UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR
15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED September 30, 2006
Commission File Number
000-28037
FIRST SOUTH BANCORP, INC.
(Exact Name of Small Business Issuer)
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
(Issuer's Telephone Number)
Indicate by check mark whether the issuer (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
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 { } No {X}
Indicate the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practical date: Common Stock, no par value,
2,133,476 shares outstanding on November 8, 2006.
FIRST SOUTH BANCORP, INC.
FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION Page
Item 1. Financial Statements
Balance Sheets .............................................. 3
Statements of Operations .................................... 4
Statements of Comprehensive Income .......................... 5
Statements of Cash Flows .................................... 6
Statements of Changes in Shareholders' Equity ............... 7
Notes to Unaudited Financial Statements ..................... 8-10
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operation ...................................11-20
Item 3. Quantitative and Qualitative Disclosures About
Market Risk ............................................... 21
Item 4. Controls and Procedures...................................... 22
Part II - OTHER INFORMATION .................................... 23
Item 6. Exhibits
SIGNATURES ............................................................. 24
2
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
FIRST SOUTH BANCORP, INC AND
SUBSIDIARY
Consolidated Balance Sheets
(Dollar amounts in thousands)
(Unaudited)
Sep. 30, Dec. 31,
2006 2005
---- ----
Assets
Cash & due from banks ............................................................ $ 2,320 $ 5,022
Due from banks - interest bearing ................................................ 15,338 13,510
Investment securities:
Securities held to maturity .................................................. 9,954 7,264
Securities available for sale ................................................ 24,522 22,097
Federal Home Loan Bank Stock ..................................................... 740 1,269
Loans ............................................................................ 287,275 268,033
Less, allowance for loan losses ............................................ (3,290) (3,000)
--------- ---------
Loans - net ...................................................................... 283,985 265,033
Property & equipment, net ........................................................ 5,356 5,289
Investment in FSBS Capital Trust ................................................. 155 155
Other assets ..................................................................... 5,266 5,093
--------- ---------
Total assets ..................................................................... $ 347,636 $ 324,732
========= =========
Liabilities
Deposits:
Noninterest-bearing ........................................................ $ 15,280 $ 13,821
Interest-bearing ........................................................... 287,027 251,904
--------- ---------
Total deposits ............................................................... 302,307 265,725
Securities sold under repurchase agreements ...................................... 3,346 5,740
Other borrowed funds ............................................................. - 15,000
Demand notes issued to the U.S. Treasury ......................................... 412 298
Subordinated debt ................................................................ 5,155 5,155
Other liabilities ................................................................ 1,615 1,943
--------- ---------
Total liabilities ............................................................ 312,835 293,861
Shareholders' equity
Common stock - no par value; 36,000,000 authorized,
Outstanding 2,129,276 and 2,103,987 respectively
Paid-in capital .................................................................. 19,601 19,422
Retained Earnings ................................................................ 15,341 11,624
Accumulated other comprehensive loss ............................................. (141) (175)
--------- ---------
Total shareholders' equity ....................................................... 34,801 30,871
--------- ---------
Total liabilities and shareholders' equity ....................................... $ 347,636 $ 324,732
========= =========
See Notes to accompanying financial statements.
