest income
was due to the yield on average interest-earning assets decreasing 93 basis
points because of the interest rate cuts. The average balance of
interest-earning assets increased 8.1% as compared to 2001. The yield on average
interest-earning assets for the year 2003 decreased to 5.89 % as compared to
6.62% for 2002 and 7.55% for 2001.
Interest Expense
Interest expense amounted to $10.7 million during 2003, a $3.2 million
(23.0%) decrease from 2002 levels, compared to a $5.0 million (26.7%) decrease
from 2001 to 2002. The decrease in interest expense during 2003 resulted from a
lower cost of interest-bearing liabilities. During 2003, the average balance of
interest-bearing liabilities increased 4.4% but was more than offset by the cost
decreasing 87 basis points as compared to 2002. During 2002 the decrease in
interest expense was due to a 164 basis point drop in the average rate paid
against a 9.5% increase in the average balance of interest-bearing liabilities
as compared to 2001. The average cost on interest-bearing liabilities for the
year 2003 decreased to 2.46% as compared to 3.33% for 2002 and 4.97% for 2001.
Net Interest Income
Net interest income totaled $17.1 million during 2003, an increase of $1.5
million, or 9.7% over 2002, when net interest income was $15.6 million. During
2002, net interest income increased $3.4 million or 28.0% over the $12.2 million
recorded during 2001. The Average Yield/Cost Analysis table analyzes the
interest-earning assets and interest-bearing liabilities for the three years
ending December 31, 2003. The Rate/Volume Analysis table identifies the causes
for changes in interest income and interest expense for 2003 and 2002. The
interest rate spread was 3.43% for 2003, compared to 3.29% for 2002 and 2.58%
for 2001. The increased interest rate spread can be attributed to the fact that
liabilities have repriced more than assets during these periods. The net yield
on interest-earning assets was 3.63% for 2003 compared to 3.51% for 2002 and
2.96% for 2001.
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, 2003 DECEMBER 31, 2002 DECEMBER 31, 2001
---------------------------- ---------------------------- -----------------------------
(Dollars in thousands) Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
--------- -------- -------- ---------- -------- -------- ---------- -------- --------
ASSETS
Interest-earning assets:
Interest-bearing deposits in
other banks $ 4,315 $ 47 1.09% $ 2,732 $ 48 1.76% $ 7,648 $ 271 3.54%
Securities:
Available for sale 40,658 1,868 4.59% 41,185 2,184 5.30% 36,671 2,212 6.03%
Held to maturity 6,164 253 4.10% 7,206 433 6.01% 7,452 400 5.37%
FHLB stock 3,855 147 3.81% 4,141 220 5.31% 3,761 254 6.75%
All loans 417,134 25,512 6.12% 390,210 26,611 6.82% 356,540 27,980 7.85%
-------- ------- ------ -------- -------- ------ --------- ------- ------
Total interest-earning assets 472,126 $27,827 5.89% 445,474 $29,496 6.62% 412,072 $31,117 7.55%
------- -------- -------
Non-interest earning assets 30,878 27,330 16,676
-------- -------- ---------
Total assets $503,004 $472,804 $428,748
======== ======== =========
LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Deposits $343,453 $ 7,291 2.12% $334,980 $10,146 3.03% $319,777 $15,353 4.80%
Borrowed funds 91,767 3,395 3.70% 81,867 3,729 4.55% 60,943 3,563 5.85%
-------- ------- -------- -------- -------- -------- -------- ------- -------
Total interest-bearing
liabilities 435,220 $10,686 2.46% 416,847 $13,875 3.33% 380,720 $18,916 4.97%
------- -------- -------
Non-interest bearing liabilities 26,714 19,855 15,588
-------- -------- --------
Total liabilities 461,934 436,702 396,308
Stockholders' equity 41,070 36,102 32,440
-------- -------- --------
Total liabilities and stockholders'
equity $503,004 $472,804 $428,748
======== ======== ========
Net interest income $17,141 $15,621 $12,201
======= ======== =======
Interest rate spread 3.43% 3.29% 2.58%
====== ====== ======
Net yield on interest-earning assets 3.63% 3.51% 2.96%
====== ====== ======
Percentage of average interest-earning
assets to average interest-bearing
liabilities 108.5% 106.9% 108.2%
====== ====== ======
- ----------------------------------------------------------------------------------------------------------------------------
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, 2002 vs. December 31, 2003 December 31, 2001 vs. December 31, 2002
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 $ 21 $ (21) $ -- $ (126) $ (97) $ (223)
Securities:
Available for sale (28) (288) (316) 255 (283) (28)
Held to maturity (57) (122) (179) (13) 46 33
FHLB stock (14) (59) (73) 24 (58) (34)
All loans 1,759 (2,860) (1,101) 2,497 (3,866) (1,369)
------- ------------ ------------- ------------ ------------ ------
Total interest-earning assets 1,681 (3,350) (1,669) 2,637 (4,258) (1,621)
------- ------------ ------------- ------------ ------------ ------
Interest expense:
Deposits 251 (3,106) (2,855) 699 (5,906) (5,207)
Borrowed funds 418 (752) (334) 1,058 (892) 166
------- ------------ ------------- ------------ ------------ ------
Total interest-bearing liabilities 669 (3,858) (3,189) 1,757 (6,798) (5,041)
------- ------------ ------------- ------------ ------------ ------
Net interest income $ 1,012 $ 508 $ 1,520 $ 880 $ 2,540 $3,420
======= ============ ============= ============ ============ ======
- ------------------------------------------------------------------------------------------------------------------------------------
Provision for Loan Losses
The provision for loan losses charged to operations was $740,000 during
2003 and 2002, compared to $460,000 during 2001. The commercial loan portfolio,
which contains loans with a higher degree of risk, continues to expand which is
why the provision for loan losses increased from 2001. Non-performing assets at
December 31, 2003 were $267,000 compared to $1.2 million at December 31, 2002
and $3.8 million at December 31, 2001. Net charge-offs for 2003 were $230,000
compared to $326,000 during 2002 and $97,000 during 2001. At December 31, 2003,
the allowance for loan losses was 0.86% of net loans as compared to 0.75% for
2002 and 0.67% for 2001. The allowance for loan losses increased to $3.4 million
at December 31, 2003 compared to $2.9 million at December 31, 2002 and $2.5
million at December 31, 2001. 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 adjustments to the allowance based on their judgments of information
available to them at the time of their examination.
Noninterest Income
Total noninterest income increased to $6.6 million during 2003, an increase
of $1.9 million or 39.6% over 2002. This compares to $4.8 million and $2.0
million during 2002 and 2001, respectively. The major component that had the
most impact on noninterest income was the gain on sale of loans resulting in net
gains of $4.2 million versus a gain of $1.9 million in 2002 and $11,000 in 2001.
