UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2005
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From __________ to __________
Commission File Number 0-30062
CAPITAL BANK CORPORATION
------------------------
(Exact name of registrant as specified in its charter)
North Carolina 56-2101930
-------------- ----------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
4901 Glenwood Avenue
Raleigh, North Carolina 27612
---------------------------------------------------
(Address of Principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (919) 645-6400
--------------
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. |X| Yes |_| No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). |X| Yes |_| No
As of May 6, 2005 there were 6,568,690 shares outstanding of the registrant's
common stock, no par value.
Capital Bank Corporation
CONTENTS
PART I - FINANCIAL INFORMATION Page No.
Item 1. Financial Statements
Condensed consolidated statements of financial condition at March 31, 2005
(Unaudited) and December 31, 2004 1
Condensed consolidated statements of income for the three months
ended March 31, 2005 and 2004 (Unaudited) 2
Condensed consolidated statements of changes in shareholders' equity for
the three months ended March 31, 2005 and 2004 (Unaudited) 3
Condensed consolidated statements of cash flows for the three months
ended March 31, 2005 and 2004 (Unaudited) 4 - 5
Notes to condensed consolidated financial statements 6 - 10
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 10 - 25
Item 3. Quantitative and Qualitative Disclosures About Market Risk 25
Item 4. Controls and Procedures 25 - 26
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 26
Item 3. Defaults Upon Senior Securities 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information 26
Item 6. Exhibits 27
Signatures 28
Item 1. Financial Statements
CAPITAL BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
March 31, 2005 and December 31, 2004
March 31, December 31,
2005 2004
- ----------------------------------------------------------------------------------------
(Dollars in thousands) (Unaudited)
ASSETS
Cash and due from banks:
Interest earning $ 369 $ 971
Noninterest earning 28,340 22,036
Federal funds sold and short term investments 4,611 4
Investment securities - available for sale, at fair value 139,575 140,946
Investment securities - held to maturity, at amortized cost 14,046 13,336
Federal Home Loan Bank stock 6,345 6,298
Loans - net of unearned income and deferred fees 647,922 654,867
Allowance for loan losses (10,372) (10,721)
--------- ---------
Net loans 637,550 644,146
--------- ---------
Premises and equipment, net 15,691 15,608
Bank owned life insurance 13,632 13,500
Deposit premium and goodwill, net 13,011 13,065
Deferred tax assets 6,516 5,985
Accrued interest receivable and other assets 7,626 6,399
--------- ---------
Total assets $ 887,312 $ 882,294
========= =========
LIABILITIES
Deposits:
Demand, noninterest bearing $ 64,744 $ 65,673
Savings and interest bearing demand deposits 202,662 193,435
Time deposits 394,772 395,868
--------- ---------
Total deposits 662,178 654,976
--------- ---------
Repurchase agreements and federal funds purchased 14,346 16,755
Federal Home Loan Bank advances 100,864 102,320
Subordinated debentures 20,620 20,620
Accrued interest payable and other liabilities 12,339 9,885
--------- ---------
Total liabilities 810,347 804,556
--------- ---------
SHAREHOLDERS' EQUITY
Common stock, no par value; 20,000,000 shares authorized;
6,565,042 and 6,612,787 issued and outstanding as of
March 31, 2005 and December 31, 2004, respectively 67,468 68,341
Retained earnings 10,253 9,092
Accumulated other comprehensive income (loss) (756) 305
--------- ---------
Total shareholders' equity 76,965 77,738
--------- ---------
Total liabilities and shareholders' equity $ 887,312 $ 882,294
========= =========
See Notes to Condensed Consolidated Financial Statements
-1-
CAPITAL BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended March 31, 2005 and 2004
2005 2004
- ----------------------------------------------------------------------------------------
(In thousands except per share data) (Unaudited)
Interest income:
Loans and loan fees $ 9,742 $ 8,471
Investment securities 1,697 1,718
Federal funds and other interest income 17 42
----------- -----------
Total interest income 11,456 10,231
----------- -----------
Interest expense:
Deposits 3,182 2,862
Borrowings and repurchase agreements 1,368 1,100
----------- -----------
Total interest expense 4,550 3,962
----------- -----------
Net interest income 6,906 6,269
Provision (credit) for loan losses (250) 116
----------- -----------
Net interest income after provision for loan losses 7,156 6,153
----------- -----------
Noninterest income:
Service charges and other fees 657 727
Mortgage banking revenues 272 337
Net gain on sale of securities 6 13
Other noninterest income 405 524
----------- -----------
Total noninterest income 1,340 1,601
----------- -----------
Noninterest expenses:
Salaries and employee benefits 3,149 2,842
Occupancy 614 572
Furniture and equipment 367 365
Data processing 311 322
Advertising 216 202
Amortization of deposit premium 54 65
Other expenses 1,439 1,269
----------- -----------
Total noninterest expenses 6,150 5,637
----------- -----------
Income before income tax expense 2,346 2,117
Income tax expense 791 737
----------- -----------
Net income $ 1,555 $ 1,380
=========== ===========
Earnings per share - basic $ 0.23 $ 0.21
=========== ===========
Earnings per share - diluted $ 0.22 $ 0.20
=========== ===========
Weighted average shares
Basic 6,754,576 6,688,946
=========== ===========
Fully diluted 6,941,776 6,886,567
=========== ===========
See Notes to Condensed Consolidated Financial Statements
-2-
Capital Bank Corporation
Consolidated Statements of Changes in Shareholders' Equity
For the Three Months Ended March 31, 2005 and 2004
(Dollars in thousands)
Shares of Other
Common Common Comprehensive Retained
Stock Stock Income Earnings Total
---------- ---------- ------------- ---------- ----------
(Unaudited)
Balance at January 1, 2004 6,541,495 $ 67,381 $ 377 $ 5,165 $ 72,923
Issuance of common stock
for options exercised 29,637 343 -- -- 343
Net income -- -- -- 1,380 1,380
Other comprehensive income -- -- 1,123 -- 1,123
----------
Comprehensive income 2,503
----------
Dividends ($0.05 per share) -- -- -- (329) (329)
---------- ---------- ---------- ---------- ----------
Balance at March 31, 2004 6,571,132 $ 67,724 $ 1,500 $ 6,216 $ 75,440
========== ========== ========== ========== ==========
Balance at January 1, 2005 6,612,787 $ 68,341 $ 305 $ 9,092 $ 77,738
Repurchase of outstanding common stock (50,000) $ (892) $ -- $ -- (892)
Issuance of common stock
for options exercised 2,255 19 -- -- 19
Net income -- -- -- 1,555 1,555
Other comprehensive loss -- -- (1,061) -- (1,061)
----------
Comprehensive income 494
----------
Dividends ($0.06 per share) -- -- -- (394) (394)
---------- ---------- ---------- ---------- ----------
Balance at March 31, 2005 6,565,042 $ 67,468 $ (756) $ 10,253 $ 76,965
========== ========== ========== ========== ==========
See Notes to Condensed Consolidated Financial Statements
-3-
CAPITAL BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, 2005 and 2004
2005 2004
- -------------------------------------------------------------------------------------
(In thousands) (Unaudited)
Cash Flows From Operating Activities
Net income $ 1,555 $ 1,380
