FORM 10-QSB - QUARTERLY OR TRANSITIONAL REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 QUARTERLY OR TRANSITIONAL REPORT
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
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[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 000-25999
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WAKE FOREST BANCSHARES, INC.
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(Exact name of small business issuer as specified in its charter)
United States of America 56-2131079
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
302 South Brooks Street
Wake Forest, North Carolina 27587
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(Address of principal executive offices)
(919)-556-5146
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(Issuer's telephone number)
N/A
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(Former name, former address and former fiscal year, if changed
since last report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes X No _____
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: As of August 12, 2004 there were
issued and outstanding 1,149,450 shares of the Issuer's common stock, $.01 par
value
Transitional Small Business Disclosure Format: Yes_____ No X
WAKE FOREST BANCSHARES, INC.
CONTENTS
Item 1. Financial Statements
Consolidated statements of financial condition at June 30, 2004 (unaudited)
and September 30, 2003 1
Consolidated statements of income for the three months ended June 30, 2004
and June 30, 2003 (unaudited) 2
Consolidated statements of income for the nine months ended June 30, 2004
and June 30, 2003 (unaudited) 3
Consolidated statements of comprehensive income for the three and nine months ended
June 30, 2004 and June 30, 2003 (unaudited) 4
Consolidated statements of cash flows for the nine months ended
June 30, 2004 and June 30, 2003 (unaudited) 5
Notes to consolidated financial statements (unaudited) 6 - 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9 -14
Item 3. Controls and Procedures 15
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 2. Changes in Securities 16
Item 3. Defaults upon Senior Securities 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Item 5. Other Information 16
Item 6. Exhibits and Reports on Form 8-K 16
Signatures 17
Exhibits 18-19
WAKE FOREST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
JUNE 30, 2004 AND SEPTEMBER 30, 2003
June 30, September 30,
ASSETS 2004 2003
---------------- ---------------
(Unaudited) *
Cash and short-term cash investments $ 9,834,150 $ 16,742,200
Investment securities:
Available for sale, at estimated market value 516,150 426,850
FHLB stock 213,800 225,900
Loans receivable, net of loan loss allowances of $707,900 at
June 30, 2004 and $640,400 at September 30, 2003 73,743,500 67,015,550
Accrued interest receivable 125,550 93,050
Foreclosed assets, net -- 442,650
Property and equipment, net 366,700 386,950
Deferred income taxes, net 213,500 205,650
Cash surrender value of life insurance 1,010,950 --
Prepaid expenses and other assets 267,400 135,300
------------ ------------
Total Assets $ 86,291,700 $ 85,674,100
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 68,714,350 $ 68,839,950
Accrued expenses and other liabilities 711,400 637,850
Dividends payable 72,000 71,450
Redeemable common stock held by the ESOP
net of unearned ESOP shares 590,250 582,950
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Total Liabilities 70,088,000 70,132,200
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Stockholders' equity:
Preferred stock, authorized 1,000,000 shares, none issued -- --
Common stock, par value $ .01, authorized 5,000,000 shares,
issued 1,216,612 shares 12,200 12,150
Additional paid-in capital 5,253,300 5,199,450
Accumulated other comprehensive income 315,050 259,700
Retained earnings, substantially restricted 11,599,950 11,045,500
Less: Common stock in treasury, at cost (976,800) (974,900)
------------ ------------
Total stockholders' equity 16,203,700 15,541,900
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Total liabilities and stockholders' equity $ 86,291,700 $ 85,674,100
============ ============
See Notes to Consolidated Financial Statements.
* Derived from Audited Consolidated Financial Statements.
1
WAKE FOREST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED JUNE 30, 2004 AND 2003
2004 2003
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Interest and dividend income:
Loans $ 1,155,800 $ 1,256,800
Investment securities 4,300 5,050
Short-term cash investments 25,900 49,650
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Total interest income 1,186,000 1,311,500
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Interest expense:
Interest on deposits 479,700 546,600
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Net interest income before provision for loan losses 706,300 764,900
Provision for loan losses (22,500) (30,000)
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Net interest income after provision for loan losses 683,800 734,900
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Noninterest income:
Service charges and fees 14,000 18,450
Secondary market fee income -- 51,800
Gain on sale of foreclosed real estate 25,500 --
Other 11,250 800
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50,750 71,050
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Noninterest expense:
Compensation and benefits 167,600 165,550
Occupancy 11,050 11,050
Federal insurance and operating assessments 9,650 10,500
Data processing 32,550 28,550
REO provisions and expense 5,450 12,450
Other operating expense 63,200 82,400
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289,500 310,500
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Income before income taxes 445,050 495,450
Income taxes 172,400 188,550
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Net income $ 272,650 $ 306,900
=========== ===========
Basic earnings per share $ 0.24 $ 0.27
Diluted earnings per share $ 0.23 $ 0.27
Dividends per share $ 0.14 $ 0.14
See Notes to Consolidated Financial Statements.
