UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
---------
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005
Commission File Number 000-30062
CAPITAL BANK CORPORATION
(Exact name of registrant as specified in its charter)
North Carolina 56-2101930
(State of incorporation) (I.R.S. Employer
Identification Number)
4901 Glenwood Avenue
Raleigh, North Carolina 27612
(Address of principal executive office)
Registrant's telephone number, including area code: (919) 645-6400
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value per share
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes |_| No |X|
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes |_| No |X|
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment of this
Form 10-K. |_|
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act:
Large accelerated filer |_| Accelerated filer |X| Non-accelerated filer |_|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes |_| No |X|
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The aggregate market value of the registrant's Common Stock, no par value per
share, as of June 30, 2005, held by those persons deemed by the registrant to be
non-affiliates was approximately $81,290,077 (5,415,728 shares held by
non-affiliates at $15.01 per share). For purposes of the forgoing calculation
only, all directors, executive officers, and 5% shareholders of the registrant
have been deemed affiliates.
As of March 6, 2006, there were 11,734,786 shares of the registrant's Common
Stock, no par value per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Document Incorporated Where
--------------------- -----
1. Portions of the registrant's Proxy Statement for the Annual Meeting Part III
of Shareholders to be held on May 25, 2006
CAPITAL BANK CORPORATION
Annual Report on Form 10-K
INDEX
PART I.................................................................................. ..............2
Item 1. Business..................................................................................2
Item 1A. Risk Factors.............................................................................10
Item 1B. Unresolved Staff Comments................................................................13
Item 2. Properties...............................................................................13
Item 3. Legal Proceedings........................................................................13
Item 4. Submission of Matters to a Vote of Security Holders......................................13
PART II............................................................................... ...............14
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities.....................................................................14
Item 6. Selected Financial Data..................................................................15
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....16
Item 7A. Quantitative and Qualitative Disclosures About Market Risk...............................32
Item 8. Financial Statements and Supplementary Data..............................................35
Item 9. Changes In and Disagreements With Accountants On Accounting and Financial Disclosure.....68
Item 9A. Controls and Procedures..................................................................68
Item 9B. Other Information........................................................................69
PART III............................................................................. ................69
Item 10. Directors and Executive Officers of the Registrant.......................................69
Item 11. Executive Compensation...................................................................69
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters..................................................................................69
Item 13. Certain Relationships and Related Transactions...........................................69
Item 14. Principal Accountant Fees and Services...................................................70
PART IV............................................................................ ..................70
Item 15. Exhibits and Financial Statement Schedules...............................................70
Signatures........................................................................................71
PART I
Item 1. Business.
General
Capital Bank Corporation (the "Company") is a financial holding company
incorporated under the laws of North Carolina on August 10, 1998. The Company's
primary function is to serve as the holding company for its wholly-owned
subsidiaries, Capital Bank and Capital Bank Investment Services, Inc. In
addition, the Company has interest in
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three trusts, Capital Bank Statutory Trust I, II and III (hereinafter
collectively referred to as the "Trusts"). These Trusts are not consolidated
with the financial statements of the Company pursuant to the provisions of FASB
Interpretation No. 46R, "Consolidation of Variable Interest Entities" ("FIN
46"). Capital Bank (the "Bank") was incorporated under the laws of the State of
North Carolina on May 30, 1997, and commenced operations as a state-chartered
banking corporation on June 20, 1997. The Bank is not a member of the Federal
Reserve System and has no subsidiaries. Capital Bank Investment Services, Inc.
("CBIS") was incorporated under the laws of the State of North Carolina on
January 3, 2001 and commenced operations as a full service investment company on
March 1, 2001. In the third quarter of 2003 CBIS ceased operations, but remains
a subsidiary of the Company.
As of December 31, 2005, the Company had assets of approximately $960.9 million,
gross loans outstanding of approximately $669.0 million and deposits of
approximately $698.5 million. The Company's corporate office is located at 4901
Glenwood Avenue, Raleigh, North Carolina 27612, and its telephone number is
(919) 645-6400. In addition to the corporate office, the Company has four branch
offices in Raleigh, three in Sanford, three in Asheville, two in Cary, one in
Siler City, one in Oxford, one in Wake Forest, two in Burlington, one in Graham,
one in Greensboro, one in Hickory, and one in Pittsboro, North Carolina.
On January 3, 2006, the Company consummated its previously announced merger with
1st State Bancorp, Inc. ("1st State Bancorp"). As a result of the merger, and
the subsequent merger of 1st State Bank, a subsidiary of 1st State Bancorp, with
and into Capital Bank, Capital Bank is the sole manager-member of First Capital
Services Company, LLC, which had previously operated as 1st State Bank's full
service investment company. In addition, as a result of the merger, Capital Bank
has one additional branch in Mebane, four additional branches in Burlington, and
two additional branches in Graham, North Carolina.
Capital Bank is a community bank engaged in the general commercial banking
business in Wake, Chatham, Granville, Alamance, Lee, Buncombe, Guilford and
Catawba Counties of North Carolina. Wake County has a diversified economic base,
comprised primarily of services, retail trade, government and manufacturing and
includes the City of Raleigh, the state capital. Lee, Granville and Chatham
counties are significant centers for various industries, including agriculture,
manufacturing, lumber and tobacco. Alamance and Guilford counties have a
diversified economic base, comprised primarily of manufacturing, agriculture,
retail and wholesale trade, government, services and utilities. Catawba County,
which includes the town of Hickory, is a regional center for manufacturing and
wholesale trade. The economic base of the city of Asheville, in Buncombe County,
is comprised primarily of services, medical, tourism and manufacturing
industries.
The Bank offers a full range of banking services, including the following:
checking accounts; savings accounts; NOW accounts; money market accounts;
certificates of deposit; loans for real estate, construction, businesses,
agriculture, personal uses, home improvement and automobiles; equity lines of
credit; credit loans; consumer loans; credit cards; individual retirement
accounts; safe deposit boxes; bank money orders; internet banking; electronic
funds transfer services including wire transfers; traveler's checks; various
investments; and free notary services to all Bank customers. In addition, the
Bank provides automated teller machine access to its customers for cash
withdrawals through nationwide ATM networks. At present, the Bank does not
provide the services of a trust department.
In the third quarter of 2004, the Bank began to offer non-insured investment
products and services through a new financial services division, creating a
partnership with Capital Investment Group, a leading Raleigh, North Carolina
based broker-dealer. The Bank hired four commission-based financial advisors
during 2004 to offer full-service brokerage to individual and corporate
customers. With the addition of the financial services division, Capital Bank
believes it now has the ability to compete with much larger institutions in
North Carolina.
The Trusts were formed for the sole purpose of issuing trust preferred
securities. The proceeds from such issuances were loaned to the Company in
exchange for the Debentures (as defined below), which are the sole assets of the
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.
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Lending Activities and Deposits
Loan Types and Lending Policies. The Company originates a variety of loans,
including loans secured by real estate, loans for construction, loans for
commercial purposes and loans to individuals for personal and household
purposes. During 2005, there were no large concentrations of credit to any
particular industry. The economic trends of the area served by the Company are
influenced by the significant industries within the region. Consistent with the
Company's emphasis on being a community-oriented financial institution,
virtually all the Company's business activity is with customers located in and
around counties in which the Company has banking offices. The ultimate
collectibility of the Company's loan portfolio is susceptible to changes in the
market conditions of these geographic regions.
The Company uses a centralized risk management process to ensure uniform credit
underwriting that adheres to the Bank's loan policy as approved annually by the
Board of Directors. Lending policies are reviewed on a regular basis to confirm
that the Company is prudent in setting its underwriting criteria. Credit risk is
managed through a number of methods including loan grading of commercial loans,
committee approval of larger loans and class and purpose coding of loans.
Management believes that early detection of credit problems through regular
contact with the Company's clients coupled with consistent reviews of the
borrowers' financial condition are important factors in overall credit risk
management. The amounts and types of loans outstanding for the past five years
ended December 31 are shown on the following table:
Loan Type 2005 2004 2003 2002 2001
------------- ------------- ------------- ------------- -------------
% of % of % of % of % of
(In thousands) Amount Total Amount Total Amount Total Amount Total Amount Total
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Commercial $ 555,366 83% $ 532,091 82% $ 474,317 76% $ 430,817 71% $ 229,386 75%
Home Equity Lines 65,566 10% 61,924 9% 58,430 9% 45,935 8% 28,383 9%
Consumer 26,222 4% 34,865 5% 42,929 7% 51,069 9% 28,201 9%
Residential mortgages 21,828 3% 25,987 4% 50,269 8% 72,788 12% 20,921 7%
-----------------------------------------------------------------------------------------------------------
$ 668,982 100% $ 654,867 100% $ 625,945 100% $ 600,609 100% $ 306,891 100%
===========================================================================================================
Deposits. The majority of the Company's deposit customers are individuals and
small to medium-size businesses located in Wake, Chatham, Granville, Alamance,
and Lee Counties, North Carolina and contiguous areas and the Asheville,
Greensboro and Hickory, North Carolina communities. The Company's deposit base
is well diversified, with no material concentration in a single industry or
group of related industries. Management of the Company does not believe that the
deposits or the business of the Company are seasonal in nature. Deposits vary
with local and national economic conditions, but management does not believe the
variances have a material effect on planning and policy making. The Company
attempts to control deposit flow through the pricing of deposits and promotional
activities. Management believes that the Company's rates are competitive with
those offered by other institutions in the same geographic area.
The following table sets forth the mix of depository accounts at the Company as
a percentage of total deposits as of December 31, 2005:
Non-interest bearing demand 11%
Interest checking 11%
Market rate investment 21%
Savings 2%
Time deposits:
Under $100,000 36%
Equal to or over $100,000 19%
--------
100%
========
Competition
Commercial banking in North Carolina is extremely competitive in large part due
to statewide branching. The Company competes in its market area with some of the
largest banking organizations in the state and the country and other community
financial institutions, such as federally and state-chartered savings and loan
institutions and credit
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unions, as well as consumer finance companies, mortgage companies and other
lenders engaged in the business of extending credit. Many of the Company's
competitors have broader geographic markets, easier access to capital and lower
cost funding and higher lending limits than the Company and are also able to
provide more services and make greater use of media advertising.
The enactment of legislation authorizing interstate banking has caused increases
in the size and financial resources of some of the Company's competitors. In
addition, as a result of interstate banking, out-of-state commercial banks may
acquire North Carolina banks and heighten the competition among banks within
North Carolina. Despite the competition in its market area, the Company believes
that it has certain competitive advantages that distinguish it from its
competition. The Company believes that its primary competitive advantages are
its strong local identity and affiliation with the communities it serves and its
emphasis on providing specialized services to small and medium-sized business
enterprises, as well as professional and upper-income individuals. The Company
offers customers modern, high-tech banking without forsaking community values
such as prompt, personal service and friendliness. The Company offers many
personalized services and attracts customers by being responsive and sensitive
to their individualized needs. The Company also relies on goodwill and referrals
from shareholders and satisfied customers, as well as traditional media to
attract new customers. To enhance a positive image in the community, the Company
supports and participates in local events and its officers and directors serve
on boards of local civic and charitable organizations.
Employees
At March 6, 2006, the Company employed 320 persons, of which 295 were full-time
and 25 were part-time. None of the Company's employees are represented by a
collective bargaining unit or agreement. The Company considers relations with
its employees to be good.
Supervision and Regulation
Holding companies, banks and many of their non-bank affiliates are extensively
regulated under both federal and state law. The following is a brief summary of
certain statutes, rules and regulations affecting the Company and the Bank. This
summary is qualified in its entirety by reference to the particular statutory
and regulatory provisions referred to below and is not intended to be an
exhaustive description of the statutes or regulations applicable to the
Company's or the Bank's business. Supervision, regulation and examination of the
Company and the Bank by bank regulatory agencies is intended primarily for the
protection of the Bank's depositors rather than holders of the Company's common
stock.
The Company is also regulated by the Securities and Exchange Commission ("SEC")
as a result of its common stock being publicly traded. Due to recent
legislation, the regulatory compliance burden of being a publicly traded company
has increased significantly over the last few years.
Holding Company Regulation
General. The Company is a holding company registered with the Federal Reserve
under the Bank Holding Company Act of 1956 (the "BHCA"). As such, the Company
and the Bank are subject to the supervision, examination and reporting
requirements contained in the BHCA and the regulation of the Federal Reserve.
The BHCA requires that a bank holding company obtain the prior approval of the
Federal Reserve before: (i) acquiring direct or indirect ownership or control of
more than five percent of the voting shares of any bank; (ii) taking any action
that causes a bank to become a subsidiary of the bank holding company; (iii)
acquiring all or substantially all of the assets of any bank; or (iv) merging or
consolidating with any other bank holding company.
The BHCA generally prohibits a bank holding company, with certain exceptions,
from engaging in activities other than banking, or managing or controlling banks
or other permissible subsidiaries, and from acquiring or retaining direct or
indirect control of any company engaged in any activities other than those
activities determined by the Federal Reserve to be closely related to banking,
or managing or controlling banks, as to be a proper incident thereto. In
determining whether a particular activity is permissible, the Federal Reserve
must consider whether the performance of such an activity can reasonably be
expected to produce benefits to the public, such as greater convenience,
increased competition or gains in efficiency, that outweigh possible adverse
effects, such as undue concentration of resources,
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decreased or unfair competition, conflicts of interest or unsound banking
practices. For example, banking, operating a thrift institution, extending
credit or servicing loans, leasing real or personal property, providing
securities brokerage services, providing certain data processing services,
acting as agent or broker in selling credit life insurance and certain other
types of insurance underwriting activities have all been determined by
regulations of the Federal Reserve to be permissible activities.
Pursuant to delegated authority, the Federal Reserve Bank of Richmond has
authority to approve certain activities of holding companies within its
district, including the Company, provided the nature of the activity has been
approved by the Federal Reserve. Despite prior approval, the Federal Reserve has
the power to order a holding company or its subsidiaries to terminate any
activity or to terminate its ownership or control of any subsidiary when it
believes that continuation of such activity or such ownership or control
constitutes a serious risk to the financial safety, soundness or stability of
any bank subsidiary of that bank holding company.
Financial Holding Companies. The Gramm-Leach-Bliley Financial Modernization Act
of 1999 (the "GLB"):
o allows bank holding companies meeting management, capital and the
Community Reinvestment Act of 1977 (the "CRA") standards to engage
in a substantially broader range of non-banking activities than was
permissible prior to enactment, including insurance underwriting and
making merchant banking investments in commercial and financial
companies;
o allows insurers and other financial services companies to acquire
banks;
o removes various restrictions that applied to bank holding company
ownership of securities firms and mutual fund advisory companies;
and
o establishes the overall regulatory structure applicable to bank
holding companies that also engage in insurance and securities
operations.
The Company is authorized to operate as a financial holding company and
therefore is eligible to engage in the broader range of activities that are
permitted by the GLB. The GLB also is designed to modify other current financial
laws, including laws related to financial privacy and community reinvestment.
The new financial privacy provisions generally prohibit financial institutions,
including the Company, from disclosing nonpublic personal financial information
to nonaffiliated third parties unless customers have the opportunity to "opt
out" of the disclosure.
Mergers and Acquisitions. The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "IBBEA") permits interstate acquisitions of banks
and bank holding companies without geographic limitation, subject to any state
requirement that the bank has been organized for a minimum period of time, not
to exceed five years, and the requirement that the bank holding company, prior
to, or following the proposed acquisition, controls no more than 10% of the
total amount of deposits of insured depository institutions in the U.S. and no
more than 30% of such deposits in any state (or such lesser or greater amount
set by state law).
In addition, the IBBEA permits a bank to merge with a bank in another state as
long as neither of the states has opted out of the IBBEA prior to May 31, 1997.
The state of North Carolina has "opted in" to such legislation. In addition, a
bank may establish and operate a de novo branch in a state in which the bank
does not maintain a branch if that state expressly permits de novo interstate
branching. As a result of North Carolina's opt-in law, North Carolina law
permits unrestricted interstate de novo branching.
Additional Restrictions and Oversight. Subsidiary banks of a bank holding
company are subject to certain restrictions imposed by the Federal Reserve on
any extensions of credit to the bank holding company or any of its subsidiaries,
investments in the stock or securities thereof and the acceptance of such stock
or securities as collateral for loans to any borrower. A bank holding company
and its subsidiaries are also prevented from engaging in certain tie-in
arrangements in connection with any extension of credit, lease or sale of
property or furnishing of services. An example of a prohibited tie-in would be
any arrangement that would condition the provision or cost of services on a
customer obtaining additional services from the bank holding company or any of
its other subsidiaries.
The Federal Reserve may issue cease and desist orders against bank holding
companies and non-bank subsidiaries to
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stop actions believed to present a serious threat to a subsidiary bank. The
Federal Reserve also regulates certain debt obligations, changes in control of
bank holding companies and capital requirements.
Under the provisions of the North Carolina law, the Company is registered with
and subject to supervision by the North Carolina Commissioner of Banks (the
"Commissioner").
Capital Requirements. The Federal Reserve has established risk-based capital
guidelines for bank holding companies. The minimum standard for the ratio of
capital to risk-weighted assets (including certain off balance sheet
obligations, such as standby letters of credit) is eight percent. At least half
of this capital must consist of common equity, retained earnings and a limited
amount of perpetual preferred stock and minority interests in the equity
accounts of consolidated subsidiaries, less certain goodwill items and other
adjustments ("Tier 1 capital"). The remainder ("Tier 2 capital") may consist of
mandatorily redeemable convertible debt securities and a limited amount of other
preferred stock, subordinated debt and loan loss reserves.
In addition, the Federal Reserve has established minimum leverage ratio
guidelines for bank holding companies. These guidelines provide for a minimum
leverage ratio of Tier 1 capital to adjusted average quarterly assets less
certain amounts ("Leverage Ratio") equal to three percent for bank holding
companies that meet certain specified criteria, including having the highest
regulatory rating. All other bank holding companies will generally be required
to maintain a Leverage Ratio of between four percent and five percent.
The guidelines also provide that bank holding companies experiencing significant
growth, whether through internal expansion or acquisitions, will be expected to
maintain strong capital ratios well above the minimum supervisory levels without
significant reliance on intangible assets. The same heightened requirements
apply to bank holding companies with supervisory, financial, operational or
managerial weaknesses, as well as to other banking institutions if warranted by
particular circumstances or the institution's risk profile. Furthermore, the
guidelines indicate that the Board of Governors of the Federal Reserve System
(the "Federal Reserve Board") will continue to consider a "tangible Tier 1
Leverage Ratio" (deducting all intangibles) in evaluating proposals for
expansion or new activity. The Federal Reserve has not advised the Company of
any specific minimum Leverage Ratio or tangible Tier 1 Leverage Ratio applicable
to it.
As of December 31, 2005, the Company had Tier 1 risk-adjusted, total regulatory
capital and leverage capital of approximately 11.73%, 13.71% and 10.64%,
respectively, all in excess of the minimum requirements. Those same ratios as of
December 31, 2004 were 11.08%, 12.33% and 9.61%, respectively.
International Money Laundering Abatement and Financial Anti-Terrorism Act Of
2001. Title III of the USA Patriot Act of 2001 contains the International Money
Laundering Abatement and Financial Anti-Terrorism Act of 2001 (the "IMLAFA").
The anti-money laundering provisions of IMLAFA impose affirmative obligations on
a broad range of financial institutions, including banks, brokers, and dealers.
Among other requirements, IMLAFA requires all financial institutions to
establish anti-money laundering programs that include, at minimum, internal
policies, procedures, and controls; specific designation of an anti-money
laundering compliance officer; ongoing employee training programs; and an
independent audit function to test the anti-money laundering program. IMLAFA
requires financial institutions that establish, maintain, administer, or manage
private banking accounts for non-United States persons or their representatives
to establish appropriate, specific, and where necessary, enhanced due diligence
policies, procedures, and controls designed to detect and report money
laundering. Additionally, IMLAFA provides for the Department of Treasury to
issue minimum standards with respect to customer identification at the time new
accounts are opened. The Company has determined the impact that IMLAFA will have
on the Bank's operations is not material. The Bank has established policies and
procedures to ensure compliance with the IMLAFA that were approved by the Board
of Directors.
Bank Regulation
The Bank is subject to numerous state and federal statutes and regulations that
affect its business, activities, and operations, and is supervised and examined
by the Commissioner and the Federal Reserve. The Federal Reserve and the
Commissioner regularly examine the operations of banks over which they exercise
jurisdiction. They have the authority to approve or disapprove the establishment
of branches, mergers, consolidations and other similar corporate actions. They
also have authority to prevent the continuance or development of unsafe or
unsound banking practices
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and other violations of law. The Federal Reserve and the Commissioner regulate
and monitor all areas of the operations of banks and their subsidiaries,
including loans, mortgages, issuances of securities, capital adequacy, loss
reserves and compliance with the CRA as well as other laws and regulations.
Interest and certain other charges collected and contracted for by banks are
also subject to state usury laws and certain federal laws concerning interest
rates.
The deposit accounts of the Bank are insured by the Bank Insurance Fund (the
"BIF") of the Federal Deposit Insurance Corporation (the "FDIC") up to a maximum
of $100,000 per insured depositor. The FDIC issues regulations and conducts
periodic examinations, requires the filing of reports and generally supervises
the operations of its insured banks. This supervision and regulation is intended
primarily for the protection of depositors. Any insured bank that is not
operated in accordance with or does not conform to FDIC regulations, policies
and directives may be sanctioned for noncompliance. Civil and criminal
proceedings may be instituted against any insured bank or any director, officer
or employee of such bank for the violation of applicable laws and regulations,
breaches of fiduciary duties or engaging in any unsafe or unsound practice. The
FDIC has the authority to terminate insurance of accounts pursuant to procedures
established for that purpose.
Under the North Carolina corporation laws, the Company may not pay a dividend or
distribution, if after giving its effect, the Company would not be able to pay
its debts as they become due in the usual course of business or the Company's
total assets would be less than its liabilities. In general, the Company's
ability to pay cash dividends is dependent upon the amount of dividends paid by
the Bank. The ability of the Bank to pay dividends to the Company is subject to
statutory and regulatory restrictions on the payment of cash dividends,
including the requirement under the North Carolina banking laws that cash
dividends be paid only out of undivided profits and only if the bank has surplus
of a specified level. The Federal Reserve also imposes limits on the Bank's
payment of dividends.
Like the Company, the Bank is required by federal regulations to maintain
certain minimum capital levels. The levels required of the Bank are the same as
required for the Company. At December 31, 2005, the Bank had Tier 1
risk-adjusted, total regulatory capital and leverage capital of approximately
10.41%, 11.62% and 9.27%, respectively, all in excess of the minimum
requirements.
The Bank is subject to insurance assessments imposed by the FDIC. The FDIC has
adopted a risk-based assessment schedule providing for annual assessment rates
ranging from 0% to .27% of an institution's average assessment base, applicable
to institutions insured by both the BIF and the Savings Association Insurance
Fund ("SAIF"). The actual assessment to be paid by each insured institution is
based on the institution's assessment risk classification, which focuses on
whether the institution is considered "well capitalized," "adequately
capitalized" or "under capitalized," as such terms are defined in the applicable
federal regulations. Within each of these three risk classifications, each
institution will be assigned to one of three subgroups based on supervisory risk
factors. In particular, regulators will assess supervisory risk based on whether
the institution is financially sound with only a few minor weaknesses (Subgroup
A), whether it has weaknesses which, if not corrected, could result in an
increased risk of loss to the BIF (Subgroup B) or whether such weaknesses pose a
substantial probability of loss to the BIF unless effective corrective action is
taken (Subgroup C). The FDIC also is authorized to impose one or more special
assessments in an amount deemed necessary to enable repayment of amounts
borrowed by the FDIC from the United States Treasury Department and all banks
are now required to pay additional annual assessments at rates set by the
Financing Corporation, which was established by the Competitive Equality Banking
Act of 1987.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
provides for, among other things, (i) publicly available annual financial
condition and management reports for certain financial institutions, including
audits by independent accountants, (ii) the establishment of uniform accounting
standards by federal banking agencies, (iii) the establishment of a "prompt
corrective action" system of regulatory supervision and intervention, based on
capitalization levels, with greater scrutiny and restrictions placed on
depository institutions with lower levels of capital, (iv) additional grounds
for the appointment of a conservator or receiver and (v) restrictions or
prohibitions on accepting brokered deposits, except for institutions which
significantly exceed minimum capital requirements. FDICIA also provides for
increased funding of the FDIC insurance funds and the implementation of
risk-based premiums.
