U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One) FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________TO_________
Commission File No. 33-31013 - A
ISLANDS BANCORP
(EXACT NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)
South Carolina 57-1082388
(State of incorporation) (I.R.S. Employer
Identification No.)
2348 Boundary Street, Beaufort SC 29902
(Address of principal executive offices)
(843) 521-1968
(Issuer's telephone number, including area code)
------------------------------------------------
Check whether the issuer (1) has 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 [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
YES [ ] NO [X]
State the number of shares outstanding of each of the issuer's classes of common
equity as of the latest practicable date:
740,260 SHARES OF COMMON STOCK, NO PAR VALUE PER SHARE, ON MAY 12, 2006
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
INDEX
PART I. FINANCIAL INFORMATION Page No.
- ----------------------------- --------
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - March 31, 2006 and December 31, 2005. . . . . . . . . . 3
Condensed Consolidated Statements of Income - Three Months Ended March 31, 2006 and 2005. . . . 4
Condensed Consolidated Statements of Shareholders' Equity and Comprehensive Income -
Three Months Ended March 31, 2006 and 2005. . . . . . . . . . . . . . . . . . . . . . . . . . 5
Condensed Consolidated Statements of Cash Flows - Three Months Ended March 31, 2006 and 2005. . 6
Notes to Condensed Consolidated Financial Statements. . . . . . . . . . . . . . . . . . . . . . 7-9
Item 2. Management's Discussion and Analysis or Plan of Operation . . . . . . . . . . . . . . . . 10-14
Item 3. Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
PART II. OTHER INFORMATION
- --------------------------
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds . . . . . . . . . . . . . . . 16
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Item 6. Exhibits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
PART I. FINANCIAL INFORMATION
- -----------------------------
ITEM 1. FINANCIAL STATEMENTS
- ----------------------------
ISLANDS BANCORP
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
MARCH 31, DECEMBER 31,
2006 2005
-------------- --------------
ASSETS (UNAUDITED)
Cash and cash equivalents
Cash and due from banks $ 1,458 $ 871
Interest bearing deposits in banks 103 134
Federal funds sold 3,093 4,835
-------------- --------------
Total cash and cash equivalents 4,654 5,840
-------------- --------------
Securities available for sale 2,701 2,269
Nonmarketable equity securities, at cost 392 356
-------------- --------------
Total securities 3,093 2,625
-------------- --------------
Loans receivable 57,525 54,310
Less allowance for loan losses 705 679
-------------- --------------
Loans, net 56,820 53,631
-------------- --------------
Premises and equipment, net 3,305 3,333
Other assets 770 778
-------------- --------------
Total assets $ 68,642 $ 66,207
============== ==============
LIABILITIES
Deposits
Noninterest bearing $ 5,888 $ 6,519
Interest bearing 53,778 51,616
-------------- --------------
Total deposits 59,666 58,135
-------------- --------------
Other borrowings 1,700 1,700
Other liabilities 482 569
-------------- --------------
Total liabilities 61,848 60,404
-------------- --------------
SHAREHOLDERS' EQUITY -
Common stock, zero par value; 10,000,000 shares authorized,
740,260 and 652,705 shares issued and outstanding at
March 31, 2006 and December 31, 2005, respectively 7,089 6,213
Retained deficit (271) (388)
Accumulated other comprehensive income (loss) (24) (22)
-------------- --------------
Total shareholders' equity 6,794 5,803
-------------- --------------
Total liabilities and shareholders' equity $ 68,642 $ 66,207
============== ==============
See notes to condensed
consolidated financial statements.
- 3 -
ISLANDS BANCORP
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
(UNAUDITED)
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
------------------------
2006 2005
----------- -----------
INTEREST INCOME
Loans, including fees $ 1,111 $ 800
Investment securities:
Taxable 25 13
Nontaxable - -
Interest bearing deposits in banks 2 -
Federal funds sold 45 14
----------- -----------
Total 1,183 827
----------- -----------
INTEREST EXPENSE
Deposits 468 264
Other borrowings 17 16
----------- -----------
Total 485 280
----------- -----------
NET INTEREST INCOME 698 547
Provision for loan losses 43 57
----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 655 490
----------- -----------
NONINTEREST INCOME
Service charges on deposit accounts 37 45
Gains on sales of loans 33 43
Other income 45 62
----------- -----------
Total noninterest income 115 150
----------- -----------
NONINTEREST EXPENSE
Salaries and employee benefits 282 260
Net occupancy expense 68 53
Other operating expense 233 138
----------- -----------
Total noninterest expense 583 451
----------- -----------
INCOME BEFORE INCOME TAXES 187 189
Income tax expense 72 64
----------- -----------
NET INCOME $ 115 $ 125
=========== ===========
EARNINGS PER SHARE
Basic $ .17 $ .19
=========== ===========
Diluted $ .16 $ .19
=========== ===========
See notes to condensed
consolidated financial statements.
