U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One) FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
------ OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2007
OR
------- TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _________to_________
Commission File No. 000-50257
CAROLINA NATIONAL CORPORATION
(Exact name of small registrant as specified in its charter)
South Carolina 57-1101005
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
1350 Main Street
Columbia, South Carolina 29201
(Address of principal executive offices, including zip code)
(803) 779-0411 (Registrant's
telephone number, including area code)
------------------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer [ ] Accelerated Filer [ ] 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 stock as of the latest practicable date.
2,592,623 shares of common stock, no par value on October 31, 2007
CAROLINA NATIONAL CORPORATION
INDEX
PART I - FINANCIAL INFORMATION Page No.
--------
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - September 30, 2007 and December 31, 2006...............................3
Condensed Consolidated Statements of Operations - Nine months ended September 30, 2007 and 2006
and Three months ended September 30, 2007 and 2006.........................................................4
Condensed Consolidated Statements of Shareholders' Equity and Comprehensive Income-
Nine months ended September 30, 2007 and 2006................................................................5
Condensed Consolidated Statements of Cash Flows - Nine months ended September 30, 2007 and 2006................6
Notes to Condensed Consolidated Financial Statements...........................................................7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.....................12-19
Item 3. Quantitative and Qualitative Disclosures About Market Risk...................................................19
Item 4T. Controls and Procedures......................................................................................19
PART II - OTHER INFORMATION
Item 6. Exhibits.....................................................................................................20
CAROLINA NATIONAL CORPORATION
Condensed Consolidated Balance Sheets
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
September 30, December 31,
2007 2006
--------------- ---------------
Assets (Unaudited) (Audited)
Cash and cash equivalents
Cash and due from banks ........................................................... $ 3,498,407 $ 3,232,394
Federal funds sold ................................................................ 17,690,000 8,803,000
------------- -------------
Total cash and cash equivalents ................................................. 21,188,407 12,035,394
------------- -------------
Investment securities
Nonmarketable equity securities ................................................... 1,275,700 644,400
------------- -------------
Total investment securities ..................................................... 1,275,700 644,400
------------- -------------
Loans receivable .................................................................... 204,472,824 194,784,723
Less allowance for loan losses .................................................... 2,593,100 2,434,900
------------- -------------
Loans, net ...................................................................... 201,879,724 192,349,823
------------- -------------
Premises, furniture and equipment, net .............................................. 1,708,289 1,486,250
Accrued interest receivable ......................................................... 1,094,587 1,119,030
Other assets ........................................................................ 879,370 1,276,905
------------- -------------
Total assets .................................................................... $ 228,026,077 $ 208,911,802
============= =============
Liabilities
Deposits
Noninterest-bearing transaction accounts .......................................... $ 18,643,769 $ 17,666,870
Interest-bearing transaction accounts ............................................. 9,055,180 10,307,063
Savings and money market .......................................................... 27,645,739 34,971,834
Time deposits $100,000 and over ................................................... 80,160,409 65,233,757
Other time deposits ............................................................... 58,823,266 47,402,659
------------- -------------
Total deposits .................................................................. 194,328,363 175,582,183
------------- -------------
Advances from Federal Home Loan Bank ................................................ - 1,000,000
Accrued interest payable ............................................................ 1,472,297 1,531,840
Other liabilities ................................................................... 196,064 204,804
------------- -------------
Total liabilities ............................................................... 195,996,724 178,318,827
------------- -------------
Shareholders' equity
Preferred stock, 10,000,000 shares authorized, none issued .......................... - -
Common stock, no par value, 20,000,000 shares authorized;
2,592,623 shares issued and outstanding as of September 30, 2007,
and 2,578,503 shares at December 31, 2006 ......................................... 31,255,309 31,061,361
Retained earnings (deficit) ......................................................... 774,044 (468,386)
------------- -------------
Total shareholders' equity ...................................................... 32,029,353 30,592,975
------------- -------------
Total liabilities and shareholders' equity ...................................... $ 228,026,077 $ 208,911,802
============= =============
See notes to condensed consolidated financial statements.
-3-
CAROLINA NATIONAL CORPORATION
Condensed Consolidated Statements of Operations
(Unaudited)
Nine Months Ended Three Months Ended
September 30, September 30,
------------- -------------
2007 2006 2007 2006
---- ---- ---- ----
Interest income
Loans, including fees .................................... $11,674,660 $ 9,098,827 $ 3,963,237 $ 3,354,665
Investment securities:
Taxable ................................................ 42,608 5,000 17,513 -
Nonmarketable equity securities ........................ 34,380 59,771 9,840 15,729
Federal funds sold ......................................... 554,899 501,234 235,172 182,769
----------- ----------- ----------- -----------
Total ................................................ 12,306,547 9,664,832 4,225,762 3,553,163
----------- ----------- ----------- -----------
Interest expense
Time deposits $100,000 and over .......................... 2,850,107 1,903,870 1,063,800 716,720
Other deposits ........................................... 3,036,121 1,878,368 1,044,073 763,013
Other Borrowings ......................................... 10,503 33,732 - 11,368
----------- ----------- ----------- -----------
Total ................................................ 5,896,731 3,815,970 2,107,873 1,491,101
----------- ----------- ----------- -----------
Net interest income ........................................ 6,409,816 5,848,862 2,117,889 2,062,062
Provision for loan losses .................................. 209,414 339,723 117,900 88,700
----------- ----------- ----------- -----------
Net interest income after provision for loan losses ........ 6,200,402 5,509,139 1,999,989 1,973,362
----------- ----------- ----------- -----------
Noninterest income
Service charges on deposit accounts ...................... 195,727 162,569 69,547 52,649
Residential mortgage origination fees .................... 16,905 73,303 6,092 19,180
Other .................................................... 71,427 63,986 25,421 21,122
----------- ----------- ----------- -----------
Total noninterest income ............................. 284,059 299,858 101,060 92,951
----------- ----------- ----------- -----------
Noninterest expenses
Salaries and employee benefits ........................... 2,115,590 1,756,661 731,310 597,287
Net occupancy ............................................ 509,952 328,985 179,463 114,183
Furniture and equipment .................................. 147,537 123,436 47,043 42,162
Other operating .......................................... 1,765,795 1,251,883 746,134 458,027
----------- ----------- ----------- -----------
Total noninterest expense ............................ 4,538,874 3,460,965 1,703,950 1,211,659
----------- ----------- ----------- -----------
Income before income taxes ................................. 1,945,587 2,348,032 397,099 854,654
Income tax expense ......................................... 703,155 829,677 141,689 325,452
----------- ----------- ----------- -----------
Net income ................................................. $ 1,242,430 $ 1,518,355 $ 255,410 $ 529,202
=========== =========== =========== ===========
Earnings per share
Basic earnings per share ................................... $ .48 $ .59 $ .10 $ .21
=========== =========== =========== ===========
Diluted earnings per share ................................. $ .47 $ .57 $ .10 $ .20
=========== =========== =========== ===========
Average shares outstanding - basic ......................... 2,579,463 2,574,006 2,581,253 2,577,303
=========== =========== =========== ===========
Average shares outstanding - diluted ....................... 2,643,230 2,660,401 2,640,770 2,668,988
=========== =========== =========== ===========
See notes to condensed consolidated financial statements.
