U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One) FORM 10QSB/A
X QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
----- OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2005
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
- ----- THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _________to_________
Commission File No. 000-50257
CAROLINA NATIONAL CORPORATION
(Exact name of small business issuer as specified in its charter)
South Carolina 57-1101005
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
1350 Main Street
Columbia, South Carolina 29201
(Address of principal executive offices, including zip code)
(803) 779-0411
(Issuer's telephone number, including area code)
------------------------------------------------
Indicate by check mark whether the issuer (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 issuer was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days.
YES [ X ] NO [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
YES [ ] NO [ X ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
1,427,303 shares of common stock, no par value as of October 31, 2005
Transitional Small Business Disclosure Format (check one): Yes [ ] No [ X ]
CAROLINA NATIONAL CORPORATION
Index
PART I - FINANCIAL INFORMATION Page No.
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - September 30, 2005 and December 31, 2004...............................3
Condensed Consolidated Statements of Operations - Nine months ended September 30, 2005 and 2004
and Three months ended September 30, 2005 and 2004.........................................................4
Condensed Consolidated Statements of Shareholders' Equity and Comprehensive Income-
Nine months ended September 30, 2005 and 2004................................................................5
Condensed Consolidated Statements of Cash Flows - Nine months ended September 30, 2005 and 2004................6
Notes to Condensed Consolidated Financial Statements...........................................................7
Item 2. Management's Discussion and Analysis or Plan of Operation..................................................11-16
Item 3. Controls and Procedures.......................................................................................17
PART II - OTHER INFORMATION
Item 6. Exhibits......................................................................................................17
CAROLINA NATIONAL CORPORATION
Condensed Consolidated Balance Sheets
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
September 30, December 31,
2005 2004
---- ----
Assets (Unaudited) (Audited)
Cash and cash equivalents
Cash and due from banks ...................................................... $ 5,334,521 $ 1,614,863
Federal funds sold ........................................................... 12,550,000 1,767,000
------------- -------------
Total cash and cash equivalents ............................................ 17,884,521 3,381,863
------------- -------------
Investment securities
Securities available for sale ................................................ 2,979,375 2,969,063
Nonmarketable equity securities .............................................. 511,200 392,400
------------- -------------
Total investment securities ................................................ 3,490,575 3,361,463
------------- -------------
Loans receivable, net of unearned income ....................................... 128,725,216 90,303,749
Less allowance for loan losses ............................................... 1,780,200 1,332,200
------------- -------------
Loans, net ................................................................. 126,945,016 88,971,549
------------- -------------
Premises, furniture and equipment, net ......................................... 685,725 710,511
Accrued interest receivable .................................................... 530,149 372,527
Deferred tax asset ............................................................. 1,367,255 1,581,010
Other assets ................................................................... 247,188 126,113
------------- -------------
Total assets ............................................................... $ 151,150,429 $ 98,505,036
============= =============
Liabilities
Deposits
Noninterest-bearing transaction accounts ..................................... $ 13,572,784 $ 10,374,841
Interest-bearing transaction accounts ........................................ 13,707,744 6,046,689
Savings and money market ..................................................... 27,074,738 24,762,926
Time deposits $100,000 and over .............................................. 45,945,374 26,901,355
Other time deposits .......................................................... 34,906,853 18,008,113
------------- -------------
Total deposits ............................................................. 135,207,493 86,093,924
------------- -------------
Notes payable .................................................................. 3,450,000 900,000
Accrued interest payable ....................................................... 655,889 289,089
Other liabilities .............................................................. 505,231 296,909
------------- -------------
Total liabilities .......................................................... 139,818,613 87,579,922
------------- -------------
Shareholders' equity
Preferred stock, 10,000,000 shares authorized, none issued ..................... - -
Common stock, no par value, 20,000,000 shares authorized;
and 1,427,303 shares issued and outstanding .................................. 13,994,796 13,994,796
Retained deficit ............................................................... (2,644,905) (3,044,801)
Accumulated other comprehensive loss ........................................... (18,075) (24,881)
------------- -------------
Total shareholders' equity ................................................. 11,331,816 10,925,114
------------- -------------
Total liabilities and shareholders' equity ................................. $ 151,150,429 $ 98,505,036
============= =============
See notes to condensed consolidated financial statements.
3
CAROLINA NATIONAL CORPORATION
Condensed Consolidated Statements of Operations
(Unaudited)
Nine Months Ended Three Months Ended
September 30, September 30,
------------- -------------
2005 2004 2005 2004
---- ---- ---- ----
Interest income
Loans, including fees ...................................... $ 5,243,136 $ 2,550,903 $ 2,059,710 $ 1,001,803
Investment securities:
Taxable .................................................. 45,000 40,706 15,000 15,000
Nonmarketable equity securities .......................... 18,476 12,606 8,952 4,050
Federal funds sold ........................................... 159,576 58,365 55,216 31,275
----------- ----------- ----------- -----------
Total .................................................. 5,466,188 2,662,580 2,138,878 1,052,128
----------- ----------- ----------- -----------
Interest expense
Time deposits $100,000 and over ............................ 820,282 278,077 291,844 123,743
Other deposits ............................................. 1,059,477 554,348 419,426 211,343
Notes Payable .............................................. 71,063 - 39,458 -
----------- ----------- ----------- -----------
Total .................................................. 1,950,822 832,425 750,728 335,086
----------- ----------- ----------- -----------
Net interest income .......................................... 3,515,366 1,830,155 1,388,150 717,042
Provision for loan losses .................................... 448,462 374,607 136,562 98,367
----------- ----------- ----------- -----------
Net interest income after provision for loan losses .......... 3,066,904 1,455,548 1,251,588 618,675
----------- ----------- ----------- -----------
Noninterest income
Service charges on deposit accounts ........................ 139,583 96,174 56,970 38,988
Residential mortgage origination fees ...................... 81,708 82,076 36,166 15,385
Other ...................................................... 49,423 29,343 14,434 11,440
----------- ----------- ----------- -----------
Total noninterest income ............................... 270,714 207,593 107,570 65,813
----------- ----------- ----------- -----------
Noninterest expenses
Salaries and employee benefits ............................. 1,614,375 1,299,633 590,692 438,449
Net occupancy .............................................. 245,740 189,838 90,689 69,487
Furniture and equipment .................................... 98,796 109,423 32,292 37,789
Other operating ............................................ 763,040 759,277 271,799 260,706
----------- ----------- ----------- -----------
Total noninterest expense .............................. 2,721,951 2,358,171 985,472 806,431
----------- ----------- ----------- -----------
Income (loss) before income taxes ............................ 615,667 (695,030) 373,686 (121,943)
Income tax expense (benefit) ................................. 215,771 (240,838) 126,485 (43,794)
----------- ----------- ----------- -----------
Net income (loss) ............................................ $ 399,896 $ (454,192) $ 247,201 $ (78,149)
=========== =========== =========== ===========
Earnings per share
Basic earnings (loss) per share .............................. $ .28 $ (.32) $ .17 $ (.05)
=========== =========== =========== ===========
Diluted earnings (loss) per share ............................ $ .27 $ (.32) $ .16 $ (.05)
=========== =========== =========== ===========
Average shares outstanding - basic ........................... 1,427,303 1,427,303 1,427,303 1,427,303
=========== =========== =========== ===========
Average shares outstanding - diluted ......................... 1,502,321 1,427,303 1,502,321 1,427,303
=========== =========== =========== ===========
See notes to condensed consolidated financial statements.