- 4 -
ISLANDS BANCORP
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
(UNAUDITED)
(DOLLARS IN THOUSANDS)
ACCUMULATED
COMMON STOCK OTHER
------------------- RETAINED COMPREHENSIVE
SHARES AMOUNT DEFICIT INCOME TOTAL
-------- --------- ---------- --------------- ----------
BALANCE, DECEMBER 31, 2004 652,705 $ 6,213 $ (927) $ (20) $ 5,266
Net income -- -- 125 -- 125
Other comprehensive income -- -- -- 6 6
-------- --------- ---------- --------------- ----------
Comprehensive income -- -- 125 6 131
-------- --------- ---------- --------------- ----------
BALANCE, MARCH 31, 2005 652,705 $ 6,213 $ (802) $ (14) $ 5,397
======== ========= ========== =============== ==========
BALANCE, DECEMBER 31, 2005 652,705 $ 6,213 $ (388) $ (22) $ 5,803
Net income -- -- 115 -- 115
Other comprehensive income -- -- -- (2) (2)
-------- --------- ---------- --------------- ----------
Comprehensive income -- -- 115 (2) 113
-------- --------- ---------- --------------- ----------
Stock-based compensation -- -- 2 -- 2
Exercise of director warrants 87,555 876 -- - 876
-------- --------- ---------- --------------- ----------
BALANCE, MARCH 31, 2006 740,260 $ 7,089 $ (271) $ (24) $ 6,794
======== ========= ========== =============== ==========
See notes to condensed
consolidated financial statements.
- 5 -
ISLANDS BANCORP
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
(UNAUDITED)
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
--------------------------
2006 2005
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 115 $ 125
Adjustments to reconcile net income to net cash provided by
operating activities
Provision for loan losses 43 57
Depreciation expense 43 36
Other, net (96) (93)
------------ ------------
Net cash provided by operating activities 105 125
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of available for sale securities (515) -
Purchases of nonmarketable equity securities (36) -
Paydowns of available for sale securities 83 93
Net increase in loans (3,215) (4,144)
Purchases of fixed assets (15) (13)
------------ ------------
Net cash used in investing activities (3,698) (4,064)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 1,531 7,392
Exercise of director warrants 876 -
------------ ------------
Net cash provided by financing activities 2,407 7,392
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,186) 3,453
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 5,840 1,540
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 4,654 $ 4,993
============ ============
CASH PAID DURING THE PERIOD FOR:
Income taxes $ - $ -
============ ============
Interest $ 461 $ 258
============ ============
See notes to condensed
consolidated financial statements.
- 6 -
ISLANDS BANCORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
- ------------------------------
The accompanying financial statements have been prepared in accordance with the
requirements for interim financial statements and, accordingly, they are
condensed and omit disclosures which would substantially duplicate those
contained in the most recent annual report on Form 10-KSB. The financial
statements, as of March 31, 2006 and for the interim periods ended March 31,
2006 and 2005, are unaudited and, in the opinion of management, include all
adjustments (consisting of normal recurring adjustments) considered necessary
for a fair presentation. The financial information as of December 31, 2005 has
been derived from the audited financial statements as of that date. For further
information, refer to the financial statements and the notes included in the
Company's Annual Report on Form 10-KSB for the year ended December 31, 2005.
NOTE 2 - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
- --------------------------------------------------
The following is a summary of recent authoritative pronouncements that could
impact the accounting, reporting, and/or disclosure of financial information by
the Company.
In February 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 155, "Accounting for
Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133
and 140". This Statement amends SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", and SFAS No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities". This
Statement resolves issues addressed in SFAS No. 133 Implementation Issue No. D1,
"Application of Statement 133 to Beneficial Interests in Securitized Financial
Assets". SFAS No. 155 is effective for all financial instruments acquired or
issued after the beginning of an entity's first fiscal year that begins after
September 15, 2006. The Company does not believe that the adoption of SFAS No.