2
WAKE FOREST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
NINE MONTHS ENDED JUNE 30, 2004 AND 2003
2004 2003
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Interest and dividend income:
Loans $ 3,432,650 $ 3,925,650
Investment securities 12,800 18,200
Short-term cash investments 91,650 163,500
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Total interest income 3,537,100 4,107,350
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Interest expense:
Interest on deposits 1,461,100 1,792,650
Interest on ESOP debt -- 450
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Total interest expense 1,461,100 1,793,100
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Net interest income before provision for loan losses 2,076,000 2,314,250
Provision for loan losses (67,500) (190,000)
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Net interest income after provision for loan losses 2,008,500 2,124,250
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Noninterest income:
Service charges and fees 43,100 44,100
Secondary market fee income 13,050 60,850
Gain on sale of investments -- 158,600
Gain on sale of foreclosed real estate 30,750
Other 12,250 1,650
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99,150 265,200
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Noninterest expense:
Compensation and benefits 475,900 518,550
Occupancy 34,500 34,550
Federal insurance and operating assessments 29,300 32,250
Data processing 90,150 86,650
REO provisions and expense 15,350 43,100
Other operating expense 204,000 222,450
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849,200 937,550
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Income before income taxes 1,258,450 1,451,900
Income taxes 481,850 557,850
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Net income $ 776,600 $ 894,050
=========== ===========
Basic earnings per share $ 0.68 $ 0.78
Diluted earnings per share $ 0.67 $ 0.78
Dividends per share $ 0.42 $ 0.38
See Notes to Consolidated Financial Statements
3
WAKE FOREST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
FOR THREE MONTHS ENDED JUNE 30: 2004 2003
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Net income $ 272,650 $ 306,900
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Other comprehensive loss, net of tax:
Unrealized gains on securities:
Unrealized holding gains (losses) arising during period 21,400 (11,800)
Less: reclassification adjustments for gains included
in net income -- --
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Other comprehensive income (loss) 21,400 (11,800)
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Comprehensive income $ 294,050 $ 295,100
========= =========
FOR NINE MONTHS ENDED JUNE 30: 2004 2003
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Net income $ 776,600 $ 894,050
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Other comprehensive loss, net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period 55,350 (29,750)
Less: reclassification adjustments for gains included
in net income -- (98,350)
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Other comprehensive income (loss) 55,350 (128,100)
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Comprehensive income $ 831,950 $ 765,950
========= =========
See Notes to Consolidated Financial Statements.
4
WAKE FOREST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED JUNE 30, 2004 AND 2003
2004 2003
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Net income $ 776,600 $ 894,050
Adjustments-noncash operating activities:
Depreciation 20,850 23,150
ESOP contribution expense credited to paid-in capital -- 16,000
Provision for loan losses 67,500 190,000
Provision for foreclosed assets -- 2,500
Gain on sale of investments -- (158,600)
Gain on sale of foreclosed assets, net (30,750) (250)
Deferred income taxes (41,800) (74,200)
Amortization of unearned ESOP shares -- 29,400
Increase in cash surrender value of life insurance (10,950) --
Changes in assets and liabilities:
Prepaid expenses and other assets (132,100) (328,000)
Accrued interest receivable (32,500) (18,750)
Accrued expenses and other liabilities 73,550 73,750
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NET CASH PROVIDED BY OPERATING ACTIVITIES 690,400 649,050
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Cash Flows From Investing Activities:
Net (increase) decrease in loans receivable (6,991,550) 8,619,850
Proceeds from sale of foreclosed assets 682,500 408,100
Redemption of FHLB stock 12,100 104,500
Capital additions to foreclosed assets (12,950) (1,700)
Proceeds from sale of available for sale investment securities -- 161,500
Purchase of Bank owned life Insurance contracts (1,000,000) --
Purchase of property and equipment (600) (5,600)
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NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (7,310,500) 9,286,650
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Cash Flows From Financing Activities:
Net decrease in deposits (125,600) (5,751,000)
Principal payments on ESOP debt -- (29,450)
Proceeds from stock options exercised 53,900 --
Repurchase of common stock for the Treasury (1,900) (57,500)
Dividends paid (214,350) (336,600)
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NET CASH USED IN FINANCING ACTIVITIES (287,950) (6,174,550)
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Net increase (decrease) in cash and cash equivalents (6,908,050) 3,761,150
Cash and cash equivalents:
Beginning 16,742,200 15,303,250
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Ending $ 9,834,150 $ 19,064,400
================ ================
Supplemental Disclosure of Cash Flow Information:
Cash payments of interest $ 1,467,200 $ 1,803,150
================ ================
Cash payment of income taxes $ 446,500 $ 627,250
================ ================
Supplemental Disclosure of Noncash transactions:
Incr. (decr.) in ESOP put option charged to retained earnings $ 7,300 $ (107,000)
================ ================
Transfer of loans to foreclosed assets $ 196,100 $ 1,149,800
================ ================
Incr. (decr.) in unrealized gain on investment securities, net of taxes $ 55,350 $ (128,100)
================ ================
See Notes to Consolidated Finanical Statements.