3
FIRST SOUTH BANCORP, INC AND SUBSIDIARY
Statements of Operations
(Unaudited)
Period ended September 30,
--------------------------
Three Months Nine Months
------------ -----------
2006 2005 2006 2005
---- ---- ---- ----
(Dollars in thousands, except per share)
Interest income
Loans, including fees ...................... $ 6,542 $ 4,953 $ 19,014 $ 14,012
Investment securities ...................... 419 231 1,172 653
Interest bearing deposits .................. 120 133 418 321
----------- ----------- ----------- -----------
Total interest income ...................... 7,081 5,317 20,604 14,986
Interest expense
Deposits and borrowings .................... 3,490 2,069 9,494 5,742
----------- ----------- ----------- -----------
Net interest income ....................................... 3,591 3,248 11,110 9,244
Provision for loan losses .................. 29 (5) 571 418
----------- ----------- ----------- -----------
Net interest income after provision ....................... 3,562 3,253 10,539 8,826
Noninterest income
Service charges on deposit accounts ........ 75 67 210 222
Other income ............................... 247 105 822 388
----------- ----------- ----------- -----------
Total noninterest income ................... 322 172 1,032 610
Noninterest expense
Salaries and benefits ...................... 1,250 958 3,580 2,807
Occupancy and equipment .................... 250 171 690 552
Other expense .............................. 490 374 1,489 1,146
Litigation Settlement ...................... - - - 1,677
----------- ----------- ----------- -----------
Total noninterest expense .................. 1,990 1,503 5,759 6,182
----------- ----------- ----------- -----------
Income before income taxes ................................ 1,894 1,922 5,812 3,254
Provision for income taxes ................. 682 677 2,096 1,149
----------- ----------- ----------- -----------
Net income ................................................ $ 1,212 $ 1,245 $ 3,716 $ 2,105
=========== =========== =========== ===========
Basic per share earnings .................................. $ 0.57 $ 0.62 $ 1.76 $ 1.02
Diluted earnings per share ................................ $ 0.56 $ 0.60 $ 1.71 $ 0.98
Weighted Average Shares Outstanding:
Basic ...................................... 2,123,973 2,018,988 2,115,103 2,061,902
Diluted .................................... 2,173,792 2,089,303 2,174,218 2,141,857
All share amounts reflect the 6 for 5 stock split distributed on May 5, 2006
See Notes to accompanying financial statements.
4
FIRST SOUTH BANCORP, INC AND SUBSIDIARY
Consolidated Statements of Comprehensive Income
(Dollars in Thousands)
(Unaudited) (Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2006 2005 2006 2005
---- ---- ---- ----
Net Income ..................................................... $ 1,212 $ 1,245 $ 3,716 $ 2,105
Other comprehensive income:
Change in unrealized holdings gains &
losses on available for sale securities .................... 281 (44) 55 (120)
Income tax benefit (expense) on other
comprehensive income (loss) ................... (107) 17 (21) 45
------- ------- ------- -------
Total other comprehensive income (loss) ........................ 174 (27) 34 (75)
------- ------- ------- -------
Comprehensive income ........................................... $ 1,386 $ 1,218 $ 3,750 $ 2,030
See Notes to accompanying financial statements.
5
FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended
September 30,
-------------
2006 2005
---- ----
(amounts in thousands)
Operating Activities
Net income ............................................................................... $ 3,716 $ 2,105
Adjustments to reconcile net income to net cash
provided by operating activities
Provision for loan losses .................................................. 571 418
Gain on called Security .................................................... - (8)
Depreciation ............................................................... 314 281
Amortization ............................................................... 10 15
Deferred Tax Provision ..................................................... 18 230
Increase in other assets ................................................... (562) (1,144)
Decrease in accrued expenses and other liabilities ......................... (193) (587)
-------- --------
Net cash provided by operating activities ................................................ 3,874 1,310
-------- --------
Investing Activities
Purchase of securities ..................................................... (11,498) (7,992)
Sale(Purchase) of restricted FHLB stock .................................... 528 (90)
Proceeds from MBS principal paydowns ....................................... 441 718
Proceeds from called securities ........................................... 6,000 4,375
Origination of loans, net of principal collected ........................... (19,248) (3,664)
Purchase of other real estate owned ........................................ (86) -
Purchase of premises and equipment ......................................... (378) (342)
-------- --------
Net cash used in investing activities .................................................... (24,241) (6,995)
-------- --------
Financing Activities
Net increase in deposits ................................................... 36,592 14,591
Net decrease in retail repurchase agreements ............................... (2,394) (1,117)
Proceeds from exercise of stock options .................................... 180 755
Net increase (decrease) in other borrowings ................................ (14,886) 37
-------- --------
Net cash provided by financing activities ................................................ 19,492 14,266
-------- --------
Net increase(decrease) in cash and cash equivalents ...................................... (875) 8,581
Cash and cash equivalents, beginning ..................................................... 18,532 13,292
-------- --------
Cash and cash equivalents, ending ........................................................ $ 17,657 $ 21,873
======== ========
See Notes to accompanying financial statements.
