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 September 30, 2005
or
[_] 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 rganization) 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
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). [_] Yes [X] No
As of November 2, 2005 there were 6,845,313 shares outstanding of the
registrant's common stock, no par value.
Capital Bank Corporation
Form 10-Q
CONTENTS
PART I - FINANCIAL INFORMATION Page No.
Item 1. Financial Statements
Condensed consolidated statements of financial condition at September 30, 2005
(Unaudited) and December 31, 2004 1
Condensed consolidated statements of income for the three months
ended September 30, 2005 and 2004 (Unaudited) 2
Condensed consolidated statements of income for the nine months
ended September 30, 2005 and 2004 (Unaudited) 3
Condensed consolidated statements of changes in shareholders' equity for
the nine months ended September 30, 2005 and 2004 (Unaudited) 4
Condensed consolidated statements of cash flows for the nine months
ended September 30, 2005 and 2004 (Unaudited) 5 - 6
Notes to condensed consolidated financial statements 7 - 12
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 12 - 32
Item 3. Quantitative and Qualitative Disclosures About Market Risk 32
Item 4. Controls and Procedures 32 - 33
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 33
Item 3. Defaults Upon Senior Securities 33
Item 4. Submission of Matters to a Vote of Security Holders 33
Item 5. Other Information 33
Item 6. Exhibits 33 - 34
Signatures 35
Item 1 Financial Statements
--------------------
CAPITAL BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, 2005 and December 31, 2004
September 30, December 31,
2005 2004
- ------------------------------------------------------------------------------------------
(Dollars in thousands, except share data) (Unaudited)
ASSETS
Cash and due from banks:
Interest earning $ 30,445 $ 971
Noninterest earning 26,756 22,036
Federal funds sold and short term investments 9,014 4
Investment securities - available for sale, at fair value 142,421 140,946
Investment securities - held to maturity, at amortized cost 12,623 13,336
Federal Home Loan Bank stock 6,345 6,298
Loans - net of unearned income and deferred fees 646,448 654,867
Allowance for loan losses (9,844) (10,721)
------------ ------------
Net loans 636,604 644,146
------------ ------------
Premises and equipment, net 15,783 15,608
Bank owned life insurance 19,618 13,500
Deposit premium and goodwill, net 12,905 13,065
Deferred tax assets 5,882 5,985
Accrued interest receivable and other assets 8,639 6,399
------------ ------------
Total assets $ 927,035 $ 882,294
============ ============
LIABILITIES
Deposits:
Demand, noninterest bearing $ 80,827 $ 65,673
Savings and interest bearing demand deposits 236,065 193,435
Time deposits 386,291 395,868
------------ ------------
Total deposits 703,183 654,976
------------ ------------
Repurchase agreements and federal funds purchased 12,620 16,755
Federal Home Loan Bank advances 98,525 102,320
Subordinated debentures 20,620 20,620
Accrued interest payable and other liabilities 9,819 9,885
------------ ------------
Total liabilities 844,767 804,556
------------ ------------
SHAREHOLDERS' EQUITY
Common stock, no par value; 20,000,000 shares authorized;
6,795,704 and 6,612,787 issued and outstanding as of
September 30, 2005 and December 31, 2004, respectively 70,278 68,341
Retained earnings 12,785 9,092
Accumulated other comprehensive (loss) income (795) 305
------------ ------------
Total shareholders' equity 82,268 77,738
------------ ------------
Total liabilities and shareholders' equity $ 927,035 $ 882,294
============ ============
See Notes to Condensed Consolidated Financial Statements
-1-
CAPITAL BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended September 30, 2005 and 2004
(Unaudited) 2005 2004
- --------------------------------------------------------------------------------------------------
(Dollars in thousands, except share and per share data)
Interest income:
Loans and loan fees $ 10,993 $ 9,162
Investment securities 1,720 1,597
Federal funds and other interest income 365 37
----------- -----------
Total interest income 13,078 10,796
----------- -----------
Interest expense:
Deposits 4,157 2,971
Borrowings and repurchase agreements 1,492 1,136
----------- -----------
Total interest expense 5,649 4,107
----------- -----------
Net interest income 7,429 6,689
Provision (credit) for loan losses (28) 268
----------- -----------
Net interest income after provision (credit) for loan losses 7,457 6,421
----------- -----------
Noninterest income:
Service charges and other fees 771 755
Mortgage banking revenues 554 305
Net gain on sale of securities -- 1
Gain on sale of branches -- 1,130
Loss on sale of mortgage loan portfolio -- (354)
Bank owned life insurance 161 68
Other noninterest income 304 375
----------- -----------
Total noninterest income 1,790 2,280
----------- -----------
Noninterest expenses:
Salaries and employee benefits 3,536 3,130
Occupancy 666 624
Furniture and equipment 356 447
Data processing 301 212
Advertising 217 226
Amortization of deposit premium 53 61
Professional fees 207 335
Telecommunications 145 148
Other expenses 1,163 996
----------- -----------
Total noninterest expenses 6,644 6,179
----------- -----------
Income before income tax expense 2,603 2,522
Income tax expense 869 872
----------- -----------
Net income $ 1,734 $ 1,650
=========== ===========
Earnings per share - basic $ 0.26 $ 0.25
=========== ===========
Earnings per share - diluted $ 0.25 $ 0.24
=========== ===========
Weighted average shares
Basic 6,800,813 6,720,211
=========== ===========
Fully diluted 6,904,321 6,883,322
=========== ===========
See Notes to Condensed Consolidated Financial Statements
-2-
CAPITAL BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Nine Months Ended September 30, 2005 and 2004
(Unaudited) 2005 2004
- --------------------------------------------------------------------------------------------------
(Dollars in thousands, except share and per share data)
Interest income:
Loans and loan fees $ 31,140 $ 26,205
Investment securities 5,144 4,867
Federal funds and other interest income 498 118
----------- -----------
Total interest income 36,782 31,190
----------- -----------
Interest expense:
Deposits 11,015 8,746
Borrowings and repurchase agreements 4,272 3,255
----------- -----------
Total interest expense 15,287 12,001
----------- -----------
Net interest income 21,495 19,189
Provision (credit) for loan losses (434) 681
----------- -----------
Net interest income after provision (credit) for loan losses 21,929 18,508
----------- -----------
Noninterest income:
Service charges and other fees 2,142 2,250
Mortgage banking revenues 1,212 1,007
Net gain on sale of securities 7 14
Gain on sale of branches -- 1,130
Loss on sale of mortgage loan portfolio -- (354)
Bank owned life insurance 385 196
Other noninterest income 963 1,182
----------- -----------
Total noninterest income 4,709 5,425
----------- -----------
Noninterest expenses:
