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, 2006
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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
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
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Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes No X
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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 1, 2006 there were
issued and outstanding 1,153,261 shares of the Issuer's common stock, $.01 par
value
Transitional Small Business Disclosure Format: Yes No X
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WAKE FOREST BANCSHARES, INC.
CONTENTS
Item 1. Financial Statements
Consolidated statements of financial condition at June 30, 2006 (unaudited)
and September 30, 2005 1
Consolidated statements of income for the three months ended June 30, 2006
and June 30, 2005 (unaudited) 2
Consolidated statements of income for the nine months ended June 30, 2006
and June 30, 2005 (unaudited) 3
Consolidated statements of comprehensive income for the three and nine months ended
June 30, 2006 and June 30, 2005 (unaudited) 4
Consolidated statements of cash flows for the nine months ended
June 30, 2006 and June 30, 2005 (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 16
Signatures 17
Exhibits 18-19
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30, 2006 and September 30, 2005
June 30, September 30,
ASSETS 2006 2005
----------------- -----------------
(Unaudited) *
Cash and short-term cash investments $ 24,522,100 $ 22,327,400
Investment securities:
Available for sale, at estimated market value 464,850 460,350
FHLB stock 197,600 182,300
Loans receivable, net of loan loss allowances of $995,000 at
June 30, 2006 and $850,000 at September 30, 2005 74,909,850 73,894,100
Accrued interest receivable 204,500 136,200
Foreclosed assets, net 1,003,800 1,003,800
Property and equipment, net 380,100 337,850
Bank owned life insurance 1,082,850 1,058,500
Deferred income taxes, net 333,800 297,150
Prepaid expenses and other assets 54,400 33,700
----------------- -----------------
Total Assets $ 103,153,850 $ 99,731,350
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 83,195,750 $ 80,905,150
Accrued interest on deposits 35,650 26,950
Accrued expenses and other liabilities 969,450 746,300
Dividends payable 88,000 77,650
Redeemable common stock held by the ESOP
net of unearned ESOP shares 587,350 569,100
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Total Liabilities 84,876,200 82,325,150
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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 1,242,506 shares at June 30, 2006 and
1,237,146 shares at September 30, 2005 12,450 12,350
Additional paid-in capital 5,589,150 5,502,050
Accumulated other comprehensive income 283,250 280,500
Retained earnings, substantially restricted 13,769,850 12,868,900
Less: Common stock in treasury, at cost (1,377,050) (1,257,600)
----------------- -----------------
Total stockholders' equity 18,277,650 17,406,200
----------------- -----------------
Total liabilities and stockholders' equity $ 103,153,850 $ 99,731,350
================= =================
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, 2006 AND 2005
2006 2005
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Interest and dividend income:
Loans $ 1,549,000 $ 1,287,100
Investment securities 6,600 4,900
Short-term cash investments 288,100 152,000
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Total interest income 1,843,700 1,444,000
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Interest expense:
Interest on deposits 760,100 602,000
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Total interest expense 760,100 602,000
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Net interest income before provision for loan losses 1,083,600 842,000
Provision for loan losses (50,000) (25,000)
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Net interest income after provision for loan losses 1,033,600 817,000
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Noninterest income:
Service charges and fees 11,600 10,200
Other 8,400 9,950
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20,000 20,150
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Noninterest expense:
Compensation and benefits 211,700 185,600
Occupancy 11,700 10,750
Federal insurance and operating assessments 11,350 10,500
Data processing 32,350 30,250
REO provisions and expense 46,300 57,600
Other operating expense 91,750 70,450
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405,150 365,150
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Income before income taxes 648,450 472,000
Income taxes 234,550 167,800
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Net income $ 413,900 $ 304,200
================= =================
Basic earnings per share $ 0.36 $ 0.26
Diluted earnings per share $ 0.36 $ 0.26
Dividends per share $ 0.17 $ 0.15
See Notes to Consolidated Financial Statements.