These gains were realized primarily as a result of the May 31, 2002 purchase of
Lumina and the high volume of refinances due to the low interest rate
environment. The Bank has also started to sell a larger percentage of its fixed
rate mortgage loan originations in the secondary market instead of through
brokered
arrangements. This change caused an increase in gain on sale of loans and a
reduction to service charges and fees on loans. Deposit related fees increased
29.1% primarily due to a new service the Bank offered beginning in April 2003,
for checking accounts with non-sufficient funds. During 2002 the Bank sold a
parking lot for $500,000, resulting in the gain on sale of real estate. No
similar transactions occurred during 2003 or 2001 other than a sale of a
building in 2003 but the gain was deferred. Net gain on sale of securities
decreased to $51,000 during 2003, a decrease of $85,000 or 62.5% from 2002. In
2002, the Bank sold more bonds to purchase mortgage-backed securities to give
the Bank greater cash flow. In 2003, Bank-owned life insurance earnings
decreased 7.2% from 2002 due to the reduction in interest rates being paid on
this investment. The majority of the insurance was purchased in September of
2001, which is the cause for the 298.1% increase in 2002 from 2001. Other income
decreased to $197,000 (11.7%) during the year 2003 as compared to $223,000
(111.7% increase) during the year 2002 and $105,000 for 2001. The majority of
the other income changes can be attributed to the change in commissions for
annuity sales and mutual funds, through UVEST Investment Services sold each
year.
Noninterest Expense
Total noninterest expense was $15.0 million during the year 2003, an
increase of $3.2 million or 26.5% from 2002. The major increase in noninterest
expense during the year 2003 can be attributed to compensation and related costs
increasing to $9.3 million (32.3%) in 2003 as compared to $7.0 million (36.9%)
in 2002 and $5.1 million in 2001. The increase was due to increases in incentive
based pay, costs of benefits, staffing levels, including the staffing for
additional branches and normal increases in salaries as well as higher
personnel costs as a result of the May 31, 2002 purchase of Lumina. The Bank's
occupancy and equipment expense was $2.7 million during 2003, an increase of
18.0% as compared to $2.3 million during 2002 and $2.1 million in 2001. The
increase in the years 2003 and 2002 can be attributed to the 2002 Lumina
purchase and 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. In 2003
there was also an increase in depreciation and other expenses due to the new
branches and upgrades in hardware and software systems. Professional and
examination fees decreased to $365,000 (36.1%) in 2003. These fees were higher
in 2002 due to organizing Holdings and the REIT. Advertising costs for the year
2003 were $579,000 an increase of 61.9% as compared to $358,000 in 2002 and
$278,000 in 2001. Other non-interest expense was $2.0 million during 2003, an
increase of 22.1% as compared to $1.6 million in 2002 and in 2001. The increase
in advertising and other expense was mainly due to the purchase of Lumina and
the opening of four new financial centers. Real estate owned expense increased
$96,000 in 2003 primarily due to losses and expenses incurred in disposing of
foreclosed properties.
Income Taxes
The effective tax rate for the years ended December 31, 2003, 2002 and 2001
was 32.4%, 36.2% and 35.5%, respectively. The decrease in 2003 resulted from the
formation of Holdings and the REIT in December 2002.
Recent Accounting Pronouncements
See Note 1 to the "Notes to Consolidated Financial Statements" for a full
description of recent accounting pronouncements including the respective
expected dates of adoption and effects on results of operations and financial
condition.
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.
SELECTED QUARTERLY DATA
The following table contains selected financial data for the Company on a
quarterly basis for the previous eight quarters.
2003 2002
Fourth Third Second First Fourth Third Second First
- ------------------------------------------------------------------------------ --------------------------------------
Dollars in Thousands
Selected Quarter-End Balances:
Assets $502,306 $496,387 $522,003 $512,578 $ 504,210 $498,035 $ 479,435 $462,846
Loans, net 401,242 388,798 394,546 401,081 390,876 386,940 384,871 375,125
Securities 47,419 48,577 42,465 47,819 49,935 51,298 48,438 47,354
FHLB stock 4,154 3,905 4,005 3,805 4,055 4,155 4,155 4,155
Deposits 367,072 362,967 373,628 375,020 357,254 359,873 360,536 352,083
Borrowed funds 89,505 88,099 104,047 94,820 104,678 96,133 80,929 74,295
Stockholders' equity 43,143 42,237 41,022 39,816 38,448 37,065 35,776 34,142
- ------------------------------------------------------------------------------ --------------------------------------
Dollars in Thousands
Selected Operations Data:
Interest income $ 6,653 $ 6,873 $ 7,116 $ 7,184 $ 7,374 $ 7,366 $ 7,393 $ 7,362
Interest expense 2,322 2,640 2,794 2,930 3,234 3,380 3,502 3,758
Net interest income 4,331 4,233 4,322 4,254 4,140 3,986 3,891 3,604
Provision for loan losses 180 180 180 200 220 120 120 280
Noninterest income 1,363 1,845 1,856 1,572 1,666 1,274 604 1,210
Noninterest expenses 3,787 3,756 3,880 3,619 3,450 3,277 2,611 2,550
Income before income taxes 1,727 2,142 2,118 2,007 2,136 1,863 1,764 1,984
Net income 1,163 1,430 1,423 1,388 1,305 1,220 1,131 1,288
- ------------------------------------------------------------------------------ --------------------------------------
Selected Financial Ratios and Other Data:
Return on average assets 0.94% 1.12% 1.13% 1.11% 1.06% 1.02% 0.98% 1.13%
Return on average equity 10.85% 13.66% 13.99% 14.29% 13.65% 13.29% 12.91% 14.99%
Average stockholders' equity to average
assets 8.65% 8.22% 8.04% 7.75% 7.74% 7.69% 7.57% 7.53%
Per Share Data:
Earnings per:
Common share - basic $ 0.41 $ 0.50 $ 0.50 $ 0.49 $ 0.46 $ 0.43 $ 0.40 $ 0.45
Common share - diluted $ 0.40 $ 0.49 $ 0.49 $ 0.48 $ 0.46 $ 0.43 $ 0.40 $ 0.45
Cash dividends declared $ 0.05 $ 0.05 $ 0.05 $ 0.05 $ 0.05 $ 0.05 $ 0.05 $ 0.05
Book value $15.14 $14.82 $14.40 $13.98 $13.56 $13.07 $12.62 $11.86
Number of common shares
outstanding 2,849,447 2,849,447 2,847,947 2,847,947 2,835,947 2,835,947 2,835,947 2,835,447
[LETTERHEAD OF DIXON HUGHES PLLC]
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 (the "Company") as of December
31, 2003 and the related consolidated statement of operations, comprehensive
income, stockholders' equity, and cash flows for the year then ended. 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 audit. The consolidated financial statements
of Cooperative Bankshares, Inc. and subsidiary as of December 31, 2002 and for
the years ended December 31, 2002 and 2001 were audited by other auditors whose
report dated January 24, 2003 expressed an unqualified opinion on those
statements.
