UNITED STATES OF AMERICA
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
Commission File Number 0-30062
CAPITAL BANK CORPORATION
(Exact name of registrant as specified in its charter)
North Carolina 56-2101930
(State of incorporation) (I.R.S. Employer
Identification Number)
4901 Glenwood Avenue
Raleigh, North Carolina
27612
(Address of principal executive office)
Registrant's telephone number, including area code: (919) 645-6400
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value per share Nasdaq National Market
(Title of Class) (Name of Exchange on Which Registered)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes |X| No |_|.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment of this
Form 10-K. |_|
The aggregate market value of the registrant's Common Stock, no par value per
share, as of June 30, 2003, held by those persons deemed by the registrant to be
non-affiliates was approximately $88,687,425.
- 1 -
As of March 12, 2004, there were 6,571,132 shares of the registrant's Common
Stock, no par value per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Document Incorporated Where
- --------------------- -----
1. Portions of the registrant's Proxy Statement for the Annual
Meeting of Shareholders to be held on June 24, 2004 Part III
CAPITAL BANK CORPORATION
Annual Report on Form 10-K
INDEX
PART I.................................................................................................2
Item 1. Business..................................................................................2
Item 2. Properties...............................................................................10
Item 3. Legal Proceedings........................................................................10
Item 4. Submission of Matters to a Vote of Security Holders......................................10
PART II...............................................................................................11
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters....................11
Item 6. Selected Financial Data..................................................................12
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....13
Item 7A. Quantitative and Qualitative Disclosures About Market Risk...............................27
Item 8. Financial Statements and Supplementary Data..............................................30
Item 9. Changes In and Disagreements With Accountants On Accounting and Financial Disclosure.....58
Item 9A. Controls and Procedures..................................................................58
PART III..............................................................................................58
Item 10. Directors and Executive Officers of the Registrant.......................................58
Item 11. Executive Compensation...................................................................58
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters .....................................................................58
Item 13. Certain Relationships and Related Transactions...........................................58
Item 14. Principal Accountant Fees and Services...................................................59
PART IV...............................................................................................59
Item 15. Exhibits, Financial Statement Schedules and Reports On Form 8-K........................59
Signatures........................................................................................60
PART I
Item 1. Business.
General
Capital Bank Corporation (the "Company") is a financial holding company
incorporated under the laws of North Carolina on August 10, 1998. The Company's
primary function is to serve as the holding company for its wholly-owned
subsidiaries, Capital Bank and Capital Bank Investment Services, Inc. In
addition, the Company has interest in two trusts, Capital Bank Statutory Trust I
and II (hereinafter collectively referred to as the "Trusts"). These Trusts are
not consolidated with the financial statements of the Company per the provisions
of FIN 46R. Capital Bank (the "Bank") was incorporated under the laws of the
State of North Carolina on May 30, 1997, and commenced operations as a
state-chartered banking corporation on June 20, 1997. The Bank is not a member
of the Federal Reserve System and has no subsidiaries. Capital Bank Investment
Services, Inc. ("CBIS") was incorporated under the laws of the State of North
Carolina on January 3, 2001 and commenced operations as a full service
investment company on March 1, 2001. In the third quarter of 2003, CBIS ceased
operations, but remains a subsidiary of the Company.
- 2 -
As of December 31, 2003, the Company had assets of approximately $857.7 million,
gross loans outstanding of approximately $625.9 million and deposits of
approximately $629.6 million. The Company's corporate office is located at 4901
Glenwood Avenue, Raleigh, North Carolina 27612, and its telephone number is
(919) 645-6400. In addition to the corporate office, the Company has four branch
offices in Raleigh, two in Cary, one in Siler City, one in Oxford, one in
Warrenton, one in Woodland, one in Seaboard, three in Sanford, three in
Burlington, one in Graham, two in Asheville and one in Hickory, North Carolina.
The Company also has a loan origination office in Greensboro, North Carolina.
Capital Bank is a community bank engaged in the general commercial banking
business in Wake, Chatham, Northampton, Granville, Warren, Alamance and Lee
Counties, North Carolina and the communities of Asheville and Hickory, North
Carolina. Wake County has a diversified economic base, comprised primarily of
services, retail trade, government and manufacturing and includes the City of
Raleigh, the state capital. Lee, Northampton, Granville, Warren and Chatham
counties are significant centers for various industries, including agriculture,
manufacturing, lumber and tobacco. Alamance County has a diversified economic
base, comprised primarily of manufacturing, agriculture, retail and wholesale
trade, government, services and utilities. The town of Hickory is a regional
center for manufacturing and wholesale trade. The economic base of the city of
Asheville is comprised primarily of services, medical, tourism and manufacturing
industries.
The Bank offers a full range of banking services, including the following:
checking accounts; savings accounts; NOW accounts; money market accounts;
certificates of deposit; loans for real estate, construction, businesses,
agriculture, personal uses, home improvement and automobiles; equity lines of
credit; credit loans; consumer loans; credit cards; individual retirement
accounts; safe deposit boxes; bank money orders; internet banking; electronic
funds transfer services including wire transfers; traveler's checks; various
investments; and free notary services to all Bank customers. In addition, the
Bank provides automated teller machine access to its customers for cash
withdrawals through nationwide ATM networks. At present, the Bank does not
provide the services of a trust department.
Throughout most of 2003, CBIS made available a full range of non-deposit
investment services to individuals and corporations, including the customers of
the Bank. These investment services included full-service securities brokerage,
asset management, financial planning and retirement services, such as 401(k)
plans, all provided exclusively through a strategic alliance with Raymond James
Financial Services, Inc. ("Raymond James"). Raymond James is a wholly owned
subsidiary of Raymond James Financial, Inc. (NYSE: RJF) and is a leading
provider of third party investment services, serving more than 250 community
banks nationwide. These services were available in the offices of the Bank
through registered investment representatives. In the later part of 2003, CBIS
ceased operations, but remains a subsidiary of the Company.
Lending Activities and Deposits
Loan Types and Lending Policies. The Company makes a variety of loans, including
loans secured by real estate, loans for construction, loans for commercial
purposes and loans to individuals for personal and household purposes. During
2003, there were no large concentrations of credit to any particular industry.
The economic trends of the area served by the Company are influenced by the
significant industries within the region. Consistent with the Company's emphasis
on being a community-oriented financial institution, virtually all the Company's
business activity is with customers located in and around counties in which the
Company has banking offices. The ultimate collectibility of the Company's loan
portfolio is susceptible to changes in the market conditions of these geographic
regions.
The Company uses a centralized risk management process to ensure uniform credit
underwriting that adheres to the Bank's loan policy as approved annually by the
Board. Lending policies are reviewed on a regular basis to confirm that the
Company is prudent in setting its underwriting criteria. Credit risk is managed
through a number of methods including loan grading of commercial loans,
committee approval of larger loans and class and purpose coding of loans.
Management believes that early detection of credit problems through regular
contact with the Company's clients coupled with consistent reviews of the
borrowers' financial condition are important factors in overall credit risk
management.
- 3 -
The following table sets forth, as of December 31, 2003, the approximate
composition of the Company's loan portfolio:
Loan Type Amount Percentage
-------- ----------
(In thousands)
Commercial $474,317 76%
Consumer 42,929 7%
Home Equity Lines 58,430 9%
Residential mortgages 50,269 8%
-------- --------
$625,945 100%
======== ========
Deposits. The majority of the Company's deposit customers are individuals and
small to medium-size businesses located in Wake, Chatham, Granville, Warren,
Northampton, Alamance, and Lee Counties, North Carolina and contiguous areas and
the Asheville and Hickory, North Carolina communities. The Company's deposit
base is well diversified, with no material concentration in a single industry or
group of related industries. Management of the Company does not believe that the
deposits or the business of the Company in general are seasonal in nature.
Deposits vary with local and national economic conditions, but not enough,
management believes, to have a material effect on planning and policy making.
The Company attempts to control deposit flow through the pricing of deposits and
promotional activities. Management believes that the Company's rates are
competitive with those offered by other institutions in the same geographic
area.
The following table sets forth the mix of depository accounts at the Company as
a percentage of total deposits as of December 31, 2003:
Non-interest bearing demand 9%
Interest checking 11%
Market rate investment 18%
Savings 3%
Time deposits:
Under $100,000 43%
Equal to or over $100,000 16%
-----
100%
=====
Competition
Commercial banking in North Carolina is extremely competitive in large part due
to statewide branching. The Company competes in its market area with some of the
largest banking organizations in the state and the country and other financial
institutions, such as federally and state-chartered savings and loan
institutions and credit unions, as well as consumer finance companies, mortgage
companies and other lenders engaged in the business of extending credit. Many of
the Company's competitors have broader geographic markets and higher lending
limits than the Company and are also able to provide more services and make
greater use of media advertising.
The enactment of legislation authorizing interstate banking has caused increases
in the size and financial resources of some of the Company's competitors. In
addition, as a result of interstate banking, out-of-state commercial banks may
acquire North Carolina banks and heighten the competition among banks in North
Carolina.
Despite the competition in its market area, the Company believes that it has
certain competitive advantages that distinguish it from its competition. The
Company believes that its primary competitive advantages are its strong local
identity and affiliation with the communities it serves and its emphasis on
providing specialized services to small and medium-sized business enterprises,
as well as professional and upper-income individuals. The Company offers
customers modern, high-tech banking without forsaking community values such as
prompt, personal service and friendliness. The Company offers many personalized
services and attracts customers by being responsive and sensitive to their
individualized needs. The Company also relies on goodwill and referrals from
shareholders and satisfied customers, as well as traditional media to attract
new customers. To enhance a positive image in the community, the Company
supports and participates in local events and its officers and directors serve
on boards of local civic and charitable organizations.
- 4 -
Employees
At March 1, 2004, the Company employed 205 persons, of which 191 were full-time
and 14 were part-time. None of its employees are represented by a collective
bargaining unit. The Company considers relations with its employees to be good.
Supervision and Regulation
Holding companies, banks and many of their non-bank affiliates are extensively
regulated under both federal and state law. The following is a brief summary of
certain statutes, rules and regulations affecting the Company and the Bank. This
summary is qualified in its entirety by reference to the particular statutory
and regulatory provisions referred to below and is not intended to be an
exhaustive description of the statutes or regulations applicable to the
Company's or the Bank's business. Supervision, regulation and examination of the
Company and the Bank by bank regulatory agencies is intended primarily for the
protection of the Bank's depositors rather than holders of the Company's common
stock.
Holding Company Regulation
General. The Company is a holding company registered with the Federal Reserve
under the Bank Holding Company Act of 1956 (the "BHCA"). As such, the Company
and the Bank are subject to the supervision, examination and reporting
requirements contained in the BHCA and the regulation of the Federal Reserve.
The BHCA requires that a bank holding company obtain the prior approval of the
Federal Reserve before: (i) acquiring direct or indirect ownership or control of
more than five percent of the voting shares of any bank; (ii) taking any action
that causes a bank to become a subsidiary of the bank holding company; (iii)
acquiring all or substantially all of the assets of any bank; or (iv) merging or
consolidating with any other bank holding company.
The BHCA generally prohibits a bank holding company, with certain exceptions,
from engaging in activities other than banking, or managing or controlling banks
or other permissible subsidiaries, and from acquiring or retaining direct or
indirect control of any company engaged in any activities other than those
activities determined by the Federal Reserve to be closely related to banking,
or managing or controlling banks, as to be a proper incident thereto. In
determining whether a particular activity is permissible, the Federal Reserve
must consider whether the performance of such an activity can reasonably be
expected to produce benefits to the public, such as greater convenience,
increased competition or gains in efficiency, that outweigh possible adverse
effects, such as undue concentration of resources, decreased or unfair
competition, conflicts of interest or unsound banking practices. For example,
banking, operating a thrift institution, extending credit or servicing loans,
leasing real or personal property, conducting securities brokerage activities,
performing certain data processing services, acting as agent or broker in
selling credit life insurance and certain other types of insurance underwriting
activities have all been determined by regulations of the Federal Reserve to be
permissible activities.
Pursuant to delegated authority, the Federal Reserve Bank of Richmond has
authority to approve certain activities of holding companies within its
district, including the Company, provided the nature of the activity has been
approved by the Federal Reserve. Despite prior approval, the Federal Reserve has
the power to order a holding company or its subsidiaries to terminate any
activity or to terminate its ownership or control of any subsidiary when it has
reasonable cause to believe that continuation of such activity or such ownership
or control constitutes a serious risk to the financial safety, soundness or
stability of any bank subsidiary of that bank holding company.
Financial Holding Companies. The Gramm-Leach-Bliley Financial Modernization Act
of 1999 (the "GLB"):
o allows bank holding companies meeting management, capital and the
Community Reinvestment Act of 1977 (the "CRA") standards to engage
in a substantially broader range of non-banking activities than was
permissible prior to enactment, including insurance underwriting and
making merchant banking investments in commercial and financial
companies;
o allows insurers and other financial services companies to acquire
banks;
o removes various restrictions that applied to bank holding company
ownership of securities firms and mutual
- 5 -
fund advisory companies; and
o establishes the overall regulatory structure applicable to bank
holding companies that also engage in insurance and securities
operations.
The Company is authorized to operate as a financial holding company and
therefore is eligible to engage in the broader range of activities that are
permitted by the GLB. The GLB also is designed to modify other current financial
laws, including laws related to financial privacy and community reinvestment.
The new financial privacy provisions generally prohibit financial institutions,
including the Company, from disclosing nonpublic personal financial information
to nonaffiliated third parties unless customers have the opportunity to "opt
out" of the disclosure.
Mergers and Acquisitions. The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "IBBEA") permits interstate acquisitions of banks
and bank holding companies without geographic limitation, subject to any state
requirement that the bank has been organized for a minimum period of time, not
to exceed five years, and the requirement that the bank holding company, prior
to, or following the proposed acquisition, controls no more than 10% of the
total amount of deposits of insured depository institutions in the U.S. and no
more than 30% of such deposits in any state (or such lesser or greater amount
set by state law).
In addition, the IBBEA permits a bank to merge with a bank in another state as
long as neither of the states has opted out of the IBBEA prior to May 31, 1997.
The state of North Carolina has "opted in" to such legislation. In addition, a
bank may establish and operate a de novo branch in a state in which the bank
does not maintain a branch if that state expressly permits de novo interstate
branching. As a result of North Carolina's opt-in law, North Carolina law
permits unrestricted interstate de novo branching.
Additional Restrictions and Oversight. Subsidiary banks of a bank holding
company are subject to certain restrictions imposed by the Federal Reserve on
any extensions of credit to the bank holding company or any of its subsidiaries,
investments in the stock or securities thereof and the acceptance of such stock
or securities as collateral for loans to any borrower. A bank holding company
and its subsidiaries are also prevented from engaging in certain tie-in
arrangements in connection with any extension of credit, lease or sale of
property or furnishing of services. An example of a prohibited tie-in would be
any arrangement that would condition the provision or cost of services on a
customer obtaining additional services from the bank holding company or any of
its other subsidiaries.
The Federal Reserve may issue cease and desist orders against bank holding
companies and non-bank subsidiaries to stop actions believed to present a
serious threat to a subsidiary bank. The Federal Reserve also regulates certain
debt obligations, changes in control of bank holding companies and capital
requirements.
Under the provisions of the North Carolina law, the Company is registered with
and subject to supervision by the North Carolina Commissioner of Banks (the
"Commissioner").
Capital Requirements. The Federal Reserve has established risk-based capital
guidelines for bank holding companies. The minimum standard for the ratio of
capital to risk-weighted assets (including certain off balance sheet
obligations, such as standby letters of credit) is eight percent. At least half
of this capital must consist of common equity, retained earnings and a limited
amount of perpetual preferred stock and minority interests in the equity
accounts of consolidated subsidiaries, less certain goodwill items and other
adjustments ("Tier 1 capital"). The remainder ("Tier 2 capital") may consist of
mandatorily redeemable convertible debt securities and a limited amount of other
preferred stock, subordinated debt and loan loss reserves.
In addition, the Federal Reserve has established minimum leverage ratio
guidelines for bank holding companies. These guidelines provide for a minimum
leverage ratio of Tier 1 capital to adjusted average quarterly assets less
certain amounts ("Leverage Ratio") equal to three percent for bank holding
companies that meet certain specified criteria, including having the highest
regulatory rating. All other bank holding companies will generally be required
to maintain a Leverage Ratio of between four percent and five percent.
The guidelines also provide that bank holding companies experiencing significant
growth, whether through internal expansion or acquisitions, will be expected to
maintain strong capital ratios substantially above the minimum supervisory
levels without significant reliance on intangible assets. The same heightened
requirements apply to bank
- 6 -
holding companies with supervisory, financial, operational or managerial
weaknesses, as well as to other banking institutions if warranted by particular
circumstances or the institution's risk profile. Furthermore, the guidelines
indicate that the Board of Governors of the Federal Reserve System (the "Federal
Reserve Board") will continue to consider a "tangible Tier 1 Leverage Ratio"
(deducting all intangibles) in evaluating proposals for expansion or new
activity. The Federal Reserve has not advised the Company of any specific
minimum Leverage Ratio or tangible Tier 1 Leverage Ratio applicable to it.
As of December 31, 2003, the Company had Tier 1 risk-adjusted, total regulatory
capital and leverage capital of approximately 10.68%, 12.13% and 8.71%,
respectively, all in excess of the minimum requirements. Those same ratios as of
December 31, 2002 were 9.03%, 10.28%, and 8.18%, respectively.
International Money Laundering Abatement and Financial Anti-Terrorism Act Of
2001. Title III of the USA Patriot Act of 2001 contains the International Money
Laundering Abatement and Financial Anti-Terrorism Act of 2001 (the "IMLAFA").
The anti-money laundering provisions of IMLAFA impose affirmative obligations on
a broad range of financial institutions, including banks, brokers, and dealers.
Among other requirements, IMLAFA requires all financial institutions to
establish anti-money laundering programs that include, at minimum, internal
policies, procedures, and controls; specific designation of an anti-money
laundering compliance officer; ongoing employee training programs; and an
independent audit function to test the anti-money laundering program. IMLAFA
requires financial institutions that establish, maintain, administer, or manage
private banking accounts for non-United States persons or their representatives
to establish appropriate, specific, and where necessary, enhanced due diligence
policies, procedures, and controls designed to detect and report money
laundering. Additionally, IMLAFA provides for the Department of Treasury to
issue minimum standards with respect to customer identification at the time new
accounts are opened. The Company has determined the impact that IMLAFA will have
on the Bank's operations is not material. The Bank has established policies and
procedures to ensure compliance with the IMLAFA that were approved by the Board
of Directors.
Bank Regulation
The Bank is subject to numerous state and federal statutes and regulations that
affect its business, activities, and operations, and is supervised and examined
by the Commissioner and the Federal Reserve. The Federal Reserve and the
Commissioner regularly examine the operations of banks over which they exercise
jurisdiction. They have the authority to approve or disapprove the establishment
of branches, mergers, consolidations and other similar corporate actions. They
also have authority to prevent the continuance or development of unsafe or
unsound banking practices and other violations of law. The Federal Reserve and
the Commissioner regulate and monitor all areas of the operations of banks and
their subsidiaries, including loans, mortgages, issuances of securities, capital
adequacy, loss reserves and compliance with the CRA as well as other laws and
regulations. Interest and certain other charges collected and contracted for by
banks are also subject to state usury laws and certain federal laws concerning
interest rates.
The deposit accounts of the Bank are insured by the Bank Insurance Fund (the
"BIF") of the Federal Deposit Insurance Corporation (the "FDIC") up to a maximum
of $100,000 per insured depositor. The FDIC issues regulations and conducts
periodic examinations, requires the filing of reports and generally supervises
the operations of its insured banks. This supervision and regulation is intended
primarily for the protection of depositors. Any insured bank that is not
operated in accordance with or does not conform to FDIC regulations, policies
and directives may be sanctioned for noncompliance. Civil and criminal
proceedings may be instituted against any insured bank or any director, officer
or employee of such bank for the violation of applicable laws and regulations,
breaches of fiduciary duties or engaging in any unsafe or unsound practice. The
FDIC has the authority to terminate insurance of accounts pursuant to procedures
established for that purpose.