2
WAKE FOREST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
NINE MONTHS ENDED JUNE 30, 2006 AND 2005
2006 2005
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Interest and dividend income:
Loans $ 4,415,200 $ 3,915,200
Investment securities 18,850 13,950
Short-term cash investments 791,000 278,650
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Total interest income 5,225,050 4,207,800
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Interest expense:
Interest on deposits 2,131,700 1,679,950
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Total interest expense 2,131,700 1,679,950
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Net interest income before provision for loan losses 3,093,350 2,527,850
Provision for loan losses (145,000) (89,600)
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Net interest income after provision for loan losses 2,948,350 2,438,250
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Noninterest income:
Service charges and fees 41,850 37,450
Secondary market fee income 7,950 4,000
Other 29,100 28,600
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78,900 70,050
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Noninterest expense:
Compensation and benefits 630,300 543,850
Occupancy 34,000 32,300
Federal insurance and operating assessments 33,950 31,350
Data processing 111,300 94,600
REO provisions and expense 131,850 63,200
Other operating expense 233,550 237,700
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1,174,950 1,003,000
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Income before income taxes 1,852,300 1,505,300
Income taxes 668,900 509,450
----------------- -----------------
Net income $ 1,183,400 $ 995,850
================= =================
Basic earnings per share $ 1.03 $ 0.86
Diluted earnings per share $ 1.02 $ 0.85
Dividends per share $ 0.51 $ 0.45
See Notes to Consolidated Financial Statements.
3
WAKE FOREST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
THREE AND NINE MONTHS ENDED JUNE 30, 2006 AND 2005
2006 2005
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FOR THE THREE MONTHS ENDED JUNE 30:
Net income $ 413,900 $ 304,200
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Other comprehensive (loss), net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period (20,200) 10,250
Less: reclassification adjustments for (losses)
included in net income - -
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Other comprehensive income (loss) (20,200) 10,250
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Comprehensive income $ 393,700 $ 314,450
================= =================
2006 2005
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FOR THE NINE MONTHS ENDED JUNE 30:
Net income $ 1,183,400 $ 995,850
----------------- -----------------
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period 2,750 (100)
Less: reclassification adjustments for gains (losses)
included in net income - -
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Other comprehensive income (loss) 2,750 (100)
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Comprehensive income $ 1,186,150 $ 995,750
================= =================
See Notes to Consolidated Financial Statements.
4
WAKE FOREST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED JUNE 30, 2006 AND 2005
2006 2005
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Net income $ 1,183,400 995,850
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 48,850 18,950
Provision for loan losses 145,000 89,600
Deferred income taxes (38,400) (23,850)
Increase in cash surrender value of life insurance (24,350) (27,450)
Changes in assets and liabilities:
Prepaid expenses and other assets (20,700) 32,000
Accrued interest receivable (68,300) (26,200)
Accrued interest on deposits 8,700 12,950
Accrued expenses and other liabilities 223,150 264,200
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NET CASH PROVIDED BY OPERATING ACTIVITIES 1,457,350 1,336,050
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Cash Flows From Investing Activities:
Net (increase) decrease in loans receivable (1,160,750) 6,792,400
Redemption of FHLB stock - 31,500
Purchase of FHLB stock (15,300) -
Purchase of property and equipment (91,100) -
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NET CASH PROVIDED BY INVESTING ACTIVITIES (1,267,150) 6,823,900
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Cash Flows From Financing Activities:
Net increase in deposits 2,290,600 10,182,950
Proceeds from exercise of stock options 68,350 174,000
Additions to paid in capital from tax effect from exercise of
of stock options 18,850 -
Repurchase of common stock for the Treasury (119,450) (180,800)
Dividends paid (253,850) (228,200)
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NET CASH PROVIDED BY FINANCING ACTIVITIES 2,004,500 9,947,950
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Net increase in cash and cash equivalents 2,194,700 18,107,900
Cash and cash equivalents:
Beginning 22,327,400 5,851,250
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Ending $ 24,522,100 23,959,150
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Supplemental Disclosure of Cash Flow Information:
Cash payments of interest $ 2,123,000 1,667,000
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Cash payment of income taxes $ 676,000 506,000
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Supplemental Disclosure of Noncash transactions:
Increase (decrease) in ESOP put option charged to
retained earnings $ 18,250 $ (119,150)
=================== ==================
Transfer of loans to foreclosed assets $ - 1,503,800
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Increase (decrease) in unrealized gain on investment
securities, net of tax $ 2,750 (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"), its 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 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 2003 (see Note 4),
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, which by law must own in excess of 50% of the stock of the
Company, currently has an ownership interest of 55.1% 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 and is
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.