4
CAROLINA NATIONAL CORPORATION
Condensed Consolidated Statements of Changes in Shareholders' Equity
For the Nine months ended September 30, 2005 and 2004
(Unaudited)
Accumulated
Common Stock Other
------------ Retained Comprehensive
Shares Amount Deficit Loss Total
------ ------ ------- ---- -----
Balance, December 31, 2003 ........... 1,427,303 $ 13,994,796 $ (2,612,031) $ - $ 11,382,765
Net loss ............................. - - (454,192) (454,192)
Other comprehensive loss,
net of tax benefit ................. (16,218) (16,218)
------------
Comprehensive loss ................... - - (470,410)
--------- ------------ ------------ ------------ ------------
Balance, September 30, 2004 .......... 1,427,303 $ 13,994,796 $ (3,066,223) $ (16,218) $ 10,912,355
========= ============ ============ ============ ============
Balance, December 31, 2004 ........... 1,427,303 $ 13,994,796 $ (3,044,801) $ (24,881) $ 10,925,114
Net income ........................... 399,896 399,896
Other comprehensive loss,
net of tax benefit ................. 6,806 6,806
------------
Comprehensive income ................. 406,702
--------- ------------ ------------ ------------ ------------
Balance, September 30, 2005 .......... 1,427,303 $ 13,994,796 $ (2,644,905) $ (18,075) $ 11,331,816
========= ============ ============ ============ ============
See notes to condensed consolidated financial statements.
5
CAROLINA NATIONAL CORPORATION
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended
September 30,
-------------
2005 2004
---- ----
Cash flows from operating activities
Adjustments to reconcile net loss to net cash used by
operating activities
Net income (loss) .......................................................... $ 399,896 $ (454,192)
Provision for loan losses .................................................. 448,462 374,607
Depreciation and amortization expense ...................................... 126,649 97,457
Discount accretion and premium amortization ................................ - 2,131
Deferred income tax expense (benefit) ...................................... 210,249 (245,295)
Increase in accrued interest receivable .................................... (157,622) (43,906)
Increase in accrued interest payable ....................................... 366,800 102,129
Decrease (increase) in other assets ........................................ (121,075) 419,060
Increase in other liabilities .............................................. 208,322 178,586
------------ ------------
Net cash provided by operating activities ................................ 1,481,681 430,577
------------ ------------
Cash flows from investing activities
Purchase of marketable equity securities ....................................... - (3,000,000)
Purchases of non-marketable equity securities .................................. (118,800) (171,600)
Securities called or redeemed .................................................. - 3,300,000
Net increase in loans .......................................................... (38,421,929) (24,951,496)
Purchase of premises, furniture and equipment .................................. (101,863) (309,471)
------------ ------------
Net cash used by investing activities ........................................ (38,642,592) (25,132,567)
------------ ------------
Cash flows from financing activities
Net decrease in federal funds purchased ........................................ - (533,000)
Net increase in demand deposits, interest-bearing
transaction accounts and savings accounts .................................... 13,170,810 18,124,269
Net increase in certificates of deposit and
other time deposits .......................................................... 35,942,759 13,028,277
Net increase in notes payable .................................................. 2,550,000 -
------------ ------------
Net cash provided by financing activities .................................... 51,663,569 30,619,546
------------ ------------
Net increase in cash and cash equivalents ........................................ 14,502,658 5,917,556
Cash and cash equivalents, beginning of period ................................... 3,381,863 2,459,441
------------ ------------
Cash and cash equivalents, end of period ......................................... $ 17,884,521 $ 8,376,997
============ ============
Cash paid during the period for:
Income taxes ................................................................... $ 6,422 $ -
============ ============
Interest ....................................................................... $ 1,584,022 $ 730,306
============ ============
See notes to condensed consolidated financial statements.
6
CAROLINA NATIONAL CORPORATION
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 1 - Basis of Presentation
The accompanying financial statements have been prepared in accordance with the
requirements for interim financial statements and, accordingly, they are
condensed and omit disclosures, which would substantially duplicate those
contained in the most recent annual report on Form 10-KSB. The financial
statements, as of September 30, 2005 and 2004 are unaudited and, in the opinion
of management, include all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation. The financial
information as of December 31, 2004 has been derived from the audited financial
statements as of that date. For further information, refer to the financial
statements and the notes included in Carolina National Corporation's 2004 Annual
Report on Form 10-KSB.