Under the North Carolina corporation laws, the Company may not pay a dividend or
distribution, if after giving its effect, the Company would not be able to pay
its debts as they become due in the usual course of business or the Company's
total assets would be less than its liabilities. In general, the Company's
ability to pay cash dividends is dependent upon the amount of dividends paid by
the Bank. The ability of the Bank to pay dividends to the Company is subject to
statutory and regulatory restrictions on the payment of cash dividends,
including the requirement under the North Carolina banking laws that cash
dividends be paid only out of undivided profits and only if the bank has surplus
of a specified level. The Federal Reserve also imposes limits on the Bank's
payment of dividends.
- 7 -
Like the Company, the Bank is required by federal regulations to maintain
certain minimum capital levels. The levels required of the Bank are the same as
required for the Company. At December 31, 2003, the Bank had Tier 1
risk-adjusted, total regulatory capital and leverage capital of approximately
10.38%, 11.63% and 8.48%, respectively, all in excess of the minimum
requirements.
The Bank is subject to insurance assessments imposed by the FDIC. The FDIC has
adopted a risk-based assessment schedule providing for annual assessment rates
ranging from 0% to .27% of an institution's average assessment base, applicable
to institutions insured by both the BIF and the Savings Association Insurance
Fund ("SAIF"). The actual assessment to be paid by each insured institution is
based on the institution's assessment risk classification, which focuses on
whether the institution is considered "well capitalized," "adequately
capitalized" or "under capitalized," as such terms are defined in the applicable
federal regulations. Within each of these three risk classifications, each
institution will be assigned to one of three subgroups based on supervisory risk
factors. In particular, regulators will assess supervisory risk based on whether
the institution is financially sound with only a few minor weaknesses (Subgroup
A), whether it has weaknesses which, if not corrected, could result in an
increased risk of loss to the BIF (Subgroup B) or whether such weaknesses pose a
substantial risk of loss to the BIF unless corrective action is taken (Subgroup
C). The FDIC also is authorized to impose one or more special assessments in an
amount deemed necessary to enable repayment of amounts borrowed by the FDIC from
the United States Treasury Department and all banks are now required to pay
additional annual assessments at rates set by the Financing Corporation, which
was established by the Competitive Equality Banking Act of 1987.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
provides for, among other things, (i) publicly available annual financial
condition and management reports for certain financial institutions, including
audits by independent accountants, (ii) the establishment of uniform accounting
standards by federal banking agencies, (iii) the establishment of a "prompt
corrective action" system of regulatory supervision and intervention, based on
capitalization levels, with greater scrutiny and restrictions placed on
depository institutions with lower levels of capital, (iv) additional grounds
for the appointment of a conservator or receiver and (v) restrictions or
prohibitions on accepting brokered deposits, except for institutions which
significantly exceed minimum capital requirements. FDICIA also provides for
increased funding of the FDIC insurance funds and the implementation of
risk-based premiums.
A central feature of FDICIA is the requirement that the federal banking agencies
take "prompt corrective action" with respect to depository institutions that do
not meet minimum capital requirements. Pursuant to FDICIA, the federal bank
regulatory authorities have adopted regulations setting forth a five-tiered
system for measuring the capital adequacy of the depository institutions that
they supervise. Under these regulations, a depository institution is classified
in one of the following capital categories: "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized" and
"critically undercapitalized." An institution may be deemed by the regulators to
be in a capitalization category that is lower than is indicated by its actual
capital position if, among other things, it receives an unsatisfactory
examination rating with respect to asset quality, management, earnings or
liquidity. FDICIA provides the federal banking agencies with significantly
expanded powers to take enforcement action against institutions which fail to
comply with capital or other standards. Such action may include the termination
of deposit insurance by the FDIC or the appointment of a receiver or conservator
for the institution.
Banks are also subject to the CRA, which requires the appropriate federal bank
regulatory agency, in connection with its examination of a bank, to assess such
bank's record in meeting the credit needs of the community served by that bank,
including low and moderate-income neighborhoods. Each institution is assigned
one of the following four ratings of its record in meeting community credit
needs: "outstanding," "satisfactory," "needs to improve" or "substantial
noncompliance." The regulatory agency's assessment of the bank's record is made
available to the public. Further, such assessment is required of any bank which
has applied to (i) charter a national bank, (ii) obtain deposit insurance
coverage for a newly chartered institution, (iii) establish a new branch office
that will accept deposits, (iv) relocate an office or (v) merge or consolidate
with, or acquire the assets or assume the liabilities of, a federally regulated
financial institution. In the case of a bank holding company applying for
approval to acquire a bank or other bank holding company, the Federal Reserve
will assess the record of each subsidiary bank of the applicant bank holding
company, and such records may be the basis for denying the application.
The GLB's "CRA Sunshine Requirements" call for financial institutions to
disclose publicly certain written agreements made in fulfillment of the CRA.
Banks that are parties to such agreements also must report to federal regulators
the amount and use of any funds expended under such agreements on an annual
basis, along with such other information as
- 8 -
regulators may require.
Monetary Policy and Economic Controls
The Company and the Bank are directly affected by governmental policies and
regulatory measures affecting the banking industry in general. Of primary
importance is the Federal Reserve Board, whose actions directly affect the money
supply which, in turn, affects banks' lending abilities by increasing or
decreasing the cost and availability of funds to banks. The Federal Reserve
Board regulates the availability of bank credit in order to combat recession and
curb inflationary pressures in the economy by open market operations in United
States government securities, changes in the discount rate on member bank
borrowings, changes in reserve requirements against bank deposits and
limitations on interest rates that banks may pay on time and savings deposits.
Deregulation of interest rates paid by banks on deposits and the types of
deposits that may be offered by banks have eliminated minimum balance
requirements and rate ceilings on various types of time deposit accounts. The
effect of these specific actions and, in general, the deregulation of deposit
interest rates has generally increased banks' cost of funds and made them more
sensitive to fluctuations in money market rates. In view of the changing
conditions in the national economy and money markets, as well as the effect of
actions by monetary and fiscal authorities, no prediction can be made as to
possible future changes in interest rates, deposit levels, loan demand, or the
business and earnings of the Bank or the Company. As a result, banks, including
the Bank, face a significant challenge to maintain acceptable net interest
margins.
Sarbanes-Oxley Act of 2002
In 2002, the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act") was signed
into law. The Sarbanes-Oxley Act represents a comprehensive revision of laws
affecting corporate governance, accounting obligations and corporate reporting.
The Sarbanes-Oxley Act is applicable to all companies with equity or debt
securities registered under the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). In particular, the Sarbanes-Oxley Act establishes: (i) new
requirements for audit committees, including independence, expertise, and
responsibilities; (ii) additional responsibilities regarding financial
statements for the Chief Executive Officer and Chief Financial Officer of the
reporting company; (iii) new standards for auditors and regulation of audits;
(iv) increased disclosure and reporting obligations for the reporting company
and their directors and executive officers; and (v) new and increased civil and
criminal penalties for violation of the securities laws. Although the Company
anticipates that it will incur additional expense in complying with the
provisions of the Sarbanes-Oxley Act and the resulting regulations, the Company
does not expect that such compliance will have a material impact on the
Company's or the Bank's results of operations or financial condition.
Executive Officers
The executive officers of the Company are as follows:
Name Age Position With Company
- ---- --- ---------------------
William C. Burkhardt 66 Chief Executive Officer
B. Grant Yarber 39 President and Chief Operating Officer
Steven E. Crouse 39 Senior Vice President, Finance and Chief Accounting Officer
Karen H. Priester 46 Senior Vice President and Chief Credit Officer
Bill Burkhardt serves as Chief Executive Officer for Capital Bank Corporation
and Capital Bank. Mr. Burkhardt has served as Chairman of Capital Bank's
executive committee since the Company's inception. He is the former President
and CEO of Austin Quality Foods, which was sold to Keebler/Kellogg Company in
2000. He serves as a director for SCANA Corporation, which acquired Public
Service Company of North Carolina in 2000. He is one of the founding directors
of the former Triangle Bank Corporation in Raleigh and also has held several key
positions with community organizations such as the Raleigh Chamber of Commerce,
Triangle Transit Authority, Raleigh-Durham Airport
- 9 -
Authority, Rex Healthcare, St. Augustine's College and Peace College in Raleigh.
Grant Yarber serves as President and Chief Operating Officer for Capital Bank
Corporation and Capital Bank, responsible for retail and commercial lending as
well as overseeing the day-to-day operations of the Bank. Prior to joining
Capital Bank in June, 2003, he was the Chief Lending Officer and Chief Credit
Officer of MountainBank in Hendersonville, N.C for 1 1/2 years. Prior to joining
MountainBank, Mr. Yarber served two years as Senior Credit Manager in the SE
Region for Bank of America in Tampa, Florida. Prior to the move to Florida, Mr.
Yarber was a State Executive for Business Banking and Professional and Executive
Banking for Bank of America in Missouri and Illinois for two years. With more
than 15 years of banking experience, Yarber has particular strength in lending
and credit management. In addition to the foregoing, his background includes
leadership positions with Bank of America, including Southeast Credit Manager
(Georgia, Florida, and Tennessee)
Steve Crouse serves as Senior Vice President, Finance and Chief Accounting
Officer for Capital Bank Corporation and Capital Bank. He formerly served as
Senior Vice President and Controller of the Bank. Mr. Crouse joined the company
in 1998. A CPA since 1990, he came to Capital Bank with eight years of public
accounting experience with McGladrey & Pullen, LLP where he focused on a
financial institution specialization.
Karen Priester serves as Senior Vice President and Chief Credit Officer of the
Bank. Prior to this position, she was Regional Credit Administrator and Wake
County Senior Lender in her five years of employment at Capital Bank. Karen has
over twenty years of banking experience, concentrating in the commercial lending
and credit areas. In her function as Chief Credit Officer, Karen is responsible
for credit quality, loan review, special assets, government lending, compliance,
and the credit department.
Website Access to Capital Bank Corporation's Filings with the Securities and
Exchange Commission
Since becoming an "accelerated filer," all of the Company's electronic filings
with the Securities and Exchange Commission ("SEC"), including the Annual Report
on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and
amendments to these reports filed or furnished pursuant to Section 13(a) or
15(d) of the Exchange Act have been made available at no cost on the
Corporation's web site, www.capitalbank-nc.com, as soon as reasonably
practicable after the Company filed such material with, or furnished it to, the
SEC. The Company's SEC filings are also available through the SEC's web site at
www.sec.gov.
Item 2. Properties.
The Company currently leases property located at 4901 Glenwood Avenue, Raleigh,
North Carolina for its principal offices and a branch office. The lease is for
approximately 21,600 square feet, of which approximately 18,600 square feet is
for the Company's principal offices and the remainder for the branch office. In
addition to this facility, the Company owns 14 properties throughout North
Carolina that are used as branch locations and which are located in Sanford (2),
Cary (2), Siler City, Oxford, Warrenton, Woodland, Burlington (3), Graham,
Hickory and Raleigh. The Company also leases 10 properties throughout North
Carolina that are used as branch locations or mortgage production offices and
which are located in Raleigh (2), Sanford, Seaboard, Asheville (2), Cary, Chapel
Hill and Greensboro. Management believes the terms of the various leases, which
are reviewed on an annual basis, are consistent with market standards and were
arrived at through arm's length bargaining.
Item 3. Legal Proceedings.
There are no pending material legal proceedings to which the Company is a party
or of which any of its property is subject. In addition, the Company is not
aware of any threatened litigation, unasserted claims or assessments that could
have a material adverse effect on the Company's business, operating results or
financial condition.
Item 4. Submission of Matters to a Vote of Security Holders
During the fourth quarter of the year ended December 31, 2003, there were no
matters submitted to a vote of the Company's shareholders.
- 10 -
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Shares of Capital Bank Corporation common stock are traded on the Nasdaq
National Market under the symbol "CBKN." As of March 7, 2004, the Company had
approximately 1,628 holders of record of its common stock. The following table
sets forth, for the indicated periods, the high and low sales prices for the
common stock (based on published sources) and the cash dividend declared per
share of the Company's common stock:
Cash
Dividends
Per Share
2003 High Low Declared
- -----------------------------------------------------------
First Quarter $14.70 $12.95 $0.05
Second Quarter $15.98 $13.20 $0.05
Third Quarter $16.40 $14.10 $0.05
Fourth Quarter $16.93 $15.09 $0.05
Cash
Dividends
Per Share
2002 High Low Declared
- -----------------------------------------------------------
First Quarter $16.50 $10.70 $0.05
Second Quarter $16.00 $14.01 $0.05
Third Quarter $15.30 $14.00 $0.05
Fourth Quarter $14.89 $12.14 $0.05
Dividend Policy. The Company's shareholders are entitled to receive such
dividends or distributions as the Board of Directors authorizes in its
discretion. The Company's ability to pay dividends is subject to the
restrictions of the North Carolina Business Corporation Act. There are also
various statutory limitations on the ability of the Bank to pay dividends to the
Company. Subject to the legal availability of funds to pay dividends, during
fiscal year 2003, the Company declared and paid quarterly dividends at an annual
rate of $0.20 per share. The Company intends to pay approximately 20% of its
annual net earnings to shareholders in the form of annual cash dividends if such
cash dividends are in the best interest of the Company in the business judgment
of its Board of Directors and are consistent with maintaining the Company's
status as a "well-capitalized" institution under applicable banking laws and
regulations.
Recent Sales of Unregistered Securities. The Company did not sell any securities
in the fiscal year ended December 31, 2003 which were not registered under the
Securities Act of 1933, as amended (the "Securities Act"), except that in June
2003 and December 2003, the Company formed the Trusts and each Trust issued
10,000 of its floating rate capital securities (the "trust preferred
securities"), with a liquidation amount of $1,000 per capital security, in
pooled offerings of trust preferred securities.
The Trusts sold their common securities to the Company for an aggregate of
$620,000, resulting in total proceeds from each offering equal to $10,310,000 or
$20,620,000 in aggregate. The Trusts then used these proceeds to purchase
$20,620,000 in principal amount of the Company's Floating Rate Junior
Subordinated Deferrable Interest Debentures (the "Debentures").
Following payment by the Company of a placement fee and other expenses of the
offering, the Company's net proceeds from the offering aggregated $20 million.
The trust preferred securities and the Debentures were issued in a private
offering to certain qualified institutional purchasers in accordance with an
exemption under Section 4(2) of the Securities Act.
- 11 -
The Company used approximately $1.9 million of the proceeds from the issuance of
the Debentures to repurchase 127,500 shares of the Company's common stock during
the three months ended June 30, 2003. The Company invested $14.0 million of the
remaining proceeds in its Bank subsidiary to support additional earning asset
growth. The remaining funds will remain in a money market account for the
Company to be used to pay dividends and other Company obligations. For more
information about the trust preferred securities and the Debentures, see Notes
to Consolidated Financial Statements - Note 11 - Subordinated Debentures.
Item 6. Selected Financial Data.
The following table sets forth selected financial information for the Company
that has been derived from the financial statements and notes thereto. This
information should be read in conjunction with Management's Discussion and
analysis of Financial Condition and Results of Operations and the consolidated
financial statements and notes thereto included elsewhere in this report.
(In thousands except share and per share data) As of and for the Years Ended December 31 (1)
2003 2002 2001 2000 1999
-------------------------------------------------------------------------
Selected Balance Sheet Data
Cash and Due From Banks $ 22,408 $ 32,837 $ 15,173 $ 27,676 $ 9,702
Federal Funds Sold 3,202 18,696 944 750 1,960
Securities 165,913 155,304 73,702 61,947 46,581
Gross Loans 625,945 600,609 306,891 242,275 159,329
Allowance for Loan Losses 11,613 9,390 4,286 3,463 2,328
Total Assets 857,734 840,976 406,741 343,620 222,337
Deposits 629,619 644,887 304,443 279,094 163,245
Borrowings 114,591 97,858 50,000 15,000 20,000
Repurchase Agreements 11,014 13,081 11,167 9,804 4,818
Shareholders' Equity 72,923 75,471 36,983 35,015 31,126
Summary of Operations
Interest Income $ 40,440 $ 36,244 $ 26,173 $ 23,751 $ 14,553
Interest Expense 16,318 15,895 14,701 13,101 7,656
-------------------------------------------------------------------------
Net Interest Income 24,122 20,349 11,472 10,650 6,897
Provision for Loan Losses 8,247 4,190 1,215 1,110 924
-------------------------------------------------------------------------
Net Interest Income After Provision For Loan Losses 15,875 16,159 10,257 9,540 5,973
Other Operating Income 10,322 7,987 4,490 2,193 1,260
Other Operating Expense (2) 25,165 17,465 11,847 9,596 8,124
-------------------------------------------------------------------------
Pre-tax Net Income 1,032 6,681 2,900 2,137 (891)
Income Tax Expense (Benefit) 38 2,374 480 (36) (40)
-------------------------------------------------------------------------
Net Income (Loss) $ 994 $ 4,307 $ 2,420 $ 2,173 $ (851)
=========================================================================
Per Share Data
Net Income (Loss) - Basic $ .15 $ .79 $ .65 $ .61 $ .22
Net Income (Loss) - Diluted .15 .76 .65 .59 (.23)
Book Value 11.15 11.44 10.28 9.57 8.51
Number of Common Shares Outstanding 6,541,495 6,595,784 3,597,339 3,658,689 3,658,689
- 12 -
As of and for the Years Ended December 31 (1)
2003 2002 2001 2000 1999
-----------------------------------------------------------------
Selected Ratios
Return On Average Assets .11% .66% .65% .73% (0.42)%
Return on Average Shareholders' Equity 1.34% 7.43% 6.69% 6.21% (2.68)%
Dividend Payout Ratio 133% 26% 0% 0% 0%
Average Shareholders' Equity to Average Total Assets 8.55% 8.89% 9.69% 11.83% 15.81%
Net Interest Margin 2.99% 3.32% 3.26% 3.78% 3.61%
(1) Capital Bank opened for business on June 20, 1997. Capital Bank
Corporation was formed on March 31, 1999.
(2) Includes non-recurring merger related costs of $90,000 and $1.6 million
for years ended December 31, 2000 and 1999, respectively.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion and analysis is intended to aid the reader in
understanding and evaluating the results of operations and financial condition
of the Company, the Bank and CBIS. In addition, the Company has interest in the
Trusts, but the Trusts are not consolidated with the Company per the provisions
of FIN 46R. This discussion is designed to provide more comprehensive
information about the major components of the Company's results of operations
and financial condition, liquidity, and capital resources than could be obtained
from reading the financial statements alone. This discussion should be read in
conjunction with the Company's consolidated financial statements, the related
notes and the selected financial data presented elsewhere in this report.
Safe Harbor Discussion
Information set forth in this Annual Report on Form 10-K contains various
"forward looking statements" within the meaning of Section 27A of the Securities
Act and Section 21E of the Exchange Act, which statements represent the
Company's judgment concerning the future and are subject to risks and
uncertainties that could cause the Company's actual operating results and
financial position to differ materially from the forward looking statements.
Such forward looking statements can be identified by the use of forward looking
terminology such as "may," "will," "expect," "anticipate," "estimate,"
"believe," or "continue," or the negative thereof or other variations thereof or
comparable terminology.
The Company cautions that any such forward looking statements are further
qualified by important factors that could cause the Company's actual operating
results to differ materially from those in the forward looking statements,
including without limitation, the management of the Company's growth, the risks
associated with possible or completed acquisitions, the risks associated with
the Bank's loan portfolio, competition within the industry, dependence on key
personnel, government regulation and the other risk factors described herein
under "Risk Factors."
Overview. Capital Bank is a full-service state chartered community bank
conducting business primarily in the Research Triangle region and surrounding
areas of North Carolina. The Bank was incorporated on May 30, 1997 and opened
its first branch in June of that same year in Raleigh. In 1999, the shareholders
of the Bank approved the reorganization of Capital Bank into a bank holding
company. In 2001, the Company received approval to become a financial holding
company.
In 2001, the Company also formed CBIS, an investment services subsidiary and
agreed to acquire an independent branch brokerage office located in Raleigh,
North Carolina. CBIS made available a full range of non-deposit investment
services to individuals and corporations, including the customers of the Bank
through the third quarter of 2003. At that time, the Company made the decision
to discontinue the operations of CBIS.
As of December 31, 2003 the Company conducted no business other than holding
stock in the Bank, CBIS, and each of the Trusts. As a community bank, the Bank's
profitability depends primarily upon its levels of net interest income, which is
the difference between interest income from interest-earning assets and interest
expense on interest-bearing liabilities. The Bank's operations are also affected
by its provision for loan losses, other operating income, and other
- 13 -
operating expenses.
