SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006
Commission File Number
000-28037
FIRST SOUTH BANCORP, INC.
(Exact Name of registrant as specified in its charter)
SOUTH CAROLINA 57-1086258
(State of Incorporation) (IRS Employer Identification number)
1450 John B. White, Sr., Blvd.
Spartanburg, South Carolina 29306
(Address of Principal Executive Office)
(864) 595-0455
(Registrant's Telephone Number)
Check whether the registrant (1) has filed all reports to be filed by Section 13
or 15(d) of the Exchange Act during the past 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) N0 ( )
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 a large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one): Large accelerated filer ( ) Accelerated filer ( ) Non-accelerated filer(X)
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act.
( ) Yes (X) No
State the number of shares outstanding of each of the registrant's classes of
common equity, as of the latest practical date: Common Stock, no par value,
2,121,437 shares outstanding on May 5, 2006.
FIRST SOUTH BANCORP, INC.
FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Balance Sheets.................................3
Consolidated Statements of Operations.......................4
Consolidated Statements of Comprehensive Income.............5
Consolidated Statements of Cash Flows.......................6
Notes to Unaudited Consolidated Financial Statements......7-9
Item 2. Management's Discussion and Analysis ...................10-19
Item 3. Quantitative and Qualitative Disclosures about Market Risk.20
Item 4. Controls and Procedures ...................................21
Part II- OTHER INFORMATION
Item 6. Exhibits...................................................22
2
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
FIRST SOUTH BANCORP, INC AND
SUBSIDIARY
Consolidated Balance Sheets
(Dollar amounts in thousands)
(Unaudited)
March 31, Dec. 31,
2006 2005
---- ----
Assets
Cash & due from banks ............................ $ 6,617 $ 5,022
Due from banks - interest bearing ................ 17,567 13,510
Investment securities:
Securities held to maturity .................. 7,148 7,264
Securities available for sale ................ 25,582 23,366
Loans ............................................ 288,342 268,033
Less, allowance for loan losses ............ (3,325) (3,000)
Loans - net ...................................... 285,017 265,033
Property & equipment, net ........................ 5,403 5,289
Investment in FSBS Capital Trust ................. 155 155
Other assets ..................................... 5,758 5,093
--------- ---------
Total assets ..................................... $ 353,247 $ 324,732
--------- ---------
Liabilities
Deposits:
Noninterest-bearing ........................ $ 15,616 $ 13,821
Interest-bearing ........................... 282,644 251,904
--------- ---------
Total deposits ............................... 298,260 265,725
Securities sold under repurchase agreements ...... 4,524 5,740
Other borrowed funds ............................. 10,000 15,000
Demand notes issued to the U.S. Treasury ......... 210 298
Subordinated debt ................................ 5,155 5,155
Other liabilities ................................ 3,053 1,943
--------- ---------
Total liabilities ............................ 321,202 293,861
Shareholders' equity
Common stock - no par value; 30,000,000
authorized,
Outstanding 1,750,444
Paid-in capital .................................. 19,422 19,422
Retained earnings ................................ 12,838 11,624
Accumulated other comprehensive income/(loss) .... (215) (175)
--------- ---------
Total shareholders' equity ....................... 32,045 30,871
Total liabilities and shareholders' equity ....... $ 353,247 $ 324,732
--------- ---------
3
FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Operations
(Unaudited)
Three Months ended,
March 31
--------
2006 2005
---- ----
(Dollars in thousands, except per share)
Interest income
Loans, including fees ................................................ $ 6,126 $ 4,390
Investment securities ................................................ 356 202
Interest bearing deposits ............................................ 127 83
------- -------
Total interest income ................................................ 6,609 4,675
Interest expense
Deposits and borrowings .............................................. 2,794 1,730
Net interest income ................................................................ 3,815 2,945
Provision for loan losses ............................................ (315) (287)
------- -------
Net interest income after provision ................................................ 3,500 2,658
Noninterest income
Service charges on deposit accounts .................................. 63 71
Other income ......................................................... 101 146
------- -------
Total noninterest income ............................................. 164 217
Noninterest expense
Salaries and benefits ................................................ 1,099 929
Occupancy and equipment .............................................. 208 202
Other expense ........................................................ 458 371
------- -------
Total noninterest expense ............................................ 1,765 1,502
Income before income taxes ......................................................... 1,899 1,373
Provision for income
taxes ................................................................ 685 499
------- -------
Net income ......................................................................... 1,214 $ 874
------- -------
Basic per share earnings ........................................................... $ 0.69 $ 0.52
Diluted earnings per share ......................................................... $ 0.67 $ 0.49
4
FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Comprehensive Income
(Dollar amounts in thousands)
(Unaudited)
Three Months ended
March 31,
---------
2006 2005
---- ----
Net Income ......................................... $ 1,214 $ 874
Other comprehensive income (loss):
Change in unrealized holdings gains &