-4-
CAROLINA NATIONAL CORPORATION
Condensed Consolidated Statements of Changes in Shareholders' Equity and
Comprehensive Income For the Nine months ended September 30, 2007 and 2006
(Unaudited)
Accumulated
Retained Other
Common Stock (Deficit)/ Comprehensive
Shares Amount Earnings Income (Loss) Total
------ ------ -------- ------------- -----
Balance, December 31, 2005 ............... 2,427,303 $28,772,288 $(2,397,568) $ (6,806) $26,367,914
Issuance of common stock, net ............ 150,000 2,245,344 2,245,344
Stock-based compensation ................. 22,406 22,406
Net income ............................... 1,518,355 1,518,355
Other comprehensive income,
net of tax benefit ..................... 6,806 6,806
-----------
Comprehensive income ..................... 1,525,161
--------- ----------- ----------- --------------- -----------
Balance, September 30, 2006 .............. 2,577,303 $31,040,038 $ (879,213) $ - $30,160,825
========= =========== =========== =============== ===========
Balance, December 31, 2006 ............... 2,578,503 $31,061,361 $ (468,386) $ - $30,592,975
=========== =========== =============== ===========
Issuance of common stock upon ............ 14,120 141,200 141,200
exercise of options, net
Stock-based compensation ................. 52,748 52,748
Net income ............................... 1,242,430 1,242,430
Other comprehensive income,
net of tax benefit ..................... - -
-----------
Comprehensive income ..................... 1,242,430
----------- ----------- ----------- --------------- -----------
Balance, September 30, 2007 .............. 2,592,623 $31,255,309 $ 774,044 $ - $32,029,353
=========== =========== =========== =============== ===========
See notes to condensed consolidated financial statements.
-5-
CAROLINA NATIONAL CORPORATION
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended
September 30,
-------------
2007 2006
---- ----
Cash flows from operating activities
Adjustments to reconcile net income to net cash used by
operating activities
Net income ..................................................................... $ 1,242,430 $ 1,518,355
Provision for loan losses ...................................................... 209,414 339,723
Depreciation and amortization expense .......................................... 230,383 165,646
Deferred income tax expense .................................................... 112,630 343,608
Stock based compensation expense ............................................... 52,748 22,406
Decrease (increase) in accrued interest receivable ............................. 24,443 (276,543)
Increase in accrued interest payable ........................................... 136,522 236,175
Decrease (increase) in other assets ............................................ 284,905 (151,338)
Decrease in other liabilities .................................................. (204,804) (649,065)
------------ ------------
Net cash provided by operating activities .................................... 2,088,671 1,548,967
------------ ------------
Cash flows from investing activities
Purchases of non-marketable equity securities .................................... (631,300) (133,200)
Securities called or redeemed .................................................... - 2,996,495
Net increase in loans ............................................................ (9,739,315) (37,001,719)
Purchase of premises, furniture and equipment .................................... (452,422) (457,243)
------------ ------------
Net cash used by investing activities .......................................... (10,823,037) (34,595,667)
------------ ------------
Cash flows from financing activities
Issuance of Common Stock, net .................................................... 141,200 2,245,344
Net (decrease) increase in demand deposits, interest-bearing
transaction accounts and savings accounts ...................................... (7,601,080) 4,772,076
Net increase in certificates of deposit and
other time deposits ............................................................ 26,347,259 23,172,677
Net decrease in advances from Federal Home Loan Bank ............................. (1,000,000) -
------------ ------------
Net cash provided by financing activities ...................................... 17,887,379 30,190,097
------------ ------------
Net increase (decrease) in cash and cash equivalents ............................... 9,153,013 (2,856,603)
Cash and cash equivalents, beginning of period ..................................... 12,035,394 20,967,712
------------ ------------
Cash and cash equivalents, end of period ........................................... $ 21,188,407 $ 18,111,109
============ ============
Cash paid during the period for:
Income taxes ..................................................................... $ 341,597 $ 539,485
============ ============
Interest ......................................................................... $ 5,760,210 $ 3,579,795
============ ============
See notes to condensed consolidated financial statements.
-6-
CAROLINA NATIONAL CORPORATION
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 1 - Basis of Presentation
The accompanying financial statements have been prepared in accordance with the
requirements for interim financial statements and, accordingly, they are
condensed and omit disclosures, which would substantially duplicate those
contained in the most recent annual report on Form 10-KSB. The financial
statements, as of September 30, 2007 and 2006 are unaudited and, in the opinion
of management, include all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation. The financial
information as of December 31, 2006 has been derived from the audited financial
statements as of that date. For further information, refer to the financial
statements and the notes included in Carolina National Corporation's (the
"Company") 2006 Annual Report on Form 10-KSB.
Note 2 - Recently Issued Accounting Pronouncements
The following is a summary of recent authoritative pronouncements that could
impact the accounting, reporting, and / or disclosure of financial information
by the Company.
In February 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting ("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 Extinguishments of Liabilities." This Statement resolves
issues addressed in SFAS No. 133 Implementation Issue No. D1, "Application of
Statement 133 to Beneficial Interests in Securitized Financial Assets." FAS 155
permits fair value re-measurement for any hybrid financial instrument that
contains an embedded derivative that otherwise would require bifurcation,
clarifies which interest only-strips and principal-only strips are not subject
to the requirements of Statement 133, establishes a requirement to evaluate
interests in securitized financial assets to identify interests that are
freestanding derivatives or that are hybrid financial instruments that contain
an embedded derivative requiring bifurcation, clarifies that concentrations of
credit risk in the form of subordination are not embedded derivatives, and
amends Statement 140 to eliminate the prohibition on a qualifying special
purpose entity from holding a derivative financial instrument that pertains to a
beneficial interest other than another derivative financial instrument. SFAS No.
155 is effective for all financial instruments acquired or issued after January
1, 2007. The adoption of SFAS No. 155 did not have a material impact on the
Company's financial position, results of operations or cash flows.
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
FASB No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," with respect to the accounting for separately
recognized servicing assets and servicing liabilities. SFAS No. 156 requires an
entity to recognize a servicing asset or servicing liability each time it
undertakes an obligation to service a financial asset by entering into a
servicing contract; requires all separately recognized servicing assets and
servicing liabilities to be initially measured at fair value, if practicable;
permits an entity to choose its subsequent measurement methods for each class of
separately recognized servicing assets and servicing liabilities; at its initial
adoption, permits a one-time reclassification of available-for-sale securities
to trading securities by entities with recognized servicing rights, without
calling into question the treatment of other available-for-sale securities under
Statement 115, provided that the available-for-sale securities are identified in
some manner as offsetting the entity's exposure to changes in fair value of
servicing assets or servicing liabilities that a servicer elects to subsequently
measure at fair value; and requires separate presentation of servicing assets
and servicing liabilities subsequently measured at fair value in the statement
of financial position and additional disclosures for all separately recognized
servicing assets and servicing liabilities. The required adoption date for SFAS
No. 156 is January 1, 2007. The adoption of SFAS No. 156 did not have a material
impact on the Company's financial position, results of operations or cash flows.