A central feature of FDICIA is the requirement that the federal banking agencies
take "prompt corrective action" with respect to depository institutions that do
not meet minimum capital requirements. Pursuant to FDICIA, the federal bank
regulatory authorities have adopted regulations setting forth a five-tiered
system for measuring the capital adequacy of the depository institutions that
they supervise. Under these regulations, a depository institution is classified
in one of
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the following capital categories: "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" and "critically
undercapitalized." An institution may be deemed by the regulators to be in a
capitalization category that is lower than is indicated by its actual capital
position if, among other things, it receives an unsatisfactory examination
rating with respect to asset quality, management, earnings or liquidity. FDICIA
provides the federal banking agencies with significantly expanded powers to take
enforcement action against institutions which fail to comply with capital or
other standards. Such action may include the termination of deposit insurance by
the FDIC or the appointment of a receiver or conservator for the institution.
Banks are also subject to the CRA, which requires the appropriate federal bank
regulatory agency, in connection with its examination of a bank, to assess such
bank's record in meeting the credit needs of the community served by that bank,
including low and moderate-income neighborhoods. Each institution is assigned
one of the following four ratings of its record in meeting community credit
needs: "outstanding," "satisfactory," "needs to improve" or "substantial
noncompliance." The regulatory agency's assessment of the bank's record is made
available to the public. Further, such assessment is required of any bank which
has applied to (i) charter a national bank, (ii) obtain deposit insurance
coverage for a newly chartered institution, (iii) establish a new branch office
that will accept deposits, (iv) relocate an office or (v) merge or consolidate
with, or acquire the assets or assume the liabilities of, a federally regulated
financial institution. In the case of a bank holding company applying for
approval to acquire a bank or other bank holding company, the Federal Reserve
will assess the record of each subsidiary bank of the applicant bank holding
company, and such records may be the basis for denying the application.
The GLB's "CRA Sunshine Requirements" call for financial institutions to
disclose publicly certain written agreements made in fulfillment of the CRA.
Banks that are parties to such agreements also must report to federal regulators
the amount and use of any funds expended under such agreements on an annual
basis, along with such other information as regulators may require.
Monetary Policy and Economic Controls
The Company and the Bank are directly affected by governmental policies and
regulatory measures affecting the banking industry in general. Of primary
importance is the Federal Reserve Board, whose actions directly affect the money
supply which, in turn, affects banks' lending abilities by increasing or
decreasing the cost and availability of funds to banks. The Federal Reserve
Board regulates the availability of bank credit in order to combat recession and
curb inflationary pressures in the economy by open market operations in United
States government securities, changes in the discount rate on member bank
borrowings, changes in reserve requirements against bank deposits and
limitations on interest rates that banks may pay on time and savings deposits.
Deregulation of interest rates paid by banks on deposits and the types of
deposits that may be offered by banks have eliminated minimum balance
requirements and rate ceilings on various types of time deposit accounts. The
effect of these specific actions and, in general, the deregulation of deposit
interest rates has generally increased banks' cost of funds and made them more
sensitive to fluctuations in money market rates. In view of the changing
conditions in the national economy and money markets, as well as the effect of
actions by monetary and fiscal authorities, no prediction can be made as to
possible future changes in interest rates, deposit levels, loan demand, or the
business and earnings of the Bank or the Company. As a result, banks, including
the Bank, face a significant challenge to maintain acceptable net interest
margins.
Executive Officers
The executive officers of the Company are:
Name Age Position With Company
- ---- --- ---------------------
B. Grant Yarber 41 President and Chief Executive Officer
A. Christine Baker 52 Executive Vice President and Chief Financial Officer
Mark J. Redmond 38 Executive Vice President and Chief Credit Officer
- 9 -
B. Grant Yarber serves as President and Chief Executive Officer for Capital Bank
Corporation and Capital Bank, overseeing the day-to-day operations of the Bank.
Mr. Yarber joined Capital Bank during the summer of 2003 as the Chief Credit
Officer and was then promoted to President and Chief Operating Officer before
his appointment to Chief Executive Officer. Mr. Yarber served previously as
Chief Lending Officer and Chief Credit Officer of MountainBank in
Hendersonville, N.C. With more than 15 years of banking experience, Mr. Yarber
has particular strength in lending and credit management. His background
includes leadership positions with Bank of America, including Southeast Credit
Manager and Regional Executive for Business Banking and Professional/Executive
Banking for Missouri and Illinois.
A. Christine Baker became Executive Vice President and Chief Financial Officer
for Capital Bank Corporation and Capital Bank effective January 3, 2006. In this
position, Ms. Baker is responsible for the financial activities of the Company,
including investment portfolio management, analyst relations and strategic
planning. Ms. Baker previously served as Treasurer and Secretary of 1st State
Bancorp, Inc., Burlington, North Carolina and Executive Vice President and Chief
Financial Officer of 1st State Bank, Burlington, North Carolina.
Mark J. Redmond serves as Executive Vice President and Chief Credit Officer for
Capital Bank Corporation and Capital Bank. Mr. Redmond previously served as
Senior Credit Officer at BB&T for three years, where he was responsible for
credit administration for the western half of Kentucky, and as a Credit Officer
with BB&T's Capital Market Group for two years. Mr. Redmond has over 13 years of
banking experience, concentrating in the commercial lending and credit areas. In
his function as Chief Credit Officer, Mr. Redmond is responsible for credit
quality, loan review, special assets, government lending, compliance, and the
credit department.
Website Access to Capital Bank Corporation's Filings with the Securities and
Exchange Commission
Since becoming an "accelerated filer," all of the Company's electronic filings
with the SEC, including the Annual Report on Form 10-K, Quarterly Reports on
Form 10-Q, Current Reports on Form 8-K and amendments to these reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), have been made available at no cost on
the Company's web site, www.capitalbank-nc.com, as soon as reasonably
practicable after the Company filed such material with, or furnished it to, the
SEC. The Company's SEC filings are also available through the SEC's web site at
www.sec.gov. In addition, any reports the Company files with the SEC are
available at the SEC's Public Reference Room at 100 F Street, N.E., Washington,
DC 20549. Information may be obtained about the Public Reference Room by calling
the SEC at 1-800-SEC-0330.
Item 1A. Risk Factors.
In addition to the other information provided in this Annual Report of Form
10-K, you should consider the following material risk factors carefully before
deciding to invest in the Company's securities. Additional risks and
uncertainties not presently known to the Company, that the Company currently
deems not material or that are similar to those faced by other companies in the
Company's industry or business in general, such as competitive conditions, may
also impact the Company's 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. References herein to "we," "us" and "our" refer
to Capital Bank Corporation, a company incorporated in North Carolina, and its
consolidated subsidiaries, unless the context otherwise requires.
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.
- 10 -
We Are Exposed to Risks in Connection with the Loans We Make
A significant source of risk for us arises from the possibility that losses will
be sustained because borrowers, guarantors and related parties may fail to
perform in accordance with the terms of their loans. We have underwriting and
credit monitoring procedures and credit policies, including the establishment
and review of the allowance for loan losses, that we believe are appropriate to
minimize this risk by assessing the likelihood of nonperformance, tracking loan
performance and diversifying our loan portfolio. Such policies and procedures,
however, may not prevent unexpected losses that could adversely affect our
results of operations.
We Compete With Larger Companies for Business
The banking and financial services business in our market areas continues to be
a competitive field and is becoming more competitive as a result of:
o Changes in regulations;
o Changes in technology and product delivery systems; and
o The accelerating pace of consolidation among financial services
providers.
We may not be able to compete effectively in our markets, and our results of
operations could be adversely affected by the nature or pace of change in
competition. We compete for loans, deposits and customers with various bank and
nonbank financial services providers, many of which have substantially greater
resources including higher total assets and capitalization, greater access to
capital markets and a broader offering of financial services.
Our Trading Volume Has Been Low Compared With Larger Banks
The trading volume in the Company's common stock on the NASDAQ National Market
has been comparable to other similarly-sized banks. Nevertheless, this trading
is relatively low when compared with more seasoned companies listed on the
NASDAQ National Market or other consolidated reporting systems or stock
exchanges. Thus, the market in the Company's common stock may be limited in
scope relative to other companies.
We Depend Heavily on Our Key Management Personnel
The Company's success depends in part on its ability to retain key executives
and to attract and retain additional qualified management personnel who have
experience both in sophisticated banking matters and in operating a small to
mid-size bank. Competition for such personnel is strong in the banking industry
and we may not be successful in attracting or retaining the personnel we
require. We expect to effectively compete in this area by offering financial
packages that include incentive-based compensation and the opportunity to join
in the rewarding work of building a growing bank.
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:
- 11 -
o The payment of dividends to our shareholders;
o Possible mergers with or acquisitions of or by other institutions;
o Our desired investments;
o Loans and interest rates on loans;
o Interest rates paid on our deposits;
o The possible expansion of our branch offices; and/or
o Our ability to provide securities or trust services.
We also are subject to capitalization guidelines set forth in federal
legislation, and could be subject to enforcement actions to the extent that we
are found by regulatory examiners to be undercapitalized. We cannot predict what
changes, if any, will be made to existing federal and state legislation and
regulations or the effect that such changes may have on our future business and
earnings prospects. The cost of compliance with regulatory requirements
including those imposed by the Securities and Exchange Commission 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 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, which 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. As a result, our ability to attract and retain
executive officers and qualified Board and committee members could be more
difficult. In addition, it may become more difficult and more expensive to
obtain director and officer liability insurance.
- 12 -
We May Not Be Able to Successfully Integrate 1st State Bancorp or to Realize the
Anticipated Benefits of our Recently Completed Merger
Our recently completed merger with 1st State Bancorp 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 Bancorp 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.
Item 1B. Unresolved Staff Comments.
Not Applicable
Item 2. Properties.
The Company currently leases property located at 4901 Glenwood Avenue, Raleigh,
North Carolina for its principal offices and a branch office. The lease is for
approximately 21,600 square feet, of which approximately 18,600 square feet is
for the company's principal offices and the remainder for the branch office. On
November 21, 2005, the Company entered into a lease for an eventual total of
approximately 55,359 rentable square feet of premises at 333 Fayetteville
Street, Raleigh, North Carolina. This space will initially serve as a branch
location (with associated office space). In addition to this facility, the
Company owns 12 properties throughout North Carolina that are used as branch
locations and which are located in Sanford (2), Cary (2), Siler City, Oxford,
Burlington (2), Graham, Greensboro, Hickory and Raleigh. The Company also leases
11 other properties throughout North Carolina that are used as branch locations,
operations facilities or mortgage production offices and which are located in
Raleigh (3), Sanford, Asheville (3), Cary, Pittsboro and Wake Forest. Management
believes the terms of the various leases, which are reviewed on an annual basis,
are consistent with market standards and were arrived at through arm's length
bargaining.
Item 3. Legal Proceedings.
There are no pending material legal proceedings to which the Company is a party
or of which any of its property is subject. In addition, the Company is not
aware of any threatened litigation, unasserted claims or assessments that could
have a material adverse effect on the Company's business, operating results or
financial condition.
Item 4. Submission of Matters to a Vote of Security Holders.
On November 30, 2005, the Company held a Special Meeting of Shareholders during
which time certain matters related to the merger of 1st State Bancorp with and
into the Company were submitted to the shareholders of the Company for a vote.
Below is a brief description of the matters, as well as the number of votes cast
for or against and the number of abstentions:
1. To approve the merger agreement, including the transactions
contemplated thereby, and the related plan of merger, dated as of June 29,
2005, between Capital Bank Corporation and 1st State Bancorp, Inc. by
which Capital Bank Corporation will acquire 1st State Bancorp, Inc.
through the merger of 1st State Bancorp, Inc. into Capital Bank
Corporation, with Capital Bank Corporation being the surviving
corporation.
- 13 -
2. To approve the issuance of up to 4,966,612 shares of Capital Bank
Corporation common stock to the shareholders of 1st State Bancorp, Inc. in
connection with Capital Bank Corporation's acquisition of 1st State
Bancorp, Inc. in a merger.
3. To approve the adjournment of the Capital Bank Corporation special
meeting, if necessary, to permit Capital Bank Corporation to solicit
additional proxies if there are insufficient votes at the special meeting
to constitute a quorum or to approve the merger agreement, including the
transactions contemplated thereby, and the related plan of merger or the
issuance of shares of Capital Bank Corporation common stock in the merger.
Each item considered was approved by the Company's shareholders. Of the
6,790,568 shares eligible to vote, 4,489,840 were voted as shown on the
following tables:
For Against/Withheld Abstain
--- ---------------- -------
Proposal 1. Merger Agreement 4,187,451 299,410 2,979
Proposal 2. Share Issuance 4,181,953 300,609 7,277
Proposal 3. Meeting Adjournment 4,140,702 366,188 4,950
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities.
Shares of Capital Bank Corporation common stock are traded on the Nasdaq
National Market under the symbol "CBKN." As of March 1, 2006, the Company had
approximately 2,170 holders of record of its common stock. The following table
sets forth, for the indicated periods, the high and low sales prices for the
common stock (based on published sources) and the cash dividend declared per
share of the Company's common stock:
Cash
Dividends
Per Share
2005 High Low Declared
--------------------------------------------------------
First Quarter $19.46 $16.35 $0.06
Second Quarter 18.48 15.00 0.06
Third Quarter 17.50 14.75 0.06
Fourth Quarter 17.00 14.76 0.06
Cash
Dividends
Per Share
2004 High Low Declared
--------------------------------------------------------
First Quarter $18.12 $15.45 $0.05
Second Quarter 17.06 15.20 0.05
Third Quarter 16.74 15.88 0.05
Fourth Quarter 18.98 15.97 0.06
Dividend Policy. The Company's shareholders are entitled to receive such
dividends or distributions as the Board of Directors authorizes in its
discretion. The Company's ability to pay dividends is subject to the
restrictions of the North Carolina Business Corporation Act. There are also
various statutory limitations on the ability of the Bank to pay dividends to the
Company. Subject to the legal availability of funds to pay dividends, during
fiscal year 2005, the Company declared and paid dividends totaling $0.24 per
share (see chart above for declared quarterly dividends). The Company currently
intends to pay approximately 20% to 30% of its annual net earnings to
shareholders in the
- 14 -
form of annual cash dividends if such cash dividends are in the best interest of
the Company in the business judgment of its Board of Directors and are
consistent with maintaining the Company's status as a "well-capitalized"
institution under applicable banking laws and regulations.
Recent Sales of Unregistered Securities. The Company did not sell any securities
in the fiscal year ended December 31, 2005 that were not registered under the
Securities Act of 1933, as amended (the "Securities Act").
Repurchases of Equity Securities. Neither the Company nor any affiliated
purchasers made any purchases of Company equity securities registered pursuant
to Section 12 of the Exchange Act, during the fourth quarter ended December 31,
2005. During the first quarter of 2006, the Company's Board of Directors
authorized the Company to acquire in the open market or in any private
transaction, from time-to-time and in accordance with applicable laws, rules and
regulations, up to 1.0 million shares of the Company's common stock. Management
plans to utilize share repurchases to manage the capital levels of the Company.
Item 6. Selected Financial Data.
The following table sets forth selected financial information for the Company
that has been derived from the financial statements and notes thereto included
elsewhere in this report. This information should be read in conjunction with
Management's Discussion and Analysis of Financial Condition and Results of
Operations and the consolidated financial statements and notes thereto included
elsewhere in this report.
(In thousands, except share and per share data) As of and for the Years Ended December 31
2005 2004 2003 2002 2001
----------------------------------------------------------------
Selected Balance Sheet Data
Cash and Due From Banks $ 68,332 $ 23,007 $ 22,408 $ 32,837 $ 15,173
Federal Funds Sold and Short Term Investments 8,757 4 3,202 18,696 944
Securities 161,601 160,580 165,913 155,304 73,702
Gross Loans 668,982 654,867 625,945 600,609 306,891
Allowance for Loan Losses 9,592 10,721 11,613 9,390 4,286
Total Assets 960,906 882,294 857,734 840,976 406,741
Deposits 698,480 654,976 629,619 644,887 304,443
Borrowings 93,173 102,320 114,591 97,858 50,000
Repurchase Agreements 14,514 16,755 11,014 13,081 11,167
Shareholders' Equity 83,492 77,738 72,923 75,471 36,983
Summary of Operations
Interest Income $ 50,749 $ 42,391 $ 40,440 $ 36,244 $ 26,173
Interest Expense 21,459 16,257 16,318 15,895 14,701
----------------------------------------------------------------
Net Interest Income 29,290 26,134 24,122 20,349 11,472
Provision (Credit) for Loan Losses (396) 1,038 8,247 4,190 1,215
----------------------------------------------------------------
Net Interest Income After Provision For Loan Losses 29,686 25,096 15,875 16,159 10,257
Other Operating Income 6,731 6,905 10,322 7,987 4,490
Other Operating Expense 26,454 23,824 25,165 17,465 11,847
----------------------------------------------------------------
Pre-tax Net Income 9,963 8,177 1,032 6,681 2,900
Income Tax Expense 3,264 2,866 38 2,374 480
----------------------------------------------------------------
Net Income $ 6,699 $ 5,311 $ 994 $ 4,307 $ 2,420
================================================================
Per Share Data
Net Income - Basic $ .99 $ .79 $ .15 $ .79 $ .65
Net Income - Diluted .97 .77 .15 .76 .65
Dividends .24 .21 .20 .20 --
Book Value 12.18 11.76 11.15 11.44 10.28
Number of Common Shares Outstanding 6,852,156 6,612,787 6,541,495 6,595,784 3,597,339
- 15 -
As of and for the Years Ended December 31
2005 2004 2003 2002 2001
-----------------------------------------------
Selected Ratios
Return On Average Assets .74% .60% .11% .66% .65%
Return on Average Shareholders' Equity 8.32% 7.04% 1.34% 7.43% 6.69%
Dividend Payout Ratio 24% 26% 133% 26% 0%
Average Shareholders' Equity to Average Total Assets 8.87% 8.58% 8.55% 8.89% 9.69%
Net Interest Margin (1) 3.59% 3.28% 3.06% 3.38% 3.28%
(1) On a tax equivalent basis
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion and analysis is intended to aid the reader in
understanding and evaluating the results of operations and financial condition
of the Company and its consolidated subsidiaries. As described above, the Trusts
are not consolidated with the financial statements of the Company pursuant to
the provisions of FIN 46. This discussion is designed to provide more
comprehensive information about the major components of the Company's results of
operations and financial condition, liquidity, and capital resources than can be
obtained from reading the financial statements alone. This discussion should be
read in conjunction with the Company's consolidated financial statements, the
related notes and the selected financial data presented elsewhere in this
report.
Safe Harbor Discussion
Information set forth in this Annual Report on Form 10-K contains various
"forward looking statements" within the meaning of Section 27A of the Securities
Act and Section 21E of the Exchange Act, which statements represent the
Company's judgment concerning the future and are subject to risks and
uncertainties that could cause the Company's actual operating results and
financial position to differ materially from the forward looking statements.
Such forward looking statements can be identified by the use of forward looking
terminology such as "may," "will," "expect," "anticipate," "estimate,"
"believe," or "continue," or the negative thereof or other variations thereof or
comparable terminology.
The Company cautions that any such forward looking statements are further
qualified by important factors that could cause the Company's actual operating
results to differ materially from those in the forward looking statements,
including without limitation, the management of the Company's growth, the risks
associated with possible or completed acquisitions, the risks associated with
the Bank's loan portfolio, competition within the industry, dependence on key
personnel, government regulation and the other risk factors described in Item
1A. Risk Factors.
Overview. Capital Bank is a full-service state chartered community bank
conducting business throughout North Carolina. The Bank operates through four
North Carolina regions; Triangle, Sandhills, Triad and Western. The Bank was
incorporated on May 30, 1997 and opened its first branch in June of that same
year in Raleigh. In 1999, the shareholders of the Bank approved the
reorganization of the Bank into a bank holding company. In 2001, the Company
received approval to become a financial holding company. As of December 31,
2005, the Company conducted no business other than holding stock in the Bank and
each of the Trusts.
The Bank's business consists principally of attracting deposits from the general
public and investing these funds in loans secured by commercial real estate,
secured and unsecured commercial and consumer loans, single-family residential
mortgage loans, and home equity lines. As a community bank, the Bank's
profitability depends primarily upon its levels of net interest income, which is
the difference between interest income from interest-earning assets and interest
expense on interest-bearing liabilities. When interest-earning assets
approximate or exceed interest-bearing liabilities, any positive interest rate
spread will generate net interest income. The Bank's profitability is also
affected by its provision for loan losses, other operating income, and other
operating expenses. Other income primarily consists of miscellaneous service
charges and ATM fees, fees generated from originating mortgage loans that are
sold and the increase in cash surrender value of bank-owned life insurance.
Operating expenses primarily consist of compensation and benefits, occupancy
related expenses, advertising, data processing, professional fees,
telecommunication and other expenses.
- 16 -
The Bank's operations are influenced significantly by local economic conditions
and by policies of financial institution regulatory authorities. The Bank's cost
of funds is influenced by interest rates on competing investments and by rates
offered on similar investments by competing financial institutions in our market
area, as well as general market interest rates. Lending activities are affected
by the demand for financing, which in turn is affected by the prevailing
interest rates.
Net income totaled $6.7 million, or $0.97 per diluted share in 2005 compared to
$5.3 million, or $0.77 per diluted share in 2004. Net interest income increased
from $26.1 million in 2004 to $29.3 million in 2005. This increase was driven by
the impact of rising interest rates, higher earning assets and higher core
funding levels. For the years ended December 31, 2005 and 2004, the net interest
margin was 3.59% and 3.28%, respectively. The provision for loan losses
decreased $1.4 million in 2005 driven by overall improvement in the credit
quality of the loan portfolio, revisions to the Bank's allowance estimation
methodology, and a reduction in net charge offs during the year ended December
31, 2005. Operating expenses increased $2.6 million, primarily due to higher
compensation and benefits expenses.
During 2005, the Company focused on the following priorities:
o Strong, sustainable earnings;
o A sound credit culture;
o Disciplined growth in existing or adjacent markets; and
o Unparalleled customer service by experienced community bankers.
On January 3, 2006, the Company completed its previously announced acquisition
of 1st State Bancorp. Based on a completed election, proration and allocation
procedure, each share of 1st State Bancorp common stock has been automatically
converted into either: (i) 2.434788 shares of the Company's common stock,
rounded to the nearest whole share; (ii) an amount equal to $27.86 in cash, plus
0.608697 shares of the Company's common stock, rounded to the nearest whole
share; or (iii) 1.684457 shares of the Company's common stock, rounded to the
nearest whole share, plus an amount equal to $11.4486 in cash.
The Company also strengthened its management team during the year with the
hiring of Mark J. Redmond as Chief Credit Officer in May 2005 and the
appointment of A. Christine Baker as Chief Financial Officer in January 2006
following the consummation of the 1st State Bancorp merger. The Company believes
it has an experienced management team in place that is dedicated to providing
exceptional value to its customers and shareholders.