We conducted our audit 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 audit provides a
reasonable basis for our opinion.
In our opinion, the 2003 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, 2003, and the results of
their operations and their cash flows for the year then ended, in conformity
with accounting principles generally accepted in the United States of America.
/s/ Dixon Hughes PLLC
Sanford, North Carolina
January 23, 2004
[LETTERHEAD OF KPMG]
INDEPENDENT AUDITOR'S 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 the
related consolidated statements of operations, comprehensive income,
stockholders' equity, and cash flows for the years ended December 31, 2002 and
2001. 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 the results of
their operations and their cash flows for the years ended December 31, 2002 and
2001, in conformity with accounting principles generally accepted in the United
States of America.
/s/ KPMG LLP
Raleigh, North Carolina
January 24, 2003
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Financial Condition
December 31, 2003 and 2002
2003 2002
----------------- -----------------
ASSETS
Cash and due from banks, noninterest-bearing $ 14,400,034 $ 11,858,603
Interest-bearing deposits in other banks 3,993,331 --
---------------- -----------------
Total cash and cash equivalents 18,393,365 11,858,603
Securities:
Available for sale (amortized cost of $43,180,913 in 2003
and $41,033,409 in 2002) 43,613,112 42,075,212
Held to maturity (estimated market value of $3,889,736
in 2003 and $8,009,087 in 2002) 3,806,376 7,859,955
FHLB stock 4,154,400 4,054,700
Loans held for sale 6,375,275 25,659,935
Loans 404,689,442 393,812,940
Less allowance for loan losses 3,447,002 2,936,795
---------------- -----------------
Net loans 401,242,440 390,876,145
Other real estate owned -- 619,163
Accrued interest receivable 1,852,366 2,239,826
Premises and equipment, net 8,665,698 7,019,219
Goodwill 1,461,543 661,543
Other assets 12,741,394 11,285,276
---------------- -----------------
Total assets $ 502,305,969 $ 504,209,577
================ =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 367,071,513 $ 357,254,096
Short-term borrowings 41,416,785 61,585,827
Escrow deposits 199,433 223,604
Accrued interest payable 180,067 284,568
Accrued expenses and other liabilities 2,207,003 3,320,629
Long-term obligations 48,087,770 43,092,592
---------------- -----------------
Total liabilities 459,162,571 465,761,316
---------------- -----------------
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,
2,849,447 and 2,835,947 issued and outstanding 2,849,447 2,835,947
Additional paid-in capital 2,638,044 2,440,645
Accumulated other comprehensive income 285,251 635,500
Retained earnings 37,370,656 32,536,169
---------------- -----------------
Total stockholders' equity 43,143,398 38,448,261
---------------- -----------------
Total liabilities and stockholders' equity $ 502,305,969 $ 504,209,577
================ =================
See accompanying notes to consolidated financial statements.
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Operations
Years Ended December 31, 2003, 2002 and 2001
2003 2002 2001
--------------- --------------- ----------------
Interest income:
Loans $ 25,512,026 $ 26,611,364 $ 27,980,414
Securities 2,120,292 2,613,110 2,611,299
Other 47,017 51,633 271,767
Dividends on FHLB stock 147,184 219,730 253,918
--------------- --------------- ----------------
Total interest income 27,826,519 29,495,837 31,117,398
--------------- --------------- ----------------
Interest expense:
Deposits 7,290,985 10,148,866 15,352,845
Borrowed funds 3,394,792 3,726,021 3,563,469
--------------- --------------- ----------------
Total interest expense 10,685,777 13,874,887 18,916,314
--------------- --------------- ----------------
Net interest income 17,140,742 15,620,950 12,201,084
Provision for loan losses 740,000 740,000 460,000
--------------- --------------- ----------------
Net interest income after
provision for loan losses 16,400,742 14,880,950 11,741,084
--------------- --------------- ----------------
Non-interest income:
Gain on sale of loans 4,248,884 1,852,388 11,150
Net gain on sale of securities 50,663 135,182 125,172
Service charges and fees on loans 437,589 649,074 731,338
Deposit-related fees 1,330,370 1,030,429 967,171
Gain on sale of real estate -- 464,977 --
Bank-owned life insurance earnings 369,996 398,528 100,104
Other income, net 196,942 223,008 105,324
--------------- --------------- ----------------
Total non-interest income 6,634,444 4,753,586 2,040,259
--------------- --------------- ----------------
Non-interest expenses:
Compensation and fringe benefits 9,284,874 7,016,029 5,124,945
Occupancy and equipment 2,733,861 2,317,141 2,073,635
Professional and examination fees 364,522 570,229 238,681
Advertising 579,314 357,775 277,758
Real estate owned 110,209 14,300 22,053
Other 1,968,061 1,612,495 1,566,080
--------------- --------------- ----------------
Total non-interest expenses 15,040,841 11,887,969 9,303,152
--------------- --------------- ----------------
Income before income taxes 7,994,345 7,746,567 4,478,191
Income tax expense 2,590,119 2,802,070 1,589,248
--------------- --------------- ----------------
Net income $ 5,404,226 $ 4,944,497 $ 2,888,943
=============== =============== ================
Net income per share:
Basic $ 1.90 $ 1.74 $ 1.03
Diluted $ 1.86 $ 1.73 $ 1.02
Weighted average common shares outstanding:
Basic 2,847,567 2,835,712 2,797,317
Diluted 2,898,907 2,859,014 2,823,191
See accompanying notes to consolidated financial statements.
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Comprehensive Income
Years December 31, 2003, 2002 and 2001
2003 2002 2001
--------------- --------------- ----------------
Net income $ 5,404,226 $ 4,944,497 $ 2,888,943
--------------- --------------- ----------------
Other comprehensive income:
Unrealized gain (loss) arising during the year (558,941) 868,332 385,127
Tax (expense) benefit 242,130 (338,649) (150,201)
Reclassification to realized gain (50,663) (135,182) (125,172)
Tax expense 17,225 52,721 48,817
--------------- --------------- ----------------
Other comprehensive income (loss) (350,249) 447,222 158,571
--------------- --------------- ----------------
Comprehensive income $ 5,053,977 $ 5,391,719 $ 3,047,514
=============== =============== ================
See accompanying notes to consolidated financial statements.