Note 2 - Recently Issued Accounting Pronouncements
The following is a summary of recent authoritative pronouncements that affect
accounting, reporting, and disclosure of financial information by the Company:
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004),
"Share-Based Payment" ("SFAS No. 123(R)"). SFAS No. 123(R) covers a wide range
of share-based compensation arrangements including share options, restricted
share plans, performance-based awards, share appreciation rights, and employee
share purchase plans. SFAS No. 123(R) will require companies to measure all
employee stock-based compensation awards using a fair value method and record
such expense in their financial statements. In addition, the adoption of SFAS
No. 123(R) requires additional accounting and disclosure related to the income
tax and cash flow effects resulting from share-based payment arrangements. SFAS
No. 123(R) is effective beginning as of the Company's next fiscal year that
begins after December 15, 2005. The Company is currently evaluating the impact
that the adoption of SFAS No. 123(R) will have on its financial position,
results of operations and cash flows. The cumulative effect of adoption, if any,
will be measured and recognized in the statement of operations on the date of
adoption.
In April 2005, the Securities and Exchange Commission's Office of the Chief
Accountant and its Division of Corporation Finance released Staff Accounting
Bulletin (SAB) No. 107 to provide guidance regarding the application of SFAS No.
123(R). SAB 107 provides interpretive guidance related to the interaction
between SFAS No. 123(R) and certain SEC rules and regulations, as well as the
staff's views regarding the valuation of share-based payment arrangements for
public companies. SAB 107 also reminds public companies of the importance of
including disclosures within filings made with the SEC relating to the
accounting for share-based payment transactions, particularly during the
transition to SFAS No. 123(R).
In November 2003, the Emerging Issues Task Force ("EITF") reached a consensus
that certain quantitative and qualitative disclosures should be required for
debt and marketable equity securities classified as available for sale or held
to maturity under SFAS No. 115 and SFAS No. 124 that are impaired at the balance
sheet date but for which other-than-temporary impairment has not been
recognized. Accordingly the EITF issued EITF No. 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments."
This issue addresses the meaning of other-than-temporary impairment and its
application to investments classified as either available for sale or held to
maturity under SFAS No. 115 and provides guidance on quantitative and
qualitative disclosures. The disclosure requirements of EITF No. 03-1 are
effective for annual financial statements for fiscal years ending after June 15,
2004. The effective date for the measurement and recognition guidance of EITF
No. 03-1 has been delayed. The FASB staff has issued a proposed Board-directed
FASB Staff Position ("FSP"), FSP EITF 03-1-a, "Implementation Guidance for the
Application of Paragraph 16 of Issue No. 03-1." The proposed FSP would provide
implementation guidance with respect to debt securities that are impaired solely
due to interest rates and/or sector spreads and analyzed for
other-than-temporary impairment under the measurement and recognition
requirements of EITF No. 03-1. The delay of the effective date for the
measurement and recognition requirements of EITF No. 03-1 will be superseded
concurrent with the final issuance of FSP EITF 03-1-a. Adopting the disclosure
provisions of EITF No. 03-1 did not have any impact on the Company's financial
position or results of operations.
Other accounting standards that have been issued or proposed by the FASB or
other standards-setting bodies that do not require adoption until a future date
are not expected to have a material impact on the consolidated financial
statements upon adoption.
7
CAROLINA NATIONAL CORPORATION
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 3 - Stock-Based Compensation
The Company has a stock-based employee compensation plan which is further
described in our Annual Report on Form 10-KSB. The Company accounts for the plan
under the recognition and measurement principles of Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees, and related
Interpretations. No stock-based employee compensation cost is reflected in net
income, as all stock options granted under the plan had an exercise price equal
to the market value of the underlying common stock on the date of grant. In
addition, the Company has stock warrants which were issued to organizers of the
Bank in connection with the initial offering. The following table illustrates
the effect on net income (loss) and earnings (losses) per share if the Company
had applied the fair value recognition provisions of SFAS No. 123, Accounting
for Stock-Based Compensation, to stock-based employee compensation for the stock
options and warrants.
During the fourth quarter of 2004, we evaluated the expected life of all options
and warrants outstanding. When originally calculating the pro forma cost of
these options and warrants, we used an expected life of 10 years, which is the
legal life of all options and warrants. We reevaluated this estimate and
concluded that it was not realistic. We reviewed the vesting periods and
expiration dates and the financial circumstances of the holders of the options
and warrants and determined that an average of 7 years was more appropriate. The
issuance of options and warrants was new to our Company and we had not carefully
evaluated this estimate initially. Therefore, we have revised the expected life
for all options and warrants to seven years. We changed no other assumptions in
our revised calculation. This has affected our total pro forma compensation cost
for all future periods. In accordance with APB 20, this change will be accounted
for prospectively over the remaining vesting periods for each of the option and
warrant issuances.
Nine Months Ended
September 30,
-------------
2005 2004
---- ----
Net income (loss), as reported ................ $ 399,896 $ (454,192)
Deduct: Total stock-based
compensation expense determined
under fair value based method
for all awards, net of related tax effects . (41,019) (140,327)
---------- ----------
Pro forma net income (loss) ................... $ 358,877 $ (594,519)
========== ==========
Earnings (loss) per share:
Basic - as reported ........................ $ .28 $ (.32)
========== ==========
Basic - pro forma .......................... $ .25 $ (.42)
========== ==========
Diluted - as reported ...................... $ .27 $ (.32)
========== ==========
Diluted - pro forma ........................ $ .24 $ (.42)
========== ==========
Three Months Ended
September 30,
-------------
2005 2004
---- ----
Net income (loss), as reported ................ $ 247,201 $ (78,149)
Deduct: Total stock-based
compensation expense determined
under fair value based method
for all awards, net of related tax effects . (13,673) (46,776)
----------- ----------
Pro forma net income (loss) ................... $ 233,528 $ (124,925)
=========== ==========
Earnings (loss) per share:
Basic - as reported ........................ $ .17 $ (.05)
=========== ==========
Basic - pro forma .......................... $ .16 $ (.09)
=========== ==========
Diluted - as reported ...................... $ .16 $ (.05)
=========== ==========
Diluted - pro forma ........................ $ .16 $ (.09)
=========== ==========
8
CAROLINA NATIONAL CORPORATION
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Basic earnings (loss) per share is computed by dividing net income (loss) by the
weighted-average number of common shares outstanding. Diluted earnings (loss)
per share is computed by dividing net income (loss) by the weighted-average
number of common shares outstanding and dilutive common share equivalents using
the treasury stock method. Dilutive common share equivalents include common
shares issuable upon exercise of outstanding stock warrants and stock options.