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of deposit premium 54 65
Depreciation 362 362
Net gains on sale of securities available for sale (6) (13)
Change in held for sale loans (1,550) 2,613
Amortization of premiums on securities, net 76 173
Deferred income tax expense 135 272
Provision (credit) for loan losses (250) 116
Changes in assets and liabilities:
Accrued interest receivable and other assets (1,243) 257
Accrued interest payable and other liabilities 2,457 413
Other operating activities, net -- 9
-------- --------
Net cash provided by operating activities 1,590 5,647
-------- --------
Cash Flows From Investing Activities
Loan (originations) repayments, net 8,280 (19,893)
Additions to premises and equipment (445) (770)
Net (purchase) sales of Federal Home Loan Bank stock (47) 852
Purchase of securities available for sale (7,491) (17,643)
Purchase of securities held to maturity (973) --
Proceeds from maturities of securities available for sale 4,637 9,009
Proceeds from sales of securities available for sale 2,430 16,013
Proceeds from maturities of securities held to maturity 261 --
Other investing activities, net -- 7
-------- --------
Net cash provided by (used in)
investing activities 6,652 (12,425)
-------- --------
Cash Flows From Financing Activities
Net increase in deposits 7,202 49,198
Net decrease in repurchase agreements (2,409) (1,092)
Net decrease in borrowings (1,456) (17,068)
Cash dividends paid (397) (328)
Issuance of common stock for options 19 343
Purchase of common stock (892) --
-------- --------
Net cash provided by financing activities 2,067 31,053
-------- --------
Net change in cash and cash equivalents 10,309 24,275
Cash and cash equivalents:
Beginning of period 23,011 25,610
-------- --------
Ending at March 31 $ 33,320 $ 49,885
======== ========
(continued on next page)
See Notes to Condensed Consolidated Financial Statements
-4-
CAPITAL BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Three Months Ended March 31, 2005 and 2004
2005 2004
- --------------------------------------------------------------------------------
(In thousands) (Unaudited)
Supplemental Disclosure of Cash Flow Information
Transfer from loans to real estate acquired
through foreclosure $ 116 $ 310
======== ========
Dividends payable $ 394 $ 329
======== ========
Cash paid for:
Income taxes $ 223 $ 63
======== ========
Interest $ 4,414 $ 3,875
======== ========
See Notes to Condensed Consolidated Financial Statements
-5-
Notes to Condensed Consolidated Financial Statements
1. Significant Accounting Policies and Interim Reporting
The accompanying unaudited condensed consolidated financial statements include
the accounts of Capital Bank Corporation (the "Company") and its wholly owned
subsidiary, Capital Bank (the "Bank"). 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 have not been consolidated with the
financial statements of the Company. The interim financial statements have been
prepared in accordance with generally accepted accounting principles. They do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements and therefore should be
read in conjunction with the audited financial statements and accompanying
footnotes in the Company's Annual Report on Form 10-K for the year ended
December 31, 2004, as amended. In the opinion of management, all adjustments
necessary for a fair presentation of the financial position and results of
operations for the periods presented have been included and all significant
intercompany transactions have been eliminated in consolidation. The results of
operations for the three month period ended March 31, 2005 are not necessarily
indicative of the results of operations that may be expected for the year ended
December 31, 2005.
The balance sheet at December 31, 2004 has been derived from the Company's
audited consolidated financial statements contained in the Company's Annual
Report on Form 10-K for the year ended December 31, 2004, as amended.
The accounting policies followed are as set forth in Note 1 of the Notes to
Financial Statements in the Company's Annual Report on Form 10-K for the year
ended December 31, 2004, as amended.
2. Comprehensive Income
Comprehensive income includes net income and all other changes to the Company's
equity, with the exception of transactions with shareholders ("other
comprehensive income"). The Company's comprehensive income for the three month
period ended March 31, 2005 and 2004 are as shown in the Company's Consolidated
Statements of Changes in Shareholder's Equity for the three months ended March
31, 2005 and 2004 (unaudited). The Company's only components of other
comprehensive income relate to unrealized gains and losses on securities
available for sale, net of the applicable income tax effect and are as follows:
As of March 31,
2005 2004
---------------------
(Dollars in thousands) (Unaudited)
Unrealized (losses) gains on securities available for sale $ (1,721) $ 1,852
Reclassification of gains recognized in net income (6) (13)
Income tax benefit (expense) 666 (716)
-------- --------
Other comprehensive income (loss) $ (1,061) $ 1,123
======== ========
-6-
3. Earnings Per Share
The Company is required to report both basic and diluted earnings per share
("EPS"). 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. Diluted EPS assumes the conversion, exercise or
issuance of all potential common stock instruments, such as stock options,
unless the effect is to reduce a loss or increase earnings per share. For the
Company, EPS is adjusted for outstanding stock options using the treasury stock
method in order to compute diluted EPS. The following tables provide a
computation and reconciliation of basic and diluted EPS for the three month
periods ended March 31, 2005 and 2004, respectively:
2005 2004
--------------------------
(Dollars in thousands) (Unaudited)
Three month periods ended March 31, 2005 and 2004:
Income available to shareholders - basic and diluted $ 1,555 $ 1,380
=========== ===========
Shares used in the computation of earnings per share:
Weighted average number of shares outstanding - basic 6,754,576 6,688,946
Incremental shares from assumed exercise of stock
options 187,200 197,621
----------- -----------
Weighted average number of shares outstanding - diluted 6,941,776 6,886,567
=========== ===========
Options to purchase approximately 692,000 shares of common stock were used in
the diluted calculation for the first quarter of 2005. An aggregate of 36,250
options were not included in the diluted calculation because the option price
exceeded the average fair market value of the associated shares of common stock
during the first quarter of 2005.
4. Stock Based Compensation
The Company has a stock option plan under which options to purchase Company
common stock may be granted periodically to certain employees. Grants of options
are made by the Board of Directors or its 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
certain vesting provisions.
The Company accounts for stock options under the provisions of APB Opinion No.
25 ("APB 25"), Accounting for Stock Issued to Employees. However, under the
provisions of Statement of Financial Accounting Standards ("SFAS") No. 123 ("FAS
123"), Accounting for Stock-Based Compensation, 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 certain assumptions. Option pricing models require the use of highly
subjective assumptions, including expected stock price volatility, which if
changed can materially affect fair value estimates.