Salaries and employee benefits 10,164 9,033
Occupancy 1,906 1,778
Furniture and equipment 1,093 1,286
Data processing 930 835
Advertising 596 650
Amortization of deposit premium 160 187
Professional fees 739 740
Telecommunications 428 387
Other expenses 3,267 2,990
----------- -----------
Total noninterest expenses 19,283 17,886
----------- -----------
Income before income tax expense 7,355 6,047
Income tax expense 2,463 2,126
----------- -----------
Net income $ 4,892 $ 3,921
=========== ===========
Earnings per share - basic $ 0.72 $ 0.59
=========== ===========
Earnings per share - diluted $ 0.71 $ 0.57
=========== ===========
Weighted average shares
Basic 6,762,292 6,706,018
=========== ===========
Fully diluted 6,905,809 6,884,400
=========== ===========
See Notes to Condensed Consolidated Financial Statements
-3-
Capital Bank Corporation
Consolidated Statements of Changes in Shareholders' Equity
For the Nine Months Ended September 30, 2005 and 2004
(Unaudited)
(Dollars in thousands, except share data)
Shares of Other
Common Common Comprehensive Retained
Stock Stock Income Earnings Total
---------- ---------- ---------- ---------- ----------
Balance at January 1, 2004 6,541,495 $ 67,381 $ 377 $ 5,165 $ 72,923
Issuance of common stock
for options exercised 51,321 500 -- -- 500
Issuance of common stock
for compensation 1,522 16 16
Net income -- -- -- 3,921 3,921
Other comprehensive income -- -- (2) -- (2)
----------
Comprehensive income 3,919
----------
Dividends ($0.15 per share) -- -- -- (988) (988)
---------- ---------- ---------- ---------- ----------
Balance at September 30, 2004 6,594,338 $ 67,897 $ 375 $ 8,098 $ 76,370
========== ========== ========== ========== ==========
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 compensation 99,258 1,588 -- -- 1,588
Issuance of common stock
for options exercised 133,659 1,241 -- -- 1,241
Net income -- -- -- 4,892 4,892
Other comprehensive income -- -- (1,100) -- (1,100)
----------
Comprehensive income 3,792
----------
Dividends ($0.18 per share) -- -- -- (1,199) (1,199)
---------- ---------- ---------- ---------- ----------
Balance at September 30, 2005 6,795,704 $ 70,278 $ (795) $ 12,785 $ 82,268
========== ========== ========== ========== ==========
See Notes to Condensed Consolidated Financial Statements
-4-
CAPITAL BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 2005 and 2004
(Unaudited) 2005 2004
- -----------------------------------------------------------------------------------------
(Dollars in thousands)
Cash Flows From Operating Activities:
Net income $ 4,892 $ 3,921
Adjustments to reconcile net income to net cash
used in operating activities:
Amortization of deposit premium 160 187
Depreciation 1,082 1,110
Net gains on sale of securities available for sale (7) (14)
Change in held for sale loans, net (5,310) (18,544)
Amortization of premiums on securities, net 235 519
Deferred income tax expense 794 273
Issuance of stock for compensation 1,588 --
Provision (credit) for loan losses (434) 681
Changes in assets and liabilities:
Accrued interest receivable and other assets (6,941) 670
Accrued interest payable and other liabilities (166) 389
Other operating activities, net -- (1,060)
---------- ----------
Net cash used for operating activities (4,107) (11,868)
---------- ----------
Cash Flows From Investing Activities:
Loan repayments (originations), net 11,958 (27,246)
Additions to premises and equipment (1,984) (2,785)
Purchase of securities available for sale (24,309) (36,252)
Purchase of securities held to maturity (1,560) (6,987)
Proceeds from maturities of securities available for sale 16,370 27,743
Proceeds from sales of securities available for sale 4,399 24,206
Proceeds from maturities of securities held to maturity 2,273 2,000
Proceeds from sales of property and equipment 726 645
Cash paid for sale of branches -- (23,054)
---------- ----------
Net cash provided by (used in)
investing activities 7,873 (41,730)
---------- ----------
Cash Flows From Financing Activities:
Net increase in deposits 48,207 56,972
Net (decrease) increase in repurchase agreements (4,135) 8,998
Net decrease in borrowings (3,795) (13,203)
Dividends paid (1,188) (987)
Issuance of common stock for options and other plans 1,241 500
Repurchase of common stock (892) --
Other financing activities, net -- 16
---------- ----------
Net cash provided by financing activities 39,438 52,296
---------- ----------
Net change in cash and cash equivalents 43,204 (1,302)
Cash and cash equivalents:
Beginning of period 23,011 25,610
---------- ----------
Ending at September 30 $ 66,215 $ 24,308
========== ==========
(continued on next page)
See Notes to Condensed Consolidated Financial Statements
-5-
CAPITAL BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Nine Months Ended September 30, 2005 and 2004
(Unaudited) 2005 2004
- ----------------------------------------------------------------------------------------
(Dollars in thousands)
Supplemental Disclosure of Cash Flow Information
Transfer from loans to real estate acquired
through foreclosure $ 1,417 $ 574
========== ==========
Dividends payable $ 408 $ 325
========== ==========
Cash paid for:
Income taxes $ 2,379 $ 988
========== ==========
Interest $ 15,123 $ 11,815
========== ==========
See Notes to Condensed Consolidated Financial Statements
-6-
Notes to Condensed Consolidated Financial Statements (Unaudited)
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 interests 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.
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 reported amounts of assets and liabilities
as well as the amounts of income and expenses during the reporting period.
Actual results could differ from those estimates.
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. All such adjustments are of a normal and recurring
nature. Certain amounts reported in prior periods have been reclassified to
conform to the current presentation. Such reclassifications have no effect on
net income or shareholders' equity as previously reported. The results of
operations for the nine month period ended September 30, 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.
In May 2005, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 154, Accounting Changes and Error
Corrections ("SFAS 154"), which replaces APB No 20, Accounting Changes, and SFAS
No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS 154
applies to all voluntary changes in accounting principles and requires
retrospective application of changes in accounting principle to prior period
financial statements, unless it is impracticable to determine either the
period-specific effects or the cumulative effects of the change. SFAS 154
carries forward without change the guidance contained in APB 20 for reporting
the correction of an error and a change in accounting estimate. SFAS 154 is
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. The Company will adopt SFAS
-7-
154 effective January 1, 2006. SFAS 154 will have no impact on the Company's
financial position or results of operations upon adoption.