There were no dilutive common share equivalents outstanding during the nine
months ended September 30, 2004 due to the net loss; therefore, basic loss per
share and diluted earnings per share were the same for 2004.
Nine Months Ended
September 30,
-------------
2005 2004
---- ----
Net income (loss) per share - basic computation:
Net income (loss) to common shareholders ....................................... $ 399,896 $ (454,192)
============== ===========
Average common shares outstanding - basic ...................................... 1,427,303 1,427,303
============== ===========
Basic income (loss) per share .................................................. $ .28 $ (.32)
============== ===========
Net income (loss) per share - dilutive computation:
Net income (loss) to common shareholders ....................................... $ 399,896 $ (454,192)
============== ===========
Average common shares outstanding - dilutive ................................... 1,502,321 1,427,303
============== ===========
Diluted income (loss) per share ................................................ $ .27 $ (.32)
============== ===========
Three Months Ended
September 30,
-------------
2005 2004
---- ----
Net income (loss) per share - basic computation:
Net income (loss) to common shareholders ....................................... $ 247,201 $ (78,149)
============== ===========
Average common shares outstanding - basic ...................................... 1,427,303 1,427,303
============== ===========
Basic income (loss) per share .................................................. $ .17 $ (.05)
============== ===========
Net income (loss) per share - dilutive computation:
Net income (loss) to common shareholders ....................................... $ 247,201 $ (78,149)
============== ===========
Average common shares outstanding - dilutive ................................... 1,502,321 1,427,303
============== ===========
Diluted income (loss) per share ............................................... $ .16 $ (.05)
============== ===========
Options that had a dilutive effect on the earnings per share calculation totaled
75,018 for the nine and three months ending September 30, 2005. Options that
could have had a dilutive effect but which were excluded from the earnings per
share calculation totaled 27,934 for the nine and three months ending September
30, 2004.
9
CAROLINA NATIONAL CORPORATION
Note 5 - Leases
The Bank entered into a lease agreement on August 15, 2005 for a branch location
in the northeast area of Richland County, South Carolina. The operating lease
has an initial ten-year term and expires January 31, 2015. The Bank has renewal
options for two additional ten year periods. The lease requires annual payments
of $36,000 for the initial lease term. Rent expense and any additional
improvements will be amortized on a straight line basis over the minimum lease
term. Rent expense associated with this lease for the nine months ended
September 30, 2005 was $8,410.
Forward Looking Statements
This report contains "forward-looking statements" within the meaning of the
securities laws. All statements that are not historical facts are
"forward-looking statements." You can identify these forward-looking statements
through our use of words such as "may," "will," "expect," "anticipate,"
"believe," "intend," "estimate," "project," "continue," or other similar words.
Forward-looking statements include, but are not limited to, statements regarding
our future business prospects, revenues, working capital, liquidity, capital
needs, interest costs, income, business operations and proposed services.
These forward-looking statements are based on current expectations, estimates
and projections about our industry, management's beliefs, and assumptions made
by management. Such information includes, without limitation, discussions as to
estimates, expectations, beliefs, plans, strategies, and objectives concerning
our future financial and operating performance. These statements are not
guarantees of future performance and are subject to risks, uncertainties and
assumptions that are difficult to predict, particularly in light of the fact
that we are a new company with limited operating history. Therefore, actual
results may differ materially from those expressed or forecasted in such
forward-looking statements. The risks and uncertainties include, but are not
limited to:
o our growth and our ability to maintain growth;
o governmental monetary and fiscal policies, as well as legislative and
regulatory changes;
o the effect of interest rate changes on our level and composition of
deposits, loan demand and the value of our loan collateral and
securities;
o the effects of competition from other financial institutions operating
in our market area and elsewhere, including institutions operating
locally, regionally, nationally and internationally, together with
competitors that offer banking products and services by mail,
telephone and computer and/or the Internet;
o failure of assumptions underlying the establishment of our allowance
for loan losses, including the value of collateral securing loans; and
o loss of consumer confidence and economic disruptions resulting from
terrorist activities.
We undertake no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
In light of these risks, uncertainties, and assumptions, the forward-looking
events discussed in this report might not occur.
10
CAROLINA NATIONAL CORPORATION
Item 2 - Management's Discussion and Analysis or Plan of Operation
The following is our discussion and analysis of certain significant factors that
have affected our financial position and operating results and those of our
subsidiary, Carolina National Bank and Trust Company (the "Bank"), during the
periods included in the accompanying financial statements. This commentary
should be read in conjunction with the financial statements and the related
notes and the other statistical information included in this report and in our
2004 Annual Report on Form 10-KSB.
Results of Operations
Net Interest Income
For the nine months ended September 30, 2005, net interest income, the major
component of the Bank's net income was $3,515,366 as compared to $1,830,155 for
the same period in 2004. For the three months ended September 30, 2005, net
interest income was $1,388,150 compared to $717,042 for the same period in 2004.