losses on available for sale securities ........ (65) (155)
Income tax (expense) benefit on other
comprehensive income (loss) ........ 25 59
------- -------
Total other comprehensive income (loss) ............ (40) (96)
------- -------
Comprehensive income ............................... $ 1,174 $ 779
5
FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Dollar amounts in thousands)
(Unaudited)
Three Months ended,
March 31,
---------
2006 2005
---- ----
Operating Activities
Net income ................................................................................. $ 1,214 $ 874
Adjustments to reconcile net income to net cash provided by operating activities
Provision for loan
losses ......................................................................... 315 287
Depreciation ................................................................... 104 92
Net Amortization of Securities ................................................. 4 1
(Increase) in cash surrender value of life insurance ........................... (8) (7)
(Increase) in other assets ..................................................... (464) (97)
Increase (decrease) in accrued expenses and other liabilities .................. 184 358
-------- --------
Net cash provided by operating activities .................................................. 1,349 1,508
-------- --------
Investing Activities
Purchase of securities available
for sale ....................................................................... (4,500) -
Sale/(Purchase) of restricted FHLB stock ....................................... 168 (90)
Proceeds from MBS principal paydowns ........................................... 167 234
Proceeds from matured available for sale
securities ..................................................................... 2,000 383
Origination of loans, net of principal
collected ...................................................................... (19,501) (5,297)
(Purchase) of premises and equipment ........................................... (262) (56)
Net cash used in investing
activities ................................................................................. (21,928) (4,826)
-------- --------
Financing Activities
Net increase in deposits ....................................................... 32,535 13,819
Net increase (decrease) in retail repurchase agreements ........................ (1,216) 1,008
Net (decrease) in other borrowings ............................................. (5,088) -
-------- --------
Net cash provided by financing activities .................................................. 26,231 14,827
-------- --------
Net increase in cash and cash equivalents .................................................. 5,652 11,509
Cash and cash equivalents,
beginning .................................................................................. 18,532 13,292
-------- --------
Cash and cash equivalents, ending .......................................................... $ 24,184 $ 24,801
-------- --------
6
FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
Notes to Unaudited Consolidated Financial Statements
Note 1. Basis of Presentation and Use of Estimates
The accompanying unaudited financial statements have been prepared in accordance
with accounting principles generally accepted in the United States for interim
financial information and with instructions to Form 10-Q and Regulation S-X of
the Securities and Exchange Commission. Accordingly, they do not contain all of
the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. However, in the
opinion of management, all adjustments considered necessary for a fair
presentation have been included. Operating results for the three months ended
March 31,2006 are not necessarily indicative of the results that may be expected
for the year ended December 31, 2006. For further information, please refer to
the financial statements and footnotes thereto for the Corporation's fiscal year
ended December 31, 2005, contained in the Corporation's 2005 Annual Report on
Form 10-KSB.
The consolidated financial statements include the accounts of the Corporation
and its wholly-owned subsidiary, the Bank. All significant intercompany balances
and transactions have been eliminated in consolidation.
Use of Estimates - The preparation of the consolidated financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect
reported amounts of assets and liabilities and disclosure of contingent
liabilities at the date of the financial statements, as well as the amounts of
income and expenses during the reporting period. Actual results could differ
from those estimates.
Note 2. Accounting for Stock-Based Compensation
The Company implemented SFAS No. 123(R),Share-Based Payment, on January 1, 2006.
However, actions by the board of directors whereby the vesting of all unvested
stock options was accelerated to December 30, 2005, avoided recognition of pre-
tax compensation expense by the Company related to the adoption of SFAS 123 (R).
As a result, the adoption of SFAS No. 123 (R) had no impact on the financial
position or results of operations of the Company.
The schedule below reflects pro forma information had the Company accounted for
stock options in 2005 using the fair value method under SFAS No.123.
(Dollar amounts in thousands, except per share amounts) Three Months
ended
March 31,
2005
----
Net income: As reported ........................................ $ 874
Deduct: Total stock-based compensation cost
determined under the fair value
method net of tax ................................. 38
-------
Pro forma ...................................................... $ 836
-------
Basic earnings per share:
As reported ....................................... $ 0.52
Pro forma ......................................... $ 0.50
Diluted earnings per share
As reported ........................................ $ 0.49
Pro forma ........................................... $ 0.47
In 2005 the fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions used for the three-month periods ended March 31, 2005; a dividend
yield of 0%, expected volatility of 50%, risk-free interest rate of 4.33%, and
expected lives of 10 years for the options.