Critical Accounting Policies and Estimates. The Company's discussion and
analysis of its financial condition and results of operations are based on the
Company's consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires the Company to make
estimates and judgments regarding uncertainties that affect the reported amounts
of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, the Company evaluates
its estimates, including those related to the reserve for loan losses,
investment and intangible asset values, income taxes, and contingencies and
litigation. The Company bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. The Company believes the following critical
accounting policies affect its more significant judgments and estimates used in
the preparation of its consolidated financial statements:
o Allowance for Loan Losses - The Company records an estimated
allowance for loan losses based on known problem loans and estimated
risk in the existing loan portfolio. The allowance calculation takes
into account historic write-off trends and current market and
economic conditions. If economic conditions were to decline
significantly or the financial condition of the Bank's customers
were to deteriorate, resulting in an impairment of their ability to
make payments, additional increases to the allowance may be
required.
o Investments - The Company records an investment impairment charge
when it believes an investment has experienced a decline in value
that is other than temporary. Future adverse changes in market
conditions and associated market values of investments could result
in losses or an inability to recover the carrying value of
- 17 -
the investments that may not be reflected in an investment's current
carrying value, thereby possibly requiring an impairment charge in
the future.
o Valuation Allowances - The Company assesses the need to record a
valuation allowance to reduce its deferred tax assets to the amount
that is more likely than not to be realized. The Company considers
anticipated future taxable income and ongoing prudent and feasible
tax planning strategies in determining the need for the valuation
allowance which, at this time, it deems not to be necessary. In the
event the Company were to determine that it would not be able to
realize all or part of its net deferred tax asset in the future, an
adjustment to the deferred tax asset would be charged to income in
the period such determination was made.
o Goodwill - Goodwill is not amortized, but is reviewed for potential
impairment on an annual basis at the reporting unit level.
Identified intangible assets are amortized on a straight-line basis.
An impairment loss is recorded to the extent that the carrying
amount of goodwill exceeds its implied fair value.
o Impairment of Long-Lived Assets - Long-lived assets, including
identified intangible assets, are evaluated for impairment if events
or circumstances indicate a possible impairment. Such evaluations
are based on undiscounted cash flow projections. The disposal of
long-lived assets is measured based on the lower of the book or fair
value less the costs to sell.
Results of Operations
Year Ended December 31, 2005 Compared with Year Ended December 31, 2004
For the year ended December 31, 2005, the Company reported net income of $6.7
million, or $0.97 per diluted share, compared to net income of $5.3 million, or
$0.77 per diluted share, for the year ended December 31, 2004. The $1.4 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 year ended December 31, 2004 included a
$1.1 million gain related to the sale of three branch locations and a $320,000
loss related to the sale of certain residential mortgage loans. There were no
significant non-recurring transactions during the year ended December 31, 2005.
Net Interest Income. Net interest income is the difference between total
interest income and total interest expense and is the Company's principal source
of earnings. The amount of net interest income is determined by the volume of
interest-earning assets, the level of rates earned on those assets, and the
volume and cost of supporting funds. Net interest income increased from $26.1
million in 2004 to $29.3 million in 2005, an increase of $3.2 million, or 12.3%.
The increase is primarily due to increases in market rates on the Bank's
interest-earning assets as its loan yields adjusted upwards with increases in
the prime rate and premium amortization slowed on its investment portfolio from
lower prepayments. During 2005, the Federal Reserve made eight 25 basis point
("bp") upward adjustments in the Open Market Committee's benchmark federal funds
rate. Since the Bank's loan portfolio adjusts with prime at a faster rate than
the time deposit portfolio, the increasing rate environment has had a positive
effect on net interest spread and net interest margin. As time deposits mature
and reprice, the margin could be negatively impacted based on pricing
competition to retain these deposits. The increasing rate environment helped
push average loan yields up to 6.64% for the year ended December 31, 2005
compared to 5.49% for the year ended December 31, 2004. Likewise, average time
deposit yields increased from 2.42% for the year ended December 31, 2004 to
3.00% for the year ended December 31, 2005.
Net interest spread is the difference between rates earned on interest-earning
assets and the interest paid on deposits and other borrowed funds. Net interest
margin is the total of net interest income divided by average earning assets.
Average earning assets in 2005 were $833.4 million, up 2.0% compared to $817.1
million for 2004. The net interest margin was 3.59% on a fully tax equivalent
("TE") basis in 2005, a 31 bp increase from the 2004 net interest margin of
3.28%. On a TE basis, net interest spread was 3.28% and 3.06% for 2005 and 2004,
respectively.
Interest income increased 19.6% in 2005 to $50.7 million from $42.4 million in
2004. This increase is primarily due to the growth in the Bank's commercial loan
portfolio and increases in overall yield as discussed above. The average yield
on interest-earning assets for 2005 was 6.17%, a 90 bp increase from the 2004
yield of 5.27%. The average loan
- 18 -
portfolio as a percentage of earning assets was 77.8% in 2005, down 1.8% from
2004. The average balances of loans, which had yields of 6.64% and 5.49% for
2005 and 2004, respectively, decreased from $650.1 million in 2004 to $648.0
million in 2004. The average balance of mortgage loans decreased from $45.6
million in 2004 to $25.4 million in 2005, primarily due to the sale of $19.4
million of residential loans in the fourth quarter of 2004. The average balances
of federal funds and other short-term investments increased from $10.7 million
in 2004 to $24.0 million in 2005 and the average yield in this category
increased 188 bps from 1.46% to 3.34% over the same time period as a result of
the increase in short-term interest rates. The tax equivalent yield on
investment securities increased from 4.60% in 2004 to 4.68% in 2005. This
increase reflects new security purchases that provided higher yields in response
to the increasing interest rate environment.
Interest expense increased 31.9% in 2005 to $21.5 million from $16.3 million in
2004. Average total interest-bearing deposits, including savings,
interest-bearing demand deposits and time deposits increased from $597.7 million
in 2004 to $606.4 million in 2005, largely due to an increase in money market
account deposits. The average rate paid on interest-bearing deposits increased
60 bps from 1.97% in 2004 to 2.57% in 2005 in response to the rising
interest-rate environment. The average rate on borrowings also increased from
3.32% in 2004 to 4.16% in 2005. This increase reflects the effects of rising
interest rates on the Bank's variable-rate borrowings and the effects of the
Bank's interest rate swap agreements, which converted portions of the Bank's
fixed rate long term debt to a floating rate. We expect the cost of borrowings
to increase in 2006 as interest rates continue to increase. Interest expense on
subordinated debt associated with the Company's three trust preferred offerings
increased from $0.9 million in 2004 to $1.3 million in 2005. The average
outstanding balance of subordinated debt increased slightly from $20.6 million
in 2004 to $21.3 million in 2005, as the Company completed the third $10.0
million trust preferred security offering in late December 2005. The average
rate on subordinated debt increased 167 bps between 2004 and 2005 as a result of
the changes to the 90 day London Interbank Offered Rate (LIBOR), which increased
from 2.56% at the end of December 2004 to 4.53% at the end of December 2005. The
subordinated debt issues pay interest at varying spreads to LIBOR and interest
expense will increase in 2006 as a result of the third trust preferred security
offering.
The following two tables set forth certain information regarding the Company's
yield on interest-earning assets and cost of interest-bearing liabilities and
the component changes in net interest income. The first table reflects the
Company's effective yield on earning assets and cost of funds. Yields and costs
are computed by dividing income or expense for the year by the respective daily
average asset or liability balance. Changes in net interest income from year to
year can be explained in terms of fluctuations in volume and rate. The second
table presents further information on those changes. For each category of
interest-earning asset and interest-bearing liability, we have provided
information on changes attributable to:
o changes in volume, which are changes in average volume multiplied by
the average rate for the previous period
o changes in rates, which are changes in average rate multiplied by
the average volume for the previous period
o changes in rate-volume, which are changes in average rate multiplied
by the changes in average volume and
o total change, which is the sum of the previous columns
- 19 -
Average Balances, Interest Earned or Paid, and Interest Yields/Rates
(Tax Equivalent Basis - Dollars in thousands) (1)
Year Ended December 31, 2005 Year Ended December 31, 2004 Year Ended December 31, 2003
-------------------------------------------------------------------------------------------
Average Amount Average Average Amount Average Average Amount Average
Balance Earned Rate Balance Earned Rate Balance Earned Rate
-------------------------------------------------------------------------------------------
Assets
Loans receivable: (2)
Commercial $ 529,711 $ 35,196 6.64% $ 506,744 $ 27,487 5.42% $ 470,147 $24,563 5.22%
Consumer 30,453 2,359 7.75% 37,841 2,536 6.70% 49,367 3,261 6.61%
Home equity 62,446 3,943 6.31% 59,865 3,015 5.04% 49,686 2,631 5.30%
Residential mortgages (3) 25,369 1,549 6.11% 45,671 2,666 5.84% 62,925 3,897 6.19%
-------------------------------------------------------------------------------------------
Total loans 647,979 43,047 6.64% 650,121 35,704 5.49% 632,125 34,352 5.43%
Investment securities (4) 161,368 7,555 4.68% 156,300 7,195 4.60% 159,030 6,514 4.10%
Federal funds sold and other
interest on short term investments 24,013 802 3.34% 10,683 156 1.46% 16,676 190 1.14%
-------------------------------------------------------------------------------------------
Total interest earning assets 833,360 $ 51,404 6.17% 817,104 $ 43,055 5.27% 807,831 $41,056 5.08%
================= ================ =================
Cash and due from banks 23,690 22,135 20,715
Other assets 61,075 51,449 47,505
Allowance for loan losses (10,234) (11,465) (10,521)
---------- ---------- ----------
Total assets $ 907,891 $ 879,223 $ 865,530
========== ========== ==========
Liabilities and Equity
Savings deposits $ 16,198 $ 82 0.51% $ 17,040 $ 45 0.26% $ 18,833 $ 71 0.38%
Interest-bearing demand deposits 200,017 3,788 1.89% 188,855 2,250 1.19% 188,624 2,087 1.11%
Time deposits 390,140 11,707 3.00% 391,783 9,487 2.42% 393,401 9,912 2.52%
-------------------------------------------------------------------------------------------
Total interest bearing deposits 606,355 15,577 2.57% 597,678 11,782 1.97% 600,858 12,070 2.01%
Borrowed funds 100,751 4,192 4.16% 102,859 3,417 3.32% 110,107 3,911 3.55%
Subordinated debt 21,264 1,314 6.18% 20,620 929 4.51% 7,123 248 3.48%
Repurchase agreements and fed
funds purchased 14,557 376 2.58% 13,433 129 0.96% 14,457 89 0.62%
-------------------------------------------------------------------------------------------
Total interest-bearing liabilities 742,927 $ 21,459 2.89% 734,590 $ 16,257 2.21% 732,545 $16,318 2.23%
================= ================ =================
Non-interest bearing deposits 71,830 60,201 50,489
Other liabilities 12,592 9,009 8,523
---------- ---------- ----------
Total liabilities 827,349 803,800 791,557
Shareholders' equity 80,542 75,423 73,973
---------- ---------- ----------
Total liabilities and equity $ 907,891 $ 879,223 $ 865,530
========== ========== ==========
Net interest spread (5) 3.28% 3.06% 2.85%
Tax equivalent adjustment $ 655 $ 664 $ 616
Net interest income and net
interest margin (6) $ 29,945 3.59% $ 26,798 3.28% $24,738 3.06%
================== ================= =================
(1) The taxable equivalent basis is computed using a blended federal and state
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
market-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.
- 20 -
Rate & Volume Variance Analysis
(Tax Equivalent Basis - Dollars in thousands) (1)
Year Ended Year Ended
December 31, 2005 December 31, 2004
vs. 2004 vs. 2003
Rate/ Rate/
Volume Rate Volume Total Volume Rate Volume Total
Variance Variance Variance Variance Variance Variance Variance Variance
------------------------------------------- --------------------------------------------
Interest Income:
Loans receivable $ (118) $ 7,486 $ (25) $ 7,343 $ 978 $ 364 $ 10 $ 1,352
Investment securities 233 123 4 360 (112) 807 (14) 681
Federal funds sold 194 201 251 646 (69) 54 (19) (34)
------------------------------------------- --------------------------------------------
Total interest income 309 7,810 230 8,349 797 1,225 (23) 1,999
------------------------------------------- --------------------------------------------
Interest Expense:
Savings and interest-bearing
demand deposits and other 115 1,390 70 1,575 (16) 154 (1) 137
Time deposits (40) 2,270 (10) 2,220 (41) (386) 2 (425)
Borrowed funds (70) 863 (18) 775 (257) (254) 17 (494)
Subordinated debt 29 345 11 385 470 73 138 681
Repurchase agreements and fed
funds purchased 11 218 18 247 (6) 50 (4) 40
------------------------------------------- --------------------------------------------
Total interest expense 45 5,086 71 5,202 150 (363) 152 (61)
------------------------------------------- --------------------------------------------
Increase (decrease) in net interest
income $ 264 $ 2,724 $ 159 $ 3,147 $ 647 $ 1,588 $ (175) $ 2,060
=========================================== ============================================
(1) The taxable equivalent basis is computed using a blended federal and state
rate of approximately 38%.
Provision for Loan Losses. The provision for loan losses is the amount charged
against earnings for the purpose of establishing an adequate allowance for loan
losses. Loan losses are, in turn, charged to this allowance rather than being
reported as a direct expense. For the year ended December 31, 2005, the credit
provision for loan losses was ($396,000) compared to a provision of $1.0 million
for the year ended December 31, 2004, a decrease of approximately $1.4 million.
The decrease in 2005 was primarily due to overall improvement in the credit
quality of the loan portfolio, revisions to the Bank's estimation methodology,
and a reduction in net charge offs during the year ended December 31, 2005.
The amount of the allowance for loan losses is established based on management's
estimate of the inherent risks associated with lending activities, estimated
fair value of collateral, past experience and present indicators such as
delinquency rates and current market conditions. The allowance is regularly
reviewed and adjusted, as necessary. Loans of $750,000 or more, as well as other
loans, are subject to specific review for impairment. The allowance for loan
losses was $9.6 million and $10.7 million on December 31, 2005 and 2004,
respectively, and represented approximately 1.43% and 1.64% of total loans
outstanding on those dates. During 2005 and 2004, the Company reclassified
($53,000) and $311,000 of the allowance which related to loss exposure on
unfunded loan commitments and letters of credit into a separate other liability
account.
During the second quarter of 2005, the Bank revised its methodology for
estimating the allowance for loan losses associated with certain commercial
loans greater than $750,000. In prior periods, the Bank generally used standard
percentage allocations based on the assigned risk rating of the commercial loan
if the loan was risk rated below a "pass" credit. Commencing in the second
quarter, the Bank began estimating a specific allowance for loan losses for
these loans. The Bank determines 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 paying ability. The effect
of the revised methodology used in the estimation of the allowance for loan
losses for 2005 was to reduce the overall amount of loan loss allocation
associated with non-pass loans greater than $750,000 by $622,000 for the year
ended December 31, 2005.
During the fourth quarter of 2005, the Bank also revised its methodology for
estimating inherent loan losses associated with unfunded loan commitments and
letters of credit. In prior periods, the Bank applied a standard percentage
allocation to the total amount of unused credit available. The revised
methodology segregates the unused credit into risk categories and incorporates
loss probabilities into the development of the loss percentage factors. The
revised
- 21 -
methodology used to estimate the contingent liability associated with unfunded
loan commitments resulted in a reduction of $53,000 to the provision for loan
losses for the year ended December 31, 2005.
The Company also experienced lower loan charge offs during 2005 compared to
2004. Management believes that this was due in part to an overall improvement in
delinquencies and favorable developments in the economy. During 2005, the
Company charged off an aggregate of $1.2 million in loans, net of $0.4 million
in recoveries. During 2004, the Company charged off an aggregate of $1.6 million
in loans, net of $0.6 million in recoveries. Included in the charge offs for
2004 was $497,000 related to one loan that had been classified as impaired at
December 31, 2003 and for which a specific reserve of $825,000 had been
established at that time. Net loan charge offs as a percent of average loan
balances outstanding decreased from .25% in 2004 to .12% in 2005.
Management has allocated the allowance for loan losses by category, as shown in
the following table. This allocation is based on management's assessment of the
risks associated with the different types of lending activities.
Allowance for Loan Losses by Category
At December 31,
-------------------------------------------------------------------------------------------------------
(Dollars in thousands) 2005 2004 2003 2002 2001
-------------------------------------------------------------------------------------------------------
% of % of % of % of % of
Total Total Total Total Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
-------------------------------------------------------------------------------------------------------
Commercial $ 8,437 83% $ 9,323 82% $ 9,885 76% $ 7,309 71% $ 3,377 75%
Consumer 373 4% 519 5% 1,012 7% 1,105 9% 438 9%
Residential mortgages 225 10% 299 9% 210 8% 468 12% 98 7%
Equity lines 557 3% 580 4% 506 9% 508 8% 373 9%
-------------------------------------------------------------------------------------------------------
$ 9,592 100% $10,721 100% $11,613 100% $ 9,390 100% $ 4,286 100%
=======================================================================================================
The following table shows changes in the allowance for loan losses arising from
loans charged off and recoveries on loans previously charged off by loan
category and additions to the allowance that have been charged to expenses.
- 22 -
Analysis of Allowance for Loan Losses
As of and For the Years Ended December 31,
------------------------------------------------------------
(Dollars in thousands) 2005 2004 2003 2002 2001
------------------------------------------------------------
Average amount of loans outstanding, net of unearned income $ 647,979 $ 650,121 $632,125 $470,058 $267,285
Amount of loans outstanding at year end, net of unearned income 668,982 654,867 625,945 600,609 306,891
Reserve for loan losses:
Balance at beginning of period $ 10,721 $ 11,613 $ 9,390 $ 4,286 $ 3,463
Adjustment for loans acquired 4,393
Loans charged off:
Commercial 469 1,390 5,631 3,545 273
Consumer 357 504 637 470 144
Equity 150 1 5 -- --
Mortgage 173 340 613 -- --
------------------------------------------------------------
Total chargeoffs 1,149 2,235 6,886 4,015 417
------------------------------------------------------------
Recoveries of loans previously charged off:
Commercial 317 411 797 263 17
Consumer 42 94 58 73 8
Equity 3 4 -- -- --
Mortgage 1 107 7 -- --
------------------------------------------------------------
Total recoveries 363 616 862 336 25
------------------------------------------------------------
Net loans charged off 786 1,619 6,024 3,679 392
------------------------------------------------------------
Provision (credit) for loan losses (396) 1,038 8,247 4,190 1,215
Reclassification to other liabilities 53 (311) -- -- --
------------------------------------------------------------
Balance at December 31 $ 9,592 $ 10,721 $ 11,613 $ 9,390 $ 4,286
============================================================
Ratio of net chargeoffs to average loans outstanding during the year 0.12% 0.25% 0.95% 0.78% 0.15%
============================================================
Allowance for loan losses as a percent of total loans 1.43% 1.64% 1.86% 1.56% 1.40%
============================================================
There were no loans classified as impaired at December 31, 2005 and 2004.
Average impaired loans during 2005 and 2004 were $1.1 million and $2.1 million,
respectively. The following table shows the total of the nonperforming assets in
the Company's portfolio as of December 31 in the years indicated. [GRAPHIC
(Dollars in thousands) 2005 2004 2003 2002 2001
------ ------ ------ ------ ------
Nonperforming assets:
Nonaccrual loans - Commercial $5,040 $3,964 $3,766 $ 982 $1,521
Nonaccrual loans - Mortgage 1,628 1,898 2,271 1,371 81
Nonaccrual loans - Construction 737 1,622 1,444 33 859
Nonaccrual loans - Consumer 176 312 258 239 590
Nonaccrual loans - Equity lines 497 415 271 422 19
------ ------ ------ ------ ------
Total nonaccrual loans 8,078 8,211 8,010 3,047 3,070
Foreclosed properties 771 418 978 947 --
------ ------ ------ ------ ------
Total nonperforming assets $8,849 $8,629 $8,988 $3,994 $3,070
====== ====== ====== ====== ======
Nonperforming assets to:
Loans outstanding at end of year 1.32% 1.32% 1.44% 0.66% 1.00%
Total assets at end of year 0.92% 0.98% 1.05% 0.48% 0.75%
Allowance for loan losses as a percent of
nonperforming loans 119% 131% 145% 308% 140%
Nonaccrual loans greater than 90 days past due were $4.4 million and $4.9
million as of December 31, 2005 and 2004, respectively. As of December 31, 2005,
nonaccrual loans include three unrelated credit relationships with an aggregate
- 23 -
balance of $3.8 million. The Company has established specific loan loss
allocations of $680,000 for these credits. The majority of the Bank's
nonperforming loans are secured by real estate collateral which management
believes should mitigate our exposure to losses compared to those loans that are
unsecured or collateralized with other types of assets.
Other Operating Income. Other operating income was $6.7 million and $6.9 million
for years ended December 31, 2005 and 2004, respectively, a decrease of $0.2
million. The decrease in other operating income is 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.
Excluding these non-recurring transactions, noninterest income increased $0.6
million for the year ended December 31, 2005 compared to the year ended December
31, 2004. This increase was primarily due to a $445,000 improvement in mortgage
fees and revenues as a result of higher period-over-period loan production, a
$280,000 increase in bank owned life insurance income due to additional
purchases in 2005 and a $335,000 gain on the sale of a real estate parcel.
Service charges and other fees decreased by $0.1 million which are primarily
attributable to the three branch locations sold in September 2004. Total service
charges and fees as a percent of the average total deposit base decreased from
..45% in 2004 to .42% in 2005.
Other Operating Expense. Other operating expense represents the costs of
operating the Company. Management regularly monitors all categories of other
operating expense in an attempt to improve productivity and operating
performance. Other operating expense increased 11.3% to $26.5 million in 2005
from $23.8 million in 2004. At December 31, 2005 and 2004 there were 21 and 20
branches, respectively, and the average number of full time equivalent ("FTE")
employees during 2005 and 2004 was 243 and 216, respectively.
Salary and employee benefits expense for the years ended December 31, 2005 and
2004 were $14.0 million and $12.1 million, respectively. Commission expense
increased from $728,000 in 2004 to $873,000 in 2005 primarily due to an increase
in mortgage production. The increase in salary and employee benefits is
primarily due to an increase of 29 FTEs since December 31, 2004, which is
consistent with management's intention to maintain adequate staffing levels to
meet customer needs and keep pace with expected growth. Incentive compensation
increased by $0.3 million from $902,000 in 2004 to $1.2 million in 2005 and the
Company incurred $243,000 in severance expenses related to certain executive and
senior officers who separated from the Company compared to $61,000 in 2004.
Occupancy expense increased from $2.4 million in 2004 to $2.6 million in 2005.
The increase was primarily a result of lease expenses associated with new branch
locations that opened during 2004 and additional space needed for expansion of
existing departments. Furniture and equipment expense decreased from $1.7
million in 2004 to $1.5 million in 2005 due to no new branches being opened in
2005 and lower depreciation expenses. Directors and advisory board expenses
increased from $428,000 in 2004 to $1.1 million in 2005 as a result of revisions
to the existing deferred compensation plan and the implementation of a new
supplemental retirement plan. Data processing costs increased from $1.1 million
in 2004 to $1.3 million in 2005 primarily due to higher transaction volumes.
Professional fees decreased from $989,000 in 2004 to $867,000 in 2005, primarily
as a result of lower accounting fees, which were higher in 2004 as a result of
the use of outside consultants in the initial assessment of internal controls.
Other expenses remained flat at $3.4 million in 2005. Retired director expenses
decreased from $409,000 in 2004 to $177,000 in 2005. This decrease was offset by
increases in travel and entertainment expenses, non-deferred loan costs, and
sponsorships which increased from $416,000, $227,000 and $106,000, respectively,
in 2004 to $507,000, $311,000 and $182,000, respectively, in 2005.
Provision for Income Taxes. The Company recorded an income tax expense of $3.3
million in 2005 compared to $2.9 million in 2004. The increase in income tax
expense is primarily the result of the change in pretax income which increased
from $8.2 million in 2004 to $10.0 million in 2005. The overall effective rate
decreased from 35.0% in 2004 to 32.8 % in 2005. The change in the effective tax
rate primarily reflects the addition of nontaxable income as the result of new
purchases of bank owned life insurance and an increase in tax-exempt interest.