For the nine months ended September 30, 2005, interest income from loans,
including fees, was $5,243,136, compared to $2,550,903 for the same period in
2004. For the three months ended September 30, 2005, interest income from loans,
including fees, was $2,059,710, compared to $1,001,803 for the same period in
2004. The improvement in the 2005 period was primarily attributable to increased
volume as the Company continued to build its loan portfolio, and substantial
increases in the rates earned.
Interest expense for the nine months ended September 30, 2005 was $1,950,822,
compared to $832,425 for the same period in 2004. Interest expense for the three
months ended September 30, 2005 was $750,728, compared to $335,086 for the same
period in 2004. Interest expense for the nine month and three month periods in
2005 increased over the same periods in the prior year as a result of the
increase in volume of interest-bearing deposits and an increase in the cost of
funds.
The average rate realized on interest-earning assets was 6.14% and 4.67%,
respectively, for the nine month periods ended September 30, 2005 and 2004. The
average rate paid on interest-bearing liabilities was 2.63% and 1.58%,
respectively, for the nine month periods ended September 30, 2005 and 2004. For
the three month periods ended September 30, 2005 and 2004, the average rate
realized on interest-earning assets was 6.54% and 4.64%, respectively and the
average rate paid on interest-bearing liabilities was 2.74% and 2.06%,
respectively.
The net interest spread and net interest margin were 3.51% and 3.95%,
respectively, for the nine month period ended September 30, 2005. The net
interest spread and net interest margin were 3.09% and 3.21%, respectively, for
the nine month period ended September 30, 2004. For the three month period ended
September 30, 2005 and 2004, the net interest spread was 3.75% and 2.75%,
respectively. For the three month period ended September 30, 2005 and 2004, the
net interest margin was 4.17% and 3.28%, respectively.
Provision and Allowance for Loan Losses
The provision for loan losses charged to operating expenses reflects the amount
deemed appropriate by management to establish an adequate reserve to meet the
present and foreseeable risk characteristics of the current loan portfolio.
Loans that are determined to be uncollectible are charged against the allowance.
Provisions for loan losses and recoveries on loans previously charged off are
added to the allowance. For the nine months ended September 30, 2005 and 2004,
the provision was $448,462 and $374,607, respectively. For the three months
ended September 30, 2005 and 2004, the provision for loans losses was $136,562
and $98,367, respectively. The allowance for loan losses represents 1.38% and
1.50% of gross loans at September 30, 2005 and 2004, respectively. There are
risks inherent in making all loans, including risks with respect to the period
of time over which loans may be repaid, risks resulting from changes in economic
and industry conditions, risks inherent in dealing with individual borrowers,
and, in the case of a collateralized loan, risks resulting from uncertainties
about the future value of the collateral. Management's judgment is based on
periodic and regular evaluation of individual loans, the overall risk
characteristics of the various portfolio segments, and prevailing and
anticipated economic conditions. Based on our analysis of such factors we assign
specific reserve amounts for any significant classified loans and we use various
percentages of the aggregate amounts of groups of other classified loans and the
different categories of non-classified loans. The percentages are set based on
our assessment of the degree of credit risk in each category after reviewing
changes in lending policies and procedures, including underwriting standards and
collection, charge-off, and recovery practices; changes in national and local
economic and business conditions; changes in the nature and volume of the
portfolio; changes in the experience and depth of lending management; changes in
the volume and severity of problem loans; the effect of external factors such as
competition, legal and regulatory requirements; and, peer comparison. Our
judgment about the adequacy of the allowance is based upon a number of estimates
and assumptions about present conditions and future events, which we believe to
11
CAROLINA NATIONAL CORPORATION
Item 2 - Management's Discussion and Analysis or Plan of Operation - continued
be reasonable, but which may not prove to be accurate. Since we have a limited
operating history, we rely heavily on the prior banking experience of our
management and peer group data in formulating our estimates and assumptions.
Thus, there is a risk that charge-offs in future periods could exceed the
allowance for loan losses or that substantial additional increases in the
allowance for loan losses could be required. Additions to the allowance for loan
losses would result in a decrease of our net income and, possibly, our capital.
Noninterest Income
Noninterest income for the nine month periods ended September 30, 2005 and 2004
was $270,714 and $207,593, respectively. Of this total, $139,583 and $96,174 was
generated from service charges on deposit accounts, which includes fees for
checks returned due to insufficient funds on deposit. Residential mortgage
origination fees totaled $81,708 and $82,076 for the nine months ended September
30, 2005 and 2004, respectively. The increase in service charges was the result
of an increase in the volume of deposits between the two periods. For the
quarters ended September 30, 2005 and 2004, noninterest income was $107,570 and
$65,813, respectively. Of this total, $56,970 and $38,988 was generated from
service charges on deposit accounts, and $36,166 and $15,385 was generated from
residential mortgage origination fees.
Noninterest Expense
Total noninterest expense for the nine months ended September 30, 2005 and 2004
was $2,721,951 and $2,358,171, respectively. This represents an increase of
$363,780, or 15.4% over the comparable period of 2004. The largest increase,
salaries and employee benefits, increased from $1,299,633 for the nine months
ended September 30, 2004 to $1,614,375 for the nine months ended September 30,
2005. The increase is primarily attributable to the hiring of additional staff
to meet the growing needs of the bank. Net occupancy expense for the nine month
period ended September 30, 2005 was $245,740 as compared to $189,838 for the
same period a year earlier. For the quarter ended September 30, 2005,
noninterest expense was $985,472, as compared to $806,431 for the same period in
2004. Salaries and benefits and other operating expenses were the largest
noninterest expenses during the 2005 quarter, totaling $590,692 and $271,799,
respectively. Salaries and benefits and other operating expenses for the 2004
quarter totaled $438,449 and $260,706, respectively. The increase from 2004 to
2005 is attributable to the overall growth of the bank.
Income Taxes
An income tax expense of $215,771 and $126,485 was recorded for the nine and
three month periods ending September 30, 2005, respectively. This compares to an
income tax benefit of $240,838 and $43,794 for the nine and three month periods
in 2004. This represents an effective tax rate of 35.0% and 34.7% for the nine
month periods ending September 30, 2005 and 2004, respectively.