In July 2006, the FASB issued FASB Interpretation No. 48 ("FIN 48"), "Accounting
for Uncertainty in Income Taxes". FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in enterprises' financial statements in
accordance with FASB Statement No. 109, "Accounting for Income Taxes". FIN 48
prescribes a recognition threshold and measurement attributable for the
financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosures and transitions. FIN 48 is effective for fiscal years
beginning after December 15, 2006. The Company does not believe that FIN 48 will
have a material impact on its financial position, results of operations or cash
flows.
-7-
CAROLINA NATIONAL CORPORATION
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 2 - Recently Issued Accounting Pronouncements - continued
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." SFAS
157 defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles, and expands disclosures about fair
value measurements. This standard does not require any new fair value
measurements, but rather eliminates inconsistencies found in various prior
pronouncements. SFAS 157 is effective for the Company on January 1, 2008 and
will not impact the Company's accounting measurements but it is expected to
result in some additional disclosures.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans" ("SFAS 158"), which
amends SFAS 87 and SFAS 106 to require recognition of the overfunded or
underfunded status of pension and other postretirement benefit plans on the
balance sheet. Under SFAS 158, gains and losses, prior service costs and
credits, and any remaining transition amounts under SFAS 87 and SFAS 106 that
have not yet been recognized through net periodic benefit cost will be
recognized in accumulated other comprehensive income, net of tax effects, until
they are amortized as a component of net periodic cost. The measurement date --
the date at which the benefit obligation and plan assets are measured -- is
required to be the company's fiscal year end. SFAS 158 is effective for
publicly-held companies for fiscal years ending after December 15, 2006, except
for the measurement date provisions, which are effective for fiscal years ending
after December 15, 2008. The Company does not have a defined benefit pension
plan. Therefore, SFAS 158 will not impact the Company's financial condition or
results of operations.
In September, 2006, The FASB ratified the consensuses reached by the FASB's
Emerging Issues Task Force ("EITF") relating to EITF 06-4 "Accounting for the
Deferred Compensation and Postretirement Benefit Aspects of Endorsement
Split-Dollar Life Insurance Arrangements". EITF 06-4 addresses employer
accounting for endorsement split-dollar life insurance arrangements that provide
a benefit to an employee that extends to postretirement periods should recognize
a liability for future benefits in accordance with SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions", or Accounting
Principles Board ("APB") Opinion No. 12, "Omnibus Opinion--1967". EITF 06-4 is
effective for fiscal years beginning after December 15, 2007. Entities should
recognize the effects of applying this Issue through either (a) a change in
accounting principle through a cumulative-effect adjustment to retained earnings
or to other components of equity or net assets in the statement of financial
position as of the beginning of the year of adoption or (b) a change in
accounting principle through retrospective application to all prior periods. The
Company does not believe the adoption of EITF 06-4 will have a material impact
on its financial position, results of operations and cash flows.
In September 2006, the FASB ratified the consensus reached related to EITF 06-5,
"Accounting for Purchases of Life Insurance--Determining the Amount That Could
Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for
Purchases of Life Insurance." EITF 06-5 states that a policyholder should
consider any additional amounts included in the contractual terms of the
insurance policy other than the cash surrender value in determining the amount
that could be realized under the insurance contract. EITF 06-5 also states that
a policyholder should determine the amount that could be realized under the life
insurance contract assuming the surrender of an individual-life by
individual-life policy (or certificate by certificate in a group policy). EITF
06-5 is effective for fiscal years beginning after December 15, 2007. The
Company does not believe the adoption of EITF 06-5 will have a material impact
on its financial position, results of operations and cash flows.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities - Including an amendment of FASB
Statement No. 115." This statement permits, but does not require, entities to
measure many financial instruments at fair value. The objective is to provide
entities with an opportunity to mitigate volatility in reported earnings caused
by measuring related assets and liabilities differently without having to apply
complex hedge accounting provisions. Entities electing this option will apply it
when the entity first recognizes an eligible instrument and will report
unrealized gains and losses on such instruments in current earnings. This
statement 1) applies to all entities, 2) specifies certain election dates, 3)
can be applied on an instrument-by-instrument basis with some exceptions, 4) is
irrevocable and 5) applies only to entire instruments. One exception is demand
deposit liabilities which are explicitly excluded as qualifying for fair value.
With respect to SFAS 115, available-for-sale and held-to-maturity securities at
the effective date are eligible for the fair value option at that date. If the
fair value option is elected for those securities at the effective date,
cumulative unrealized gains and losses at that date shall be included in the
cumulative-effect adjustment and thereafter, such securities will be accounted
for as trading securities. SFAS 159 is effective for the Company on January 1,
2008. The Company is currently analyzing whether to elect the fair value option
under SFAS 159.
Other accounting standards that have been issued or proposed by the FASB or
other standards-setting bodies are not expected to have a material impact on the
Company's financial position, results of operations or cash flows.
-8-
CAROLINA NATIONAL CORPORATION
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 3 - Earnings Per Share
Basic earnings per share is computed by dividing net income by the
weighted-average number of common shares outstanding. Diluted earnings per share
is computed by dividing net income by the weighted-average number of common
shares outstanding and dilutive common share equivalents using the treasury
stock method. Dilutive common share equivalents include common shares issuable
upon exercise of outstanding stock warrants and stock options.
Nine Months Ended
September 30,
-------------
2007 2006
---- ----
Net income per share - basic computation:
Net income to common shareholders ............................................ $ 1,242,430 $1,518,355
============== ==========
Average common shares outstanding - basic .................................... 2,579,463 2,574,006
============== ==========
Basic income per share ....................................................... $ .48 $ .59
============== ==========
Net income per share - dilutive computation:
Net income to common shareholders ............................................ $ 1,242,430 $1,518,355
============== ==========
Average common shares outstanding - dilutive ................................. 2,643,230 2,660,401
============== ==========
Diluted income per share ..................................................... $ .47 $ .57
============== ==========
Three Months Ended
September 30,
-------------
2007 2006
---- ----
Net income per share - basic computation:
Net income to common shareholders ............................................ $ 255,410 $ 529,202
============== ==========
Average common shares outstanding - basic .................................... 2,581,253 2,577,303
============== ==========
Basic income per share ....................................................... $ .10 $ .21
============== ==========
Net income per share - dilutive computation:
Net income to common shareholders ............................................ $ 255,410 $ 529,202
============== ==========
Average common shares outstanding - dilutive ................................. 2,640,770 2,668,988
============== ==========
Diluted income per share ..................................................... $ .10 $ .20
============== ==========
Options that had a dilutive effect on the earnings per share calculation totaled
294,639 for the nine and three months ending September 30, 2007. A total of
4,630 of the outstanding options were anti-dilutive for the nine month period
ending September 30, 2007.
