UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________
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 MARCH 31, 2003
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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 Number 000-27205
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PEOPLES BANCORP OF NORTH CAROLINA, INC.
---------------------------------------
(Exact name of registrant as specified in its charter)
NORTH CAROLINA 56-2132396
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
518 WEST C STREET
NEWTON, NORTH CAROLINA 28658
---------------------- -----
(Address of principal executive office) (Zip Code)
(828) 464-5620
--------------
(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 an accelerated filer (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.
3,133,547 SHARES OF COMMON STOCK, NO PAR VALUE, OUTSTANDING AT MAY 14, 2003.
- ----------------------------------------------------------------------------
INDEX
PART I - FINANCIAL INFORMATION PAGE(S)
Item 1. Financial Statements
Consolidated Balance Sheets at March 31, 2003 (Unaudited) and
December 31, 2002 3
Consolidated Statements of Earnings for the three months ended
March 31, 2003 and 2002 (Unaudited) 4
Consolidated Statements of Comprehensive Income for the three
months ended March 31, 2003 and 2002 (Unaudited) 5
Consolidated Statements of Cash Flows for the three months ended
March 31, 2003 and 2002 (Unaudited) 6-7
Notes to Consolidated Financial Statements (Unaudited) 8-10
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations 11-15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 16
Item 4. Controls and Procedures 17
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 18
Item 2. Changes in Securities and Use of Proceeds 18
Item 3. Defaults upon Senior Securities 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 18-19
Signatures 20
Certifications 21-22
This Form 10-Q contains forward-looking statements. These statements are
subject to certain risks and uncertainties that could cause actual results to
differ materially from those anticipated in the forward-looking statements.
Factors that might cause such a difference include, but are not limited to,
changes in interest rate environment, management's business strategy, national,
regional, and local market conditions and legislative and regulatory conditions.
Readers should not place undue reliance on forward-looking statements,
which reflect management's view only as of the date hereof. The Company
undertakes no obligation to publicly revise these forward-looking statements to
reflect subsequent events or circumstances. Readers should also carefully
review the risk factors described in other documents the Company files from time
to time with the Securities and Exchange Commission.
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
March 31, December 31,
Assets 2003 2002
- ------ ------------- ------------
(Unaudited)
Cash and due from banks $ 15,596,019 13,803,665
Federal funds sold 15,144,000 1,774,000
------------- ------------
Cash and cash equivalents 30,740,019 15,577,665
Investment securities available for sale 70,555,422 71,735,705
Other investments 4,271,973 4,345,573
------------- ------------
Total securities 74,827,395 76,081,278
Mortgage loans held for sale 5,786,084 5,064,635
Loans, net 521,260,319 519,121,840
Premises and equipment, net 15,224,207 15,620,977
Cash surrender value of life insurance 4,891,598 4,828,708
Accrued interest receivable and other assets 8,602,454 8,446,435
------------- ------------
Total assets $ 661,332,076 644,741,538
============= ============
Liabilities and Shareholders' Equity
------------------------------------
Deposits:
Non-interest bearing demand $ 69,411,825 67,398,458
NOW, MMDA & savings 152,260,665 156,554,189
Time, $100,000 or more 180,963,909 160,836,596
Other time 134,107,971 130,949,712
------------- ------------
Total deposits 536,744,370 515,738,955
Demand notes payable to U.S. Treasury 537,019 1,600,000
FHLB borrowings 58,000,000 63,071,429
Trust preferred securities 14,000,000 14,000,000
Accrued interest payable and other liabilities 2,355,144 1,726,421
------------- ------------
Total liabilities 611,636,533 596,136,805
------------- ------------
Shareholders' equity:
Preferred stock, no par value; authorized
5,000,000 shares; no shares issued
and outstanding - -
Common stock, no par value; authorized
20,000,000 shares; issued and
outstanding 3,133,547 shares 35,097,773 35,097,773
Retained earnings 13,199,096 12,094,363
Accumulated other comprehensive income 1,398,674 1,412,597
------------- ------------
Total shareholders' equity 49,695,543 48,604,733
------------- ------------
Total liabilities and shareholders' equity $ 661,332,076 644,741,538
============= ============
See accompanying notes to consolidated financial statements.