In fiscal 2003, the Bank dealt with credit quality issues from a small number of
large loans. Also, during the second half of the year, the Company announced
changes in its executive leadership team including the resignation of the
Company's Chief Executive Officer and Chief Financial Officer (effective at the
end of the fiscal year). However, the Company has assembled a new leadership
team which includes the new positions of Chief Operating Officer, Chief
Accounting Officer, Retail Banking Executive, Director of Operations and Human
Resources Manager and the Company has replaced its Chief Credit Officer. With a
new leadership team in place and the continued dedication of its employees and
its strong board of directors, the Company is confident that it can remain
focused on its core goals of being performance driven, community focused and
dedicated to providing exceptional value to its customers and shareholders.
Critical Accounting Policies and Estimates. The Company's discussion and
analysis of its financial condition and results of operations are based upon the
Company's consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires the Company to make
estimates and judgments regarding uncertainties that affect the reported amounts
of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, the Company evaluates
its estimates, including those related to the reserve for loan losses,
investment and intangible asset values, income taxes, and contingencies and
litigation. The Company bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. The Company believes the following critical
accounting policies affect its more significant judgments and estimates used in
the preparation of its consolidated financial statements:
o Loan Loss Reserves - The Company records estimated loan loss
reserves based on known problem loans and estimated deficiencies in
the existing loan portfolio. The reserve calculation takes into
account historic write-off trends and current market and economic
conditions. If economic conditions were to decline significantly or
the financial condition of the Bank's customers were to deteriorate,
resulting in an impairment of their ability to make payments,
additional reserves may be required.
o Investments - The Company records an investment impairment charge
when it believes an investment has experienced a decline in value
that is other than temporary. Future adverse changes in market
conditions and associated market values of investments could result
in losses or an inability to recover the carrying value of the
investments that may not be reflected in an investment's current
carrying value, thereby possibly requiring an impairment charge in
the future.
o Valuation Allowances - The Company assesses the need to record a
valuation allowance to reduce its deferred tax assets to the amount
that is more likely than not to be realized. The Company considers
anticipated future taxable income and ongoing prudent and feasible
tax planning strategies in determining the need for the valuation
allowance which, at this time, it deems not to be necessary. In the
event the Company were to determine that it would not be able to
realize all or part of its net deferred tax asset in the future, an
adjustment to the deferred tax asset would be charged to income in
the period such determination was made.
o Purchase Accounting for Business Combinations - The Company accounts
for all business combinations using the purchase method of
accounting. As a result, net assets acquired are recorded at fair
value at the date of acquisition and the historical costs basis of
individual assets and liabilities are adjusted to reflect their fair
value.
o Goodwill - Goodwill is not amortized, but is reviewed for potential
impairment on an annual basis at the reporting unit level.
Identified intangible assets are amortized on a straight-line basis.
An impairment loss is recorded to the extent that the carrying
amount of goodwill exceeds its implied value.
o Impairment of Long-Lived Assets - Long-lived assets, including
identified intangible assets, are evaluated for impairment if events
or circumstances indicate a possible impairment. Such evaluations
are based on undiscounted cash flow projections. The disposal of
long-lived assets is measured based on the lower of the
- 14 -
book or fair value less the costs to sell.
Results of Operations. The Company reported net income of $994,000, $4.3
million, and $2.4 million for the years ended December 31, 2003, 2002 and 2001,
respectively. On a fully diluted per share basis, net income for 2003, 2002, and
2001 was $.15, $.76 and $.65, respectively.
Year Ended December 31, 2003 Compared with Year Ended December 31, 2002
Net Interest Income. Net interest income is the difference between total
interest income and total interest expense and is the Company's principal source
of earnings. The amount of net interest income is determined by the volume of
interest-earning assets, the level of rates earned on those assets, and the
volume and cost of supporting funds. Net interest income increased from $20.3
million in 2002 to $24.1 million in 2003, an increase of $3.8 million or 19%.
The increase during the period is primarily due to increases in the average
volume of interest-bearing assets and liabilities as the Bank has experienced
internal growth. The increase was negatively affected by a decline in market
rates during 2003. Rates dropped by 25 basis points in July 2003. In 2002, the
Federal Reserve held interest rates steady for a majority of the year, but made
one move in November that resulted in an additional 50 basis point drop in the
prime rate to 4.25%. In addition, during 2001, the prime rate dropped from 9.00%
in January to 4.75% in December with a decline in rates of at least 25 basis
points in every month of 2001 except July as the Federal Reserve made 11
separate moves to reduce interest rates in efforts to stimulate the economy. The
Company has felt the effects of these changes over an extended period of time
due to the long term repricing or maturity dates of some of its assets and
liabilities. Since the Bank's loan portfolio adjusts with prime at a faster rate
than the deposit portfolio, the declining rate environments have a negative
effect on net interest spread and net interest margin. Net interest spread is
the difference between rates earned on interest-earning assets and the interest
paid on deposits and other borrowed funds. Net interest margin is the total of
net interest income divided by average earning assets. Average earning assets in
2003 were $807.8 million, up 32% when compared to $612.2 million for 2002. The
net interest margin was 2.99% in 2003, a 33 basis point decline from the 2002
net interest margin of 3.32%. Net interest spread was 2.78% and 3.03% for 2003
and 2002, respectively.
Interest income increased 12% in 2003 to $40.4 million from $36.2 million in
2002. This increase is primarily due to the growth in the Bank's loan portfolio.
The average yield on interest-earning assets for 2003 was 5.01%, a decline of 91
basis points from the 2002 yield of 5.92%. The decrease in average yield during
2003 was primarily attributable to the overall decline in market rates as
explained above. The average loan portfolio as a percentage of earning assets
was 78% in 2003, up 1% from 2002. The average balances of loans, which had
yields of 5.43% and 6.30% for 2003 and 2002, respectively, increased from $470.1
million in 2002 to $632.1 million in 2003. The average balances of federal funds
and other short-term investments decreased from $22.3 million in 2002 to $16.7
million in 2003, and the average yield in this category dropped 52 basis points
from 1.66% to 1.14% over the same time period. Investment yield decreased from
5.23% in 2002 to 3.71% in 2003. This decrease reflects the results of the
decline in market interest rates over the last three years as mortgage backed
security ("MBS") pay-downs increased significantly when the borrowers making up
the underlying securities moved to refinance their mortgages. Increases in MBS
payment speeds accelerated the amortization of premiums associated with the
purchases and dropped the investment yield.
Interest expense increased 3% in 2003 to $16.3 million from the $15.9 million
recorded during 2002. This increase is primarily due to a significant increase
in average interest-bearing deposits, which went from $463.3 million in 2002 to
$600.9 million in 2003. In addition, average borrowed funds increased year over
year from $72.7 million in 2002 to $110.3 million in 2003. Also, during 2003 the
Company incurred junior subordinated debt associated with two trust preferred
securities offerings. See Notes to Consolidated Financial Statements - Note 11 -
Subordinated Debentures. The income effects of increases in volume were
significantly offset by declines in rates during the period. The average rates
on interest-bearing deposits decreased from 2.71% in 2002 to 2.01% in 2003. The
decrease in average rates during 2003 is reflective of the overall decrease in
market rates offered during 2003 as compared to the previous year. As previously
mentioned, the Bank's loan portfolio adjusted with prime at a faster rate than
the deposit portfolio as a result of the Federal Reserve's actions to decrease
interest rates. Much of the effect of the rapid rate declines of 2001 did not
take place on the deposit portfolio until 2002 and 2003. In particular, the
average rate on time deposits, which represented 54% of all interest bearing
liabilities during 2003, dropped 73 basis points in 2003 from 3.25% in 2002 to
2.52% in 2003.
The following two tables set forth certain information regarding the Company's
yield on interest-earning assets and
- 15 -
cost of interest-bearing liabilities and the component changes in net interest
income. The first table reflects the Company's effective yield on earning assets
and cost of funds. Yields and costs are computed by dividing income or expense
for the year by the respective daily average asset or liability balance. Changes
in net interest income from year to year can be explained in terms of
fluctuations in volume and rate. The second table presents further information
on those changes.
Average Balances, Interest Earned or Paid, and Interest Yields/Rates
(Dollars in thousands)
Year Ended December 31, 2003 Year Ended December 31, 2002 Year Ended December 31, 2001
-------------------------------------------------------------------------------------------
Average Amount Average Average Amount Average Average Amount Average
Balance Earned Rate Balance Earned Rate Balance Earned Rate
-------------------------------------------------------------------------------------------
Assets
Loans receivable: (1)
Commercial $470,147 $ 24,563 5.22% $324,900 $19,573 6.02% $ 191,215 $14,772 7.73%
Consumer 49,367 3,261 6.61% 36,408 2,852 7.83% 25,467 2,267 8.90%
Home equity 49,686 2,631 5.30% 39,483 2,368 6.00% 26,323 2,012 7.64%
Residential mortgages 62,925 3,897 6.19% 69,267 4,808 6.94% 24,280 1,931 7.95%
-------------------------------------------------------------------------------------------
Total loans 632,125 34,352 5.43% 470,058 29,601 6.30% 267,285 20,982 7.85%
Investment securities 159,030 5,898 3.71% 119,925 6,273 5.23% 71,748 4,674 6.51%
Federal funds sold and other
interest on short term investments 16,676 190 1.14% 22,259 370 1.66% 13,207 517 3.91%
-------------------------------------------------------------------------------------------
Total interest earning assets 807,831 $ 40,440 5.01% 612,242 $36,244 5.92% 352,240 $26,173 7.43%
================ ================ ===============
Cash and due from banks 20,715 15,965 9,679
Other assets 47,505 30,871 15,409
Reserve for loan losses (10,521) (7,157) (3,980)
-------- -------- ---------
Total assets $865,530 $651,921 $ 373,348
======== ======== =========
Liabilities and Equity
Savings deposits $ 18,833 $ 71 0.38% $ 19,103 $ 170 0.89% $ 6,283 $ 92 1.46%
Interest-bearing demand deposits 188,624 2,087 1.11% 147,427 2,746 1.86% 77,872 2,417 3.10%
Time deposits 393,401 9,912 2.52% 296,790 9,651 3.25% 187,207 10,416 5.56%
-------------------------------------------------------------------------------------------
Total interest bearing deposits 600,858 12,070 2.01% 463,320 12,567 2.71% 271,362 12,925 4.76%
Borrowed funds 110,286 3,913 3.55% 72,714 3,118 4.29% 26,288 1,427 5.43%
Subordinated Debt 7,123 248 3.48% -- -- 0.00% -- -- 0.00%
Repurchase agreements 14,278 87 0.61% 14,254 210 1.47% 10,966 349 3.18%
-------------------------------------------------------------------------------------------
Total interest-bearing liabilities 732,545 $ 16,318 2.23% 550,288 $15,895 2.89% 308,616 $14,701 4.76%
================ ================ ===============
Non-interest bearing deposits 50,489 35,064 24,312
Other liabilities 8,523 8,610 4,231
-------- -------- ---------
Total liabilities 791,557 593,962 337,159
Shareholders' equity 73,973 57,959 36,189
-------- -------- ---------
Total liabilities and equity $865,530 $651,921 $ 373,348
======== ======== =========
Net interest spread (2) 2.78% 3.03% 2.67%
Net interest income and net
interest margin (3) $ 24,122 2.99% $20,349 3.32% $11,472 3.26%
================ ================ ===============
(1) Loans receivable include nonaccrual loans for which accrual of interest
has not been recorded. See Note 1 to the Financial Statements, "Summary of
Significant Accounting Policies - Income Recognition on Impaired and
Nonaccrual Loans"
(2) Net interest spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing
liabilities.
(3) Net interest margin represents the net interest income divided by average
interest-earning assets.
- 16 -
Rate & Volume Variance Analysis
Years Ended Years Ended
December 31, 2003 December 31, 2002
vs. 2002 vs. 2001
Rate/ Rate/
(Dollars in thousands) Volume Rate Volume Total Volume Rate Volume Total
Variance Variance Variance Variance Variance Variance Variance Variance
--------------------------------------------- -------------------------------------------
Interest Income:
Loans receivable $ 10,206 $ (4,056) $ (1,399) $ 4,751 $ 15,918 $ (4,150) $ (3,149) $ 8,619
Investment securities 2,045 (1,825) (595) (375) 3,138 (921) (618) 1,599
Federal funds sold (93) (116) 29 (180) 354 (297) (204) (147)
--------------------------------------------- -------------------------------------------
Total interest income 12,158 (5,997) (1,965) 4,196 19,410 (5,368) (3,971) 10,071
--------------------------------------------- -------------------------------------------
Interest Expense:
Savings and interest-bearing
demand deposits and other 717 (1,184) (291) (758) 2,456 (1,035) (1,014) 407
Time deposits 3,142 (2,174) (707) 261 6,097 (4,328) (2,534) (765)
Borrowed funds 1,611 (538) (278) 795 2,520 (300) (529) 1,691
Subordinated debt 248 -- -- 248 -- -- -- --
Repurchase agreements -- (123) -- (123) 105 (187) (57) (139)
--------------------------------------------- -------------------------------------------
Total interest expense 5,718 (4,019) (1,276) 423 11,178 (5,850) (4,134) 1,194
--------------------------------------------- -------------------------------------------
Increase (decrease) in net interest
income $ 6,440 $ (1,978) $ (689) $ 3,773 $ 8,232 $ 482 $ 163 $ 8,877
============================================= ===========================================
Provision for Loan Losses. The provision for loan losses is the amount charged
against earnings for the purpose of establishing an adequate allowance for
probable loan losses. Loan losses are, in turn, charged to this allowance rather
than being reported as a direct expense. In 2003 and 2002, amounts expensed as
loan loss provisions were $8.2 million and $4.2 million, respectively. The
amount of the allowance for loan losses is established based on management's
estimate of the inherent risks associated with lending activities, estimated
fair value of collateral, past experience and present indicators such as
delinquency rates and current market conditions. This estimate is regularly
reviewed and modified, as necessary. Loans of $750,000 or more are subject to
specific review for impairment in accordance with Statement of Financial
Accounting Standards No. 114. The allowance for loan losses was $11.6 million
and $9.4 million on December 31, 2003 and 2002, respectively, and represented
approximately 1.86% and 1.56% of total loans outstanding on those dates.
The Company experienced higher loan charge offs during 2003 when compared to the
previous year. Management believes that this is due in part to a weakened
economy and in part to some large credit issues identified in the second quarter
of 2003. As a result of these credit issues, management engaged two independent
credit review firms in the latter part of 2003 to perform a detailed analysis of
the Bank's loan portfolio. As a result of the review, management identified
loans during that period aggregating approximately $2.7 million that were
classified as a loss. In addition, management significantly increased its
internal loan watch list. During 2003, the Company charged off an aggregate of
$6.0 million in loans, net of $862,000 in recoveries. Of that amount, $4.3
million related to five business customer relationships. During 2002, the
Company charged off $3.7 million in loans, net of $336,000 in recoveries.
Also as a result of the loan review, the Company effected certain changes to try
to protect against such credit losses going forward, including procedural
changes in the loan approval and credit review processes, changes in individual
lending limits and centralization of the Company's lending functions into one
facility. The Company has also added a lender support area where all consumer
loans are centrally underwritten and approved. In addition, a new position was
created, Chief Operating Officer, to manage the lending and credit functions of
the Company and to run the day to day operations of the Bank.
- 17 -
Management has allocated the allowance for loan losses by category. This
allocation is based on management's assessment of the risk associated with the
different types of lending activities.
At December 31,
-------------------------------------------------------------
(Dollars in thousands) 2003 2002
-------------------------------------------------------------
Allowance % of Loans to Allowance % of Loans to
Amount Total Loans Amount Total Loans
-------------------------------------------------------------
Commercial $ 9,885 76% $ 7,309 71%
Consumer 1,012 7% 1,105 9%
Residential mortgages 210 8% 468 12%
Equity lines 506 9% 508 8%
--------------------------- --------------------------
$ 11,613 100% $ 9,390 100%
=========================== ==========================
The following table shows changes in the allowance for loan losses arising from
loans charged off and recoveries on loans previously charged off by loan
category and additions to the allowance that have been charged to expenses.
Analysis of Reserve for Loan Losses
As of and For the
Years Ended
December, 31
----------------------------------
(Dollars in thousands) 2003 2002 2001
----------------------------------
Average amount of loans outstanding, net of unearned income $632,125 $470,058 $267,285
Amount of loans outstanding at year end, net of unearned income 625,945 600,609 306,891
Reserve for loan losses:
Balance at beginning of period $ 9,390 $ 4,286 $ 3,463
Adjustment for loans acquired -- 4,593 --
Loans charged off:
Commercial 5,631 3,545 273
Consumer 637 470 144
Equity 5 -- --
Mortgage 613 -- --
----------------------------------
Total chargeoffs 6,886 4,015 417
----------------------------------
Recoveries of loans previously charged off:
Commercial 797 263 17
Consumer 58 73 8
Mortgage 7 -- --
----------------------------------
Total recoveries 862 336 25
----------------------------------
Net loans charged off 6,024 3,679 392
----------------------------------
Provision for loan losses 8,247 4,190 1,215
----------------------------------
Balance at December 31 $ 11,613 $ 9,390 $ 4,286
==================================
Ratio of net chargeoffs to average loans outstanding during the year 0.95% 0.78% 0.15%
==================================
- 18 -
The following table shows the total of the nonperforming assets in the Company's
portfolio as of December 31, 2003 and 2002. Loans deemed to be impaired at
December 31, 2003 and 2002 amounted to $3.0 million and $1.2 million,
respectively. Average impaired loans during 2003 and 2002 were $3.2 million and
$2.2 million, respectively.
(Dollars in thousands) 2003 2002
--------- --------
Nonperforming assets:
Nonaccrual loans - Commercial $ 3,766 $ 1,015
Nonaccrual loans - Consumer 1,702 239
Nonaccrual loans - Mortgage 2,271 1,371
Nonaccrual loans - Equity lines 271 422
--------- --------
Total nonaccrual loans 8,010 3,047
Foreclosed properties 978 947
--------- --------
Total nonperforming assets $ 8,988 $ 3,994
========= ========
Nonperforming assets to:
Loans outstanding at end of year 1.44% 0.66%
Total assets at end of year 1.05% 0.48%
Other Operating Income. Other operating income was $10.3 million and $8.0
million for years ended December 31, 2003 and 2002, respectively, an increase of
29%. The increase in other operating income for 2003 is primarily attributable
to increases in fees associated with deposit accounts and a large increase in
fees associated with the Company's mortgage loan origination activities. The
large increase in fees associated with the mortgage loan origination activities
was a direct result of attractive mortgage rates during 2003 and 2002 due to the
lower interest rate environment. Mortgage loan origination fees increased from
$3.3 million during 2002 to $4.9 million for 2003. Fees associated with deposit
accounts increased primarily as a result of the increased volume of average
deposit accounts. However, the total average deposit base increased from $498.4
million in 2002 to $651.3 million in 2003. Service charges and fees have
increased from $2.4 million in 2002 to $2.9 million in 2003. Total service
charges and fees as a percent of the average total deposit base dropped from
..47% in 2002 to .43% in 2003. Finally, the Company realized gains of $442,000 on
the sale of investment securities during 2003 versus a realized gain of $981,000
in 2002.
Other Operating Expense. Other operating expense represents the overhead
expenses of the Company. Management regularly monitors all categories of other
operating expense in an attempt to improve productivity and operating
performance. Other operating expense increased 44% to $25.2 million in 2003 from
$17.5 million in 2002. The increase in 2003 reflects a full year of expenses
associated with the integration of the four additional branches in connection
with the acquisition of First Community Corporation in January 2002 and three
additional branches in connection with the acquisition of High Street
Corporation in December 2002. At December 31, 2002 there were 21 branches and
the average number of full time equivalent employees was 173. At December 31,
2003 there were 21 branches and the average number of full time equivalent
employees was 218.
Specific categories of expenses and related causes for increases are as follows:
Salary and employee benefits expense for the years ended December 31, 2003 and
2002 were $13.9 million and $9.8 million, respectively. Increases were the
result of additional personnel hired as new branches and departments were added
or obtained through acquisition as discussed above. In addition, during 2003 the
Company incurred $1.2 million in severance expenses related to certain executive
and senior officers who separated from the Company. Commission expense increased
from $1.6 million in 2002 to $2.2 million in 2003. Because these commissions are
driven by the underlying mortgage fee income, the increase, $600,000, or 38%,
closely related to the 44% increase in mortgage origination fees.