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Stockholders' Equity
Years Ended December 31, 2003, 2002 and 2001
Accumulated
Additional other Total
Common paid-in comprehensive Retained stockholders'
stock capital income earnings equity
------------ ------------ ------------ ------------ ------------
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
Exercise of stock options 13,500 173,590 - - 187,090
Tax benefit of stock option exercise - 23,809 - - 23,809
Other comprehensive loss, net of taxes - - (350,249) - (350,249)
Net income for year - - - 5,404,226 5,404,226
Cash dividends ($.20 per share) - - - (569,739) (569,739)
------------ ------------ ------------ ------------ ------------
Balance, December 31, 2003 $ 2,849,447 $ 2,638,044 $ 285,251 $ 37,370,656 $ 43,143,398
============ ============ ============ ============ ============
See accompanying notes to consolidated financial statements.
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years Ended December 31, 2003, 2002 and 2001
2003 2002 2001
--------------- --------------- ----------------
Net income $ 5,404,226 $ 4,944,497 $ 2,888,943
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Net accretion and amortization 395,330 300,135 45,494
Depreciation 880,767 801,173 669,842
Net gain on sale of securities (50,663) (135,182) (125,172)
Gain on sale of loans (4,248,884) (1,777,314) (11,150)
Deferred tax benefit (188,149) (3,990) (276,589)
Loss (gain) on sales of premises and equipment -- (464,977) 8,621
Loss (gain) on sales of foreclosed real estate 63,890 (6,855) 3,793
Valuation losses on foreclosed real estate 8,663 -- 2,807
Provision for loan losses 740,000 740,000 460,000
Proceeds from sales of loans 275,871,442 106,027,979 506,245
Loan originations held for sale (252,499,961) (129,910,600) --
Changes in assets and liabilities:
Accrued interest receivable 387,460 397,541 139,037
Prepaid expenses and other assets (274,672) (148,324) (843,020)
Accrued interest payable (104,501) 20,177 (36,005)
Accrued expenses and other liabilities (1,610,964) 2,225,719 269,985
--------------- --------------- ----------------
Net cash provided (used) by operating activities 24,773,984 (16,990,021) 3,702,831
--------------- --------------- ----------------
Purchases of securities available for sale (26,936,750) (29,203,805) (82,123,753)
Purchases of securities held to maturity (2,981,945) (4,165,348) --
Purchase of Lumina Mortgage Company (400,000) (773,188) --
Proceeds from maturity of securities available for sale 13,900,000 -- 16,000,000
Proceeds from sale of securities available for sale 1,060,000 24,058,015 43,107,351
Proceeds from maturities of securities held to maturity 5,000,000 -- 8,000,000
Repayments of mortgage-backed securities available for sale 9,654,231 6,721,816 2,413,006
Repayments of mortgage-backed securities held to maturity 1,865,872 1,192,533 --
Loan originations, net of principal repayments (11,243,814) (18,120,668) (28,044,846)
Proceeds from disposals of foreclosed real estate 854,428 221,207 643,413
Purchases of premises and equipment (3,140,041) (1,311,187) (902,513)
Proceeds from sales of premises and equipment -- 499,071 3,518
Net expenditures on foreclosed real estate (8,236) (111,829) (35,352)
Purchases of FHLB stock (2,149,900) (350,000) (399,600)
Proceeds from sale of FHLB stock 2,050,200 450,200 --
Purchases of life insurance -- (1,000,000) (8,088,704)
--------------- --------------- ----------------
Net cash used in investing activities (12,475,955) (21,893,183) (49,427,480)
--------------- --------------- ----------------
Net increase in deposits 9,817,417 17,424,044 12,517,728
Net proceeds (repayments) on short-term borrowings (35,169,042) 6,585,827 5,000,000
Repayments on long-term obligations (4,822) (4,564) (4,321)
Proceeds received on long-term obligations 20,000,000 15,000,000 23,000,000
Proceeds from issuance of common stock, net 187,090 5,425 261,249
Dividends paid (569,739) (567,163) (563,034)
Net change in escrow deposits (24,171) 2,660 (339,831)
--------------- --------------- ----------------
Net cash provided (used) by financing activities (5,763,267) 38,446,229 39,871,791
--------------- --------------- ----------------
Increase (decrease) in cash and cash equivalents 6,534,762 (436,975) (5,852,858)
Cash and cash equivalents:
Beginning of year 11,858,603 12,295,578 18,148,436
--------------- --------------- ----------------
End of year $ 18,393,365 $ 11,858,603 $ 12,295,578
=============== =============== ================
See accompanying notes to consolidated financial statements.
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Continued)
Years Ended December 31, 2003, 2002 and 2001
2003 2002 2001
--------------- --------------- ----------------
Cash paid for:
Interest $ 10,790,278 $ 13,854,710 $ 18,952,319
Income taxes 3,278,665 2,597,763 1,699,583
Summary of noncash investing and financing activities:
Transfer from loans to other real estate owned 479,462 989,602 1,151,318
Transfer of premises and equipment to other real
real estate owned -- -- 21,427
Loans to facilitate the sale of foreclosed
real estate 72,000 918,450 --
Unrealized gains (losses) on securities available
for sale, net of taxes (350,249) 447,222 158,571
Transfer of securities from held to maturity to
available for sale at fair value -- -- 5,946,000
Accrual of goodwill for purchase of
Lumina Mortgage Company 400,000 -- --
Long-term obligations reclassified to short-term
borrowings 15,000,000 20,000,000 15,000,000
Sale and leaseback of premises and equipment:
Increase in other receivable for proceeds on sale 733,942 -- --
Deferred gain on sale 121,147 -- --
See accompanying notes to consolidated financial statements.
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(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' majority owned subsidiary, CS&L Real Estate
Trust, Inc. (REIT). All significant intercompany transactions have been
eliminated.
Nature of Operations
The Company operates 24 offices (including 20 full service branches) in
Eastern North Carolina, 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, 2003, the daily average gross reserve requirement was
$1,107,000.
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(1) Basis of Presentation and Significant Accounting Policies (Continued)
Significant Accounting Policies (Continued)
(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.
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(1) Basis of Presentation and Significant Accounting Policies (Continued)
Significant Accounting Policies (Continued)
(e) Loans and Allowance for Loan Losses (Continued)
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 adjustments 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.
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.
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(1) Basis of Presentation and Significant Accounting Policies (Continued)
(g) Transfers and Servicing of Financial Assets
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) Goodwill
Goodwill resulting from the acquisition of Lumina Mortgage Company in
2002 is not amortized but is tested for impairment annually or more
often if an event or circumstance indicates that an impairment loss
has been incurred.
(k) 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.
(l) 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.
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(1) Basis of Presentation and Significant Accounting Policies (Continued)
(l) Stock-Based Compensation (Continued)
Year ended December 31,
2003 2002 2001
--------------- --------------- ----------------
Net income, as reported $ 5,404,226 $ 4,944,497 $ 2,888,943
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)
--------------- --------------- ----------------
Proforma net income $ 5,404,226 $ 4,883,954 $ 2,859,846
=============== =============== ================
Earnings per share:
Basic - as reported $ 1.90 $ 1.74 $ 1.03
=============== =============== ================
Basic - proforma $ 1.90 $ 1.72 $ 1.02
=============== =============== ================
Diluted- as reported $ 1.86 $ 1.73 $ 1.02
=============== =============== ================
Diluted - proforma $ 1.86 $ 1.71 $ 1.01
=============== =============== ================
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 and 2001. The weighted average fair values of options
granted in 2002 and 2001 were $3.60 and $2.65, respectively. No
options were granted in 2003.