Year Ended December 31, 2004 Compared with Year Ended December 31, 2003
Net Interest Income. Net interest income increased from $24.1 million in 2003 to
$26.1 million in 2004, an increase of $2.0 million, or 8%. The increase during
the period is primarily due to increases in market rates on the Bank's
interest-earning assets as its loan yields adjusted upwards with increases in
the prime rate and premium amortization slowed on its investment portfolio from
lower prepayments. Over the last six months of 2004, the Federal Reserve
- 24 -
made five 25 basis point upward adjustments in the Open Market Committee's
benchmark federal funds rate. In addition, the Bank's net interest income was
positively affected by a shift in the mix of its earning assets as the Bank
replaced lower yielding federal funds with higher yielding loans. Average
federal funds and short term investments, yielding only 1.14% in 2003, dropped
by $6.0 million from December 31, 2003 to December 31, 2004 while average loans,
yielding 5.49% in 2004, increased by almost $18.0 million. The increase in
average loans takes into account the effect of the following two nonrecurring
transactions that occurred during the period:
o The Company completed the sale of its Northern Region branches in
Warrenton, Seaboard and Woodland in September 2004. In those branch
sales, the Company sold approximately $39.6 million of deposits and
$12.8 million of loans, as well as other assets. The $39.6 million
of deposits sold were comprised of $2.0 million non-interest bearing
demand, $11.8 million of money market, savings and interest checking
and $25.8 million of time deposits. A pre-tax gain of $1.2 million
was recognized on the sale, which is included in non-interest
income.
o In December 2004, the Company sold approximately $19.4 million of
its mortgage loans. In conjunction with this sale, a loss of
$320,000 was recorded in non-interest income. A charge-off of
$199,000 associated with these loans was taken in the third quarter
of 2004 for reserves previously established.
Net interest margin is the total of net interest income divided by average
earning assets. Average earning assets in 2004 were $817.1 million, up 1.15%
when compared to $807.8 million for 2003. The net interest margin was 3.28% on a
fully tax equivalent basis in 2004, a 22 bp increase from the 2003 net interest
margin of 3.06%. On a TE basis, net interest spread was 3.06% and 2.85% for 2004
and 2003, respectively.
Interest income increased 5% in 2004 to $42.4 million from $40.4 million in
2003. This increase is primarily due to the growth in the Bank's loan portfolio
and increases in overall yield as discussed above. The average yield on
interest-earning assets for 2004 was 5.27%, a 19 bp increase from the 2003 yield
of 5.08%. The average loan portfolio as a percentage of earning assets was 80%
in 2004, up 2% from 2003. The average balances of loans, which had yields of
5.49% and 5.43% for 2004 and 2003, respectively, increased from $632.1 million
in 2003 to $650.1 million in 2004. The average balances of federal funds and
other short-term investments decreased from $16.7 million in 2003 to $10.7
million in 2004 as these funds were used to fund loan growth, and the average
yield in this category increased 32 bps from 1.14% to 1.46% over the same time
period. Investment yield increased on an TE basis from 4.10% in 2003 to 4.60% in
2004. This change reflects increases in market interest rates over the last year
as mortgage backed security ("MBS") pay-downs have decreased from the prior year
due to a decline mortgage prepayments. Increases in MBS payment speeds in the
prior year accelerated the amortization of premiums associated with the assets
and decreased the investment yield.
Interest expense remained relatively flat in 2004 compared to 2003. Interest
expense in both years was $16.3 million. Average total interest-bearing
deposits, including savings, interest-bearing demand deposits and time deposits
declined slightly, from $600.9 million in 2003 to $597.7 million in 2004,
largely as a result the sale of three branches which had deposits of $39.6
million. In addition, the average rate paid on interest-bearing deposits
declined 4 bps between 2003 and 2004 as those customers with time deposits
shortened up the terms on those deposits in anticipation of higher future rates.
The average rate on borrowings also declined from 3.55% in 2003 to 3.31% in
2004. This decline in a rising interest rate environment reflects the full year
effect of interest rate swap agreements put into effect in July of 2003 which
converted portions of the Bank's fixed rate long term debt to a floating rate.
Decreases in interest expense in the areas discussed above were offset by an
increase in interest paid on subordinated debt associated with two trust
preferred offerings completed in 2003. The average outstanding balance of
subordinated debt increased year over year from $7.1 million in 2003 to $20.6
million in 2004, adding an additional $470,000 of interest expense as a result
of this volume increase.
Provision for Loan Losses. In 2004 and 2003, amounts expensed as loan loss
provisions were $1.0 million and $8.2 million, respectively. The allowance for
loan losses was $10.7 million and $11.6 million on December 31, 2004 and 2003,
respectively, and represented approximately 1.64% and 1.86% of total loans
outstanding on those dates. During the year, the Company reclassified $311,000
of the allowance which related to loss exposure on unfunded loan commitments and
letters of credit into a separate other liability account.
The Company experienced higher loan charge offs during 2003 when compared to
2004. Management believes that
- 25 -
this was due in part to a weakened economy and in part to some large credit
issues identified in the second quarter of 2003. As a result of those credit
issues, management engaged two independent credit review firms in the latter
part of 2003 to perform a detailed analysis of the Bank's loan portfolio. As a
result of the review, management identified loans during that period aggregating
approximately $2.7 million that were classified as a loss. In addition,
management significantly increased its internal loan watch list. During 2003,
the Company charged off an aggregate of $6.0 million in loans, net of $862,000
in recoveries. Of that amount, $4.3 million related to five business customer
relationships. During 2004, the Company charged off an aggregate of $1.6 million
in loans, net of $616,000 in recoveries. Included in the charge offs for 2004
was $497,000 related to one loan that had been classified as impaired at
December 31, 2003 and for which a specific reserve of $825,000 had been
established at that time.
Also as a result of the 2003 loan review, the Company effected certain changes
to try to mitigate such credit losses going forward, including procedural
changes in the loan approval and credit review processes, changes in individual
lending limits and centralization of the Company's lending operations functions
into one facility. The Company also added a lender support area where all
consumer loans are centrally underwritten and approved.
Other Operating Income. Other operating income was $6.9 million and $10.3
million for years ended December 31, 2004 and 2003, respectively, a decrease of
$3.4 million or 33%. The decrease in other operating income for 2004 is
primarily attributable to a substantial drop in fee income recorded by the
Bank's mortgage department as a result of industry-wide decreased mortgage
refinance business caused by increases in mortgage loan interest rates. Mortgage
origination fees fell 74% to $1.3 million in 2004 from the $4.9 million earned
in the twelve month period ended December 31, 2003. Securities gains also fell
96% from $442,000 during 2003 to $18,000 during 2004. The mortgage revenue and
securities gains decline between the two periods was partially offset by two
significant non-recurring transactions occurring in the third quarter of 2004
discussed under "Net Interest Income" above.
Fees associated with deposit accounts remained fairly flat year over year with
recorded balances of $2.9 million in both 2004 and 2003. The sale of the three
mature branches impacted service charges in the latter part of 2004 as the sold
branches had higher fee income than the newly opened branches. Total service
charges and fees as a percent of the average total deposit base increased from
..44% in 2003 to .45% in 2004.
Other Operating Expense. Other operating expense decreased 5% to $23.8 million
in 2004 from $25.2 million in 2003. At December 31, 2003 there were 21 branches
and the average number of full time equivalent employees during the year was
220. At December 31, 2004 the Bank had 20 branches and the average number of
full time equivalent employees during the year was 216.
Salary and employee benefits expense for the years ended December 31, 2004 and
2003 were $12.1 million and $13.9 million, respectively. Commission expense
decreased from $2.2 million in 2003 to $728,000 in 2004. These commissions are
driven largely by mortgage fee income which decreased 74%. In addition, during
2003 the Company incurred $1.2 million in severance expenses related to certain
executive and senior officers who separated from the Company compared to
severance expenses during 2004 of only $61,000.
Occupancy expense increased from $2.2 million in 2003 to $2.4 million in 2004.
The increase was primarily a result of lease expenses associated with new
locations and additional space needed for expansion of existing departments.
Furniture and equipment expense increased from $1.5 million in 2003 to $1.7
million in 2004 due to the increase in assets associated with the new locations
and general expansion. Telecommunications expense increased from $337,000 to
$542,000 as we added bandwidth for more rapid data communication. The increased
bandwidth was required to implement upgrades in the data processing software
from its main data processing supplier. Public relations and advertising costs
increased 21%, or $148,000, from $721,000 to $869,000 due to the branch openings
and deposit campaign in 2004.
Other expenses decreased from $3.6 million in 2003 to $3.4 million in 2004. The
primary cause for the decrease was a $310,000 write down in real estate owned
made in September of 2003. There were no such significant real estate write
downs in 2004. However, this decrease was partially offset by increases in other
areas including increased travel and entertainment expenses from $291,000 to
$416,000 and an increase in franchise taxes from $159,000 to $219,000. All such
increases were a direct result of changes in the business plan of the Company,
the changing of the footprint of the organization, or expansion of existing
departments.
- 26 -
Provision for Income Taxes. The Company recorded an income tax expense of $2.9
million in 2004 compared to $38,000 for 2003. The increase in income tax expense
is primarily the result of a significant increase in pretax net income which
increased from $1.0 million in 2003 to $8.2 million in 2004. The overall
effective rate adjusted upwards from 3.7% in 2003 to 35.0% in 2004. The rate for
2003 reflects the impact of permanent differences such as nontaxable municipal
bond interest and bank owned life insurance income on a smaller net income base.
Financial Condition. The Company's financial condition is measured in terms of
its asset and liability composition, asset quality, capital resources, and
liquidity. The growth and composition of assets and liabilities during 2005 and
2004 reflect the repositioning within the Company's primary markets and growth
as a result of its internal business development activities.
Total assets increased from $882.3 million at December 31, 2004 to $960.9
million at December 31, 2005. The increase in total assets of $78.6 million in
2005 includes $33.2 million of cash held in escrow at the Company's stock
transfer agent for payment of merger consideration to 1st State Bancorp
shareholders on consummation of the merger transaction. Excluding the amount in
escrow, total assets increased $45.4 million, or 5.1%. The largest components of
asset growth were in cash and cash equivalents and loans which increased by
$20.9 million and $14.1 million, respectively, from December 31, 2004 to
December 31, 2005.
Total liabilities increased from $804.6 million at December 31, 2004 to $877.4
million at December 31, 2005. The primary reasons for the increase between the
periods was deposit growth of $43.5 million, as the Company has used this source
as its primary means to fund loan growth, and new short-term debt and
subordinated debentures borrowings of $30.0 million and $10.3 million,
respectively, associated with the financing of the 1st State Bancorp merger
transaction. The Company repaid the short term borrowing shortly after the
merger closed with proceeds from the sale of a portion of 1st State Bank's
investment security portfolio.
Stockholders' equity increased from $77.7 million at December 31, 2004 to $83.5
million at December 31, 2005. The increase of $5.8 million, or 7.5%, primarily
reflects an increase of $5.1 million in retained earnings, comprised of $6.7
million of net income less dividends of $1.6 million offset by a $ 2.0 million
increase in unrealized losses on available-for-sale investment securities, which
is included in accumulated other comprehensive income. Common stock increased
$2.6 million, largely the result of issuances of stock pursuant to stock option
exercises.
Assets
Cash and Cash Equivalents. Cash and cash equivalents, including
non-interest-bearing and interest-bearing cash, federal funds sold and
short-term investments, increased from $23.0 million as of December 31, 2004 to
$77.1 million as of December 31, 2005, with 2005 including $33.2 million of cash
held in escrow at the Company's stock transfer agent for payment of merger
consideration to 1st State Bancorp shareholders on consummation of the merger
transaction. Excluding the amount in escrow, cash and cash equivalents increased
by $20.9 million, which is primarily the result of deposit growth exceeding
outlays for loan funding. The Company also increased its cash position to fund
certain expenses associated with the 1st State Bancorp merger transaction.
Loan Portfolio. Total loans were $669.0 million and $654.9 million as of
December 31, 2005 and 2004, respectively. The increase was the result of
internal growth. At December 31, 2005, commercial loans, mortgage loans,
consumer loans, and equity lines were $555.4 million, $21.8 million, $26.2
million, and $65.6 million, respectively. At December 31, 2004, commercial
loans, mortgage loans, consumer loans, and equity lines were $532.1 million,
$26.0 million, $34.9 million, and $61.9 million, respectively. See Notes to
Consolidated Financial Statements - Note 6 - Loans and Allowances for Loan
Losses. The commercial loan portfolio is comprised mainly of loans to small and
mid-sized businesses with revenues up to $25 million. There were no significant
concentrations of credit to any one industry, class, or category. The following
table reflects the maturities of the commercial loan portfolio and the mix of
the commercial loans that mature greater than one year in the loan portfolio
between fixed rate and adjustable rate notes as of December 31, 2005.
- 27 -
(Dollars in thousands)
Commercial loans:
Due within one year $195,566
Due one through five years 297,935
Due after five years 61,865
--------
$555,366
========
Commercial loans due after 1 year:
Fixed rate $174,104
Variable rate 185,696
--------
$359,800
========
Although there were no large concentrations of credit to any particular
industry, the economic trends of the area in North Carolina served by the
Company are influenced by the significant industries within the region. The
Company's primary business activity is with customers located in the Research
Triangle area (Raleigh, Durham, and Chapel Hill) and its surrounding counties,
the Alamance County area (Burlington and Graham), and the Interstate 40 corridor
between Asheville and Hickory. The ultimate collectibility of the Company's loan
portfolio is susceptible to changes in the market conditions of these geographic
regions.
The Company uses a centralized risk management process to ensure uniform credit
underwriting that adheres to Company policy. Lending policies are reviewed on a
regular basis to confirm that the Company is prudent in setting its underwriting
criteria. Credit risk is managed through a number of methods including loan
grading of commercial loans, committee approval of larger loans, and class and
purpose coding of loans. Management believes that early detection of credit
problems through regular contact with the Company's customers coupled with
consistent reviews of the borrowers' financial condition are important factors
in overall credit risk management.
Management charged off loans totaling $0.8 million and $1.6 million, net of
recoveries, as uncollectible during 2005 and 2004, respectively. At December 31,
2005 and 2004, the allowance for loan losses as a percentage of total loans was
1.43% and 1.64%, respectively. Management believes the allowance for loan losses
of $9.6 million at December 31, 2005 provides adequate coverage of the probable
inherent losses in the loan portfolio.
Investment Securities. Investment securities represent the second largest
component of earning assets. The Company's securities portfolio consists
primarily of debt securities issued by U.S. government agencies, mortgage-backed
securities issued by Fannie Mae and Freddie Mac, highly-rated collateralized
mortgage obligations ("CMOs") and municipal bonds which have been segregated
into one of two categories: available-for-sale or held-to-maturity. The
available-for-sale classification allows flexibility in the management of
interest rate risk, liquidity, and loan portfolio growth while the
held-to-maturity classification protects the balance sheet against market value
fluctuations in a rising rate environment. The Company has the positive intent
and the ability to hold held-to-maturity securities until their maturity or
prepayment. Securities available-for-sale are carried at their fair value and
the mark-to-market adjustment was $2.7 million in net unrealized losses at
December 31, 2005. After considering applicable tax benefits, the mark-to-market
adjustment decreased total stockholders' equity by $1.7 million. Future
fluctuations in stockholders' equity will occur due to changes in the fair
values of available-for-sale securities.
On December 31, 2005 and 2004, the recorded value of investments totaled $161.6
million and $160.6 million, respectively. At December 31, 2005 and 2004, $149.3
million and $147.2 million, respectively, of these securities were classified as
available-for-sale and recorded at fair value and $12.3 million and $13.3
million, respectively, were classified as held-to-maturity and recorded at
amortized cost. Available-for-sale securities includes Federal Home Loan Bank
stock with a fair value of $6.1 million and $6.3 million as of December 31, 2005
and 2004, respectively.
Factors affecting the growth of the investment securities portfolio include loan
growth, the interest rates available for reinvesting maturing securities and
changes in the interest rate yield curve. Due to an expected rising interest
rate environment, the Company may curtail or refrain from the reinvestment of
cash flows from its investment portfolio, instead using proceeds to pay off
wholesale funding liabilities and deleveraging the balance sheet thereby
improving capital ratios but lowering net interest income. The Company may also
increase the investment portfolio depending on core deposit growth.
- 28 -
The Company has reviewed the investment portfolio and does not believe any of
the declines in fair value are other-than-temporary. The Company anticipates
that substantially all of the book value of the investments will be recovered
over the life of any securities whose market value is below amortized cost.
The following table reflects the carrying value of the Company's investment
securities portfolio at the dates indicated.
At December 31,
------------------------------
2005 2004 2003
-------- -------- --------
(Dollars in thousands)
Available-for-sale:
U.S. Agency securities $ 50,917 $ 35,172 $ 35,338
Municipal bonds and other 25,144 24,830 25,383
Mortgage-backed securities 67,178 80,944 99,495
-------- -------- --------
Total $143,239 $140,946 $160,216
======== ======== ========
Held-to-maturity:
U.S. Agency securities $ 4,590 $ 5,000 $ --
Municipal bonds 300 300 --
Mortgage-backed securities 7,444 8,036 --
-------- -------- --------
Total $ 12,334 $ 13,336 $ --
======== ======== ========
The following table reflects the debt securities by contractual maturities as of
December 31, 2005. Expected maturities will differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties.
Carrying Average Carrying Average
Value Yield Value Yield
---------------------------------------------
U.S. Agency securities (1)
Within 1 year $ 1,991 4.57% -- --
After 1 but within 5 years 38,294 4.20% $ 4,590 4.16%
After 5 years 10,632 4.96% -- --
-------------------- ---------------------
Total U.S. Agency securities 50,917 4.38% 4,590 4.16%
-------------------- ---------------------
Municipal bonds and other (1)
Within 1 year -- -- -- --
After 1 but within 5 years 2,641 4.69% -- --
After 5 years 22,503 6.30% 300 4.50%
-------------------- ---------------------
Total Municipal bonds 25,144 6.13% 300 4.50%
-------------------- ---------------------
Mortgage-backed securities
Within 1 year -- -- -- --
After 1 but within 5 years 4,787 4.08% -- --
After 5 years 62,391 4.65% 7,444 4.71%
-------------------- ---------------------
Total Mortgage-backed securities 67,178 4.61% 7,444 4.71%
-------------------- ---------------------
(1) Municipal bonds and agency securities shown at tax equivalent yield.
Deposits. Total deposits increased from $655.0 million at December 31, 2004 to
$698.5 million at December 31, 2005. Of these amounts, $77.8 million and $65.7
million were in the form of non-interest-bearing demand deposits at December 31,
2005 and 2004, respectively, and $620.7 million and $589.3 million were in the
form of interest-bearing deposits at December 31, 2005 and 2004, respectively.
Balances in time deposit of $100,000 and greater were $129.9 million and $135.3
million at December 31, 2005 and 2004, respectively. The largest decrease in
time deposits of $100,000 or greater was in brokered deposits, which decreased
from $20.3 million at December 31, 2004 to $6.9 million at December 31, 2005 as
the Company's core deposit growth reduced the need for wholesale funding in
2005.
- 29 -
The following table reflects the maturities of certificates of deposit of
$100,000 and over as of December 31, 2005:
Average
Maturity (Dollars in thousands) Amount Rate
---------------------
Three months or less $ 17,642 3.32%
Over three months to six months 19,631 3.43%
Over six months to twelve months 47,274 3.85%
Over twelve months 45,336 3.76%
---------------------
$129,883 3.68%
=====================
Debt. At December 31, 2005 and 2004, the Company's outstanding advances with the
Federal Home Loan Bank ("FHLB") were $93.2 million and $102.3 million,
respectively. During the year ended December 31, 2005, the maximum outstanding
advances were $116.2 million. The Company had average outstanding FHLB advances
of $100.7 million and $102.8 million with effective costs of borrowing of 4.16%
and 3.32% at December 31, 2005 and 2004, respectively. At December 31, 2005,
approximately $62.1 million are fixed rate advances and $31.1 million are
variable rate advances including $25.0 million of long-term advances for which
the fixed interest rate has been converted to a variable rate through interest
rate swaps discussed below. The Company borrowed $30.0 million on December 27,
2005 from an unaffiliated financial institution, the proceeds of which were used
to help finance the cash portion of the 1st State Bancorp merger transaction.
The short-term debt matures on January 31, 2006 and the Company repaid the debt
in-full prior to maturity with proceeds from the sale of certain 1st State Bank
investment securities.
Capital Resources. Total shareholders' equity at December 31, 2005 and 2004,
including unrealized gains (losses) net of taxes on available for sale
securities of ($1.7) million in 2005 and $0.3 million in 2004, was $83.5 million
and $77.7 million, respectively. The increase is primarily the result of the
change in retained earnings, comprised of $6.7 million of net income less
dividends of $1.6 million. Common stock increased $2.6 million, largely the
result of issuances of stock pursuant to stock option exercises.
The Company paid cash dividends of $0.24 per share during 2005 and $0.21 per
share during 2004. At December 31, 2005, the Company had a leverage ratio of
10.64%, a Tier 1 capital ratio of 11.73%, and a risk based capital ratio of
13.71%. These ratios exceed the federal regulatory minimum requirements for a
"well capitalized" bank and increased from year-end 2004 levels. See Notes to
Consolidated Financial Statements - Note 14 - Regulatory Matters and
Restrictions for additional information on regulatory capital requirements.
The Board of Directors has previously authorized the repurchase of up to 150,000
shares of the Company's common stock through public or private transactions. The
Company repurchased 50,000 shares at an average cost per share of $17.84 in 2005
and did not repurchase any shares in 2004. During the first quarter of 2006, the
Company's Board of Directors authorized the Company to acquire in the open
market or in any private transaction, from time-to-time and in accordance with
applicable laws, rules and regulations, up to 1.0 million shares of the
Company's common stock. Management plans to utilize share repurchases to manage
the capital levels of the Company. The Company had approximately 11.7 million
shares of common stock outstanding as of March 6, 2006.
On December 29, 2005, the Compensation Committee of the Board of Directors of
the Company approved the acceleration of vesting of all currently outstanding
unvested stock options awarded under the Company's Equity Incentive Plan.
Options to purchase 67,200 shares of the Company's common stock, which would
otherwise have vested from time to time over the next five years, became
immediately exercisable on December 30, 2005 as a result of the Compensation
Committee's action. Substantially all of the options were out-of-the money as of
December 30, 2005 and the charge associated with in-the-money options was not
material. The Compensation Committee believed that it was in the best interest
of the shareholders to accelerate vesting of these options, as acceleration of
vesting will result in a positive effect on future earnings of the Company. As a
result of the acceleration of vesting, approximately $331,000 of future
compensation expense that would have been recognized in operating results under
Statement of Financial Accounting Standards No. 123R, Shared-Based Payment, over
the next five years was eliminated. See Notes to Consolidated Financial
Statements -Note 1 - Summary of Significant Accounting Policies.
- 30 -
Asset/Liability Management. Asset/liability management functions to maximize
profitability within established guidelines for interest rate risk, liquidity,
and capital adequacy. Measurement and monitoring of liquidity, interest rate
risk, and capital adequacy are performed centrally through the Board's
Asset/Liability Management Committee, and reported under guidelines established
by management, the Board of Directors and regulators. . See Item 7A. -
Quantitative and Qualitative Disclosures About Market Risk for information about
interest rate risk.
Liquidity management involves the ability to meet the cash flow requirements of
depositors wanting to withdraw funds or borrowers needing assurance that
sufficient funds will be available to meet their credit needs. To ensure the
Company is positioned to meet immediate and future cash demands, management
relies on internal analysis of its liquidity, knowledge of current economic and
market trends and forecasts of future conditions. Regulatory agencies set
certain minimum liquidity standards including the setting of a reserve
requirement by the Federal Reserve. The Company must submit weekly reports to
the Federal Reserve to ensure that it meets those requirements. At December 31,
2005, the Company met all of its liquidity requirements.
The Company had $43.9 million in its most liquid assets, cash and cash
equivalents at December 31, 2005, excluding $33.2 million of cash held in escrow
by the Company's stock transfer agent for payment to 1st State Bancorp
shareholders on consummation of the merger transaction. The Company's principal
sources of funds are deposits, short-term borrowings and capital. Core deposits
(total deposits less certificates of deposits in the amount of $100,000 or
more), one of the most stable sources of liquidity, together with equity capital
funded $652.1 million, or 67.9%, of total assets at December 31, 2005. At
December 31, 2004, core deposits and equity capital totaled $597.4 million, or
67.7%, of total assets.