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 nine month
periods ended September 30, 2005 and 2004 are as shown in the Company's
Consolidated Statements of Changes in Shareholders' Equity for the nine months
ended September 30, 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:
CAPITAL BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE
INCOME (LOSS)
Three and Nine Months Ended September 30, 2005 and 2004
(Unaudited) 2005 2004
- -------------------------------------------------------------------------------------------
(Dollars in thousands)
Three month period ended September 30, 2005 and 2004:
Net income $ 1,734 $ 1,650
Reclassification of gains recognized in net income -- (1)
Unrealized gains (losses) on securities available for sale (1,060) 3,848
Income tax benefit (expense) 408 (1,484)
---------- ----------
Comprehensive income $ 1,082 $ 4,013
========== ==========
Nine month period ended September 30, 2005 and 2004:
Net income $ 4,892 $ 3,921
Reclassification of gains recognized in net income (7) (14)
Unrealized gains (losses) on securities available for sale (1,783) 23
Income tax benefit (expense) 690 (11)
---------- ----------
Comprehensive income $ 3,792 $ 3,919
========== ==========
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 and nine
month periods ended September 30, 2005 and 2004:
-8-
2005 2004
-----------------------
(Dollars in thousands, except share data)
Three month periods ended September 30, 2005 and 2004:
Income available to shareholders - basic and diluted $ 1,734 $ 1,650
========== ==========
Shares used in the computation of earnings per share:
Weighted average number of shares outstanding - basic 6,800,813 6,720,211
Incremental shares from assumed exercise of stock
options 103,508 163,111
---------- ----------
Weighted average number of shares outstanding - diluted 6,904,321 6,883,322
========== ==========
Nine month periods ended September 30, 2005 and 2004:
Income available to shareholders - basic and diluted $ 4,892 $ 3,921
========== ==========
Shares used in the computation of earnings per share:
Weighted average number of shares outstanding - basic 6,762,292 6,706,018
Incremental shares from assumed exercise of stock
options 143,517 178,382
---------- ----------
Weighted average number of shares outstanding - diluted 6,905,809 6,884,400
========== ==========
Options to purchase approximately 458,015 shares of common stock were used in
the diluted calculation. An aggregate of 80,850 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.
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 SFAS No. 123 , Accounting for Stock-Based Compensation("SFAS
123"), 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 ("SFAS 148"), Accounting for Stock-Based Compensation --
Transition and Disclosure, companies are required to disclose for each period
for which an income
-9-
statement is 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 SFAS
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 SFAS 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 SFAS 123 for recognition purposes.
The Company granted options to purchase 9,600 shares of common stock at a
weighted average price of $16.84 during the first nine months of 2005. For the
three and nine month periods ended September 30, 2005 and 2004, 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, except per share data)
Three month periods ended September 30, 2005 and 2004:
Net income, as reported $ 1,734 $ 1,650
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects (33) (26)
----------------------
Pro forma net income $ 1,701 $ 1,624
======================
Earnings per share:
Basic - as reported $ 0.26 $ 0.25
Basic - pro forma $ 0.25 $ 0.24
Diluted - as reported $ 0.25 $ 0.24
Diluted - pro forma $ 0.25 $ 0.24
Nine month periods ended September 30, 2005 and 2004:
Net income, as reported $ 4,892 $ 3,921
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects (119) (77)
----------------------
Pro forma net income $ 4,773 $ 3,844
======================
Earnings per share:
Basic - as reported $ 0.72 $ 0.58
Basic - pro forma $ 0.71 $ 0.57
Diluted - as reported $ 0.71 $ 0.57
Diluted - pro forma $ 0.70 $ 0.56
-10-
In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share Based
Payment ("SFAS 123R"), which replaces SFAS 123, and supercedes APB 25. SFAS 123R
requires companies to expense at fair value all costs resulting from
shared-based compensation transactions, except for equity instruments held by
employee share ownership plans. SFAS 123R as issued by the FASB was effective as
of the beginning of the first period that begins after June 15, 2005. On March
29, 2005, the Securities and Exchange Commission ("SEC") issued Staff Accounting
Bulletin No. 107, which summarizes the views of the SEC regarding the
interaction between SFAS 123R and certain SEC rules and regulations and provides
the SEC's views on the valuation of share-based payment arrangements for public
companies. The Company will consider this guidance in its adoption of SFAS 123R.
On April 14, 2005, the SEC adopted a rule that amended the effective date of
SFAS 123R. The SEC's new rules allows companies to implement SFAS 123R at the
beginning of the next fiscal year. The Company plans to adopt SFAS 123R
effective January 1, 2006. Additional details on the expected impact on the
Company as a result of implementation of SFAS 123R are included in footnote 1 to
the Notes to Consolidated Financial Statements in the Company's Annual Report on
Form 10-K, as amended.
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 September 30, 2005:
(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 $ 24,926 $ 185 $ 18,405 $ 600 $ 43,331 $ 785
Municipal bonds 1,847 20 2,107 79 3,954 99
Mortgage-backed securities 54,276 735 11,830 378 66,106 1,113
---------------------------------------------------------------------------
81,049 940 32,342 1,057 113,391 1,997
---------------------------------------------------------------------------
Held to maturity
Direct obligations of U.S.
government agencies 2,561 30 1,957 39 4,518 69
Municipal bonds 294 6 -- -- 294 6
Mortgage-backed securities 7,603 133 -- -- 7,603 133
---------------------------------------------------------------------------
10,458 169 1,957 39 12,415 208
---------------------------------------------------------------------------
$ 91,507 $ 1,109 $ 34,299 $ 1,096 $ 125,806 $ 2,205
===========================================================================
The unrealized losses on the Company's investments in direct obligations of U.S.
government agencies and mortgage-backed securities were primarily the result of
interest rate changes. Mortgage-backed securities include securities issued by
government agencies and corporate entities. The Company has the ability and
intent to hold these investments until a recovery of fair value, which may be
maturity. Accordingly, the Company does not consider these investments to be
other-than-temporarily impaired at September 30, 2005.
-11-
6. Loans
The composition of the loan portfolio by loan classification at September 30,
2005 and December 31, 2004 is as follows:
September 30, December 31,
(Dollars in thousands) 2005 2004
-------------- --------------
Commercial $ 525,005 $ 531,834
Consumer 31,435 34,865
Home equity lines 62,502 61,925
Residential mortgages 27,198 26,020
-------------- --------------
646,140 654,644
Plus deferred loan costs, net 308 223
-------------- --------------
$ 646,448 $ 654,867
============== ==============
Loans held for sale as of September 30, 2005 and December 31, 2004 were $8.6
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 and nine month period ended September 30, 2005 and 2004
for Capital Bank Corporation (the "Company") and it's wholly owned subsidiary,
Capital Bank (the "Bank"). 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").
-12-
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.
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
non-bank 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
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The trading volume in our 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 our common stock may be limited in scope relative to other
companies.
We Depend Heavily on Our Key Management Personnel
Our success depends in part on our 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. Our 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
-14-
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 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.