-9-
CAROLINA NATIONAL CORPORATION
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 4 - Stock Compensation Plans and Arrangements
Under the terms of an employment agreement with the Company's Chief Executive
Officer (CEO), stock options were granted to him as part of his compensation and
benefits package. Under the agreement, the CEO was granted 64,701 stock options
on July 15, 2002. These options vest at a rate of 20% per year for five years,
beginning with the grant date. The options have an exercise price of $10.00 per
share and terminate ten years after the date of grant.
On April 23, 2003 the Company established the Carolina National Corporation 2003
Stock Option Plan, ("2003 Stock Plan") that provides for the granting of options
to purchase up to 129,402 shares of the Company's common stock to directors,
officers, or employees of the Company. Additionally, on May 7, 2007 the Company
established The Carolina National Corporation Long Term Incentive Plan ("Long
Term Plan") that provides for the granting of stock options, stock appreciation
rights ("SARS"), restricted stock, performance units, and other stock-based
awards covering up to 227,100 shares of the common stock to directors, officers,
employees, or consultants of the Company. The per-share exercise price of stock
options granted under both plans is the fair market value of the common stock at
the time of the grant, and the strike price of freestanding SARs under the Long
Term Plan is also the fair market value of the common stock on the date of grant
unless provided otherwise by the Compensation Committee. As of September 30,
2007, there were 51,075 shares available for grant under the 2003 Stock Plan and
227,100 shares available for grant under the Long Term Plan. As of September 30,
2007, no shares had been granted under the Long Term Plan.
There were 22,940 options granted during the nine months ended September 30,
2007. These options were awarded to directors in lieu of director fees, at a
weighted average price of $16.41. A total of 20,000 of these grants were made on
July 1, 2007 with a vesting period of five years, while the remaining 2,940
shares were vested upon their date of grant. There were no options granted
during the nine months ended September 30, 2006.
Fair values were estimated on the date of grant using the Black-Scholes
option-pricing model with the following assumptions used for the 2007 grants. No
options were granted during the first nine months of 2006. A total of 1,105
options were granted on January 22, 2007 with a dividend yield of 0.00%, an
expected volatility of 38.66%, a risk-free interest rate of 4.88% and an
expected life of 10 years. An additional grant was made on April 1, 2007 for 852
shares, with a dividend yield of 0.00%, an expected volatility of 20.29%, a
risk-free interest rate of 5.05%, and an expected life of 10 years. A total of
20,983 shares were granted on July 1, 2007 with a dividend yield of 0.00%, and
expected volatility of 21.08%, a risk-free interest rate of 5.00%, and an
expected life of 7 years.
The following is a summary of the activity under the 2003 Stock Plan for the
three months ending September 30, 2007 and 2006.
2007 2006
---- ----
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
Outstanding at beginning of the period ......................... 91,731 $ 10.60 92,501 $ 10.00
Granted ........................................................ 20,983 16.26 5,900 18.49
Exercised ...................................................... 14,000 10.00 - -
Forfeited ...................................................... - - - -
------ --------- ------ ---------
Outstanding at the end of the period ........................... 98,714 13.30 98,401 10.51
====== ========= ====== =========
The following is a summary of the activity under the 2003 Stock Plan for the
nine months ending September 30, 2007 and 2006.
2007 2006
---- ----
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
Outstanding at beginning of the period ......................... 94,301 $ 10.55 94,501 $ 10.00
Granted ........................................................ 22,940 16.41 5,900 18.49
Exercised ...................................................... 14,120 10.00 - -
Forfeited ...................................................... 4,407 13.01 2,000 13.50
------ --------- ------ ---------
Outstanding at the end of the period ........................... 98,714 11.85 98,401 10.44
====== ========= ====== =========
-10-
CAROLINA NATIONAL CORPORATION
Notes to Condensed Consolidated Financial Statements
(Unaudited)
The organizers and Directors of the Company received an aggregate total of
200,555 stock warrants, or two stock warrants for each three shares of the
Company's common stock purchased by the directors in the initial public
offering. Each warrant entitles its holder to purchase one share of the
Company's common stock for $10.00. As of September 30, 2006, all warrants were
fully vested. All unexercised warrants will expire on July 15, 2012.
During the nine months ending September 30, 2007, no warrants were exercised.
There were no warrants exercised during the nine months ending September 30,
2006. No warrants were granted or forfeited in either year. There were 200,555
warrants outstanding at September 30, 2007.
Note 6 - Merger with First Bancshares, Inc.
On August 26, 2007, Carolina National Corporation (the "Company") and First
National Bancshares, Inc. ("First National") entered into an Agreement and Plan
of Merger (the "Merger Agreement") pursuant to which the Company will merge with
and into First National, with First National as the surviving entity, in a cash
and stock transaction valued at approximately $59.3 million. Under the terms of
the Merger Agreement, shareholders of the Company will receive for each share
common stock owned one of the following: (i) 1.4678 shares of First National
common stock, (ii) $21.65 in cash, or (iii) a combination of both cash and
shares of First National common stock. In total, 70% of Carolina National's
outstanding shares of common stock will be exchanged for shares of First
National common stock and 30% of Carolina National's outstanding shares of
common stock will be exchanged for cash. The merger is currently expected to be
completed in the first quarter of calendar 2008, pending receipt of the
approvals of the shareholders of each company and regulatory approvals. The
Merger Agreement also provides that the Company must pay to First National a
cash fee of $500,000 if the Merger Agreement is terminated under certain
conditions.
In connection with the Merger Agreement, the Company engaged the services of an
Investment Banking Firm. The terms of the engagement with the Investment Bankers
called for the payment of an advisory fee upon signing the engagement, the
payment of an additional fee upon the delivery of a fairness opinion, and for a
fee to be paid to the Investment Banking Firm by the Company based on the total
purchase price of the transaction if, in fact, an acquisition did occur. The
advisory fee was paid in May 2007, and the fairness opinion fee was paid in
August 2007. Both are included in other operating expense. Currently the
acquisition by First National Bancshares, Inc. is anticipated to be consummated
during the first quarter of 2008. It the transaction does occur, the Company
will be obligated to pay an additional fee to the Investment Banking firm of
approximately $764,500 for the services provided.
-11-
CAROLINA NATIONAL CORPORATION
Forward Looking Statements
This report contains "forward-looking statements" within the meaning of the
securities laws. All statements that are not historical facts are
"forward-looking statements." You can identify these forward-looking statements
through our use of words such as "may," "will," "expect," "anticipate,"
"believe," "intend," "estimate," "project," "continue," or other similar words.
Forward-looking statements include, but are not limited to, statements regarding
our future business prospects, revenues, working capital, liquidity, capital
needs, interest costs, income, business operations and proposed services.