6
FIRST SOUTH BANCORP INC., AND SUBISIDIARY
Statements of Changes in Shareholders' Equity
Year-ended December 31, 2005 and Nine Months Ended September 30, 2006
(Unaudited)
(dollars in thousands, except per share)
ACCUMULATED
SHARES OF OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE SHAREHOLDERS'
STOCK CAPITAL EARNINGS INCOME/(LOSS) EQUITY
----- ------- -------- ------------- ------
Balance at December 31, 2004 ............... 1,682,490 $ 18,637,856 $ 8,224,862 $ (18,861) $ 26,843,857
Net income ................................. 3,400,004 3,400,004
Exercised Stock Options .................... 67,954 783,778 783,778
Net change in
unrealized gain on
available for sale
securities, net of tax ..................... (156,434) (156,434)
------------ ------------ ------------ ------------ ------------
Balance at December 31, 2005 ............... 1,750,444 19,421,634 11,624,866 (175,295) 30,871,205
Six for five(6 for 5) Common Stock Split ... 353,543
------------ ------------ ------------ ------------ ------------
Beginning Balance January 1, 2006 .......... 2,103,987 19,421,634 11,624,866 (175,295) 30,871,205
Net income ................................. 3,715,727 3,715,727
Exercised Stock Options .................... 25,289 179,505 179,505
Net change in
unrealized gain on
available for sale
securities, net of tax ..................... 34,249 34,249
------------ ------------ ------------ ------------ ------------
Balance at September 30, 2006 .............. 2,129,276 $ 19,601,139 $ 15,340,593 $ (141,046) $ 34,800,686
========= ============ ============ ============ ============
7
FIRST SOUTH BANCORP, INC. AND SUBSIDIARY
Notes to Unaudited Financial Statements
Note 1 - Basis of Presentation
The accompanying unaudited financial statements have been prepared in accordance
with generally accepted accounting principles 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 notes required by generally accepted accounting principles
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 nine months ended September 30, 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 notes thereto for the Company's fiscal year ended December 31,
2005, contained in the Company's annual report on Form 10-KSB.
The consolidated financial statements include the accounts of the Company 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.
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) has no impact on the financial
presentation of results of operations of the Company.
Prior to the adoption of FAS 123(R), the Company accounted for stock options in
accordance with APB Opinion No. 25, and accordingly, no compensation expense was
recorded for stock options. 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)
Nine Months ended
September 30,
-------------
2005
----
Net income: As reported .............................. $ 2,105
Deduct: Total stock-based compensation cost
determined under the fair value
method net of tax ....................... 76
---------
Pro forma ............................................ $ 2,029
=========
Basic earnings per share:
As reported ............................. $ 1.02
Pro forma ............................... $ .98
Diluted earnings per share
As reported .............................. $ .98
Pro forma ................................ $ .95
8
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions used for the nine-month periods ended September 30, 2005; dividend
yield of 0%, expected volatility of 50%, risk-free interest rates of 4.33% for
2005 and expected lives of 10 years for the options.
Note 2 - Earnings per Share
Earnings per share has been determined under the provisions of
Statement of Financial Accounting Standards No. 128, Earnings Per Share, which
requires the Company to present basic and diluted net income per share. The
assumed conversion of stock options creates the difference between basic and
diluted net income per share. Income per share is calculated by dividing net
income by the weighted average number of common shares outstanding for each of
the periods presented.
The only potentially dilutive stock of the Company as defined in FASB
128, 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 and nine month periods ended September 30, 2006 and 2005. (Dollars are in
thousands, except for per share data.)
Nine Months Ended Three Months Ended
September 30, September 30,
------------- -------------
2006 2005 2006 2005
---- ---- ---- ----
Net Income (in thousands) .......................... $ 3,716 $ 2,105 $ 1,212 $ 1,245
Weighted average outstanding shares ................ 2,115,103 2,061,902 2,123,973 2,018,988
Basic Earnings Per Share ........................... $ 1.76 $ 1.02 $ 0.57 $ 0.62
Weighted average outstanding shares ................ 2,115,103 2,061,902 2,123,973 2,018,988
Dilutive effect of stock options ................... 59,115 79,955 49,820 70,315
---------- ---------- ---------- ----------
Weighted average diluted shares .................... 2,174,218 2,141,857 2,173,793 2,089,303
Diluted earnings per share ......................... $ 1.71 $ 0.98 $ 0.56 $ 0.60
All Share amounts reflect the 6 for 5 stock split distributed May 5, 2006
Note 3 - Litigation
The Company recorded an expense of $1.7 million in June 2005 in connection with
the settlement of the lawsuit described in Item 3 of the Company's annual report
on Form 10-KSB for the year ended December 31, 2005.
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.
9
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements,"
which establishes a framework for measuring fair value in generally accepted
accounting principles and expands disclosures about fair value measurements.