In addition, we may 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 that could decrease our 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 SEC
regulations, are creating uncertainty for companies such as ours. 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. In addition, it may become more difficult and more
expensive to obtain director and officer liability insurance. As a result, our
ability to attract and retain executive officers and qualified Board and
committee members could be more difficult.
-15-
Our Proposed Transaction with 1st State Bancorp, Inc. is Subject to
Uncertainties.
Our proposed transaction with 1st State Bancorp, Inc. ("1st State') is subject
to customary closing conditions, including regulatory and shareholder approval.
If any of the conditions to closing are not satisfied or waived, the proposed
transaction would not be completed. In addition, the merger agreement relating
to the proposed transaction can be terminated prior to completion of the
transaction under certain circumstances, including where 1st State Bancorp
receives an acquisition proposal from a third party that its board believes is
more favorable to its shareholders than the proposed transaction (after
following specific procedures described in our merger agreement with 1st State).
If the merger agreement is terminated, the proposed transaction would not be
completed, and, in certain circumstances, 1st State could be required to pay us
a termination fee of $2 million. If the merger is not completed, the value of
our common stock could decline. We are currently targeting to close the proposed
transaction, assuming the satisfaction or waiver of all conditions, in the first
quarter of 2006. The closing of the proposed transaction could be delayed beyond
the first quarter of 2006 due to many factors, including factors beyond the
control of either party.
We May Not Be Able to Successfully Integrate 1st State or to Realize the
Anticipated Benefits of the Proposed Merger
Our proposed merger with 1st State involves the combination of two bank holding
companies that previously have operated independently. A successful combination
of the operations of the two entities will depend substantially on our ability
to consolidate operations, systems and procedures and to eliminate redundancies
and costs. We may not be able to combine the operations of 1st State with our
operations without encountering difficulties, such as:
o the loss of key employees and customers;
o the disruption of operations and business;
o inability to maintain and increase competitive presence;
o deposit attrition, customer loss and revenue loss;
o possible inconsistencies in standards, control procedures and
policies;
o unexpected problems with costs, operations, personnel, technology
and credit; and/or
o problems with the assimilation of new operations, sites or
personnel, which could divert resources from regular banking
operations.
Further, although meaningful cost savings are anticipated as a result of the
merger, such expected cost savings may not be realized. Finally, any cost
savings that are realized may be offset by losses in revenues or other charges
to earnings.
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
-16-
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.
The 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 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 Trusts. 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:
-17-
o The Company reported net income for the third quarter 2005 of $1.7
million compared to $1.6 million in the third quarter of 2004. Fully
diluted earnings per share were $0.25 and $0.24 for the third
quarter of 2005 and 2004, respectively. The third quarter of 2004
includes two non-recurring transactions; a $1.1 million pre-tax gain
from the sale of three branch locations and a $0.3 million pre-tax
loss from the sale of a portion of the Bank's mortgage loan
portfolio. There were no non-recurring transactions during the third
quarter of 2005.
o For the nine months ended September 30, 2005 and 2004 the Company
reported net income of $4.9 million and $3.9 million, respectively.
Fully diluted earnings per share were $0.71 and $0.57 for the nine
months ended September 30, 2005 and 2004, respectively.
o The (credit) provision for loan losses was $(28,000) and $268,000
for the third quarter of 2005 and 2004, respectively. Net
charge-offs for the third quarter of 2005 were $0.1 million, or
0.07% of average loans compared to $0.4 million, or 0.22% of average
loans, for the third quarter of 2004. For the nine months ended
September 30, 2005, the (credit) provision for loan losses was $(0.4
million) compared to $0.7 million for the nine months ended
September 30, 2004. Net charge-offs for the nine months ended
September 30, 2005 were $0.4 million, or 0.07% of average loans,
compared to $1.0 million, or 0.20% of average loans, for the nine
months ended September 30, 2004. The decrease in the provision for
loan losses and net charge-offs reflects the improving credit
quality of the underlying loan portfolio.
o Net interest income was $7.4 million for the third quarter of 2005
and $21.5 million for the nine months ended September 30, 2005
compared to $6.7 million and $19.2 million for the comparable
periods in 2004. The Company's net interest margin increased
compared to the third quarter of 2004 by 26 basis points to 3.57% in
the third quarter of 2005. For the nine months ended September 30,
2005 and 2004, the net interest margin was 3.55% and 3.22%,
respectively. The increase is attributable to increases in
short-term interest rates as the Federal Reserve Open Market
Committee's benchmark federal funds rate has been increased eight
times since September 30, 2004, reaching 3.75% at September 30,
2005.
o Noninterest income was $1.8 million for the third quarter of 2005
and $4.7 million for the nine months ended September 30, 2005 versus
$2.3 million and $5.4 million for the comparable periods of 2004.
The decrease was primarily due to a gain of $1.1 million from the
sale of certain branches offset by a loss of $0.3 million on the
sale of certain mortgages in the third quarter of 2004. Excluding
the effects of these two transactions, noninterest income would have
been $1.5 million and $4.7 million for the third quarter and nine
months ender September 30, 2004, respectively.
o Noninterest expense was $6.6 million for the third quarter of 2005
and $19.3 million for the nine months ended September 30, 2005
compared to $6.2 million and $17.9 million, respectively, for the
same periods of 2004. Salaries and employee benefits increased by
$0.4 million and $1.1 million in the third quarter and nine months
ender September 30, 2005, respectively, compared to the same periods
in 2004. Approximately 17% of the increase for the nine months ended
September 30, 2005 was attributable to severance payments for an
executive officer that left the Company in April 2005. The remaining
-18-
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.
Merger with 1st State Bancorp, Inc.
On June 29, 2005, the Company announced that it had entered into a definitive
agreement with 1st State, headquartered in Burlington, North Carolina whereby
1st State will be merged with and into the Company. 1st State shareholders will
receive approximately $37.15 (in cash and/or stock or a combination of both) per
share of 1st State common stock. On September 9, 2005 the Company filed a
Registration Statement on Form S-4 with the SEC to register up to 4,966,612
shares of Company common stock that could be issued in connection with the
proposed transaction. The Company mailed the related joint proxy
statement/prospectus to its shareholders on or about October 14, 2005, setting
forth matters relating to the transaction to be voted upon at the upcoming
Special Meeting of Shareholders to be held on November 29, 2005. The Form S-4
describes the proposed transaction in detail and provides, among other things,
highlights and terms of the proposed merger and pro forma financial information
on the Company and 1st State.