Occupancy expense increased from $1.6 million in 2002 to $2.2 million in 2003.
The increase was primarily a result of lease expenses associated with new
locations and additional space needed for expansion of existing departments.
Furniture and equipment expense increased from $1.1 million in 2002 to $1.5
million in 2003 due to the increase in these assets needed for the new locations
and general expansion. Other operating expenses increased from $3.0 million in
2002 to $5.0 million in 2003. The increases in other operating expenses from
2002 to 2003 included a 76% increase in telephone expenses from $191,000 to
$337,000, a 37% increase in postage from $256,000 to $351,000, and a 25%
- 19 -
increase in public relations and advertising costs from $578,000 to $721,000. In
addition, courier costs, or those costs associated with getting customer
transactions to the Bank's outside processing center, increased due to the
additional branches being serviced by such couriers. All such increases were a
direct result of a full year of expense on the new branches or expansion of
existing departments and were within management's expected ranges. In the third
quarter of 2003, the Bank also incurred write downs of the carrying value of
certain real estate held for sale of $310,000.
Provision for Income Taxes. Throughout 2002, the Company recorded income tax
expenses of $2.4 million. The Company recorded an income tax expense of $38,000
in 2003. The decrease in income tax expense was primarily the result of the loss
recorded in the third quarter of 2003 and an overall drop in net taxable income.
The third quarter loss reflects the significant charge-offs, the increase in the
allowance for loan losses and the related loan loss provision recorded during
that period. The overall effective rate dropped from 35.5% in 2002 to 3.7% in
2003. That rate reflects the impact of permanent differences such as nontaxable
municipal bond interest on a smaller net income base. Total permanent
differences in 2003 were $1.0 million in 2003 compared to $536,000 in 2002. The
largest single component of this increase was an increase in municipal bond
interest, which increased from $532,000 in 2002 to $997,000 in 2003.
Year Ended December 31, 2002 Compared with Year Ended December 31, 2001
Net Interest Income. Net interest income increased between 2001 and 2002 by $8.8
million or 77% from the 2001 amount of $11.5 million. The increase during the
period is primarily due to significant increases in the average volume of
interest-bearing assets and liabilities as the Bank experienced rapid growth
both internally and through acquisition during 2002. The increase was negatively
affected by a rapid and significant decline in market rates during 2001 and
slight declines again in 2002. During 2001, the prime rate dropped from 9.00% in
January to 4.75% in December and dropped an additional 50 basis points in
November 2002 to 4.25%. Though rates remained somewhat steady during 2002, net
interest income was affected by an entire year of the lower rates put in place
during 2001.
Interest income in 2002 was $36.2 million, a 38% increase from the $26.2 million
earned in 2001. This increase is primarily due to the significant growth in the
Company's loan portfolio due to the internal growth and acquisitions occurring
in 2002. The average yield for 2002 was 5.92%, down 151 basis points from 7.43%
in 2001. The decrease in average yield during 2002 was primarily attributable to
the overall decline in market rates as explained above. The average loan
portfolio as a percentage of earning assets was 77% in 2002, up 1% from 2001.
The average balances of loans, which had yields of 6.30% and 7.85% for 2002 and
2001, respectively, increased from $267.0 million in 2001 to $470.1 million in
2002. The average balances of federal funds and other short-term investments
grew from $13.2 million in 2001 to $22.3 million in 2002, but the average yield
in this category dropped 225 basis points from 3.91% to 1.66% over the same time
period. Investment yield decreased from 6.51% in 2001 to 5.23% in 2002. This
decrease reflects the results of the decline in market rates over the last two
years. This decrease was also attributable to a large number of federal agency
bonds with high yields that were purchased at discounts in previous years being
called during 2001 by the various agencies associated with the investment. When
those bonds were called, the associated discounts were taken into income as
yield adjustments. During 2001, investments with a par value of $28.0 million
were called with $243,000 in discounts remaining at call date, all of which was
taken into income as yield adjustments.
Interest expense increased 8% in 2002 to $15.9 million from the $14.7 million
recorded during 2001. This increase is primarily due to a significant increase
in average interest-bearing deposits, which went from $271.4 million in 2001 to
$463.3 million in 2002. In addition, average borrowed funds increased year over
year from $26.3 million in 2001 to $72.7 million in 2002. The income effects of
increases in volume were partially offset by declines in rates during these
periods. The average rates on interest-bearing deposits decreased from 4.76% in
2001 to 2.71% in 2002. The decrease in average rates during 2002 is reflective
of the overall decrease in market rates offered during 2002 as compared to the
previous year. As previously mentioned, the Bank's loan portfolio adjusted with
prime at a faster rate than the deposit portfolio as a result of the Federal
Reserve's actions to decrease interest rates in 2001. Much of the effect of
their actions on the deposit base took place in 2002. In particular, the average
rate on time deposits, which represented 54% of all interest bearing liabilities
during 2002, dropped 231 basis points from 5.56% in 2001 to 3.25% in 2002.
Provision for Loan Losses. In 2002 and 2001, amounts expensed as loan loss
provisions were $4.2 million and $1.2 million, respectively. The increase
between the periods is the result of the growth of the loan portfolio from 2001
to 2002 as average loans increased from $267.3 million in 2001 to $470.1 million
in 2002.
- 20 -
During 2002, the Company charged off $3.7 million in loans, net of $336,000 in
recoveries. Charge-offs in 2001 amounted to $392,000, net of $25,000 in
recoveries.
Other Operating Income. Other operating income was $8.0 million and $4.5 million
for years ended December 31, 2002 and 2001, respectively, an increase of 78%.
The increase in other operating income for 2002 is primarily attributable to
increases in fees associated with deposit accounts and a large increase in fees
associated with the Company's mortgage loan origination activities. The large
increase in fees associated with the mortgage loan origination activities was a
direct result of attractive mortgage rates during 2002 due to the lower interest
rate environment. Mortgage loan origination fees increased from $2.0 million in
2001 to $3.3 million during 2002. Fees associated with deposit accounts
increased primarily as a result of the increased volume of deposit accounts.
Total service charges and fees as a percent of the deposit base dropped from
..57% in 2001 to .36% in 2002. However, the addition of a new overdraft checking
privilege program called Bounce Free checking, which the Company added during
the second quarter of 2001, substantially increased fee income from the previous
year. Service charges and fees, which include the Bounce Free checking program,
increased from $1.7 million in 2001 to $2.4 million in 2002. Finally, the
Company realized gains of $981,000 on the sale of investment securities during
2002 versus a realized gain of $190,000 in 2001.
Other Operating Expense. Other operating expense increased 52% to $18.0 million
in 2002 from $11.8 million in 2001. The increase in 2002 reflects the additional
operating costs associated with growth as the Bank added more staff to handle
increases in volume of business as a result of internal growth and the
acquisition of two other financial institutions during the year. At December 31,
2001 there were 14 branches and 127 full time equivalent employees. During 2002,
the Bank added 7 branches through acquisition and accompanying support
personnel, expanded both the commercial lending area and the mortgage
origination group, and had an overall increase in the volume of transactions
processed and the number of customers. At December 31, 2002 there were 21
branches and 231 full time equivalent employees.
Specific categories of expenses and related causes for increases are as follows:
Salary and employee benefits expense for the years ended December 31, 2002 and
2001 were $9.8 million and $6.3 million, respectively. The increases were the
result of additional personnel hired as new branches and departments were added
or obtained through acquisition as discussed above.
Occupancy expense increased from $1.2 million in 2001 to $1.6 million in 2002.
The increase was primarily a result of lease expenses associated with new
locations and additional space needed for expansion of existing departments.
Furniture and equipment expense increased from $703,000 in 2001 to $1.1 million
in 2002 due to the increase in these assets needed for the new locations and
general expansion. Other operating expenses increased from $3.0 million in 2002
to $5.0 million in 2003. The increases in other operating expenses from 2001 to
2002 included a 53% increase in telephone expenses from $125,000 to $191,000, a
43% increase in postage from $178,000 to $256,000, and a 68% increase in public
relations and advertising costs from $346,000 to $578,000. In addition, courier
costs, or those costs associated with getting customer work to the Bank's
outside processing center, increased due to the additional branches being
serviced by such couriers. All such increases were a direct result of the new
branches or expansion of existing departments and were within management's
expected ranges.
Provision for Income Taxes. During 2001, the Company reversed valuation
allowances on deferred tax assets resulting in a one-time net tax benefit of
$356,000. That benefit was offset by additional tax expenses during 2001 to
leave a net tax expense during that year of $480,000. Throughout 2002, the
Company was fully taxable and recorded a tax expense of $2.4 million.
Financial Condition. The Company's financial condition is measured in terms of
its asset and liability composition, asset quality, capital resources, and
liquidity. The growth and composition of assets and liabilities during 2003 and
2002 reflected the integration of the four additional branches in connection
with the acquisition of First Community Financial Corporation in early 2002 and
three additional branches in connection with the acquisition of High Street
Corporation in December 2002 as well as the Company's internal business
development activities. Through 2002, the Company had not engaged in investment
strategies involving derivative financial instruments. In 2003, the Company
entered into interest rate swap agreements to manage interest rate risk. See
Item 7A. Quantitative and Qualitative Disclosure About Market Risk and Notes to
Consolidated Financial Statements - Note 10 - Derivative Financial
- 21 -
Instruments. Asset and liability management is conducted without the use of
forward-based contracts, options, or other synthetic financial instruments
derived from the value of an underlying asset, reference rate, or index.
Total assets were $857.7 million and $841.0 million at December 31, 2003 and
2002, respectively. The increase in total assets of $16.7 million in 2003, or
2%, reflects slight internal growth as the Company completed no acquisitions
during 2003. The largest component of asset growth was the increase in loans.
Total liabilities increased from $765.5 million in 2002 to $784.7 million in
2003. The primary cause for the increase between the periods is an increase in
borrowings of $16.7 million and debt resulting from the issuance by the Company
of subordinated debentures as the Company has used these sources to fund loan
growth during a declining deposit period.
Stockholders' equity decreased from $75.5 million in 2002 to $72.9 million in
2003. The decrease is due in part to a stock buyback program, whereby the
Company acquired $2.7 million worth of its outstanding stock, and in part to
payment of $1.3 million in dividends. Net income for 2003 of $994,000 was offset
by unrealized depreciation in the fair values of investments of $916,000 as a
result of the changing interest rate environment.
Assets
Cash and Cash Equivalents. Cash and cash equivalents, including
non-interest-bearing and interest-bearing cash and federal funds sold, decreased
from $51.5 million in 2002 to $25.6 million in 2003. The decrease is primarily
the result of growth in loans and investments and the outlay of cash needed to
fund those loans and purchase those investments exceeding growth in deposits and
borrowings.
Loan Portfolio. Total loans were $625.9 million and $600.6 million as of
December 31, 2003 and 2002, respectively. Loan growth was slow compared to prior
years though all increases were the result of internal growth as the Company
completed no acquisitions in 2003. Accordingly, the Company's business
development activities were key factors in the growth of the loan portfolio
during 2003. At December 31, 2003, commercial loans, mortgage loans, consumer
loans, and equity lines were $474.3 million, $50.2 million, $42.9 million, and
$58.4 million, respectively. At December 31, 2002, commercial loans, mortgage
loans, consumer loans, and equity lines were $430.9 million, $72.7 million,
$51.1 million, and $45.9 million, respectively. The commercial loan portfolio is
comprised mainly of loans to small and mid-sized businesses with revenues up to
$25 million. There were no significant concentrations of credit to any one
industry, class, or category. The following table reflects the maturities of the
commercial loan portfolio and the mix of the commercial loans that mature
greater than one year in the loan portfolio between fixed rate and adjustable
rate notes.
(Dollars in thousands)
Commercial loans:
Due within one year $146,566
Due one through five years 260,919
Due after five years 66,832
--------
$474,317
========
Commercial loans due after 1 year:
Fixed rate $136,409
Variable rate 191,342
--------
$327,751
========
Although there were no large concentrations of credit to any particular
industry, the economic trends of the area served by the Company are influenced
by the significant industries within the region. The Company's primary business
activity is with customers located in the Research Triangle area of North
Carolina (Raleigh, Durham, and Chapel Hill) and its surrounding counties, the
Alamance County area (Burlington and Graham, North Carolina), and the Interstate
40 corridor between Asheville and Hickory, North Carolina. The ultimate
collectibility of the Company's loan portfolio is susceptible to changes in the
market conditions of these geographic regions.
- 22 -
The Company uses a centralized risk management process to ensure uniform credit
underwriting that adheres to Company policy. Lending policies are reviewed on a
regular basis to confirm that the Company is prudent in setting its underwriting
criteria. Credit risk is managed through a number of methods including loan
grading of commercial loans, committee approval of larger loans, and class and
purpose coding of loans. Management believes that early detection of credit
problems through regular contact with the Company's customers coupled with
consistent reviews of the borrowers' financial condition are important factors
in overall credit risk management.
Management charged off loans totaling $6.0 million, $3.7 million, and $392,000
net of recoveries, as uncollectible during 2003, 2002 and 2001, respectively.
The large increase in the 2003 amount was the result of five large commercial
loan relationships that totaled $4.3 million, or 72% of the total amount charged
off, as well as continued softening in the economy and isolated instances of
specific business problems. At December 31, 2003 and 2002, the allowance for
loan losses as a percentage of total loans was 1.86% and 1.56%, respectively.
Management believes the allowance for loan losses of $11.6 million at 2003
provides adequate coverage of the probable losses in the loan portfolio.
Investment Securities. Investment securities represent the second largest
component of earning assets. On December 31, 2003 and 2002, investments totaled
$160.2 million and $150.3 million, respectively. At December 31, 2003 and 2002,
all investments were classified as "available for sale". This classification
allows flexibility in the management of interest rate risk, liquidity, and loan
portfolio growth. The following table reflects the debt securities by
contractual maturities as of December 31, 2003. Expected maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
Securities Available For Sale Portfolio
(Dollars in thousands) 1 Year or Less 1 - 5 Years 5 - 10 Years 10 or More Years Total
---------------------------------------------------------------------------------------------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
---------------------------------------------------------------------------------------------------
US Agency securities $ -- -- $ 9,129 4.04% $ 21,374 4.43% $ 4,823 4.30% $ 35,326 4.26%
Municipal bonds (1) -- -- -- -- 7,274 5.94% 18,109 6.42% 25,383 6.28%
Mortgage-backed securities 43 9.09% 2,339 4.77% 16,621 4.12% 80,504 4.62% 99,507 4.54%
------- -------- -------- --------- ---------
$ 43 $ 11,468 $ 45,269 $ 103,436 $ 160,216
======= ======== ======== ========= =========
(1) Municipal bonds shown at tax equivalent yield.
Money Market Investments and Federal Funds. At December 31, 2003 and 2002, the
Company had $3.8 million and $32.6 million, respectively, in short-term money
market investments and federal funds. These figures include interest-bearing
cash accounts. The decrease between the periods was the result of a need to use
interest earning cash and Fed Funds to fund a growth in loans during a period
when deposits were declining.
Liabilities. During 2003 and 2002, the Company relied on deposits, advances from
the Federal Home Loan Bank, repurchase agreements, proceeds from the issuance of
subordinated debentures in connection with trust preferred securities offerings
and excess liquidity to fund its earning assets.
Deposits. Total deposits decreased from $644.9 million at December 31, 2002 to
$629.6 million at December 31, 2003. Of these amounts, $50.2 million and $58.3
million were in the form of non-interest-bearing demand deposits at December 31,
2002 and 2003, respectively, and $594.6 million and $571.3 million were in the
form of interest-bearing deposits at December 31, 2002 and 2003, respectively.
Balances in certificates of deposit of $100,000 and over were $119.5 million and
$103.1 million at December 31, 2002 and 2003, respectively. Management believes
that the decline in deposits is due primarily to investors moving funds to the
stock market to take advantage of higher returns.
- 23 -
The following table reflects the maturities of certificates of deposit of
$100,000 and over as of December 31, 2003:
Maturity Average
(Dollars in thousands) Amount Rate
--------------------
Three months or less $26,353 2.14%
Over three months to six months 24,347 2.14%
Over six months to twelve months 30,106 2.78%
Over twelve months 22,338 3.19%
--------------------
$103,144 2.55%
====================
Debt. At December 31, 2003 and 2002, the Company's outstanding advances with the
Federal Home Loan Bank were $114.6 million and $97.9 million, respectively.
During the year ended December 31, 2003, the maximum outstanding advances were
$114.6 million. The Company had average outstanding FHLB advances of $110.3
million and $72.7 million with weighted average rates of 3.55% and 4.29% at
December 31, 2003 and 2002, respectively. These advances were used to provide
additional funding at favorable rates to accommodate loan growth.
Capital Resources. Total shareholders' equity for 2003 and 2002, excluding
unrealized gains net of taxes on available for sale securities of $377,000 in
2003 and $1.3 million in 2002, was $72.5million and $74.2 million, respectively.
Equity decreased primarily as a result of a stock buyback program as described
above. In addition, the Company paid cash dividends of $0.20 per share during
2003 and 2002. At December 31, 2003, the Company had a leverage ratio of 8.71%,
a Tier 1 capital ratio of 10.68%, and a risk based capital ratio of 12.13%.
These ratios exceed the federal regulatory minimum requirements for a "well
capitalized" bank.
Asset/Liability Management. Asset/liability management functions to maximize
profitability within established guidelines for interest rate risk, liquidity,
and capital adequacy. Measurement and monitoring of liquidity, interest rate
risk, and capital adequacy are performed centrally through the Asset/Liability
Management Committee, and reported under guidelines established by management,
the Board of Directors and regulators. Oversight on asset/liability management
matters is provided by the Board of Directors through its Asset/Liability
Management Committee.
Liquidity management involves the ability to meet the cash flow requirements of
depositors wanting to withdraw funds or borrowers needing assurance that
sufficient funds will be available to meet their credit needs. To ensure the
Company is positioned to meet immediate and future cash demands, management
relies on internal analysis of its liquidity, knowledge of current economic and
market trends and forecasts of future conditions. Regulatory agencies set
certain minimum liquidity standards including the setting of a reserve
requirement by the Federal Reserve. The Company must submit weekly reports to
the Federal Reserve to ensure that it meets those requirements. At December 31,
2003, the Company met all of its liquidity requirements.
The Company had $25.6 million in its most liquid assets, cash and cash
equivalents at December 31, 2003. The Company's principal sources of funds are
deposits, short-term borrowings and capital. Core deposits (total deposits less
certificates of deposits in the amount of $100,000 or more), one of the most
stable sources of liquidity, together with equity capital funded $599.4 million
or 69.9% of total assets at December 31, 2003. At December 31, 2002, core
deposits and equity capital totaled $600.9 million or 71.5% of total assets.
The Company's liquidity can best be demonstrated by an analysis of its cash
flows. In 2003, subordinated debentures issued in connection with a trust
preferred securities offering were utilized to fund $20.1 million in new
internal loan growth. In addition, the Company had other financing activities
including additional borrowings from the Federal Home Loan Bank of $16.7
million. These sources of funds helped to offset a net decrease in deposits of
$15.3 million. Operating activities also provided $16.8 million of liquidity for
the year ended December 31, 2003, compared to $911,000 and $3.4 million in 2002
and 2001, respectively. The principal elements of operating activities are net
income, increased for significant non-cash expenses for the provision for loan
losses and depreciation and amortization.
A secondary source of liquidity for the Company comes from investing activities,
principally the sales of, maturities of and cash flows from investment
securities. During 2003 and 2002, due to the declining interest rate
environment, the cash flow from mortgage-backed securities accelerated as
borrowers holding the underlying mortgages refinanced and certain securities
with call features were called. The cash received from these events, combined
with maturities,
- 24 -
amounted to $103.6 million, compared to $76.6 million in 2002 and $53.8 million
in 2001. As of December 31, 2003, the Company had approximately $43,000 of
investment securities that mature in 12 months. During 2003, the Company
purchased $116.5 million of investment securities to replace the securities
sold, called or matured during the same period and to meet liquidity needs.