Net Income (loss)
The combination of the above factors resulted in a net income of $399,896 for
the nine months ended September 30, 2005 as compared to a net loss of $454,192
for the same period in 2004. The net income for 2005 is primarily the result of
our increased earning asset base and the increase in net interest margin. The
loss in 2004 was primarily a result of noninterest expenses associated with
operating two full service branches and funding our provision for loan losses.
The net income before taxes of $615,667 was partially offset by income tax
expenses of $215,771 for the nine months ended September 30, 2005. The net loss
before taxes of $695,030 was partially offset by the income tax benefit of
$240,838 for the nine months ended September 30, 2004. The net income for the
three months ended September 30, 2005 was $247,201, as compared to a net loss of
$78,149 for the same period in 2004.
Financial Condition
Assets and Liabilities
During the first nine months of 2005, as we continued to build our business,
total assets increased $52,645,393, or 53.4%, when compared to December 31,
2004. Federal funds sold increased to $12,550,000 at September 30, 2005 as a
result of strong deposit growth. Total loans increased $38,421,467, or 42.5%,
during the first nine months of 2005. Total deposits also increased by
$49,113,569, or 57.0% from the December 31, 2004 amount of $86,093,924. Time
deposits increased $35,942,759, or 80.0%, during the first nine months of 2005.
Savings and money market deposits increased $2,311,812, or 9.3%, during the same
period. Transaction accounts increased $10,858,998, or 66.1% during the first
nine months of 2005.
12
CAROLINA NATIONAL CORPORATION
Item 2 - Management's Discussion and Analysis or Plan of Operation - continued
Investment Securities
Investment securities increased from $3,361,463 at December 31, 2004 to
$3,490,575 at September 30, 2005. All of the Bank's marketable investment
securities were designated as available-for-sale at September 30, 2005 and 2004.
Loans
We experienced significant loan growth during the first nine months of 2005 as
we continued to work to establish our presence in the marketplace. Gross loans,
net of unearned income, increased $38,421,467, or 42.5%, during the period. As
shown below, the largest category of the loan portfolio was mortgage loans for
commercial properties, which increased 62.5%, or $17,859,906, from December 31,
2004 to September 30, 2005. Balances within the major loans receivable
categories as of September 30, 2005 and December 31, 2004 are as follows:
September 30, December 31,
2005 2004
---- ----
Mortgage loans on real estate:
Residential 1-4 Family .............. $ 16,802,863 $ 12,419,144
Multifamily ......................... 218,370 222,617
Commercial .......................... 46,447,329 28,587,423
Construction ........................ 22,994,395 15,063,632
Second Mortgage loans ............... 1,671,884 1,368,602
Equity Lines of Credit .............. 23,615,455 18,229,803
------------ ------------
111,750,296 75,891,221
Commercial and industrial .................. 14,792,931 11,490,226
Consumer ................................... 2,164,263 2,917,672
Other ...................................... 17,726 4,630
------------ ------------
Total loans, net of unearned income ........ $128,725,216 $ 90,303,749
============ ============
Risk Elements in the Loan Portfolio
We assign each of our loans a numerical grade of one through nine based on our
analysis of the risks of loss for the loan. The loans with a grade of one are
those we believe have the least amount of risk of loss, while we consider those
with a grade of nine to have the highest risk of loss. Criticized loans (risk
grade 5) are loans that have potential weaknesses that deserve close attention
and which could, if uncorrected, result in deterioration of the prospects for
repayment or the Bank's credit position at a future date. Classified loans (risk
grade 6, 7 and 8) are loans that are inadequately protected by the sound worth
and paying capacity of the borrower or any collateral and as to which there is a
distinct possibility or probability that we will sustain a loss if the
deficiencies are not corrected. Charged-off loans are risk grade 9. At September
30, 2005, the Bank had one criticized loan in the amount of $1,228,671. The loan
is collateralized by real estate and at December 31, 2004, the balance was
$1,270,393. We did not have any classified loans or any loans in nonaccrual
status or loans past due for more than 90 days as of September 30, 2005, or
December 31, 2004. At September 30, 2005, 87.8% of the dollar amount our
portfolio was risk graded 1, 2 or 3 in our judgment.
The Bank accounts for impaired loans in accordance with SFAS No. 114,
"Accounting by Creditors for Impairment of a Loan. " This statement requires
that all lenders value a loan at the loan's fair value if it is probable that
the lender will be unable to collect all amounts due according to the terms of
the loan agreement. Fair value may be determined based upon the present value of
expected cash flows, market price of the loan, if available, or value of the
underlying collateral. Expected cash flows are required to be discounted at the
loan's effective interest rate. SFAS No. 114 was amended by SFAS No. 118 to
allow a lender to use existing methods for recognizing interest income on an
impaired loan and by requiring additional disclosures about how a creditor
recognizes interest income on an impaired loan.
Under SFAS No. 114, as amended by SFAS No. 118, when the ultimate collectibility
of an impaired loan's principal is in doubt, wholly or partially, all cash
receipts are applied to principal. Once the reported principal balance has been
reduced to zero, future cash receipts are applied to interest income, to the
extent that any interest has been foregone. Further cash receipts are recorded
as recoveries of any amounts previously charged off. When this doubt does not
exist, cash receipts are applied under the contractual terms of the loan
agreement first to interest income then to principal.
A loan is also considered impaired if its terms are modified in a troubled debt
restructuring. For these accruing impaired loans, cash receipts are typically
applied to principal and interest receivable in accordance with the terms of the
13
CAROLINA NATIONAL CORPORATION
Item 2 - Management's Discussion and Analysis or Plan of Operation - continued
restructured loan agreement. Interest income is recognized on these loans using
the accrual method of accounting. We did not have any impaired loans as of
September 30, 2005, or December 31, 2004.