On September 26, 2005, the Federal Reserve Bank of Richmond approved the
Company's application to acquire 1st State pursuant to Section 3(a)(5) of the
Bank Holding Company Act. On October 31, 2005, the Regional Director of the
Atlanta Regional Office of the Federal Deposit Insurance Corporation approved
the Bank's application to merge with 1st State Bank. The Bank is presently
awaiting approval from the North Carolina Banking Commission with respect to the
merger of the Bank and 1st State Bank. Subject to receipt of such regulatory
approvals, consummation of the merger of the Company and 1st State, and other
customary closing conditions, the Company plans to consummate the subsidiary
bank merger in the first quarter of 2006.
Financial Condition
Total consolidated assets of the Company at September 30, 2005 were $927.0
million compared to $882.3 million at December 31, 2004, an increase of $44.7
million, or approximately 5.1%. Overall growth in the balance sheet was due to
growth of core deposits, especially demand deposits and money market deposits,
which increased from $249.0 million at December 31, 2004 to $307.7 million at
September 30, 2005.
Total earning assets were $847.3 million at September 30, 2005 compared to
$816.4 million at December 31, 2004. Earning assets represented 91.4% and 92.5%
of total assets as of September 30, 2005 and December 31, 2004, respectively.
Loan balances were $646.4 million at September 30, 2005, a decrease of $8.5
million from December 31, 2004. At September 30, 2005, investment securities
were $161.3 million, an increase of $0.8 million from December 31, 2004.
Interest-earning cash, federal funds sold and short term investments were $39.5
million at September 30, 2005, an increase of $38.5 million from December 31,
2004. The Company has increased its holdings of short-term investment assets to
maintain liquidity for loan fundings and future commitments. Earning assets
exclude bank owned life insurance, which increased from $13.5 million at
December 31, 2004 to $19.6 million at September 30, 2005.
-19-
The allowance for loan losses as of September 30, 2005 was $9.8 million and
represented approximately 1.52% of total loans and 1.54% of loans excluding
those held for sale at September 30, 2005. The allowance for loan losses
decreased $0.9 million 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.
Total deposits as of September 30, 2005 were $703.2 million, an increase of
$48.2 million, or 7.4%, from December 31, 2004. The increase was primarily the
result of strong internal growth fueled by a successful core deposit campaign.
For 2005, the Company prioritized the growth of savings and interest bearing
demand deposit accounts, which increased by $42.6 million from December 31, 2004
to $236.1 million at September 30, 2005. The average balance of these accounts
also increased significantly with the average balance being $230.7 million
during the third quarter of 2005 compared to $189.9 million and $211.8 million
during the first and second quarter of 2005, respectively. At September 30,
2005, the Company experienced a net decrease of $9.6 million, or 2.6%, in
certificates of deposit ("CDs") compared to December 31, 2004. Approximately
$10.5 million of this decrease is attributable to brokered CDs. In addition, the
Company has not aggressively priced certain maturing CDs where the customer has
no other banking relationship with the Company. Time deposits represented 54.9%
of total deposits at September 30, 2005 compared to 60.4% at December 31, 2004.
Noninterest bearing DDAs were $80.8 million at September 30, 2005, an increase
of $15.2 million, or 23.1%, from December 31, 2004. This increase was also
attributable to the Company's aforementioned core deposit campaign, which
resulted in over 2,500 new accounts being opened through September 30, 2005. The
average balance of noninterest DDA accounts was $76.7 million during the third
quarter of 2005 compared to $62.0 million and $68.3 million during the first and
second quarter of 2005, respectively.
Total consolidated shareholders' equity was $82.2 million as of September 30,
2005, an increase of $4.5 million from December 31, 2004. Retained earnings
increased by $3.7 million reflecting the net income during the nine month period
ended September 30, 2005 less dividends paid during that same time, offset by a
$1.1 million decrease in accumulated other comprehensive income due to declines
in the market value of available for sale investment securities as a result of
the increase in interest rates. Common stock increased by $1.9 million as a
result of repurchases of the Company's stock pursuant to an approved repurchase
plan during the first quarter of 2005 offset by the issuance of shares under
various plans. See Item 1. Financial Statements - Consolidated Statements of
Changes in Shareholders' Equity for additional information.
Results of Operations
Three month period ended September 30, 2005
- -------------------------------------------
For the three month period ended September 30, 2005, the Company reported net
income of $1.7 million, or $0.25 per diluted share, compared to net income of
$1.6 million, or $0.24 per diluted share, for the three month period ended
September 30, 2004. Net income increased by $0.1 million between periods as a
result of an increase in net interest income, primarily due to an improved net
interest margin, offset by a decrease in noninterest income and an increase in
noninterest expenses (such increase in noninterest expenses was primarily due to
higher salary and benefit expenses). Noninterest income for the three month
period ended September 30, 2004
-20-
includes a $1.1 million gain related to the sale of three branch locations and a
$0.3 million loss related to the sale of certain residential mortgage loans.
There were no non-recurring transactions in same period for 2005.
Net interest income increased $0.7 million, or approximately 11.1%, from $6.7
million for the three month period ended September 30, 2004, to $7.4 million for
the three month period ended September 30, 2005. Average earning assets
increased $20.7 million to $844.0 million for the three month period ended
September 30, 2005 from $823.3 million for the three month period ended
September 30, 2004. Average interest bearing liabilities increased $13.6 million
to $753.4 million for the three month ended September 30, 2005 from $739.8 for
the three month period ended September 30, 2004. The net interest margin on a
fully taxable equivalent basis increased 26 basis points to 3.57% for the three
month period ended September 30, 2005 from 3.31% for the three month period
ended September 30, 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 eight
corresponding increases in the Bank's prime interest rate starting on September
30, 2004. The Company's balance sheet remains asset-sensitive and, as a result,
its interest earning assets re-price faster than its interest bearing
liabilities. Since September 30, 2004, the Bank has increased its prime rate by
200 basis points to 6.75% in response to FOMC rate increases. The Company cannot
be certain of the direction of the benchmark federal funds rates as set by the
FOMC. Further increases by the FOMC will affect the level of the Company's prime
rate and likely increase the effective cost of interest-bearing liabilities.
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.