Under SFAS No. 148 ("FAS 148"), Accounting for Stock-Based
Compensation--Transition and Disclosure, companies are required to disclose for
each period for which an income statement is
-7-
presented an accounting policy footnote that includes: (i) the method of
accounting for stock options; (ii) total stock compensation cost that is
recognized in the income statement and would have been recognized had FAS 123
been adopted for recognition purposes as of its effective date; and (iii) pro
forma net income and earnings per share (where applicable) that would have been
reported had FAS 123 been adopted for recognition purposes as of its effective
date. These disclosures are required to be made in annual financial statements
and in quarterly information provided to shareholders without regard to whether
the entity has adopted FAS 123 for recognition purposes.
The Company granted 1,000 options to purchase its shares of common stock at a
weighted average price of $18.37 during the first three months of 2005. For the
three month period ended March 31, 2005, the following table summarizes the net
income and stock-based compensation expense, as reported, compared to pro forma
amounts had the fair value method been applied:
2005 2004
------------------
(Dollars in thousands) (Unaudited)
Three month periods ended March 31, 2005 and 2004:
Net income, as reported $ 1,555 $ 1,380
Add: Stock-based employee compensation expenses included
in reported net income, net of tax effects -- --
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects (48) (42)
------------------
Pro forma net income $ 1,507 $ 1,338
==================
Earnings per share:
Basic - as reported $ 0.23 $ 0.21
Basic - pro forma $ 0.22 $ 0.20
Diluted - as reported $ 0.22 $ 0.20
Diluted - pro forma $ 0.22 $ 0.19
The implementation of SFAS 123R has been delayed and will not take effect until
January 1, 2006. Additional details on the impact for the Company is included in
the Company's Annual Report on Form 10-K, as amended, in footnote 1 to the Note
to Consolidated Financial Statements.
5. Investment Securities
The following table shows the gross unrealized losses and fair value of the
Company's investments with unrealized losses that are not deemed to be
other-than-temporarily impaired, aggregated by investment category and length of
time that individual securities have been in a continuous unrealized loss
position, at March 31, 2005:
-8-
(Unaudited)
(Dollars in thousands) Less Than 12 Months 12 Months or Greater Total
----------------------------------------------------------------------
Unrealized Unrealized Unrealized
Description of Security Fair Value Losses Fair Value Losses Fair Value Losses
- -----------------------------------------------------------------------------------------------------
Available for sale
Direct obligations of U.S.
government agencies $ 15,891 $ 192 $ 16,842 $ 674 $ 32,733 $ 866
Municipal bonds 2,204 33 2,409 100 4,613 133
Federal agency mortgage-
backed securities 53,358 531 15,433 463 68,791 994
--------------------------------------------------------------------
71,453 756 34,684 1,237 106,137 1,993
--------------------------------------------------------------------
Held to maturity
Direct obligations of U.S.
government agencies 4,927 71 -- -- 4,927 71
Municipal bonds 293 7 -- -- 293 7
Federal agency mortgage-
backed securities 7,650 126 -- -- 7,650 126
--------------------------------------------------------------------
12,870 204 -- -- 12,870 204
--------------------------------------------------------------------
$ 84,323 $ 960 $ 34,684 $ 1,237 $119,007 $ 2,197
====================================================================
Government Agency Obligations. The unrealized losses on the Company's
investments in direct obligations of U.S. government agencies were the result of
interest rate increases. The contractual terms of these investments do not
permit the issuer to settle the securities at a price materially less than the
amortized cost of the investment. Because the Company has the ability and intent
to hold these investments until a recovery of fair value, which may be maturity,
the Company does not consider these investments to be other-than-temporarily
impaired at March 31, 2005.
Federal Agency Mortgage-Backed Securities. The unrealized losses on the
Company's investment in agency mortgage-backed securities issued by FNMA, FHLMC,
and GNMA were caused by interest rate increases. The Company purchased most of
these investments at either a discount or a premium relative to their face
amount, and the contractual cash flows of each is guaranteed by the issuer
organization. Accordingly, it is expected that the securities would not be
settled at a price materially less than the amortized cost of the Company's
investment. Because the decline in market value is attributable to changes in
interest rates and not credit quality and because the Company has the ability to
hold these investments until a recovery of fair value, which may be maturity,
the Company does not consider these investments to be other-than-temporarily
impaired at March 31, 2005.
6. Loans
The composition of the loan portfolio by loan classification at March 31, 2005
and December 31, 2004 is as follows:
-9-
March 31, December 31,
(Dollars in thousands) 2005 2004
--------- ---------
Commercial $ 527,306 $ 531,834
Consumer 31,990 34,865
Home equity lines 61,989 61,925
Residential mortgages 26,287 26,020
--------- ---------
647,572 654,644
Plus deferred loan costs, net 350 223
--------- ---------
$ 647,922 $ 654,867
========= =========
Loans held for sale as of March 31, 2005 and December 31, 2004 were $4.9 million
and $3.4 million, respectively, and were included in the residential mortgage
category.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- ------- -----------------------------------------------------------------------
of Operations
- -------------
The following discussion presents an overview of the unaudited financial
statements for the three month period ended March 31, 2005 and 2004 for Capital
Bank Corporation (the "Company") and its wholly owned subsidiary. This
discussion and analysis is intended to provide pertinent information concerning
financial position, results of operations, liquidity, and capital resources for
the periods covered and should be read in conjunction with the unaudited
financial statements and related footnotes contained in Part I, Item 1 of this
report.
Information set forth below contains various forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended (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 to differ materially. 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 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, as well as the factors
set forth in this discussion and analysis, and the Company's periodic reports
and other filings with the Securities and Exchange Commission ("the SEC").
Risk Factors
You should consider the following material risk factors carefully before
deciding to invest in Capital Bank Corporation securities. Additional risks and
uncertainties not presently known to us, that we may currently deem to be
immaterial or that are similar to those faced by other companies in our industry
or business in general, such as competitive conditions, may also impact our
business operations. If any of the events described below occur, the Company's
business, financial condition, or results of operations could be materially
adversely affected. In that event, the trading price of the Company's common
stock may decline, in which case the value of your investment may decline as
well.
-10-
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.
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. 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.
We Compete With Larger Companies for 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
nonbank financial services providers, many of which have substantially greater
resources including higher total assets and capitalization, greater access to
capital markets and a broader offering 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.
-11-
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 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 undercapitalized. 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
including those imposed by the SEC may adversely affect our ability to operate
profitably.
There Are Potential Risks Associated With Future Acquisitions and Expansions
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 the
Company's common stock in connection with such acquisitions.
-12-
Any given acquisition, if and when consummated, may adversely affect our results
of operations or overall financial condition.
We may also expand our branch network through de novo branches in existing or
new markets. These de novo branches will have expenses in excess of revenues for
varying periods after opening which could decrease the Company's reported
earnings.