The Company's liquidity can best be demonstrated by an analysis of its cash
flows. In 2005, the Company used a net increase in deposits of $43.5 million to
fund $14.1 million in net new loan growth and $20.9 million of additional cash
and cash equivalents. Operating activities also provided $8.4 million of
liquidity for the year ended December 31, 2005, compared to $10.9 million for
the year ended December 31, 2004. The principal elements of operating activities
are net income, increased for significant non-cash expenses for the provision
for loan losses and depreciation and amortization.
A secondary source of liquidity for the Company comes from investing activities,
principally the sales of, maturities of, and cash flows from, investment
securities. As of December 31, 2005, the Company had less than $3.0 million of
investment securities that mature in the next 12 months, although the
mortgage-backed securities will have principal reductions and agency securities
may be called by the issuer. During 2005, the Company purchased $32.0 million of
investment securities, repayments on mortgage-backed securities were $23.8
million and $5.2 million of investment securities were sold or called.
Additional sources of liquidity are available to the Bank through the Federal
Reserve System and through membership in the FHLB system. As of December 31,
2005, the Bank had a maximum borrowing capacity of $99.0 million through the
FHLB of Atlanta. These funds can be made available with various maturities and
interest rate structures. Borrowings cannot exceed twenty percent of total
assets or twenty times the amount of FHLB stock owned by the borrowing bank. At
December 31, 2005, the Bank owned $6.0 million worth of FHLB stock or 6.4%
percent of its outstanding advances of $93.2 million. Borrowings are
collateralized by a blanket lien by the FHLB on the Bank's qualifying assets.
The Company also has liquidity from other sources such as federal funds lines,
repurchased agreement lines and brokered CDs. These liquidity sources require
collateral in the case of repurchase agreements but are generally unsecured or
easily utilized by the Company.
The following table reflects expected maturities of contractual obligations and
expected expirations of ongoing commitments that affect the Company's liquidity.
- 31 -
Payments Due By Period
----------------------------------------------------------
Less Than 1 - 3 3 - 5 More Than
(In thousands) 1 Year Years Years 5 Years Total
----------------------------------------------------------
Contractual Obligations
FHLB Advances $ -- $ 14,794 $ 5,000 $ 73,379 $ 93,173
Short-Term Debt 30,000 30,000
Subordinated Debentures -- -- -- 30,930 30,930
Operating Leases 1,627 4,301 4,164 9,052 19,144
----------------------------------------------------------
$ 31,627 $ 19,095 $ 9,164 $ 113,361 $ 173,247
==========================================================
Amount of Commitment Expiration by Period
----------------------------------------------------------
Less Than 1 - 3 3 - 5 More Than Total
1 Year Years Years 5 Years Committed
----------------------------------------------------------
Commercial Commitments
Commercial Letters of Credit $ 8,563 $ -- $ -- $ -- $ 8,563
Other Commercial Loan Commitments 58,154 35,970 7,208 17,263 118,595
----------------------------------------------------------
$ 66,717 $ 35,970 $ 7,208 $ 17,263 $ 127,158
----------------------------------------------------------
Effects of Inflation. The Company's financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America, which require the measurement of financial position and operating
results in terms of historic dollars without consideration for changes in the
relative purchasing power of money over time due to inflation. The rate of
inflation has been relatively moderate over the past few years; however, the
effect of inflation on interest rates can materially impact Bank operations,
which rely on the spread between the yield on earning assets and rates paid on
deposits and borrowings as the major source of earnings. Operating costs, such
as salaries and wages, occupancy and equipment costs, can also be negatively
impacted by inflation.
Recent Accounting Developments. Please refer to Notes to Consolidated Financial
Statements - Note 1 - Summary of Significant Accounting Policies for a
discussion of recent accounting developments.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The Company hopes to reach its strategic financial objectives through the
effective management of market risk. Like many financial institutions, the
Company's most significant market risk exposure is interest rate risk. The
Company's primary goal in managing interest rate risk is to minimize the effect
that changes in interest rates have on interest income and expense. This is
accomplished through the active management of asset and liability portfolios,
which includes the strategic pricing of asset and liability accounts and
ensuring a proper maturity combination of assets and liabilities. The goal of
these activities is the development of maturity and repricing opportunities in
the Company's portfolios of assets and liabilities that will produce consistent
net interest income during periods of changing interest rates. The Company's
Asset/Liability Committee ("ALCO"), made up of members of management and the
Board, monitors loan, investment, and liability portfolios to ensure
comprehensive management of interest rate risk. These portfolios are analyzed to
ensure proper fixed and variable-rate mixes under several interest rate
scenarios.
The asset/liability management process is intended to accomplish relatively
stable net interest margins and assure liquidity by coordinating the amounts,
maturities, or repricing opportunities of earning assets, deposits, and borrowed
funds. The ALCO has the responsibility to determine and achieve the most
appropriate volume and combination of earning assets and interest-bearing
liabilities, and ensure an adequate level of liquidity and capital, within the
context of corporate performance objectives. The ALCO also sets policy
guidelines and establishes long-term strategies with respect to interest rate
risk exposure and liquidity. The ALCO meets regularly to review the Company's
interest rate risk and liquidity positions in relation to present and
prospective market and business conditions, and adopts balance sheet management
strategies intended to ensure that the potential impact of earnings and
liquidity as a result of fluctuations in interest rates is within acceptable
guidelines.
In 2003, the Bank began using financial instruments, commonly known as
derivatives, to manage various financial risks. The derivatives used presently
by the Bank consist of interest rate swaps and swaptions. A derivative is a
financial instrument that derives its cash flows, and therefore its value, by
reference to an underlying instrument, index,
- 32 -
or referenced interest rate. The Bank uses derivatives to hedge its
interest-bearing liabilities. These hedges resulted in a net increase in net
interest income of $21,000 in 2005 and $490,000 in 2004. The Company anticipates
the benefit to net interest income of the swaps and swaptions will decrease in
2006 as short-term interest rates continue to increase and the hedges will
decrease net interest income.
Derivative contracts are written in amounts referred to as notional amounts.
Notional amounts only provide the basis for calculating payments between
counterparties and do not represent amounts to be exchanged between parties and
are not a measure of financial risk. On December 31, 2005, the Bank had
derivative financial instruments outstanding with notional amounts totaling
$25.0 million. See Notes to Consolidated Financial Statements - Note 10 -
Derivative Financial Instruments for additional information.
As a financial institution, most of the Company's assets and liabilities are
monetary in nature. This differs greatly from most commercial and industrial
companies balance sheets, which are comprised primarily of fixed assets or
inventories. Movements in interest rates and actions of the Board of Governors
of the Federal Reserve System ("FRB") to regulate the availability and cost of
credit have a greater effect on a financial institution's profitability than do
the effects of higher costs for goods and services. Through its balance sheet
management function, which is monitored by the ALCO, the Company believes it is
positioned to respond to changing needs for liquidity, changes in interest rates
and inflationary trends.
The Company utilizes an outside asset liability management advisory firm to help
management evaluate interest rate risk and develop asset/liability management
strategies. One tool used is a computer simulation model which projects the
Company's performance under different interest rate scenarios. Analyses are
prepared quarterly which evaluate the Company's performance in a base strategy
that reflects the Company's 2005 and 2006 operating plan. Three interest rate
scenarios (Flat, Rising and Declining) are applied to the base strategy to
determine the effect of changing interest rates on net interest income. The
December 31, 2005 analysis indicates that interest rate risk exposure over a
twelve-month time horizon is within the guidelines established by the Board of
Directors.
The Company's interest rate sensitivity is illustrated in the following table.
The Company continues to be "asset sensitive" at December 31, 2005 as its assets
reprice faster than its liabilities. The table reflects rate-sensitive positions
at December 31, 2005, and is not necessarily indicative of positions on other
dates. The carrying amounts of interest rate sensitive assets and liabilities
are presented in the periods in which they next reprice to market rates or
mature and are aggregated to show the interest rate sensitivity gap. To reflect
anticipated prepayments, certain asset and liability categories are shown in the
table using estimated cash flows rather than contractual cash flows.
- 33 -
Interest Rate Sensitivity
Within One to Two to After
One Year Two Years Five Years Five Years Total
-----------------------------------------------------------
(Dollars in thousands)
Assets
Securities and other interest-earning
assets (1) $ 50,321 $ 31,502 $ 64,904 $ 14,874 $ 161,601
Federal funds sold 13,360 -- -- -- 13,360
Loans and leases (2) 505,400 29,328 117,851 6,811 659,390
-----------------------------------------------------------
Total interest-earning assets 569,081 60,830 182,755 21,685 834,351
Noninterest-earning assets -- -- -- 126,555 126,555
-----------------------------------------------------------
$ 569,081 $ 60,830 $ 182,755 $ 148,240 $ 960,906
===========================================================
Liabilities
Non Maturity Interest-Bearing Deposits (3) $ 84,711 $ 97,510 $ 54,784 $ -- $ 237,005
Other Time Deposits 249,736 117,859 15,992 41 383,628
Borrowings 42,979 25,475 15,854 23,379 107,687
Subordinated Debt -- -- -- 30,930 30,930
-----------------------------------------------------------
Total interest-bearing liabilities 377,426 240,844 86,630 54,350 759,250
Non Maturity Non-Interest-Bearing Deposits (3) 9,732 9,731 29,191 29,193 77,847
Other Noninterest-bearing liabilities -- -- -- 10,317 10,317
Equity -- -- -- 83,492 83,492
-----------------------------------------------------------
387,158 250,575 115,821 177,352 930,906
===========================================================
Interest-rate sensitivity gap $ 181,923 $(189,745) $ 66,934 $ (29,112) $ 30,000
===========================================================
Cumulative interest-rate sensitivity gap $ 181,923 $ (7,822) $ 59,112 $ 30,000
===============================================
(1) Securities based on amortized cost
(2) Loans and leases include loans held for sale and are net of unearned
income
(3) Projected runoff of deposits that do not have a contractual maturity date
was computed based on decay rate assumptions developed by bank regulators
to assist banks in addressing FDICIA rule 305
For the upcoming twelve month period in the flat rate scenario, the Company is
projected to earn $34.9 million in net interest income. The projected results
exclude the impact of the 1st State Bancorp merger transaction. In the rising
rate scenario, which contemplates a 200 bp gradual increase in interest rates
over a twelve month period, the Company's projected net interest income would
improve by $2.9 million, or 8.4%. Conversely, the Company will see a decline in
projected net interest income of $1.7 million or 3.7%, if rates gradually
decline 200 bps, as is contemplated in the declining rate scenario. If interest
rates were to immediately increase and decrease by 200 bps, respectively, the
Company's projected net interest income would increase by $5.2 million and
decrease by $3.3 million, respectively. Actual results could differ from these
estimates.
The table does not reflect the impact of the hedging strategies mentioned above.
These interest rate hedges, accounted for as Fair Value Hedges, were designed to
convert $25.0 million of long-term advances from fixed rates to a variable rate
which is reset quarterly based on 90 day LIBOR. The swaps are collateralized by
certain investment securities and mature as follows:
Effective
Year Amount Variable Rate
-------------------------------------------------
2009 $ 10,000,000 LIBOR + 1.87
2011 15,000,000 LIBOR + 2.02
- 34 -
Item 8. Financial Statements and Supplementary Data.
Capital Bank Corporation
Consolidated Balance Sheets
December 31, 2005 and 2004
(In thousands, except share data)
Assets 2005 2004
--------- ---------
Cash and due from banks:
Interest-earning $ 4,603 $ 971
Noninterest earning 30,544 22,036
Cash held in escrow (Note 1) 33,185 --
Federal funds sold and short term investments 8,757 4
Investment securities - available for sale, at fair value (Note 4) 143,239 140,946
Investment securities - held to maturity, at amortized cost (Note 4) 12,334 13,336
Federal Home Loan Bank stock (Note 5) 6,027 6,298
Loans-net of unearned income and deferred fees (Note 6) 668,982 654,867
Less allowance for loan losses (9,592) (10,721)
--------- ---------
Net loans 659,390 644,146
--------- ---------
Premises and equipment, net (Note 7) 14,868 15,608
Bank owned life insurance 19,857 13,500
Deposit premium and goodwill, net (Note 3) 12,853 13,065
Deferred income tax (Note 12) 6,305 5,985
Accrued interest receivable and other assets 8,944 6,399
--------- ---------
Total assets $ 960,906 $ 882,294
========= =========
Liabilities and Shareholders' Equity
Deposits (Note 8):
Demand, non-interest bearing $ 77,847 $ 65,673
Savings and interest bearing checking 91,427 93,116
Money market deposit accounts 145,578 100,319
Time deposits less than $100,000 253,745 260,574
Time deposits $100,000 and greater 129,883 135,294
--------- ---------
Total deposits 698,480 654,976
--------- ---------
Repurchase agreements and fed funds purchased (Note 9) 14,514 16,755
Short-term debt (Note 9) 30,000 --
Federal Home Loan Bank advances (Note 9) 93,173 102,320
Subordinated debentures (Note 11) 30,930 20,620
Accrued interest payable and other liabilities 10,317 9,885
--------- ---------
Total liabilities 877,414 804,556
--------- ---------
Commitments and contingencies (Notes 13, 14, 15, 16 and 17)
Shareholders' equity:
Common stock, no par value; 20,000,000 shares authorized, 6,852,156
and 6,612,787 issued and outstanding as of 2005 and 2004, respectively 70,985 68,341
Accumulated other comprehensive(loss) income (1,672) 305
Retained earnings 14,179 9,092
--------- ---------
Total shareholders' equity 83,492 77,738
--------- ---------
Total liabilities and shareholders' equity $ 960,906 $ 882,294
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
- 35 -
Capital Bank Corporation
Consolidated Statements of Operations
For the Years Ended December 31, 2005, 2004, and 2003
(In thousands except per share data)
2005 2004 2003
--------------------------------
Interest income:
Loans and fees on loans $ 43,047 $ 35,704 $ 34,352
Investment securities 6,900 6,531 5,898
Federal funds and other interest income 802 156 190
-------- -------- --------
Total interest income 50,749 42,391 40,440
-------- -------- --------
Interest expense:
Deposits 15,577 11,782 12,070
Borrowings and repurchase agreements 5,882 4,475 4,248
-------- -------- --------
Total interest expense 21,459 16,257 16,318
-------- -------- --------
Net interest income 29,290 26,134 24,122
Provision (credit) for loan losses (396) 1,038 8,247
-------- -------- --------
Net interest income after provision for loan losses 29,686 25,096 15,875
-------- -------- --------
Other operating income:
Service charges and fees 2,862 2,948 2,858
Net gain on sale of securities 7 18 442
Mortgage fees and revenues 1,733 1,288 4,864
Gain on sale of branches -- 1,164 --
Loss on sale of mortgage loan portfolio -- (320) --
Bank owned life insurance 546 266 179
Other fees and income 1,583 1,541 1,979
-------- -------- --------
Total other operating income 6,731 6,905 10,322
-------- -------- --------
Other operating expenses:
Personnel 13,999 12,125 13,895
Occupancy 2,565 2,366 2,226
Data processing 1,263 1,130 1,164
Furniture and equipment 1,468 1,683 1,469
Director fees 1,138 428 415
Amortization of intangibles 212 247 310
Advertising 876 869 721
Professional fees 867 989 1,017
Telecommunications 592 542 337
Other 3,474 3,445 3,611
-------- -------- --------
Total other operating expenses 26,454 23,824 25,165
-------- -------- --------
Net income before income tax expense 9,963 8,177 1,032
Income tax expense 3,264 2,866 38
-------- -------- --------
Net income $ 6,699 $ 5,311 $ 994
======== ======== ========
Net income per share - basic $ .99 $ .79 $ .15
======== ======== ========
Net income per share - diluted $ .97 $ .77 $ .15
======== ======== ========
Dividends per share $ .24 $ .21 $ .20
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
- 36 -
Capital Bank Corporation
Consolidated Statements of Changes in Shareholders' Equity
For the Years Ended December 31, 2005, 2004, and 2003
(In thousands, except share and per share data)
Accumulated
Other
Number Common Comprehensive Retained
of Shares Stock Income (Loss) Earnings Total
---------- ---------- ------------- ---------- ----------
Balance at January 1, 2003 6,595,784 $ 68,697 $ 1,293 $ 5,481 $ 75,471
Repurchase of outstanding common stock (182,500) (2,701) -- -- (2,701)
Issuance of common stock for compensation 2,357 24 -- -- 24
Issuance of common stock for options excercised 125,854 1,171 -- -- 1,171
Noncash compensation 190 190
Net income -- -- -- 994 994
Unrealized gain on securities, net of deferred tax
expense of $577 -- -- (916) -- (916)
----------
Comprehensive income 78
Cash dividends ($0.20 per share) -- -- -- (1,310) (1,310)
---------- ---------- ------------- ---------- ----------
Balance at December 31, 2003 6,541,495 67,381 377 5,165 72,923
Issuance of common stock for compensation 2,028 22 -- -- 22
Issuance of common stock for options excercised 69,264 938 -- -- 938
Net income -- -- -- 5,311 5,311
Unrealized loss on securities, net of deferred tax
benefit of $45 -- -- (72) -- (72)
----------
Comprehensive income 5,239
Cash dividends ($0.21 per share) -- -- -- (1,384) (1,384)
---------- ---------- ------------- ---------- ----------
Balance at December 31, 2004 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 115,866 1,401 -- -- 1,401
Issuance of common stock for options excercised 173,503 1,640 -- -- 1,640
Noncash compensation -- 495 -- -- 495
Net income -- -- -- 6,699 6,699
Unrealized loss on securities, net of deferred tax
benefit of $1,241 -- -- (1,977) -- (1,977)
----------
Comprehensive income 4,722
Cash dividends ($0.24 per share) -- -- -- (1,612) (1,612)
---------- ---------- ------------- ---------- ----------
Balance at December 31, 2005 6,852,156 $ 70,985 $ (1,672) $ 14,179 $ 83,492
========== ========== ============= ========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
- 37 -
Capital Bank Corporation
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2005, 2004, and 2003
(In thousands)
2005 2004 2003
---------------------------------
Net income $ 6,699 $ 5,311 $ 994
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization of intangibles 212 247 310
Writedown of intangible assets -- -- 10
Depreciation 1,423 1,480 1,459
(Gain) loss on disposal of fixed assets (335) 70 (160)
Amortization of premiums/discounts on securities, net 308 637 1,971
Gain on sale of investments (7) (18) (442)
Funding of held for sale loans (95,815) (69,893) (259,041)
Proceeds from sale of held for sale loans 94,926 71,334 264,447
Provision (credit) for loan losses (396) 1,038 8,247
Deferred tax (benefit) expense 912 523 (564)
Issuance of stock for compensation 1,401 22 24
Other noncash compensation 495 -- 190
Gain on sale of branches -- (1,164) --
Loss on sale of mortgage portfolio -- 320 --
Changes in assets and liabilities:
Accrued interest receivable and other assets (1,854) 1,130 222
Accrued interest payable and other liabilities 472 (110) (885)
-------- -------- ---------
Net cash provided by operating activities 8,441 10,927 16,782
-------- -------- ---------
Cash flows from investing activities:
Loan orginations, net of principal repayments (15,553) (64,755) (37,620)
Additions to premises and equipment (2,958) (3,871) (2,712)
Proceeds from sale of fixed assets 2,610 645 622
Net (purchase) sale of Federal Home Loan Bank stock 271 (600) (681)
Purchase of securities available for sale (16,492) (17,014) (43,462)
Purchase of securities held to maturity (1,560) (15,477) --
Purchase of mortgage-backed securities available for sale (13,759) (24,317) (73,051)
Purchase of bank owned life insurance (5,500) (3,500) (6,000)
Proceeds from calls/maturities of securities available for sale 20,037 33,945 87,704
Proceeds from sales of securities available for sale 4,399 25,920 15,859
Proceeds from calls/maturities of securities held to maturity 2,566 2,140 --
Capitalized purchase cost of acquisitions -- -- (38)
Proceeds from sale of mortgage portfolio -- 18,667 --
Net cash paid in branch sale -- (23,054) --
-------- -------- ---------
Net cash used by investing activities (25,939) (71,271) (59,379)
-------- -------- ---------
The accompanying notes are an integral part of these consolidated financial
statements.
- 38 -
Capital Bank Corporation
Consolidated Statements of Cash Flows (Continued)
For the Years Ended December 31, 2005, 2004, and 2003
(In thousands)
2005 2004 2003
--------------------------------
Cash flows from financing activities:
Net increase (decrease) in deposits $ 43,504 $ 64,911 $(15,268)
Net increase (decrease) in repurchase agreements (2,241) 5,741 (2,067)
Proceeds from Federal Home Loan Bank borrowings 37,500 42,500 71,000
Principal repayments of Federal Home Loan Bank borrowings (46,647) (54,771) (54,267)
Proceeds from short-term debt 30,000 -- --
Cash held in escrow (33,185) -- --
Proceeds from subordinated debentures, net of issuance costs 10,310 -- 20,120
Repurchase of outstanding common stock (892) -- (2,701)
Exercise of stock options 1,640 679 1,171
Cash dividends paid (1,598) (1,315) (1,314)
-------- -------- --------
Net cash provided by financing activities 38,391 57,745 16,674
-------- -------- --------
Net change in cash and cash equivalents 20,893 (2,599) (25,923)
Cash and cash equivalents at beginning of year 23,011 25,610 51,533
-------- -------- --------
Cash and cash equivalents at end of year $ 43,904 $ 23,011 $ 25,610
======== ======== ========
Supplemental Disclosure of Cash Flow Information:
Cash payments for interest $ 21,099 $ 16,131 $ 16,552
======== ======== ========
Cash payments for income taxes $ 2,742 $ 1,398 $ 1,008
======== ======== ========
Dividends payable $ 411 $ 397 $ 328
======== ======== ========
Transfers from loans to real estate acquired through foreclosure $ 1,539 $ 1,221 $ 854
======== ======== ========
Sale of Northern Region branches:
Loans, net of allowance $ -- $ 12,830 $ --
Premises and equipment -- 258 --
Other assets and liabilities, net -- 1,030 --
Goodwill written off -- 1,218 --
Deposits -- (39,554) --
Net gain on sale -- 1,164 --
-------- -------- --------
Net cash and cash equivalents sold $ -- $(23,054) $ --
======== ======== ========
Sale of mortgage portfolio:
Loans, net of allowance $ -- $ 18,722 $ --
Real estate owned -- 152 --
Other assets and liabilities, net -- 113 --
Net loss on sale -- (320) --
-------- -------- --------
Net cash and cash equivalents acquired $ -- $ 18,667 $ --
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
- 39 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. Summary of Significant Accounting Policies
Organization and Nature of Operations
Capital Bank Corporation (the "Company") is a financial holding company
incorporated under the laws of North Carolina on August 10, 1998. The
Company's primary function is to serve as the holding company for its
wholly-owned subsidiaries, Capital Bank and Capital Bank Investment
Services, Inc ("CBIS"). In addition, the Company has interest in three
trusts, Capital Bank Statutory Trust I, II, and III (hereinafter
collectively referred to as the "Trusts"). The Trusts are not consolidated
with the financial statements of the Company pursuant to the provisions of
FIN 46R. Capital Bank (the "Bank") was incorporated under the laws of
North Carolina on May 30, 1997 and commenced operations on June 20, 1997.
The Bank is not a member of the Federal Reserve System and has no
subsidiaries. The Bank is a community bank engaged in general commercial
banking, providing a full range of banking services. The majority of the
Bank's customers are individuals and small to medium-size businesses. The
Bank's primary source of revenue is interest earned from loans to
customers and from invested cash and securities and non-interest income
derived from various fees.
The Bank operates throughout North Carolina with branch facilities located
in Raleigh (4), Sanford (3), Burlington (2), Asheville (3), Greensboro,
Cary (2), Oxford, Hickory, Siler City, Graham, Wake Forest and Pittsboro.