2002 2001
--------------- ----------------
Risk-free interest rate 4.79% 4.86%
Dividend yield 1.45% 1.85%
Expected volatility 25% 20%
Expected lives (in years) 8 8
(m) 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 accumulated other
comprehensive income is unrealized gains and losses on securities
available for sale.
(n) 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.
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(1) Basis of Presentation and Significant Accounting Policies (Continued)
(n) Segment Information (Continued)
The Company has determined that it operates primarily in one operating
segment providing 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.
(o) 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 commitment 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.
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 $1,461,543. 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 adopted SFAS No. 143 on January 1, 2003. The adoption of
SFAS No. 143 did not have a material effect on the Company's
consolidated financial statements.
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(1) Basis of Presentation and Significant Accounting Policies (Continued)
(o) New Accounting Pronouncements (Continued)
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.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
No. 133 on Derivative Instruments and Hedging Activities." SFAS No.
149 improves financial reporting by requiring that contracts with
comparable characteristics be accounted for similarly. In particular,
SFAS No. 149 clarifies under what circumstances a contract with an
initial net investment meets the characteristic of a derivative,
clarifies when a derivative contains a financing component, amends the
definition of an "underlying" to conform it to language used in FIN 45
and amends certain other existing pronouncements. SFAS No. 149 is
effective for contracts entered into or modified after June 30, 2003,
and for hedging relationships designated after June 30, 2003. In
addition, with some exceptions, all provisions of SFAS No. 149 should
be applied prospectively. The adoption of SFAS No. 149 did not have a
material impact on the consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity." This Statement establishes standards for how an issuer
classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an
issuer classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). This Statement is
effective for financial instruments entered into or modified by the
Company after May 31, 2003, and is effective at the beginning of the
first interim period beginning after June 15, 2003. However, the FASB
has deferred indefinitely the classification and measurement
provisions as they related to certain mandatorily redeemable
noncontrolling interests. The adoption of SFAS No. 150 did not have a
material impact on the consolidated financial statements.
In January 2003, the FASB issued Interpretation No. (FIN) 46,
"Consolidation of Variable Interest Entities." This interpretation
addresses the consolidation by business enterprises of variable
interest entities as defined in the interpretation. In December 2003,
the FASB issued a revision to FIN 46 (FIN 46R) to clarify some of the
provisions of FIN 46 and to exempt certain entities from its
requirements. FIN 46R is effective for public entities that have
interests in structures that are commonly referred to as
special-purpose entities for periods ending after December 15, 2003.
Application by public entities, other than small business issuers, for
all other types of variable interest entities is required in financial
statements for periods ending after March 15, 2004. The Company does
not expect that FIN 46 and FIN 46R will have a material impact on its
consolidated financial statements.
In November 2003, the Emerging Issues Task Force (EITF) reached a
partial consensus on Issue 03-1, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments." Issue 03-1
requires certain quantitative and qualitative disclosures for
investments subject to SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," that are impaired at the
balance sheet date but for which an other-than-temporary impairment
has not been recognized. The Company adopted the partial consensus on
Issue 03-1 during 2003 and has provided the new disclosures in
footnote 2. The EITF is expected to continue deliberating other
aspects of Issue 03-1, including when to recognize
other-than-temporary impairment.
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(1) Basis of Presentation and Significant Accounting Policies (Continued)
(o) New Accounting Pronouncements (Continued)
In December 2003, the FASB issued SFAS No. 132 (Revised 2003),
Employers' Disclosures about Pensions and Other Postretirement
Benefits. This Statement retains the disclosure requirements in SFAS
No. 132 and requires additional details about plan assets, benefit
obligations, cash flows, benefit costs, assumptions used and other
relevant information for companies with pension plans and other
postretirement benefit plans. A description of investment policies and
strategies and target allocation percentages, or target ranges, for
asset categories also are required in financial statements. These new
disclosures are required for years ending after December 15, 2003. The
Company adopted SFAS No. 132 (Revised 2003) during 2003 and has
provided the new disclosures in Note 9. Additional disclosures
regarding projections of future benefit payments will be required for
years ending after June 15, 2004.
(2) Securities
Securities as of December 31, 2003 and 2002 are summarized as follows:
2003
----------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ----------- ---------- ---------
SECURITIES AVAILABLE FOR SALE:
U.S. Government and
agency securities $ 25,148,511 $ 358,052 $ -- $ 25,506,563
Mortgage-backed securities 11,584,165 201,541 296,928 11,488,778
Marketable equity securities 4,975,000 74,625 -- 5,049,625
Corporate bonds 1,473,237 94,909 -- 1,568,146
-------------- ------------- ------------- ---------------
Total $ 43,180,913 $ 729,127 $ 296,928 $ 43,613,112
============== ============= ============= ===============
SECURITIES HELD TO MATURITY:
Mortgage-backed securities $ 3,806,376 $ 83,360 $ -- $ 3,889,736
-------------- ------------- ------------- ---------------
Total $ 3,806,376 $ 83,360 $ -- $ 3,889,736
============== ============= ============= ===============
2002
-------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
----------- ---------- ---------- ----------
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
-------------- ------------- ------------- ---------------
Total $ 7,859,955 $ 149,132 $ -- $ 8,009,087
============== ============= ============= ===============
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(2) Securities (Continued)
The following table shows investments' gross unrealized losses and fair
value, aggregated by investment category and length of time that the
individual securities have been in a continuous unrealized loss position,
at December 31, 2003.
Less Than 12 Months 12 Months or More Total
------------------------ ------------------------ -------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
value losses value losses value losses
----------- ----------- ---------- ----------- ----------- -----------
SECURITIES AVAILABLE FOR SALE:
Mortgage-backed securities $ 4,908,602 $ 296,928 $ -- $ -- $ 4,908,602 $ 296,928
----------- ----------- ---------- ----------- ----------- -----------
Total temporarily impaired
securities $ 4,908,602 $ 296,928 $ -- $ -- $ 4,908,602 $ 296,928
=========== =========== ========== =========== =========== ===========
Temporarily impaired securities consist of one security that is an agency
backed collateralized mortgage obligation. This security has been
temporarily impaired for a short-term, is agency backed and does not have a
premium associated with it. Therefore, the Company believes the impairment
is temporary and relates to the current interest rate environment and is
not a permanent impairment.