3
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
Consolidated Statements of Earnings (Unaudited)
Three months ended March 31, 2003 and 2002
2003 2002
------------ ---------
Interest income:
Interest and fees on loans $ 7,783,423 7,815,535
Interest on federal funds sold 16,929 10,748
Interest on investment securities:
U.S. Government agencies 635,126 700,696
States and political subdivisions 149,661 440,443
Other 108,967 121,732
------------ ---------
Total interest income 8,694,106 9,089,154
------------ ---------
Interest expense:
NOW, MMDA & Savings deposits 306,760 510,353
Time deposits 2,102,756 3,218,866
FHLB borrowings 659,941 684,909
Trust preferred securities 166,250 183,750
Other 2,236 9,634
------------ ---------
Total interest expense 3,237,943 4,607,512
------------ ---------
Net interest income 5,456,163 4,481,642
Provision for loan losses 793,000 500,000
------------ ---------
Net interest income after provision for loan losses 4,663,163 3,981,642
------------ ---------
Other income:
Service charges 772,151 660,496
Other service charges and fees 159,438 162,868
Mortgage banking income 190,357 229,954
Insurance and brokerage commissions 96,961 119,628
Gain on sale of credit card portfolio 478,759 -
Miscellaneous 286,692 350,997
------------ ---------
Total other income 1,984,358 1,523,943
------------ ---------
Other expense:
Salaries and employee benefits 2,563,794 2,437,002
Occupancy 834,889 759,342
Other 1,048,250 1,018,365
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Total other expenses 4,446,933 4,214,709
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Earnings before income taxes 2,200,588 1,290,876
Income taxes 782,500 405,000
------------ ---------
Net earnings $ 1,418,088 885,876
============ =========
Net earnings per share $ 0.45 0.28
============ =========
Diluted earnings per share $ 0.45 0.28
============ =========
Cash dividends declared per share $ 0.10 0.10
============ =========
See accompanying notes to consolidated financial statements.
4
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Unaudited)
Three months ended March 31, 2003 and 2002
2003 2002
------------- ---------
Net earnings $ 1,418,088 885,876
------------- ---------
Other comprehensive income, net of tax:
Unrealized gains (losses) on investment securities, net
of taxes of $37,078 and $(76,732), respectively 58,116 (120,269)
Unrealized (loss) on derivative financial instruments
qualifying as cash flow hedges, net of tax of
$(45,961) and $0, respectively (72,039) -
------------- ---------
Other comprehensive income (13,923) (120,269)
------------- ---------
Comprehensive income $ 1,404,165 765,607
============= =========
See accompanying notes to consolidated financial statements.
5
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
Three months ended March 31, 2003 and 2002
2003 2002
------------- ------------
Cash flows from operating activities:
Net earnings $ 1,418,088 885,876
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Depreciation, amortization and accretion 457,488 373,361
Provision for loan losses 793,000 500,000
Gain on sale of mortgage loans - (16,852)
Gain on sale of other real estate - (12,290)
Change in:
Cash surrender value of life insurance (62,890) (61,427)
Other assets (342,364) (412,167)
Other liabilities 628,723 809,303
Mortgage loans held for sale (721,449) 1,473,961
------------- ------------
Net cash provided by operating activities 2,170,596 3,539,765
------------- ------------
Cash flows from investing activities:
Purchase of investment securities available-for-sale (4,503,287) (500,000)
Proceeds from calls and maturities of investment securities
available-for-sale 5,743,587 4,753,519
Change in other investments 73,600 (300,000)
Net change in loans (2,963,688) (4,725,660)
Proceeds (purchases) of premises and equipment 83,895 (327,946)
Proceeds from sale of other real estate - 183,173
------------- ------------
Net cash used in investing activities (1,565,893) (916,914)
------------- ------------
Cash flows from financing activities:
Net change in deposits 21,005,415 8,250,339
Net change in demand notes payable to U.S. Treasury (1,062,981) 1,482,013
Proceeds from FHLB borrowings 29,850,000 10,000,000
Repayments of FHLB advances (34,921,428) (16,071,429)
Transaction costs associated with trust preferred securities - (35,699)
Common stock repurchased - (1,146,250)
Proceeds from exercise of options - 4,225
Cash dividends (313,355) (314,538)
------------- ------------
Net cash provided by financing activities 14,557,651 2,168,661
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Net change in cash and cash equivalents 15,162,354 4,791,512
Cash and cash equivalents at beginning of the period 15,577,665 15,303,320
------------- ------------
Cash and cash equivalents at end of the period $ 30,740,019 20,094,832
============= ============
6
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
Three months ended March 31, 2003 and 2002
(Continued)
2003 2002
------------- ------------
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 3,288,321 4,655,903
Income taxes $ 53,397 -
Noncash investing and financing activities:
Change in net unrealized gain (loss) on investment securities
available for sale and derivative financial instruments, net of tax $ (13,923) (120,269)
Transfer of loans to other real estate $ 32,209 -
See accompanying notes to consolidated financial statements.
7
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
(1) Summary of Significant Accounting Policies
----------------------------------------------
The consolidated financial statements include the financial statements of
Peoples Bancorp of North Carolina, Inc. and its wholly owned subsidiaries,
PEBK Capital Trust I and Peoples Bank (the "Bank"), along with the Bank's
wholly owned subsidiaries, Peoples Investment Services, Inc. and Real
Estate Advisory Services, Inc. (collectively called the "Company"). All
significant intercompany balances and transactions have been eliminated in
consolidation.
The consolidated financial statements in this report are unaudited. In the
opinion of management, all adjustments (none of which were other than
normal accruals) necessary for a fair presentation of the financial
position and results of operations for the periods presented have been
included.
Management of the Company has made a number of estimates and assumptions
relating to reporting of assets and liabilities and the disclosure of
contingent assets and liabilities to prepare these consolidated financial
statements in conformity with accounting principles generally accepted in
the United States of America. Actual results could differ from those
estimates.