7
FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
Note 3 - Earnings per Share
Earnings per share has been determined under the provisions of statement of
Financial Accounting Standards No. 128, Earnings Per Share. For the quarters
ended March 31, 2006 and 2005, basic earnings per share has been computed based
upon the weighted average common shares outstanding of 1,750,444 and 1,682,490,
respectively.
The only potential stock of the Company as defined in Statement of Financial
Accounting Standards No. 128, Earnings Per Share, is stock options granted to
various officers and employees of the Bank. The following is a summary of the
diluted earnings per share calculation for the three months ended March 31, 2006
and 2005 (Dollars in thousands, except share and per share data):
Three Months Ended
March 31,
---------
2006 2005
---- ----
Net Income ................................... $ 1,214 $ 874
Weighted average outstanding shares .......... 1,750,444 1,682,490
Dilutive effect of stock options ............. 50,958 109,948
---------- ----------
Weighted average diluted shares .............. 1,801,402 1,792,438
Diluted earnings per share ................... $ 0.67 $ 0.49
Note 4 - Impact of Recently Issued Accounting Standards
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid
Financial Instruments, an amendment of FASB Statements No. 133 and 140. This
Statement amends SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, and SFAS No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities, and resolves issues in
Statement No. 133 Implementation Issue No. D1, Application of Statement 133 to
Beneficial Interests in Securitized Financial Assets. The provisions of this
statement are effective for all financial instruments acquired or issued after
the beginning of an entity's first fiscal year that begins after September 15,
2006. The adoption of SFAS No. 155 is not expected to have a material impact on
the consolidated financial statements of the Company.
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of
Financial Assets, an amendment of FASB Statement No. 140. This statement amends
SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities, a replacement of FASB Statement 125 with respect
to the accounting for separately recognized servicing assets and servicing
liabilities. The provisions of this statement are effective for fiscal years
beginning after September 15, 2006. The adoption of SFAS No. 156 is not expected
to have a material impact on the consolidated financial statements of the
Company.
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.
8
FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
Forward Looking Statements
Statements included in this Form 10-Q which are not historical in
nature are intended to be, and are hereby identified as "forward-looking
statements" for purposes of the safe harbor provided by Section 21E of the
Securities and Exchange Act of 1934, as amended. Words such as "estimate",
"project", "intend", "expect", "believe", "anticipate", "plan", and similar
expressions identify forward looking statements. The Company cautions readers
that forward looking statements, including without limitation, those relating to
the Company's new offices, future business prospects, revenues, working capital,
liquidity, capital needs, adequacy of allowance for loan losses, interest costs,
and income, are subject to certain risks and uncertainties that could cause
actual results to differ from those indicated in forward looking statements, due
to several important factors herein identified, among others, and other risks
and factors identified from time to time in the Company's reports filed with the
Securities and Exchange Commission. 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 the Company's 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 the Company is
a relatively new company with limited operating history. Therefore, actual
results may differ from those expressed or forecasted in such forward-looking
statements. The risks and uncertainties include, but are not limited to:
o The Company's growth and ability to maintain growth;
o government 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 the Company's market areas and elsewhere, including institutions
operating locally, regionally, nationally and internationally;
o failure of assumptions underlying the establishment of the allowance
for loan losses, including the value of collateral securing loans; and
o loss of consumer confidence and economic disruptions resulting from
terrorist activities.
The Company undertakes 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.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This discussion is intended to assist in understanding the financial
condition and results of operations of the Company, and should be read in
conjunction with the financial statements and related notes contained elsewhere
herein and in the Company's 2005 annual report on Form 10-KSB. Because the Bank
is responsible for all of the Company's operations, the discussion will refer to
the results of operations of the Bank.
9
RESULTS OF OPERATIONS: THREE MONTH PERIOD ENDED MARCH 31, 2006 COMPARED TO THE
SAME PERIOD ENDED MARCH 31, 2005.