These forward-looking statements are based on current expectations, estimates
and projections about our industry, management's beliefs, and assumptions made
by management. Such information includes, without limitation, discussions as to
estimates, expectations, beliefs, plans, strategies, and objectives concerning
our future financial and operating performance. These statements are not
guarantees of future performance and are subject to risks, uncertainties and
assumptions that are difficult to predict, particularly in light of the fact
that we are a new company with limited operating history. Therefore, actual
results may differ materially from those expressed or forecasted in such
forward-looking statements. The risks and uncertainties include, but are not
limited to:
o our growth and our ability to maintain growth;
o governmental monetary and fiscal policies, as well as legislative and
regulatory changes;
o the effect of interest rate changes on our level and composition of
deposits, loan demand and the value of our loan collateral and
securities;
o the effects of competition from other financial institutions operating
in our market area and elsewhere, including institutions operating
locally, regionally, nationally and internationally, together with
competitors that offer banking products and services by mail,
telephone and computer and/or the Internet;
o failure of our customers to repay loans;
o failure of assumptions underlying the establishment of our allowance
for loan losses, including the value of collateral securing loans; and
o loss of consumer confidence and economic disruptions resulting from
terrorist activities.
We undertake no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
In light of these risks, uncertainties, and assumptions, the forward-looking
events discussed in this report might not occur.
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following is our discussion and analysis of certain significant factors that
have affected our financial position and operating results and those of our
subsidiary, Carolina National Bank and Trust Company (the "bank"), during the
periods included in the accompanying financial statements. This commentary
should be read in conjunction with the financial statements and the related
notes and the other statistical information included in this report and in our
2006 Annual Report on Form 10-KSB.
Results of Operations
Net Interest Income
For the nine months ended September 30, 2007, net interest income, the major
component of the Bank's net income was $6,409,816 as compared to $5,848,862 for
the same period in 2006. For the three months ended September 30, 2007, net
interest income was $2,117,889 compared to $2,062,062 for the same period in
2006. For the nine months ended September 30, 2007, interest income from loans,
including fees, was $11,674,660, compared to $9,098,827 for the same period in
2006. For the three months ended September 30, 2007, interest income from loans,
including fees, was $3,963,237, compared to $3,354,665 for the same period in
2006. These increases in net interest income and interest income from loans and
fees were primarily due to a 16.2% growth in loans outstanding since September
30, 2006.
-12-
CAROLINA NATIONAL CORPORATION
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations - continued
Interest expense for the nine months ended September 30, 2007 was $5,896,731,
compared to $3,815,970 for the same period in 2006. Interest expense for the
three months ended September 30, 2007 was $2,107,873, compared to $1,491,101 for
the same period in 2006. Interest expense for the nine month and three month
periods in 2007 increased over the same periods in the prior year due to the
need to support our loan growth with higher priced certificates of deposits as
other deposits decreased approximately $7,601,079 during the first nine months
and $1,036,146 during the third quarter of 2007. The reduction in those deposits
during the first nine months was largely due to the transfer of money market
deposits to certificates of deposits, as well as increased competition in our
market for money market deposits from new entrants into our market place. The
reduction in such deposits during the third quarter of 2007 was mostly due to
loss of deposits held in for short term purposes in escrow accounts.
The average rate realized on interest-earning assets was 7.67% and 7.41%,
respectively, for the nine month periods ended September 30, 2007 and 2006. The
average rate paid on interest-bearing liabilities was 4.68% and 3.84%,
respectively, for the nine month periods ended September 30, 2007 and 2006. For
the three month periods ended September 30, 2007 and 2006, the average rate
realized on interest-earning assets was 7.53% and 7.57%, respectively and the
average rate paid on interest-bearing liabilities was 4.73% and 4.14%,
respectively. The improvement in the rate realized on earning assets for the
nine month period of 2007 was primarily the result of increases in the Bank's
prime lending rate as a result of the changes in the federal funds rate due to
stepped increases in the rate by the Federal Reserve Board during 2006 and the
first two quarters of 2007. The September 18, 2007 decrease in the federal funds
rate had little effect because it occurred near the end of the period. The rate
realized on earning assets for the third quarter of 2007, compared to the same
period of 2006 was basically flat. The increase in rates paid on interest
bearing deposits during the first nine months and third quarter of 2007 over
2006 is primarily due to the need to support asset growth during the period with
higher priced certificates of deposits.
The net interest spread and net interest margin were 2.99% and 4.00%,
respectively, for the nine month period ended September 30, 2007. The net
interest spread and net interest margin were 3.57% and 4.48%, respectively, for
the nine month period ended September 30, 2006. For the three month periods
ended September 30, 2007 and 2006, the net interest spread was 2.79% and 3.43%,
respectively. For the three month periods ended September 30, 2007 and 2006, the
net interest margin was 3.77% and 4.39%, respectively. The decrease both the
interest spread and the net interest margin for the first nine months and third
quarter of 2007 as compared with the same periods in 2006 was principally due to
the need to support asset growth during the period with higher priced
certificates of deposits. Management continues to focus its efforts on the
attraction of cheaper transaction deposits to support its current asset base and
future growth.
Provision and Allowance for Loan Losses
The provision for loan losses charged to operating expenses reflects the amount
deemed appropriate by management to establish an adequate reserve to meet the
estimated losses in the current loan portfolio. Loans that are determined to be
uncollectible are charged against the allowance. Provisions for loan losses and
recoveries on loans previously charged off are added to the allowance. For the
nine months ended September 30, 2007 and 2006, the provision was $209,414 and
$339,723, respectively. For the three months ended September 30, 2007 and 2006,
the provision for loans losses was $117,900 and $88,700, respectively. The
allowance for loan losses represents 1.27% and 1.26% of gross loans at September
30, 2007 and 2006, respectively.
There are risks inherent in making all loans, including risks with respect to
the period of time over which loans may be repaid, risks resulting from changes
in economic and industry conditions, risks inherent in dealing with individual
borrowers, and, in the case of a collateralized loan, risks resulting from
uncertainties about the future value of the collateral. We maintain an allowance
for loan losses based on, among other things, an evaluation of economic
conditions, and regular reviews of delinquencies and loan portfolio quality. Our
judgment about the adequacy of the allowance is based upon a number of estimates
and assumptions about present conditions and future events, which we believe to
be reasonable, but which may not prove to be accurate. Management continuously
reviews the loan portfolio and grades the portfolio based on the Company's
historical experience and underwriting standards. Management has changed its
allocation process to provide for specifically identified loans, or homogeneous
loan categories. As a result, the provision expense for the first nine months of
2007 reflects this change. However, management is aware that there is a risk
that charge-offs in future periods could exceed the allowance for loan losses or
that substantial additional increases in the allowance for loan losses could be
required. Additions to the allowance for loan losses would result in a decrease
of our net income and, possibly, our capital.
-13-
CAROLINA NATIONAL CORPORATION
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations - continued
Noninterest Income
Noninterest income for the nine month periods ended September
30, 2007 and 2006 was $284,059 and $299,858, respectively. Of this total,
$195,727 and $162,569, respectfully, was generated from service charges on
deposit accounts, which includes NSF fees. Residential mortgage origination fees
totaled $16,905 and $73,303 for the nine months ended September 30, 2007 and
2006, respectively. The increase in service charges was the result of an
increase in the number of transaction deposit accounts between the two periods.