Compliance with Changing Regulation of Corporate Governance and Public
Disclosure May Result in Additional Risks and Expenses
Changing laws, regulations and standards relating to corporate governance and
public disclosure, including the Sarbanes-Oxley Act of 2002 and new federal
securities regulations, are creating uncertainty for us. These laws, regulations
and standards are subject to varying interpretations in many cases, and as a
result, their application in practice may evolve over time as new guidance is
provided by regulatory and governing bodies, which could result in continuing
uncertainty regarding compliance matters and higher costs necessitated by
ongoing revisions to disclosure and governance practices. We are committed to
maintaining high standards of corporate governance and public disclosure. As a
result, our efforts to comply with evolving laws, regulations and standards have
resulted in, and are likely to continue to result in, increased expenses and a
diversion of management time and attention. In particular, our efforts to comply
with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations
regarding management's required assessment of our internal control over
financial reporting and our external auditors' audit of that assessment has
required the commitment of significant financial and managerial resources. We
expect these efforts to require the continued commitment of significant
resources. Further, the members of our Board of Directors, members of the Audit
or Compensation committees, our Chief Executive Officer, our Chief Financial
Officer and certain other of our executive officers could face an increased risk
of personal liability in connection with the performance of their duties. As a
result, our ability to attract and retain executive officers and qualified Board
and committee members could be more difficult. In addition, it may become more
difficult and more expensive to obtain director and officer liability insurance.
Overview
Capital Bank Corporation is a financial holding company incorporated under the
laws of the state of North Carolina on August 10, 1998. The Company's primary
function is to serve as the holding company for its wholly-owned subsidiary,
Capital Bank (the "Bank"). 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 have not been consolidated with the financial
statements of the Company. 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 is a community bank engaged in the general commercial banking
business in Wake, Chatham, Granville, Alamance, Lee, Buncombe, Guilford and
Catawba Counties of 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, Granville, and Chatham
counties are significant centers for various industries, including agriculture,
manufacturing, lumber and tobacco. Alamance and Guilford counties have a
diversified economic base, comprised primarily of manufacturing, agriculture,
retail and
-13-
wholesale trade, government, services and utilities. Catawba County, which
includes Hickory, is a regional center for manufacturing and wholesale trade.
The economic base of Buncombe County is comprised primarily of services,
medical, tourism and manufacturing industries and includes the city of
Asheville.
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; home equity lines
of credit; consumer loans; 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.
The Bank offers non-insured investment products and services by Capital Bank
Financial Services through a partnership with Capital Investment Group, a
leading Raleigh, North Carolina based broker-dealer. The Bank employs
commission-based financial advisors to offer full-service brokerage to
individual and corporate customers.
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 subordinated debentures ("the Debentures"), 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.
The Company has no operations other than those of its subsidiaries.
Executive Summary
As discussed in more detail below, the following is a brief summary of certain
of our significant quarterly results:
o The Company recorded an increase in net income for the first quarter
2005 compared to the first quarter of 2004. Net income for the
quarter was $1.6 million, or $0.22 per fully diluted share, compared
to $1.4 million, or $0.20 per fully diluted share, in the first
quarter of 2004.
o For the three months ended March 31, 2005, the credit for loan
losses was $(250,000) compared to a provision of $116,000 for the
three months ended March 31, 2004. Net charge-offs for the three
months ended March 31, 2005 were $99,000 or 0.06% of average loans,
compared to $508,000, or 0.32% of average loans, for the three
months ended March 31, 2004. The significant decline in the
provision expense during the quarter was primarily due to a decline
in the volume of charged-off loans and a decrease in the size of the
loan portfolio in the first quarter.
-14-
o Net interest income increased $637,000, or approximately 10%, from
$6.3 million for the three month period ended March 31, 2004, to
$6.9 million for the same period in 2005. The Company's net interest
margin increased compared to first quarter of 2004 by 34 basis
points to 3.53% in first quarter of 2005. Net interest margin
improved primarily due to seven 25 basis point increases in the
Federal Reserve Open Market Committee's benchmark federal funds rate
beginning on June 30, 2004.
o Noninterest income for the three month period ended March 31, 2005,
was $1.3 million compared to $1.6 million for the same period in
2004, a decrease of 16%. The largest single component of the decline
was due to gains of $108,000 recorded in the first quarter of 2004
on the sale of repossessed property compared to losses of $17,000
during the same period of 2005.
o Noninterest expense was $6.2 million for the three month period
ended March 31, 2005 compared to $5.6 million for the same period of
2004. Increases in salaries and employee benefits, the largest
noninterest expense category, were the primary cause of the overall
noninterest expense increase as those costs moved to $3.1 million
for the three month period ended March 31, 2005 from $2.8 million
for the same period in 2004. This increase was primarily due to an
increase in the number of personnel employed by the Company and
management's intention to maintain adequate staffing to meet
customer's needs and keep pace with expected growth.
Financial Condition
Total consolidated assets of the Company at March 31, 2005 were $887.3 million
compared to $882.3 million at December 31, 2004, an increase of $5.0 million, or
almost 1%. Overall growth in the balance sheet was due to modest internal growth
resulting primarily from a successful core deposit campaign during the first
quarter of 2005.
On March 31, 2005, loans, including loans held for sale of $4.9 million, were
$647.9 million, down $6.9 million, or 1%, from December 31, 2004. The net
decrease is due to lower than anticipated loan growth coupled with the
prepayment by certain customers of their outstanding loans from the Company.
While many customers sought fixed rate loans in anticipation of continued
increases in interest rates on variable rate loans, the Company continued to
price fixed rate loans at rates which provide an appropriate spread to its
funding costs. As a result, the Company has lost several loans to other
institutions willing to provide lower rates. The actual number of notes
originated during the quarter was higher than the number originated in the
fourth quarter.
At March 31, 2005, investment securities were $160.0 million, down $614,000 from
December 31, 2004. The decline primarily reflects a drop in the market value of
bonds in the portfolio as market rates increased along with increases in the
federal funds rate. Federal funds sold and short term investments were $4.6
million, up $4.6 million from December 31, 2004. At year end, the Company was in
a federal funds purchased position, however increases in deposits later in the
quarter and a decrease in the loan portfolio over the first quarter of 2005
resulted in additional short term liquidity at quarter end.
Earning assets represented 91.6% of total assets as of March 31, 2005. The
allowance for loan losses as of March 31, 2005 was $10.4 million and represented
approximately 1.60% of total
-15-
loans and 1.61% of loans excluding those held for sale at the end of the period.
The allowance for loan losses decreased $349,000, from the December 31, 2004
balance of $10.7 million. Management believes that the amount of the allowance
is adequate to absorb probable losses inherent in the current loan portfolio.
See "Asset Quality" for further discussion of the allowance for loan losses.