Net Income For the first three months of 2006, First South Bancorp, Inc. earned
a net income of approximately $1.214 million, or $ .65 per diluted share,
compared to approximately $874 thousand, or $ .49 per diluted share, for the
same period in 2005. Earnings per share increased by 32.6%. The 38.9% increase
in net income is attributed to several factors including a 29.5% increase in net
interest income from $2.9 million during the first three months in 2005 to $3.8
million during the same period in 2006. The provision for loan losses increased
from $287 thousand in the first quarter of 2005 to $315 thousand during the same
period in 2006. Noninterest income declined 24.4% from $217 thousand in 2005 to
$164 thousand during the first three months of 2006. Most of the $53 thousand
decline resulted from a $21 thousand decline in loan brokerage fees and a $19
thousand decline in investment brokerage service fees. Noninterest expense
experienced a 17.5% increase from $1.5 million in the first quarter of 2005 to
$1.8 million in the same period in 2006. This increase was primarily attributed
to the increase in salaries and benefits expense of $170 thousand from the first
quarter of 2005. With the total number of full-time equivalent employees
remaining approximately the same in 2006 as 2005, 61 versus 59, respectively,
the increased personnel expense is primarily attributable to higher salaries and
benefits paid to existing 2005 to 2006 employees during the first quarter of
2006. Profitability Earnings of financial institutions are most commonly
measured through ROAA (return on average assets) and ROAE (return on average
equity). Return on average assets is the income for the period, annualized,
divided by the average assets for the period. Return on average equity is the
income for the period, annualized, divided by the average equity for the period.
As is shown in Table One, ROAA and ROAE for the first quarter of 2006 was 1.45%
and 15.49%, respectively.
Table One
Selected Earnings Ratios
at or for the Quarter Ending
March 31,
---------
2006 2005
---- ----
Return on Average Assets ....................... 1.45% 1.15%
Return on Average Equity ....................... 15.49% 12.75%
Dividend Payout Ratio .......................... N/A N/A
Average Shareholders' Equity
as a Percentage of Average
Assets ......................................... 9.34% 8.99%
Performance results as measured by ROAA and ROAE can be primarily attributed to
changes in the volume and composition of earning assets and the interest rate
environment. Details of these changes are provided in the following discussion
of net interest income.
Net Interest Income
Net interest income, the major component of First South Bancorp's income, is the
amount by which interest and fees on earning assets exceeds the interest paid on
interest-bearing liabilities, primarily deposits. Net interest income for the
first three months of 2006 increased over that of the same period in 2005 by
$870 thousand, or 29.5%. This increase was almost exclusively the result of an
economic environment in which interest rates were rising and the Company's
earning assets repriced higher and more rapidly than interest-bearing
liabilities.
Though total average interest-bearing liabilities experienced a larger increase
than average interest-earning assets from March 31, 2005, to March 31, 2006,
$34.8 million versus $33.7 million, respectively, the yield on earning assets
over the twelve months grew faster than the funding cost of interest-bearing
liabilities. The yield on earning assets for the first quarter of 2006, as
compared to the same period in 2005, increased by 173 basis points, while the
increase in the funding cost of interest-bearing liabilities from the first
quarter of 2005 to that of 2006 increased by 116 basis points. The net result of
the volume and rate changes between the two first quarter periods was an
improvement of 57 basis points in the interest spread for the first quarter of
2006.
Table Two includes a detailed comparison of the average balances, yields and
rates for the interest sensitive segments of the Company's balance sheets for
the three months ended March 31, 2006 and 2005.
10
Table Two Net Interest Income and Average Balance Analysis
for the Three Months Ended March 31,
2006 and 2005
(Amounts in thousands)
Interest Average
Average Balance Income/Expense Yield/Cost
--------------- -------------- ----------
Interest-Earning Assets 2006 2005 2006 2005 2006 2005
---- ---- ---- ---- ---- ----
Int. Bearing Due from Banks ........................ $ 11,752 $ 13,819 $ 127 $ 83 4.38% 2.44%
Investments ........................................ 32,706 21,680 356 202 4.41% 3.78%
Loans .............................................. 281,887 257,106 6,126 4,390 8.81% 6.92%
--------- --------- --------- ---------
Total Interest Earning Assets ...................... 326,345 292,605 6,609 4,675 8.21% 6.48%
Noninterest-Earning Assets
Cash & Due From Banks .............................. 6,391 5,328
Allowance for Loan Losses .......................... (3,102) (3,034)