-21-
Average Balances, Interest Earned or Paid, and Interest Yields/Rates
Three Months Ended September 30, 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 $519,300 $ 8,920 6.81% $515,969 $ 7,121 5.49%
Consumer 31,686 635 7.95% 37,886 627 6.58%
Home equity 60,697 1,011 6.61% 59,807 757 5.04%
Residential mortgages (3) 26,060 427 6.50% 46,966 657 5.57%
------------------------------------------------------------------
Total loans 637,743 10,993 6.84% 660,628 9,162 5.52%
Investment securities (4) 162,282 1,884 4.61% 152,648 1,762 4.59%
Federal funds sold and other
interest on short term investments 43,967 365 3.29% 10,023 37 1.47%
------------------------------------------------------------------
Total interest earning assets 843,992 $ 13,242 6.22% 823,299 $ 10,961 5.30%
==================== ===================
Cash and due from banks 24,759 22,887
Other assets 63,453 50,226
Allowance for loan losses (10,062) (11,559)
--------- --------
Total assets $922,142 $884,853
========= ========
Liabilities and Equity
Savings deposits $ 16,831 $ 22 0.52% $ 17,098 $ 13 0.30%
Interest-bearing demand deposits 213,824 1,090 2.02% 197,725 589 1.19%
Time deposits 389,925 3,045 3.10% 393,377 2,369 2.40%
------------------------------------------------------------------
Total interest bearing deposits 620,580 4,157 2.66% 608,200 2,971 1.94%
Borrowed funds 99,648 1,073 4.27% 99,063 872 3.50%
Trust preferred debt 20,620 331 6.37% 20,620 238 4.59%
Repurchase agreements 12,605 88 2.77% 11,942 26 0.87%
------------------------------------------------------------------
Total interest-bearing liabilities 753,453 $ 5,649 2.97% 739,825 $ 4,107 2.21%
==================== ===================
Non-interest bearing deposits 76,731 61,121
Other liabilities 10,352 9,463
-------- --------
Total liabilities 840,536 810,409
Shareholders' equity 81,606 74,444
-------- --------
Total liabilities and shareholders' equity $922,142 $884,853
======== ========
Net interest spread (5) 3.25% 3.09%
Tax equivalent adjustment $ 164 $ 165
Net interest income and net
interest margin (6) $ 7,593 3.57% $ 6,854 3.31%
(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.
-22-
Yields on commercial, consumer, and home equity increased 132 basis points, 137
basis points and 157 basis points, respectively, in the third 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% of the total loan portfolio at September 30,
2005 compared to 70% at September 30, 2004.
The yield on investment securities on a tax-equivalent basis increased from
4.59% in the third quarter of 2004 to 4.61% in the third quarter of 2005. The
slight increase is due to higher yields on new investment securities purchased
during 2005. Longer term rates have increased much less significantly than
short-term rates. The majority of the investment portfolio is in medium to long
term maturity investments and, as a result, the Company's yield on investments
will not increase rapidly if long term rates begin to increase.
The average rate paid on time deposits increased from 2.40% to 3.10% for the
three months ended September 30, 2005 compared to the same period in 2004, a 70
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 for
the remainder of 2005.
The rate on borrowings for the three month period ended September 30, 2005
increased to 4.27% from 3.50% for the three month period ended September 30,
2004. In July of 2003, the Bank entered into interest rate swap agreements on
$25.0 million of its 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 September 30, 2005, the credit provision for
loan losses was $(28,000) compared to a provision of $268,000 for the same
period in 2004, a decrease of approximately $296,000. The decrease in 2005 was
primarily due to improvements in the risk rating classifications of certain
loans contained in the portfolio and other factors as discussed more fully below
under "Asset Quality".
Noninterest income for the three month period ended September 30, 2005, was $1.8
million compared to $2.3 million for the same period in 2004, a decrease of $0.5
million, or 21.5%. The decrease was primarily due to the sale of three branch
locations and certain residential mortgage loans during the third quarter of
2004. These two transactions resulted in a net gain of $0.8 million. Absent
these non-recurring transactions, noninterest income would have increased $0.3
million for the three month period ended September 30, 2005 compared to the same
period in 2004. This increase was primarily due to an improvement in mortgage
banking revenues as a result of higher period-over-period loan production.
Noninterest expense for the three month period ended September 30, 2005 was $6.6
million compared to $6.2 million for the corresponding period in 2004. Salaries
and employee benefits, representing the largest noninterest expense category,
increased to $3.5 million for the three month period ended September 30, 2005,
from $3.1 million for the same period in 2004. The increase was primarily due to
the change in the number of personnel employed by the Company and management's
intention to maintain adequate staffing to meet customer's needs and keep
-23-
pace with expected growth. As of September 30, 2005, the Company had 247
full-time equivalent employees ("FTEs") compared to 223 for the same date in
2004 and 227 at December 31, 2004. Other expenses increased to $1.2 million for
the three month period ended September 30, 2005, from $1.0 million in the same
period in 2004. The increase was primarily due to costs associated with a new
director retirement program and higher director fees in 2005 partially offset by
lower equipment costs.
As previously disclosed, in contemplation of the proposed merger of 1st State
with and into the Company, which is subject to regulatory and shareholder
approval as well as other customary closing conditions and which is discussed in
more detail in the Company's Current Report on Form 8-K as filed with the SEC on
June 29, 2005, the Company plans to consolidate its state-wide operations into
1st State's headquarters building in Burlington, North Carolina. The Company
anticipates that such consolidation will include data processing services and
item processing, which to date have been provided by an outside vendor. In
conjunction with processing in-house, the Company will be required to purchase
additional software and equipment. The Company will continue to utilize the
outside vendor for item processing and data processing on a month-to-month basis
after its contract expires at the end of 2005, until the conversion is
completed. The Company estimates the total cost of the conversion to be between
$1.8 million to $2.5 million.
The Company's effective tax rate for the third quarter of 2005 was 33.3%
compared to 34.6% for the comparable period of 2004. Income tax expense for the
third quarter of 2005 and 2004 was $0.9 million. The Company forecasts its
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 change in the
effective tax rate was 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 and again in May 2005.
Results of Operations
Nine month period ended September 30, 2005
- ------------------------------------------
For the nine month period ended September 30, 2005, the Company reported net
income of $4.9 million, or $0.71 per diluted share, compared to net income of
$3.9 million, or $0.57 per diluted share, for the nine month period ended
September 30, 2004. The $1.0 million increase in net income was the result of an
increase in net interest income, primarily due to an improved net interest
margin, and a decrease in the loan loss provision, partially offset by a
decrease in noninterest income and an increase in noninterest expenses,
primarily due to higher salary and benefit expenses. Noninterest income for the
nine month period ended September 30, 2004 includes a $1.1 million gain related
to the sale of three branch locations and a $0.3 million loss related to the
sale of certain residential mortgage loans. There were no non-recurring
transactions during the same period in 2005.