Deposits as of March 31, 2005 were $662.2 million, an increase of $7.2 million,
or 1%, from December 31, 2004. The overall net growth was primarily the result
of strong internal growth fueled by a successful core deposit campaign during
the first quarter. One of the Company's highest priorities for 2005 is the
growth of non-time deposits including demand deposit accounts ("DDA") and money
market accounts. During the first three months of 2005, the Company experienced
a net decrease of $1.1 million, or 0.3%, in certificates of deposit ("CDs")
compared to December 31, 2004. In the first quarter of 2004, the Company had a
deposit campaign which originated a significant number of thirteen month CDs.
These thirteen month CDs will continue to mature through early May. In addition,
the Company has not aggressively priced certain maturing CDs where the customer
has no other banking relationship with the Company. Certificates of deposit
represented 59.6% of total deposits at March 31, 2005 compared to 60.4% at
December 31, 2004.
Noninterest bearing DDAs decreased to $64.7 million at March 31, 2005, a
decrease of $929,000, or 1%, from $65.7 million at December 31, 2004. During the
first quarter of 2005, the Company focused on gathering money market accounts
and, accordingly, the Bank began an advertising and promotional campaign
designed to attract more of those types of deposits. As a result of the
campaign, savings, interest bearing DDAs, and money market accounts increased to
$202.7 million at March 31, 2005, an increase of $9.2 million, or 5%, from
$193.4 million at December 31, 2004.
Total consolidated shareholders' equity was $77.0 million as of March 31, 2005,
a decrease of $773,000 from December 31, 2004. Retained earnings increased by
$1.2 million reflecting the net income during the three month period ended March
31, 2005 less dividends paid during that same time, offset by a $1.1 million
decline in accumulated other comprehensive income due to declines in the market
value of the investment portfolio. Common stock decreased by $873,000 as a
result of repurchases of the Company's stock pursuant to an approved repurchase
plan. See Part I - Consolidated Statements of Changes in Shareholders' Equity
for additional information and Part II Item 2 for details of the share
repurchase.
Results of Operations
Three month period ended March 31, 2005
- ---------------------------------------
For the three month period ended March 31, 2005, the Company reported net income
of $1.6 million, or $.22 per diluted share, compared to net income of $1.4
million or $.20 per diluted share, for the three month period ended March 31,
2004. The improved net income was due to improved net interest margins and a
lower provision for loan losses for the comparable periods.
Net interest income increased $637,000, or approximately 10%, from $6.3 million
for the three month period ended March 31, 2004, to $6.9 million for the same
period in 2005. Average earning assets increased $6.6 million period over period
while average interest bearing liabilities decreased $3.2 million. The net
interest margin on a fully taxable equivalent basis increased 34
-16-
basis points quarter-over-quarter to 3.53% for the three month period ended
March 31, 2005 from 3.19% for the same time period for 2004. The increase in the
net interest margin is primarily attributed to increases in the benchmark
federal funds rates as determined by the Federal Reserve Open Market Committee
("FOMC"), resulting in seven corresponding increases in the prime interest rate
starting on June 30, 2004. The Company's balance sheet remains asset-sensitive
and, as a result, its interest earning assets reprice quicker than its interest
bearing liabilities. Since June 30, 2004 the Bank has increased its prime rate
by 175 basis points to 5.75% in response to FOMC rate increases. The FOMC met
again on May 3, 2005 and increased rates by another 25 basis points.
The following table shows 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.
-17-
Average Balances, Interest Earned or Paid, and Interest Yields/Rates
Three Months Ended March 31, 2005 and 2004
(Taxable Equivalent Basis - Dollars in Thousands) (1)
2005 2004
--------------------------------------------------------------------------
Average Amount Average Average Amount Average
Balance Earned Rate Balance Earned Rate
--------------------------------------------------------------------------
Assets
Loans receivable: (2)
Commercial $ 533,246 $ 7,927 6.03% $ 482,844 $ 6,344 5.26%
Consumer 31,823 567 7.23% 39,149 663 6.77%
Home equity 61,913 874 5.73% 59,299 722 4.87%
Residential mortgages (3) 25,447 374 5.96% 47,972 742 6.19%
-------------------------------------------------------------------------
Total loans 652,429 9,742 6.06% 629,264 8,471 5.38%
Investment securities (4) 157,963 1,861 4.78% 162,290 1,886 4.65%
Federal funds sold and other
interest on short term investments 2,571 17 2.68% 14,847 42 1.13%
-------------------------------------------------------------------------
Total interest earning assets 812,963 $ 11,620 5.80% 806,401 $ 10,399 5.16%
===================== =====================
Cash and due from banks 22,466 24,022
Other assets 55,346 51,765
Allowance for loan losses (10,863) (11,715)
--------- ---------
Total assets $ 879,912 $ 870,473
========= =========
Liabilities and Equity
Savings deposits $ 15,751 $ 10 0.26% $ 17,287 $ 11 0.25%
Interest-bearing demand deposits 174,133 638 1.49% 184,229 493 1.07%
Time deposits 395,926 2,534 2.60% 387,597 2,358 2.43%
-------------------------------------------------------------------------
Total interest bearing deposits 585,810 3,182 2.20% 589,113 2,862 1.94%
Borrowed funds 106,541 1,019 3.88% 110,760 869 3.14%
Trust preferred debt 20,620 276 5.43% 20,620 216 4.19%
Repurchase agreements 15,480 73 1.91% 11,183 15 0.54%
-------------------------------------------------------------------------
Total interest-bearing liabilities 728,451 $ 4,550 2.53% 731,676 $ 3,962 2.17%
===================== =====================
Non-interest bearing deposits 61,977 55,919
Other liabilities 11,008 8,399
--------- ---------
Total liabilities 801,436 795,994
Shareholders' equity 78,476 74,479
--------- ---------
Total liabilities and equity $ 879,912 $ 870,473
========= =========
Net interest spread (5) 3.26% 2.99%
Tax equivalent adjustment $ 164 $ 168
Net interest income and net
interest margin (6) $ 7,070 3.53% $ 6,437 3.19%
(1) The taxable equivalent basis is computed using a blended federal and state
tax rate of approximately 38%.
(2) Loans receivable include nonaccrual loans for which accrual of interest
has not been recorded.
(3) Includes loans held for sale.
(4) The average balance for investment securities exclude the effect of their
mark-to-market adjustment, if any.
(5) Net interest spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing
liabilities.
(6) Net interest margin represents the net interest income divided by average
interest-earning assets.
-18-
Yields on commercial loans, home equity and consumer loans increased 77 basis
points, 86 basis points and 46 basis points, respectively, in the first quarter
of 2005 compared to the same period in 2004. Higher yields in 2005 reflect the
increase in the prime rate charged by the Bank between those two periods.
Variable rate loans made up approximately 69.3% of the total loan portfolio at
March 31, 2005 compared to 67.3% at March 31, 2004.