NOTE 3. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements (except for the
consolidated statement of financial condition at September 30, 2005, which is
derived from audited consolidated 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, 2006 are not necessarily indicative of the results
of operations that may be expected for the Company's fiscal year ending
September 30, 2006. The accounting policies followed are as set forth in Note 1
of the Notes to Consolidated Financial Statements in the Company's September 30,
2005 Annual Report to Stockholders.
NOTE 4. DIVIDENDS DECLARED
On June 19, 2006, the Board of Directors of the Company declared a dividend of
$0.17 a share for stockholders of record as of June 30, 2006 and payable on July
10, 2006. The dividends declared were accrued and reported as dividends payable
in the June 30, 2006 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.
6
WAKE FOREST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 2006 and 2005 is
presented below.
For the Three Months Ended June 30: 2006 2005
----------------- -----------------
Weighted average shares outstanding for Basic EPS 1,152,661 1,157,354
Plus incremental shares from assumed issuances of shares
pursuant to stock option and stock award plans 4,621 9,508
----------------- -----------------
Weighted average shares outstanding for diluted EPS 1,157,282 1,166,862
================= =================
For the Nine Months Ended June 30: 2006 2005
----------------- -----------------
Weighted average shares outstanding for Basic EPS 1,152,709 1,154,668
Plus incremental shares from assumed issuances of shares
pursuant to stock option and stock award plans 5,734 11,540
----------------- -----------------
Weighted average shares outstanding for diluted EPS 1,158,443 1,166,208
================= =================
NOTE 6. STOCK OPTION PLAN
In 1995, the Financial Accounting Standards Board (FASB) issued Standard No.
123, Accounting For Stock-Based Compensation, 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.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure (Statement 148). Statement 148 amends
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 amends 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 is 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. Accordingly, no compensation cost has been
recorded and none would have been required in 2006 or 2005 because the five year
period over which the options vested and would have been expensed under SFAS No.
123 expired. Effective with the Company's first annual period beginning after
December 15, 2005, the voluntary change to the fair value based method of
accounting for stock based compensation becomes mandatory pursuant to SFAS No.
123 "Revised." This Statement focuses primarily on accounting for transactions
in which an entity obtains employee services in share-based payment
transactions. SFAS No. 123(R) requires that the fair value of such equity
instruments be recognized as an expense in the historical financial statements
as services are performed.
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 and expire on January 21, 2007. No options have been
granted since that date and stockholder approval has not been requested for the
issuance of any additional stock options. Previously granted options totaling
13,500 were returned to the Plan due to employment separation of the option
holders and are available for grant, subject to expiration in 2007. The options
are 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, 2006 and 2005 is presented below:
2006 2005
----------------- ------------------
Stock options outstanding at beginning of the quarter 11,442 23,246
Granted - -
Exercised - (4,129)
Terminated - -
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Stock options outstanding at end of the quarter 11,442 19,117
================= ==================
Stock options exercisable at end of the quarter 11,442 19,117
================= ==================
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, 2005 AND JUNE 30, 2006
Total assets increased by $3.5 million to $103.2 million at June 30, 2006 from
$99.7 million at September 30, 2005. The increase in total assets during the
nine month period ended June 30, 2006 occurred primarily due to an increase in
deposits and cash generated from internal operating activities during the
period. Due to adequate levels of current liquidity, deposits were priced to
meet competition and retain certain accounts but not to aggressively attract
additional funds. Deposits increased by $2.3 million during the nine month
period ended June 30, 2006. The Company attempts to maintain a certain level of
liquidity to fund loan growth and to provide a cushion for its construction loan
commitments. During the current nine month period, cash and short term cash
investments increased by approximately $2.2 million.
Net loans receivable increased by $1.0 million to $74.9 million at June 30, 2006
from $73.9 million at September 30, 2005. The increase occurred primarily
because of an increase in the Company's construction and prime based loan
portfolios. The Company's construction loan portfolio increased by $2.0 million
and its prime based loan portfolio increased by $1.4 million during the nine
month period ended June 30, 2006. The Company's construction loan portfolio
characteristically expands in the spring and early summer corresponding with the
area's typical selling season and declines in the fall and winter. The Company's
primary lending area continues to demonstrate signs of a healthy real estate
market. However, sustained employment growth across a wide spectrum of the local
economic base and moderate interest rate levels will ultimately determine
whether loan demand can be maintained. The high tech sector of the area's
employment base has been hit hard during the past several years and its slow
recovery has somewhat impeded growth in the overall real estate market. Assuming
local economic conditions continue to improve, management believes that the
long-term fundamentals of its lending markets provide potential for future loan
expansion. However, there can be no assurances that such loan demand can or will
materialize in the future.