Net interest income increased $2.3 million, or approximately 12%, from $19.2
million for the nine month period ended September 30, 2004, to $21.5 million for
the same period in 2005. Average earning assets for the nine month period ended
September 30, 2005 increased $11.6 million compared to the same period in 2004,
while average interest bearing liabilities increased $4.9 million. Average loan
balances for the nine month period ended September 30, 2005 decreased $1.2
million compared to the same period in 2004 while the average rate earned on
-24-
loans increased by 103 basis points to 6.44%. Average interest bearing deposits
for the nine month period ended September 30, 2005 increased $1.8 million
compared to the same period in 2004 and the average rate paid increased by 50
basis points to 2.44%. The net interest margin on a fully taxable equivalent
basis increased 33 basis points to 3.55% for the nine month period ended
September 30, 2005 from 3.22% 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 FOMC and the asset sensitive position
of the Company's balance sheet. Further increases by the FOMC will likely
increase the effective cost of interest-bearing liabilities and have a negative
effect on net interest margins.
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.
-25-
Average Balances, Interest Earned or Paid, and Interest Yields/Rates
Nine Months Ended September 30, 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 $ 527,204 $ 25,316 6.42% $ 501,205 $ 19,961 5.32%
Consumer 31,606 1,796 7.60% 38,842 1,957 6.73%
Home equity 61,455 2,839 6.18% 59,767 2,203 4.92%
Residential mortgages (3) 25,882 1,189 6.14% 47,508 2,084 5.86%
-----------------------------------------------------------------------
Total loans 646,147 31,140 6.44% 647,322 26,205 5.41%
Investment securities (4) 160,400 5,635 4.70% 156,394 5,368 4.58%
Federal funds sold and other
interest on short term investments 21,225 498 3.14% 12,467 118 1.26%
-----------------------------------------------------------------------
Total interest earning assets 827,772 $ 37,273 6.02% 816,183 $ 31,691 5.19%
==================== =====================
Cash and due from banks 23,501 21,907
Other assets 58,881 51,268
Allowance for loan losses (10,410) (11,555)
--------- ---------
Total assets $ 899,744 $ 877,803
========= =========
Liabilities and Equity
Savings deposits $ 16,607 $ 63 0.51% $ 17,390 $ 35 0.27%
Interest-bearing demand deposits 194,156 2,576 1.77% 189,661 1,604 1.13%
Time deposits 392,365 8,376 2.85% 394,243 7,107 2.41%
-----------------------------------------------------------------------
Total interest bearing deposits 603,128 11,015 2.44% 601,294 8,746 1.94%
Borrowed funds 102,336 3,119 4.07% 102,175 2,533 3.30%
Trust preferred debt 20,620 912 5.91% 20,620 668 4.33%
Repurchase agreements 14,139 241 2.28% 11,228 54 0.64%
-----------------------------------------------------------------------
Total interest-bearing liabilities 740,223 $ 15,287 2.76% 735,317 $ 12,001 2.18%
==================== =====================
Non-interest bearing deposits 69,007 59,111
Other liabilities 10,918 8,967
--------- ---------
Total liabilities 820,148 803,395
Shareholders' equity 79,596 74,408
--------- ---------
Total liabilities and shareholders' equity $ 899,744 $ 877,803
========= =========
Net interest spread (5) 3.26% 3.01%
Tax equivalent adjustment $ 491 $ 501
Net interest income and net
interest margin (6) $ 21,986 3.55% $ 19,690 3.22%
(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.
-26-
For the nine month period ended September 30, 2005, the credit provision for
loan losses was $(0.4 million) compared to a provision of $0.7 million for the
same period in 2004, a decrease of approximately $1.1 million. The decrease in
2005 was primarily due to a reduction in charge offs during the nine month
period ended September 30, 2005, which dropped to $0.4 million from $1.0 million
recorded in same period in 2004 and improvements in the risk rating
classifications of certain loans contained in the portfolio. See "Asset Quality"
below for further discussion of the allowance for loan losses.
Noninterest income for the nine month period ended September 30, 2005, was $4.7
million compared to $5.4 million for the same period in 2004, a decrease of $0.7
million, or 13.2%. The decrease was primarily due to the sale of three branch
locations and certain residential mortgage loans during the third quarter of
2004. These two transactions resulted in a net gain of $0.8 million. Absent
these non-recurring transactions, noninterest income increased $0.1 million for
the nine month period ended September 30, 2005 compared to the same period in
2004. This increase was primarily due to a $0.2 million improvement in mortgage
banking revenues as a result of higher period-over-period loan production and a
$0.2 million increase in bank owned life insurance income due to additional
purchases in 2005. Service charges and other fees decreased by $0.1 million
which are primarily attributable to the three branch locations sold in September
2004.
Noninterest expense for the nine month period ended September 30, 2005 was $19.3
million compared to $17.9 million for the corresponding period in 2004. Salaries
and employee benefits increased by $1.2 million to $10.2 million in the nine
month period ended September 30, 2005 from $9.0 million in the same period in
2004. This increase reflects an increase of 24 FTE's since September 30, 2004,
which is consistent with management's intention to maintain adequate staffing
levels to meet customer needs and keep pace with expected growth. Occupancy
expense for the nine month period ended September 30, 2005 increased by $0.1
million from the same period in 2004 largely due to the opening of new locations
that have a higher cost structure than those branch locations sold in September
2004. The Company added a new branch in Pittsboro during the second quarter of
2005 while branches were opened during May through August 2004 in Greensboro,
Wake Forest, and Asheville, North Carolina. Furniture and equipment expense for
the nine month period ended September 30, 2005 decreased $0.2 million from the
same period in 2004 primarily due to of the amount of equipment expense
associated with the initial startup of these new locations. Other expenses for
the nine month period ended September 30, 2005 increased by $0.3 million from
the same period in 2004 primarily due to higher director fees partially offset
by lower equipment costs
The Company recorded an income tax expense of $2.5 million and $2.1 million for
the nine months ended September 30, 2005 and 2004, respectively. The Company's
effective tax rate for the nine months ended September 30, 2005 was 33.5%
compared to 35.2% for the comparable period of 2004. 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 and during the second quarter of 2005.
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
-27-
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 estimates the amount of allowance needed to cover probable losses in
the portfolio by applying a loss allowance factor to each risk grade. Consumer
loans and mortgages are not risk graded, but a loss allocation factor is
utilized for these loans based on historical losses. The loss allocation factors
have been developed based on the Bank's 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 loan loss allowance is adjusted to an amount
that management believes is adequate to absorb probable losses inherent in the
loan portfolio as of the balance sheet date presented.
During the second quarter of 2005, the Company adjusted its methodology for
estimating the allowance for loan losses associated with certain commercial
loans greater than $750,000. In prior periods, the Company generally used
standard percentage allocations based on the risk rating of the commercial loan
if the loan was risk rated below a "pass" credit. Commencing in the second
quarter, the Company began estimating a specific allowance for loan losses for
these loans. We determine the level of specific allowance based on the facts and
circumstances of each loan, including among other factors, payment history,
collateral values, guarantor liquidity, and net worth. The effect of the revised
methodology used in the estimation of the allowance for loan losses on the third
quarter was to reduce the overall amount of loan loss allocation associated with
non-pass loans greater than $750,000 by approximately $90,000 and approximately
$400,000 for the nine months ended September 30, 2005.