SFAS No. 157 defines fair vale as the price that would be received to sell as an
asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date. SFAS No. 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years. The adoption of SFAS No. 157 is not
expected to have a material impact on the consolidated financial statements of
the Company.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB
Stateement NO. 87, 88, 106, and 132(R)," which requires a business entity to
recognize the over funded or under funded status of a single-employer defined
benefit postretirement plan as an asset or liability in its statement of
financial position and to recognize changes in that funded status in
comprehensive income in the year in which the changes occur. SFAS No. 158also
requires a business entity to measure the funded status of a plan s of the date
of its year-end statement of financial position, with limited exceptions. The
provisions of this statement are effective as of the end of the first fiscal
year ending after December 15, 2006. The adoption of SFAS No. 158 is not
expected to have a material impact on the consolidated financial statements of
the Company.
In June 2006, the FASB issued FASB Interpretation No. 48 ("FIN 48"), "Accounting
for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109,
"which established that the financial statement effects of a tax position taken
or expected to be take in a tax return are to be recognized in the financial
statements when it is more likely than not, based on the technical merits, that
the position will be sustained upon examination. FIN 48 is effective for fiscal
years beginning after December 15, 2006. The adoption of this new standard is
not expected to have a material impact on the consolidated financial statements
of the Company.
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 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;
10
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 Operation
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.
RESULTS OF OPERATIONS: THREE MONTH PERIOD ENDED SEPTEMBER 30, 2006, COMPARED TO
THE SAME PERIOD ENDED SEPTEMBER 30, 2005, AND NINE MONTH PERIOD ENDED SEPTEMBER
30, 2006, COMPARED TO SEPTEMBER 30, 2005.
Net Income
For the quarter ended September 30, 2006, First South Bancorp, Inc. earned a net
profit of $1,212,000, a decrease of $33,000, or 2.7%, from the same period in
2005. Basic per share quarterly earnings were $.57 in 2006 and $.62 in 2005. The
decrease in earnings in 2006, as compared to the same quarter in 2005, can be
primarily attributed to the $487,000, or 32.4%, increase in non-interest expense
discussed below. The increase in net interest income and non-interest income for
the third quarter of 2006, over the same period in 2005, $343,000 and $150,000,
respectively, reduced the negative effect on earnings the increase in
non-interest expense would have had otherwise.
For the nine month period ended on September 30, 2006, the Company earned a net
profit of $3,716,000, a $1,611,000, or 76.5%, increase over the same nine month
period in 2005. Though changes between the nine month periods of 2006 and 2005
in all income and expense categories, as detailed in the Statement of
Operations, contributed to the net amount of the 2006 increase in net income,
the $1,677,000 litigation settlement expense in 2005, which substantially
reduced 2005 net profit, was, by far, the most significant factor contributing
the increase in net income in 2006.
Profitability
Earnings of financial institutions are often 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 three month period ending September 30, 2006 were 1.39% and 14.00%,
respectively. For the nine months ended September 30, 2006, ROAA and ROAE were
1.44% and 15.04%. The percentages increase for the first nine months of 2006, as
compared to the same period in 2005, can be largely attributed to the impact of
the expense in June of 2005 associated with the mediated legal settlement
referred to above.
11
Table One Selected Earnings Ratios
For Three Months Ending For Nine Months Ending
September 30, September 30,
------------- -------------
2006 2005 2006 2005
---- ---- ---- ----
Return on Average Assets ........... 1.39% 1.62% 1.44% 0.92%
Return on Average Equity ........... 14.00% 16.89% 15.04% 9.88%
Dividend Payout Ratio .............. N/A N/A N/A N/A
Average Stockholders Equity
as a Percentage of Average Assets .. 9.93% 9.59% 9.56% 9.30%
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
quarter ended September 30,2006 increased by $343,000, or 10.6%, over the 2005
quarter. Net interest income for the first nine months of 2006 increased by
$1,866,000,or 20.2%, over the same period in 2005.
Several factors contributed to this increase including growth in average earning
assets, increase in earning asset yield, and increase in interest rate spread.
Average earning assets for the first nine months of 2006 increased by $39.0
million, or 13.3%, from the same nine month period in 2005. The earning assets
yield increased by 145 basis points from 6.82 % for the nine month period ending
September 30, 2005, to 8.27 % for the same period in 2006. With the overall cost
of interest-bearing liabilities between these two nine month periods increasing
132 basis points, from 2.98 % in 2005 to 4.30 % in 2006, the bank experienced a
13 basis points improvement in the interest spread, the difference between the
net yield on earning assets and the cost of interest-bearing liabilities.