The maturities of securities at December 31, 2003 are summarized as
follows:
Estimated
Amortized Market
Cost Value
------------- -------------
Held to maturity:
Within 1 year $ -- $ --
Mortgage-backed securities 3,806,376 3,889,736
-------------- --------------
$ 3,806,376 $ 3,889,736
============== ==============
Available for sale:
Within 1 year $ 200,371 $ 201,812
After 1 year through 5 years 16,461,437 16,808,796
After 5 years through 10 years 9,959,940 10,064,101
Marketable equity securities 4,975,000 5,049,625
Mortgage-backed securities 11,584,165 11,488,778
-------------- --------------
$ 43,180,913 $ 43,613,112
============== ==============
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, 2003, sales of investment securities
resulted in gross realized gains of $50,663 in 2003, gross realized gains
of $135,182 in 2002, and gross realized gains of $125,172 in 2001.
Investment securities having an aggregate carrying value of $15,214,100 at
December 31, 2003 were pledged to secure public funds on deposit.
Investment securities having an aggregate carrying value of $201,812 at
December 31, 2003 were pledged to secure repurchase agreements. Investment
securities having an aggregate carrying value of $1,568,146 at December 31,
2003 were pledged to secure the Treasury tax and loan account with the
Federal Reserve Bank.
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(3) Loans
Loans at December 31, 2003 and 2002 are summarized as follows (in
thousands):
2003 2002
-------------- --------------
Real estate:
Construction and land development $ 57,598 $ 51,431
Mortgage:
1-4 family residential 206,476 204,395
Multi-family residential 13,357 17,044
Commercial 91,627 87,257
Equity line 16,006 14,541
Other 359 363
-------------- --------------
Total real estate loans 385,423 375,031
Commercial, industrial and agricultural 14,599 13,717
Consumer 6,069 6,396
-------------- --------------
Total gross loans 406,091 395,144
Unamortized net deferred fees (1,402) (1,331)
-------------- --------------
Loans $ 404,689 $ 393,813
============== ==============
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, 2003 (in thousands):
Balance at beginning of year $ 7,807
New loans 2,255
Repayments (838)
--------------
Balance at end of year $ 9,224
==============
Activity in the allowance for loan losses for the years ended December
31, 2003, 2002 and 2001 is summarized as follows (in thousands):
2003 2002 2001
------------- ------------- ----------------
Balance at beginning of year $ 2,937 $ 2,523 $ 2,160
Provision for loan losses 740 740 460
Loans charged-off (237) (360) (106)
Recoveries 7 34 9
------------- ------------- ---------------
Balance at end of year $ 3,447 $ 2,937 $ 2,523
============= ============= ===============
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(3) Loans (Continued)
The following is a summary of nonperforming assets at December 31, 2003 and
2002 (in thousands):
2003 2002
------------- ----------------
Loans 90 days past due and still accruing interest $ 147 $ 249
Nonaccrual loans 120 335
Other real estate owned -- 619
------------- ---------------
Total $ 267 $ 1,203
============= ===============
At December 31, 2003, 2002 and 2001, the recorded investment in loans
considered impaired in accordance with SFAS No. 114 totaled $120,372,
$334,289 and $505,378, respectively, with no corresponding valuation
allowances. For the years ended December 31, 2003, 2002 and 2001, the
average recorded investment in impaired loans was approximately $150,000,
$254,000 and $513,000, 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, 2003 and 2002 (in thousands):
2003 2002
------------- ----------------
Undisbursed portion of home equity lines of credit collateralized
primarily by junior liens on 1-4 family
properties $ 15,431 $ 14,130
Other commitments and credit lines 15,275 13,843
Undisbursed portion of construction loans 45,311 32,667
Fixed-rate mortgage loan commitments 1,031 879
Adjustable-rate mortgage loan commitments 5,815 5,614
Available-for-sale mortgage loan commitments 2,954 3,729
------------- ---------------
Total $ 85,817 $ 70,862
============= ===============
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
most of 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.
Loans serviced for others are not included in the accompanying consolidated
balance sheets. The unpaid principal balances of mortgage and other loans
serviced for others were approximately $44,851,000, $44,809,000 and
$56,041,000 at December 31, 2003, 2002 and 2001, respectively. The carrying
value of capitalized servicing rights is included in other assets. Changes
in mortgage servicing rights capitalized for the year ended December 31,
2003 are as follows:
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(3) Loans (Continued)
2003
-------------
Mortgage servicing rights, beginning of year $ 73,240
Mortgage servicing rights, capitalized 162,064
-------------
235,304
Accumulated amortization 33,742
-------------
Mortgage servicing rights, end of year, net
of amortization $ 201,562
=============
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.
(4) Premises and Equipment
Premises and equipment at December 31, 2003 and 2002 are summarized as
follows (in thousands):
2003 2002
------------- ----------------
Land $ 2,239 $ 2,526
Buildings 6,486 5,539
Leasehold improvements 1,058 369
Furniture and equipment 7,523 6,516
------------- ---------------
17,306 14,950
Less accumulated depreciation and amortization (8,640) (7,931)
------------- ---------------
Premises and equipment, net $ 8,666 $ 7,019
============= ===============
(5) Deposits
Deposits at December 31, 2003 and 2002 are summarized as follows (in
thousands):
2003 2002
------------- ----------------
Demand $ 26,608 $ 19,800
Checking with interest 25,891 20,630
Money market accounts 26,630 24,213
Savings 21,417 20,345
Time deposits of $100 or more 91,834 85,831
Other time deposits 174,692 186,435
------------- ---------------
Total $ 367,072 $ 357,254
============= ===============
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(5) Deposits (Continued)
At December 31, 2003, the scheduled maturities of time deposits were (in
thousands):
2004 $ 233,608
2005 29,350
2006 3,465
2007 82
2008 -
Thereafter 21
-------------
Total time deposits $ 266,526
=============
(6) Borrowed Funds
Borrowed funds and the corresponding weighted average rates (WAR) at
December 31, 2003 and 2002 are summarized as follows:
2003 WAR 2002 WAR
---------------- -------------- -------------- ----------------
Advances from FHLB $ 83,000,000 3.06% $ 81,000,000 3.84%
Affordable Housing Program
advances from FHLB 87,770 3.50% 92,592 3.50%
Advances for loans held
for sale 6,251,087 3.86% 23,485,233 4.09%
Repurchase agreements 165,698 0.37% 100,594 0.70%
---------------- --------------
Total $ 89,504,555 $ 104,678,419
================ ==============
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, 2003 was approximately $145,667,000. 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 $83 million
during the years ended December 31, 2003, 2002 and 2001, respectively.
Annual principal maturities of Federal Home Bank advances for the years
subsequent to December 31, 2003 are as follows (in thousands):
2004 $ 35,000
2005 10,000
2006 10,000
2008 5,000
2010 10,000
2011 13,000
-------------
$ 83,000
=============
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.