For the quarters ended September 30, 2007 and 2006, noninterest income was
$101,060 and $92,951, respectively. Of this total, $69,547 and $52,649,
respectfully, was generated from service charges on deposit accounts, and $6,092
and $19,180, respectively, was generated from residential mortgage origination
fees. The increase in service charges for the first nine months and third
quarter of 2007 over 2006 is primarily the result of improved earnings on
deposit services due to management's emphasis on the attraction of transaction
deposit products during both periods. The decline in earnings related to
residential mortgage origination fees for both the first nine months and the
three months ending September 30, 2007 from the same period last year was
primarly due the change in demand for both the national and local markets for
residential home sales.
Noninterest Expense
Total noninterest expense for the nine months ended September 30, 2007 and 2006
was $4,538,874 and $3,460,965, respectively. This represents an increase of
$1,077,910, or 31.1% over the comparable period of 2006. Salaries and employee
benefits, increased from $1,756,661 for the nine months ended September 30, 2006
to $2,115,590 for the nine months ended September 30, 2007. This increase is
mostly attributable to the hiring of additional staff to strengthen the
infrastructure of the bank and to meet the growing needs of the bank, as well
as, the hiring of staff to support the opening of a new full service branch
during the fourth quarter of 2006.
Net occupancy expense for both the nine month period and three month period
ended September 30, 2007 was $657,489 as compared to $452,421 and $226,506 as
compared to $156,345 for the same periods a year earlier. The increase in
occupancy expense for the both periods reported for 2007 over the same periods
of 2006 is principally due to the opening of a new full service branch during
the fourth quarter of 2006 and the relocation of the operations department
during the second quarter of 2007.
For the quarter ended September 30, 2007, noninterest expense was $1,703,950, as
compared to $1,211,659 for the same period in 2006. Increased salaries and
benefits, and other operating expenses were the largest noninterest expenses
during the quarter ending September 30 2007, as salaries and benefits increased
by $134,023 for the third quarter of 2007 over the same period reported in 2006
due to additional staffing for the full service branch which opened during the
fourth quarter of 2006 and additional staff hired to strengthen the bank's
infrastructure.
Total other operating expenses increased by $513,913 for the first nine months
and $288,107 during the third quarter of 2007 over the same two periods in 2006.
The increase in other operating expenses for the first nine months of 2007 was
largely due to operating and data processing expenses to support the branch
location opened in the fourth quarter of 2006 and expenses related to the
pending merger with First National Bancshares, Inc., (First National). The
increase in other operating expenses for the third quarter of 2007 over the same
period in 2006 was almost entirely related to costs associated with the pending
merger with First National.
Income Taxes
An income tax expense of $703,155 and $141,689 was recorded for the nine and
three month periods ending September 30, 2007, respectively. This compares to an
income tax expense of $829,677 and $325,452 for the nine and three month periods
in 2006. This represents an effective tax rate of 36.1% and 35.3% for the nine
month periods ending September 30, 2007 and 2006, respectively.
Net Income
The combination of the above factors resulted in a net income of $1,242,430 for
the nine months ended September 30, 2007 as compared to net income of $1,518,355
for the same period in 2006. The decline in net income for the nine months ended
September 30, 2007 is primarily the result of additional expenses to support the
new full service branch opened during the fourth quarter of 2006, increased
expenses to strengthen the bank's infrastructure and nonrecurring expenses
related to the pending merger with First National. The net income before taxes
of $1,945,587 was offset by an income tax expense of $703,155 for the nine
months ended September 30, 2007. The net income before taxes of $2,348,032 was
offset by an income tax expense of $829,677 for the nine months ended September
30, 2006. For the same reasons the net income for the three months ended
September 30, 2007 was $255,410, as compared to a net income of $529,202 for the
same period in 2006.
-14-
CAROLINA NATIONAL CORPORATION
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations- continued
Financial Condition
Assets and Liabilities
During the first nine months of 2007, total assets increased $19,114,275, or
9.1%, when compared to December 31, 2006. Federal funds sold increased to
$17,690,000 at September 30, 2007 as total deposits grew by $18,746,180 during
the period to support loan growth and to increase the bank's liquidity position.
Total loans increased $9,688,100, or 5.0%, during the first nine months of 2007.
As previously mentioned, total deposits increased by $18,746,180, or 10.7% from
the December 31, 2006 amount of $175,582,183. Time deposits increased
$26,347,259, or 23.4%, during the first nine months of 2007. Savings and money
market deposits decreased by 21.0% during the reporting period, while total
transaction deposits decreased by 1.0%.
Loans
The bank experienced modest loan growth during the first nine months of 2007 as
we continued to work to establish our presence in the marketplace. Gross loans,
net of unearned income, increased $9,688,100, or 5.0%, during the period. As
shown below, the largest category of the loan portfolio was construction loans,
which increased 21.7%, or $9,686,987 from December 31, 2006 to September 30,
2007. Balances within the major loans receivable categories as of September 30,
2007 and December 31, 2006 are as follows:
September 30, December 31,
2007 2006
---- ----
Mortgage loans on real estate:
Residential 1-4 Family ............................................ $ 22,682,575 $ 24,574,431
Multifamily ....................................................... 565,418 937,203
Commercial ........................................................ 78,727,416 73,015,515
Construction ...................................................... 54,395,650 44,708,663
Second Mortgage loans ............................................. 1,749,276 1,498,413
Equity Lines of Credit ............................................ 27,222,724 27,429,465
------------ ------------
185,343,059 172,163,690
Commercial and industrial ................................................ 16,611,553 20,363,359
Consumer ................................................................. 2,518,212 2,257,674
------------ ------------
Total loans, net of unearned income ...................................... $204,472,824 $194,784,723
============ ============
Risk Elements in the Loan Portfolio
Criticized loans are loans that have potential weaknesses that deserve close
attention and which could, if uncorrected, result in deterioration of the
prospects for repayment or our credit position at a future date. Classified
loans are loans that are inadequately protected by the sound worth and paying
capacity of the borrower or any collateral and as to which there is a distinct
possibility or probability that we will sustain a loss if the deficiencies are
not corrected. At September 30, 2007, the bank had four criticized loans
totaling $1,394,325 and sixteen classified loans totaling $4,327,928. As of
December 31, 2006, the bank had three criticized loans totaling $1,592,879 and
eight classified loans totaling $653,313. Of the classified loans for September
30, 2007, fourteen loans totaling $2,956,049 were on nonaccrual status, and at
December 31, 2006 all eight classified loans were on nonaccrual status. Had the
fourteen loans in nonaccrual status as of September 30, 2007 remained on accrual
status, the bank would have recognized an additional $55,114 in interest income
for the period. The fourteen loans in nonaccrual status as of September 30, 2007
are collateralized with real estate and, accordingly, the bank expects to
recover most of the principal balances of those loans. As of September 30, 2007
the bank had no loans 90 days, or more past due and accruing interest. At
December 31, 2006 the bank had one loan 90 days, or more past due in the amount
of $425,000 and accruing interest. This loan was brought current during the
first quarter of 2007.