Investments: Fair Value ............................ (282) (72)
Premises & Equipment ............................... 5,338 5,269
Investment in unconsolidated subsidiary ............ 155 155
Interest Receivable & Other ........................ 5,618 4,520
--------- --------
Total Noninterest-Earning Assets ................... 14,118 12,166
--------- --------
TOTAL ASSETS ....................................... $ 340,463 $ 304,771
--------- ---------
Interest-Bearing Liabilities
NOW Accounts ....................................... $ 33,745 $ 35,697 $ 278 $ 201 3.34% 2.28%
Money Market & Savings ............................. 46,717 52,480 444 293 3.85% 2.26%
Time Deposits & IRAs ............................... 189,929 146,881 1,826 1,032 3.90% 2.85%
Fed funds and Purchased and Repos .................. 4,147 4,816 39 24 3.81% 2.02%
Other Borrowed Funds ............................... 10,111 10,000 113 111 4.53% 4.50%
Subordinated Debt .................................. 5,000 5,000 93 68 7.54% 5.52%
Demand Notes Issued to Treasury .................... 164 189 1 1 2.47% 2.15%
--------- --------- ------- ---------
Total Interest-Bearing Liabilities ................. 289,813 255,063 2,794 1,730 3.91% 2.75%
Noninterest-Bearing Liabilities
Demand Deposits .................................... 15,705 19,945
Interest Payable ................................... 1,001 643
Other Liabilities .................................. 1,898 1,703
--------- --------
Total Noninterest-Bearing Liabilities .............. 18,604 22,291
Stockholders' Equity ............................... 32,046 27,417
--------- ---------
TOTAL LIABILITIES & EQUITY ......................... $ 340,463 $ 304,771
--------- ---------
Net Interest Income ................................ $ 3,815 $ 2,945
--------- ---------
Net Yield on Earning Assets ...................... 4.74% 4.08%
Interest Rate Spread ............................. 4.30% 3.73%
11
Noninterest Income
Noninterest income for the first three months of 2006 declined from $217
thousand during the first three months in 2005 to $164 thousand in 2006, a 24.4%
decrease. Service charges decreased by $8 thousand from $71 thousand during the
first quarter of 2005 to $63 thousand during the same period in 2006. This
decrease resulted primarily from the increase in 2006 of the earnings allowance
interest rate which resulted in a larger credit against business account service
charges determined through full account analysis. The largest dollar decline in
any of the three categories of noninterest income was experienced in the area of
commissions and fees. The $38 thousand decline in total commissions and fees in
2006 was most directly related to the $40.8 thousand decline from the first
quarter's 2005 total brokerage services income of $94.4 thousand.
Table Three provides a three month 2006 to 2005 comparison of various categories
of noninterest income.
Table Three Summary of Total Noninterest Income
for theThree Months Ended March 31
2006 and 2005
(Amounts in thousands)
2006 2005
---- ----
Service Charges .............................. $ 63 $ 71
Commissions & Fees ........................... 90 128
Other Noninterest
Income ....................................... 11 18
---- ----
Total ........................................ $164 $217
Noninterest Expense
Noninterest expense for the first three months of 2006 increased by $263
thousand, or 17.5%, over the first three months of the 2005 total of $1.5
million. The increase in salaries and employee benefits was the primary reason
for the overall increase in noninterest expense as this particular expense grew
from $929 thousand during the first quarter of 2005 to $1.099 million during the
same period in 2006, a $170 thousand or 18.3% increase. This increase resulted
primarily from increases in salaries and benefits for existing employees and to
a lesser extent, the increase in full time equivalent employees from 59 as of
March 31, 2005 to 61 as of March 31, 2006. Table Four provides a three month
2006 to 2005 comparison of various categories of noninterest expense.
Table Four Summary of Total Noninterest Expense
For the Three Months Ended March 31
2006 and 2005
(Amounts in thousands)
2006 2005
---- ----
Salaries & Employee Benefits .............. $1,099 $ 929
Occupancy & Equipment ..................... 208 202
Other expense ............................. 458 371
------ ------
Total ..................................... $1,765 $1,502
12
Income Taxes
Provision for income taxes for the three months ended March 31, 2006 was $685
thousand as compared to $499 thousand in 2005 during the same period, a 37.3%
increase. This increase was due to the overall increase in income before taxes
of $526 thousand or 38.3% during the same period.
CHANGES IN FINANCIAL POSITION
Investment portfolio
During the first three months of 2006, five government agency issues for a total
of $4,500,000 were purchased. The average annual yield on these purchased
investments is 5.36 %. During the same period, one agency issue in the amount of
$2,000,000 with an annual yield of 3.04% matured.