The yield on investment securities on a tax-equivalent basis increased from
4.65% in the first quarter of 2004 to 4.78% in the first quarter of 2005. The
investment yield in 2004 was negatively affected by higher premium amortizations
on mortgage backed securities ("MBS") as the average expected lives of the MBS
portfolio were shortened due to significant prepayments of the underlying
mortgage loans. MBS premium amortizations were approximately $76,000 in the
first quarter of 2005 compared to approximately $169,000 for the same period in
the prior year. Longer term rates have increased much less significantly than
short-term rates. The majority of the investment portfolio is in longer maturity
investments and, as a result, the Company's yield on investments will not
increase rapidly if long term rates begin to increase.
The rate paid on CDs increased from 2.43% to 2.60% from March 31, 2004 compared
to the same period in 2005, a 17 basis point rise, as new certificates were
opened at higher rates due to the rising interest rate environment. Rates on
shorter maturity CDs have increased significantly with the FOMC interest rate
increases and management anticipates the Bank's CD funding costs will increase
on a quarterly basis going forward, especially as the thirteen month CDs mature
and are repriced.
The rate on borrowings increased year over year from 3.15% to 3.88%. In July of
2003, the Bank entered into interest rate swap agreements on $25.0 million of
the outstanding Federal Home Loan Bank advances to swap fixed rate borrowings to
a variable rate. The net effect of the swaps has been to reduce interest and,
accordingly, the net effective rate paid on those advances. As short-term
interest rates have increased following the FOMC rate increases, the overall
effective yield on borrowings has increased. The increases in short-term rates
are also responsible for the increase in the cost of the Company's subordinated
debentures.
For the three month period ended March 31, 2005, the credit for loan losses was
$(250,000) compared to a provision of $116,000 for the same period in 2004, a
decrease of approximately $366,000. The decline in 2005 was primarily due to a
reduction in charge offs during the three month period ended March 31, 2005,
which dropped to $99,000 from $508,000 recorded in the same period of 2004,
improvements in the risk rating classifications of certain loans contained in
the portfolio and overall reduction of the loan portfolio as discussed above.
See "Asset Quality" for further discussion of the allowance for loan losses.
Noninterest income for the three month period ended March 31, 2004, was $1.3
million compared to $1.6 million for the same period in 2004, a decrease of
$261,000, or 16%. The largest single component of this decrease was a decline of
$119,000, or 23% in other noninterest income. This decrease was the result of
net gains of approximately $108,000 on sales of repossessed property recorded in
the first quarter of 2004 compared to net losses of approximately $17,000 for
the same period in 2005. Mortgage production, another large component of
noninterest income, was impacted by industry wide lower origination volumes
caused by higher mortgage interest rates. Mortgage revenues fell 19% to $272,000
in the first quarter of 2005 from $337,000 earned in the three month period
ended March 31, 2004. Deposit service charges and other fees also decreased
-19-
from $727,000 as of March 31, 2004 to $657,000 as of the same period in 2005.
This decrease is primarily due to a decrease in the number of deposit accounts
on which the fees are being charged due to the sale of three branches in the
latter part of 2004. Non-sufficient funds ("NSF") fees, one of the components of
deposit service charges and other fees, decreased to $441,000 during the three
months ended March 31, 2005 from $474,000 during the same period in 2004, also a
result of the decline in the number of deposit accounts on which these fees are
charged as a result of the branch sale and also a decrease in the number of NSF
occurrences. ATM fees, which are fees charged to individuals who are not
customers of the Bank, were not affected by the branch sale and increased 32%,
from $72,000 in the three month period ended March 31, 2004 to $95,000 in the
three month period ended March 31, 2005.
Noninterest expense for the three month period ended March 31, 2005 was $6.2
million compared to $5.6 million for the corresponding period in 2004. Salaries
and employee benefits, representing the largest noninterest expense category,
increased to $3.1 million for the three month period ended March 31, 2005, from
$2.8 million for the same period in 2004. This increase reflects an increase in
the number of personnel employed by the Company consistent with management's
intention to maintain adequate staffing levels to meet customer needs and keep
pace with expected growth. As of March 31, 2005, the Company had 241 full-time
equivalent employees ("FTEs") compared to 204 for the same date in 2004 and 227
at December 31, 2004. Almost a third of the increased FTEs are commissioned
positions added in the mortgage and retail brokerage areas.
Increases in noninterest expense also reflect a significant increase in
professional fees. Professional fees increased 56%, or $115,000, to $322,000 for
the three month period ended March 31, 2005 from $207,000 for the same period in
2004. Specific items within this category include legal collection expenses,
which increased approximately $54,000 to $89,000 for the period ended March 31,
2005 from $35,000 for the same period in 2004 and consulting, which increased
approximately $54,000 to $80,000 in 2005 from $26,000 in the comparable prior
year period.
Occupancy costs, the second largest component of noninterest expenses, increased
$42,000, or 7%, to $614,000 for the three month period ended March 31, 2005 from
$572,000 for the same period in 2004. This increase is primarily the result of
an increased number of locations as the Company has expanded its branch presence
into Greensboro and Wake Forest, North Carolina and has added an additional
branch in the Asheville, North Carolina area during the third quarter. In
addition, the Company moved its operations center to a new facility to
centralize the operations and credit administration functions during the early
part of 2004. The Bank also opened a new branch in Pittsboro during the second
quarter of 2005 and plans to relocate another branch in Cary late in the second
quarter of 2005.
The Company's effective tax rate for the first quarter of 2005 was 33.7%
compared to 34.8% for the comparable period of 2004. The Company forecasts it
taxable and non-taxable income and calculates the effective tax rate for the
entire year which is then applied to the three month period. The changes in the
effective tax rate are due to changes in forecasted levels of taxable and tax
exempt income and the decline for these comparable periods primarily reflects
the addition of nontaxable income as the result of a purchase of bank owned life
insurance in the latter part of 2004.
-20-
The Company recorded an income tax expense of $791,000 during the three month
period ended March 31, 2005 compared to an expense of $737,000 during the same
period in 2004. At March 31, 2005, the Company had net deferred tax assets of
$6.5 million resulting from timing differences associated primarily with the
deductibility of certain expenses reflected on the financial statements and the
mark-to-market of unrealized security losses.
Asset Quality
Determining the allowance for loan losses is based on a number of factors, many
of which are subject to judgments made by management. At the origination of each
commercial loan, management assesses the relative risk of the loan and assigns a
corresponding risk grade. To ascertain that the credit quality is maintained
after the loan is booked, the Bank has a procedure whereby a loan review officer
performs an annual review of all loans that exceed a predetermined threshold
amount, all unsecured loans over a predetermined loan amount, a sampling of
loans within a lender's authority, and a sampling of the entire loan pool. Loans
are reviewed for credit quality, sufficiency of credit and collateral
documentation, proper loan approval, covenant, policy and procedure adherence,
and continuing accuracy of the loan grade. This officer reports directly to the
Chief Credit Officer and will report on a sampling of loans each month to the
Loan Committee of the Bank's Board of Directors. On an as needed basis, the Bank
will hire an outside third party firm to review the Bank's loan portfolio to
ensure quality standards and reasonableness of risk assessment.