Additional sources of liquidity are available to the Bank through the Federal
Reserve System and through membership in the Federal Home Loan Bank system. As
of December 31, 2003, the Bank had a maximum borrowing capacity of $171.5
million through the Federal Home Loan Bank of Atlanta. These funds can be made
available with various maturities and interest rate structures. Borrowings
cannot exceed twenty percent of total assets or twenty times the amount of
Federal Home Loan Bank stock owned by the borrowing bank. At December 31, 2003,
the Bank owned $5.7 million worth of Federal Home Loan Bank stock or five
percent of its outstanding advances of $114.6 million. Borrowings are
collateralized by a blanket lien by the Federal Home Loan Bank on the Bank's
qualifying assets.
The following table reflects expected maturities of contractual obligations and
expected expirations of ongoing commitments that affect the Company's liquidity.
Payments Due By Period
---------------------------------------------------------
Less Than 1 - 3 3 - 5 More Than
(In thousands) 1 Year Years Years 5 Years Total
---------------------------------------------------------
Contractual Obligations
FHLB Advances $ 17,000 $ 5,000 $ 5,000 $ 87,591 $114,591
Subordinated Debentures -- -- -- 20,620 20,620
Operating Leases 970 1,805 1,680 6,607 11,062
---------------------------------------------------------
$ 17,970 $ 6,805 $ 6,680 $114,818 $146,273
=========================================================
Amount of Commitment Expiration by Period
---------------------------------------------------------
Less Than 1 - 3 3 - 5 More Than Total
1 Year Years Years 5 Years Committed
---------------------------------------------------------
Commercial Commitments
Commercial Letters of Credit $ 1,635 $ -- $ -- $ -- $ 1,635
Other Commercial Loan Commitments 38,838 4,409 3,054 6,345 52,646
---------------------------------------------------------
$ 40,473 $ 4,409 $ 3,054 $ 6,345 $ 54,281
=========================================================
Effects of Inflation. The Company's financial statements have been prepared in
accordance with generally accepted accounting principles, which require the
measurement of financial position and operating results in terms of historic
dollars without consideration for changes in the relative purchasing power of
money over time due to inflation. The rate of inflation has been relatively
moderate over the past few years; however, the effect of inflation on interest
rates can materially impact Bank operations, which rely on the spread between
the yield on earning assets and rates paid on deposits and borrowings as the
major source of earnings. Operating costs, such as salaries and wages, occupancy
and equipment costs, can also be negatively impacted by inflation.
Risk Factors
You should consider the following material risk factors carefully before
deciding to invest in the Company's securities. If any of the events described
below occur, our business, financial condition, or results of operations could
be materially adversely affected. In that event, the trading price of our common
stock may decline, in which case the value of your investment may decline as
well.
Our Results Are Impacted by the Economic Conditions of our Principal
Operating Regions
Our operations are concentrated throughout Central and Western North
Carolina. As a result of this geographic concentration, our results may
correlate to the economic conditions in these areas. Deterioration in
economic conditions in any of these market areas, particularly in the
industries on which these geographic areas depend, may adversely affect
the quality of our loan portfolio and the demand for our products and
services, and accordingly, our results of operations.
- 25 -
We Are Exposed to Risks in Connection with the Loans We Make
A significant source of risk for us arises from the possibility that
losses will be sustained because borrowers, guarantors and related parties
may fail to perform in accordance with the terms of their loans. During
2003, the Company was required to reclassify one large commercial
borrowing relationship as a loss, which relationship consisted of three
loans to a furniture accessories import company and its owner in the
aggregate total of $2.5 million. The loan was included in the portfolio of
High Street Corporation, which the Company acquired in December 2002.
We have underwriting and credit monitoring procedures and credit policies,
including the establishment and review of the allowance for loan losses,
that we believe are appropriate to minimize this risk by assessing the
likelihood of nonperformance, tracking loan performance and diversifying
our loan portfolio. Such policies and procedures, however, may not prevent
unexpected losses that could adversely affect our results of operations.
During 2003, as a result of the reclassification, management engaged two
independent credit review firms to perform a detail analysis of the Bank's
loan portfolio. As a result of the review, management significantly
increased its internal loan watch list and effected certain changes to try
to protect against such credit losses going forward, including procedural
changes in the loan approval and credit review processes, changes in
individual lending limits and centralization of the Company's lending
functions into one facility. The Company has also added a lender support
area where all consumer loans are centrally underwritten and approved and
created a new position of Chief Operating Officer to manage the lending
and credit functions of the Company and to run the day to day operations
of the Bank.
We Compete with Larger Companies for Some of the Same Business
The banking and financial services business in our market areas continues
to be a competitive field and is becoming more competitive as a result of:
o Changes in regulations;
o Changes in technology and product delivery systems; and
o The accelerating pace of consolidation among financial services
providers.
We may not be able to compete effectively in our markets, and our results
of operations could be adversely affected by the nature or pace of change
in competition. We compete for loans, deposits and customers with various
bank and non-bank financial services providers, many of which are larger
in total assets and capitalization, have greater access to capital markets
and offer a broader array of financial services.
Our Trading Volume Has Been Low Compared with Larger Banks
The trading volume in the Company's common stock on the Nasdaq National
Market has been comparable to other similarly-sized banks. Nevertheless,
this trading is relatively low when compared with more seasoned companies
listed on the Nasdaq National Market or other consolidated reporting
systems or stock exchanges. Thus, the market in the Company's common stock
may be limited in scope relative to other companies.
We Depend Heavily on Our Key Management Personnel
The Company's success depends in part on its ability to retain key
executives and to attract and retain additional qualified management
personnel who have experience both in sophisticated banking matters and in
operating a small to mid-size bank. Competition for such personnel is
strong in the banking industry and we may not be successful in attracting
or retaining the personnel we require. We expect to effectively compete in
this area by offering financial packages that include incentive-based
compensation and the opportunity to join in the rewarding work of building
a growing bank.
Technological Advances Impact Our Business
The banking industry is undergoing technological changes with frequent
introductions of new technology-driven products and services. In addition
to improving customer services, the effective use of technology increases
efficiency and enables financial institutions to reduce costs. The
Company's future success will
- 26 -
depend, in part, on our ability to address the needs of our customers by
using technology to provide products and services that will satisfy
customer demands for convenience as well as to create additional
efficiencies in our operations. Many of our competitors have substantially
greater resources than we do to invest in technological improvements. We
may not be able to effectively implement new technology-driven products
and services or successfully market such products and services to our
customers.
Government Regulations May Prevent or Impair Our Ability to Pay Dividends,
Engage in Acquisitions or Operate in Other Ways
Current and future legislation and the policies established by federal and
state regulatory authorities will affect our operations. We are subject to
supervision and periodic examination by the Federal Deposit Insurance
Corporation and the North Carolina State Banking Commission. Banking
regulations, designed primarily for the protection of depositors, may
limit our growth and the return to you, our investors, by restricting
certain of our activities, such as:
o The payment of dividends to our shareholders;
o Possible mergers with or acquisitions of or by other institutions;
o Our desired investments;
o Loans and interest rates on loans;
o Interest rates paid on our deposits;
o The possible expansion of our branch offices; and/or
o Our ability to provide securities or trust services.
We also are subject to capitalization guidelines set forth in federal
legislation, and could be subject to enforcement actions to the extent
that we are found by regulatory examiners to be under capitalized. We
cannot predict what changes, if any, will be made to existing federal and
state legislation and regulations or the effect that such changes may have
on our future business and earnings prospects. The cost of compliance with
regulatory requirements may adversely affect our ability to operate
profitably.
There Are Potential Risks Associated with Future Acquisitions
We intend to continue to explore expanding our branch system through
selective acquisitions of existing banks or bank branches in the Research
Triangle area and other North Carolina markets. We cannot say with any
certainty that we will be able to consummate, or if consummated,
successfully integrate, future acquisitions, or that we will not incur
disruptions or unexpected expenses in integrating such acquisitions. In
the ordinary course of business, we evaluate potential acquisitions that
would bolster our ability to cater to the small business, individual and
residential lending markets in North Carolina. In attempting to make such
acquisitions, we anticipate competing with other financial institutions,
many of which have greater financial and operational resources. In
addition, since the consideration for an acquired bank or branch may
involve cash, notes or the issuance of shares of common stock, existing
shareholders could experience dilution in the value of their shares of our
common stock in connection with such acquisitions. Any given acquisition,
if and when consummated, may adversely affect our results of operations or
overall financial condition.
Recent Accounting Developments. Please refer to Notes to Consolidated Financial
Statements - Note 1 - Summary of Significant Accounting Policies for a
discussion of recent accounting developments.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company hopes to reach its strategic financial objectives through the
effective management of market risk. Like many financial institutions, the
Company's most significant market risk exposure is interest rate risk. The
Company's primary goal in managing interest rate risk is to minimize the effect
that changes in interest rates have on interest income and expense. This is
accomplished through the active management of asset and liability portfolios,
which includes the strategic pricing of asset and liability accounts and
ensuring a proper maturity combination of assets and liabilities. The goal of
these activities is the development of maturity and repricing opportunities in
the Company's portfolios of assets and liabilities that will produce consistent
net interest income during periods of changing interest rates. The Company's
Asset/Liability Committee ("ALCO"), made up of members of management and the
Board,
- 27 -
monitors loan, investment, and liability portfolios to ensure comprehensive
management of interest rate risk. These portfolios are analyzed to ensure proper
fixed and variable-rate mixes under several interest rate scenarios.
The asset/liability management process is intended to accomplish relatively
stable net interest margins and assure liquidity by coordinating the amounts,
maturities, or repricing opportunities of earning assets, deposits, and borrowed
funds. The ALCO has the responsibility to determine and achieve the most
appropriate volume and combination of earning assets and interest-bearing
liabilities, and ensure an adequate level of liquidity and capital, within the
context of corporate performance objectives. The ALCO also sets policy
guidelines and establishes long-term strategies with respect to interest rate
risk exposure and liquidity. The ALCO meets regularly to review the Company's
interest rate risk and liquidity positions in relation to present and
prospective market and business conditions, and adopts balance sheet management
strategies intended to ensure that the potential impact of earnings and
liquidity as a result of fluctuations in interest rates is within acceptable
guidelines.
In 2003, the Bank began using financial instruments, commonly known as
derivatives, to manage various financial risks. The instruments consist of
interest rate swaps and swaptions. A derivative is a financial instrument that
derives its cash flows, and therefore its value, by reference to an underlying
instrument, index, or referenced interest rate. The Bank uses derivatives to
hedge its interest-bearing liabilities. These hedges resulted in a net increase
in net interest income of $238,000 in 2003.
Derivative contracts are written in amounts referred to as notional amounts.
Notional amounts only provide the basis for calculating payments between
counterparties and do not represent amounts to be exchanged between parties and
are not a measure of financial risk. On December 31, 2003, the Bank had
derivative financial instruments outstanding with notional amounts totaling $25
million. See Notes to Consolidated Financial Statements - Note 10 - Derivative
Financial Instruments for additional information.
As a financial institution, most of the Company's assets and liabilities are
monetary in nature. This differs greatly from most commercial and industrial
companies balance sheets, which are comprised primarily of fixed assets or
inventories. Movements in interest rates and actions of the Board of Governors
of the Federal Reserve System ("FRB") to regulate the availability and cost of
credit have a greater effect on a financial institution's profitability than do
the effects of higher costs for goods and services. Through its balance sheet
management function, which is monitored by the ALCO, the Company is positioned
to respond to changing needs for liquidity, changes in interest rates and
inflationary trends.
The Company utilizes an outside asset liability management advisory firm to help
management evaluate interest rate risk and develop asset/liability management
strategies. One tool used is a computer simulation model which projects the
Company's performance under different interest rate scenarios. Analyses are
prepared quarterly which evaluate the Company's performance in a base strategy
which reflects the Company's 2003 and 2004 operating plan. Three interest rate
scenarios (Flat, Rising and Declining) are applied to the base strategy to
determine the effect of changing interest rates on net interest income. The
December 31, 2003 analysis of the Company indicates that interest rate risk
exposure over a twelve-month time horizon is within the guidelines established
by the Board of Directors.
The Company's interest rate sensitivity is illustrated in the following table.
The table reflects rate-sensitive positions at December 31, 2003, and is not
necessarily indicative of positions on other dates. The carrying amounts of
interest rate sensitive assets and liabilities are presented in the periods in
which they next reprice to market rates or mature and are aggregated to show the
interest rate sensitivity gap. To reflect anticipated prepayments, certain asset
and liability categories are shown in the table using estimated cash flows
rather than contractual cash flows. The table does not reflect the impact of
hedging strategies.
- 28 -
Within One to Two to After
(In thousands) One Year Two Years Five Years Five Years Total
---------------------------------------------------------------------------
Assets
Securities and other interest-earning
assets (1) $ 89,072 $ 36,178 $ 19,814 $ 20,849 $ 165,913
Federal funds sold 3,202 -- -- -- 3,202
Loans and leases (2) 470,263 12,913 117,981 24,788 625,945
---------------------------------------------------------------------------
Total interest-earning assets 562,537 49,091 137,795 45,637 795,060
---------------------------------------------------------------------------
Liabilities
Non Maturity Deposits (3) 61,740 61,678 77,034 -- 200,452
Other Time Deposits 291,719 37,214 41,884 -- 370,817
Borrowings 34,925 4,998 4,998 80,684 125,605
---------------------------------------------------------------------------
Total interest-bearing liabilities 388,384 103,890 123,916 80,684 $ 696,874
---------------------------------------------------------------------------
Asset-liability gap 174,153 (54,799) 13,879 (35,047)
----------------------------------------------------------
Cumulative interest-rate sensitivity gap $ 174,153 $ 119,354 $ 133,233 $ 98,186
==========================================================
(1) Securities based on amortized cost
(2) Loans and leases include loans held for sale and are net of unearned
income
(3) Projected runoff of deposits that do not have a contractual maturity date
was computed based on decay rate assumptions developed by bank regulators
to assist banks in addressing FDICIA rule 305
For the upcoming twelve month period in the Flat rate scenario, the Company is
projected to earn $26.2 million in net interest income. In the rising rate
scenario, which contemplates a 200 basis point increase in interest rates over a
twelve month period, the Company is expected to see its annualized net interest
income improve by $2.5 million, or 9.49%. Conversely, the Company will see a
decline in net interest income of $2.3 million, or 8.86%, if rates decline 200
basis points, as is contemplated in the declining rate scenario.
- 29 -
Item 8. Financial Statements and Supplementary Data.
Capital Bank Corporation
Consolidated Balance Sheets
December 31, 2003 and 2002
(In thousands, except share data)
2003 2002
------------ ------------
Assets
Cash and due from banks:
Interest-earning $ 569 $ 13,925
Noninterest earning 21,839 18,912
Federal funds sold 3,202 18,696
Securities available for sale (Note 4): 60,710 36,398
Mortgage-backed securities available for sale (Note 4) 99,506 113,889
Federal Home Loan Bank stock (Note 5) 5,697 5,017
Loans (Note 6) 625,945 600,609
Less allowance for loan losses (11,613) (9,390)
------------ ------------
Net loans 614,332 591,219
------------ ------------
Accrued interest receivable 3,220 3,455
Premises and equipment, net (Note 7) 14,190 13,399
Deposit premium and goodwill, net (Note 3) 14,530 14,884
Deferred income tax 6,492 5,174
Other assets 13,447 6,008
------------ ------------
Total assets $ 857,734 $ 840,976
============ ============
Liabilities and Shareholders' Equity
Deposits (Note 8):
Demand deposits $ 58,350 $ 50,238
Savings and interest bearing checking 84,701 120,472
Money market deposit accounts 115,751 103,736
Time deposits less than $100,000 267,673 250,940
Time deposits $100,000 and greater 103,144 119,501
------------ ------------
Total deposits 629,619 644,887
------------ ------------
Repurchase agreements 11,014 13,081
Federal Home Loan Bank advances (Note 9) 114,591 97,858
Subordinated debentures (Note 16) 20,620 --
Accrued interest payable and other liabilities 8,967 9,679
------------ ------------
Total liabilities 784,811 765,505
------------ ------------
Commitments and contingencies (Notes 13, 14, 16 and 17) Shareholders' equity:
Common stock, no par value; 20,000,000 shares authorized, 6,541,495
and 6,595,784 issued and outstanding as of 2003 and 2002, respectively 67,381 68,697
Accumulated other comprehensive income 377 1,293
Retained earnings 5,165 5,481
------------ ------------
Total shareholders' equity 72,923 75,471
------------ ------------
Total liabilities and shareholders' equity $ 857,734 $ 840,976
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
- 30 -
Capital Bank Corporation
Consolidated Statements of Operations
For the Years Ended December 31, 2003, 2002, and 2001
(In thousands except per share data)
2003 2002 2001
---------- ---------- ----------
Interest income:
Loans and fees on loans $ 34,352 $ 29,601 $ 20,982
Investment securities 5,898 6,273 4,674
Federal funds and other interest income 190 370 517
---------- ---------- ----------
Total interest income 40,440 36,244 26,173
---------- ---------- ----------
Interest expense:
Deposits 12,070 12,567 12,925
Borrowings 4,161 3,118 1,427
Repurchase agreements 87 210 349
---------- ---------- ----------
Total interest expense 16,318 15,895 14,701
---------- ---------- ----------
Net interest income 24,122 20,349 11,472
Provision for loan losses 8,247 4,190 1,215
---------- ---------- ----------
Net interest income after provision for loan losses 15,875 16,159 10,257
---------- ---------- ----------
Other operating income:
Service charges and fees 2,858 2,350 1,735
Net gain on sale of securities 442 981 190
Mortgage origination fees 4,864 3,294 1,999
Other fees and income 2,158 1,362 566
---------- ---------- ----------
Total other operating income 10,322 7,987 4,490
---------- ---------- ----------
Other operating expenses:
Personnel 13,895 9,821 6,317
Occupancy 2,226 1,557 1,152
Data processing 1,164 917 649
Furniture and equipment 1,469 1,141 703
Amortization of intangibles 310 180 598
Advertising 721 578 346
Professional fees 1,017 304 350
Director fees 415 243 210
Other 3,948 2,724 1,522
---------- ---------- ----------
Total other operating expenses 25,165 17,465 11,847
---------- ---------- ----------
Net income before income tax expense 1,032 6,681 2,900
Income tax expense 38 2,374 480
---------- ---------- ----------
Net income $ 994 $ 4,307 $ 2,420
========== ========== ==========
Net income per share - basic $ .15 $ .79 $ .65
========== ========== ==========
Net income per share - diluted $ .15 $ .76 $ .65
========== ========== ==========
Dividends per share $ .20 $ .20 $ --
========== ========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
- 31 -
Capital Bank Corporation
Consolidated Statements of Changes in Shareholders' Equity
For the Years Ended December 31, 2003, 2002, and 2001
(In thousands)
Accumulated Retained
Other Earnings
Common Comprehensive (Accumulated
Stock Income (Loss) Deficit) Total
---------- -------------- ------------ ----------
Balance at January 1, 2001 $ 34,806 $ 323 $ (114) $ 35,015
Repurchase of outstanding common stock (702) -- -- (702)
Reissuance of common stock
for options exercised 5 -- -- 5
Net income -- -- 2,420 2,420
Other comprehensive income -- 245 -- 245
----------
Comprehensive income 2,665
---------- ---------- ---------- ----------
Balance at December 31, 2001 34,109 568 2,306 36,983
Repurchase of outstanding common stock (4,945) -- -- (4,945)
Issuance of common stock
for compensation 57 -- -- 57
Issuance of common stock
for options exercised 990 -- -- 990
Issuance of common stock
for acquisition of subsidiaries 38,486 -- -- 38,486
Net income -- -- 4,307 4,307
Other comprehensive income -- 725 -- 725
----------
Comprehensive income 5,032
Cash dividends paid or accrued -- -- (1,132) (1,132)
---------- ---------- ---------- ----------
Balance at December 31, 2002 68,697 1,293 5,481 75,471
Repurchase of outstanding common stock (2,701) -- -- (2,701)
Issuance of common stock
for compensation 24 -- -- 24
Issuance of common stock
for options exercised 1,171 -- -- 1,171
Noncash compensation 190 -- -- 190
Net income -- -- 994 994
Other comprehensive income -- (916) -- (916)
----------
Comprehensive income 78
Cash dividends paid or accrued -- -- (1,310) (1,310)
---------- ---------- ---------- ----------
Balance at December 31, 2003 $ 67,381 $ 377 $ 5,165 $ 72,923
========== ========== ========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
- 32 -
Capital Bank Corporation
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2003, 2002, and 2001
(In thousands)
2003 2002 2001
-------------------------------------------
Net income $ 994 $ 4,307 $ 2,420
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization of deposit premium and goodwill 310 180 598
Writedown of intangible assets 10 -- --
Depreciation 1,459 1,228 810
Gain on disposal of equipment (160) -- (2)
Amortization of premiums/discounts on securities, net 1,971 922 32
Gain on sale of investments (442) (981) (190)
Funding of held for sale loans (259,041) (191,608) --
Proceeds from sale of held for sale loans 264,447 181,366 --
Provision for loan losses 8,247 4,190 1,215
Deferred tax (benefit) expense (564) 130 (978)
Issuance of stock for compensation 24 57 --
Other noncash compensation 190 -- --
Changes in assets and liabilities:
Accrued interest receivable 235 163 493
Accrued interest payable (234) 131 (176)
Other assets (13) 547 (404)
Other liabilities (651) 279 (383)
--------- --------- ---------
Net cash provided by operating activities 16,782 911 3,435
--------- --------- ---------
Cash flows from investing activities:
Net increase in loans (37,620) (23,946) (65,008)
Additions to premises and equipment (2,712) (1,145) (706)
Proceeds from sale of equipment 622 1 38
Net (purchase) sale of Federal Home Loan Bank stock (681) 91 (1,500)
Purchase of securities available for sale (43,462) (33,851) (31,006)
Purchase of mortgage-backed securities available for sale (73,051) (71,883) (32,317)
Purchase of bank owned life insurance (6,000) -- --
Proceeds from calls/maturities of securities available for sale 87,704 35,124 39,032
Proceeds from sales of securities available for sale 15,859 41,434 14,796
Capitalized purchase costs of acquisitions (38) (47) (88)
Net cash acquired from acquisitions -- 20,695 --
--------- --------- ---------
Net cash used by investing activities (59,379) (33,527) (76,759)
--------- --------- ---------
The accompanying notes are an integral part of these consolidated financial
statements.