Critical Accounting Policies
------------------------------
The Company's accounting policies are fundamental to understanding
management's discussion and analysis of results of operations and financial
condition. Many of the Company's accounting policies require significant
judgment regarding valuation of assets and liabilities and/or significant
interpretation of the specific accounting guidance. A description of the
Company's significant accounting policies can be found in Note 1 of the
Notes to Consolidated Financial Statements in the Company's 2003 Annual
Report to Shareholders which is Appendix A to the Proxy Statement for the
May 1, 2003 Annual Meeting of Shareholders. The following is a summary of
the more judgmental and complex accounting policies of the Company.
Many of the Company's assets and liabilities are recorded using various
valuation techniques that require significant judgment as to
recoverability. The collectability of loans is reflected through the
Company's estimate of the allowance for loan losses. The Company performs
periodic and systematic detailed reviews of its lending portfolio to assess
overall collectability. In addition, certain assets and liabilities are
reflected at their estimated fair value in the consolidated financial
statements. Such amounts are based on either quoted market prices or
estimated values derived by the Company utilizing dealer quotes or market
comparisons.
There are other complex accounting standards that require the Company to
employ significant judgment in interpreting and applying certain of the
principles prescribed by those standards. These judgments include, but are
not limited to, the determination of whether a financial instrument or
other contract meets the definition of a derivative in accordance with
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (SFAS 133), and the
applicable hedge deferral criteria and the accounting for the transfer of
financial assets and extinguishments of liabilities in accordance with the
Statement of Financial Accounting Standards No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities" (SFAS 140).
(2) Allowance for Loan Losses
----------------------------
The following is an analysis of the allowance for loan losses for the three
months ended March 31, 2003 and 2002:
2003 2002
----------- ----------
Balance, beginning of period $7,247,906 6,090,570
Provision for loan losses 793,000 500,000
Less:
Charge-offs (483,696) (153,956)
Recoveries 48,914 45,280
----------- ----------
Net charge-offs (434,782) (108,676)
----------- ----------
Balance, end of period $7,606,124 5,115,241
=========== ==========
8
(3) Net Earnings Per Share
----------------------
Net earnings per common share is based on the weighted average number of
common shares outstanding during the period while the effects of potential
common shares outstanding during the period are included in diluted
earnings per share. The average market price during the year is used to
compute equivalent shares.
The reconciliation of the amounts used in the computation of both "basic
earnings per share" and "diluted earnings per share" for the three months
ended March 31, 2003 and 2002 is as follows:
For the three months ended March 31, 2003
- -----------------------------------------
Per Share
Net Earnings Common Shares Amount
------------- ------------- -------
Basic earnings per share $ 1,418,088 3,133,547 $ 0.45
=======
Effect of dilutive securities:
Stock options - 7,922
------------- -------------
Diluted earnings per share $ 1,418,088 3,141,469 $ 0.45
============= ============= =======
For the three months ended March 31, 2002
- -----------------------------------------
Per Share
Net Earnings Common Shares Amount
------------- ------------- -------
Basic earnings per share $ 885,876 3,186,238 $ 0.28
=======
Effect of dilutive securities:
Stock options - 6,553
------------- -------------
Diluted earnings per share $ 885,876 3,192,791 $ 0.28
============= ============= =======
(4) Derivative Instruments and Hedging Activities
-------------------------------------------------
In the normal course of business, the Company enters into derivative
contracts to manage interest rate risk by modifying the characteristics of
the related balance sheet instruments in order to reduce the adverse effect
of changes in interest rates. All derivative financial instruments are
recorded at fair value in the financial statements.
On the date a derivative contract is entered into, the Company designates
the derivative as a fair value hedge, a cash flow hedge, or a trading
instrument. Changes in the fair value of instruments used as fair value
hedges are accounted for in the earnings of the period simultaneous with
accounting for the fair value change of the item being hedged. Changes in
the fair value of the effective portion of cash flow hedges are accounted
for in other comprehensive income rather than earnings. Changes in fair
value of instruments that are not intended as a hedge are accounted for in
the earnings of the period of the change.
The Company formally documents all hedging relationships, including an
assessment that the derivative instruments are expected to be highly
effective in offsetting the changes in fair values or cash flows of the
hedged items.
As of March 31, 2003, the Company had cash flow hedges with a notional
amount of $60 million. These derivative instruments consisted of two
interest rate swap agreements that were used to convert floating rate loans
to fixed rate for a period of two years ending in June 2004 and July 2004.
Interest rate swap agreements generally involve the exchange of fixed and
variable rate interest payments between two parties, based on a common
notional principal amount and maturity date. The terms of the swaps are
determined based on management's assessment of future interest rates and
other factors. The Company recorded an asset of $1.4 million for the fair
value of these cash flow hedges resulting in an after-tax increase in other
comprehensive income of $842,500. As of March 31, 2003, no ineffectiveness
was recorded in earnings.
Additionally, on April 1, 2003, the Company entered into an interest rate
swap agreement with a notional amount of $25 million to be accounted for as
a cash flow hedge. This hedge transaction had no effect on the financial
statements of the Company as of March 31, 2003.