5
WAKE FOREST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF BUSINESS
Wake Forest Bancshares, Inc. (the "Company") is located in Wake Forest, North
Carolina and is the parent stock holding company of Wake Forest Federal Savings
and Loan Association (the "Association" or "Wake Forest Federal"), it's only
subsidiary. The Company conducts no business other than holding all of the stock
in the Association, investing dividends received from the Association,
repurchasing its common stock from time to time, and distributing dividends on
its common stock to its shareholders. The Association's principal activities
consist of obtaining deposits and providing mortgage credit to customers in its
primary market area, the counties of Wake and Franklin, North Carolina. The
Company's and the Association's primary regulator is the Office of Thrift
Supervision (OTS) and its deposits are insured by the Savings Association
Insurance Fund (SAIF) of the Federal Deposit Insurance Corporation (FDIC).
NOTE 2. ORGANIZATIONAL STRUCTURE
The Company is majority owned by the Wake Forest Bancorp, M.H.C., (the "MHC") a
mutual holding company. Members of the MHC consist of depositors and certain
borrowers of the Association, who have the sole authority to elect the board of
directors of the MHC for as long as it remains in mutual form. Initially, the
MHC's principal assets consisted of 635,000 shares of the Association's common
stock (now converted to the Company's common stock) and $100,000 in cash
received from the Association as initial capital. Prior to the second quarter of
2003, the MHC received its proportional share of dividends declared and paid by
the Association (now the Company), and such funds are invested in deposits with
the Association. The MHC has waived its receipt of the Company's dividend for
the past five quarters. The MHC, which by law must own in excess of 50% of the
stock of the Company, currently has an ownership interest of 55.2% of the
Company. The mutual holding company is registered as a savings and loan holding
company and is subject to regulation, examination, and supervision by the OTS.
The Company was formed on May 7, 1999 solely for the purpose of becoming a
savings and loan holding company and had no prior operating history. The
formation of the Company had no impact on the operations of the Association or
the MHC. The Association continues to operate at the same location, with the
same management, and subject to all the rights, obligations and liabilities of
the Association which existed immediately prior to the formation of the Company.
The Board of Directors of the Association capitalized the Company with $100,000.
Future capitalization of the Company will depend upon dividends declared by the
Association based on future earnings, or the raising of additional capital by
the Company through a future issuance of securities, debt or by other means. The
Board of Directors of the Company has no present plans or intentions with
respect to any future issuance of securities or debt at this time.
The establishment of the Company was treated similar to a pooling of interests
for accounting purposes. Therefore, the consolidated capitalization, assets,
liabilities, income and expenses of the Company immediately following its
formation were substantially the same as those of the Association immediately
prior to the formation, all of which are shown on the Company's books at their
historical recorded values.
NOTE 3. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements (except for the
consolidated statement of financial condition at September 30, 2003, which is
derived from audited financial statements) have been prepared in accordance with
generally accepted accounting principles for interim financial information and
Regulation S-B. Accordingly, they do not include all of the information required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (none of which were other than
normal recurring accruals) necessary for a fair presentation of the financial
position and results of operations for the periods presented have been included.
The results of operations for the three and nine month periods ended June 30,
2004 are not necessarily indicative of the results of operations that may be
expected for the Company's fiscal year ending September 30, 2004. The accounting
policies followed are as set forth in Note 1 of the Notes to Consolidated
Financial Statements in the Company's September 30, 2003 Annual Report to
Stockholders.
6
WAKE FOREST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4. DIVIDENDS DECLARED
On June 21, 2004, the Board of Directors of the Company declared a dividend of
$0.14 a share for stockholders of record as of June 30, 2004 and payable on July
12, 2004. The dividends declared were accrued and reported as dividends payable
in the June 30, 2004 Consolidated Statement of Financial Condition. Wake Forest
Bancorp, Inc., the mutual holding company, waived the receipt of the dividend
declared by the Company this quarter.
NOTE 5. EARNINGS PER SHARE
Basic earnings per share amounts are based on the weighted average shares of
common stock outstanding. Diluted earnings per share assumes the conversion,
exercise or issuance of all potential common stock instruments such as options,
warrants and convertible securities, unless the effect is to reduce a loss or
increase earnings per share. This presentation has been adopted for all periods
presented. There were no adjustments required to net income for any period in
the computation of diluted earnings per share. The reconciliation of weighted
average shares outstanding for the computation of basic and diluted earnings per
share for the three and nine month periods ended June 30, 2004 and 2003 is
presented below.