-15-
CAROLINA NATIONAL CORPORATION
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations - continued
Allowance for Loan Losses
Activity in the Allowance for Loan Losses for the nine months ended September
30, 2007 and 2006 is as follows:
Nine Months Ended
September 30,
-------------
2007 2006
---- ----
Balance, January 1, .............................................................. $ 2,434,900 $ 1,882,099
Provision for loan losses for the period ......................................... 209,414 339,723
Net loans charged-off for the period ............................................. (51,214) (2,222)
------------- -------------
Balance, end of period ........................................................... $ 2,593,100 $ 2,219,600
============= =============
Gross loans outstanding, end of period ........................................... $ 204,472,824 $ 176,151,799
Allowance for loan losses to loans outstanding, end of period .................... 1.27% 1.26%
Deposits
For the nine months ended September 30, 2007, total deposits increased by
$18,746,180, or 10.7%, from December 31, 2006. The largest increase was in time
deposits, which increased $26,347,259, or 23.4%, from December 31, 2006 to the
nine months ended September 30, 2007. This increase was attributable to the need
to acquire funds to support the loan growth experienced during the period,
improve the bank's liquidity position and offset the decrease in transaction
deposit balances during the period. Expressed in percentages,
noninterest-bearing deposits increased 5.5% , while all other interest-bearing
deposits , excluding certificate of deposits, decreased by 18.9%. For the nine
months ended September 30, 2007, brokered deposits totaled $53,139,000 which
represents a 16.9% increase over the December 31, 2006 brokered deposit total of
$45,446,000. As of September 30, 2007 the scheduled maturity of brokered CD's
was approximately $9,099,000 maturing in 2007, $40,186,000 maturing in 2008, and
$3,854,000 in 2009.
Balances within the major deposit categories as of September 30, 2007 and
December 31, 2006 are as follows:
September 30, December 31,
2007 2006
---- ----
Noninterest-bearing demand deposits ...................................... $ 18,643,769 $ 17,666,870
Interest-bearing demand deposits ......................................... 9,055,180 10,307,063
Savings and money market ................................................. 27,645,739 34,971,834
Time deposits $100,000 and over .......................................... 80,160,409 65,233,757
Other time deposits ...................................................... 58,823,266 47,402,659
------------ ------------
$194,328,363 $175,582,183
============ ============
Time deposits of $100,000 and over included brokered deposits of $53,139,000 as
of September 30, 2007, and $45,446,000 as of December 31, 2006.
-16-
CAROLINA NATIONAL CORPORATION
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations - continued
Off-Balance Sheet Risk
Through its operations, the bank has made contractual commitments to extend
credit in the ordinary course of its business activities. These commitments are
legally binding agreements to lend money to the bank's customers at
predetermined interest rates for a specified period of time. At September 30,
2007, the bank had issued commitments to extend credit of $40,648,367 and
standby letters of credit of $2,910,131 through various types of commercial
lending arrangements. Approximately $38,192,083, or 87.7% of these commitments
to extend credit had variable rates.
The following table sets forth the length of time until maturity for unused
commitments to extend credit and standby letters of credit at September 30,
2007.
After One After Three
Within Through Through Within Greater
One Three Twelve One Than
Month Months Months Year One Year Total
----- ------ ------ ---- -------- -----
Unused commitments
to extend credit ........... $ 449,018 $ 696,750 $13,999,530 $15,145,298 $25,503,069 $40,648,367
Standby letters .............. - 2,500 2,907,631 2,910,131 - 2,910,131
of credit
----------- ----------- ----------- ----------- ----------- -----------
Totals ..................... $ 449,018 $ 699,250 $16,907,161 $18,055,429 $25,503,069 $43,558,498
=========== =========== =========== =========== =========== ===========
Based on historical experience in the banking industry, we expect that many of
the commitments and letters of credit will expire unused or not fully funded.
Accordingly, the amounts in the table above do not necessarily reflect the
bank's need for funds in the periods shown.
The bank evaluates each customer's credit worthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary by the bank upon
extension of credit, is based on its credit evaluation of the borrower.
Collateral varies but may include accounts receivable, inventory, property,
plant and equipment, and commercial and residential real estate.
Liquidity
Liquidity management involves monitoring our sources and uses of funds in order
to meet our day-to-day cash flow requirements while maximizing profits.
Liquidity represents the ability of a company to convert assets into cash or
cash equivalents without significant loss and to raise additional funds by
increasing liabilities. Without proper liquidity management, we would not be
able to perform the primary function of a financial intermediary and would,
therefore, not be able to meet the needs of the communities we serve.
Liquidity management is made more complex because different balance sheet
components are subject to varying degrees of management control. For example,
the timing of maturities of the investment portfolio is relatively predictable
and subject to control at the time investment decisions are made. However, net
deposit inflows and outflows are far less predictable and are not subject to
nearly the same degree of control.
We meet our liquidity needs by structuring aggregate maturity terms of loans and
investments to coincide with aggregate maturity terms of funding sources while
maintaining sufficient excess funds for unplanned contingencies. One measure of
liquidity is the loan-to-total borrowed funds (which includes deposits) ratio,
which was at 105.2% at September 30, 2007 and 110.3% at December 31, 2006.
Federal Funds sold which totaled $17,690,000 at September 30, 2007, are a ready
source of liquidity. We also have a short term line of credit available with a
correspondent bank to purchase federal funds for periods from one to fourteen
days. At September 30, 2007, the above unused federal funds borrowing line of
credit totaled $6,200,000. We also have a line of credit to borrow funds from
the Federal Home Loan Bank of Atlanta up to 10% of the Bank's total assets
reported at the end of each previous quarter, which gave us the ability to
borrow up to $22,566,657 at September 30, 2007. At September 30, 2007, no funds
were borrowed from the Federal Home Loan Bank line. We also have a line of
credit to borrow funds from Chase Bank up to $10,000,000. As of September 30,
2007, no funds had been drawn on the Chase Bank line.
-17-
CAROLINA NATIONAL CORPORATION
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations- continued
Capital Resources
Total shareholders' equity increased from $30,592,975 at December 31, 2006 to
$32,029,352 at September 30, 2007. The increase is due to stock-based
compensation of $52,748, the exercise of stock options of $141,200 and net
income for the period of $1,242,430.
The bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a material effect on the bank's
financial position. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the bank must meet specific capital
guidelines that involve quantitative measures of the bank's assets, liabilities,
and certain off-balance-sheet items as calculated under regulatory accounting
practices. The bank's capital amounts and classifications are also subject to
qualitative judgments by the regulators about components, risk weightings, and
other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the bank to maintain minimum ratios of Tier 1 and total capital as a
percentage of assets and off-balance-sheet exposures, adjusted for risk weights
ranging from 0% to 100%. Tier 1 capital of the bank consists of common
shareholders' equity, excluding the unrealized gain or loss on securities
available-for-sale, minus certain intangible assets. The bank's Tier 2 capital
consists of the allowance for loan losses and subordinated debt subject to
certain limitations. Total capital for purposes of computing the capital ratios
consists of the sum of Tier 1 and Tier 2 capital. The regulatory minimum
requirements are 4% for Tier 1 capital and 8% for total risk-based capital.