9
(5) Commitments and Contingencies
-------------------------------
The Company is party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend
credit, standby letters of credit and financial guarantees. Those
instruments involve, to varying degrees, elements of credit risk in excess
of the amount recognized in the balance sheet. The contract amounts of
those instruments reflect the extent of involvement the Company has in
particular classes of financial instruments. At March 31, 2003, the
contractual amounts of the Company's commitments to extend credit and
standby letters of credit were $104.8 million and $2.0 million,
respectively.
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates and because they may
expire without being drawn upon, the total commitment amount of $104.8
million does not necessarily represent future cash requirements. Standby
letters of credit and financial guarantees written are conditional
commitments issued by the Company to guarantee the performance of a
customer to a third party.
The Company has an overall interest rate-risk management strategy that
incorporates the use of derivative instruments to minimize significant
unplanned fluctuations in earnings that are caused by interest rate
volatility. By using derivative instruments, the Company is exposed to
credit and market risk. If the counterparty fails to perform, credit risk
is equal to the extent of the fair-value gain in the derivative. The
Company attempts to minimize the credit risk in derivative instruments by
entering into transactions with counterparties that are reviewed
periodically by the Company and are believed to be of high quality.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
Summary. Net earnings for the first quarter of 2003 were $1.4 million, or
$.45 basic and diluted net earnings per share. Net earnings from recurring
operations for the three months ended March 31, 2003 were $1.1 million, or $.36
basic and diluted net earnings per share, representing a 27% increase over first
quarter 2002 net earnings from recurring operations of $886,000, or $.28 basic
and diluted net earnings per share. Non-recurring income for the first quarter
of 2003 amounted to $294,000, net of income tax expense, associated with the
sale of the Bank's $3.7 million credit card portfolio. The Company did not have
any non-recurring income in first quarter 2002.
The annualized return on average assets was 0.88% and annualized return on
average shareholders' equity was 11.51% for the three months ended March 31,
2003. Excluding non-recurring income, the annualized return on average assets
was 0.70% for the three months ended March 31, 2003 compared to 0.58% for the
same period in 2002, and annualized return on average shareholders' equity was
9.18% for the three months ended March 31, 2003 compared to 7.78% for the same
period in 2002.
Net Interest Income. Net interest income, the major component of the
Company's net income, was $5.5 million for the three months ended March 31,
2003, an increase of 22% over the $4.5 million earned in the same period in
2002. The increase in 2003 first quarter net interest income was primarily
attributable to a decrease in the cost of funds.
Interest income decreased $395,000 or 4% for the three months ended March
31, 2003 compared with the same period in 2002. The decrease was due to a
decrease in the yield on earning assets, which is primarily attributable to
reductions in the prime commercial lending rate of the Bank, coupled with a
decrease in balances in the available-for-sale investment portfolio.
Interest expense decreased $1.4 million or 30% for the three months ended
March 31, 2003 compared with the same period in 2002. The decrease in interest
expense was due to a decrease in the cost of funds to 2.45% for the three months
ended March 31, 2003 from 3.61% for the same period in 2002, partially offset by
an increase in volume of interest bearing liabilities. The decrease in the cost
of funds is primarily attributable to a decrease in the average rate paid on
certificates of deposit to 2.79% for the three months ended March 31, 2003 from
4.55% for the same period one year ago.
Provision for Loan Losses. For the three months ended March 31, 2003 the
Bank provided $793,000 to the allowance for loan losses compared to $500,000 for
the three months ended March 31, 2002. The increase in the provision for loan
losses reflects an increase in non-performing assets resulting from the
continued slowdown in the local economy.
Non-Interest Income. Total non-interest income was $2.0 million in the
first quarter of 2003 as compared to $1.5 million for the same period in 2002.
Service charges were $772,000 for the three months ended March 31, 2003, a 17%
increase over the same period in 2002. This is primarily attributable to an
increase in account maintenance fees. The Company recognized a gain of $479,000
on the sale of the Bank's credit card portfolio during first quarter 2003.
Miscellaneous income decreased 18% to $287,000 for the three months ended March
31, 2003. The decrease in miscellaneous income is primarily attributable to a
reduction in merchant processing income, resulting from the sale of merchant
credit card processing services during second quarter 2002. Excluding
non-recurring income associated with the sale of the Bank's credit card
portfolio, non-interest income for the three months ended March 31, 2003
decreased 1% as compared to the same period last year.
Non-Interest Expense. Total non-interest expense was $4.4 million in the
first quarter of 2003, an increase of 6% over the same period in 2002. Salary
and employee benefits totaled $2.6 million for the three months ended March 31,
2003 as compared to $2.4 million for the first quarter of 2002. This increase is
11
primarily attributable to an increase in the accrual of management and employee
incentives and payroll taxes for the three months ended March 31, 2003.
Occupancy expense increased 10% for the quarter ended March 31, 2003 due to
overhead expenses associated with new branches. Other expense remained at $1.0
million for the three months ended March 31, 2003 and 2002.