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(6) Borrowed Funds (Continued)
Lumina borrows money on a short-term basis principally from another
financial institution to fund its loans that are held for sale. The balance
of this borrowing was $6.3 million and $23.5 million at December 31, 2003
and 2002, respectively. Borrowings for loans that were funded from this
line of credit within 60 days were at a rate of 3.37% and borrowings for
loans that were funded more than 60 days ($668,000) were at a rate of
8.00%. 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 is currently
being renegotiated, but the financial institution continues to supply
sufficient funds for loans originated by Lumina.
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, 2003, 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, 2003 and 2002, 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.
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
--------------------------------
2003 2002 2003 2002
---------------- -------------- -------------- ----------------
Risk-based capital:
Tier I capital $ 41,486 $ 37,193
Total capital 44,933 40,130
Risk-adjusted assets 370,895 364,763
Quarterly average tangible assets 493,548 494,455
Tier I capital ratio 11.19% 10.20% 6.00% 6.00%
Total capital ratio 12.11% 11.00% 10.00% 10.00%
Leverage capital ratio 8.41% 7.52% 5.00% 5.00%
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(7) Regulatory Matters and Capital Requirements (Continued)
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 $1,954,815 at December 31, 2003.
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 Bank 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 Bank 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 $366,814, $164,618 and
$34,537 for the years 2003, 2002 and 2001, respectively.
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 2003, 2002 and 2001.
The compensation expense incurred by the Bank for the 401(k) was $105,027,
$90,098, and $78,585 for the years ended December 31, 2003, 2002 and 2001,
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.
In 2002, the Bank implemented a non-qualifying deferred compensation plan
for certain key executive officers. The Bank has purchased life insurance
policies on the participating officers in order to provide future funding
of benefit payments. Benefits for each officer participating in the plan
will accrue and vest during the period of employment, and will be paid in
monthly benefit payments over the participant's life after retirement. The
plan also provides for payment of disability or death benefits in the event
a participating officer becomes permanently disabled or dies prior to
attainment of retirement age. If the Bank has a change in control before
the officer reaches age 65, the participating officer will be entitled to a
benefit. Provisions of $228,445 in 2003 were expensed for future benefits
to be provided under this plan. The total liability under this plan was
$351,787 at December 31, 2003 and is included in accrued expenses and other
liabilities in the accompanying consolidated statements of financial
condition.
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(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, 2003, 2002 and 2001:
2003 2002 2001
------------- ------------- ----------------
Net income (numerator) $ 5,404,226 $ 4,944,497 $ 2,888,943
============= ============= ================
Shares for basic EPS (denominator) 2,847,567 2,835,712 2,797,317
Dilutive effect of stock options 51,340 23,302 25,874
------------- ------------- ----------------
Shares for diluted EPS (denominator) 2,898,907 2,859,014 2,823,191
============= ============= ================
For the years ended December 31, 2003, 2002 and 2001, there were 0, 14,204
and 14,204, 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 calculations of the dilutive
effect of stock options.
(10) Income Taxes
Income tax expense consists of the following components for the years ended
December 31, 2003, 2002 and 2001:
2003 2002 2001
------------- ------------- ----------------
Current tax expense:
Federal $ 2,664,960 $ 2,379,444 $ 1,651,815
State 113,308 426,616 214,022
------------- ------------- ----------------
Total current tax expense 2,778,268 2,806,060 1,865,837
------------- ------------- ----------------
Deferred tax expense (benefit):
Federal (191,112) (113,579) (227,083)
State 2,963 109,589 (49,506)
------------- ------------- ----------------
Total deferred tax benefit (188,149) (3,990) (276,589)
------------- ------------- ----------------
Total tax expense $ 2,590,119 $ 2,802,070 $ 1,589,248
============= ============= ================
The components of the net deferred tax asset at December 31, 2003 and 2002
are as follows:
2003 2002
-------------- ---------------
Deferred tax assets:
Allowance for loan losses $ 1,328,819 $ 1,132,134
Deferred compensation 326,814 226,150
Other 3,587 --
-------------- ---------------
Total gross deferred tax assets 1,659,220 1,358,284
Valuation allowance (113,223) (82,469)
-------------- ---------------
Total net deferred tax assets 1,545,997 1,275,815
-------------- ---------------
Deferred tax liabilities:
Deferred loan fees 77,573 120,264
FHLB stock 99,259 169,829
Premises and equipment 530,853 366,004
Unrealized gain on securities available for sale 146,948 406,303
Goodwill 33,901 3,456
-------------- ---------------
Total gross deferred tax liabilities 888,534 1,065,856
-------------- ---------------
Net deferred tax asset $ 657,463 $ 209,959
============== ===============
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(10) Income Taxes (Continued)
The Company has established a valuation allowance at December 31, 2003
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, 2003, the valuation allowance increased $30,754.
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, 2003, 2002 and 2001 are as follows:
2003 2002 2001
------------- ------------- ----------------
Income taxes at federal tax rate $ 2,718,077 $ 2,633,833 $ 1,522,585
Increase (decrease) resulting from:
State income taxes, net of federal
income tax benefit 76,739 353,895 108,581
Cash surrender value of bank owned
life insurance (125,799) (135,500) (34,035)
Tax exempt securities (72,701) (72,701) (36,350)
Other (6,197) 22,543 28,467
------------ ------------- ----------------
Total $ 2,590,119 $ 2,802,070 $ 1,589,248
============ ============= ================
Retained earnings at December 31, 2003 and 2002 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.