For the Three Months Ended June 30: 2004 2003
---------------- -------------
Weighted average shares outstanding for Basic EPS 1,147,066 1,144,966
Plus incremental shares from assumed issuances of shares
pursuant to stock option plans 15,113 9,311
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Weighted average shares outstanding for diluted EPS 1,162,179 1,154,277
=============== ===============
For the Nine Months Ended June 30: 2004 2003
---------------- -------------
Weighted average shares outstanding for Basic EPS 1,145,530 1,144,742
Plus incremental shares from assumed issuances of shares
pursuant to stock option plans 15,755 7,909
--------------- ---------------
Weighted average shares outstanding for diluted EPS 1,161,285 1,152,651
=============== ===============
NOTE 6. STOCK OPTION PLAN
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure (Statement 148). Statement 148 amended
SFAS No. 123, Accounting for Stock-Based Compensation (Statement 123), to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, this Statement amended the disclosure requirements of Statement 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. Statement 148 was effective for
financial statements for fiscal years ending after December 15, 2002. The
Company continues to account for its stock-based compensation in accordance with
APB 25 and has adopted the disclosure provisions of Statement 148 effective for
all periods presented herein.
The Company has a stock option plan for the benefit of its officers, directors,
and key employees. Options totaling 54,000 at a grant price of $12.75 were
granted on January 22, 1997. No options have been granted since that date.
Previously granted options totaling 13,500 were returned to the Plan due to
employment separation of the option holders. The options aree exercisable at the
rate of 20% annually for years during periods of service as an employee or
director, and expire after ten years. Accelerated vesting may occur in certain
circumstances as disclosed in the plan documents. Options are exercisable at the
fair value on the date of grant.
7
WAKE FOREST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6. STOCK OPTION PLAN (CONTINUED)
A summary of the changes in the Company's options during the quarters ended June
30, 2004 and 2003 is presented below:
2004 2003
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Stock options outstanding at beginning of the quarter 37,336 37,336
Granted -- --
Exercised (4,229) --
Terminated -- --
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Stock options outstanding at end of the quarter
33,107 37,336
========== ==========
Stock options exercisable at end of the quarter
33,107 37,336
========== ==========
Grants of options under the plan are accounted for following Accounting
Principles Board (APB) Opinion No. 25 and its related interpretations.
Accordingly, no compensation cost has been recorded. In 1995, the Financial
Accounting Standards Board issued Standard No. 123, which requires disclosures
concerning the fair value of options and encourages accounting recognition for
options using the fair value method. The Company has elected to apply the
disclosure-only provisions of the Statement.
However, had compensation cost been recorded based on the fair value ($4.17 per
share) of awards at the grant date, there would have been no pro forma impact on
the Company's net income and earnings per share for the quarters or nine month
periods ended June 30, 2004 and 2003 because the five year period over which the
options vested (and would have been expensed under SFAS No. 123) expired during
the year ended September 30, 2002. The fair value of each grant was estimated at
the grant date using the Black-Scholes option-pricing model with the following
assumptions for 1997 when the options were granted: dividend rate of 2.75%;
risk-free interest rate of 5.87%; expected lives of 10 years; and price
volatility of 26.51%.
8
WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
Information set forth below contains various forward-looking statements within
the meaning of Section 27A of the Securities and Exchange Act of 1933 and
Section 21E of the Securities Exchange Act of 1934, which statements represent
the Company's judgment concerning the future and are subject to risks and
uncertainties that could cause the Company's actual operating results to differ
materially. Such forward-looking statements can be identified by the use of
forward-looking terminology, such as "may", "will", "expect", "anticipate",
"estimate", "believe", or "continue", or the negative thereof or other
variations thereof or comparable terminology. The Company cautions that such
forward-looking statements are further qualified by important factors that could
cause the Company's actual operating results to differ materially from those in
the forward-looking statements, as well as the factors set forth in the
Company's periodic reports and other filings with the SEC.
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2003 AND JUNE 30, 2004
Total assets increased by $617,600 to $86.3 million at June 30, 2004 from $85.7
million at September 30, 2003. Total assets increased during the nine months
ended June 30, 2004 primarily due to capital growth associated with the
Company's earnings for the same period. Because the Company currently has a
sufficient amount of liquidity, deposits were not priced aggressively to retain
certain accounts or to attract additional funds from competition until very
recently in the current quarter. Cash and short term cash investments decreased
by approximately $6.9 million during the nine month period due to an increase in
the Company's loan portfolio during the same period.