Allowance for Loan Losses
Activity in the allowance for loan losses for the nine months ended September
30, 2005 and 2004 is as follows:
Nine Months Ended
September 30,
-------------
2005 2004
---- ----
Balance, January 1, ............................................................. $ 1,332,200 $ 826,593
Provision for loan losses for the period ........................................ $ 448,462 $ 374,607
Net loans (charged-off) recovered for the period ................................ (462) -
------------- -------------
Balance, end of period .......................................................... $ 1,780,200 $ 1,201,200
============= =============
Gross loans outstanding, end of period .......................................... $ 128,725,216 $ 79,981,969
Allowance for loan losses to loans outstanding, end of period ................... 1.38% 1.50%
We do not allocate the allowance for loan losses to specific categories of
loans. Instead, we evaluate the adequacy of the allowance for loan losses on an
overall portfolio basis utilizing our credit grading system which we apply to
each loan. We have an independent credit review officer who reviews loan files
and determines the grading of each loan. Also, on a quarterly basis, management
reviews the size and composition of the loan portfolio in light of current and
anticipated economic conditions in an effort to evaluate risks associated with
the portfolio. This evaluation takes into consideration information about
specific borrower situations and estimated collateral values, economic
conditions, and other factors. At September 30, 2005, we had one criticized loan
in the amount of $1.3 million. The loan is collateralized by real estate and at
December 31, 2004 the balance was $1.3 million. We did not have any classified
loans or any loans in nonaccrual status or loans past due for more than 90 days
as of September 30, 2005, or December 31, 2004. We did not have any impaired
loans as of September 30, 2005, or December 31, 2004.
Deposits
At September 30, 2005, total deposits had increased by $49,113,569, or 57.0%,
from December 31, 2004. The largest increase was in time deposits, which
increased $35,942,759, or 80.0%, from December 31, 2004 to September 30, 2005.
This increase was attributable to the opening of new accounts during the first
nine months of 2005. Expressed in percentages, noninterest-bearing deposits
increased 30.8% and interest-bearing demand deposits increased 126.7%. At
September 30, 2005, brokered deposits totaled $29,255,000 which represents a
52.5% increase over the December 31, 2004 brokered deposits total of
$19,183,000.
Balances within the major deposit categories as of September 30, 2005 and
December 31, 2004 are as follows:
September 30, December 31,
2005 2004
---- ----
Noninterest-bearing demand deposits ........ $ 13,572,784 $ 10,374,841
Interest-bearing demand deposits ........... 13,707,744 6,046,689
Savings and money market ................... 27,074,738 24,762,926
Time deposits $100,000 and over ............ 45,945,374 26,901,355
Other time deposits ........................ 34,906,853 18,008,113
------------ ------------
Total Deposits ................ $135,207,493 $ 86,093,924
============ ============
Notes Payable
We have a $7,000,000 line of credit with Chase Bank with a variable interest
rate based on the 30 day LIBOR plus 275 basis points. As of September 30, 2005,
14
CAROLINA NATIONAL CORPORATION
Item 2 - Management's Discussion and Analysis or Plan of Operation - continued
we had drawn $2,450,000 of this line. The line of credit matures in March, 2006.
In addition, we have credit available at Federal Home Loan Bank of Atlanta up to
10% of the Bank's total assets reported at the end of each previous quarter. As
of September 30, 2005, we had drawn $1,000,000 on this line at a fixed rate of
4.51% with a maturity date of March 26, 2007.
Off-Balance Sheet Risk
Through its operations, the Bank has made contractual commitments to extend
credit in the ordinary course of its business activities. These commitments are
legally binding agreements to lend money to the Bank's customers at
predetermined interest rates for a specified period of time. At September 30,
2005, the Bank had issued commitments to extend credit of $32,152,422 and
standby letters of credit of $448,352 through various types of commercial
lending arrangements. Approximately $28 million of these commitments to extend
credit had variable rates.
The following table sets forth the length of time until maturity for unused
commitments to extend credit and standby letters of credit at September 30,
2005.
After One After Three
Within Through Through Within Greater
One Three Twelve One Than
Month Months Months Year One Year Total
----- ------ ------ ---- -------- -----
Unused commitments
to extend credit .......... $ 268,915 $ 858,864 $ 6,861,264 $ 7,989,043 $ 24,163,379 $ 32,152,422
Standby letters .............
of credit ................. 250,000 80,000 118,352 448,352 448,352
------------- ----------- ------------- ------------- ------------- -------------
Totals .................... $ 518,915 $ 938,864 $ 6,979,616 $ 8,437,395 $ 24,163,379 $ 32,600,774
============= =========== ============= ============= ============= =============
Based on historical experience in the banking industry, we expect that many of
the commitments and letters of credit will expire unused or not fully funded.
Accordingly, the amounts in the table above do not necessarily reflect the
Bank's need for funds in the periods shown.
The Bank evaluates each customer's credit worthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary by the Bank upon
extension of credit, is based on its credit evaluation of the borrower.
Collateral varies but may include accounts receivable, inventory, property,
plant and equipment, and commercial and residential real estate.
Liquidity Management
Liquidity management involves monitoring our sources and uses of funds in order
to meet our day-to-day cash flow requirements while maximizing profits.
Liquidity represents the ability of a Company to convert assets into cash or
cash equivalents without significant loss and to raise additional funds by
increasing liabilities. Without proper liquidity management, we would not be
able to perform the primary function of a financial intermediary and would,
therefore, not be able to meet the needs of the communities we serve.
Liquidity management is made more complex because different balance sheet
components are subject to varying degrees of management control. For example,
the timing of maturities of the investment portfolio is relatively predictable
and subject to control at the time investment decisions are made. However, net
deposit inflows and outflows are far less predictable and are not subject to
nearly the same degree of control. We also have the ability to obtain funds from
various financial institutions should the need arise.