Table Five Analysis of Investment Securities
(Amounts in thousands)
December 31 ,2005 Available-for-Sale Held-for-Investment
------------------ -------------------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
---- ---------- ---- ----------
Due in one year or less ............................ $ 9,000 $ 8,938 $ - $ -
Due from one to five years ......................... 10,491 10,327 4,000 3,990
Due from five to 10 years
Due after ten years ................................ 1,123 1,105 481 634
Mortgage backed securities ......................... 766 742 783 795
------- ------- ------- -------
$22,380 $22,097 $ 7,264 $ 7,427
------- ------- ------- -------
March 31, 2006 Available-for-Sale Held-for-Investment
------------------ -------------------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
---- ---------- ---- ----------
Due in one year or less ............................ $ 7,000 $ 6,954 $ - $ -
Due from one to five years ......................... 11,491 11,286 4,000 3,955
Due from five to 10 years
Due after ten years ................................ 1,123 1,093 481 641
Mortgage backed securities ......................... 715 692 667 676
------- ------- ------- -------
$24,829 $24,482 $ 7,148 $ 7,260
------- ------- ------- -------
Excludes equity securities with no readily determinable market value of $1.269
million on December 31, 2005 and $1.101 million on March 31, 2006.
13
Loan portfolio
From December 31, 2005 to March 31, 2006 total loans grew from $268.5 million to
$288.3 million, or 7.4%. For the twelve month period between March 31, 2005 and
March 31, 2006, loans increased by $28.3 million, or 10.9%. The percentage
composition of the loan portfolio, as shown in Table Six, changed slightly as
the percentage of real estate loans grew by 1.3% of the total portfolio from
81.8% on March 31, 2005 to 83.1% on March 31, 2006. Commercial and industrial
loans decreased by 1.24% as a percentage of the loan portfolio from 17.98% on
March 31, 2005 to 16.74% as of March 31 ,2006.
As shown in Table Seven, Variable Rate Loans comprised 87.7% of the total loan
portfolio. On March 31, 2006, there were thirteen loans totaling $2.2 million on
non-accrual status.
Table Six Analysis of Loans
March 31 Balances
(Amounts in thousands)
Real Estate: 2006 2005
---- ----
Construction/Land Development ......................... $ 15,909 5.52% $ 18,394 7.07%
1-4 Family Residential Properties ..................... 68,982 23.92% 66,695 25.65%
Multifamily Residential Properties .................... 6,978 2.42% 4,081 1.57%
Nonfarm Nonresidential Properties ..................... 144,630 50.16% 122,502 47.10%
Other Real Estate Loans ............................... 3,230 1.12% 1,185 0.46%
Commercial & Industrial .................................. 48,279 16.74% 46,754 17.98%
Consumer .............................................. 361 0.12% 435 0.17%
-------- ----- -------- -----
Total ............................................. $288,342 100.0% $260,046 100.0%
-------- ----- -------- -----
Table Seven Analysis of Loan Maturities and Repricing Frequency
as of March 31, 2006
(Amounts in thousands)
Within >3 Months >1 Year >3 Years Over
3 Months 12 Months 3 Years 5 Years 5 Years Total
-------- --------- ------- ------- ------- -----
Variable Rate Loans ........................................ $250,945 $ - $ - $ - $ - $250,945
Fixed Rate Loans ........................................... $ 7,255 $6,815 $9,553 $9,998 $1,576 $ 35,197
-------- ------ ------ ------ ------ --------
Total Loans ................................................ $258,200 $6,815 $9,553 $9,998 $1,576 $286,142
-------- ------ ------ ------ ------ --------
Excludes loans on non-accrural status of $2.2 million
14
The allowance for loan losses is analyzed monthly in accordance with a board
approved plan. This judgmental analysis is based upon a model that assigns a
risk rating on each individual loan and considers the loss risks associated with
various risk categories in relationship to the current and forecasted economic
environment. Management also monitors the overall portfolio, as well as the
level of reserves maintained by peer banks. The monthly provision for loan
losses may fluctuate based on the results of this analysis. The increase of
$28,000 in loan loss provision for the quarter end March 31, 2006, as compared
to the same quarter in 2005, was primarily due to the bank's formula for
calculating the allowance for loan losses based on loan grades and the growth
the bank experienced. Table Eight provides the results of the year-to-date
analysis for the quarters ending March 31, 2006 and 2005, as well as the amounts
charged to this reserve as a loss and credited to this reserve as a recovery.