- 33 -
Capital Bank Corporation
Consolidated Statements of Cash Flows (Continued)
For the Years Ended December 31, 2003, 2002, and 2001
(In thousands)
2003 2002 2001
----------- ----------- -----------
Cash flows from financing activities:
Net increase (decrease) in deposits $ (15,268) $ 51,718 $ 25,349
Net increase (decrease) in repurchase agreements (2,067) 1,914 1,363
Proceeds from Federal Home Loan Bank borrowings 71,000 86,123 45,000
Principal repayments of Federal Home Loan Bank borrowings (54,267) (66,969) (10,000)
Proceeds from subordinated debentures, net of issuance costs 20,120 -- --
Repurchase of outstanding common stock (2,701) (4,945) (702)
Exercise of common stock options 1,171 990 5
Cash dividends paid (1,314) (799) --
----------- ----------- -----------
Net cash provided by financing activities 16,674 68,032 61,015
----------- ----------- -----------
Net change in cash and cash equivalents (25,923) 35,416 (12,309)
Cash and cash equivalents at beginning of year 51,533 16,117 28,426
----------- ----------- -----------
Cash and cash equivalents at end of year $ 25,610 $ 51,533 $ 16,117
=========== =========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
- 34 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. Summary of Significant Accounting Policies
Organization and Nature of Operations
Capital Bank Corporation (the "Company") is a financial holding company
incorporated under the laws of North Carolina on August 10, 1998. The
Company's primary function is to serve as the holding company for its
wholly-owned subsidiaries, Capital Bank and Capital Bank Investment
Services, Inc. In addition, the Company has interest in two trusts,
Capital Bank Statutory Trust I and II (hereinafter collectively referred
to as the "Trusts"). The Trusts are not consolidated with the financial
statements of the Company per the provisions of FIN 46R. Capital Bank (the
"Bank") was incorporated under the laws of North Carolina on May 30, 1997
and commenced operations on June 20, 1997. The Bank is not a member of the
Federal Reserve System and has no subsidiaries. The Bank is a community
bank engaged in general commercial banking, providing a full range of
banking services. The majority of the Bank's customers are individuals and
small to medium-size businesses. The Bank's primary source of revenue is
interest earned from loans to customers and from invested cash and
securities and non-interest income derived from various fees.
The Bank operates throughout North Carolina with branch facilities located
in Raleigh (4), Sanford (3), Burlington (3), Asheville (2), Cary (2),
Oxford, Hickory, Siler City, Graham, Warrenton, Woodland and Seaboard. The
Company's corporate headquarters are located on Glenwood Avenue in
Raleigh, North Carolina.
On January 18, 2002, the Company completed the acquisition of First
Community Financial Corporation ("First Community") and its subsidiary,
Community Savings Bank, Inc. ("Community Savings Bank"). Community Savings
Bank operated four banking offices in Alamance County, North Carolina. At
the close of business on March 15, 2002, Community Savings Bank was merged
into the Bank and the banking offices of Community Savings Bank opened for
business on March 18, 2002 under the Capital Bank name.
On December 1, 2002, the Company completed the acquisition of High Street
Corporation ("High Street"), the holding company for High Street Banking
Company ("High Street Bank"). High Street Bank operated three banking
offices, two in Asheville, North Carolina and one in Hickory, North
Carolina. At the close of business on December 6, 2002, High Street Bank
was merged into the Bank and the banking offices of High Street Bank
opened for business on December 9, 2002 under the Capital Bank name.
The investment services subsidiary, CBIS, previously made available a full
range of non-deposit investment and insurance services to individuals and
corporations, including the customers of the Bank. These investment
services included full-service securities brokerage, asset management,
financial planning and retirement services, such as 401(k) plans and
annuities, which were provided exclusively through a strategic alliance
with Raymond James Financial Services, Inc. ("Raymond James"). Raymond
James is a wholly owned subsidiary of Raymond James Financial, Inc. (NYSE:
RJF) and is a leading provider of third party investment services, serving
more than 250 community banks nationwide. During the third quarter of
2003, CBIS ceased operations and its customer accounts were transferred to
Raymond James. In connection with the discontinuance of the operations of
CBIS, its assets, primarily furniture and computers with a net book value
less than $15,000, were transferred to be used in the operation of the
Bank and the remaining intangibles, about $10,000, related to the start up
of the Company were written off. Management intends to leave the
subsidiary intact but inactive.
The Trusts were formed for the sole purpose of issuing trust preferred
securities. The proceeds from such issuances were loaned to the Company in
exchange for the Debentures (as defined below), which are the sole assets
of the Trust. A portion of the proceeds from the issuance of the
Debentures were used by the Company to repurchase shares of Company common
stock. The Company's obligation under the Debentures constitutes a full
and unconditional guarantee by the Company of the Trust's obligations
under the trust preferred securities. The Trusts have no operations other
than those that are incidental to the issuance of the trust preferred
securities. See Notes to Consolidated Financial Statements - Note 11 -
Subordinated Debentures.
- 35 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The Company has no operations other than those of its subsidiary, Capital
Bank. The Company's profitability depends principally upon the net
interest income, provision for loan losses, other operating income and
other operating expenses of the Bank.
Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany accounts
and transactions have been eliminated in consolidation.
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 at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include demand and time deposits (with original
maturities of 90 days or less) at other institutions and federal funds
sold. Generally, federal funds are purchased and sold for one-day periods.
At times, the Bank places deposits with high credit quality financial
institutions in amounts which at may be in excess of federally insured
limits.
Securities
Investments in certain securities are classified into three categories and
accounted for as follows:
1. Securities Held to Maturity - Debt securities that the institution
has the positive intent and ability to hold to maturity are
classified as held to maturity and reported at amortized cost; or
2. Trading Securities - Debt and equity securities that are bought and
held principally for the purpose of selling in the near term are
classified as trading securities and reported at fair value, with
unrealized gains and losses included in earnings; or
3. Securities Available for Sale - 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 reported as
other comprehensive income, a separate component of shareholders'
equity.
The classification of securities is generally determined at the date of
purchase. Gains and losses on sales of securities, computed based on
specific identification of the adjusted cost of each security, are
included in other income at the time of the sales.
Premiums and discounts on debt securities are recognized in interest
income using the level interest yield method over the period to maturity,
or when the debt securities are called.
Loans Held for Sale
Mortgage loans held for sale are valued at the lower of cost or market as
determined by outstanding commitments from investors or current investor
yield requirements, calculated on the aggregate loan basis.
Loans and Allowance for Loan Losses
Loans are stated at the amount of unpaid principal, reduced by an
allowance for loan losses and net deferred loan origination fees and
costs. Interest on loans is calculated by using the simple interest method
on daily balances of the principal amount outstanding. Deferred loan fees
and costs are amortized to interest income over the contractual life of
the loan using the level interest yield method.
A loan is considered impaired, based on current information and events, if
it is probable that the Bank will be unable to collect the scheduled
payments of principal and interest when due according to the contractual
- 36 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
terms of the loan agreement. Uncollateralized loans are measured for
impairment based on the present value of expected future cash flows
discounted at the historical effective interest rate, while all
collateral-dependent loans are measured for impairment based on the fair
value of the collateral.
Loans deemed to be impaired at December 31, 2003 and 2002 amounted to $3.0
million and $1.2 million, respectively. Average impaired loans during 2003
and 2002 were $3.2 million and $2.2 million, respectively.
The Bank 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 include the accumulation
of related data. This data includes loan payment status, borrowers'
financial data and borrowers' operating factors such as cash flows,
operating income or loss, etc. It is possible that these factors and
management's evaluation of the adequacy of the allowance for loan losses
will change.
The allowance for loan losses is established through a provision for loan
losses charged to expense. Loans are charged against the allowance for
loan losses when management believes that the collectibility of the
principal is unlikely. The allowance is an amount that management believes
will be adequate to absorb probable losses on existing loans that may
become uncollectible, based on 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,
overall portfolio quality, review of specific problem loans, and current
economic conditions and trends that may affect the borrowers' ability to
pay.
Income Recognition on Impaired and Nonaccrual Loans
Loans, including impaired loans, are generally classified as nonaccrual if
they are past due as to maturity or 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. If a loan or a portion of a loan is classified as
doubtful or as partially charged off, the loan is generally classified as
nonaccrual. 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.
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) of
interest and principal by the borrower in accordance with the contractual
terms.
While a loan is classified as nonaccrual and the future collectibility of
the recorded loan balance is doubtful, collections of interest and
principal are generally applied as a reduction to the principal
outstanding, except in the case of loans with scheduled amortizations
where the payment is generally applied to the oldest payment due. 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.
Foreclosed Assets
Any assets acquired as a result of foreclosure are valued at the lower of
the recorded investment in the loan or fair value less estimated costs to
sell. The recorded investment is the sum of the outstanding principal loan
balance and foreclosure costs associated with the loan. Any excess of the
recorded investment over the fair value of the property received is
charged to the allowance for loan losses. Valuations will be periodically
performed by management and any subsequent write-downs due to the carrying
value of a property exceeding its estimated fair value less estimated
costs to sell are charged against other expenses.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation
and amortization. Depreciation and amortization are computed by the
straight-line method based on estimated service lives of assets. Useful
lives range from 3 to 10 years for furniture and equipment. The cost of
leasehold improvements is being amortized using the straight-line method
over the terms of the related leases. Repairs and maintenance are charged
to expense as incurred.
- 37 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Upon disposition, the asset and related accumulated depreciation or
amortization are relieved and any gains or losses are reflected in
operations.
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
will 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. The effect on deferred taxes of a
change in tax rates is recognized in income in the period that includes
the enactment date. A valuation allowance is recorded for deferred tax
assets if the Company cannot determine that the benefits will more likely
than not be realized.
Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities
The Company applies a financial-components approach that focuses on
control when accounting and reporting for transfers and servicing of
financial assets and extinguishments of liabilities. Under that approach,
after a transfer of financial assets, an entity recognizes the financial
and servicing assets it controls and the liabilities it has incurred,
derecognizes financial assets when control has been surrendered, and
derecognizes liabilities when extinguished. This approach provides
consistent standards for distinguishing transfers of financial assets that
are sales from transfers that are secured borrowings.
Net Income Per Share
The Company follows Statement of Financial Accounting Standards ("SFAS")
No. 128, "Earnings Per Share". In accordance with SFAS No. 128, the
Company has presented both basic and diluted EPS on the face of the
Consolidated Statements of Operations. Basic EPS excludes dilution and is
computed by dividing income available to common shareholders by the
weighted average number of common shares outstanding for the period. The
weighted average number of shares outstanding for 2003, 2002, and 2001
were as follows:
2003 2002 2001
---------- ---------- ----------
(In thousands except number of shares)
Income available to stockholders - basic and diluted $ 994 $ 4,307 $ 2,420
========== ========== ==========
Shares used in the computation of earnings per share:
Weighted average number of shares outstanding - basic 6,655,926 5,467,735 3,712,280
Incremental shares from assumed exercise of stock
options 137,946 195,214 34,561
---------- ---------- ----------
Weighted average number of shares outstanding - diluted 6,793,872 5,662,949 3,746,841
========== ========== ==========
Comprehensive Income
The Company follows SFAS No. 130, "Reporting Comprehensive Income". SFAS
No. 130 establishes standards for reporting and displaying comprehensive
income (loss) and its components (revenues, expenses, gains, and losses)
in general-purpose financial statements.
The Company's only components of other comprehensive income relate to
unrealized gains and losses on available for sale securities. Information
concerning the Company's other comprehensive income (loss) for the years
ended December 31, 2003, 2002 and 2001 is as follows:
- 38 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2003 2002 2001
------- ------- -------
(In thousands)
Unrealized (losses) gains on securities available for sale $(1,038) $ 2,137 $ 793
Reclassification of gains recognized in net income (442) (981) (190)
Income tax benefit (expense) 564 (431) (358)
------- ------- -------
Other comprehensive income (loss) $ (916) $ 725 $ 245
======= ======= =======
Segment Information
The Company follows the provisions of SFAS No. 131 "Disclosures about
Segments of an Enterprise and Related Information." The Statement requires
that public business enterprises report certain information about
operating segments in their annual financial statements and in condensed
financial statements of interim periods issued to shareholders. 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 segment information and those
used in the enterprise's general-purpose financial statements, and changes
in the measurement of segment amounts from period to period.
Operating segments are components of an enterprise about which separate
financial information is available that is evaluated regularly by the
chief operating decision maker in deciding how to allocate resources, and
in assessing performance. The Company has determined that it has one
significant operating segment, the providing of general commercial
financial services to customers located in the single geographic area of
North 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.
Employers Disclosures about Pensions and Other Postretirement Benefits
The Company follows the provisions of SFAS No. 132, "Employers Disclosures
about Pensions and Other Postretirement Benefits". This Statement requires
certain disclosures about pension and other postretirement benefit plans.
New Pronouncements
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities", which addresses consolidation of variable interest
entities ("VIEs"), some of which are also referred to as special purpose
entities ("SPEs"). VIEs are entities in which equity investors do not have
the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. Under the
provisions of FIN 46, a company is to consolidate a VIE if the company has
a variable interest (or combination of variable interests) that will
absorb a majority of the VIE's expected losses if they occur, receive a
majority of the VIE's expected residual returns if they occur or both. The
company that consolidates a VIE is called the primary beneficiary. The
provisions of FIN 46 are applicable to variable interests in VIEs created
after January 31, 2003. Variable interests in VIEs created before February
1, 2003, are subject to the provisions of FIN 46 no later than July 1,
2003. In October 2003, the FASB issued guidance that provides for a
deferral of the effective date of applying FIN 46 to entities created
before February 1, 2003, to no later than December 31, 2003. In addition,
the deferral permits a public company to apply FIN 46 to some or all of
the VIEs in which it holds an interest.
In late December 2003, the Financial Accounting Standards Board issued
FASB Interpretation No. 46 (Revised 2003), "Consolidation of Variable
Interest Entities" ("FIN 46R"). This revision clarified and/or modified
certain provisions of FIN 46 and exempted certain entities from the
original requirements of FIN 46.
The Company has interests in two trusts, Capital Bank Statutory Trust I
and Capital Bank Statutory Trust II, which qualify as VIEs under FIN 46R.
Capital Bank Statutory Trust I ("Trust I") was established in June 2003
and its balances were included in the consolidated Form 10-Qs for the
quarters ended June 30 and September 30, 2003. Capital Bank Statutory
Trust II ("Trust I") was established in December 2003.
- 39 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The Company adopted the provisions of FIN 46R for the quarter and year
ended December 31, 2003. Application of the revised rules resulted in the
determination that the Company was not the primary beneficiary of the
trusts described above. Based on guidance included in FIN 46R, the Company
deconsolidated the assets and liabilities of Capital Bank Statutory Trust
I and Trust II (collectively, the "Trusts") effective December 31, 2003.
Trust II issued $10 million of capital securities in December 2003. The
deconsolidation of the Trusts removed $20.0 million of Mandatorily
Redeemable Capital Securities issued by these Trusts while adding $20.6
million of junior subordinated debentures and $620,000 million of other
assets to the Consolidated Balance Sheet at December 31, 2003. The assets
represent the Company's ownership of common stock issued by the Trusts.
The deconsolidation had no impact on consolidated net income for the third
or fourth quarters of 2003 or for the full year 2003.
The Company did not consolidate or deconsolidate any other significant
variable interest entities in connection with the implementation of FIN
46R; thus the implementation did not have a material impact on its
consolidated financial position or results of operations, other than as
indicated above.
2. Significant Activities
On January 18, 2002, the Company acquired First Community Financial
Corporation ("First Community"), the holding company for Community Savings
Bank, Inc. ("Community Savings Bank"). Community Savings Bank was
originally chartered in 1934, and its market area consists of the
communities in Alamance County, North Carolina. Community Savings Bank
primarily engaged in soliciting deposit accounts from businesses and the
general public and making commercial loans, construction loans,
residential real estate loans, home equity line of credit loans, consumer
loans and various investments. As a result of the acquisition, the Company
issued an additional 1.9 million shares of common stock. The transaction
was accounted for under the purchase method and is intended to qualify as
a tax-free reorganization under Section 368(a) of the Internal Revenue
Code.
On December 1, 2002, the Company acquired High Street Corporation ("High
Street"), the holding company for High Street Banking Company ("High
Street Bank"). High Street had no significant assets other than the
outstanding capital stock of High Street Bank. High Street Bank was
originally incorporated on April 25, 1997, and its market area consisted
of the communities of Asheville and Hickory, North Carolina. High Street
Bank's activities were similar to those described above for Community
Savings Bank. As a result of the acquisition, the Company issued an
additional 1.3 million shares of common stock. The transaction was
accounted for under the purchase method and is intended to qualify as a
tax-free reorganization under Section 368(a) of the Internal Revenue Code.
The following table reflects the unaudited pro forma combined results of
operations for the years ended December 31, 2002 and 2001, assuming these
acquisitions had occurred at the beginning of fiscal 2002:
2002 2001
------- -------
(In thousands except per share amounts)
Net interest income $24,436 $25,532
Net income 3,530 3,079
Net earnings per diluted share 0.51 0.44
In management's opinion, these unaudited pro forma amounts are not
necessarily indicative of what actual combined results of operations might
have been if the acquisitions had been effective at the beginning of
fiscal 2001.
- 40 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
A summary of estimated fair values of assets acquired and liabilities
assumed was as follows:
(In thousands) First High
Community Street Total
--------- --------- ---------
Loans receivable $ 134,149 $ 126,175 $ 260,324
Premises and equipment 5,424 3,050 8,474
Deposit premium 782 976 1,758
Goodwill 3,835 5,319 9,154
Other assets 52,661 28,333 80,994
Deposits (156,241) (132,485) (288,726)
Borrowings (16,414) (12,290) (28,704)
Other liabilities (3,342) (1,446) (4,788)
--------- --------- ---------
Investment in subsidiary, net of dividends to shareholders
and capitalized acquisition costs $ 20,854 $ 17,632 $ 38,486
========= ========= =========
During 2003, the Company made several changes to the branch structure
including the consolidation of two branches in Oxford into one main Oxford
facility in a new location and the opening of an additional branch in
Raleigh. In addition, during the third quarter of 2003, the Company made
the decision to discontinue the operations of CBIS. CBIS will remain an
inactive subsidiary of the Company. Also during 2003, the Company entered
into two separate offerings of trust preferred securities, one in June by
Trust I and the other in December by Trust II. See Notes to Consolidated
Financial Statements - Note 11 - Subordinated Debentures for additional
information on these Trusts.