The Company's corporate headquarters are located on Glenwood Avenue in
Raleigh, North Carolina.
The Trusts were formed for the sole purpose of issuing trust preferred
securities. The proceeds from such issuances were loaned to the Company in
exchange for the Debentures (as defined below), which are the sole assets
of the Trust. A portion of the proceeds from the issuance of the
Debentures were used by the Company to repurchase shares of Company common
stock. The Company's obligation under the Debentures constitutes a full
and unconditional guarantee by the Company of the Trust's obligations
under the trust preferred securities. The Trusts have no operations other
than those that are incidental to the issuance of the trust preferred
securities. See Note 11 - Subordinated Debentures.
The Company has no operations other than those of its subsidiaries.
Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany accounts
and transactions have been eliminated in consolidation.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. The
more significant estimates that are particularly susceptible to
significant change relate to the determination of the allowance for loan
losses, valuation of goodwill and intangible assets, valuation of
investments, and tax assets, liabilities and expense. Actual results could
differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include demand and time deposits (with original
maturities of 90 days or less) at other institutions, federal funds sold
and other short term investments. Generally, federal funds are purchased
and sold for one-day periods. At times, the Bank places deposits with high
credit quality financial institutions in amounts which may be in excess of
federally insured limits. Banks are required to maintain reserve and
clearing balances with the FRB. Accordingly, the Bank has amounts
restricted for this purpose of $11,852 and $11,696 included in cash and
due from banks on the Consolidated Balance Sheet at December 31, 2005 and
2004, respectively. Cash held in escrow represents funds the Company was
required to deposit with its
- 40 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
transfer agent for payment to 1st State Bancorp shareholders on
consummation of the merger transaction and was invested in an
institutional money market account.
Securities
Investments in certain securities are classified into three categories and
accounted for as follows:
1. Held-to-Maturity - Debt securities that the institution has the
positive intent and ability to hold to maturity are classified as
held to maturity and reported at amortized cost; or
2. Trading Securities - Debt and equity securities that are bought and
held principally for the purpose of selling in the near term are
classified as trading securities and reported at fair value, with
unrealized gains and losses included in earnings; or
3. Available-for-Sale - Debt and equity securities not classified as
either held to maturity securities or trading securities are
classified as available for sale securities and reported at fair
value, with unrealized gains and losses reported as other
comprehensive income, a separate component of shareholders' equity.
The initial classification of securities is determined at the date of
purchase. Gains and losses on sales of securities, computed based on
specific identification of the adjusted cost of each security, are
included in other income at the time of the sales.
Premiums and discounts on debt securities are recognized in interest
income using the level interest yield method over the period to maturity,
or when the debt securities are called.
Loans Held for Sale
Mortgage loans held for sale are valued at the lower of cost or market as
determined by outstanding commitments from investors or current investor
yield requirements, calculated on the aggregate loan basis. At December
31, 2005 and 2004, there were approximately $4.2 million and $3.4 million,
respectively, in loans held for sale which are classified as loans on the
consolidated balance sheet.
Through the normal course of originating loans held for sale, the
customer's interest rate is fixed upon lock-in by the customer. The Bank
enters into a best efforts commitment to sell the loan to an investor
after the rate lock-in by the customer. Rate lock commitments for loans
held for sale are valued based on the net revenues to be realized upon
sale to an investor less any value attributable to the servicing rights
which are also sold to the investor.
Loans and Allowance for Loan Losses
Loans are stated at the amount of unpaid principal, reduced by an
allowance for loan losses and net deferred loan origination fees and
costs. Interest on loans is calculated by using the simple interest method
on daily balances of the principal amount outstanding. Deferred loan fees
and costs are amortized to interest income over the contractual life of
the loan using the level interest yield method.
A loan is considered impaired, based on current information and events, if
it is probable that the Bank will be unable to collect the scheduled
payments of principal and interest when due according to the contractual
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 loans classified as impaired at December 31, 2005 and 2004.
The Bank uses several factors in determining if a loan is impaired. The
internal asset classification procedures include a thorough review of
significant loans and lending relationships and include the accumulation
of related data. This data includes loan payment status, borrowers'
financial data and borrowers' operating factors such as cash flows,
operating income or loss, etc. It is possible that these factors and
management's evaluation of the adequacy of the allowance for loan losses
will change.
The allowance for loan losses is established through a provision for loan
losses charged to expense. Loans are charged against the allowance for
loan losses when management believes that the collectibility of the
principal is unlikely. The allowance is an amount that management believes
will be adequate to absorb
- 41 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
probable losses on existing loans that may become uncollectible, based on
evaluations of the collectibility of loans and prior loan loss experience.
The evaluations take into consideration such factors as changes in the
nature and volume of the loan portfolio, overall portfolio quality, review
of specific problem loans, and current economic conditions and trends that
may affect the borrowers' ability to pay.
Income Recognition on Impaired and Nonaccrual Loans
Loans, including impaired loans, are generally classified as nonaccrual if
they are past due as to maturity or payment of principal or interest for a
period of more than 90 days, unless such loans are well-secured and in the
process of collection. If a loan or a portion of a loan is classified as
doubtful or as partially charged off, the loan is generally classified as
nonaccrual. Loans that are on a current payment status or past due less
than 90 days may also be classified as nonaccrual if repayment in full of
principal and/or interest is in doubt.
Loans may be returned to accrual status when all principal and interest
amounts contractually due (including arrearages) are reasonably assured of
repayment within an acceptable period of time, and there is a sustained
period of repayment performance of interest and principal by the borrower
in accordance with the contractual terms.
While a loan is classified as nonaccrual and the future collectibility of
the recorded loan balance is doubtful, collections of interest and
principal are generally applied as a reduction to the principal
outstanding, except in the case of loans with scheduled amortizations
where the payment is generally applied to the oldest payment due. When the
future collectibility of the recorded loan balance is expected, interest
income may be recognized on a cash basis. In the case where a nonaccrual
loan had been partially charged-off, recognition of interest on a cash
basis is limited to that which would have been recognized on the recorded
loan balance at the contractual interest rate. Receipts in excess of that
amount are recorded as recoveries to the allowance for loan losses until
prior charge-offs have been fully recovered.
Foreclosed Assets
Any assets acquired as a result of foreclosure are valued at the lower of
the recorded investment in the loan or fair value less estimated costs to
sell. The recorded investment is the sum of the outstanding principal loan
balance and foreclosure costs associated with the loan. Any excess of the
recorded investment over the fair value of the property received is
charged to the allowance for loan losses. Valuations will be periodically
performed by management and any subsequent write-downs due to the carrying
value of a property exceeding its estimated fair value less estimated
costs to sell are charged against other expenses.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation
and amortization. Depreciation and amortization are computed by the
straight-line method based on estimated service lives of assets. Useful
lives range from 3 to 10 years for furniture and equipment. The cost of
leasehold improvements is being amortized using the straight-line method
over the terms of the related leases. Repairs and maintenance are charged
to expense as incurred.
Upon disposition, the asset and related accumulated depreciation or
amortization are relieved and any gains or losses are reflected in
operations.
Income Taxes
Deferred tax asset and liability balances are determined by application to
temporary differences of the tax rate expected to be in effect when taxes
will become payable or receivable. Temporary differences are differences
between the tax basis of assets and liabilities and their reported amounts
in the consolidated financial statements that will result in taxable or
deductible amounts in future years. The effect on deferred taxes of a
change in tax rates is recognized in income in the period that includes
the enactment date. A valuation allowance is recorded for deferred tax
assets if the Company determines that it is more likely than not that some
portion or all of the deferred tax assets will not be realized.
Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities
The Company applies a financial-components approach that focuses on
control when accounting and reporting for transfers and servicing of
financial assets and extinguishments of liabilities. Under that
- 42 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
approach, after a transfer of financial assets, an entity recognizes the
financial and servicing assets it controls and the liabilities it has
incurred, derecognizes financial assets when control has been surrendered,
and derecognizes liabilities when extinguished. This approach provides
consistent standards for distinguishing transfers of financial assets that
are sales from transfers that are secured borrowings.
Derivatives
The Company uses derivatives to manage interest rate risk. The instruments
consist of interest rate swaps and swaptions. A derivative is a financial
instrument that derives its cash flows, and therefore its value, by
reference to an underlying instrument, index, or referenced interest rate.
The Bank uses derivatives, accounted for as fair value hedges, to hedge
its fixed rate interest-bearing liabilities.
Under Statement of Financial Accounting Standards ("SFAS) No. 133,
Accounting for Derivatives and Hedging Activities, derivatives are
recorded on the consolidated balance sheet at fair value. For fair value
hedges, the change in the fair value of the derivative and the
corresponding change in fair value of the hedged risk in the underlying
item being hedged are accounted for in earnings. Any difference in these
two changes in fair value results in hedge ineffectiveness that results in
a net impact to earnings.
Derivative contracts are written in amounts referred to as notional
amounts. Notional amounts only provide the basis for calculating payments
between counterparties and do not represent amounts to be exchanged
between parties and are not a measure of financial risk.
Stock Option Plans
The Company's Equity Incentive Plan is a stock-based incentive
compensation plan covering certain officers and directors. The Company
grants stock options under the incentive plan for a fixed number of shares
with an exercise price equal to the fair value of the shares on the date
of grant. The Company has elected to account for these stock option grants
in accordance with Accounting Principles Board ("APB") Opinion No. 25,
Accounting for Stock Issued to Employees, and accordingly, recognizes no
compensation expense for these stock option grants.
The Company discloses pro forma net income and earnings per share in these
notes as if compensation was measured under the fair value based method
promulgated under SFAS No. 123, Accounting for Stock-Based Compensation.
Under the fair value based method, compensation cost is measured at the
grant date of the option based on the value of the award and is recognized
over the service period, which is usually the vesting period.
On December 29, 2005, the Compensation Committee of the Board of Directors
of the Company approved the acceleration of vesting of all currently
outstanding unvested stock options awarded under the Company's Equity
Incentive Plan. Options to purchase 67,200 shares of the Company's common
stock, which would otherwise have vested from time to time over the next
five years, became immediately exercisable on December 30, 2005 as a
result of the Compensation Committee's action. The Compensation Committee
believed that it was in the best interest of the shareholders to
accelerate vesting of these options, as acceleration of vesting will
result in a positive effect on future earnings of the Company. As a result
of the acceleration of vesting, approximately $331,000 of future
compensation expense that would have been recognized in operating results
under SFAS No. 123R, Shared-Based Payment, over the next five years was
eliminated.
Had compensation expense for the stock option plans been determined in
accordance with SFAS No. 123, the Company's net income and net income per
share for the years ended December 31, 2005, 2004 and 2003 would have been
reduced to the pro forma amounts indicated below. The pro forma amounts
for 2005 include $203,000, net of tax, resulting from the accelerated
vesting of stock options. These pro forma amounts may not be
representative of the effect on reported net income in future years.
- 43 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(In thousands, except per share data) 2005 2004 2003
----------------------------
Net income As reported $ 6,999 $ 5,311 $ 994
Pro forma 6,402 5,095 922
Net income per share - Basic As reported $ 0.99 $ 0.79 $ 0.15
Pro forma 0.94 0.76 0.14
Net income per share - Diluted As reported $ 0.97 $ 0.77 $ 0.15
Pro forma 0.93 0.74 0.14
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 values of the options granted in 2005, 2004 and 2003 are
estimated on the date of the grants using the Black-Scholes option-pricing
model. Option pricing models require the use of highly subjective
assumptions, including expected stock volatility, which when changed can
materially affect fair value estimates. The fair values were estimated
using the following weighted-average assumptions:
2005 2004 2003
-----------------------------------
Dividend yield 1.31% 1.04% 1.20%
Expected volatility 27.2% 27.7% 28.0%
Risk-free interest rate 4.03% 3.92% 3.72%
Expected life 7 years 7 years 7 years
The weighted average fair value of options granted during 2005, 2004 and
2003 was $5.40, $5.99, and $5.15, respectively.
Net Income Per Share
The Company follows SFAS No. 128, Earnings Per Share. In accordance with
SFAS No. 128, the Company has presented both basic and diluted EPS on the
face of the Consolidated Statements of Operations. Basic EPS excludes
dilution and is computed by dividing income available to common
shareholders by the weighted average number of common shares outstanding
for the period. The weighted average number of shares outstanding for
2005, 2004, and 2003 were as follows:
2005 2004 2003
------------------------------------
(In thousands, except number of shares)
Income available to stockholders - basic and diluted $ 6,699 $ 5,311 $ 994
========== ========== ==========
Shares used in the computation of earnings per share:
Weighted average number of shares outstanding - basic 6,790,846 6,712,502 6,655,926
Incremental shares from assumed exercise of stock
options 129,542 173,198 137,946
---------- ---------- ----------
Weighted average number of shares outstanding - diluted 6,920,388 6,885,700 6,793,872
========== ========== ==========
Comprehensive Income
The Company follows SFAS No. 130, Reporting Comprehensive Income. SFAS No.
130 establishes standards for reporting and displaying comprehensive
income (loss) and its components (revenues, expenses, gains, and losses)
in general-purpose financial statements.
- 44 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The Company's only components of other comprehensive income relate to
unrealized gains and losses on available for sale securities. Information
concerning the Company's other comprehensive income (loss) for the years
ended December 31, 2005, 2004 and 2003 is as follows:
2005 2004 2003
---------------------------
(In thousands)
Unrealized losses on securities available for sale $(3,211) $(99) $(1,051)
Reclassification of gains recognized in net income (7) (18) (442)
Income tax benefit 1,241 45 577
------- ---- -------
Other comprehensive income (loss) $(1,977) $(72) $ (916)
======= ==== =======
Segment Information
The Company follows the provisions of SFAS No. 131 Disclosures about
Segments of an Enterprise and Related Information. SFAS No.131 requires
that public business enterprises report certain information about
operating segments in their annual financial statements and in condensed
financial statements of interim periods issued to shareholders. It also
requires that the public business enterprises report related disclosures
and descriptive information about products and services provided by
significant segments, geographic areas, and major customers, differences
between the measurements used in reporting segment information and those
used in the enterprise's general-purpose financial statements, and changes
in the measurement of segment amounts from period to period.
Operating segments are components of an enterprise about which separate
financial information is available that is evaluated regularly by the
chief operating decision maker in deciding how to allocate resources, and
in assessing performance. The Company has determined that it has one
significant operating segment, the providing of general commercial
financial services to customers located in the single geographic area of
North Carolina. The various products are those generally offered by
community banks, and the allocation of resources is based on the overall
performance of the institution, versus the individual branches or
products.
Reclassifications
Certain items included in the 2004 and 2003 financial statements have been
reclassified to conform to the 2005 presentation. These reclassifications
have no effect on net income or shareholders' equity previously reported.
New Pronouncements
In December 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 123R, Share-Based Payment. This standard is a revision of SFAS
No. 123, Accounting for Stock-Based Compensation, and supersedes APB No.
25, Accounting for Stock Issued to Employees, and its related
implementation guidance. SFAS No. 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 No. 123R as originally issued by the FASB was
effective as of the beginning of the first period that begins after June
15, 2005. On April 14, 2005, the SEC adopted a rule that amended the
effective date of SFAS No. 123R. The SEC's new rule allows companies to
implement SFAS No. 123R at the beginning of the next fiscal year. The
Company plans to adopt SFAS No. 123R effective January 1, 2006. Under SFAS
No. 123R, the Company will recognize compensation expense for the fair
value of its share purchase rights over the vesting period. As a result of
the Company's acceleration of vesting of employee stock options noted
previously, the adoption of SFAS No. 123R is not expected to have a
material impact on the Company's financial position.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error
Corrections, which replaces APB No. 20, Accounting Changes, and SFAS No.
3, Reporting Accounting Changes in Interim Financial Statements. SFAS No.
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 No. 154 carries forward without change the guidance contained
in APB No. 20 for reporting the correction of
- 45 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
an error and a change in accounting estimate. SFAS No. 154 is effective
for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. The Company will adopt SFAS No. 154
effective January 1, 2006. SFAS No. 154 will have no impact on the
Company's financial position or results of operations upon adoption.
2. Significant Transactions
On June 29, 2005, the Company entered into an agreement to acquire 1st
State Bancorp ("1st State Bancorp"), the holding company for 1st State
Bank, Inc. ("1st State Bank"). This transaction closed on January 3, 2006
and will be accounted for as a purchase. The total purchase price is
expected to be approximately $121.1 million, including transactions costs
of $6.3 million. Under the terms of the merger agreement, the Company will
issue approximately 4.9 million shares of common stock and pay
$40.1million in cash in exchange for 100% of 1st State Bancorp's
outstanding common stock and stock options. The transaction will be
accounted for under the purchase method and is intended to qualify as a
tax-free reorganization under Section 368(a) of the Internal Revenue Code.
The following table reflects the unaudited pro forma combined results of
operations for the year ended December 31, 2005 assuming the acquisition
had occurred at the beginning of fiscal 2005:
(In thousands, except per share amounts)
Net interest income $41,289
Net income $ 4,835
Net earnings per diluted share $ 0.41
In management's opinion, these unaudited pro forma amounts are not
necessarily indicative of what actual combined results of operations might
have been if the acquisition had been effective at the beginning of fiscal
2005.
A summary of estimated preliminary fair values of assets acquired and
liabilities assumed was as follows:
1st State Bancorp
----------------
Loans receivable, net of allowance for loan losses $ 231,387
Investment securities $ 110,107
Premises and equipment 8,025
Deposit premium 5,331
Goodwill 46,033
Other assets 29,111
Deposits (272,037)
Borrowings (34,144)
Other liabilities (2,761)
---------
Investment in subsidiary, net of dividends to shareholders
and capitalized acquisition costs $ 121,052
=========
In connection with the 1st State Bancorp acquisition, in December 2005 the
Company issued $30.0 million in short-term notes to an unaffiliated entity
and entered into a third $10.0 million offering of trust preferred
securities issued by Trust III. See Note 11 - Subordinated Debentures and
Note 9 - Borrowings for additional information on the Trusts and the
short-term debt, respectively.
During 2004, the Company made changes to its branch structure including
the sale of three branches in Warrenton, Seaboard and Woodland to other
financial institutions in the third quarter. Included in the sale were
approximately $39.6 million of deposits and $12.8 million of loans, as
well as other assets. With the closing of the branch sale, the Company was
required to make payments of $23.0 million dollars to cover the excess of
liabilities over assets assumed
- 46 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
by the acquiring companies. The Company recorded a $1.2 million
non-recurring gain on this sale in 2004. Also during the third quarter of
2004, the Company sold a portion of the mortgage portfolio that had been
acquired in a previous bank acquisition and was being serviced by an
independent organization. The sale included approximately $19.2 million in
loans and $152,000 in foreclosed assets. The Company recorded a $320,000
non-recurring loss on this sale.
During 2003, the Company made several changes to its branch structure
including the consolidation of two branches in Oxford into one main Oxford
facility in a new location and the opening of an additional branch in
Raleigh. In addition, during the third quarter of 2003, the Company made
the decision to discontinue the operations of CBIS. CBIS will remain an
inactive subsidiary of the Company. Also during 2003, the Company entered
into two separate $10.0 million offerings of trust preferred securities,
one in June by Trust I and the other in December by Trust II. See Note 11
- Subordinated Debentures for additional information on the Trusts.
3. Goodwill and Other Intangible Assets
Net assets of companies acquired in purchase transactions are recorded at
fair value at the date of acquisition, and as such, the historical cost
basis of individual assets and liabilities are adjusted to reflect their
fair value. Identified intangibles are amortized on a straight-line basis
over the period benefited. Goodwill is no longer amortized, but is
reviewed for potential impairment at least annually at the reporting unit
level. An impairment loss is recorded to the extent that the carrying
amount of goodwill exceeds its implied fair value. Other intangible assets
are evaluated for impairment if events and circumstances indicate a
possible impairment. Such evaluation of other intangible assets is based
on undiscounted cash flow projections. No impairment charges were recorded
in 2005 and 2004 based on the evaluation and a $10,000 charge was recorded
in 2003 related to the shutdown of CBIS.
As of December 31, 2005 and 2004, intangible assets, primarily deposit
premiums paid for acquisitions, and goodwill were as follows:
Accumulated
(In thousands) Gross Amortization Net
------------------------------------
At December 31, 2005
From January 2002 acquisition of First Community Bank:
Deposit premium $ 782 $ (489) $ 293
Goodwill 3,834 -- 3,834
-------- ------------ --------
4,616 (489) 4,127
-------- ------------ --------
From December 2002 acquisition of High Street Bank:
Deposit premium 976 (464) 512
Goodwill 5,381 -- 5,381
-------- ------------ --------
6,357 (464) 5,893
-------- ------------ --------
From April 2000 branch acquisitions:
Goodwill 1,996 (347) 1,649
From June 1997 branch acquisitions:
Goodwill 2,164 (980) 1,184
-------- ------------ --------
$ 15,133 $ (2,280) $ 12,853
======== ============ ========
- 47 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Accumulated
Gross Amortization Net
------------------------------------
At December 31, 2004
From January 2002 acquisition of First Community Bank:
Deposit premium $ 782 $ (404) $ 378
Goodwill 3,834 -- 3,834
-------- ------------ --------
4,616 (404) 4,212
-------- ------------ --------
From December 2002 acquisition of High Street Bank:
Deposit premium 976 (337) 639
Goodwill 5,381 -- 5,381
-------- ------------ --------
6,357 (337) 6,020
-------- ------------ --------
From April 2000 branch acquisitions:
Goodwill 1,996 (347) 1,649
From June 1997 branch acquisitions:
Goodwill 2,164 (980) 1,184
-------- ------------ --------
$ 15,133 $ (2,068) $ 13,065
======== ============ ========
Deposit premiums are amortized over a period of up to 10 years using an
accelerated method. During 2005 and 2004, deposit premiums were reduced by
amortization expenses of $212,000 and $247,000, respectively. In addition,
during 2004, goodwill was reduced by $1.2 million in connection with
deposits sold in branch sales. Estimated amortization expense for the next
five fiscal years is as follows: 2006-$184,000; 2007-$160,000;
2008-$136,000; 2009-$112,000; 2010-$87,000.
4. Investment Securities
Investment securities at December 31, 2005 and 2004 are summarized as
follows:
- 48 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
(In thousands) Cost Gains Losses Value
---------- ---------- ---------- ----------
2005
----
Available-for-sale:
U.S. Agency obligations $ 52,046 $ 2 $ 1,131 $ 50,917
Municipal bonds and other 24,804 512 172 25,144
Mortgage-backed securities 69,110 10 1,942 67,178
---------- ---------- ---------- ----------
145,960 524 3,245 143,239
---------- ---------- ---------- ----------
Held-to-maturity:
U.S. Agency obligations $ 4,590 $ -- $ 105 4,485
Municipal bonds 300 -- 10 290
Mortgage-backed securities 7,444 -- 203 7,241
---------- ---------- ---------- ----------
12,334 -- 318 12,016
---------- ---------- ---------- ----------
$ 158,294 $ 524 $ 3,563 $ 155,255
========== ========== ========== ==========
Gross Gross
Amortized Unrealized Unrealized Fair
(In thousands) Cost Gains Losses Value
---------- ---------- ---------- ----------
2004
----
Available-for-sale:
U.S. Agency obligations $ 35,511 $ 86 $ 425 $ 35,172
Municipal bonds 24,087 828 85 24,830
Mortgage-backed securities 80,851 427 334 80,944
---------- ---------- ---------- ----------
140,449 1,341 844 140,946
---------- ---------- ---------- ----------
Held-to-maturity:
U.S. Agency obligations $ 5,000 $ 2 $ 12 4,990
Municipal bonds 300 -- -- 300
Mortgage-backed securities 8,036 15 68 7,983
---------- ---------- ---------- ----------
13,336 17 80 13,273
---------- ---------- ---------- ----------
$ 153,785 $ 1,358 $ 924 $ 154,219
========== ========== ========== ==========
The amortized cost and estimated market values of securities at December
31, 2005 by contractual maturities are shown below. Expected maturities
will differ from contractual maturities because borrowers may have the
right to call or prepay obligations with or without call or prepayment
penalties.