Table Two includes a detailed comparison of the average balances, annualized
yields and rates for the interest sensitive segments of the Corporation's
balance sheets for the nine months ended September 30, 2006 and 2005.
12
Table Two Net Interest Income and Average Balance Analysis
for the Nine Months Ended September 30,
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 ........................ $ 11,679 $ 14,739 $ 418 $ 321 4.79% 2.91%
Investments ........................................ 33,861 23,199 1,172 653 4.63% 3.76%
Loans .............................................. 287,441 256,040 19,014 14,012 8.84% 7.32%
--------- --------- --------- --------- ---- ----
Total Interest Earning Assets ...................... 332,981 293,978 20,604 14,986 8.27% 6.82%
Noninterest Earning Assets
Cash & Due From Banks .............................. 5,465 5,425
Allowance for Loan Losses .......................... (3,224) (3,046)
Investments: Fair Value Adjustment ................. (356) (120)
Premises & Equipment ............................... 5,396 5,266
Investment in unconsolidated subsidiary ............ 155 155
Interest Receivable & Other ........................ 5,398 4,515
--------- ---------
Total Noninterest Earning Assets ................... 12,834 12,195
--------- ---------
TOTAL ASSETS ....................................... $ 345,815 $ 306,173
========= =========
Interest Bearing Liabilities
NOW Accounts ....................................... $ 31,896 $ 39,151 $ 838 $ 706 3.51% 2.41%
Money Market & Savings ............................. 51,849 50,952 1,670 927 4.31% 2.43%
Time Deposits & IRAs ............................... 193,741 148,035 6,262 3,463 4.32% 3.13%
Fed Funds Purchased & Repos ........................ 4,817 4,426 150 80 4.16% 2.42%
Other borrowed funds ............................... 7,542 10,000 270 338 4.79% 4.52%
Subordinated debt .................................. 5,000 5,000 298 224 7.97% 5.99%
Demand Notes Issued to Treasury .................... 187 214 6 4 4.29% 2.50%
--------- --------- --------- --------- ---- ----
Total Interest Bearing Liabilities ................. 295,032 257,778 9,494 5,742 4.30% 2.98%
Noninterest Bearing Liabilities
Demand Deposits .................................... 15,053 17,492
Interest Payable ................................... 990 682
Other Liabilities .................................. 1,701 1,733
--------- ---------
Total Non Int Bearing Liabilities .................. 17,744 19,907
Stockholder's Equity ............................... 33,039 28,488
--------- ---------
TOTAL LIABILITIES & EQUITY ......................... $ 345,815 $ 306,173
========= =========
Net Interest Income ................................ $ 11,110 $ 9,244
========= =========
Net Yield on Earning Assets ...................... 4.46% 4.20%
Interest Rate Spread ............................. 3.97% 3.84%
Other Income
Total other, or non-interest, income for both the three and nine month periods
ending September 30, 2006, increased over the same three and nine month periods
of 2005. The three month period increase in 2006 was $149 thousand, or 86.1%,
and nine month period increase was $422 thousand, or 69.2%. With changes in
service charge income for both the three and nine month periods on a comparative
basis being an insignificant factor in the total increased amounts, the other
two categories of non-interest income clearly accounted for the difference. The
Commissions and Fees category in both the three and nine month periods accounted
for the greatest portion of the increase in 2006 over that of 2005. This
category of non-interest income includes fees received from loan brokerage
services, which increased by $96 thousand in third quarter of 2006 compared to
the same period in 2005 and by $222 thousand for the nine month period ended
September 30, 2006, compared to the same period in 2005.