155 will have a material impact on its financial position, results of operations
and cash flows.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets - an amendment of FASB Statement No. 140". This Statement
amends FASB No. 140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities", with respect to the accounting for
separately recognized servicing assets and servicing liabilities. SFAS No. 156
requires an entity to recognize a servicing asset or servicing liability each
time it undertakes an obligation to service a financial asset by entering into a
servicing contract; requires all separately recognized servicing assets and
servicing liabilities to be initially measured at fair value, if practicable;
permits an entity to choose its subsequent measurement methods for each class of
separately recognized servicing assets and servicing liabilities; at its initial
adoption, permits a one-time reclassification of available-for-sale securities
to trading securities by entities with recognized servicing rights, without
calling into question the treatment of other available-for-sale securities under
SFAS No. 115, provided that the available-for-sale securities are identified in
some manner as offsetting the entity's exposure to changes in fair value of
servicing assets or servicing liabilities that a servicer elects to subsequently
measure at fair value; and requires separate presentation of servicing assets
and servicing liabilities subsequently measured at fair value in the statement
of financial position and additional disclosures for all separately recognized
servicing assets and servicing liabilities. An entity should adopt SFAS No. 156
as of the beginning of its first fiscal year that begins after September 15,
2006. The Company does not believe the adoption of SFAS No. 156 will have a
material impact on its financial position, results of operations and cash flows.
Other accounting standards that have been issued or proposed by the FASB or
other standards-setting bodies are not expected to have a material impact on the
Company's financial position, results of operations and cash flows.
- 7 -
NOTE 3 - STOCK-BASED COMPENSATION
- ---------------------------------
On January 1, 2006, the Company adopted the fair value recognition provisions of
SFAS No. 123(R), "Accounting for Stock-Based Compensation", to account for
compensation costs under its stock option plan. The Company previously utilized
the intrinsic value method under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees (as amended)" ("APB 25"). Under the
intrinsic value method prescribed by APB 25, no compensation costs were
recognized for the Company's stock options because the option exercise price in
its plan equals the market price on the date of grant. Prior to January 1,
2006, the Company only disclosed the pro forma effects on net income and
earnings per share as if the fair value recognition provisions of SFAS 123(R)
had been utilized.
In adopting SFAS No. 123, the Company elected to use the modified prospective
method to account for the transition from the intrinsic value method to the fair
value recognition method. Under the modified prospective method, compensation
cost is recognized from the adoption date forward for all new stock options
granted and for any outstanding unvested awards as if the fair value method had
been applied to those awards as of the date of grant. The following table
illustrates the effect on net income and earnings per share as if the fair value
based method had been applied to all outstanding and unvested awards in each
period (in thousands, except per share amounts).
THREE MONTHS ENDED MARCH 31,
------------------------------------
2006 2005
----------------- -----------------
Net income as reported $ 115 $ 125
Add: Stock-based employee compensation expense included in
reported net income, net of related tax effects 1 -
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards, net of related
tax effects (1) (15)
----------------- -----------------
Pro forma net income including stock-based compensation cost based
on fair-value method $ 115 $ 110
================= =================
Earnings per share:
Basic-as reported $ 0.17 $ 0.19
================= =================
Basic-pro forma $ 0.17 $ 0.17
================= =================
Diluted-as reported $ 0.16 $ 0.19
================= =================
Diluted-pro forma $ 0.16 $ 0.17
================= =================
NOTE 4 - EARNINGS PER SHARE
- ---------------------------
A reconciliation of the numerators and denominators used to calculate basic and
diluted earnings per share for the three month periods ended March 31, 2006 and
2005 are as follows (in thousands, except share and per share amounts):
THREE MONTHS ENDED MARCH 31, 2006
--------------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
-------------- ------------- -------------
BASIC EARNINGS PER SHARE
Income available to common shareholders $ 115 683,121 $ 0.17
=============
EFFECT OF DILUTIVE SECURITIES
Stock options and warrants - 31,770
-------------- -------------
DILUTED EARNINGS PER SHARE
Income available to common shareholders
plus assumed conversions $ 115 714,891 $ 0.16
============== ============= =============
- 8 -
THREE MONTHS ENDED MARCH 31, 2005
--------------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
-------------- ------------- -------------
BASIC EARNINGS PER SHARE
Income available to common shareholders $ 125 652,705 $ 0.19
=============
EFFECT OF DILUTIVE SECURITIES
Stock options and warrants - -
-------------- -------------
DILUTED EARNINGS PER SHARE
Income available to common shareholders
plus assumed conversions $ 125 652,705 $ 0.19
============== ============= =============
NOTE 5 - COMPREHENSIVE INCOME
- -----------------------------
Comprehensive income includes net income and other comprehensive income, which
is defined as nonowner related transactions in equity. The following table sets
forth the amounts of other comprehensive income included in equity along with
the related tax effect for the three month periods ended March 31, 2006 and 2005
(in thousands):
THREE MONTHS ENDED MARCH 31, 2006
----------------------------------------------
PRE-TAX (EXPENSE) NET-OF-TAX
AMOUNT BENEFIT AMOUNT
-------------- -------------- --------------
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during the period $ (3) $ 1 $ (2)
Plus: reclassification adjustment for gains (losses)
realized in net income - - -
-------------- -------------- --------------
Net unrealized gains (losses) on securities (3) 1 (2)
-------------- -------------- --------------
Other comprehensive income (loss) $ (3) $ 1 $ (2)
============== ============== ==============
THREE MONTHS ENDED MARCH 31, 2005
--------------------------------------------
PRE-TAX (EXPENSE) NET-OF-TAX
AMOUNT BENEFIT AMOUNT
------------- -------------- -------------
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during the period $ 9 $ (3) $ 6
Plus: reclassification adjustment for gains (losses)
realized in net income - - -
------------- -------------- -------------
Net unrealized gains (losses) on securities 9 (3) 6
------------- -------------- -------------
Other comprehensive income $ 9 $ (3) $ 6
============= ============== =============
Accumulated other comprehensive income consists solely of the unrealized gain
(loss) on securities available-for-sale, net of the deferred tax effects.