The bank is also required to maintain capital at a minimum level based on
quarterly average assets, which is known as the leverage ratio. Only the
strongest banks are allowed to maintain capital at the minimum requirement of
3%. All others are subject to maintaining ratios 1% to 2% above the minimum.
The Federal Deposit Insurance Corporation has established risk-based capital
requirements for banks and the Federal Reserve has established similar
requirements for bank holding companies. As of September 30, 2007, the Company
exceeded the adequately capitalized requirement of the Federal Reserve, and the
bank exceeded the well capitalized and adequately capitalized requirement of the
FDIC as shown in the following table.
Capital Ratios
--------------
Adequately Capitalized Well Capitalized
(Dollars in thousands) Actual Requirement Requirement
------ ----------- -----------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
The Bank
Total capital (to risk-weighted assets) .............. $31,462 14.98% $16,801 8.00% $21,001 10.00%
Tier 1 capital (to risk-weighted assets) ............. 28,869 13.75% 7,986 4.00% 12,186 6.00%
Tier 1 capital (to average assets) ................... 28,869 13.15% 8,365 4.00% 10,559 5.00%
The Company
Total capital (to risk-weighted assets) .............. $34,208 16.28% $16,809 8.00% $ N/A N/A
Tier 1 capital (to risk-weighted assets) ............. 31,615 15.05% 7,990 4.00% N/A N/A
Tier 1 capital (to average assets) ................... 31,615 14.40% 8,365 4.00% N/A N/A
We have a credit facility with Chase Bank which will allow us to borrow up to
$10 million, subject to a number of conditions, which we could use to increase
the total regulatory capital of the Bank up to 50% of Tier 1 capital. At
September 30, 2007, we did not have any monies borrowed on this line of credit.
-18-
CAROLINA NATIONAL CORPORATION
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations- continued
Critical Accounting Policies
We have adopted various accounting policies which govern the application of
accounting principles generally accepted in the United States of America in the
preparation of our financial statements. Our significant accounting policies are
described in the notes to the consolidated financial statements at December 31,
2006 as filed in our annual report on Form 10-KSB. Certain accounting policies
involve significant judgments and assumptions by us which have a material impact
on the carrying value of certain assets and liabilities. We consider these
accounting policies to be critical accounting policies. The judgments and
assumptions we use are based on historical experience and other factors, which
we believe to be reasonable under the circumstances. Because of the nature of
the judgments and assumptions we make, actual results could differ from these
judgments and estimates which could have a major impact on the carrying values
of our assets and liabilities and our results of operations.
We believe the allowance for loan losses is a critical accounting policy that
requires the most significant judgments and estimates used in preparation of our
consolidated financial statements. Refer to the portions of our 2006 Annual
Report on Form 10-KSB and this Form 10-Q that address our allowance for loan
losses for description of our processes and methodology for determining our
allowance for loan losses.
Impact of Inflation
Unlike most industrial companies, the assets and liabilities of financial
institutions such as the Bank are primarily monetary in nature. Therefore,
interest rates have a more significant effect on the Bank's performance than do
the effects of changes in the general rate of inflation and changes in prices.
In addition, interest rates do not necessarily move in the same direction or in
the same magnitude as the prices of goods and services. As discussed previously,
management seeks to manage the relationships between interest sensitive assets
and liabilities in order to protect against wide interest rate fluctuations,
including those resulting from inflation.
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
Market risk is the risk of loss from adverse changes in market prices and rates.
Our market risk arises principally from interest rate risk inherent in our
lending, deposit, and borrowing activities. Management actively monitors and
manages its interest rate risk exposure. In addition to other risks that we
manage in the normal course of business, such as credit quality and liquidity,
management considers interest rate risk to be a significant market risk that
could potentially have a material effect on our financial condition and results
of operations. Other types of market risks, such as foreign currency risk and
commodity price risk, do not arise in the normal course of our business
activities.
The primary objective of asset and liability management is to manage interest
rate risk and achieve reasonable stability in net interest income throughout
interest rate cycles. This is achieved by maintaining the proper balance of
rate-sensitive earning assets and rate-sensitive interest-bearing liabilities.
The relationship of rate-sensitive earning assets to rate-sensitive
interest-bearing liabilities is the principal factor in projecting the effect
that fluctuating interest rates will have on future net interest income.
Rate-sensitive assets and liabilities are those that can be repriced to current
market rates within a relatively short time period. Management monitors the rate
sensitivity of earning assets and interest-bearing liabilities over the entire
life of these instruments, but places particular emphasis on the next twelve
months. At September 30, 2007, on a cumulative basis through 12 months,
rate-sensitive liabilities exceeded rate-sensitive assets by approximately $43
million, or 18.9%. This liability-sensitive position is largely attributable to
fixed rate loans being funded by short term liabilities. Management has
implemented a new calling program to gather core deposits as a strategy to
lengthen the average terms of liabilities.
Item 4T. Controls and Procedures
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.
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.
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CAROLINA NATIONAL CORPORATION
PART II - OTHER INFORMATION
Item 6. Exhibits
Exhibits:
Exhibit 10.1 - Agreement and Plan of Merger by and between First National
Bancshares, Inc., and Carolina National Corporation dated as of August 26,
2007. (Incorporated by reference to Exhibit 99 to Current Report on Form
8-K filed on August 28, 2007 by First National Bancshares, Inc., SEC
Accession No. 000114204-07-046755.)
Exhibit 31.1 - Certification of Principal Executive Officer required by
Rule 13a-14(a) or Rule 15d - 14(a) of the Securities Exchange Act of 1934,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2 - Certification of Principal Financial Officer required by
Rule 13a-14(a) or Rule 15d - 14(a) of the Securities Exchange Act of 1934,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.1 - Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
Exhibit 32.2 - Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
By: s/Roger B. Whaley
------------------------------------
Roger B. Whaley
Date: November 13, 2007 President & Chief Executive Officer
By: s/Harry R. Brown
------------------------------------
Harry R. Brown
Date: November 13, 2007 Chief Financial Officer
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CAROLINA NATIONAL CORPORATION
EXHIBIT INDEX
10.1 Agreement and Plan of Merger by and between First National Bancshares,
Inc., and Carolina National Corporation dated as of August 26, 2007.
(Incorporated by reference to Exhibit 99 to Current Report on Form 8-K
filed on August 28, 2007 by First National Bancshares, Inc., SEC
Accession No. 000114204-07-046755.)
31.1 Certification of Principal Executive Officer required by Rule 13a-14(a)
or Rule 15d - 14(a) of the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Principal Financial Officer required by Rule 13a-14(a)
or Rule 15d - 14(a) of the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 o of the Sarbanes-Oxley Act of
2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
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