Income Taxes. The Company reported income taxes of $783,000 and $405,000
for the first quarters of 2003 and 2002, respectively. This represented
effective tax rates of 36% and 31% for the respective periods. This increase in
the effective tax rate is attributable to a decrease in non-taxable interest
income.
ANALYSIS OF FINANCIAL CONDITION
Investment Securities. Available-for-sale securities amounted to $70.6
million at March 31, 2003 compared to $71.7 million at December 31, 2002. This
decrease is attributable to paydowns on mortgage-backed securities and
maturities, which were partially offset by additional securities purchases
during the three months ended March 31, 2003. Average investment securities for
the three months ended March 31, 2003 amounted to $69.1 million compared to
$77.4 million for the year ended December 31, 2002.
Loans. At March 31, 2003, loans amounted to $528.9 million compared to
$526.4 million at December 31, 2002, an increase of $2.5 million. Average loans
represented 87% of total earning assets for the three months ended March 31,
2003, compared to 86% for the year ended December 31, 2002. Mortgage loans held
for sale were $5.8 million and $5.1 million at March 31, 2003 and December 31,
2002, respectively.
Allowance for Loan Losses. The allowance for loan losses reflects
management's assessment and estimate of the risks associated with extending
credit and its evaluation of the quality of the loan portfolio. The Bank
periodically analyzes the loan portfolio in an effort to review asset quality
and to establish an allowance for loan losses that management believes will be
adequate in light of anticipated risks and loan losses. In assessing the
adequacy of the allowance, size, quality and risk of loans in the portfolio are
reviewed. Other factors considered are:
- the Bank's loan loss experience;
- the amount of past due and non-performing loans;
- specific known risks;
- the status and amount of other past due and non-performing assets;
- underlying estimated values of collateral securing loans;
- current and anticipated economic conditions; and
- other factors which management believes affect the allowance for
potential credit losses.
An analysis of the credit quality of the loan portfolio and the adequacy of
the allowance for loan losses is prepared by the Bank's credit administration
personnel and presented to the Bank's Executive and Loan Committee on a regular
basis. The allowance is the total of specific reserves allocated to significant
individual credits plus a general reserve. After individual loans with specific
allocations have been deducted, the general reserve is calculated by applying
general reserve percentages to the nine risk grades within the portfolio. Loans
are categorized as one of nine risk grades based on management's assessment of
the overall credit quality of the loan, including payment history, financial
position of the borrower, underlying collateral and internal credit review. The
general reserve percentages are determined by management based on its evaluation
of losses inherent in the various risk grades of loans. The allowance for loan
losses is established through charges to expense in the form of a provision for
loan losses. Loan losses and recoveries are charged and credited directly to
the allowance.
12
The following table presents the percentage of loans assigned to each risk
grade along with the general reserve percentage applied to loans in each risk
grade at March 31, 2003 and December 31, 2002.
LOAN RISK GRADE ANALYSIS: PERCENTAGE OF LOANS GENERAL RESERVE
BY RISK GRADE PERCENTAGE
------------------------------------------------
3/31/2003 12/31/2002 3/31/2003 12/31/2002
---------- ----------- ---------- -----------
Risk 1 (Excellent Quality) 9.30% 8.92% 0.15% 0.15%
Risk 2 (High Quality) 31.65% 33.19% 0.50% 0.50%
Risk 3 (Good Quality) 47.62% 46.28% 1.00% 1.00%
Risk 4 (Management Attention) 5.40% 5.33% 2.50% 2.50%
Risk 5 (Watch) 3.22% 3.32% 7.00% 7.00%
Risk 6 (Substandard) 1.29% 2.04% 12.00% 12.00%
Risk 7 (Low Substandard) 0.11% 0.03% 25.00% 25.00%
Risk 8 (Doubtful) 0.00% 0.00% 50.00% 50.00%
Risk 9 (Loss) 0.00% 0.01% 100.00% 100.00%
At March 31, 2003 there were four relationships exceeding $1 million each
(which totaled $10.9 million) in the Watch risk grade and two relationships
exceeding $1 million each (which totaled $4.9 million) in the Substandard risk
grade. Balances of individual relationships exceeding $1 million in these risk
grades ranged from $1.6 million to $3.9 million. If current operating conditions
for these customers remain stable, it is not expected that any of the
relationships with balances exceeding $1 million will become non-performing
assets within the next three to six months. If unforeseen events were to occur,
it is possible that the viability of one or more of these customers could
require the reclassification of their loans to non-accrual.
An allowance for loan losses is also established, as necessary, for
individual loans considered to be impaired in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 114. A loan is considered impaired
when, based on current information and events, it is probable that all amounts
due according to the contractual terms of the loan will not be collected.
Impaired loans are measured based on the present value of expected future cash
flows, discounted at the loan's effective interest rate, or at the loan's
observable market price, or the fair value of collateral if the loan is
collateral dependent. At March 31, 2003 and December 31, 2002, the recorded
investment in loans that were considered to be impaired under SFAS No. 114 was
approximately $7.8 million and $4.8 million, respectively, with related
allowance for loan losses of approximately $1.3 million and $676,000,
respectively.