Investment securities increased by $19,800 to $662,450 at June 30, 2006 from
$642,650 at September 30, 2005. The slight increase is attributable to a $4,500
unrealized gain in the Company's investment in FHLMC stock during the past nine
months and a required $15,300 purchase of FHLB stock during the same period. The
Company has decided to maintain higher levels of short term liquidity in order
to minimize interest rate risk and because there is currently very little gained
in investment returns from extending maturities. As a result, the Company has
not been actively involved in buying and selling securities. At June 30, 2006,
the Company's investment portfolio, which consisted of FHLB stock and FHLMC
stock, had approximately $457,000 in unrealized gains.
The Company had no borrowings outstanding during the period because its current
level of liquidity was sufficient to fund lending and other cash commitments.
The Company has recorded a liability of $587,350 at June 30, 2006 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 all participants were to
request the balance of their account from the Company in cash instead of stock.
9
WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2005 AND JUNE 30, 2006
(CONTINUED)
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, 2006 the Company had repurchased 89,845 shares of its common stock. The
program continues until completed or terminated by the Board of Directors.
Retained earnings increased by $900,950 to $13.8 million at June 30, 2006 from
$12.9 million at September 30, 2005. The increase is primarily attributable to
the Company's earnings of $1,183,400 during the nine month period ended June 30,
2006, reduced by $264,200 in dividends declared during the period and a $18,250
charge to retained earnings to reflect the change in the fair value of the ESOP
shares subject to the put option. At June 30, 2006 the Company's capital
amounted to $18.3 million, which as a percentage of total assets was 17.72%. The
Company and the Association are both required to meet certain capital
requirements as established by the OTS. At June 30, 2006, all capital
requirements were met.
ASSET QUALITY
The Company's level of non-performing assets, defined as loans past due 90 days
or more and foreclosed real estate, as a percentage of total assets outstanding,
was 1.22% at June 30, 2006 and 1.78% at September 30, 2005. At June 30, 2006,
non-performing assets amounted to $1.3 million and consisted of two delinquent
loans on single family residential properties ($253,000) and one foreclosed
commercial property ($1.0 million). The commercial property consisted of a
convenience store and an adjacent tract of land, in total 3.81 acres located on
a major highway outside of Wake Forest. While the commercial property's location
is considered highly desirable, the Company decided that an environmental
assessment was necessary to properly market the tract due to the historical uses
of the property. Petroleum contamination consistent with operating a gas station
and a truck maintenance facility over an extended period of time was found on
parts of the property. Environmental assessment is currently ongoing. Although
the Company does not currently believe the contamination will have any
significant effect on the potential development of the property, the Company is
committed to determining the extent of any required clean-up and ongoing
monitoring steps in order to properly preserve the value of the property. At
this time, the Company does not believe that the ongoing environmental costs
will materially impact the value of the property and no loss is expected on its
ultimate sale. The Company has expensed approximately $190,000 to date on
environmental assessment activities. At September 30, 2005, the Company had
$770,850 in loans delinquent 90 days or more.
The Company's loan loss allowance amounted to $995,000 at June 30, 2006 and
management believes that it has sufficient allowances established to cover any
losses within its loan portfolio. The allowance for loan losses is established
based upon probable losses that are estimated to have occurred through a
provision for loan losses charged to earnings. During the past five years, the
Association's loan portfolio has gradually trended towards a greater
concentration of residential construction loans, land, and land development
loans, which generally involves a greater degree of credit risk and collection
issues. As a result, the Company has provided relatively higher levels of loan
loss provisions and resulting allowances during this period than what has
historically been considered necessary.
The Company had no loan charge-offs during the current quarter or nine month
period ended June 30, 2006. However, in addition to the two non-performing loans
described above, the Company has seen a significant increase in the number of 60
day or more delinquent loans during the current quarter. The majority of the 60
day delinquencies occurred within the construction and land development loan
categories and many of these loans are prime based so rate increases over the
last couple of years have caused payment amounts to escalate and may have
contributed to the delinquent status. The spike in delinquencies during the
current quarter resulted in a higher level of loan loss provision for the
period.
10
WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
ASSET QUALITY (CONTINUED)
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 under the provisions of SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan", and a formula allowance for the remainder
of the portfolio under the provisions of SFAS No. 5, "Accounting for
Contingencies." Because the Company only originates loans securing by real
estate, specific problem loans are graded using the standard regulatory
classifications and are evaluated for impairment under SFAS No. 114 based upon
the collateral's fair value less estimated cost of disposal.