13
Table Three Summary of Total Noninterest Income
for the Nine Months Ended September 30, for the Three Months Ended September 30,
2006 and 2005 2006 and 2005
------------- -------------
(Amounts in thousands) (Amounts in thousands)
2006 2005 2006 2005
---- ---- ---- ----
Service Charges ......................... $ 210 $ 222 $ 75 $ 67
Commissions & Fees ...................... 723 348 229 95
Other Noninterest Income ................ 99 40 18 10
------- ----- ----- ----
Total ................................... $ 1,032 $ 610 $ 322 $ 172
Other Expense
Other, or non-interest expense, excluding the $1,677 litigation settlement
expense in 2005, as referenced earlier under the Income and Profitability
headings, increased by $1.254 million during the nine months ended September 30,
2006, as compared to the same period in 2005. $773 thousand, or 61.6%, of the
total $1,254 adjusted total increase was in the category of Salaries and
Benefits expense. Of the total $773 thousand increase in salaries and benefits
expense, approximately $604 thousand, or 78.2%, resulted from an increase in the
number of full-time equivalent employees from 59 on September 30, 2005, to 67 on
September 30, 2006. During 2006, additional space was leased in both the
Bluffton and Columbia office locations. The additional expense of these
expansions, as well as the opening of a loan production office in Greenville,
S.C. in July, were significant factors in the increased Occupancy & Equipment
and Other non-interest expense categories for the nine month period of 2006, as
compared to the same period in 2005.
The $487 thousand, or 32.4%, increase in non-interest expense for the three
month period ended September 30, 2006, as compared to the same three month
period in 2005, resulted from the same personnel, premises, and equipment
additions noted in the above paragraph discussing the nine month comparison.
Table Four provides a comparison of various categories of non-interest expense
for the nine and three month periods ending September 30, 2006, compared to the
same periods in 2005.
Table Four Summary of Total Noninterest Expense
For the Nine Months Ended September 30, For the Three Months Ended September 30,
2006 and 2005 2006 and 2005
------------- -------------
(Amounts in thousands) (Amounts in thousands)
2006 2005 2006 2005
---- ---- ---- ----
Salaries & Employee Benefits ............... $ 3,580 $ 2,807 $ 1,250 $ 958
Occupancy & Equipment ...................... 690 552 250 171
Other expense .............................. 1,489 1,146 490 374
Net Litigation Settlement ................... - 1,677 - -
------- ------- ------- -------
Total $ 5,759 $ 6,182 $ 1,990 $ 1,503
Income Taxes
Provision for income taxes for the nine months ended September 30, 2006, was
$2,096,000, or 36% of the nine month period's pretax income of $5,812,000. The
provision for income taxes for the three month period ending September 30, 2006,
was $682,000, or 36% of the three month period's pretax income of $1,894,000. In
2005 the nine and three month periods' income taxes were $1,149,000, or 35.3%,
and $677,000, or 35.2%, of pretax income, respectively.
14
CHANGES IN FINANCIAL POSITION
Investment portfolio
During the first nine months of 2006, $6,000,000 in government agency securities
with a weighted average rate of 3.36% matured. During the same nine month
period, $11,498,150 in government agency securities with a weighted average rate
of 5.78% were purchased. During this nine month period, $441,154 in principal
was received as payments on two GNMA issues. On September 30, 2006, $7,231,378
(Book Value) of investment portfolio holdings were pledged against Treasury, Tax
and Loan deposits and repurchase agreement accounts.
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 .......................... 1,000 985 2,000 2,008
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
======= ======= ======= =======
September 30, 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 $ 6,947 $ - $ -
Due from one to five years ......................... 7,493 7,388 4,000 3,969
Due from five to 10 years .......................... 6,500 6,476 4,998 5,034
Due after ten years ................................ 3,123 3,095 482 634
Mortgage backed securities ......................... 633 616 474 480
------- ------- ------- -------
$24,749 $24,522 $ 9,954 $10,117
======= ======= ======= =======
Excludes FHLB equity securities of $1,269 on December 31, 2005 and $740 on
September 30, 2006
Loan portfolio
From December 31, 2005 to September 30, 2006, loans increased by $19.2 million,
or 7.2%. As is shown in Table Six, loans secured by real estate at September 30,
2006, continued to comprise a substantial percentage of the total loan
portfolio, 82.3% versus 83.0% at December 31, 2005. The Company's loan portfolio
at September 30, 2006, as shown in Table Seven, is comprised of $227.8 million,
or 80.1%, of variable rate loans, a decrease from $238.9 million or 89.6 %, at
December 31, 2005.