- 9 -
Item 2. Management's Discussion and Analysis or Plan of Operation
- ------------------------------------------------------------------
The following is a discussion of the Company's financial condition as of March
31, 2006 compared to December 31, 2005, and the results of operations for the
three months ended March 31, 2006 compared to the three months ended March 31,
2005. This discussion should be read in conjunction with our condensed financial
statements and accompanying notes appearing in this report and in conjunction
with the financial statements and related notes and disclosures in our Annual
Report on Form 10-KSB for the year ended December 31, 2005. This report
contains "forward-looking statements" relating to, without limitation, future
economic performance, plans and objectives of management for future operations,
and projections of revenues and other financial items that are based on the
beliefs of management, as well as assumptions made by and information currently
available to management. The words "expect," "estimate," "anticipate,"
"believe," "project," "intend," "plan," and similar expressions, are intended to
identify forward-looking statements. Our actual results may differ materially
from the results discussed in the forward-looking statements, and our operating
performance each quarter is subject to various risks and uncertainties that are
discussed in detail in our filings with the Securities and Exchange Commission.
RESULTS OF OPERATIONS
- ---------------------
NET INTEREST INCOME
- -------------------
For the three months ended March 31, 2006, net interest income, the major
component of net income, increased $151,000, or 27.6%, to $698,000 as compared
to $547,000 for the same period in 2005. Interest and fee income from loans
increased $311,000, or 38.9%, for the three months ended March 31, 2006 compared
to the same period in 2005 as the Bank continues to experience growth in the
loan portfolio. Average loans outstanding were $44,300,000 during the first
quarter of 2005 compared to $56,128,000 for the same period in 2006. In
addition, loan portfolio yields increased from 7.32% during the first quarter of
2005 to 8.03% for the same period in 2006 due to the rising interest rate
environment during this time.
Interest expense for the three months ended March 31, 2006 was $485,000 as
compared to $280,000 for the same period in 2005. The average rate paid on
interest-bearing liabilities increased from 2.70% during the first quarter of
2005 to 3.54% for the same period in 2006, along with an increase in average
interest-bearing liabilities from $42,104,000 during the first quarter of 2005
to $55,697,000 for the same period in 2006.
The interest rate spread, which is the difference between the yield on earning
assets and the rate paid on liabilities, was 4.07% for the three months ended
March 31, 2006, compared to 4.15% for the same period in 2005. The net interest
margin, which is net interest income divided by average earning assets, was
4.49% for the first three months of 2006 compared to 4.53% for the same period
in 2005.
PROVISION AND ALLOWANCE FOR LOAN LOSSES
- ---------------------------------------
The provision for loan losses is the charge to operating earnings that
management believes is necessary to maintain the allowance for loan losses at an
adequate level to reflect the losses inherent in the loan portfolio. For the
three months ended March 31, 2006, the provision charged to expense was $43,000,
as compared to $57,000 for the same period in 2005. The allowance for loan
losses represents 1.23% of gross loans at March 31, 2006 compared to 1.00% at
March 31, 2005.