We meet our liquidity needs by structuring aggregate maturity terms of loans and
investments to coincide with aggregate maturity terms of funding sources while
maintaining sufficient excess funds for unplanned contingencies. One measure of
liquidity is the loan-to-total borrowed funds (which includes deposits) ratio,
which was at 92.8% at September 30, 2005 and 103.8% at December 31, 2004.
Securities available-for-sale, which totaled $2,979,375 at September 30, 2005,
and federal funds sold which totaled $12,550,000 at September 30, 2005, are a
ready source of liquidity. We also have a short term line of credit available
with a correspondent bank to purchase federal funds for periods from one to
fourteen days. At September 30, 2005, the unused federal funds borrowing line of
credit totaled $2,700,000. We also have a line of credit to borrow funds from
the Federal Home Loan Bank of Atlanta up to 10% of the Bank's total assets
15
CAROLINA NATIONAL CORPORATION
Item 2 - Management's Discussion and Analysis or Plan of Operation - continued
reported at the end of each previous quarter, which gave us the ability to
borrow up to $13,533,600 at September 30, 2005. At September 30, 2005, we had
borrowed $1,000,000 from the Federal Home Loan Bank. We also have a line of
credit to borrow funds from Chase Bank up to $7,000,000. As of September 30,
2005, we had borrowed $2,450,000 under this line.
Capital Resources
The capital base for the Company increased by $406,702 for the first nine months
of 2005, due to operating income and by unrealized gains on available for sale
securities. The Company's Tier 1 capital to risk-weighted asset ratio was 7.81%
as of September 30, 2005.
The Federal Deposit Insurance Corporation has established risk-based capital
requirements for banks and the Federal Reserve has established similar
requirements for bank holding companies that are applied to bank holding
companies with more than $150 million in assets. As of September 30, 2005, the
Company exceeded the adequately capitalized requirement of the Federal Reserve,
and the subsidiary bank exceeded the well capitalized and adequately capitalized
requirement as shown in the table below. Our bank relies on "brokered"
certificates of deposit as an important funding source for its loan portfolio.
To be able to obtain "brokered" deposits without receiving prior approval of the
FDIC, the bank must meet or exceed the ratios to be considered "well-
capitalized." As of September 30, 2005, the bank slightly exceeded the required
ratios. However, we could borrow an additional $4.6 million under a pre-existing
line of credit with Chase Bank, and inject it into the bank as Tier 1 or Tier 2
capital as needed to maintain the bank's "well-capitalized" status for a period
of time.
Capital Ratios
--------------
Well Capitalized Adequately Capitalized
(Dollars in thousands) Actual Requirement Requirement
------ ----------- -----------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
The Bank
Total capital (to risk-weighted assets) .................. $13,439 10.05% $13,371 10.00% $10,697 8.00%
Tier 1 capital (to risk-weighted assets) ................. 8,816 6.59% 8,023 6.00% 5,348 4.00%
Tier 1 capital (to average assets) ....................... 8,816 6.68% 6,594 5.00% 5,275 4.00%
The Company
Total capital (to risk-weighted assets) .................. $12,174 9.06% N/A N/A $10,754 8.00%
Tier 1 capital (to risk-weighted assets) ................. 10,493 7.81% N/A N/A 5,377 4.00%
Tier 1 capital (to average assets) ....................... 10,493 7.84% N/A N/A 5,354 4.00%
On September 30, 2005, the Company filed a registration statement with the U. S.
Securities and Exchange Commission with the purpose of selling approximately $15
million of common stock. The purpose of the offering is to increase the capital
of the Company and subsidiary bank in order to open additional branch offices
and continue the rapid growth of the loan portfolio and other assets. It is
anticipated the offering will be complete by the end of 2005.
Critical Accounting Policies
We have adopted various accounting policies which govern the application of
accounting principles generally accepted in the United States of America in the
preparation of our financial statements. Our significant accounting policies are
described in the notes to the consolidated financial statements at December 31,
2004 as filed in our annual report on Form 10-KSB. Certain accounting policies
involve significant judgments and assumptions by us which have a material impact
on the carrying value of certain assets and liabilities. We consider these
16
CAROLINA NATIONAL CORPORATION
accounting policies to be critical accounting policies. The judgments and
assumptions we use are based on historical experience and other factors, which
we believe to be reasonable under the circumstances. Because of the nature of
the judgments and assumptions we make, actual results could differ from these
judgments and estimates which could have a major impact on the carrying values
of our assets and liabilities and our results of operations.
We believe the allowance for loan losses is a critical accounting policy that
requires the most significant judgments and estimates used in preparation of our
consolidated financial statements. Refer to the portions of our 2004 Annual
Report on Form 10-KSB and this Form 10-QSB that address our allowance for loan
losses for description of our processes and methodology for determining our
allowance for loan losses.
Item 3. Controls and Procedures
(a) Based on the evaluation required by 17 C.F.R. Section 240.13a-15(b) or
240.15d-15(b) of the Company's disclosure controls and procedures (as
defined in 17 C.F.R. Sections 240.13a-15(e) and 240.15d-15(e)), the
Company's chief executive officer and chief financial officer concluded
that such controls and procedures, as of the end of the period covered by
this quarterly report, were effective.
(b) There has been no change in the Company's internal control over financial
reporting during the most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
Part II - Other Information
Item 6. Exhibits
10.1* Lease between Carolina National Bank & Trust Company and
MCW-RC-SC-North Pointe, LLC.
31.1 Certification of Principal Executive Officer required by Rule
13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of
1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
31.2 Certification of Principal Financial Officer required by Rule
13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of
1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
- ------------
*Previoulsy filed.
17
CAROLINA NATIONAL CORPORATION
SIGNATURE
In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
By:s/Roger B. Whaley
-----------------------------------
Roger B. Whaley
President & Chief Executive Officer
Date: November 28, 2005 By:s/Rollo F. Ingram
----------------------------------
Rollo F. Ingram
Chief Financial Officer
18