3. Goodwill and Other Intangible Assets - Adoption of SFAS No. 142
Net assets of companies acquired in purchase transactions are recorded at
fair value at the date of acquisition, and as such, the historical cost
basis of individual assets and liabilities are adjusted to reflect their
fair value. Identified intangibles are amortized on a straight-line basis
over the period benefited. Before the adoption of SFAS No. 142 "Goodwill
and Other Intangible Assets", the Company amortized goodwill on a
straight-line basis over seven to ten years. Under SFAS No. 142, goodwill
is no longer amortized, but is reviewed for potential impairment
of each year at the reporting unit level. The impairment test is performed
in two phases. The first step of the goodwill impairment test, used to
identify potential impairment, compares the fair value of the reporting
unit with its carrying amount, including goodwill. If the fair value of
the reporting unit exceeds its carrying amount, goodwill of the reporting
unit is considered not impaired; however, if the carrying amount of the
reporting unit exceeds its fair value an additional procedure must be
performed. That additional procedure compares the implied fair value of
the reporting unit's goodwill (as defined in SFAS No. 142) with the
carrying amount of that goodwill. An impairment loss is recorded to the
extent that the carrying amount of goodwill exceeds its implied fair
value. Other intangible assets are evaluated for impairment if events and
circumstances indicate a possible impairment. Such evaluation of other
intangible assets is based on undiscounted cash flow projections.
- 41 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
As of December 31, 2003 and 2002, intangible assets, primarily deposit
premiums paid for acquisitions, and goodwill are as follows:
Accumulated
Gross Amortization Net
------------------------------------------
(In thousands)
At December 31, 2003
From January 2002 acquisition of First Community:
Deposit premium $ 782 $ (304) $ 478
Goodwill 3,835 -- 3,835
---------- ---------- ----------
4,617 (304) 4,313
---------- ---------- ----------
From December 2002 acquisition of High Street:
Deposit premium 976 (190) 786
Goodwill 5,380 -- 5,380
---------- ---------- ----------
6,356 (190) 6,166
---------- ---------- ----------
From April 2000 branch acquisitions:
Goodwill 3,471 (604) 2,867
From June 1997 branch acquisitions:
Goodwill 2,164 (980) 1,184
---------- ---------- ----------
$ 16,608 $ (2,078) $ 14,530
========== ========== ==========
At December 31, 2002
From January 2002 acquisition of First Community:
Deposit premium $ 782 $ (164) $ 618
Goodwill 3,835 -- 3,835
---------- ---------- ----------
4,617 (164) 4,453
---------- ---------- ----------
From December 2002 acquisition of High Street:
Deposit premium 976 (15) 961
Goodwill 5,319 -- 5,319
---------- ---------- ----------
6,295 (15) 6,280
---------- ---------- ----------
From March 2001 acquisition of CBIS:
Goodwill 121 (33) 88
Capitalized startup costs 15 (3) 12
---------- ---------- ----------
136 (36) 100
---------- ---------- ----------
From April 2000 branch acquisitions:
Goodwill 3,471 (604) 2,867
From June 1997 branch acquisitions:
Goodwill 2,164 (980) 1,184
---------- ---------- ----------
$ 16,683 $ (1,799) $ 14,884
========== ========== ==========
Valuation of the Company's goodwill pursuant to this pronouncement
resulted in no write-downs for impairment other than approximately
$10,000 written off as a result of the discontinuance of the operations
of
- 42 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
CBIS. Additionally, SFAS No. 142 requires a reconciliation of previously
reported net income and earnings per share, adjusted for changes pursuant
to this statement. Following is the pro forma effect of the adoption of
SFAS No. 142:
Year Ended
December 31,
2002
------------
(In thousands except per share data)
Reported net income $ 2,420
Goodwill amortization, net of tax 371
-----------
Adjusted net income $ 2,791
===========
Basic earnings per share:
Reported net income $ 0.65
Goodwill amortization, net of tax 0.10
-----------
Adjusted net income $ 0.75
===========
Diluted earnings per share:
Reported net income $ 0.65
Goodwill amortization, net of tax 0.10
-----------
Adjusted net income $ 0.75
===========
4. Securities
Securities at December 31, 2003 and 2002 are summarized as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(In thousands) Cost Gains Losses Value
----------- ----------- ----------- -----------
2003
Available for sale:
U.S. Agency obligations $ 35,747 $ 87 $ 507 $ 35,327
Municipal bonds 24,678 769 64 25,383
----------- ----------- ----------- -----------
60,425 856 571 60,710
Mortgage-backed securities 99,189 859 542 99,506
----------- ----------- ----------- -----------
$ 159,614 $ 1,715 $ 1,113 $ 160,216
=========== =========== =========== ===========
- 43 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(In thousands) Cost Gains Losses Value
----------- ----------- ----------- -----------
2002
Available for sale:
U.S. Agency obligations $ 15,179 $ 152 $ -- $ 15,331
Corporate bonds 1,020 -- 3 1,017
Municipal bonds 19,879 296 125 20,050
----------- ----------- ----------- -----------
36,078 448 128 36,398
Mortgage-backed securities 112,127 1,881 119 113,889
----------- ----------- ----------- -----------
$ 148,205 $ 2,329 $ 247 $ 150,287
=========== =========== =========== ===========
The amortized cost and estimated market values of securities at December
31, 2003 by contractual maturities are shown below. Expected maturities
will differ from contractual maturities because borrowers may have the
right to call or prepay obligations with or without call or prepayment
penalties.
Estimated
Amortized Market
(In thousands) Cost Value
------------------------
Available for sale:
Due in one year or less $ 43 $ 43
Due after one year through five years 11,444 11,468
Due after five years through ten years 45,182 45,269
Due after ten years 102,945 103,436
---------- ----------
$ 159,614 $ 160,216
========== ==========
During the years ended December 31, 2003, 2002 and 2001, the Company had
gross realized gains of $442,000, $981,000 and $190,000, respectively, on
sales of available for sale securities with book values of $15.4 million,
$40.5 million and $14.6 million.
Securities with an amortized cost of $72.7 million were pledged as of
December 31, 2003 to secure public deposits, repurchase agreements, and
Federal Home Loan Bank advances.
5. Federal Home Loan Bank Stock
The Company, as member of the Federal Home Loan Bank System, is required
to maintain an investment in capital stock of the FHLB 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 the FHLB stock, and
it has no quoted market value, therefore, cost approximates market at
December 31, 2003 and 2002.
- 44 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
6. Loans and Allowance for Loan Losses
The composition of the loan portfolio by loan classification at December
31, 2003 and 2002 is as follows:
(In thousands) 2003 2002
-----------------------------
Commercial $ 474,104 $ 430,847
Consumer 42,929 51,069
Home equity lines 58,430 45,935
Residential mortgages 50,437 73,146
----------- -----------
625,900 600,997
Less deferred loan fees (costs), net (45) 388
----------- -----------
$ 625,945 $ 600,609
=========== ===========
A summary of activity in the allowance for loan losses for the years ended
December 31, 2003, 2002, and 2001 is as follows:
(In thousands) 2003 2002 2001
--------------------------------------------
Balance at beginning of year $ 9,390 $ 4,286 $ 3,463
Allowance for loan losses transferred from acquired companies -- 4,593 --
Provision for loan losses 8,247 4,190 1,215
Loans charged-off, net of recoveries (6,024) (3,679) (392)
---------- ---------- ----------
Balance at end of year $ 11,613 $ 9,390 $ 4,286
========== ========== ==========
At December 31, 2003, nonperforming assets consisted of nonaccrual loans
in the amount of $8.0 million and foreclosed real estate of $978,000. At
December 31, 2002, nonperforming assets consisted of nonaccrual loans in
the amount of $3.0 million and foreclosed real estate of $947,000.
Unrecognized income on nonaccrual loans at December 31, 2003 and 2002 was
$262,000 and $229,000, respectively. At December 31, 2002, loans past due
greater than 90 days and still accruing interest amounted to $14,000.
There were no such loans at December 31, 2003.
In the normal course of business, certain directors and executive officers
of the Company, including their immediate families and companies in which
they have an interest, may be loan customers. Total loans to such groups
at December 31, 2003 and activity during the year ended December 31, 2003,
is summarized as follows:
(In thousands) 2003 2002 2001
--------------------------------------------
Beginning balance $ 15,288 $ 8,286 $ 9,990
New loans 14,562 13,015 5,333
Principal repayments (4,048) (6,013) (7,037)
Reclassifications (2,410) -- --
---------- ---------- ----------
Ending balance $ 23,392 $ 15,288 $ 8,286
========== ========== ==========
In addition, such groups had available lines of credit in the amount of
$5.4 million at December 31, 2003. The Company paid an aggregate of
approximately $922,000, $705,000, and $608,000 to companies owned by
members of the board of directors for leased space, equipment,
construction and consulting services during 2003, 2002 and 2001,
respectively.
- 45 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
7. Premises and Equipment
Premises and equipment at December 31, 2003 and 2002 are as follows:
2003 2002
-----------------------------
(In thousands)
Land $ 4,679 $ 4,378
Buildings and leasehold improvements 8,492 7,329
Furniture and equipment 8,344 7,589
Automobiles 256 303
Construction in progress 2 82
----------- -----------
21,773 19,681
Less accumulated depreciation and amortization (7,583) (6,282)
----------- -----------
$ 14,190 $ 13,399
=========== ===========
8. Deposits
At December 31, 2003, the scheduled maturities of certificates of deposit
are as follows:
Weighted
Average
(In thousands) Balance Rate
----------- -----------
2004 $ 291,683 2.31%
2005 37,215 2.49%
2006 24,302 3.85%
2007 17,282 3.30%
2008 and thereafter 335 3.24%
----------- -----------
$ 370,817 2.48%
=========== ===========
9. Federal Home Loan Bank Advances
Advances from the Federal Home Loan Bank had a weighted average rate of
4.21% and 4.30% at December 31, 2003 and 2002, respectively, and were
collateralized by certain 1 - 4 family mortgages, multifamily first
mortgage loans and qualifying commercial loans totaling $93.7 million and
$95.1 million at year-end 2003 and 2002, respectively. In addition, the
Company pledged certain investment securities with an amortized cost of
$32.3 million and $26.0 million at December 31, 2003 and 2002 (Note 4).
Advances outstanding at December 31, 2003 mature from March 2004 through
April 2013.
At December 31, 2003, the Company had an additional $57.6 million of
credit available with the Federal Home Loan Bank.
10. Derivative Financial Instruments
The Company maintains positions in derivative financial instruments to
manage interest rate risk, to facilitate asset/liability management
strategies, and to manage other risk exposures. The most common derivative
instruments used by companies are forward rate agreements, interest rate
swaps, and put and call options.
In July 2003, the Company entered into interest rate swap agreements to
convert portions of its fixed rate long-term debt to floating rate.
Because of the effectiveness of the swap agreements against the related
debt instruments, the adjustments needed to record the swaps at fair value
were offset by the adjustments needed to record the related debt
instruments at fair value and the net difference between those amounts
were deemed to
- 46 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
be immaterial. For the year ended December 31, 2003, the Company recorded
net reductions in interest expense paid on debt of approximately $238,000.
11. Subordinated Debentures
In June 2003 and December 2003, the Company formed the Trusts. Each issued
10,000 of its floating rate capital securities (the "trust preferred
securities"), with a liquidation amount of $1,000 per capital security, in
pooled offerings of trust preferred securities. The Trusts sold their
common securities to the Company for an aggregate of $620,000, resulting
in total proceeds from each offering equal to $10,310,000 or $20,620,000
in aggregate. The Trusts then used these proceeds to purchase $20,620,000
in principal amount of the Company's Floating Rate Junior Subordinated
Deferrable Interest Debentures (the "Debentures"). Following payment by
the Company of a placement fee and other expenses of the offering, the
Company's net proceeds from the offering aggregated $20 million.
The trust preferred securities have a 30 year maturity and are redeemable
after 5 years with certain exceptions. Prior to the redemption date, the
trust preferred securities may be redeemed at the option of the Company
after the occurrence of certain events, including without limitation
events that would have a negative tax effect on the Company or the Trusts,
would cause the trust preferred securities to no longer qualify as Tier 1
capital, or would result in the Trusts being treated as an investment
company. The Trusts' ability to pay amounts due on the trust preferred
securities is solely dependent upon the Company making payment on the
Debentures. The Company's obligation under the Debentures constitutes a
full and unconditional guarantee by the Company of the Trusts' obligations
under the trust preferred securities.
The Debentures, which are subordinate and junior in right of payment to
all present and future senior indebtedness and certain other financial
obligations of the Company, are the sole assets of the Trusts and the
Company's payment under the Debentures is the sole source of revenue for
the Trusts.
Per the provisions of FIN 46R, the assets and liabilities of the Trusts
are not consolidated into the consolidated financial statements of the
Company. Interest on the Debentures is included in the Company's Condensed
Consolidated Statements of Income as interest expense. The Floating Rate
Junior Subordinated Deferrable Interest Debentures are presented as a
separate category of long-term debt on the Consolidated Statements of
Financial Condition entitled "Subordinated Debentures." For regulatory
purposes, the $20 million of trust preferred securities qualifies as Tier
1 capital, subject to certain limitations, or Tier 2 capital in accordance
with regulatory reporting requirements.
The Company used approximately $1.9 million of the proceeds from the
issuance of the Debentures to repurchase 127,500 shares of the Company's
common stock during the three months ended June 30, 2003. The Company
invested $14.0 million of the remaining proceeds in its Bank subsidiary to
support additional earning asset growth. The remaining funds will remain
in a money market account for the Company to be used to pay dividends and
other Company obligations.
12. Income Taxes
Income taxes charged to operations for the years ended December 31, 2003,
2002, and 2001 consist of the following components:
(In thousands) 2003 2002 2001
----------------------------------
Current income tax expense $ 602 $ 2,244 $ 1,458
Deferred income tax expense (benefit) (564) 130 (978)
------- ------- -------
Total income tax expense $ 38 $ 2,374 $ 480
======= ======= =======
The difference between income tax expense and the amount computed by
applying the statutory federal income tax rate of 34% was primarily the
result of permanent differences such as nontaxable municipal bond interest
and increases in cash surrender value of life insurance. In addition, 2002
had certain non-deductible
- 47 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
merger related expenses and 2001 included a reversal in the valuation
allowance on the net deferred tax assets.
Significant components of deferred tax assets and liabilities at December
31, 2003 and 2002 are as follows:
(In thousands) 2003 2002
-------------------------
Deferred tax assets:
Allowance for loan losses $ 4,477 $ 3,620
Deferred compensation 1,645 1,791
Net operating loss carryforwards 1,306 1,589
Directors fees 697 540
Contributions carryforwards 171 224
--------- ---------
Total deferred tax assets 8,296 7,764
--------- ---------
Deferred tax liabilities:
Unrealized security gains (250) (814)
Depreciation (535) (553)
Purchase accounting adjustments (338) (633)
FHLB stock (304) (302)
Other (377) (288)
--------- ---------
Total deferred tax liabilites (1,804) (2,590)
--------- ---------
Net deferred tax assets $ 6,492 $ 5,174
========= =========
13. Leases
The Company has noncancelable operating leases for its corporate office
and branch locations that expire at various times through 2027. Future
minimum lease payments under the leases for years subsequent to December
31, 2003 are as follows:
(In thousands)
2003 $ 970
2004 957
2005 848
2006 851
2007 829
Thereafter 6,607
-----------
$ 11,062
===========
During 2003, 2002, and 2001, payments under operating leases were $1.1
million, $806,000, and $666,000, respectively.
14. Regulatory Matters and Restrictions
The Company and the Bank are subject to various regulatory capital
requirements administered by the 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
consolidated financial statements. Quantitative measures established by
regulation to ensure capital adequacy require the Bank to maintain minimum
amounts and ratios, as set forth in the table below. As of June 30, 2003,
the most recent notification from regulators, the Bank was categorized as
"well capitalized" by regulatory authorities. There are no conditions or
events since that date that management believes could have an adverse
effect on the Bank's category. Management believes that as of December 31,
2003, the Company meets all capital requirements to which it is subject.
- 48 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The Bank, as a North Carolina banking corporation, may pay dividends only
out of undivided profits as determined pursuant to North Carolina General
Statues Section 53-87. However, regulatory authorities may limit payment
of dividends by any bank when it is determined that such a limitation is
in the public interest and is necessary to ensure financial soundness of
the bank.
To be categorized as well capitalized, the Company and the Bank must
maintain minimum amounts and ratios. The Company's actual capital amounts
and ratios as of December 31, 2003 and 2002 and the minimum requirements
are presented in the following table.
Minimum Requirements To Be:
Actual Adequately Capitalized Well Capitalized
------------------- ---------------------- --------------------
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
2003
Total Capital (to Risk Weighted Assets) $84,692 12.13% $55,853 8.00% $69,817 10.00%
Tier I Capital (to Risk Weighted Assets) 74,572 10.68% 27,927 4.00% 41,890 6.00%
Tier I Capital (to Average Assets) 74,572 8.71% 34,262 4.00% 42,827 5.00%
2002
Total Capital (to Risk Weighted Assets) $66,329 10.28% $51,614 8.00% $64,517 10.00%
Tier I Capital (to Risk Weighted Assets) 58,248 9.03% 25,807 4.00% 38,710 6.00%
Tier I Capital (to Average Assets) 58,248 8.18% 28,502 4.00% 35,628 5.00%
15. Employee Benefit Plans
401(k) Plan
The Company instituted a 401(k) plan (the "Plan") for the benefit of its
employees, which includes provisions for employee contributions, subject
to limitation under the Internal Revenue Code, with the Company to match
contributions up to 6% of the employee's salary. The Plan provides that
employees' contributions are 100% vested at all times and the Company's
contributions vest 20% after the second year of service, an additional 20%
after the third and fourth years of service and the remaining 40% after
the fifth year of service. Further, the Company may make additional
contributions on a discretionary basis. Aggregate contributions for 2003,
2002, and 2001 were $387,000, $342,000, and $225,000, respectively.
16. Stock Options
The Company has stock option plans providing for the issuance of up to
650,000 options to purchase shares of the Corporation's stock to officers
and directors. At December 31, 2003, options for 194,400 shares of common
stock remained available for future issuance.
Grants of options are made by the Board or the Compensation Committee. All
grants must be at no less than fair market value on the date of grant,
must be exercised no later than 10 years from the date of grant, and may
be subject to some vesting provisions.
- 49 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
A summary of the activity during the years ending December 31, 2003, 2002
and 2001 of the Company's stock option plan, including the weighted
average exercise price ("WAEP") is presented below:
2003 2002 2001
-----------------------------------------------------------------------------
Shares WAEP Shares WAEP Shares WAEP
-------- -------- -------- -------- -------- --------
Outstanding at beginning of year 785,616 $ 9.70 415,944 $ 10.43 313,744 $ 10.36
Granted 81,000 15.82 16,000 12.54 108,350 10.62
Assumed in connection with acquisitions -- -- 502,977 8.13 -- --
Exercised (125,854) 9.31 (147,645) 6.71 (650) 9.44
Terminated (36,972) 11.16 (1,660) 10.25 (5,500) 9.94
-------- -------- -------- -------- -------- --------
Outstanding at end of year 703,790 $ 10.40 785,616 $ 9.70 415,944 $ 10.43
======== ======== ======== ======== ======== ========
Options exercisable at year-end 590,560 $ 9.66 720,394 $ 9.61 343,714 $ 10.52
======== ======== ======== ======== ======== ========
The following table summarizes information about the stock options at
December 31, 2003:
Weighted
Average
Remaining
Number Contractual Number
Exercise Price Outstanding Life in Years Exercisable
-------------- ----------- ------------- -----------
$6.62 - $8.00 241,707 6.4 231,507
$8.01 - $10.00 75,646 4.4 74,824
$10.01 - $12.00 171,418 6.6 161,410
$12.01 - $14.00 116,136 4.6 106,536
$14.01 - $16.00 79,883 8.9 16,283
$16.01 - $16.57 19,000 9.8 --
------- ------------ -------
703,790 6.3 590,560
======= =========== =======
The Company accounts for its stock options under the provisions of APB
Opinion No. 25. However, the Company is required to disclose the pro forma
effects on net income as if it had recorded compensation based on the fair
value of options granted. The fair value of each option grant is estimated
on the date of grant using the Black-Scholes option-pricing model with the
following assumptions used for grants:
2003 2002 2001
-----------------------------------
Dividend yield 1.20% 1.46% --
Expected volatility 28.0% 29.7% 29.6%
Riskfree interest rate 3.72% 3.93% 4.95%
Expected life 7 years 7 years 7 years
The weighted average fair value of options granted during 2003, 2002 and
2001 was $5.15, $4.47, and $4.57, respectively.