The Company calculates the amount of allowance needed to cover probable losses
in the portfolio by applying a reserve percentage to each risk grade. Consumer
loans and mortgages are not risk graded, but a percentage is reserved for these
loans based on historical losses. The reserve percentages have been developed
based on historical losses and industry trends. In addition to this quantitative
analysis, a qualitative assessment of the general economic trends, portfolio
concentration and the trend of delinquencies are taken into consideration. The
allowance is adjusted accordingly to an amount that management believes will be
adequate to absorb probable losses on existing loans that may become
uncollectible.
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. Based
on this allowance calculation, management recorded a credit provision of
$250,000 for the three month period ended March 31, 2005 compared to an expense
of $116,000 for the same period in the prior year. The significant decline in
the provision expense during the quarter was primarily due to a decline in the
volume of charged-off loans and a decrease in the size of the loan portfolio
from December 31, 2004 to March 31, 2005. In addition, the quantitative and
qualitative analysis of reserves showed an overall improvement in the risk
inherent in the portfolio, despite the increase in nonperforming loans. Loan
loss reserves were 1.60% and 1.64% of gross loans, respectively, as of March 31,
2005 and December 31, 2004. Loan loss reserves as a percent of loans excluding
loans held for sale were 1.61% and 1.65% as of March 31, 2005 and December 31,
2004, respectively. The following table presents an analysis of changes in the
allowance for loan losses for the three month period ended March 31, 2005 and
2004, respectively:
-21-
Three Months
Ended March 31,
2005 2004
-------- --------
(Dollars in thousands)
Allowance for loan losses, beginning of period $ 10,721 $ 11,613
Net charge-offs:
Loans charged off:
Commercial 96 447
Consumer 159 185
Mortgage 51 --
-------- --------
Total charge-offs 306 632
-------- --------
Recoveries of loans previously charged off:
Commercial 201 54
Consumer 6 4
Mortgage -- 66
-------- --------
Total recoveries 207 124
-------- --------
Total net charge-offs 99 508
-------- --------
Loss provisions (credits) charged to operations (250) 116
-------- --------
Allowance for loan losses, end of period $ 10,372 $ 11,221
======== ========
Net charge-offs to average loans during the
period (annualized) 0.06% 0.32%
Allowance as a percent of gross loans 1.60% 1.75%
Allowance as a percent of gross loans excluding
loans held for sale 1.61% 1.75%
Net charge-offs have declined, as management has allocated significant resources
to improving the overall credit quality of the loan portfolio. Management
believes these efforts will result in lower net charge-offs during 2005 than in
2004 and 2003, however, material changes in economic and other factors could
effect net charge-offs for 2005.
The following table presents an analysis of nonperforming assets as of March 31,
2005 and 2004 and December 31, 2004:
-22-
March 31, December 31,
2005 2004 2004
-------- -------- --------
(Dollars in thousands)
Nonaccrual loans:
Commercial and commercial real estate $ 5,797 $ 3,339 $ 3,964
Mortgage 1,880 1,980 1,898
Construction 2,374 580 1,622
Consumer 195 252 312
Equity lines 323 326 415
-------- -------- --------
Total nonaccrual loans 10,569 6,477 8,211
Foreclosed property held 431 416 418
-------- -------- --------
Total nonperforming assets $ 11,000 $ 6,893 $ 8,629
======== ======== ========
Nonperforming loans to total loans 1.63% 1.01% 1.32%
Nonperforming assets to total assets 1.24% 0.77% 0.98%
Allowance coverage of nonperforming loans 98% 173% 131%
On March 31, 2005, nonperforming assets were $11.0 million, a $2.3 million
increase from year end 2004. The majority of the Company's nonperforming loans
are secured by real estate and to a lesser extent the Company relies on the
support of guarantors. The Company monitors the value of the underlying
collateral and the liquidity of the guarantors on a periodic basis. Based on
this review and analysis, the Company does not currently anticipate significant
losses associated with the nonperforming loans or the increase during the
quarter in nonperforming loans.
The increase in nonperforming loans during the quarter was largely attributable
to five customers. These loans are primarily secured by real estate and, in some
instances the Company is receiving payments on the loans. One loan reached
nonperforming status largely due to delays in preparing and closing on a renewed
note after the current note matured in the fourth quarter of 2004.
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 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. There were no impaired
loans at March 31, 2005 or December 31, 2004 compared to $3.0 million at March
31, 2004. Average impaired loans during the first quarter of 2004 were also $3.0
million.
The Bank uses several factors in determining if a loan is impaired. Internal
asset classification procedures include a review of significant loans and
lending relationships by both management and third party credit review firms and
includes the accumulation of related data such as loan payment status,
borrowers' financial data and borrowers' operating factors such as cash flows,
operating income or loss. The Company's determination of the allowance for loan
losses is subject to management's judgment and analysis of many internal and
external factors. While management is comfortable with the adequacy of the
current allowance, changes in factors and management's future evaluation of the
adequacy of the allowance for loan losses will change.
-23-
Foreclosed property increased to $431,000 at March 31, 2005 from $416,000 at
March 31, 2004. The Company is actively marketing all of its foreclosed
property. All foreclosed assets are recorded at the lower of cost or market.
Liquidity and Capital Resources
The Company's liquidity management involves planning to meet the Company's
anticipated funding needs at a reasonable cost. Liquidity management is guided
by policies formulated by the Company's senior management and the
Asset/Liability Management Committee of the Company's Board of Directors. The
Company had $33.3 million in its most liquid assets, cash and cash equivalents,
as of March 31, 2005. The Company's principal sources of funds are loan
repayments, deposits, Federal Home Loan Bank borrowings and capital and, to a
lesser extent, investment repayments. 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 68.1% of total
assets at March 31, 2005 compared to 67.7% at December 31, 2004. In addition,
the Company has the ability to take advantage of various other funding programs
available from the Federal Home Loan Bank of Atlanta, as well as access to
funding through various brokered deposit programs, federal funds lines and
security repurchase agreements.
The management of equity is a critical aspect of capital management in any
business. The determination of the appropriate amount of equity is affected by a
wide number of factors. The primary factor for a regulated financial institution
is the amount of capital needed to meet regulatory requirements, although other
factors, such as the "risk equity" the business requires and balance sheet
leverage, also affect the determination.