The allowance for loan losses increased to $7.6 million or 1.44% of total
loans outstanding at March 31, 2003 as compared to $7.2 million, or 1.38% of
total loans outstanding as of December 31, 2002. This increase in the allowance
for loan losses is attributable to higher levels of loans included in the risk
grades Watch, Substandard and Low Substandard, which are the risk grades given
to loans with a greater risk of loss. The increase in Watch and Substandard is
due to the adverse impact of the slow economy.
The Bank's allowance for loan losses is also subject to regulatory
examinations and determinations as to adequacy, which may take into account such
factors as the methodology used to calculate the allowance for loan losses and
the size of the allowance for loan losses compared to a group of peer banks
identified by the regulators. During their routine examinations of banks, the
FDIC and the North Carolina Commissioner of Banks may require the Company to
recognize additions to the allowance based on their judgments about information
available to them at the time of their examination.
While it is the Bank's policy to charge off in the current period loans for
which a loss is considered probable, there are additional risks of future losses
which cannot be quantified precisely or attributed to particular loans or
classes of loans. Because these risks include the state of the economy,
management's judgment as to the adequacy of the allowance is necessarily
approximate and imprecise. After review of all relevant matters affecting loan
collectability, management believes that the allowance for loan losses is
appropriate.
The Company grants loans and extensions of credit primarily within the
Catawba Valley region of North Carolina, which encompasses Catawba, Alexander,
Iredell and Lincoln counties. Although the Bank has a diversified loan
portfolio, a substantial portion of the loan portfolio is collateralized by real
estate, which is dependent upon the real estate market. Non-real estate loans
also can be affected by local economic conditions.
13
At March 31, 2003, approximately 7% of the Company's portfolio was not secured
by any type of collateral. Unsecured loans generally involve higher credit risk
than secured loans and, in the event of customer default, the Company has a
higher exposure to potential loan losses.
Non-performing Assets. Non-performing assets totaled $9.6 million at March
31, 2003 or 1.45% of total assets, compared to $6.6 million at December 31,
2002, or 1.03% of total assets. Non-accrual loans were $7.4 million at March
31, 2003, an increase of $2.8 million from non-accruals of $4.6 million at
December 31, 2002. As a percentage of total loans outstanding, non-accrual
loans were 1.41% at March 31, 2003 compared to 0.87% at December 31, 2002. The
Bank had loans ninety days past due and still accruing at March 31, 2003 of
$335,000 as compared to $238,000 at December 31, 2002. Repossessed assets as of
March 31, 2003 and December 31, 2002 totaled $1.5 million and consisted of three
aircraft taken in collection of loans.
Total non-performing loans, which includes non-accrual loans and loans
ninety days past due and still accruing, were $7.8 million and $4.8 million at
March 31, 2003 and December 31, 2002, respectively. This increase was
significantly affected by a real estate development customer that was adversely
impacted by the slowdown in area businesses. The ratio of non-performing loans
to total loans was 1.47% at March 31, 2003, as compared to 0.92% at December 31,
2002.
Deposits. Total deposits at March 31, 2003 were $536.7 million, an
increase of 4% over deposits of $515.7 million at December 31, 2002.
Certificates of deposit in amounts greater than $100,000 or more totaled $181.0
million at March 31, 2003 as compared to $160.8 million at December 31, 2002.
At March 31, 2003, brokered deposits amounted to $54.8 million as compared to
$39.9 million at December 31, 2002. This reflects management's efforts to
manage the cost of funds by replacing high cost local deposits with lower cost
brokered deposits to fund loan growth. Brokered deposits are generally
considered to be more susceptible to withdrawal as a result of interest rate
changes and to be a less stable source of funds, as compared to deposits from
the local market.
Borrowed Funds. Borrowings from the Federal Home Loan Bank of Atlanta
("FHLB") totaled $58.0 million at March 31, 2003 compared to $63.1 million at
December 31, 2002. The average balance of FHLB borrowings for the three months
ended March 31, 2003 was $62.5 million compared to $61.0 million for the year
ended December 31, 2002. At March 31, 2003, FHLB borrowings with maturities
exceeding one year amounted to $58.0 million. The Company had no federal funds
purchased as of March 31, 2003 or December 31, 2002.
Interest Rate Risk Management. The objective of the Company's interest
rate risk management strategies is to identify and manage the sensitivity of net
interest income to changing interest rates, in order to achieve the Company's
overall financial goals.
The Company manages its exposure to fluctuations in interest rates through
policies established by the Asset/Liability Committee ("ALCO") of the Bank. The
ALCO meets monthly and has the responsibility for approving asset/liability
management policies, formulating and implementing strategies to improve balance
sheet positioning and/or earnings and reviewing the interest rate sensitivity of
the Company.
In order to assist in achieving a desired level of interest rate
sensitivity, the Company entered into off-balance sheet contracts that are
considered derivative financial instruments. These contracts consist of
interest rate swap agreements under which the Company converted $60.0 million of
variable rate loans to a fixed rate. At March 31, 2003, the Company had two
interest rate swap contracts outstanding, accounted for as cash flow hedges.