There are risks inherent in making all loans, including risks with respect to
the period of time over which loans may be repaid, risks resulting from changes
in economic and industry conditions, risks inherent in dealing with individual
borrowers, and, in the case of a collateralized loan, risks resulting from
uncertainties about the future value of the collateral. The Company maintains
an allowance for loan losses based on, among other things, historical
experience, an evaluation of economic conditions, and regular reviews of
delinquencies and loan portfolio quality. Management's judgment about the
adequacy of the allowance is based upon a number of estimates and assumptions
about present conditions and future events, which are believed to be reasonable,
but which may not prove to be accurate. Thus, there is a risk that charge-offs
in future periods could exceed the allowance for loan losses or that substantial
additional increases in the allowance for loan losses could be required.
Additions to the allowance for loan losses would result in a decrease of net
income and possibly capital.
- 10 -
NONINTEREST INCOME
- ------------------
Noninterest income for the three months ended March 31, 2006 was $115,000, a
decrease of $35,000 from the comparable period in 2005. The largest component
of noninterest income was service charges on deposit accounts, which totaled
$37,000 for the three months ended March 31, 2006, as compared to $45,000 for
the three months ended March 31, 2005. The decrease in service charges was
primarily due to a decrease in overdraft and NSF fees. Gains on sales of loans
decreased by $10,000 and were $33,000 for the three months ended March 31, 2006
compared to $43,000 for the comparable period in 2005. The decrease was
primarily due to less SBA loan sale activity in 2006. Other income decreased by
$17,000 and totaled $45,000 for the three months ended March 31, 2006 compared
to $62,000 for the comparable period in 2005. The decrease was primarily due to
a decrease in secondary market mortgage broker fees.
NONINTEREST EXPENSE
- -------------------
Noninterest expense for the three months ended March 31, 2006 was $583,000, an
increase of $132,000 from the comparable period in 2005. Salaries and employee
benefits totaled $282,000 for the three months ended March 31, 2006, an increase
of $22,000 from the comparable period in 2005. The increase was primarily due to
an increase in the number of employees, normal salary increases and increases in
employee benefits expense. Net occupancy expense totaled $68,000 for the three
months ended March 31, 2006, an increase of $15,000 from the comparable period
in 2005. The increase was primarily due to increased depreciation expense and
increases in maintenance and repairs. Other noninterest expense totaled
$233,000 for the three months ended March 31, 2006, an increase of $95,000 from
the comparable period in 2005. The increase was primarily due to increases in
data processing and advertising expenses in order to support the Bank's growth,
and an increase in legal fees related to executive officer changes and
preparation and review of additional filings with the SEC.
INCOME TAXES
- ------------
Income tax expense for the three months ended March 31, 2006 was $72,000 as
compared to $64,000 for the same period in 2005. All of the Company's net
operating losses have been utilized for tax purposes, and the Company is now
fully taxable for both Federal and state income tax purposes.
NET INCOME
- ----------
The combination of the above factors resulted in net income for the three months
ended March 31, 2006 of $115,000 as compared to net income of $125,000 for the
same period in 2005.
FINANCIAL CONDITION
- -------------------
ASSETS AND LIABILITIES
- ----------------------
During the first three months of 2006, total assets increased $2,435,000, or
3.7%, when compared to December 31, 2005. The primary growth in assets was
composed of an increase in loans receivable of $3,215,000, or 5.9%, during the
first three months of 2006. Total deposits increased $1,531,000, or 2.6%, from
the December 31, 2005 amount of $58,135,000. Federal funds sold decreased by
$1,742,000 during the first three months of 2006 in order to fund the increase
in loans in excess of deposit growth.
INVESTMENT SECURITIES
- ---------------------
Securities available for sale increased from $2,269,000 at December 31, 2005 to
$2,701,000 at March 31, 2006 primarily due to the purchase of SCM securities now
that the Bank is fully taxable. All of the Bank's marketable investment
securities were designated as available-for-sale at March 31, 2006. The increase
of $36,000 in nonmarketable equity securities was due to a required purchase of
additional FHLB stock.
- 11 -
LOANS
- -----
Balances within the major loan categories as of March 31, 2006 and December 31,
2005 are as follows (in thousands):
MARCH 31, DECEMBER 31,
2006 2005
------------- -------------
Real estate - construction $ 20,148 $ 17,082
Real estate - mortgage 28,765 25,995
Commercial and industrial 5,949 8,640
Consumer and other 2,663 2,593
------------- -------------
$ 57,525 $ 54,310
============= =============
The Bank continued its trend of loan growth during the first three months of
2006. Outstanding loans increased $3,215,000, or 5.9%, during the period. As
shown above, the main component of growth in the loan portfolio was real estate
- - construction loans which increased 17.9%, or $3,066,000, from December 31,
2005 to March 31, 2006.