Had compensation cost for the Company's stock-based compensation plans, as
described above, been determined consistent with SFAS No. 123, the
Company's net income and income per share for the years
- 50 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
ended December 31, 2003, 2002 and 2001 would have been decreased to the
pro forma amounts indicated below:
(In thousands, except per share data) 2003 2002 2001
-----------------------------------
Net income As reported $ 994 $ 4,307 $ 2,420
Pro forma 922 3,474 2,338
Net income per share - Basic As reported $ 0.15 $ 0.79 $ 0.65
Pro forma 0.14 0.64 0.63
Net income per share - Diluted As reported $ 0.15 $ 0.76 $ 0.65
Pro forma 0.14 0.62 0.63
17. Financial Instruments with Off-Balance Sheet Risk and Concentrations of
Credit Risk
To meet the financial needs of its customers, the Company is party to
financial instruments with off-balance sheet risk in the normal course of
business. At December 31, 2003, these financial instruments were comprised
entirely of unused lines of credit. These instruments involve, to varying
degrees, elements of credit risk in excess of the amount recognized in the
balance sheet.
The Company's exposure to credit loss in the event of nonperformance by
the other party is represented by the contractual amount of those
instruments. The Company uses the same credit policies in making these
commitments as they do for on-balance sheet instruments. The amount of
collateral obtained, if deemed necessary by the Company, upon extension of
credit is based on management's credit evaluation of the borrower.
Collateral held varies but may include trade accounts receivable,
property, plant, and equipment and income-producing commercial properties.
Since many unused lines of credit expire without being drawn upon, the
total commitment amounts do not necessarily represent future cash
requirements.
Unused lines of credit were $115.3 million and $133.8 million,
respectively, at the end of 2003 and 2002. Outstanding letters of credit
were $1.6 million and $792,000, respectively, at December 31, 2003 and
2002.
The Bank's lending is concentrated primarily in Wake, Chatham,
Northampton, Alamance, Buncombe, Catawba, Granville, Warren, and Lee
counties in North Carolina.
18. Fair Value of Financial Instruments
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments",
requires the disclosure of estimated fair values for financial
instruments. Quoted market prices, if available, are utilized as an
estimate of the fair value of financial instruments. Because no quoted
market prices exist for a significant part of the Company's financial
instruments, the fair value of such instruments has been derived based on
management's assumptions with respect to future economic conditions, the
amount and timing of future cash flows and estimated discount rates.
Different assumptions could significantly affect these estimates.
Accordingly, the net amounts ultimately collected could be materially
different from the estimates presented below. In addition, these estimates
are only indicative of the values of individual financial instruments and
should not be considered an indication of the fair value of the Company
taken as a whole.
The fair values of cash and due from banks, Federal funds sold, interest
bearing deposits in banks and accrued interest receivable/payable are
equal to the carrying value due to the nature of the financial
instruments. The estimated fair values of investment securities and
mortgage-backed securities are provided in Note 4 - Securities.
- 51 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The fair value of the net loan portfolio has been estimated using the
present value of expected cash flows, discounted at an interest rate
giving consideration to estimated prepayment risk and credit loss factors.
The fair value of the Bank's loan portfolio at December 31, 2003 and 2002
were as follows:
(In thousands)
Loans:
2003 2002
--------------------------
Carrying amount $ 614,332 $ 591,219
Estimated fair value 617,705 595,170
The fair values of deposit liabilities and repurchase agreements with no
stated maturities have been estimated to equal the carrying amount (the
amount payable on demand), totaling $269.8 million and $287.5 million at
December 31, 2003 and 2002, respectively. Therefore, the fair value
estimates for these products do not reflect the benefits that the Bank
receives from the low-cost, long-term funding they provide. These benefits
are considered significant.
The fair values of certificates of deposits and advances from the FHLB is
estimated by discounting the future cash flows using the current rates
offered for similar deposits and advances with the same remaining
maturities. The carrying value and estimated fair values of certificates
of deposit and FHLB advances at December 31, 2003 and 2002 were as
follows:
(In thousands) 2003 2002
--------------------------
Certificates of deposits:
Carrying amount $ 370,817 $ 370,441
Estimated fair value 373,286 371,592
Advances from the FHLB:
Carrying amount $ 114,591 $ 97,858
Estimated fair value 115,203 98,472
There is no material difference between the carrying amount and estimated
fair value of off-balance sheet items totaling $116.9 million and $134.6
million at December 31, 2003 and 2002, respectively, which are primarily
comprised of unfunded loan commitments.
The Company's remaining assets and liabilities are not considered
financial instruments.
- 52 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
19. Parent Company Financial Information
Condensed financial information of the financial holding company of the
Bank at December 31, 2003 and 2002 and for the years ended December 31,
2003, 2002, and 2001 is presented below:
(In thousands)
Condensed Balance Sheets 2003 2002
----------------------------
Assets:
Cash $ 3,514 $ 415
Equity investment in subsidiary 90,245 76,553
Other assets 495 --
----------- -----------
Total assets $ 94,254 $ 76,968
=========== ===========
Liabilities:
Subordinated debentures $ 20,630 $ --
Deferred tax liabilities 237 814
Dividends payable 327 333
Other liabilities 137 350
----------- -----------
Total liabilities 21,331 1,497
----------- -----------
Shareholders' equity:
Common stock 64,425 65,742
Accumulated other comprehensive income 377 1,293
Retained earnings 8,121 8,436
----------- -----------
Total shareholders' equity 72,923 75,471
----------- -----------
Total liabilities and shareholders' equity $ 94,254 $ 76,968
=========== ===========
(In thousands)
Condensed Statements of Operations 2003 2002 2001
-----------------------------------------------
Dividends from wholly-owned subsidiaries $ 750 $ 2,750 $ 600
Equity in earnings of subsidiaries 401 1,570 1,820
Other income 15 -- --
Interest expense (249) -- --
Other expenses (4) (13) --
Income tax benefit 81 -- --
----------- ----------- -----------
Net income $ 994 $ 4,307 $ 2,420
=========== =========== ===========
- 53 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(In thousands)
Condensed Statements of Cash Flows 2003 2002 2001
--------------------------------------------
Operating activities:
Net income $ 994 $ 4,307 $ 2,420
Equity in undistributed earnings of subsidiary (401) (1,570) (1,820)
Net change in other assets and liabilities (200) -- --
---------- ---------- ----------
Cash flow provided by (used in) operating activities 393 2,737 600
---------- ---------- ----------
Investing activities:
Additional investment in subsidiaries (14,594) -- --
---------- ---------- ----------
Cash flow provided by (used in) investing activities (14,594) -- --
---------- ---------- ----------
Financing activities:
Proceeds from issuance of common stock 1,171 990 6
Payments to repurchase common stock (2,677) (4,945) (703)
Proceeds from issuance of subordinated debentures, net
of issuance costs 20,120 -- --
Dividends paid (1,314) (799) --
Net cash from acquisitions -- 2,429 --
---------- ---------- ----------
Cash flow provided by (used in) financing activities 17,300 (2,325) (697)
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents 3,099 412 (97)
Cash and cash equivalents, beginning of year 415 3 100
---------- ---------- ----------
Cash and cash equivalents, end of year $ 3,514 $ 415 $ 3
========== ========== ==========
- 54 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
20. Selected Quarterly Financial Data (Unaudited)
Selected unaudited quarterly balances and results for the years ended
December 31, 2003 and 2002 are as follows:
2003
-------------------------------------------------------------
Three Months Ended
-------------------------------------------------------------
(In thousands except per share data) Dec. 31 Sept. 30 June 30 March 31
-------------------------------------------------------------
Assets $ 857,734 $ 871,780 $ 908,677 $ 856,076
Loans 625,945 637,745 645,525 622,015
Investment securities 165,913 166,940 161,938 155,835
Deposits 629,619 656,030 684,180 652,690
Shareholders' equity 72,923 70,776 75,144 76,512
Net interest income $ 6,274 $ 5,941 $ 5,972 $ 5,935
Provision for loan losses (12) 4,963 2,696 600
Other operating income 1,898 3,080 2,739 2,605
Other operating expenses 5,847 7,593 5,777 5,948
Income taxes 766 (1,392) (47) 711
---------- ---------- ---------- ----------
Net income(loss) $ 1,571 $ (2,143) $ 285 $ 1,281
========== ========== ========== ==========
Net income per share(loss) - Basic $ .24 $ (.32) $ .04 $ .19
========== ========== ========== ==========
Net income per share(loss) - Diluted $ .24 $ (.32) $ .04 $ .19
========== ========== ========== ==========
2002
-------------------------------------------------------------
Three Months Ended
-------------------------------------------------------------
(In thousands except per share data) Dec. 31 Sept. 30 June 30 March 31
-------------------------------------------------------------
Assets $ 840,976 $ 659,382 $ 642,126 $ 641,571
Loans 600,609 475,865 467,071 453,243
Investment securities 155,304 123,533 114,039 111,150
Deposits 644,887 521,930 503,021 482,119
Shareholders' equity 75,471 56,811 55,341 55,341
Net interest income $ 5,472 $ 4,969 $ 5,139 $ 4,769
Provision for loan losses 400 2,560 705 525
Other operating income 2,490 2,364 1,548 1,585
Other operating expenses 5,098 4,119 4,162 4,086
Income taxes 827 219 603 725
---------- ---------- ---------- ----------
Net income $ 1,637 $ 435 $ 1,217 $ 1,018
========== ========== ========== ==========
Net income per share - Basic $ .29 $ .08 $ .22 $ .20
========== ========== ========== ==========
Net income per share - Diluted $ .28 $ .08 $ .21 $ .19
========== ========== ========== ==========
- 55 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
21. Supplemental Disclosure of Cash Flow Information
2003 2002
----------- -----------
(In thousands)
Cash payments for interest $ 16,552 $ 15,237
=========== ===========
Cash payments for income taxes $ 1,008 $ 1,775
=========== ===========
Transfers from loans to real estate acquired
through foreclosure $ 854 $ 1,708
=========== ===========
Purchase of First Community:
Loans, net of reserves $ -- $ (134,149)
Investments -- (39,001)
Other assets acquired -- (10,435)
Goodwill and deposit premium -- (4,617)
Deposits -- 156,241
Borrowings -- 16,414
Other liabilities assumed -- 3,342
Issuance of stock -- 20,854
----------- -----------
Net cash and cash equivalents acquired $ -- $ 8,649
=========== ===========
Purchase of High Street:
Loans, net of reserves $ -- $ (126,175)
Investments -- (12,275)
Other assets acquired -- (7,062)
Goodwill and deposit premium -- (6,295)
Deposits -- 132,485
Borrowings -- 12,290
Other liabilities assumed -- 1,446
Issuance of stock -- 17,632
----------- -----------
Net cash and cash equivalents acquired $ -- $ 12,046
=========== ===========
- 56 -
Report of Independent Auditors
The Board of Directors and Shareholders
Capital Bank Corporation
Raleigh, North Carolina
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of changes in shareholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Capital Bank Corporation at December 31, 2003 and 2002, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2003 in conformity with accounting principles generally accepted in
the United States of America. These financial statements are the responsibility
of the Company's management; our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States of America, which 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, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Note 1 and 3 to the consolidated financial statements in 2002,
the Company adopted the provisions of Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets and Statement of
Financial Accounting Standards No. 147, Acquisition of Certain Financial
Institutions.
/s/ PricewaterhouseCoopers, LLP
February 27, 2004
- 57 -
Item 9. Changes In and Disagreements With Accountants On Accounting and
Financial Disclosure.
None.
Item 9A. Controls and Procedures.
(a) Evaluation of disclosure controls and procedures.
As required by paragraph (b) of Rule 13a-15 under the Exchange Act, our Chief
Executive Officer and our Chief Accounting Officer have evaluated the
effectiveness of our disclosure controls and procedures (as such term is defined
in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the
period covered by this report. Based on such evaluation, our Chief Executive
Officer and our Chief Accounting Officer conclude that, as of the end of the
period covered by this report, our disclosure controls and procedures are
effective, in that they provide reasonable assurance that the information
required to be disclosed by the Company in the reports that it files or submits
under the Exchange Act is recorded, processed, summarized and reported within
the time periods required by the SEC's rules and forms.
(b) Changes in internal control over financial reporting.
There have been no changes in our internal control over financial reporting (as
such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)
during the period covered by this report that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
PART III
This Part incorporates certain information from the definitive proxy statement
(the "2004 Proxy Statement") for the Company's 2004 Annual Meeting of
Shareholders, to be filed with the SEC on or about April 26, 2004 which is not
later than 120 days after the end of the Company's fiscal year.
Item 10. Directors and Executive Officers of the Registrant.
Information concerning the Company's executive officers is included under the
caption "Executive Officers" on page 9 of this report. Information concerning
the Company's directors and filing of certain reports of beneficial ownership is
incorporated by reference to the Company's 2004 Proxy Statement. We have adopted
a Code of Business Conduct and Ethics (our "Code of Ethics") that applies to our
employees, officers and directors. The complete Code of Ethics is available on
our website at www.capitalbank-nc.com. If at any time it is not available on our
website, we will provide a copy upon written request made to our Corporate
Secretary, Capital Bank Corporation, 4901 Glenwood Avenue, Raleigh, North
Carolina 27612 (telephone - 919-645-6400). Information on our website is not
part of this report. If we amend or grant any waiver from a provision of our
Code of Ethics that applies to our executive officers, we will publicly disclose
such amendment or waiver as required by applicable law, including by posting
such amendment or waiver on our website at www.capitalbank-nc.com or by filing a
Current Report on Form 8-K.
Item 11. Executive Compensation.
This information is incorporated by reference to the Company's 2004 Proxy
Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
This information is incorporated by reference to the Company's 2004 Proxy
Statement.
Item 13. Certain Relationships and Related Transactions.
This information is incorporated by reference to the Company's 2004 Proxy
Statement.
- 58 -
Item 14. Principal Accountant Fees and Services
This information is incorporated by reference to the Company's 2004 Proxy
Statement.
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports On Form 8-K.
(a)(1) Financial Statements. The financial statements and information listed
below are included in this report in Part I, Item 8:
Financial Statements and Information
Consolidated Balance Sheets as of December 31, 2003 and 2002
Consolidated Statements of Operations for the years ended December 31,
2003, 2002 and 2001
Consolidated Statements of Changes in Shareholders' Equity for the years
ended December 31, 2003, 2002 and 2001
Consolidated Statements of Cash Flows for the years ended December 31,
2003, 2002 and 2001
Notes to Consolidated Financial Statements
Report of Independent Auditors
(a)(2) Financial Statement Schedules. All applicable financial statement
schedules required under Regulation S-X and pursuant to Industry Guide 3 under
the Securities Act have been included in the Notes to the Consolidated Financial
Statements.
(a)(3) Exhibits. The exhibits required by Item 601 of Regulation S-K are listed
in the Exhibit Index immediately following the signature pages to this report.
(b) Reports on Form 8-K. During the last quarter of the period covered by this
report, the Company filed the following Current Reports on Form 8-K:
(1) Current Report on Form 8-K furnished on October 16, 2003, containing
a press release reporting its anticipated financial results for the
quarterly period ended September 30, 2003. Information furnished in
the Form 8-K referenced in the prior sentence is not deemed to be
filed with the SEC.
(2) Current Report on Form 8-K furnished on October 30, 2003, containing
a press release reporting financial results for the quarterly period
ended September 30, 2003, which included selected financial data for
the quarter ended September 30, 2003 and for other selected periods.
Information furnished in the Form 8-K referenced in the prior
sentence is not deemed to be filed with the SEC.
- 59 -
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in Raleigh, North
Carolina, on the 12th day of March, 2004.
CAPITAL BANK CORPORATION
By: /s/ William C. Burkhardt
-------------------------------------
William C. Burkhardt
Chief Executive Officer
- 60 -
SIGNATURES AND POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints William C. Burkhardt and Steven E. Crouse, and each of
them, with full power to act without the other, his true and lawful
attorneys-in-fact and agents, with full powers of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any or all amendments to this report, and to file the same,
with all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully for all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents, or their substitutes, may
lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant in
the capacities indicated and on March 12, 2004.
Signature Title
--------- -----
/s/ William C. Burkhardt
- -------------------------- Chief Executive Officer and Director
William C. Burkhardt
/s/ Steven E. Crouse
- ------------------------- Senior Vice President, Finance and Chief Accounting
Steven E. Crouse Officer (Principal Financial and Accounting Officer)
/s/ Charles F. Atkins
- -------------------------- Director
Charles F. Atkins
/s/ Leopold I. Cohen
- -------------------------- Director
Leopold I. Cohen
/s/ William R. Gilliam
- -------------------------- Vice Chairman of the Board of Directors
William R. Gilliam
/s/ John F. Grimes, III
- ------------------------- Director
John F. Grimes, III
/s/ Robert L. Jones
- -------------------------- Director
Robert L. Jones
- 61 -
/s/ Oscar A. Keller, III
- ----------------------------- Chairman of the Board of Directors
Oscar A. Keller, III
/s/ Oscar A. Keller, Jr.
- ---------------------------- Director
Oscar A. Keller, Jr.
/s/ James D. Moser
- ---------------------------- Director
James D. Moser
/s/ George R. Perkins, III
- ---------------------------- Director
George R. Perkins, III
/s/ Don W. Perry
- ---------------------------- Director
Don W. Perry
/s/ Carl H. Ricker, Jr.
- ---------------------------- Director
Carl H. Ricker, Jr.
/s/ J. Rex Thomas
- ---------------------------- Director
J. Rex Thomas
/s/ Samuel J. Wornom, III
- ---------------------------- Director
Samuel J. Wornom, III
- 62 -
EXHIBIT INDEX
Exhibit No. Description
Exhibit No. Description
- ----------- -----------
3.01(1) Articles of Incorporation of the Company
3.02(2) Bylaws of the Company, as amended to date
4.01(1) Specimen Common Stock Certificate of the Company
4.02 In accordance with Item 601(b)(4)(iii)(A) of Regulation S-K,
certain instruments respecting long-term debt of the registrant
have been omitted but will be furnished to the Commission upon
request.
10.01(1,3) Equity Incentive Plan
10.02(1,3) Deferred Compensation Plan for Outside Directors
10.03(3,4) Employment Agreement dated July 22, 2003 between B. Grant Yarber
and Capital Bank Corporation
10.04(5) Lease Agreement, dated November 16, 1999, between Crabtree Park,
LLC and the Company.
10.05(2) Agreement, dated November 2001 between Fiserv Solutions, Inc.
and the Company.
21 Subsidiaries of the Registrant
23 Consent of Independent Accountants
31.01 Certification of Chief Executive Officer Pursuant to Rule
13a-14(a) or Rule 15d-14(a), As Adopted Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.02 Certification of Chief Accounting Officer Pursuant to Rule
13a-14(a) or Rule 15d-14(a), As Adopted Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.01 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted
Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002. [This
exhibit is being furnished pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and shall not, except to the extent
required by that act, be deemed to be incorporated by reference
into any document or filed herewith for purposes of liability
under the Securities Exchange Act of 1934, as amended, or the
Securities Act of 1933, as amended, as the case may be.]
32.02 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted
Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002. [This
exhibit is being furnished pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and shall not, except to the extent
required by that act, be deemed to be incorporated by reference
into any document or filed herewith for purposes of liability
under the Securities Exchange Act of 1934, as amended, or the
Securities Act of 1933, as amended, as the case may be.]
1. Incorporated by reference to the Company's Registration Statement on Form S-4
filed with the SEC on October 19, 1998, as amended on November 10, 1998,
December 21, 1998 and February 8, 1999.
2. Incorporated by reference to the Company's Annual Report on Form 10-K filed
with the SEC on March 29, 2002.
3. Denotes a management contract or compensatory plan, contract or arrangement.
4. Incorporated by reference to the Company's Quarterly Report on Form 10-Q
filed with the SEC on November 14, 2003.
5. Incorporated by reference to the Company's Annual Report on Form 10-K filed
with the SEC on March 27, 2000.
- 63 -