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(11) Stock Option Plan (Continued)
A summary of the status of the Option Plan as of December 31, 2003, 2002
and 2001, and changes during the years then ended is presented below:
2003 2002 2001
------------------------- -------------------------- --------------------------
Weighted Weighted Weighted
average average average
option option option
Number price Number price Number price
----------- ---------- ----------- ------------ ---------- -----------
Options outstanding,
beginning of year 141,943 $ 11.28 117,943 $ 11.37 246,457 $ 6.85
Granted -- -- 25,500 10.85 18,000 13.38
Exercised (13,500) 13.86 (500) 10.85 (141,537) 3.77
Forfeited -- -- (1,000) 11.00 (4,977) 10.86
----------- ---------- ----------- ----------- ----------- -----------
Options outstanding,
end of year 128,443 $ 11.01 141,943 $ 11.28 117,943 $ 11.37
=========== ========== =========== =========== =========== ===========
The following table summarizes additional information about the Option Plan
at December 31, 2003:
Remaining
Number Contractual Number
Exercise Price Outstanding Life Exercisable
------------------- ----------------------- ------------------ ----------------------
$ 7.50 10,000 .25 years 10,000
10.50 5,424 3.25 years 5,424
10.85 23,000 8.00 years 23,000
10.94 9,000 5.70 years 9,000
11.00 10,315 6.00 years 10,315
11.06 58,500 5.50 years 58,500
11.50 8,000 8.00 years 8,000
19.50 4,204 4.00 years 4,204
----------------------- ------------------ ----------------------
128,443 5.60 years 128,443
======================= ================== ======================
(12) Parent Company Financial Information
Condensed financial information of Cooperative Bankshares, Inc., the parent
company, at December 31, 2003 and 2002 and for the years ended December 31,
2003, 2002 and 2001 is presented below:
Condensed Statements of Financial Condition
2003 2002
-------------- ---------------
Assets:
Cash $ 2,433 $ 1,913
Equity investment in subsidiary 43,233,958 38,490,495
Other assets 142,472 141,797
-------------- ---------------
$ 43,378,863 $ 38,634,205
============== ===============
Liabilities and stockholders' equity:
Other liabilities $ 235,465 $ 185,944
Stockholders' equity 43,143,398 38,448,261
-------------- ---------------
$ 43,378,863 $ 38,634,205
============== ===============
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(12) Parent Company Financial Information (Continued)
Condensed Statements of Operations
2003 2002 2001
------------- ------------- ---------------
Dividends from subsidiary $ 397,649 $ 575,739 $ 347,309
Equity in undistributed net income of subsidiary 5,069,903 4,426,679 2,586,569
Miscellaneous expenses (63,326) (57,921) (44,935)
------------- ------------- ---------------
$ 5,404,226 $ 4,944,497 $ 2,888,943
============= ============= ===============
Condensed Statements of Cash Flows
2003 2002 2001
------------- ------------- ---------------
Operating activities:
Net income $ 5,404,226 $ 4,944,497 $ 2,888,943
Equity in undistributed net income of subsidiary (5,069,903) (4,426,680) (2,586,569)
Change in other assets (675) (25) (6,042)
Change in other liabilities 49,521 44,106 6,036
------------- ------------- ---------------
Net cash provided by operating activities 383,169 561,898 302,368
------------- ------------- ---------------
Financing activities:
Proceeds from issuance of common stock, net 187,090 5,425 261,249
Cash dividends paid (569,739) (567,163) (563,034)
------------- ------------- ---------------
Net cash used in financing activities (382,649) (561,738) (301,785)
------------- ------------- ---------------
Increase in cash and cash equivalents 520 160 583
Cash and cash equivalents, beginning of year 1,913 1,753 1,170
------------- ------------- ---------------
Cash and cash equivalents, end of year $ 2,433 $ 1,913 $ 1,753
============= ============= ===============
(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. The agreement was subsequently amended to change the contingent
payments into two payments of $400,000 each payable on July 31, 2003 and
2004. These payments are considered additional purchase price and,
accordingly, goodwill related to this acquisition was increased by
$800,000.
Goodwill at December 31, 2002 $ 661,543
Additions to goodwill 800,000
------------
Goodwill at December 31, 2003 $ 1,461,543
============
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(13) Acquisition (Continued)
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.
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.
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(14) Fair Value of Financial Instruments (Continued)
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.
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.
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
(14) Fair Value of Financial Instruments (Continued)
The carrying amounts and estimated fair values of the Company's financial
instruments at December 31, 2003 and 2002 are as follows (in thousands):
2003 2002
------------------------------- -------------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------------ -------------- ------------ --------------
Financial assets:
Cash and cash equivalents $ 18,393 $ 18,393 $ 11,859 $ 11,859
Securities:
Available for sale 43,613 43,613 42,075 42,075
Held to maturity 3,806 3,890 7,860 8,009
Loans held for sale 6,375 6,375 25,660 25,660
Loans, net 401,242 407,076 390,876 397,001
FHLB stock 4,154 4,154 4,055 4,055
Accrued interest receivable 1,852 1,852 2,240 2,240
Financial liabilities:
Deposits 367,072 367,676 357,254 357,915
Borrowed funds 89,505 89,468 104,678 106,089
Accrued interest payable 180 180 285 285
(15) Asset Sale
During December 2003, the Company sold the Ogden branch for $800,000. A
gain of $121,147 was deferred because the Company is now leasing this
property and another property, under operating leases, from the purchases
of the Ogden branch. This gain will be recognized as a reduction of rental
expense over the lives of these leases.
During February 2002, the Company sold a parking lot for $500,000. A gain
of $464,977 was realized on the sale.
(16) 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 $312,000,
$200,000 and $98,000 during 2003, 2002 and 2001, respectively.
Future minimum lease payments under noncancelable operating leases as of
December 31, 2003 are (in thousands):
Year ending December 31:
2004 $ 487
2005 424
2006 257
2007 246
2008 247
After 2008 3,331
-----------------
Total minimum lease payments $ 4,992
=================
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
OFFICERS OF LUMINA MORTGAGE COMPANY
Linda B. Skipper President
Frederick Willetts, III Vice President
Dickson B. Bridger Secretary
Todd L. Sammons Treasurer
COOPERATIVE BANK LOCATIONS
Beaufort Southport
Belhaven Tabor City
Elizabethtown Wallace
Jacksonville (2) Washington (2)
Kill Devil Hills Whiteville
Morehead City (2) Wilmington (6)
Corolla (Loan Production Office)
LUMINA MORTGAGE LOCATIONS
Wilmington, North Carolina; North Myrtle Beach, South Carolina; Virginia Beach,
Virginia
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 Suite 600
P.O. Box 29522 1220 19th Street, NW
Raleigh, North Carolina 27626-0522 Washington, DC 20036
ANNUAL MEETING INDEPENDENT AUDITORS
The Annual Meeting of Stockholders of Cooperative Dixon Hughes PLLC
Bankshares, Inc. will be held: Post Office Box 70
HILTON WILMINGTON RIVERSIDE Sanford, North Carolina 27331-0070
301 NORTH WATER STREET, WILMINGTON, NC 28401
APRIL 30, 2004 AT 11:00 A.M.
FORM 10-K
Copies of Form 10-K may be obtained without charge by
writing to: Linda B. Garland at the Corporate
Headquarters address or visit the company website at
www.coop-bank.com.
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)."
CAPITAL STOCK
Cooperative Bankshares, Inc. stock is traded on the NASDAQ National Market under
the symbol "COOP". As of December 31, 2003, there were 2,849,447 shares
outstanding, which were held by 523 stockholders of record. A $0.05 per share
dividend was declared each quarter in 2003 and 2002. Stock performance for 2003
and 2002 is given in the following table
Quarterly Common Stock Data
2003 2002
----------------------------------------------------------------------------------------------
High Low High Low
Quarters Ended
----------------------------------------------------------------------------------------------
December $26.400 $22.350 $17.000 $13.850
September 26.760 19.000 15.000 13.000
June 20.250 18.470 16.000 12.040
March 19.650 15.950 12.394 10.401
----------------------------------------------------------------------------------------------