RISK ELEMENTS IN THE LOAN PORTFOLIO
- -----------------------------------
The following is a summary of risk elements in the loan portfolio (in
thousands):
MARCH 31, DECEMBER 31,
2006 2005
------------- -------------
Nonaccrual loans $ 306 $ 313
Accruing loans more than 90 days past due $ - $ 107
Loans identified by the internal review mechanism:
Criticized $ 1,248 $ 1,546
Classified $ 503 $ 551
Criticized loans have potential weaknesses that deserve close attention and
could, if uncorrected, result in deterioration of the prospects for repayment or
the Bank's credit position at a future date. Classified loans are inadequately
protected by the sound worth and paying capacity of the borrower or any
collateral and there is a distinct possibility or probability that we will
sustain a loss if the deficiencies are not corrected.
ALLOWANCE FOR LOAN LOSSES
- -------------------------
Activity in the allowance for loan losses is as follows (dollars in thousands):
THREE MONTHS ENDED MARCH 31,
------------------------------------
2006 2005
----------------- -----------------
Balance, beginning of period $ 679 $ 488
Provision for loan losses 43 57
Net loans (charged-off) recovered (17) -
----------------- -----------------
Balance, end of period $ 705 $ 545
================= =================
Loans outstanding, end of period $ 57,525 $ 54,310
Allowance for loan losses to loans outstanding 1.23% 1.00%
- 12 -
DEPOSITS
- --------
Balances within the major deposit categories as of March 31, 2006 and December
31, 2005 are as follows (in thousands):
MARCH 31, DECEMBER 31,
2006 2005
------------- -------------
Noninterest-bearing demand deposits $ 5,888 $ 6,519
Interest-bearing demand deposits 11,290 7,463
Savings deposits 1,248 878
Time deposits $100,000 and over 13,513 13,348
Other time deposits 27,727 29,927
------------- -------------
$ 59,666 $ 58,135
============= =============
At March 31, 2006, total deposits had increased by $1,531,000, or 2.6%, from
December 31, 2005. The largest increase was in interest-bearing demand
deposits, which increased $3,827,000 from December 31, 2005 to March 31, 2006.
This increase is primarily due to increases in balances maintained in the Bank's
business checking accounts.
LIQUIDITY
- ---------
The Bank meets its liquidity needs through scheduled maturities of loans and
investments and through pricing policies designed to attract interest-bearing
deposits. The level of liquidity is measured by the loan-to-total borrowed
funds (which includes deposits) ratio, which was 93.7% and 90.8% at March 31,
2006 and December 31, 2005, respectively.
At March 31, 2006, the Company's primary sources of liquidity included Federal
funds sold of $3,093,000 and securities available-for-sale totaling $2,701,000.
The Bank also has lines of credit available with correspondent banks to purchase
federal funds for periods from one to 14 days. At March 31, 2006, unused lines
of credit totaled $5,440,000.
OFF-BALANCE SHEET RISK
- ----------------------
Through its operations, the Bank has made contractual commitments to extend
credit in the ordinary course of its business activities. These commitments are
legally binding agreements to lend money to the Bank's customers at
predetermined interest rates for a specified period of time. At March 31, 2006,
the Bank had issued commitments to extend credit of $11,031,000 and standby
letters of credit totaling $318,000.
Based on historical experience, many of the commitments and letters of credit
will expire unfunded. Accordingly, the above amounts do not necessarily reflect
the Bank's need for funds in the future.
The Bank evaluates each customer's creditworthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary by the Bank upon
extension of credit, is based on its credit evaluation of the borrower.
Collateral varies but may include accounts receivable, inventory, property,
plant and equipment, commercial and residential real estate.
CRITICAL ACCOUNTING POLICIES
- ----------------------------
The Company has adopted various accounting policies which govern the application
of accounting principles generally accepted in the United States in the
preparation of its financial statements. The significant accounting policies are
described in the notes to the consolidated financial statements at December 31,
2005 as filed in the Annual Report on Form 10-KSB. Certain accounting policies
involve significant judgments and assumptions which have a material impact on
the carrying value of certain assets and liabilities. Management considers these
accounting policies to be critical accounting policies. The judgments and
assumptions used are based on historical experience and other factors, which
management believes to be reasonable under the circumstances. Because of the
nature of the judgments and assumptions, actual results could differ from these
judgments and estimates which could have a major impact on the carrying values
of assets and liabilities and results of operations.