Net loans receivable increased by $6.7 million to $73.7 million at June 30, 2004
from $67.0 million at September 30, 2003. The increase is a sign of improving
economic conditions in the Company's primary lending markets, particularly in
the area of residential construction where the Company experienced the bulk of
its loan growth. However, significant employment growth has not yet materialized
and a job creating expansion will ultimately determine whether the current loan
demand is sustainable. The high tech sector of the area's employment base has
been hit hard during the past couple of years and has negatively impacted growth
in the overall real estate market. Assuming economic conditions improve,
management believes that the long-term fundamentals of its markets provide
potential for future loan expansion because the Company operates in markets that
until recently had sustained significant growth and strong loan demand. However,
there can be no assurances that such loan demand can or will materialize in the
future.
Investment securities increased by $77,200 to $729,950 at June 30, 2004 from
$652,750 at September 30, 2003. The slight increase is primarily attributable to
unrealized gains in the Company's investment in FHLMC stock. The Company has
maintained higher levels of liquidity due to loan demand and the historically
low investment rates available in the market. For the past couple of years, the
Company's intent has been to retain a short position in its investments due to
the interest rate risk associated with extending the maturities of its
investment portfolio should rates begin to rise. As a result, the Company has
not been actively involved in the buying and selling securities. At June 30,
2004, the Company's investment portfolio, which consisted primarily of FHLB
stock and FHLMC stock, had approximately $508,000 in unrealized gains.
During the current quarter, the Company purchased split-dollar insurance
contracts on the lives of its employees in order to help defray the cost
associated with its group health insurance plan. The amount of the contracts
purchased totaled $1.0 million and is shown as other assets in the Company's
consolidated balance sheet. Interest credits on the policies in the form of
increases in the cash surrender value of the policies is shown as other
non-interest income in the Company's consolidated statement of income.
9
WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2003 AND JUNE 30, 2004
(CONTINUED)
The Company had no borrowings outstanding during the period because its current
level of liquidity was sufficient to fund the growth in its loan portfolio. The
Company has recorded a liability of $590,250 at June 30, 2004 for the ESOP put
option which represents the potential liability owed to participants based on
the current market value of the Company's stock if in the unlikely event, all
participants were to request the balance of their account from the Company in
cash instead of stock. Should that occur, the Company would repurchase those
shares as treasury stock.
The Company has an ongoing stock repurchase program authorizing management to
repurchase shares of its outstanding common stock. The repurchases are made
through registered broker-dealers from shareholders in open market purchases at
the discretion of management. The Company intends to hold the shares repurchased
as treasury shares, and may utilize such shares to fund stock benefit plans or
for any other general corporate purposes permitted by applicable law. At June
30, 2004 the Company had repurchased 71,391 shares of its common stock. The
program continues until completed or terminated by the Board of Directors.
Retained earnings increased by $554,450 to $11.6 million at June 30, 2004 from
$11.0 million at September 30, 2003. The increase is attributable to the
Company's earnings of $776,600 during the nine month period ended June 30, 2004,
reduced by $214,900 in dividends declared during the period and a $7,250 charge
to retained earnings to reflect the change in the fair value of the ESOP shares
subject to the put option. At June 30, 2004 the Company's stockholders' equity
amounted to $16.2 million, which as a percentage of total assets was 18.78%.
Under the OTS's prompt corrective action regulations, the Company and the
Association are considered well capitalized if their ratio of total capital to
risk-weighted assets is at least 10%, their ratio of core capital (Tier 1) to
risk-weighted assets is at least 6.0%, and their ratio of core capital to total
average assets is at least 5.0%. Both the Company and the Association met all of
the above requirements and are considered well capitalized.
ASSET QUALITY
The Company's level of non-performing loans, defined as loans past due 90 days
or more, as a percentage of loans outstanding was 0.37% at September 30, 2003,
and 3.23%, 2.57%, and 2.06% at the end of each quarter during the current year,
respectively. At June 30, 2004, non-performing loans amounted to $1,538,050 and
consisted solely of one commercial loan collateralized by two convenience stores
and an adjacent tract of land ($1,487,600) and one single-family residential
mortgage loan ($50,450). Although the Company has started foreclosure
proceedings on both loans, currently no loss is expected on the ultimate
collection of these two loans. Subsequent to June 30, 2004, the commercial loan
borrower filed for Chapter 11 bankruptcy. Both loans have been placed on
non-accrual status. The commercial loan has a loan-to-value ratio of
approximately 65% based upon the latest appraisal of the collateral property.
The Company had no loan charge-offs during the current quarter.
The allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to earnings. Loan losses
are charged against the allowance when management believes the uncollectibility
of a loan balance is confirmed. Subsequent recoveries, if any, are credited to
the allowance. The allowance for loan losses is evaluated on a regular basis by
management and is based upon management's periodic review of the collectibility
of the loans in light of historical experience, the nature and volume of the
loan portfolio, adverse situations that may affect the borrower's ability to
repay, estimated value of any underlying collateral and prevailing economic
conditions. This evaluation is inherently subjective as it requires estimates
that are susceptible to significant revision as more information becomes
available.