15
Table Six Analysis of Loans
December 31, 2005 and September 30, 2006
(Dollars in thousands)
Real Estate: Sept. 30, 2006 Dec. 31, 2005
-------------- -------------
Construction/Land Development ....................... $ 22,931 7.97% $ 14,041 5.23%
1-4 Family Residential Properties ................... 62,429 21.69% 65,187 24.28%
Multifamily Residential Properties .................. 5,794 2.01% 3,761 1.40%
Nonfarm Nonresidential Properties ................... 142,727 49.60% 136,692 50.90%
Other Real Estate Loans ............................. 2,965 1.03% 3,211 1.20%
Commercial & Industrial ................................ 50,345 17.49% 45,230 16.84%
Consumer ............................................... 589 0.20% 409 0.15%
--------- ---------
Total .................................................. $ 287,780 100.0% $ 268,531 100.0%
===== =====
Less: Allowance for Loan Losses ....................... (3,290) (3,000)
Net Deferred Loan fees ....................... (505) (498)
--------- ---------
$ 283,985 $ 265,033
========= =========
Table Seven Analysis of Loan Maturities and Repricing Frequency
as of September 30, 2006
(Dollars in thousands)
Within >3 Months >1 Year >3 Years Over
3 Months 12 Months 3 Years 5 Years 5 Years Total
-------- --------- ------- ------- ------- -----
Variable Rate Loans ................ $227,771 $ - $ - $ - $ - $227,771
Fixed Rate Loans ................... 3,333 13,052 21,308 17,864 987 56,544
-------- -------- -------- -------- -------- --------
Total Loans ........................ $231,104 $ 13,052 $ 21,308 $ 17,864 $ 987 $284,315
Excludes loans on non-accrural status of $3,465
Allowance for loan losses
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 risk categories in
relation to the current and forecasted economic environment. The Company 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 increased provision of $153,000 to the loan loss
reserve during the first nine months of 2006, as compared to the same nine month
period in 2005, was primarily due to an increase in non-performing loans in 2006
and to maintain the reserve balance at a level consistent with the level
determined by the applied methodology. Table Eight provides the details of the
activity in the loan loss reserve account for the nine month periods ending
September 30, 2006 and 2005.
Table Eight Analysis of the Allowance for Loan Losses
for the Nine Months Ended September 30
(Dollars in thousands)
2006 2005
---- ----
Balance at Beginning of Year ................. $ 3,000 $ 2,900
Provision Charged to Operations .............. 571 418
Loans Charged-Off ............................ (305) (328)
Loan Recoveries .............................. 24 10
------- -------
Balance at End Of Period ..................... $ 3,290 $ 3,000
16
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 earning assets and interest bearing liabilities within defined
time periods is referred to as "gap" analysis. The 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 September 30, 2006, the cumulative one
year gap was a negative gap, or liability sensitive position, of $14.8 million.
At September 30, 2006, the cumulative five year gap was a positive, or asset
sensitive position, of $22.1 million. A negative gap position means liabilities
would be expected to reprice faster than assets and a positive gap means assets
would be expected to reprice faster than liabilities if interest rates changed.
The Company's gap position at September 30, 2006 is within policy limits
established to reduce the adverse impact on earnings which movements in interest
rates can cause. Competition in the Company's market 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 September 30, 2006.
17
Table Nine Distribution of Interest-Earning Assets and Interest-Bearing Liabilities
Repricing Schedule as of September 30, 2006
(Dollars in thousands)
One Year Over One Year Over
or Less to Five Years Five Years Total
------- ------------- ---------- -----
Interest Earning Assets
Due From Banks ................................................. $ 15,337 $ - $ - $ 15,337
Investment Securities* ......................................... 7,000 11,493 16,211 34,704
FHLB Stock ..................................................... 740 - - 740
Loans** ........................................................ 244,156 39,172 987 284,315
========= ========= ========= =========
Total .......................................................... $ 267,233 $ 50,665 $ 17,198 $ 335,096
*Amortized Cost
**Excludes $3,465 in loans on non-accrural status
Interest Bearing Liabilities
NOW Accounts ................................................... $ 28,204 $ - $ - $ 28,204
Savings & MMIA ................................................. 60,061 - - 60,061
Time Deposits:$100 & > ......................................... 67,099 5,656 - 72,755
Time Deposits: <$100 ........................................... 117,871 8,136 - 126,007
Repurchase Agreements .......................................... 3,346 - - 3,346
Subordinated Debt (Trust Preferred Sec.) ....................... 5,000 - - 5,000
Other Borrowed Funds ........................................... 412 - - 412
========= ========= ========= =========