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Management believes the allowance for loan losses is a critical accounting
policy that requires the most significant judgments and estimates used in
preparation of our consolidated financial statements. Refer to the portions of
our 2005 Annual Report on Form 10-KSB and this Form 10-QSB that address the
allowance for loan losses for a description of our processes and methodology for
determining the allowance for loan losses.
CAPITAL RESOURCES
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Total shareholders' equity increased from $5,803,000 at December 31, 2005 to
$6,794,000 at March 31, 2006. The increase is due to net income of $115,000 and
the exercise of director warrants totaling $876,000.
The Federal Reserve Board and bank regulatory agencies require bank holding
companies and financial institutions to maintain capital at adequate levels.
Because the Company has total assets of less than $150 million, its capital
adequacy is judged only on the adequacy of the Bank's capital. Quantitative
measures established by regulation to ensure capital adequacy require the Bank
to maintain minimum ratios of Tier 1 and total capital as a percentage of assets
and off-balance sheet exposures, adjusted for risk-weights ranging from 0% to
100%. Under the risk-based standard, capital is classified into two tiers. For
the Bank, Tier 1 capital consists of common shareholders' equity, excluding the
unrealized gain (loss) on available-for-sale securities, minus certain
intangible assets. For the Bank, Tier 2 capital consists of the reserve for
loan losses subject to certain limitations. An institution's qualifying capital
base for purposes of its risk-based capital ratio consists of the sum of its
Tier 1 and Tier 2 capital. The regulatory minimum requirements are 4% for Tier
1 and 8% for total risk-based capital.
Banks and bank holding companies are also required to maintain capital at a
minimum level based on total assets, which is known as the leverage ratio. The
minimum requirement for the leverage ratio is 3%; however all but the highest
rated institutions are required to maintain ratios 100 to 200 basis points above
the minimum. The Bank exceeded its minimum regulatory capital ratios as of
March 31, 2006, as well as the ratios to be considered "well capitalized."
The following table summarizes the Bank's risk-based capital at March 31, 2006:
Shareholders' equity $ 6,631,000
Less: unrealized gains/losses on securities held for sale 24,000
Less: disallowed servicing assets (11,000)
------------
Tier 1 capital 6,644,000
Plus: allowance for loan losses (1) 705,000
------------
Total capital $ 7,349,000
============
Risk-weighted assets $57,714,000
============
Risk-based capital ratios
Tier 1 capital (to risk-weighted assets) 11.51%
Total capital (to risk-weighted assets) 12.73%
Tier 1 capital (to total average assets) 9.88%
(1) Limited to 1.25% of risk-weighted assets
ITEM 3. CONTROLS AND PROCEDURES
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As of the end of the period covered by this Quarterly Report on Form 10-QSB, our
principal executive officer and our principal financial officer have evaluated
the effectiveness of our "disclosure controls and procedures" ("Disclosure
Controls"). Disclosure Controls, as defined in Rule 13a-15(e) of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), are procedures that are
designed with the objective of ensuring that information required to be
disclosed in our reports filed under the Exchange Act, such as this Quarterly
Report, is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms. Disclosure Controls are also designed
with the objective of ensuring that such information is accumulated and
communicated to our management, including our principal executive officer and
our principal financial officer, as appropriate to allow timely decisions
regarding required disclosure.
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Our management, including our principal executive officer and our principal
financial officer, does not expect that our Disclosure Controls will prevent all
error and all fraud. A control system, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Further, the design of a control
system must reflect the fact that there are resource constraints, and the
benefits of controls must be considered relative to their costs. Because of the
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within the company have been detected. These inherent limitations include
the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or mistake. The design of any
system of controls also is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions.
Based upon their controls evaluation, our principal executive officer and our
principal financial officer have concluded that our Disclosure Controls are
effective at a reasonable assurance level.
There have been no changes in our internal controls over financial reporting
during the past fiscal year that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
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ITEM 1. LEGAL PROCEEDINGS
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As previously reported, on November 15, 2005, the Company terminated the
employment of William B. Gossett as the president and chief executive officer of
the Company and the Bank. Mr. Gossett's employment was terminated for cause
under specific provisions of his employment agreement as a result of regulatory
actions stemming from the 2005 Office of the Comptroller of the Currency ("OCC")
examination of the Bank. Among other things, the OCC commented on management's
failure to properly address issues noted in prior exam reports. As a result of
the OCC examination, each Board member has signed a Commitment Letter with the
OCC agreeing to take proper action to correct all noted issues. Currently, all
of the noted issues have been or are being corrected and the OCC has commented
favorably on the progress being made by the Bank. Management believes the
Commitment Letter will not have a material adverse effect on our operations.