10
WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
ASSET QUALITY (CONTINUED)
Although management believes it has established and maintained the allowance for
loan losses at appropriate levels, future adjustments may be necessary if
economic, real estate and other conditions differ substantially from the current
operating environment. In addition, regulatory examiners may require the
Association to recognize adjustments to the allowance for loan losses based on
their judgments about information available to them at the time of their
examination.
The Company records provisions for loan losses based upon known problem loans
and estimated deficiencies in the existing loan portfolio. The Company's
methodology for assessing the appropriateness of the allowance for loan losses
consists of two key components, which are a specific allowance for identified
problem or impaired loans and a formula allowance for the remainder of the
portfolio. Based on management's analysis of the adequacy of its allowances,
loan loss provisions totaling $22,500 and $67,500 were provided during the three
and nine month periods ended June 30, 2004, respectively. The Company's
allowance for loan losses expressed as a percentage of gross loans outstanding
was 0.95% at June 30, 2004 and at September 30, 2003. The Company's loan loss
allowance was $707,900 at June 30, 2004.
As of June 30, 2004, the Company has no foreclosed assets. During the current
quarter, the Association sold foreclosed property with a cost basis of $358,750
and incurred a net gain of $23,950 upon disposition. For the nine month period
June 30, 2004, the Company had a net gain of $27,250 on the disposal of
foreclosed properties. The Company had foreclosure related expense of $5,450
during the current quarter as compared to expense of $12,450 for the same
quarter a year earlier and $15,350 for nine months ended June 30, 2004.
COMPARISON OF OPERATING RESULTS FOR THE THREE AND NINE MONTHS ENDED JUNE 30,
2004 AND 2003
GENERAL. Net income for the three month period ended June 30, 2004 was $272,650
($0.23 per share) as compared to $306,900 ($0.27 per share) earned during the
same quarter in 2003. Net income for the nine month period ended June 30, 2004
was $776,600 ($0.67 per share) as compared to $894,050 ($0.78 per share) earned
during the same period in 2003. As discussed below, decreases in net interest
income between the comparable periods coupled with decreases in non-interest
income and non-interest expense were primarily responsible for the change in net
income during the current quarter and nine month period ended June 30, 2004 as
compared to the same periods one year earlier.
INTEREST INCOME. Interest income decreased by $125,500 from $1,311,500 for the
three months ended June 30, 2003 to $1,186,000 for the three months ended June
30, 2004. The decline in interest income resulted from both a 0.16% decrease in
the average yield on interest-earning assets and a $915,000 decrease in the
average balance of interest-earning assets between the quarters. Interest income
decreased by $570,250 from $4,107,350 for the nine months ended June 30, 2003 to
$3,537,100 for the nine months ended June 30, 2004. The decline in interest
income resulted from both a 0.46% basis point decrease in the yield on
interest-earning assets and a $2.8 million decrease in the average balance of
interest-earning assets between the nine month periods. The Company's yield on
interest earning assets was 5.50% and 5.73% for the quarter and nine month
period ended June 30, 2003, respectively, and 5.34% and 5.27% for the quarter
and nine month period ended June 30, 2004, respectively. The changes in yield
occurred primarily due to fluctuations in market rates outstanding during the
periods.
11
WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
INTEREST EXPENSE. Interest expense decreased by $66,900 from $546,600 for the
three months ended June 30, 2003 to $479,700 for the three months ended June 30,
2004. The decrease was the result of both a 0.29% decrease in the Company's cost
of funds and a $1.6 million decline in the average balance of interest-bearing
liabilities between the quarters. Interest expense decreased by $332,000 from
$1,793,100 for the nine months ended June 30, 2003 to $1,461,100 for the nine
months ended June 30, 2004. The decrease was the result of both a 0.43% decrease
in the Company's cost of funds and a $3.5 million decline in the average balance
of interest-bearing liabilities between the nine month periods. The Company's
cost of funds was 3.08% and 3.26% for the quarter and nine month period ended
June 30, 2003, respectively, and 2.79% and 2.83% for the quarter and nine month
period ended June 30, 2004, respectively. The change in the Company's cost of
funds occurred primarily due to fluctuations in market rates between the
periods.
NET INTEREST INCOME. Net interest income decreased by $58,600 from $764,900 for
the three months ended June 30, 2003 to $706,300 for the three months ended June
30, 2004. Net interest income decreased by $238,250 from $2,314,250 for the nine
months ended June 30, 2003 to $2,076,000 for the nine months ended June 30,
2004. As explained above, the changes in net interest income resulted primarily
from fluctuations in both the yields on interest-earning assets and the cost of
funds on interest-bearing liabilities between the periods and the average
balances outstanding among the periods. The Company's interest rate margin was
3.38% and 3.30% for the current quarter and nine month period ended June 30,
2004; respectively, as compared to 3.62% and 3.56% for the quarter and nine
month period ended June 30, 2003; respectively.