During the second quarter of 2004, the Board of Directors approved a stock
repurchase plan authorizing the repurchase of up to 50,000 shares of the
Company's stock. In December 2004, the Board of Directors approved the
repurchase of an additional 100,000 shares in December 2004. The principal
purpose of the stock repurchase program is to manage the equity capital relative
to the growth of the Company, to offset the dilutive effect of employee
equity-based compensation and to enhance long term shareholder value. The
repurchase program will be affected through regular open-market purchases.
During the first quarter of 2005, the Company repurchased 50,000 shares at a
weighted average price of $17.84 per share. See Part II, Item 2 for details of
the Company's share repurchases.
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 March 31, 2005 and the minimum requirements are presented in the following
table:
-24-
Minimum
Requirements To Be
Actual Well Capitalized
------------------- -------------------
(Dollars in thousands) Amount Ratio Amount Ratio
-------- --------- -------- ---------
Capital Bank Corporation
------------------------
Total Capital (to Risk Weighted Assets) $93,480 12.47% $74,966 10.00%
Tier I Capital (to Risk Weighted Assets) 84,093 11.22% 44,980 6.00%
Tier I Capital (to Average Assets) 84,093 9.71% 43,314 5.00%
Capital Bank
------------
Total Capital (to Risk Weighted Assets) $88,373 11.81% $74,816 10.00%
Tier I Capital (to Risk Weighted Assets) 79,005 10.56% 44,890 6.00%
Tier I Capital (to Average Assets) 79,005 9.14% 43,240 5.00%
Consolidated capital ratios improved from December 31, 2004 due to the increase
in capital associated with the Company's first quarter earnings. Total capital
to risk weighted assets, Tier I capital to risk weighted assets and Tier I
capital to average assets on a consolidated basis as of December 31, 2004 were
12.33%, 11.08% and 9.61%, respectively.
Shareholders' equity was $77.0 million, or $11.72 per share, at March 31, 2005.
Management believes this level of shareholders' equity provides adequate capital
to support the Company's growth and to maintain a well capitalized position.
Item 3 Quantitative and Qualitative Disclosures About Market Risk
- ------ ----------------------------------------------------------
The Company has not experienced any material change in the risk of its portfolio
of interest earning assets and interest bearing liabilities from December 31,
2004 to March 31, 2005.
Item 4 Controls and Procedures
- ------ -----------------------
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our Exchange Act reports is
recorded, processed, summarized and reported within the time periods required by
the SEC's rules and forms, and that such information is accumulated and
communicated to the Company's management, including its Chief Executive Officer
("CEO") and Chief Financial Officer ("CFO"), as appropriate, to allow timely
decisions regarding disclosure. Management necessarily applied its judgment in
assessing the costs and benefits of such controls and procedures, which, by
their nature, can provide only reasonable assurance regarding management's
control objectives.
As required by paragraph (b) of Rule 13a-15 under the Exchange Act, an
evaluation was carried out under the supervision and with the participation of
the Company's management, including the CEO and CFO, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures as of
the end of the period covered by this report. Based upon that evaluation, the
CEO and CFO concluded that the Company's disclosure controls and procedures are
effective in timely alerting them to material information relating to the
Company that is required to be included in our Exchange Act filings.
-25-
Changes in Internal Control
There were no changes in the Company's internal control over financial reporting
(as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred
during the period covered by this report that have materially affected or are
reasonably likely to materially affect, the Company's internal control over
financial reporting. Management has implemented changes in internal controls as
a result of remediation of matters identified through its review of internal
controls over financial reporting as required under Section 404 of the Sarbanes
Oxley Act, however it does not believe any of the changes implemented were
material in nature.
Part II - Other Information
Item 1 Legal Proceedings
- ------ -----------------
There are no material pending legal proceedings to which the Company is a party
or to 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
condition.
Item 2 Unregistered Sale of Equity Securities and Use of Proceeds
- ------ ----------------------------------------------------------
Issuer Purchase of Equity Securities
------------------------------------
Total Number
of Shares Maximum Number
Purchased as of Shares That
Part of Publicly May Yet Be
Total Number Average Price Announced Purchased Under
of Shares Paid per Plans or Plans or
Month of Purchased Share Programs Programs
- --------------- -------------------------------------------------------------------
January 2005 -- $ -- -- 150,000
February 2005 20,000 18.80 20,000 130,000
March 2005 30,000 17.20 30,000 100,000
-------------------------------------------
50,000 17.84 50,000
===========================================
On June 28, 2004, the Corporation announced that the Board of Directors had
authorized a program for the repurchase of up to 50,000 shares of common stock.
All of these shares were repurchased in the first quarter of 2005.
On December 22, 2004, the Corporation announced that the Board of Directors had
authorized the repurchase of up to an additional 100,000 shares of common stock.
Item 3 Defaults Upon Senior Securities
- ------ -------------------------------
None
Item 4 Submission of Matters to a Vote of Security Holders
- ------ ---------------------------------------------------
None
Item 5 Other Information
- ------ -----------------
None
-26-
Item 6 Exhibits
- ------ --------
Exhibit 4.1 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.
Exhibit 10.1 Agreement between Capital Bank and Karen H. Priester dated
April 25, 2005 (incorporated herein by reference to Exhibit
10.1 to the Capital Bank Corporation Current Report on Form
8-K, as filed with the Securities Exchange Commission on April
28, 2005)
Exhibit 31.1 Certification of B. Grant Yarber pursuant to Rule 13a-14(a)
and 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification of Richard W. Edwards pursuant to Rule 13a-14(a)
and 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
Exhibit 32.1 Certification of B. Grant Yarber 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.]
Exhibit 32.2 Certification of Richard W. Edwards 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.]
-27-
Signatures
Pursuant to the requirements 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.
CAPITAL BANK CORPORATION
Date: May 9, 2005 By: /s/ Richard W. Edwards
----------------------
Richard W. Edwards
Chief Financial Officer
-28-
Exhibit Index
- --------------------------------------------------------------------------------
Exhibit 4.1 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.
- --------------------------------------------------------------------------------
Exhibit 10.1 Agreement between Capital Bank and Karen H. Priester dated
April 25, 2005 (incorporated herein by reference to Exhibit
10.1 to the Capital Bank Corporation Current Report on Form
8-K, as filed with the Securities Exchange Commission on April
28, 2005)
- --------------------------------------------------------------------------------
Exhibit 31.1 Certification of B. Grant Yarber pursuant to Rule 13a-14(a)
and 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
- --------------------------------------------------------------------------------
Exhibit 31.2 Certification of Richard W. Edwards pursuant to Rule 13a-14(a)
and 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
- --------------------------------------------------------------------------------
Exhibit 32.1 Certification of B. Grant Yarber 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.]
- --------------------------------------------------------------------------------
Exhibit 32.2 Certification of Richard W. Edwards 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.]
- --------------------------------------------------------------------------------
-29-