- 49 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(In thousands) Available-for-Sale Held-to-Maturity
-------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
-------------------------------------------------
U.S. Agency securities:
Due within one year $ 2,000 $ 40,285 $ -- $ --
Due after one year through five years 39,146 38,294 4,590 4,485
Due after five years through ten years 8,900 8,733 -- --
Due after ten years 2,000 1,899 -- --
----------------------- -----------------------
Total U.S. Agency securities 50,046 48,926 4,590 4,485
----------------------- -----------------------
Municipal bonds and other:
Due within one year -- -- -- --
Due after one year through five years 2,676 2,641 -- --
Due after five years through ten years 7,236 7,349 300 290
Due after ten years 14,892 15,154 -- --
----------------------- -----------------------
Total Municipal bonds 24,804 25,144 300 290
----------------------- -----------------------
Mortgage-backed securities:
Due within one year -- -- -- --
Due after one year through five years 4,896 4,787 -- --
Due after five years through ten years 2,291 2,248 -- --
Due after ten years 61,923 60,143 7,444 7,241
----------------------- -----------------------
Total Mortgage-backed securities 69,110 67,178 7,444 7,241
----------------------- -----------------------
$ 143,960 $ 141,248 $ 12,334 $ 12,016
======================= =======================
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 December 31, 2005 and 2004:
- 50 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(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 $ 25,036 $ 298 $ 22,978 $ 833 $ 48,014 $ 1,131
Municipal bonds and other 2,555 39 2,788 133 5,343 172
Mortgage-backed securities 42,997 969 22,728 973 65,725 1,942
---------------------------------------------------------------------------
70,588 1,306 48,494 1,939 119,082 3,245
---------------------------------------------------------------------------
Held-to-maturity:
Direct obligations of U.S.
government agencies 591 3 3,894 102 4,485 105
Municipal bonds 290 10 -- -- 290 10
Mortgage-backed securities 4,932 133 2,309 70 7,241 203
---------------------------------------------------------------------------
5,813 146 6,203 172 12,016 318
---------------------------------------------------------------------------
Total at December 31, 2005 $ 76,401 $ 1,452 $ 54,697 $ 2,111 $ 131,098 $ 3,563
===========================================================================
Available-for-sale:
Direct obligations of U.S.
government agencies $ 18,568 $ 181 $ 6,756 $ 244 $ 25,324 $ 425
Municipal bonds and other 1,569 43 1,268 42 2,837 85
Mortgage-backed securities 20,537 131 10,030 203 30,567 334
---------------------------------------------------------------------------
40,674 355 18,054 489 58,728 844
---------------------------------------------------------------------------
Held-to-maturity:
Direct obligations of U.S.
government agencies 3,982 12 -- -- 3,982 12
Municipal bonds -- -- -- -- -- --
Mortgage-backed securities 2,842 68 -- -- 2,842 68
---------------------------------------------------------------------------
6,824 80 -- -- 6,824 80
---------------------------------------------------------------------------
Total at December 31, 2004 $ 47,498 $ 435 $ 18,054 $ 489 $ 65,552 $ 924
===========================================================================
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 December 31, 2005.
During the years ended December 31, 2005, 2004 and 2003, the Company had
gross realized gains of $7,000, $18,000 and $442,000, respectively, on
sales of available-for-sale securities with book values of $2.2 million,
$25.9 million and $15.4 million, respectively.
Securities with a fair value of $59.7 million were pledged as of December
31, 2005 to secure public deposits, repurchase agreements, and FHLB
advances.
5. Federal Home Loan Bank Stock
During 2004, in order to raise additional capital, the Federal Home Loan
Bank ("FHLB") restructured the stock ownership requirements in order to be
a member of the FHLB System. As a member, the Bank is required to maintain
an investment in capital stock of the FHLB in an amount equal to 0.20% of
its total assets as of December 31st of the prior year (up to a maximum of
$25.0 million) plus 4.5% of its outstanding FHLB advances. No ready market
exists for the FHLB stock, and it has no quoted market value, therefore,
cost approximates market at December 31, 2005 and 2004.
- 51 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
6. Loans and Allowance for Loan Losses
The composition of the loan portfolio by loan classification at December
31, 2005 and 2004 is as follows:
(In thousands) 2005 2004
----------------------
Commercial $555,198 $531,834
Consumer 26,222 34,865
Home equity lines 65,566 61,925
Residential mortgages 21,863 26,020
-------- --------
668,849 654,644
Plus deferred loan costs, net 133 223
$668,982 $654,867
======== ========
A summary of activity in the allowance for loan losses for the years ended
December 31, 2005, 2004, and 2003 is as follows:
(In thousands) 2005 2004 2003
--------------------------------
Balance at beginning of year $ 10,721 $ 11,613 $ 9,390
Provision (credit) for loan losses (396) 1,038 8,247
Loans charged-off, net of recoveries (786) (1,619) (6,024)
Reclassified 53 (311) --
-------- -------- --------
Balance at end of year $ 9,592 $ 10,721 $ 11,613
======== ======== ========
In 2005 and 2004, the Company reclassified $53,000 and ($311,000),
respectively, of the allowance for loan losses related to the estimated
loss exposure on unfunded loan commitments and letters of credit into a
separate liability account.
At December 31, 2005, nonperforming assets consisted of nonaccrual loans
in the amount of $8.1 million and foreclosed real estate of $771,000. At
December 31, 2004, nonperforming assets consisted of nonaccrual loans in
the amount of $8.2 million and foreclosed real estate of $418,000.
Unrecognized income on nonaccrual loans at December 31, 2005 and 2004 was
$361,000 and $275,000, respectively. At December 31, 2005 and 2004, there
were no loans past due greater than 90 days still accruing interest.
In the normal course of business, certain directors and executive officers
of the Company, including their immediate families and companies in which
they have an interest, may be loan customers. Total loans to such groups
and activity during the years ended December 31, 2005, 2004 and 2003, is
summarized as follows:
(In thousands) 2005 2004 2003
------------------------------------
Beginning balance $ 31,285 $ 23,392 $ 15,288
New loans 11,378 16,737 14,562
Principal repayments (10,482) (8,844) (4,048)
Reclassifications -- -- (2,410)
-------- -------- --------
Ending balance $ 32,181 $ 31,285 $ 23,392
======== ======== ========
In addition, such groups had available lines of credit in the amount of
$27.2 million at December 31, 2005. In the ordinary course of business,
the Company engages in business transactions with certain of its
directors. Such transactions are competitively negotiated at arms-length
by the Company and are not considered to
- 52 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
include terms which are unfavorable to the Company. Certain deposits are
held by related parties, and the rates and terms of these accounts are
consistent with those of non-related parties. The Company paid an
aggregate of approximately $1.5 million, $1.0 million, and $0.9 million to
companies owned by members of the board of directors for leased space,
equipment, construction and consulting services during 2005, 2004 and
2003, respectively.
7. Premises and Equipment
Premises and equipment at December 31, 2005 and 2004 are as follows:
2005 2004
--------------------
(In thousands)
Land $ 3,770 $ 4,813
Buildings and leasehold improvements 9,777 8,863
Furniture and equipment 10,053 9,488
Automobiles 235 324
Construction in progress 1,044 959
-------- --------
24,879 24,447
Less accumulated depreciation and amortization (10,011) (8,839)
-------- --------
$ 14,868 $ 15,608
======== ========
8. Deposits
At December 31, 2005, the scheduled maturities of certificates of deposit
are as follows:
Weighted
Average
(In thousands) Balance Rate
----------- -----------
2006 $ 249,773 3.53%
2007 117,860 3.65%
2008 5,568 3.98%
2009 8,277 4.03%
2010 and thereafter 2,150 4.40%
----------- -----------
$ 383,628 3.57%
=========== ===========
9. Borrowings
Short term borrowed funds. Following is an analysis of short-term borrowed
funds at December 31, 2005 and 2004:
- 53 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Weighted Interest At Any
(Dollars in thousands) Balance Avg Rate Balance Rate Month End
------------------------ ------------------- ----------
2005
Short-term debt $ 30,000 7.25% $ 411 7.25% $ 30,000
Fed funds purchased -- -- 258 3.02% --
Repurchase agreements 14,514 3.48% 14,299 2.58% 18,598
-------- -----------------
$ 44,514 $ 14,968 2.71%
======== =================
2004
Fed funds purchased $ 1,573 2.70% $ 564 1.77% $ 2,137
Repurchase agreements 15,182 1.68% 12,301 0.89% 17,875
-------- -----------------
$ 16,755 $ 12,865 0.92%
======== =================
Interest on federal funds purchased totaled $8,000 in 2005 and $10,000 in
2004. Repurchase agreements are collateralized by U.S. government agency
and mortgage-backed securities with fair values of $17.8 million at
December 31, 2005. Interest expense on securities sold under agreements to
repurchase totaled $368,000 in 2005 and $109,000 in 2004. The Company
borrowed $30.0 million on December 27, 2005 from an unaffiliated financial
institution, the proceeds of which were used to help finance the cash
portion of the 1st State Bancorp merger transaction. The short-term debt
matures on January 31, 2006 and the Company repaid the debt in-full prior
to maturity with proceeds from the sale of certain 1st State Bank
investment securities. The short-term debt was collateralized by the
Bank's common stock.
Federal Home Loan Bank Advances. Advances from the FHLB had a weighted
average rate of 4.31% and 4.08% at December 31, 2005 and 2004,
respectively, and were collateralized by certain 1 - 4 family mortgages,
multifamily first mortgage loans, home equity loans and qualifying
commercial loans totaling $98.5 million and $103.5 million at year-end
2005 and 2004, respectively. In addition, the Company pledged certain
investment securities with a fair value of $19.6 million and $25.2 million
at December 31, 2005 and 2004. See Note 4 - Securities.
At December 31, 2005, the scheduled maturities of FHLB advances were as
follows:
Weighted
Average
(Dollars in thousands) Balance Rate
---------- ----------
2006 $ -- --
2007 3,000 4.19%
2008 -- --
2009 11,794 4.76%
2010 and thereafter 78,379 4.24%
---------- ----------
$ 93,173 4.31%
========== ==========
At December 31, 2005, the Company had an additional $99.0 million of
credit available with the FHLB.
10. Derivative Financial Instruments
The Company maintains positions in derivative financial instruments to
manage interest rate risk, to facilitate asset/liability management
strategies, and to manage other risk exposures.
In July 2003, the Company entered into interest rate swap agreements to
convert portions of its fixed rate FHLB advances to floating interest
rates. The Company accounts for interest rate swaps as a hedge of the fair
value of the designated FHLB advances. Because of the effectiveness of the
swap agreements against the related debt instruments, the adjustments
needed to record the swaps at fair value were offset by the
- 54 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
adjustments needed to record the related debt instruments at fair value
and the net difference between those amounts were not material.
These interest rate hedges, accounted for as fair value hedges, have an
aggregated notional amount of $25.0 million and reset quarterly at
variable rates based on 90 day LIBOR. The counterparty for these hedges is
a firm with an investment grade rating by a nationally recognized
investment rating service. The swaps are collateralized by certain
investment securities and are summarized as follows:
Effective
Maturity Notional Amount Variable Rate
-----------------------------------------------
2009 $ 10,000,000 LIBOR + 1.87
2011 15,000,000 LIBOR + 2.02
11. Subordinated Debentures
The Company formed Trust III, Trust II and Trust I in December 2005,
December 2003 and June 2003, respectively. Each issued 10.0 million of its
floating rate capital securities (the "trust preferred securities"), with
a liquidation amount of $1,000 per capital security, in pooled offerings
of trust preferred securities. The Trusts sold their common securities to
the Company for an aggregate of $0.9 million, resulting in total proceeds
from each offering equal to $10.3 million or $30.9 million in aggregate.
The Trusts then used these proceeds to purchase $30.9 million in principal
amount of the Company's Floating Rate Junior Subordinated Deferrable
Interest Debentures (the "Debentures"). Following payment by the Company
of a placement fee and other expenses of the offering, the Company's net
proceeds from the offerings aggregated $30.0 million.
The trust preferred securities have a 30 year maturity and are redeemable
after 5 years by the Company with certain exceptions. Prior to the
redemption date, the trust preferred securities may be redeemed at the
option of the Company after the occurrence of certain events, including
without limitation events that would have a negative tax effect on the
Company or the Trusts, would cause the trust preferred securities to no
longer qualify as Tier 1 capital, or would result in the Trusts being
treated as an investment company. The Trusts' ability to pay amounts due
on the trust preferred securities is solely dependent upon the Company
making payment on the Debentures. The Company's obligation under the
Debentures constitutes a full and unconditional guarantee by the Company
of the Trusts' obligations under the trust preferred securities.
The securities associated with each trust are floating rate, based on 90
day LIBOR, and adjust quarterly. Trust I securities adjust at LIBOR +
3.10%, Trust II securities adjust at LIBOR + 2.85% and Trust III
securities adjust at LIBOR +1.40%.
The Debentures, which are subordinate and junior in right of payment to
all present and future senior indebtedness and certain other financial
obligations of the Company, are the sole assets of the Trusts and the
Company's payment under the Debentures is the sole source of revenue for
the Trusts.
Pursuant to FIN 46R, the assets and liabilities of the Trusts are not
consolidated into the consolidated financial statements of the Company.
Interest on the Debentures is included in the Company's Condensed
Consolidated Statements of Income as interest expense. The Debentures are
presented as a separate category of long-term debt on the Consolidated
Statements of Financial Condition entitled "Subordinated Debentures." For
regulatory purposes, the $30.0 million of trust preferred securities
qualifies as Tier 1 capital, subject to certain limitations, or Tier 2
capital in accordance with regulatory reporting requirements.
12. Income Taxes
Income taxes charged to operations for the years ended December 31, 2005,
2004, and 2003 consist of the following components:
- 55 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(In thousands) 2005 2004 2003
-----------------------
Current income tax expense $2,352 $2,343 $ 602
Deferred income tax expense (benefit) 912 523 (564)
------ ------ -----
Total income tax expense $3,264 $2,866 $ 38
====== ====== =====
Income taxes for the years ended December 31, 2005, 2004 and 2003 were
allocated as follows:
(In thousands) 2005 2004 2003
--------------------------------
Income from continuing operations $ 3,264 $ 2,866 $ 38
Shareholders' equity, for unrealized gains (losses) on
securities available for sale (1,241) (45) (577)
Shareholders' equity, for compensation expense for tax
purposes in excess of financial reporting purposes (480) (259) --
--------------------------------
$ 1,543 $ 2,562 $ (539)
================================
A reconciliation of the difference between income tax expense and the
amount computed by applying the statutory federal income tax rate of 34%
is as follows:
Amount % of Pretax Income
-------------------------------- ------------------------------
(Dollars in thousands) 2005 2004 2003 2005 2004 2003
-------------------------------------------------------------------------- ------------------------------
Tax expense at statutory rate on income
before taxes $ 3,387 $ 2,780 $ 351 34.00% 34.00% 34.00%
State taxes, net of federal benefit 388 372 112 3.89% 4.55% 10.85%
Increase (reduction) in taxes resulting
from:
Tax exempt interest on investment
securities (394) (366) (339) -3.95% -4.48% -32.85%
Non-taxable life insurance income (223) (50) (62) -2.24% -0.61% -6.01%
Other, net 106 130 (24) 1.06% 1.59% -2.31%
-------------------------------- ------------------------------
$ 3,264 $ 2,866 $ 38 32.76% 35.05% 3.68%
================================ ==============================
Significant components of deferred tax assets and liabilities at December
31, 2005 and 2004 are as follows:
- 56 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(In thousands) 2005 2004
--------------------
Deferred tax assets:
Allowance for loan losses $ 3,797 $ 4,224
Deferred compensation 1,525 1,496
Net operating loss carryforwards 752 1,022
Directors' fees 536 845
Unrealized security losses 1,049 --
Contribution carryforwards -- 13
-------- --------
Total deferred tax assets 7,659 7,600
-------- --------
Deferred tax liabilities:
Unrealized security gains -- (192)
Depreciation (456) (608)
Purchase accounting adjustments (256) (206)
FHLB stock (304) (304)
Other (338) (305)
-------- --------
Total deferred tax liabilites (1,354) (1,615)
-------- --------
Net deferred tax assets $ 6,305 $ 5,9850
======== ========
At December 31, 2005 and 2004, the Company had net deferred tax assets of
$6.3 million and $6.0 million, respectively. A valuation allowance is
provided when it is more likely than not that some portion of the deferred
tax asset will not be realized. In management's opinion, it is more likely
than not that the results of future operations will generate sufficient
taxable income to recognize the deferred tax assets.
Included in deferred tax assets are the tax benefits derived from net
operating loss carryforwards totaling $2.2 million relating to a prior
acquisition which expire in various amounts through 2022. Management
expects to utilize all of these carryforward amounts before they expire.
13. Leases
The Company has noncancelable operating leases for its corporate office
and branch locations that expire at various times through 2027. Future
minimum lease payments under the leases for years subsequent to December
31, 2005 are as follows:
(In thousands)
2006 $ 1,627
2007 1,999
2008 2,302
2009 2,196
2010 1,968
Thereafter 9,052
-------
$19,144
=======
During 2005, 2004, and 2003, rent expense under operating leases were $1.4
million, $1.2 million, and $1.1 million, respectively.
14. Regulatory Matters and Restrictions
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal and state banking agencies.
Failure to meet minimum capital requirements can initiate certain
mandatory, and possibly additional discretionary, actions by regulators
that, if undertaken, could have a direct material effect on the
consolidated financial statements. Quantitative measures established by
regulation to ensure capital adequacy require the Bank to maintain minimum
amounts and ratios, as set forth in the table below. As of September 30,
2005, the most recent notification from regulators, the Bank was
categorized as "well
- 57 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
capitalized" by regulatory authorities. There are no conditions or events
since that date that management believes could have an adverse effect on
the Bank's category. Management believes that as of December 31, 2005, the
Company meets all capital requirements to which it is subject.
The Bank, as a North Carolina banking corporation, may pay dividends only
out of undivided profits as determined pursuant to North Carolina General
Statues Section 53-87. At December 31, 2005, the undivided profits of the
Bank totaled $12.5 million. However, regulatory authorities may limit
payment of dividends by any bank when it is determined that such a
limitation is in the public interest and is necessary to ensure financial
soundness of the bank.
To be categorized as well capitalized, the Company and the Bank must
maintain minimum amounts and ratios. The Company's actual capital amounts
and ratios as of December 31, 2005 and 2004 and the minimum requirements
are presented in the following table.
Minimum Requirements To Be:
Actual Adequately Capitalized Well Capitalized
------------------- ---------------------- -------------------
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
-------- -------- -------- -------- -------- --------
2005
Total Capital (to Risk Weighted Assets) $111,228 13.71% $ 64,890 8.00% $ 81,112 10.00%
Tier I Capital (to Risk Weighted Assets) 95,176 11.73% 32,445 4.00% 48,667 6.00%
Tier I Capital (to Average Assets) 95,176 10.64% 35,765 4.00% 44,706 5.00%
2004
Total Capital (to Risk Weighted Assets) $ 92,971 12.33% $ 60,310 8.00% $ 75,387 10.00%
Tier I Capital (to Risk Weighted Assets) 83,528 11.08% 30,155 4.00% 45,232 6.00%
Tier I Capital (to Average Assets) 83,528 9.61% 34,783 4.00% 43,479 5.00%
15. Employee Benefit Plans
401(k) Plan
The Company maintains a 401(k) plan (the "Plan") for the benefit of its
employees, which includes provisions for employee contributions, subject
to limitation under the Internal Revenue Code, with the Company to match
contributions up to 6% of the employees' salary. The Plan provides that
employees' contributions are 100% vested at all times and the Company's
contributions vest 20% after the second year of service, an additional 20%
after the third and fourth years of service and the remaining 40% after
the fifth year of service. Further, the Company may make additional
contributions on a discretionary basis. Aggregate contributions for 2005,
2004, and 2003 were $281,000, $366,000, and $387,000, respectively.
Supplemental Retirement Plans
In May 2005, the Company established two supplemental retirement plans for
the benefit of certain executive officers and certain directors of the
Company. The Capital Bank Defined Benefit Supplemental Retirement Plan
("Executive Plan") covers the Company's chief executive officer and
certain other members of senior management. Under the Executive Plan, the
participants will receive a supplemental retirement benefit equal to a
targeted percentage of the participant's average annual salary during the
last three years of employment. Under the Executive Plan, benefits vest
over an eight year period with the first 20% vesting after four years of
service and 20% vesting annually thereafter. The Capital Bank Supplemental
Retirement Plan for Directors ("Director Plan") covers certain directors
and provides for a fixed annual retirement benefit to be paid for a number
of years equal to the director's total years of service, up to a maximum
of ten years. For the year ended December 31, 2005, the Company recognized
$89,000 and $320,000 of expense related to the Executive Plan and Director
Plan, respectively. The liability associated with the two plans is
included in Other Liabilities. As of December 31, 2005, the Executive Plan
had four participants and the Directors Plan had 14 participants.
- 58 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
In 2005, the Company invested $5.5 million in bank-owned life insurance
("BOLI"), which may be used, at the Company's sole discretion, to fund the
benefits payable under the Executive Plan and Director Plan. As of
December 31, 2005, cash surrender values from the BOLI policies equaled
$5.6 million.
16. Stock Options and Stock Plans
The Company has stock option plans providing for the issuance of up to
650,000 options to purchase shares of the Company's stock to officers and
directors. At December 31, 2005, options for 186,709 shares of common
stock remained available for future issuance. In addition, there were
approximately 567,000 options which were assumed under various plans from
previously acquired financial institutions, of which approximately 218,000
remain outstanding.
Grants of options are made by the Board or the Compensation Committee. All
grants must be at no less than fair market value on the date of grant,
must be exercised no later than 10 years from the date of grant, and may
be subject to some vesting provisions. All options outstanding as of
December 31, 2005 were fully vested.
A summary of the activity during the years ending December 31, 2005, 2004
and 2003 of the Company's stock option plans, including the weighted
average exercise price ("WAEP") is presented below:
2005 2004 2003
------------------------------------------------------------------
Shares WAEP Shares WAEP Shares WAEP
-------- -------- -------- -------- -------- --------
Outstanding at beginning of year 693,524 $ 11.25 704,540 $ 10.40 786,366 $ 9.70
Granted 9,600 16.84 84,250 17.85 81,000 15.82
Exercised (173,503) 9.45 (69,264) 9.80 (125,854) 9.31
Terminated (33,799) 16.17 (26,002) 13.58 (36,972) 11.16
-------- -------- -------- -------- -------- --------
Outstanding at end of year 495,822 $ 11.65 693,524 $ 11.25 704,540 $ 10.40
======== ======== ======== ======== ======== ========
Options exercisable at year-end 495,822 $ 11.65 580,010 $ 10.31 590,560 $ 9.66
======== ======== ======== ======== ======== ========
The following table summarizes information about the Company's stock
options at December 31, 2005:
Weighted
Average
Remaining
Number Contractual Number
Exercise Price Outstanding Life in Years Exercisable
------------------ ------------- ------------- ------------
$6.62 - $9.00 172,768 4.00 172,768
$9.01 - $12.00 105,201 5.31 105,201
$12.01 - $15.00 74,692 2.32 74,692
$15.01 - $18.00 82,911 7.29 82,911
$18.01 - $18.37 60,250 8.99 60,250
------------------ ---------- --------- ----------
495,822 5.18 495,822
========== ========= ==========
Deferred Compensation for Non-Employee Directors. Effective January 1,
2005, the Company amended and restated the Capital Bank Corporation
Deferred Compensation Plan for Non-Employee Directors ("Deferred
Compensation Plan"). Under the Deferred Compensation Plan, eligible
directors may elect to defer all or part of their directors' fees for a
calendar year, in exchange for common stock of the Company, based on the
year-end share price. The amount deferred, if elected, is equal to 125
percent of their total director's fees. Each participant is fully vested
in his account balance. The Deferred Compensation Plan generally provides
for payment of share units either in shares of common
- 59 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
stock of the Company or cash (at the Company's option) after the
participant ceases to serve as a director for any reason.