Table Eight Analysis of the Allowance for Loan Losses
for the Three Months Ended March 31
2006 2005
---- ----
Balance at Beginning of Year ......... $3,000,000 $2,900,000
Provision Charged to Operations ...... 315,000 287,000
Loans Charged-Off .................... 0 (39,000)
Loan Recoveries ...................... 10,000 2,000
---------- ----------
Balance at End Of Period ............. $3,325,000 $3,150,000
Interest rate risk
Financial institutions are subject to interest rate risk to the degree that
their interest bearing liabilities (consisting principally of customer deposits)
mature or reprice more or less frequently, or on a different basis, than their
interest earning assets (generally consisting of intermediate or long-term loans
and investment securities). The match between the scheduled repricing and
maturities of the Bank's earning assets and interest bearing liabilities within
defined time periods is referred to as "gap" analysis. The Bank's
Asset/Liability Management Committee is responsible for managing the risks
associated with changing interest rates and their impact on earnings. The
regular evaluation of the sensitivity of net interest income to changes in
interest rates is an integral part of interest rate risk management. At March
31, 2006, the cumulative one-year gap for the Bank was a positive, or asset
sensitive, $22.8 million. At March 31, 2006, the cumulative five-year gap for
the Bank was a positive $34.7 million. A positive gap means that assets would
reprice faster than liabilities if interest rates changed. The Bank's gap is
within policy limits which were established to reduce the adverse impact on
earnings which movements in interest rates can cause. Intense competition in the
Bank's markets continues to pressure quality loan rates downward while
conversely pressuring deposit rates upward. Table Nine demonstrates how the
relationship between interest-bearing assets and interest-bearing liabilities
was calculated for March 31, 2006.
15
Table Nine Distribution of Interest-Earning Assets and Interest-Bearing Liabilities
Repricing Schedule as of March 31, 2006
(Amounts in thousands)
One Year Over One Year Over
or Less to Five Years Five Years Total
------- ------------- ---------- -----
Interest Earning Assets
Due From Banks ............................ $ 17,567 $ - $ - $ 17,567
Investment Securities* .................... 7,667 16,207 8,104 31,978
FHLB Stock ................................ 1,100 - - 1,100
Loans** ................................... 265,015 19,551 1,576 286,142
-------- ------- ------- --------
Total ..................................... $291,349 $35,758 $ 9,680 $336,787
*Amortized Cost
**Excludes $2.2 million in loans on non-accrural status.
Interest Bearing
Liabilities
NOW Accounts .............................. $ 34,203 $ - $ - $ 34,203
Savings & MMIA ............................ 49,605 - - 49,605
Time Deposits:$100 & > .................... 59,945 8,331 - 68,276
Time Deposits: <$100m ..................... 115,020 15,538 - 130,558
Repurchase Agreements ..................... 4,524 - - 4,524
Other Borrowed Funds ...................... 5,210 - 10,000 15,210
-------- ------- ------- --------
Total ..................................... $268,507 $23,869 $10,000 $302,376
Period Gap ................................ $ 22,842 $11,889 $ (320) $ 34,411
Cumulative Gap ............................ $ 22,842 $34,731 $34,411
Period Gap Ratios:
Interest Sensitive
Assets to
Interest Sensitive Liabilities .......... 108.5% 149.8% .9%
Cumulative Gap Ratios:
Interest Sensitive
Assets to
Interest Sensitive Liabilities .......... 108.5% 111.9% 111.4%
3 Months Over 3 Months Over One
Time Deposits & Less to 12 Months Year Total
------ ------------ ---- -----
$100,000 and Greater ...................... $20,323 $39,622 $8,331 $68,276
16
Liquidity
Liquidity is the ability to meet current and future obligations through
liquidation or the maturity of existing assets or the acquisition of additional
liabilities. Adequate liquidity is necessary to meet the requirements of
customers for loans and deposit withdrawals in the most timely and economical
manner. Some liquidity is ensured by maintaining assets which may be immediately
converted into cash at minimal cost (amounts due from banks and federal funds
sold). However, the most manageable sources of liquidity are composed of
liabilities, with the primary focus on liquidity management being the ability to
obtain deposits within the Bank's service area. Core deposits (total deposits
less wholesale time deposits) provide a relatively stable funding base, and were
equal to 61% of total assets at March 31, 2006. Asset liquidity is provided from
several sources, including amounts due from banks and federal funds sold, and
funds from maturing loans. The Bank is a member of the FHLB of Atlanta and, as
such, has the ability to increase its borrowings from that institution. The bank
also has $12 million available through lines of credit with other banks as an
additional source of liquidity funding. Management believes that the Bank's
overall liquidity sources are adequate to meet its operating needs.
Capital Resources
The $4.543 million increase in Tier 1 capital for the Company during the twelve
month period between March 31, 2005 and 2006 resulted from a $3.759 million
increase in retained earnings and the exercising of stock options in the amount
of $783.8 thousand. The difference in total risk based capital of $1.325 million
between the Bank and the Holding Company as of March 31, 2006 is due to the
Board's intent to keep at this time that amount of capital at the Holding
Company level.
The Company and the Bank are subject to regulatory capital adequacy standards.