Under the first swap agreement, the Company received 6.33% and paid 4.25% (based
on the prime rate at March 31, 2003) on a notional amount of $40.0 million. The
swap agreement matures in June 2004. Under the second swap agreement, the
Company received 6.05% and paid 4.25% (based on the prime rate at March 31,
2003) on a notional amount of $20.0 million. The swap agreement matures in July
2004. Management believes that the risk associated with using this type of
derivative financial instrument to mitigate interest rate risk should not have
any material unintended impact on the Company's financial condition or results
of operations.
14
Liquidity. The Bank's liquidity position is generally determined by the
need to respond to short term demand for funds created by deposit withdrawals
and the need to provide resources to fund assets, typically in the form of
loans. How the Bank responds to these needs is affected by the Bank's ability to
attract deposits, the maturity of its loans and securities, the flexibility of
assets within the securities portfolio, the current earnings of the Bank, and
the ability to borrow funds from other sources.
The Bank's primary sources of liquidity are cash and cash equivalents,
available-for-sale securities, deposit growth, and the cash flows from principal
and interest payments on loans and other earning assets. In addition, the Bank
is able, on a short-term basis, to borrow funds from the Federal Reserve System,
FHLB and The Bankers Bank, and is also able to purchase federal funds from other
financial institutions.
At March 31, 2003, the Bank had a significant amount of deposits in amounts
greater than $100,000, including brokered deposits. The balance and cost of
these deposits are more susceptible to changes in the interest rate environment
than other deposits. The Bank had a line of credit with the FHLB equal to 20%
of the Bank's total assets, with an outstanding balance of $58.0 million at
March 31, 2003. The Bank also has the ability to borrow up to $26.5 million for
the purchase of overnight federal funds from three correspondent financial
institutions.
The liquidity ratio for the Bank, which is defined as net cash, interest
bearing deposits with banks, Federal Funds sold, certain investment securities
and certain FHLB advances available under the line of credit, as a percentage of
net deposits (adjusted for deposit runoff projections) and short-term
liabilities was 21.41% at March 31, 2003 and 17.85% at December 31, 2002. The
December 31, 2002 ratio has been restated to reflect changes in the FHLB
borrowing availability calculation, which the Bank recognizes as a factor of its
liquidity. The minimum required liquidity ratio as defined in the Bank's
Asset/Liability and Interest Rate Risk Management Policy is 20%.
Capital Resources. Shareholders' equity at March 31, 2003 was $49.7
million compared to $48.6 million at December 31, 2002. At March 31, 2003 and
December 31, 2002, unrealized gains and losses, net of taxes, amounted to gains
of $1.3 million and $1.4 million, respectively. Annualized return on average
equity , including non-recurring income, for the three months ended March 31,
2003 was 11.51% compared to 7.12% for the year ended December 31, 2002. Total
cash dividends paid during the three months ended March 31, 2003 amounted to
$313,000, a decrease of 1% compared to total cash dividends of $315,000 paid for
the first three months of 2002. This decrease is attributable to a reduction in
shares outstanding due to stock repurchase activity. The Company repurchased
$1.1 million, or 73,500 shares of its common stock during the three months ended
March 31, 2002 as part of the stock repurchase plan implemented in February
2002, which expired in February 2003. There is not a repurchase plan in effect
at March 31, 2003.
Under the regulatory capital guidelines, financial institutions are
currently required to maintain a total risk-based capital ratio of 8.0% or
greater, with a Tier 1 risk-based capital ratio of 4.0% or greater. Tier 1
capital is generally defined as shareholders' equity and Trust Preferred
Securities less all intangible assets and goodwill. The Company's Tier I capital
ratio was 10.85% and 10.76% at March 31, 2003 and December 31, 2002,
respectively. Total risk-based capital is defined as Tier 1 capital plus
supplementary capital. Supplementary capital, or Tier 2 capital, consists of the
Company's allowance for loan losses, not exceeding 1.25% of the Company's
risk-weighted assets. Total risk-based capital ratio is therefore defined as the
ratio of total capital (Tier 1 capital and Tier 2 capital) to risk-weighted
assets. The Company's total risk-based capital ratio was 12.10% and 12.01% at
March 31, 2003 and December 31, 2002, respectively. In addition to the Tier I
and total risk-based capital requirements, financial institutions are also
required to maintain a leverage ratio of Tier 1 capital to total average assets
of 4.0% or greater. The Company's Tier I leverage capital ratio was 9.57% and
9.78% at March 31, 2003 and December 31, 2002, respectively.
A bank is considered to be "well capitalized" if it has a total risk-based
capital ratio of 10.0 % or greater, a Tier I risk-based capital ratio of 6.0% or
greater, and has a leverage ratio of 5.0% or greater. Based upon these
guidelines, the Bank was considered to be "well capitalized" at March 31, 2003
and December 31, 2002.
15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in the quantitative and qualitative
disclosures about market risks as of March 31, 2003 from that presented in the
Company's Annual Report on Form 10-K for the fiscal year ended December 31,
2002.