Total .......................................................... $ 281,993 $ 13,792 $ - $ 295,785
Period Gap ..................................................... $ (14,760) $ 36,873 $ 17,198 $ 39,311
Cumulative Gap ................................................. $ (14,760) $ 22,113 $ 39,311
Period Gap Ratios:
Interest Sensitive Assets to
Interest Sensitive Liabilities ............................... 94.8% 367.4% -
Cumulative Gap Ratios:
Interest Sensitive Assets to
Interest Sensitive Liabilities ............................... 94.8% 107.5% 113.3%
3 Months Over 3 Months Over One
Time Deposits & Less to 12 Months Year Total
------ ------------ ---- -----
$100 and Greater ........... $15,321 $51,778 $ 5,656 $72,755
18
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 that may be immediately
converted into cash at minimal cost(amounts due from banks and overnight invest-
ments). However, the most manageable sources of liquidity are composed of
liabilities, with the primary focus on liquidity management being the ability to
obtain deposits in the Bank's service areas. Core deposits (total deposits less
wholesale time deposits) provide a relatively stable funding base. At September
30, 2006, core deposits equaled approximately 72% of total deposits. Asset
liquidity is provided from several sources, including amounts due from banks and
overnight investments, and funds from maturing loans. The Bank is a member of
the Federal Home Loan Bank of Atlanta and, as such, has the ability to borrow
against the security of its 1-4 family residential mortgage loans and commercial
loans. The Bank also has $12 million available through lines of credit with
other banks as an additional source of liquidity funding. Management believes
the Company's overall liquidity sources are adequate to meet its operating
needs.
Off-Balance Sheet Risk
Through its operations, the Company 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 Company's customers at
predetermined interest rates for a specified period of time. At September 30,
2006, the Company had issued commitments to extend credit of $47,617,000 and
standby letters of credit of $6,297,000 through various types of commercial
lending arrangements. Approximately 91.0% of these commitments to extend credit
had variable rates. Past experience indicates that many of the commitments to
extend credit will expire not fully used. As noted under "Liquidity", the
Company believes that it has adequate sources of liquidity to fund commitments
drawn upon by borrowers.
Capital Resources
The Company experienced a $3.895 million increase in Tier 1 capital to $39.880
million during the nine month period from December 31, 2005 to September 30,
2006. The increase resulted exclusively from an increase in retained earnings
$3.716 million and $179 thousand from the exercise of stock options. At
September 30, 2006, the Bank had Tier 1 capital of $33.491 million.
The Holding 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 Improvements 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 September 30, 2006, the
Bank met all of the minimum capital requirements to be well capitalized.
The Bank's and Company's September 30, 2006, capital ratios are presented in the
following table, compared with the required "well capitalized" and minimum
ratios under the FDIC regulatory definitions and guidelines:
19
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
------ ----- ------ ----- ------ -----
September 30, 2006
Total Capital
(To Risk Weighted Assets) ....... $41,681 14.20% $23,482 >8.0% $29,352 >10.0%
Tier 1 Capital
(To Risk Weighted Assets) ....... $33,491 11.41% $11,741 >4.0% $17,611 >6.0%
Tier 1 Capital
(To Average Assets) ............. $33,491 9.69% $13,831 >4.0% $17,289 >5.0%
The Holding Company
(Dollar Amounts in Thousands)
For Capital
Actual Adequacy Purposes
------ -----------------
Amount Ratio Amount Ratio
------ ----- ------ -----
September 30, 2006
Total Capital
(To Risk Weighted Assets) $43,285 14.75% $23,495 >8.0%
Tier 1 Capital
(To Risk Weighted Assets) $39,880 13.59% $11,747 >4.0%
Tier 1 Capital
(To Average Assets) $39,880 11.53% $13,836 >4.0%
20
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. 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 September 30, 2006, the cumulative one year interest sensitivity GAP had
changed from a positive or asset sensitive position on December 31, 2005 of
$29.1 million to a negative or liability sensitive position of $14.8 million.
Management, based on simulation model projections of the adverse effect on the
Bank's Net interest income from a decline in interest rates, began at mid-year
to reposition the Bank's balance sheet to reduce the potential negative effect
on earnings of a decline in interest rates.
21
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.
22
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
23
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
November 13, 2006 ---------------------------------------------
Barry L. Slider, President and Chief Executive
Officer
s/V. Lewis Shuler
---------------------------------------------
V. Lewis Shuler, Executive Vice President
(Principal Accounting Officer)
24
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
25