17. Financial Instruments with Off-Balance Sheet Risk and Concentrations of
Credit Risk
To meet the financial needs of its customers, the Company is party to
financial instruments with off-balance sheet risk in the normal course of
business. At December 31, 2005, these financial instruments were comprised
entirely of unused lines of credit. These instruments involve, to varying
degrees, elements of credit risk in excess of the amount recognized in the
balance sheet.
The Company's exposure to credit loss in the event of nonperformance by
the other party is represented by the contractual amount of those
instruments. The Company uses the same credit policies in making these
commitments as they do for on-balance sheet instruments. The amount of
collateral obtained, if deemed necessary by the Company, upon extension of
credit is based on management's credit evaluation of the borrower.
Collateral held varies but may include trade accounts receivable,
property, plant, and equipment and income-producing commercial properties.
Since many unused lines of credit expire without being drawn upon, the
total commitment amounts do not necessarily represent future cash
requirements.
Unused lines of credit were $188.2 million and $123.2 million,
respectively, at the end of 2005 and 2004. Outstanding letters of credit
were $8.6 million and $1.4 million, respectively, at December 31, 2005 and
2004.
The Bank's lending is concentrated primarily in Wake, Chatham, Alamance,
Buncombe, Catawba, Granville, and Lee counties in North Carolina.
18. Fair Value of Financial Instruments
SFAS No. 107, Disclosures about Fair Value of Financial Instruments,
requires the disclosure of estimated fair values for financial
instruments. Quoted market prices, if available, are utilized as an
estimate of the fair value of financial instruments. Because no quoted
market prices exist for a significant part of the Company's financial
instruments, the fair value of such instruments has been derived based on
management's assumptions with respect to future economic conditions, the
amount and timing of future cash flows and estimated discount rates.
Different assumptions could significantly affect these estimates.
Accordingly, the net amounts ultimately collected could be materially
different from the estimates presented below. In addition, these estimates
are only indicative of the values of individual financial instruments and
should not be considered an indication of the fair value of the Company
taken as a whole.
The fair values of cash and due from banks, Federal funds sold, interest
bearing deposits in banks and accrued interest receivable/payable are
equal to the carrying value due to the nature of the financial
instruments. The estimated fair values of investment securities are
provided in Note 4 - Securities.
The fair value of the net loan portfolio has been estimated using the
present value of expected cash flows, discounted at an interest rate
giving consideration to estimated prepayment risk and credit loss factors.
The fair value of the Bank's loan portfolio at December 31, 2005 and 2004
was as follows:
(In thousands) 2005 2004
-----------------------
Loans:
Carrying amount $659,390 $644,146
Estimated fair value 654,317 643,663
The deposit liabilities and repurchase agreements with no stated
maturities are predominately at variable rates and, accordingly, the fair
values have been estimated to equal the carrying amounts (the amount
payable on demand), totaling $329.4 million and $275.9 million at December
31, 2005 and 2004, respectively.
The fair values of certificates of deposits, advances from the FHLB and
subordinated debt are estimated by discounting the future cash flows using
the current rates offered for similar deposits, advances and
- 60 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
subordinated debt with the same remaining maturities. The carrying value
and estimated fair values of certificates of deposit, FHLB advances and
subordinated debt at December 31, 2005 and 2004 were as follows:
(In thousands) 2005 2004
-----------------------
Certificates of deposits:
Carrying amount $383,628 $395,868
Estimated fair value 382,208 395,348
Advances from the FHLB:
Carrying amount $ 93,173 $102,320
Estimated fair value 92,875 102,762
Subordinated Debt:
Carrying amount $ 30,930 $ 20,620
Estimated fair value 31,757 21,170
There is no material difference between the carrying amount of $0 and
estimated fair value of off-balance sheet items totaling $196.8 million
and $124.6 million at December 31, 2005 and 2004, respectively, which are
primarily comprised of unfunded loan commitments.
The Company's remaining assets and liabilities are not considered
financial instruments.
- 61 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
19. Parent Company Financial Information
Condensed financial information of the financial holding company of the
Bank at December 31, 2005 and 2004 and for the years ended December 31,
2005, 2004, and 2003 is presented below:
(In thousands)
Condensed Balance Sheets 2005 2004
--------------------
Assets:
Cash $ 46,109 $ 5,885
Equity investment in subsidiary 96,135 92,020
Other assets 1,704 1,126
--------- -------
Total assets $ 143,948 $99,031
========= =======
Liabilities:
Subordinated debentures $ 30,930 $20,620
Short-term debt 30,000 --
Deferred tax (asset) liability (1,049) 192
Dividends payable 411 397
Other liabilities 164 84
--------- -------
Total liabilities 60,456 21,293
--------- -------
Shareholders' equity:
Common stock 70,985 68,341
Accumulated other comprehensive (loss) income (1,672) 305
Retained earnings 14,179 9,092
--------- -------
Total shareholders' equity 83,492 77,738
--------- -------
Total liabilities and shareholders' equity $ 143,948 $99,031
========= =======
(In thousands)
Condensed Statements of Operations 2005 2004 2003
--------------------------------
Dividends from wholly-owned subsidiaries $ 500 $ 4,000 $ 750
Undistributed earnings of subsidiaries 7,018 1,892 401
Other income 160 66 15
Interest expense (1,352) (929) (249)
Other expenses (49) (17) (4)
-------- -------- --------
Net income before tax benefits 6,277 5,012 913
Income tax benefit 422 299 81
-------- -------- --------
Net income $ 6,699 $ 5,311 $ 994
======== ======== ========
- 62 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(In thousands)
Condensed Statements of Cash Flows 2005 2004 2003
--------------------------------
Operating activities:
Net income $ 6,699 $ 5,311 $ 994
Equity in undistributed earnings of subsidiary (7,018) (1,892) (401)
Other noncash compensation 495 -- --
Net change in other assets and liabilities (503) (693) (200)
-------- -------- --------
Cash flow (used in) provided by operating activities (327) 2,726 393
-------- -------- --------
Investing activities:
Additional investment in subsidiaries (310) -- (14,594)
-------- -------- --------
Cash flow used in investing activities (310) -- (14,594)
-------- -------- --------
Financing activities:
Proceeds from issuance of common stock 3,041 960 1,171
Payments to repurchase common stock (892) -- (2,677)
Proceeds from issuance of short-term debt 30,000 -- --
Cash held in escrow (33,185) -- --
Proceeds from issuance of subordinated debentures, net
of issuance costs 10,310 -- 20,120
Dividends paid (1,598) (1,315) (1,314)
-------- -------- --------
Cash flow provided by (used in) financing activities 7,676 (355) 17,300
-------- -------- --------
Net increase in cash and cash equivalents 7,039 2,371 3,099
Cash and cash equivalents, beginning of year 5,885 3,514 415
-------- -------- --------
Cash and cash equivalents, end of year $ 12,924 $ 5,885 $ 3,514
======== ======== ========
20. Selected Quarterly Financial Data (Unaudited)
Selected unaudited quarterly balances and results for the years ended
December 31, 2005 and 2004 are as follows:
2005
----------------------------------------------
Three Months Ended
----------------------------------------------
(In thousands, except per share data) Dec. 31 Sept. 30 June 30 March 31
----------------------------------------------
Assets $960,906 $ 927,035 $ 917,392 $ 887,312
Loans 668,982 646,448 648,765 647,922
Investment securities 161,601 161,389 161,822 159,966
Deposits 698,480 703,183 689,997 662,178
Shareholders' equity 83,492 82,268 79,499 76,965
Net interest income $ 7,795 $ 7,429 $ 7,160 $ 6,906
Provision (credit) for loan losses 38 (28) (156) (250)
Other operating income 2,022 1,790 1,579 1,340
Other operating expenses 7,171 6,644 6,489 6,150
Income taxes 801 869 803 791
-------- --------- --------- ---------
Net income $ 1,807 $ 1,734 $ 1,603 $ 1,555
======== ========= ========= =========
Net income per share - Basic $ .26 $ .26 $ .24 $ .23
======== ========= ========= =========
Net income per share - Diluted $ .26 $ .25 $ .23 $ .22
======== ========= ========= =========
- 63 -
Capital Bank Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2004
---------------------------------------------
Three Months Ended
---------------------------------------------
(In thousands, except per share data) Dec. 31 Sept. 30 June 30 March 31
---------------------------------------------
Assets $ 882,294 $ 875,713 $ 885,754 $ 891,703
Loans 654,867 657,359 657,537 642,407
Investment securities 160,580 154,694 150,340 159,349
Deposits 654,976 647,037 671,796 678,817
Shareholders' equity 77,738 76,370 72,615 75,440
Net interest income $ 6,945 $ 6,689 $ 6,231 $ 6,269
Provision for loan losses 357 268 297 116
Other operating income 1,480 2,280 1,544 1,601
Other operating expenses 5,938 6,179 6,070 5,637
Income taxes 740 872 517 737
--------- --------- --------- ---------
Net income $ 1,390 $ 1,650 $ 891 $ 1,380
========= ========= ========= =========
Net income per share - Basic $ .21 $ .25 $ .13 $ .21
========= ========= ========= =========
Net income per share - Diluted $ .20 $ .24 $ .13 $ .20
========= ========= ========= =========
- 64 -
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Capital Bank Corporation
We have audited the accompanying consolidated balance sheet of Capital Bank
Corporation and subsidiaries as of December 31, 2005, and the related
consolidated statements of operations, changes in shareholders' equity, and cash
flows for the year ended December 31, 2005. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Capital Bank
Corporation and subsidiaries as of December 31, 2005, and the results of its
operations and its cash flows for the year ended December 31, 2005, in
conformity with accounting principles generally accepted in the United States of
America.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Capital Bank
Corporation's internal control over financial reporting as of December 31, 2005,
based on criteria established in Internal Control--Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)
and our report dated March 14, 2006, expressed an unqualified opinion.
/s/ GRANT THORNTON LLP
Raleigh, North Carolina
March 14, 2006
- 65 -
Report of Independent Registered Public Accounting Firm
The Board of Directors and
Shareholders of Capital Bank Corporation
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control Over Financial Reporting, that Capital
Bank Corporation (a North Carolina Corporation) maintained effective internal
control over financial reporting as of December 31, 2005, based on criteria
established in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Capital Bank
Corporation's management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express an
opinion on management's assessment and an opinion on the effectiveness of the
company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that Capital Bank Corporation maintained
effective internal control over financial reporting as of December 31, 2005, is
fairly stated, in all material respects, based on criteria established in
Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Also in our opinion, Capital
Bank Corporation maintained, in all material respects, effective internal
control over financial reporting as of December 31, 2005, based on criteria
established in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheet of
Capital Bank Corporation and subsidiaries as of December 31, 2005, and the
related consolidated statements of operations, changes in shareholders' equity,
and cash flows for the year ended December 31, 2005, and our report dated March
14, 2006, expressed an unqualified opinion on those consolidated financial
statements.
/s/ GRANT THORNTON LLP
Raleigh, North Carolina
March 14, 2006
- 66 -
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Capital Bank Corporation
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, of changes in shareholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Capital Bank Corporation at December 31, 2004, and the results of its operations
and its cash flows for each of the two years in the period ended December 31,
2004 in conformity with accounting principles generally accepted in the United
States of America. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Raleigh, North Carolina
March 10, 2005
- 67 -
Item 9. Changes In and Disagreements With Accountants On Accounting and
Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures. The Company's management,
under the supervision of and with the participation of the Company's Chief
Executive Officer and Chief Financial Officer, has evaluated the effectiveness
of the Company's disclosure controls and procedures, as such term is defined in
Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the
period covered by this report. Based on such evaluation, the Company's Chief
Executive Officer and Chief Financial Officer have concluded that, as of the end
of such period, the Company's disclosure controls and procedures are effective
in that they are reasonably designed to ensure that all material information
relating to the Company required to be included in the Company's reports filed
or submitted under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the rules and forms of the
Securities and Exchange Commission.
Changes in Internal Control Over Financial Reporting. There have not been any
changes in the Company's internal control over financial reporting, as such term
is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, during the
Company's fiscal quarter ended December 31, 2005 that have materially affected,
or are reasonably likely to materially affect, the Company's internal control
over financial reporting. From time to time, the Company makes changes to its
internal control over financial reporting that are intended to enhance the
effectiveness of its internal control over financial reporting and which do not
have a material effect on its overall internal control over financial reporting.
Management's Report on Internal Control Over Financial Reporting. The Company's
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as that term is defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act. The Company's internal control over financial
reporting was designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external
purposes in accordance with accounting principles generally accepted in the
United States.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with policies or procedures may deteriorate.
Management has assessed the effectiveness of the Company's internal control over
financial reporting as of December 31, 2005. Management based its assessment on
the criteria for effective internal control over financial reporting set forth
by the Committee of Sponsoring Organizations of the Treadway Commission in
Internal Control- Integrated Framework. Based on this assessment, management
concluded that, as of December 31, 2005, the Company maintained effective
internal control over financial reporting.
Limitations on the Effectiveness of Controls. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Further, the design of disclosure controls and internal control over financial
reporting must reflect the fact that there are resource constraints, and the
benefits of controls must be considered relative to their costs. Because of the
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within the Company have been detected.
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The Company plans to continue to evaluate the effectiveness of its disclosure
controls and procedures and its internal control over financial reporting on an
ongoing basis and will take action as appropriate.
Report of Independent Registered Public Accounting Firm on Internal Control Over
Financial Reporting
The Company's independent registered public accounting firm, Grant Thornton
LLP, has audited management's assessment of the effectiveness of the Company's
internal control over financial reporting as of December 31, 2005, as stated in
its report, which is included herein in Report of Independent Registered Public
Accounting Firm in Item 8 of Part II.
Item 9B. Other Information.
Not Applicable
PART III
This Part incorporates certain information from the definitive proxy statement
(the "2006 Proxy Statement") for the Company's 2006 Annual Meeting of
Shareholders, to be filed with the SEC within 120 days after the end of the
Company's fiscal year.
Item 10. Directors and Executive Officers of the Registrant.
Information concerning the Company's executive officers is included under the
caption "Executive Officers" on page 9 of this report. Information concerning
the Company's directors and filing of certain reports of beneficial ownership is
incorporated by reference to the sections entitled "Proposal 1: Election of
Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the
2006 Proxy Statement. Information concerning the audit committee of the
Company's Board of Directors is incorporated by reference to the section
entitled "Information About Our Board of Directors - Board of Director
Committees - Audit Committee" in the 2006 Proxy Statement. There have been no
material changes to the procedures by which security holders may recommend
nominees to the Company's Board of Directors since the date of the Company's
Proxy Statement for the Company's 2005 Annual Meeting of Shareholders.
We have adopted a Code of Business Conduct and Ethics (our "Code of Ethics")
that applies to our employees, officers and directors. The complete Code of
Ethics is available on our website at www.capitalbank-nc.com. If at any time it
is not available on our website, we will provide a copy upon written request
made to our Corporate Secretary, Capital Bank Corporation, 4901 Glenwood Avenue,
Raleigh, North Carolina 27612 (telephone - 919-645-6400). Information on our
website is not part of this report. If we amend or grant any waiver from a
provision of our Code of Ethics that applies to our executive officers, we will
publicly disclose such amendment or waiver as required by applicable law,
including by posting such amendment or waiver on our website at
www.capitalbank-nc.com or by filing a Current Report on Form 8-K.
Item 11. Executive Compensation.
This information is incorporated by reference from the section entitled
"Compensation" in the 2006 Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
This information is incorporated by reference from the sections entitled
"Principal Shareholders" and "Compensation - Equity Compensation Plan
Information" in the 2006 Proxy Statement.
Item 13. Certain Relationships and Related Transactions.
This information is incorporated by reference from the section entitled
"Compensation - Certain Transactions" in the 2006 Proxy Statement.
- 69 -
Item 14. Principal Accountant Fees and Services.
This information is incorporated by reference from the section entitled
"Proposal 2: Ratification of Appointment of Independent Registered Public
Accounting Firm - Audit Firm Fee Summary" in the 2006 Proxy Statement.
PART IV
Item 15. Exhibits and Financial Statement Schedules.
(a)(1) Financial Statements. The financial statements and information listed
below are included in this report in Part II, Item 8:
Financial Statements and Information
------------------------------------
Consolidated Balance Sheets as of December 31, 2005 and 2004
Consolidated Statements of Operations for the years ended December 31,
2005, 2004 and 2003
Consolidated Statements of Changes in Shareholders' Equity for the years
ended December 31, 2005, 2004 and 2003
Consolidated Statements of Cash Flows for the years ended December 31,
2005, 2004 and 2003
Notes to Consolidated Financial Statements
Reports of Independent Registered Public Accounting Firm
(a)(2) Financial Statement Schedules. All applicable financial statement
schedules required under Regulation S-X and pursuant to Industry Guide 3 under
the Securities Act have been included in the Notes to the Consolidated Financial
Statements.
(a)(3) Exhibits. The exhibits required by Item 601 of Regulation S-K are listed
in the Exhibit Index immediately following the signature pages to this report.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in Raleigh, North
Carolina, on the 15th day of March, 2006.
CAPITAL BANK CORPORATION
By: /s/ B. Grant Yarber
-------------------------------------
B. Grant Yarber
President and Chief Executive Officer
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SIGNATURES AND POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints B. Grant Yarber, A. Christine Baker, and George C.
Nicholson, and each of them, with full power to act without the other, his true
and lawful attorneys-in-fact and agents, with full powers of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any or all amendments to this report, and to file the same,
with all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully for all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents, or their substitutes, may
lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant in
the capacities indicated and on March 15, 2006.
Signature Title
--------- -----
/s/B. Grant Yarber
- ------------------------ President and Chief Executive Officer and Director
B. Grant Yarber (Principal Executive Officer)
/s/A. Christine Baker
- ------------------------ Chief Financial Officer
A. Christine Baker (Principal Financial Officer)
/s/George C. Nicholson
- ------------------------ Chief Accounting Officer
George C. Nicholson (Principal Accounting Officer)
/s/Charles F. Atkins
- ------------------------ Director
Charles F. Atkins
/s/James A. Barnwell, Jr.
- ------------------------ Director
James A. Barnwell, Jr.
/s/William C. Burkhardt
- ------------------------ Director
William C. Burkhardt
/s/Leopold I. Cohen
- ------------------------ Director
Leopold I. Cohen
/s/John. F. Grimes
- ------------------------ Director
John F. Grimes, III
/s/Robert L. Jones
- ------------------------ Director
Robert L. Jones
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/s/Oscar A. Keller, III
- ------------------------ Chairman of the Board of Directors
Oscar A. Keller, III
/s/Oscar A. Keller, Jr.
- ------------------------ Director
Oscar A. Keller, Jr.
/s/Ernest A. Koury, Jr.
- ------------------------ Director
Ernest A. Koury, Jr.
/s/James G. McClure, Jr.
- ------------------------ Director
James G. McClure, Jr.
/s/James D. Moser, Jr.
- ------------------------ Director
James D. Moser, Jr.
/s/George R. Perkins, III
- ------------------------ Director
George R. Perkins, III
/s/Don W. Perry
- ------------------------ Director
Don W. Perry
/s/Carl H. Ricker
- ------------------------ Director
Carl H. Ricker, Jr.
/s/Richard H. Shirley
- ------------------------ Director
Richard H. Shirley
/s/J. Rex Thomas
- ------------------------ Director
J. Rex Thomas
/s/Samuel J. Wornom, III
- ------------------------- Director
Samuel J. Wornom, III
- 73 -
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
Merger Agreement, dated June 29, 2005, by and among Capital Bank Corporation
and 1st State Bancorp, Inc. (incorporated by reference to Exhibit 2.1 to Capital
2.01 Bank Corporation's Current Report on Form 8-K filed with the Securities and
Exchange Commission on June 29, 2005)
List of Schedules Omitted from Merger Agreement included as Exhibit 2.1 above
(incorporated by reference to Exhibit 2.2 to Capital Bank Corporation's Current
2.02 Report on Form 8-K filed with the Securities and Exchange Commission on June
29, 2005)
Articles of Incorporation of the Company (incorporated by reference to Exhibit 3.1
to the Company's Registration Statement on Form S-4 filed with the SEC on
3.01 October 19, 1998, as amended on November 10, 1998, December 21, 1998 and
February 8, 1999)
Bylaws of the Company, as amended to date (incorporated by reference to Exhibit
3.02 3.02 to the Company's Annual Report on Form 10-K filed with the SEC on March
29, 2002)
Specimen Common Stock Certificate of the Company (incorporated by reference
to Exhibit 4.1 to the Company's Registration Statement on Form S-4 filed with the
4.01 SEC on October 19, 1998, as amended on November 10, 1998, December 21, 1998
and February 8, 1999)
In accordance with Item 601(b) (4) (iii) (A) of Regulation S-K, certain instruments
4.02 respecting long-term debt of the registrant have been omitted but will be furnished
to the Commission upon request.
Equity Incentive Plan (incorporated by reference to Exhibit 10.02 to the
10.01 Company's Annual Report on Form 10-K filed with the SEC on March 28, 2003)
(management contract or compensatory plan, contract or arrangement)
Amended and Restated Deferred Compensation Plan for Outside Directors
(incorporated by reference from Appendix A to the Company's Proxy Statement
10.02 for Annual Meeting held on May 26, 2005) (management contract or
compensatory plan, contract or arrangement)
Capital Bank Defined Benefit Supplemental Executive Retirement Plan
(incorporated by reference to Exhibit 10.1 to the Company's Current Report on
10.03 Form 8-K filed with the SEC on May 27, 2005) (management contract or
compensatory plan, contract or arrangement)
Capital Bank Supplemental Retirement Plan for Directors (incorporated by
reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with
10.04 the SEC on May 27, 2005) (management contract or compensatory plan, contract
or arrangement)
Employment Agreement dated April 21, 2004 between B. Grant Yarber and
Capital Bank Corporation (incorporated by reference to Exhibit 10.1 to the
10.05 Company's Quarterly Report on Form 10-Q filed with the SEC on May 7, 2004)
(management contract or compensatory plan, contract or arrangement)
- 74 -
Employment Agreement dated January 3, 2006 between A. Christine Baker and
Capital Bank Corporation (incorporated by reference to Exhibit 10.1 to the
10.06 Company's Current Report on Form 8-K filed with the SEC on January 9, 2006)
(management contract or compensatory plan, contract or arrangement)
Employment Agreement dated April 16, 2004 between Richard W. Edwards and
Capital Bank Corporation (incorporated by reference to Exhibit 10.2 to the
10.07 Company's Quarterly Report on Form 10-Q filed with the SEC on May 7, 2004)
(management contract or compensatory plan, contract or arrangement)
Change of Control Agreement dated May 3, 2004 between Karen H. Priester and
10.08 Capital Bank (incorporated by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q filed with the SEC on August 3, 2004)
(management contract or compensatory plan, contract or arrangement)
Lease Agreement, dated November 16, 1999, between Crabtree Park, LLC and the
10.09 Company (incorporated by reference to Exhibit 10.01 to the Company's Annual
Report on Form 10-K filed with the SEC on March 27, 2000)
Lease Agreement, dated November 1, 2005, by and between Capital Bank
Corporation and 333 Ventures, LLC (incorporated by reference to Exhibit 10.1 to
10.10 the Company's Current Report on Form 8-K filed with the SEC on November 28,
2005)
Agreement, dated November 2001 between Fiserv Solutions, Inc. and the
10.11 Company (incorporated by reference to Exhibit 10.08 to the Company's Annual
Report on Form 10-K filed with the SEC on March 29, 2002)
Letter from PricewaterhouseCoopers LLP (incorporated by reference to Exhibit
16.1 16.1 to the Company's Current Report on Form 8-K filed with the SEC on April
12, 2005)
21 Subsidiaries of the Registrant
23.01 Consent of Independent Registered Public Accounting Firm
23.02 Consent of Independent Registered Public Accounting Firm
Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule 15d-
31.01 14(a), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-
31.02 14(a), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section
906 of The Sarbanes-Oxley Act of 2002. [This exhibit is being furnished pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the
32.01 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.]
Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section
32.02 906 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
- 75 -
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.]
- 76 -