On February 1, 2006, Mr. Gossett, a principal security holder of the Company,
filed a claim with the U.S. Department of Labor Occupational Safety and Health
Administration against the Company and the Bank under 18 U.S.C 1514A. Mr.
Gossett alleges that his termination was in retaliation against him for raising
what the Company determined were minor concerns regarding his ability to provide
the certifications of the principal executive and financial officer which were
required to be filed with the Company's Report on Form 10-QSB for the quarter
ended September 30, 2005. Prior to filing the Form 10-QSB in question, however,
Mr. Gossett's concerns were fully resolved and he provided the required
certifications. The Form 10-QSB in question was timely filed and fully complied
with the requirements of Section 13(a) of the Securities Exchange Act of 1934,
as amended.
Mr. Gossett claims that he is entitled to receive an amount equal to two times
his salary as in effect at the time of his termination, or approximately
$323,000, together with attorney fees and the reinstatement of options to
acquire 19,581 shares of the Company's stock, which were forfeited upon his
termination. Under the terms of his employment agreement dated July 27, 1999,
Mr. Gossett is not entitled to these payments or reinstatement of his options
since we believe he was properly terminated for cause.
The Company believes that Mr. Gossett's allegations are without merit and is
vigorously contesting his claim.
We do not believe Mr. Gossett's claim represents a material proceeding to which
the Company is a party. Accordingly, there are no material pending legal
proceedings to which the Company is a party or of which any of its properties
are subject, nor are there material proceedings known to the Company to be
contemplated by any governmental authority. Additionally, the Company is
unaware of any material proceedings, pending or contemplated, in which any
existing or proposed director, officer or affiliate, or any principal security
holder of the Company or any associate of any of the foregoing, is a party or
has an interest adverse to the Company.
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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
- --------------------------------------------------------------------
On February 9, 2006, William B. Gossett, the Company's former President and
Chief Executive Officer, exercised warrants to purchase 30,127 shares of the
Company's common stock at an exercise price of $10.00 per share, or an aggregate
of $301,270. These shares were issued pursuant to the exemption from
registration under Section 4(2) of the Securities Act of 1933.
In March 2006, five of the Company's directors exercised warrants to purchase an
aggregate of 57,428 shares of the Company's common stock at an exercise price of
$10.00 per share, or an aggregate of $574,280. These shares were issued
pursuant to the exemption from registration under Section 4(2) of the Securities
Act of 1933.
ITEM 5. OTHER INFORMATION
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Effective as of November 17, 2005, Islands Community Bank entered into a five
year Contract of Employment with John R. Perrill regarding his employment as the
Bank's Senior Loan Officer and Acting Chief Executive Officer. Mr. Perrill will
serve as the Acting Chief Executive Officer until a permanent Chief Executive
Officer is appointed. Under the terms of the agreement, Mr. Perrill will
receive an annual base salary of $135,000 per year and is entitled to salary
increases pursuant to the Bank's Salary and Bonus Incentive Plan. In addition,
Mr. Perrill is entitled to payment of service and social club dues, a car or
travel allowance of $600 per month, health insurance premiums and to participate
in other customary benefit programs offered to all employees, such as retirement
plans and vacation time.
The agreement provides that, in the event Mr. Perrill is terminated by the Bank
without cause (as defined in the agreement), Mr. Perrill is entitled to a lump
sum severance payment equal to the sum of his salary as in effect at the
effective time of the termination of employment and the amount of bonus earned
during the prior calendar year. In the event the Bank is sold within a five
year period from the effective date of the agreement and Mr. Perrill is not
provided continued employment under substantially the same terms and conditions
as provided in the agreement, Mr. Perrill is entitled to two years severance
pay.
ITEM 6. EXHIBITS
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Exhibit 10.7 - Contract of Employment by and between Islands Community Bank and
John R. Perrill dated as of November 17, 2005.
Exhibit 31.1 - Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2 - Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
Exhibit 32 - Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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ISLANDS BANCORP
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
By: /s/ John R. Perrill
-------------------------------
John R. Perrill
Acting Chief Executive Officer
Date: May 12, 2006 By: /s/ Carol J. Nelson
-------------------------------
Carol J. Nelson
Chief Financial Officer
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ISLANDS BANCORP
INDEX TO EXHIBITS
Exhibit
Number Description
- ------- -----------
10.7 John R. Perrill Employment Agreement
31.1 Rule 13a-14(a) Certification of the Chief Executive Officer.
31.2 Rule 13a-14(a) Certification of the Chief Financial Officer.
32 Section 1350 Certifications.
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