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 (credit) provisions of
$(28,000) and $(434,000) for the three and nine month periods ended September
30, 2005, respectively, compared to an expense of $268,000 and $681,000,
respectively, for the same periods in the prior year. In addition to the change
in methodology with large non-pass loans, the Company saw an overall improvement
in delinquencies and the risk ratings of the portfolio during the quarter which
also contributed to the reduction in provision expense. The allowance for loan
losses was 1.52% and 1.64% of gross loans, respectively, as of September 30,
2005 and December 31, 2004. The allowance for loan losses as a percent of loans
excluding loans held for sale was 1.54% and 1.65% as of September 30, 2005 and
December 31, 2004, respectively. The following table presents an analysis of
changes in the allowance for loan losses for the three and nine month periods
ended September 30, 2005 and 2004, respectively:
-28-
Three Months Nine Months
Ended September 30, Ended September 30,
2005 2004 2005 2004
-------- -------- -------- --------
(Dollars in thousands)
Allowance for loan losses, beginning of period $ 10,075 $ 11,417 $ 10,721 $ 11,613
Net charge-offs:
Loans charged off:
Commercial 116 147 212 608
Consumer 12 37 292 356
Mortgage 34 266 144 336
-------- -------- -------- --------
Total charge-offs 162 450 648 1,300
-------- -------- -------- --------
Recoveries of loans previously charged off:
Commercial 27 61 251 148
Consumer 17 26 42 88
Mortgage -- -- -- 92
-------- -------- -------- --------
Total recoveries 44 87 293 328
-------- -------- -------- --------
Total net charge-offs 118 363 355 972
-------- -------- -------- --------
Loss provisions (credits) charged to operations (113) 268 (522) 681
-------- -------- -------- --------
Allowance for loan losses, end of period $ 9,844 $ 11,322 $ 9,844 $ 11,322
======== ======== ======== ========
Net charge-offs to average loans during the
period (annualized) 0.07% 0.22% 0.07% 0.20%
Allowance as a percent of gross loans 1.52% 1.72%
Allowance as a percent of gross loans excluding
loans held for sale 1.54% 1.79%
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, unforeseen changes in economic and other factors could
effect net charge-offs during the fourth quarter of 2005.
The following table presents an analysis of nonperforming assets as of September
30, 2005 and 2004 and December 31, 2004:
-29-
September 30, December 31,
2005 2004 2004
---------- ---------- ----------
(Dollars in thousands)
Nonaccrual loans:
Commercial and commercial real estate $ 3,915 $ 4,401 $ 3,964
Mortgage 1,711 2,034 1,898
Construction 1,302 1,314 1,622
Equity lines 592 363 415
Consumer 239 151 312
---------- ---------- ----------
Total nonaccrual loans 7,759 8,263 8,211
Foreclosed property held 1,608 825 418
---------- ---------- ----------
Total nonperforming assets $ 9,367 $ 9,088 $ 8,629
========== ========== ==========
Nonperforming loans to total loans 1.20% 1.26% 1.32%
Nonperforming assets to total assets 1.01% 1.04% 0.98%
Allowance coverage of nonperforming loans 127% 137% 131%
On September 30, 2005, nonperforming assets were $9.4 million, an increase of
$0.8 million from December 31, 2004. The increase in nonperforming loans during
the year was largely attributable to four customers. These loans are primarily
secured by real estate and, in some instances the Company is receiving some
payments on the loans. 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 any material losses
associated with the September 30, 2005 nonperforming loans.
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 September 30, 2005 and December 31, 2004.
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.
Foreclosed property increased to $1.6 million at September 30, 2005 from $0.4
million at December 31, 2004. The increase is largely attributable to the
foreclosure of certain nonaccrual
-30-
loans during the year. 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 $66.2 million in its most liquid assets, cash and cash equivalents,
as of September 30, 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 70.1% of total
assets at September 30, 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. The principal purpose of the stock
repurchase program is to manage 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 Company plans to effect the
repurchase program through 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. There were no repurchases during the second and third quarters
of 2005.
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 September 30, 2005 and the minimum requirements are presented in the
following table:
-31-
Minimum
Requirements To Be
Actual Well Capitalized
--------------------- ---------------------
(Dollars in thousands) Amount Ratio Amount Ratio
-------- -------- -------- --------
Capital Bank Corporation
------------------------
Total Capital (to Risk Weighted Assets) $ 99,482 12.80% $ 77,694 10.00%
Tier I Capital (to Risk Weighted Assets) 89,764 11.55% 46,616 6.00%
Tier I Capital (to Average Assets) 89,764 10.13% 44,323 5.00%
Capital Bank
------------
Total Capital (to Risk Weighted Assets) $ 92,246 11.91% $ 77,461 10.00%
Tier I Capital (to Risk Weighted Assets) 82,556 10.66% 46,477 6.00%
Tier I Capital (to Average Assets) 82,556 9.10% 45,344 5.00%
Consolidated capital ratios improved from December 31, 2004 due to the increase
in capital associated with the Company's retention of earnings for the nine
months ended September 30, 2005 in excess of dividends and balance sheet growth.
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 $82.3 million, or $12.11 per share, at September 30,
2005. Management believes this level of shareholders' equity provides adequate
capital to support the Company's growth and to maintain a well capitalized
position.
The merger agreement with 1st State calls for the payment of a portion (up to
35%) of the total merger consideration in cash. This cash consideration is
currently anticipated to be obtained by the Company through a combination of
short-term financing and the issuance (by a to-be-formed subsidiary of the
Company) of additional trust preferred securities. Such subsidiary will be
formed for the sole purpose of the issuance transaction and will only have those
assets and operations that are incidental to such issuance. It is not expected
that the financing transactions and/or payment of cash consideration to the
shareholders of 1st State will have a material adverse effect on the Company's
post-merger liquidity position or capital ratios.
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 September 30, 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 its 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.
-32-
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 its Exchange Act filings.
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 control over
financial reporting as a result of remediation of matters identified through its
review of internal control 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
----------------------------------------------------------
None
Item 3 Defaults Upon Senior Securities
-------------------------------
None
Item 4 Submission of Matters to a Vote of Security Holders
---------------------------------------------------
None
Item 5 Other Information
-----------------
None
Item 6 Exhibits
--------
-33-
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 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 William R. Lampley 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 William R. Lampley 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.]
-34-
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: November 4, 2005 By: /s/B. Grant Yarber
---------------------
B. Grant Yarber
Chief Executive Officer
-35-
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 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 William R. Lampley 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 William R. Lampley 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.]
-36-