PROVISION FOR LOAN LOSSES. The Company provided $22,500 and $67,500 in loan loss
provisions during the current quarter and nine month period ended June 30, 2004;
respectively, as compared to $30,000 and $190,000 during the three and nine
month periods; respectively, a year earlier. Provisions, which are charged to
operations, and the resulting loan loss allowances are amounts the Company's
management believes will be adequate to absorb losses that are estimated to have
occurred. Loans are charged off against the allowance when management believes
that uncollectibility is confirmed. Subsequent recoveries, if any, are credited
to the allowance. The primary causes for the higher than normal loan loss
provisions in the previous year were due in part to a surge in loan
delinquencies and a continued pattern of sluggish local economic conditions at
that time. In large part, those factors have stabilized or lessened during the
current year and the Company's loan loss provisions reflect those dynamics.
The allowance for loan losses is evaluated on a regular basis by management and
is based upon management's periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of the underlying collateral and prevailing economic conditions. Although
management uses a systematic method for determining the adequacy of its
allowances, the evaluation is inherently subjective as it requires estimates
that are susceptible to significant revisions as more information becomes
available.
NON-INTEREST INCOME. The Company's non-interest income is primarily comprised on
various fees and service charges on customer accounts as well as gains on sale
of assets and fees earned from secondary market originations. During the current
quarter and nine months year-to-date, the Company generated other non-interest
income of $50,750 and $99,150, respectively. In addition to service charges on
customer accounts, the Company reported gains from disposal of foreclosed assets
of $25,500 and $30,750 for the three and nine months ended June 30, 2004. During
the three and nine month periods ended June 30, 2003, the Company reported fees
of $51,800 and $60,850 from originating and selling mortgage loans in the
secondary market. Refinancing activity spurred by the low interest rate
environment has slowed considerably during the current year with a corresponding
drop in fee income. In addition, the Company has originated $2.7 million in
long-term single-family mortgage loans for its own portfolio during the current
year instead of selling such loans in the secondary market. During the second
quarter of 2003, the Company sold 3,000 shares of FHLMC stock with a cost basis
of approximately $2,950 and realized a gain of $158,600. There were no
investment sales during the nine month period ended June 30, 2004. The Company
continues to hold 8,154 shares of FHLMC stock in its investment portfolio.
12
WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
NON-INTEREST EXPENSE. Non-interest expense decreased by $21,000 to $289,500 for
the three month period ended June 30, 2004 from $310,500 for the comparable
quarter in 2003. Non-interest expense decreased by $88,350 to $849,200 for the
nine month period ended June 30, 2004 from $937,550 for the same period a year
earlier. The only significant change during the current quarter was in other
operating expense which decreased by $19,200 from 2003 to 2004 with decreases in
loan processing expense, legal expense, and office supplies being the primary
categories contributing to the decline. Only two categories of expense,
compensation and related benefits and REO provisions and expense, changed
significantly between the nine month periods ended June 30, 2004 and 2003.
Compensation and related benefits decreased from $518,550 during the nine months
ended June 30, 2003 to $475,900 during the most recent nine month period. The
decrease in compensation and benefits occurred primarily because of a reduction
in retirement plan expense associated with the final funding of the
Association's employee stock option plan during 2003. Expenses associated with
real estate owned totaled $43,100 for the nine month period ended June 30, 2003
as compared to expense of $15,350 for the nine month period ended June 30, 2004.
The Company's foreclosure cost is directly related to the number of properties
managed. During 2003, the Company managed up to thirteen foreclosed properties
while in the first nine months of 2004, only four properties have required
foreclosure and currently the Company has no foreclosed properties on hand.
CAPITAL RESOURCES AND LIQUIDITY
The term "liquidity" generally refers to an organization's ability to generate
adequate amounts of funds to meet its needs for cash. More specifically for
financial institutions, liquidity ensures that adequate funds are available to
meet deposit withdrawals, fund loan and capital expenditure commitments,
maintain reserve requirements, pay operating expenses, and provide funds for
debt service, dividends to stockholders, and other institutional commitments.
Funds are primarily provided through financial resources from operating
activities, expansion of the deposit base, borrowings, through the sale or
maturity of investments, the ability to raise equity capital, or maintenance of
shorter term interest-earning deposits.