All other loans with unidentified impairment issues are pooled and segmented by
major loan types (single-family residential properties, construction loans,
commercial real estate, land, etc.). Loan loss rates for these categories are
then generated by capturing historical loan losses net of recoveries over a five
and ten year period, with added weight given to the more recent five year
period. Qualitative factors that may affect loan collectibility such as
geographical concentrations, local economic conditions, and delinquency trends
are also considered in determining the Company's best estimate of the range of
credit losses. This evaluation is inherently subjective as it requires estimates
that are susceptible to significant revision as more information becomes
available. The allowance for loan losses is evaluated on a regular basis by
management.
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 values 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.
COMPARISON OF OPERATING RESULTS FOR THE THREE AND NINE MONTHS ENDED JUNE 30,
2006 AND 2005
GENERAL. Net income for the three month period ended June 30, 2006 was $413,900,
or $109,700 more than the $304,200 earned during the same quarter in 2005. Net
income for the nine month period ended June 30, 2006 was $1,183,400, or $187,550
more than the $995,850 earned during the same period in 2005. As discussed
below, changes in net interest income between the comparable periods was
primarily responsible for the change in net income during the current quarter
and nine month period end June 30,2006 when compared to the same periods a year
earlier.
INTEREST INCOME. Interest income increased by $399,700 from $1,444,000 for the
three months ended June 30, 2005 to $1,843,700 for the three months ended June
30, 2006. The increase in interest income resulted from both a 132 basis point
increase in the average yield on interest earning assets between the quarters
and an increase of $4.6 million in the average balance of interest-earning
assets outstanding between the periods. Interest income increased by $1,017,250
from $4,207,800 for the nine months ended June 30, 2005 to $5,225,050 for the
nine months ended June 30, 2006. The increase in interest income resulted from
both an 98 basis point increase in the average yield on interest earning assets
between the nine month periods and an increase of $7.0 million in the average
balance of interest-earning assets outstanding between the periods. The
Company's yield on interest earning assets was 7.13% and 6.75% for the quarter
and nine month period ended June 30, 2006; respectively, and 5.81% and 5.77% for
the quarter and nine month period ended June 30, 2005; respectively. The changes
in yield occurred primarily due to fluctuations in market rates outstanding
during the periods. A significant portion of the Company's assets are able to
re-price quickly when market rates influenced by Federal Reserve rate movements
change.
11
WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
COMPARISON OF OPERATING RESULTS FOR THE THREE AND NINE MONTHS ENDED JUNE 30,
2006 AND 2005 (CONTINUED)
INTEREST EXPENSE. Interest expense increased by $158,100 from $602,000 for the
three months ended June 30, 2005 to $760,100 for the three months ended June 30,
2006. Interest expense increased by $451,750 from $1,679,950 for the nine months
ended June 30, 2005 to $2,131,700 for the nine months ended June 30, 2006. The
increases were the result of both an increase in the Company's cost of funds
between the periods and an increase in the average balance of deposits
outstanding between the periods. The Company's cost of funds increased by 70
basis points and 56 basis points for the three and nine month periods ended June
30, 2006; respectively, as compared to the same periods a year earlier. As a
result of overall higher market rates, the Company's cost of funds increased
from 3.09% and 3.00% for the quarter and nine month period ended June 30, 2005;
respectively, to 3.79% and 3.56% for the quarter and nine month period ended
June 30, 2006, respectively. The Company's average balance of deposits
outstanding increased by $2.9 million and $5.3 million for the three and nine
month periods ended June 30, 2006, respectively, as compared to the same periods
a year earlier.
NET INTEREST INCOME. Net interest income increased by $241,600 from $842,000 for
the three months ended June 30, 2005 to $1,083,600 for the three months ended
June 30, 2006. Net interest income increased by $565,500 from $2,527,850 for the
nine months ended June 30, 2005 to $3,093,350 for the nine months ended June 30,
2006. 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 as well as changes in
the level of interest earning assets and interest-bearing liabilities. The
Company's net interest margin was 4.41% and 4.23% for the current quarter and
nine months ended June 30, 2006 versus 3.60% and 3.73% for the same quarter and
nine month period a year earlier.