16
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains systems of disclosure controls and procedures and
internal controls and procedures for financial reporting designed to provide
reasonable assurance as to the reliability of its published financial statements
and other disclosures included in this Quarterly Report of Form 10-Q. The Board
of Directors, operating through its Audit and Review Committee, which is
composed entirely of independent outside directors, provides oversight to the
financial reporting process.
The Chief Executive Officer and the Chief Financial Officer of the Company
(its principal executive officer and principal financial officer, respectively)
have concluded, based on their evaluation as of a date within 90 days prior to
the date of the filing of this Report, that the Company's disclosure controls
and procedures and internal controls and procedures for financial reporting are
effective to ensure that information required to be disclosed by the Company in
the reports filed or submitted by it under the Securities Exchange Act of 1934,
as amended, is recorded, processed, summarized and reported within the time
periods specified in the applicable rules and forms. The Company's Chief
Executive Officer and Chief Financial Officer have also concluded, based on
their evaluation as of a date within 90 days prior to the date of filing of this
Report, that the Company's disclosure controls and procedures and internal
controls and procedures for financial reporting are designed to ensure that
information required to be disclosed by the Company in such reports is
accumulated and communicated to the Company's management, including the Chief
Executive Officer and the Chief Financial Officer, as appropriate to allow
timely decisions regarding required disclosure.
There were no significant changes in the Company's internal controls or in
other factors that could significantly affect these controls subsequent to the
date of such evaluation.
17
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the opinion of management, the Company is not involved in any
pending legal proceedings other than routine, non-material proceedings
occurring in the ordinary course of business.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit(3)(i) Articles of Incorporation of Peoples Bancorp of
North Carolina, Inc., incorporated by reference to
Exhibit (3)(i) to the Form 8-A filed with the
Securities and Exchange Commission on September 2,
1999
Exhibit(3)(ii) Amended and Restated Bylaws of Peoples Bancorp of
North Carolina, Inc., incorporated by reference to
Exhibit (3)(ii) to the Form 10-K filed with the
Securities and Exchange Commission on March 28,
2002
Exhibit(4) Specimen Stock Certificate, incorporated by
reference to Exhibit (4) to the Form 8-A filed
with the Securities and Exchange Commission on
September 2, 1999
Exhibit(10)(a) Employment Agreement between Peoples Bank and Tony
W. Wolfe incorporated by reference to Exhibit
(10)(a) to the Form 10-K filed with the Securities
and Exchange Commission on March 30, 2000
Exhibit(10)(b) Employment Agreement between Peoples Bank and
Joseph F. Beaman, Jr. incorporated by reference to
Exhibit (10)(b) to the Form 10-K filed with the
Securities and Exchange Commission on
18
March 30, 2000
Exhibit(10)(c) Employment Agreement between Peoples Bank and
William D. Cable incorporated by reference to
Exhibit (10)(d) to the Form 10-K filed with the
Securities and Exchange Commission on March 30,
2000
Exhibit(10)(d) Employment Agreement between Peoples Bank and
Lance A. Sellers incorporated by reference to
Exhibit (10)(e) to the Form 10-K filed with the
Securities and Exchange Commission on March 30,
2000
Exhibit(10)(e) Peoples Bancorp of North Carolina, Inc. Omnibus
Stock Ownership and Long Term Incentive Plan
incorporated by reference to Exhibit (10)(f) to
the Form 10-K filed with the Securities and
Exchange Commission on March 30, 2000
Exhibit(10)(f) Employment Agreement between Peoples Bank and A.
Joseph Lampron incorporated by reference to
Exhibit (10)(g) to the Form 10-K filed with the
Securities and Exchange Commission on March 28,
2002
Exhibit(10)(g) Peoples Bank Directors' and Officers' Deferral
Plan, incorporated by reference to Exhibit (10)(h)
to the Form 10-K filed with the Securities and
Exchange Commission on March 28, 2002
Exhibit(10)(h) Rabbi Trust for the Peoples Bank Directors' and
Officers' Deferral Plan, incorporated by reference
to Exhibit (10)(i) to the Form 10-K filed with the
Securities and Exchange Commission on March 28,
2002
Exhibit(10)(i) Description of Service Recognition Program
maintained by Peoples Bank, incorporated by
reference to Exhibit (10)(i) to the Form 10-K
filed with the Securities and Exchange Commission
on March 27, 2003
Exhibit(99)(a) Certification of Chief Executive Officer
Exhibit(99)(b) Certification of Chief Financial Officer
Exhibit(99)(c) Certification Pursuant to 18 U.S.C. Section 1350
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K during the quarter ended
March 31, 2003.
19
SIGNATURES
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.
Peoples Bancorp of North Carolina, Inc.
May 14, 2003 By: /s/ Tony W. Wolfe
------------------- ----------------------------------
Date Tony W. Wolfe
President and Chief Executive Officer
(Principal Executive Officer)
May 14, 2003 By: /s/ A. Joseph Lampron
------------------- ----------------------------------
Date A. Joseph Lampron
Executive Vice President and Chief
Financial Officer
(Principal Financial and Principal
Accounting Officer)
20