During the nine month period ended June 30, 2004, cash and cash equivalents, a
significant source of liquidity, decreased by approximately $6.9 million. Net
loan originations of approximately $7.0 million were the primary use of cash
during the nine month period. The purchase of bank owned life insurance also
utilized $1.0 million in cash during the period. Proceeds from the Company's
operations contributed $701,350 in cash during the nine month period. Given its
excess liquidity and its ability to borrow from the Federal Home Loan Bank of
Atlanta, the Company believes that it will have sufficient funds available to
meet anticipated future loan commitments, unexpected deposit withdrawals, and
other cash requirements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The accounting policies followed are as set forth in Note 1 of the Notes to
Financial Statements in the Company's 2003 Annual Report on Form 10-KSB. The
Company has not experienced any material change in its critical accounting
policies since September 30, 2003. The Company's discussion and analysis of its
financial condition and results of operations are based upon its consolidated
financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States. The preparation of these
financial statements requires the Company to make estimates and judgments
regarding uncertainties that affect the reported amounts of assets, liabilities,
revenues and expenses. On an ongoing basis, the Company evaluates its estimates
which are based upon historical experience and on other assumptions that are
believed to be reasonable under the circumstances. Actual results may differ
from these estimates under different assumptions or conditions. The Company
considers the following accounting policies to be most critical in their
potential effect on its financial position or results of operations.
13
WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES AND ESTIMATES (CONTINUED)
Allowance for Loan Losses
The most critical estimate concerns the Company's allowance for loan losses. The
Company records provisions for loan losses based upon known problem loans and
estimated deficiencies in the existing loan portfolio. The Company's methodology
for assessing the appropriations of the allowance for loan losses consists of
two key components, which are a specific allowance for identified problem or
impaired loans and a formula allowance for the remainder of the portfolio.
A loan is considered impaired when, based on current information and events, it
is probable that the Association will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms of
the loan agreement. Factors considered by management in determining impairment
include payment status, collateral value, and the probability of collecting
scheduled principal and interest payments when due. Loans that experience
insignificant payment delays and payment shortfalls generally are not classified
as impaired. Management determines the significance of payment delays and
payment shortfalls on a case-by-case basis, taking into consideration all of the
circumstances surrounding the loan and the borrower, including the length of the
delay, the reasons for the delay, the borrower's prior payment record, and the
amount of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan-by-loan basis for commercial and construction
loans by either the present value of expected future cash flows discounted at
the loan's effective interest rate, the loan's obtainable market price, or the
fair value of the collateral if the loan is collateral dependent. This
evaluation is inherently subjective as it requires material estimates that may
be susceptible to significant change. Large groups of smaller balance
homogeneous loans are collectively evaluated for impairment. Accordingly, the
Association does not typcially separately identify individual residential loans
for impairment disclosures.
The adequacy of the allowance is also reviewed by management based upon its
evaluation of then-existing economic and business conditions affecting the key
lending areas of the Company and other conditions, such as new loan products,
collateral values, loan concentrations, changes in the mix and volume of the
loan portfolio; trends in portfolio credit quality, including delinquency and
charge-off rates; and current economic conditions that may affect a borrower's
ability to repay. Although management believes it has established and maintained
the allowance for loan losses at appropriate levels, future adjustments may be
necessary if economic, real estate and other conditions differ substantially
from the current operating environment.
Interest Income Recognition:
Interest on loans is included in income as earned based upon interest rates
applied to unpaid principal. Interest is not accrued on loans 90 days or more
past due unless the loans are adequately secured and in the process of
collection. Interest is not accrued on other loans when management believes
collection is doubtful. All loans considered impaired are non-accruing. Interest
on non-accruing loans is recognized as payments are received when the ultimate
collectibility of interest is no longer considered doubtful. When a loan is
placed on non-accrual status, all interest previously accrued is reversed
against current-period interest income.
14
WAKE FOREST BANCSHARES, INC.
JUNE 30, 2004
ITEM 3. CONTROLS AND PROCEDURES
Management, including the Company's Chief Executive Officer and Chief Financial
Officer, has evaluated the effectiveness of the Company's disclosure controls
and procedures (as defined in Exchange Act Rules 13a-15(f) and 15d-15(e)) as of
the end of the period covered by this report. Based upon that evaluation, the
Chief Executive Officer and Chief Financial Officer concluded that the
disclosure controls and procedures were effective, in all material respects, to
ensure that information required to be disclosed in the reports the Company
files and submits under the Exchange Act is recorded, processed, summarized and
reported as and when required.
There have been no changes in the Company's internal control over financial
reporting identified in connection with the evaluation that occurred during the
Company's last fiscal quarter that has materially affected, or that is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
15
WAKE FOREST BANCSHARES, INC.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is not engaged in any material legal proceedings
at the present time. Occasionally, the Association is a party
to legal proceedings within the normal course of business
wherein it enforces its security interest in loans made by it,
and other matters of a similar nature.
Item 2. Changes in Securities None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
a) The Company filed a Form 8-K on April 20, 2004 to disclose
its second quarter earnings.
b) Exhibit 31 Certification of Pursuant to 18 U.S.C. Section
1350, as adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
c) Exhibit 32 Certification of Pursuant to 18 U.S.C. Section
1350, as adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
16
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.
WAKE FOREST BANCSHARES, INC.
Dated August 11, 2004 By: s/s Robert C. White
----------------- ----------------------------
Robert C. White
Chief Executive Officer and
Chief Financial Officer
17