Under these standards, financial institutions are required to maintain certain
minimum capital ratios of capital to risk-weighted assets and average total
assets. Under the provisions of the Federal Deposit Insurance Corporation
Improvement Act of 1991, federal financial institutions regulatory authorities
are required to implement prescribed "prompt corrective action" upon the
deterioration of the capital position of a bank. If the capital position of an
affected institution were to fall below certain levels, increasingly stringent
regulatory corrective actions are mandated. At March 31, 2005 the Company and
the Bank met all of the requirements to be well capitalized.
Off-Balance Sheet Arrangements
The Company, through the operations of the Bank, makes contractual commitments
to extend credit in the ordinary course of its business activities. These
commitments are legally binding agreements to lend money to customers of the
Bank at predetermined interest rates for a specific period of time. At March 31,
2006, the Bank had issued commitments to extend credit of $43.1 million through
various types of lending arrangements. Of these commitments, 81.9 %, or $35.3
million, expire within one year, and 18.1 %, or $7.8 million, expiring in more
than one year. Past experience indicates that many of theses commitments to
extend credit will expire unused.
The Company evaluates each customer's creditworthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary by the Company upon the
extension of credit, is based on the credit evaluation of the borrower.
Collateral varies, but may include accounts receivable, inventory, property,
plant and equipment, commercial and residential real estate.
17
The Bank's and Company's March 31, 2006 capital ratios are presented in the
following table, compared with the "well capitalized" and minimum ratios under
the FDIC regulatory definitions and guidelines:
The Bank To Be Well
(Dollar Amounts in Thousands) Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------ ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
March 31, 2006
Total Capital
(To Risk Weighted Assets) ...... $39,203 13.50% $23,233 >8.0% $29,041 >10.0%
Tier I Capital
(To Risk Weighted Assets) ...... $30,978 10.67% $10,324 >4.0% $17,425 >6.0%
Tier I Capital
(To Average Assets) ............ $30,978 9.10% $13,609 >4.0% $17,012 >5.0%
The Holding Company To Be Well
Capitalized Under
(Dollar Amounts in Thousands) For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------ ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
March 31, 2006
Total Capital
(To Risk Weighted Assets) ...... $40,528 13.96% $23,233 >8.0% $29,041 >10.0%
Tier I Capital
(To Risk Weighted Assets) ...... $32,303 11.12% $10,324 >4.0% $17,425 >6.0%
Tier I Capital
(To Average Assets) ............ $32,660 9.49% $13,610 >4.0% $17,012 >5.0%
18
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The Company's exposure to market risk is primarily related to the risk of loss
from adverse changes in market prices and rates. This risk arises principally
from interest rate risk inherent in the Company's lending, deposit gathering and
borrowing activities. Management actively monitors and manages its interest rate
risk exposure. Although the Company manages other risks, such as credit quality
and liquidity risk in the normal course of business, management considers
interest rate risk to be its most significant market risk, and this risk could
potentially have the largest material effect on the Company's financial
condition and results of operations. Other types of market risk, such as
commodity price risk and foreign currency exchange risk, do not arise in the
normal course of the Company's community banking operations.
The Company periodically uses a simulation model to assist in the management of
interest rate risk. As of March 31, 2006, the model indicates that net interest
income would increase approximately $1.4 million in the next twelve months if
interest rates rose 100 basis points. Conversely, net interest income would
decrease approximately $950 thousand in the next twelve months if interest rates
declined 100 basis points. Since the model incorporates the use of estimated
changes in growth and mix of both earning assets and interest-bearing
liabilities over established time periods, as well as projected changes in
interest rates, the resulting "What-if" scenarios are heavily dependant on
accurate forecasts and can not be relied on as indicative of actual future
results.
As of March 31, 2006, there was no significant change from the interest
sensitivity analysis performed and disclosed in the 2005 Annual Report on Form
10-KSB filed with the Securities and Exchange Commission.
Item 4 - 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.
19
PART II - OTHER INFORMATION
Item 6 - Exhibits
Exhibit No. Description
31.1 13a-14(a)/15d-14(a) Certifications of Chief Executive Officer
31.2 13a-14(a)/15d-14(a) Certifications of Chief Financial Officer
32 Section 1350 Certifications
20
SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
First South Bancorp, Inc.
s/Barry L. Slider
May 12, 2006 ---------------------------------------------
Barry L. Slider, President and CEO
s/V. Lewis Shuler
---------------------------------------------
V. Lewis Shuler, Executive Vice President
(Principal Accounting Officer)
21
Exhibit Index
Exhibit No. Description
31.1 13a-14(a)/15d-14(a) Certifications of Chief Executive Officer
31.2 13a-14(a)/15d-14(a) Certifications of Chief Financial Officer
32 Section 1350 Certifications
22