PROVISION FOR LOAN LOSSES. The Company provided $50,000 and $145,000 in loan
loss provisions during the current quarter and nine month period ended June 30,
2006; respectively, as compared to $25,000 and $89,600 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 in the portfolio. Loans are charged off against the allowance when
management believes that uncollectibility is confirmed. Subsequent recoveries,
if any, are credited to the allowance. The Association's loan portfolio has
gradually trended towards a greater concentration of builder construction loans,
land, and land development loans which generally involve a greater degree of
credit risk and collection issues. Also, many of these types of loans involve
lending relationships which are larger than what the Company has traditionally
maintained. As a result, the Company has provided relatively higher levels of
loan loss provisions and resulting allowances during current periods than what
has historically been considered necessary. In addition, the Company experienced
a significant increased level of delinquent loans during the current quarter as
compared to prior periods. The increased delinquencies impacted the level of
loan loss provision considered necessary for the quarter . None of the
provisions provided during the reported periods occurred due to the impairment
of specific loans as required by SFAS No. 114.
NON-INTEREST INCOME. The Company's non-interest income is primarily comprised on
various fees and service charges on customer accounts, income from bank owned
life insurance products, as well as security gains and fees earned from
secondary market originations. The Company did not have any investment sales
during any of the periods being reported upon. In addition, the Company has been
originating residential mortgage loans for its own portfolio over the periods
being reported upon and therefore very little secondary marketing income has
been generated over those same periods.
NON-INTEREST EXPENSE. Non-interest expense increased by $40,000 to $405,150 for
the three month period ended June 30, 2006 from $365,150 for the comparable
quarter in 2005. Non-interest expense increased by $171,950 to $1,174,950 for
the nine month period ended June 30, 2006 from $1,003,000 for the same period a
year earlier. Compensation and related benefits increased by $26,100 and $86,450
during the quarter and nine months ended June 30, 2006, respectively, as
compared to the same periods a year earlier. The increase in compensation and
benefits occurred primarily because the Company has accrued a higher level of
bonuses associated with the greater earnings in 2006 as compared to the same
periods a year earlier, and healthcare costs have risen by approximately 25%
during the current year.
12
WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
NON-INTEREST EXPENSE (CONTINUED)
REO provisions and expense decreased by $11,300 during the current quarter and
increased by $68,650 during the nine month period ended June 30, 2006 versus the
same periods a year earlier as a result of environmental assessment activities
associated with the Company's foreclosed 3.81 acre tract on highway 98 outside
of Wake Forest, North Carolina. The decrease in REO expense during the current
quarter as compared to same period in 2005 occurred because significantly all of
the assessment testing during 2005 was performed during the quarter ended June
30, 2005. During 2006, assessment activities and expense have increased but have
occurred throughout the nine month period ended June 30, 2006.
Data processing expense increased by $16,700 during the nine month periods ended
June 30, 2006 and other operating expense increased by $21,300 during the
current quarter as compared to the same periods a year earlier because the
Company recently completed a computer systems upgrade and conversion, resulting
in additional travel and training cost as well as depreciation expense on new
equipment.
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, 2006, cash and cash equivalents, a
significant source of liquidity, increased by approximately $2.2 million. A net
increase in deposits of $2.3 million and net cash provided by operating
activities of $1.5 million were the primary factors which contributed to the
increase in cash during the current nine month period. A net increase in loan
originations of $1.2 million was the most significant use of cash during the
nine month period ended June 30, 2006. 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.
OFF-BALANCE SHEET TRANSACTIONS
In the normal course of business, the Association engages in a variety of
financial transactions that, under generally accepted accounting principles,
either are not recorded on the balance sheet or are recorded on the balance
sheet in amounts that differ from the full contract or notional amounts.
Primarily the Association is a 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, revolving lines of credit, and the undisbursed portion of
construction loans. Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amounts recognized in the
statement of financial condition. The contract or notional amounts of those
instruments reflect the extent of involvement the Association has in particular
classes of financial instruments. The Association's exposure to credit loss in
the event of nonperformance by the other party to the financial instrument for
commitments to extend credit is represented by the contractual notional amount
of those instruments. The Association uses the same credit policies in making
commitments and conditional obligations as it does for on-balance-sheet
instruments. At June 30, 2006, the Association had outstanding loan commitments
amounting to approximately $5.7 million. The undisbursed portion of construction
loans amounted to $13.8 million and unused lines of credit amounted to $7.3
million at June 30, 2006.
13
WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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 2005 Annual Report on Form 10-KSB. The
Company has not experienced any material change in its critical accounting
policies since September 30, 2005. 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:
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 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, 2006
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
a) 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.
b) 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, 2006 By: s/s Robert C. White
------------------------------ -----------------------------
Robert C. White
Chief Executive Officer and
Chief Financial Officer
17