UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
- --- ACT OF 1934 For the quarterly period ended September 30, 2005
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
For the transition period from to
------------ ------------
COMMISSION FILE NUMBER 1-5735
UNION FINANCIAL BANCSHARES, INC.
--------------------------------
(Exact name of registrant as specified in its Charter)
Delaware 57-1001177
-------- ----------
(State or other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
203 West Main Street, Union, South Carolina 29379
-------------------------------------------------
(Address of Principal Executive Offices)
(864) 429-1864
--------------
(Registrant's telephone number, including area code)
Not Applicable
--------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.) Yes No X
--- ---
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act.) Yes No X
--- ---
The Corporation had 1,916,482 shares, $0.01 par value, of common stock issued
and outstanding as of October 25, 2005.
1
UNION FINANCIAL BANCSHARES, INC.
INDEX
Part I. Financial Information Page
- ------- --------------------- ----
Item 1. Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets as of September 30, 2005 and
December 31, 2004 3
Consolidated Statements of Income for the three and nine
months ended September 30, 2005 and 2004 4
Consolidated Statements of Cash Flows for the nine
months ended September 30, 2005 and 2004 5
Consolidated Statements of Shareholders' Equity for the
nine months ended September 30, 2005 and 2004 6
Notes to Consolidated Financial Statements 7-10
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 11-21
Item 3. Quantitative and Qualitative Disclosures
about Market Risk 21-23
Item 4. Controls and Procedures 23
Part II. Other Information
- -------- -----------------
Item 1. Legal Proceedings 24
Item 2. Unregistered Sales of Equity Securities and
Use of Proceeds 24
Item 3. Defaults Upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security
Holders 25
Item 5. Other Information 25
Item 6. Exhibits 25
Signatures 26
2
Part 1. Financial Information
UNION FINANCIAL BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS
September 30, 2005 (unaudited) and December 31, 2004
September 30, December 31,
ASSETS 2005 2004
---------------- ---------------
(DOLLARS IN THOUSANDS)
Cash $ 7,623 $ 1,586
Short term interest-earning deposits 3,361 11,611
---------------- ---------------
Total cash and cash equivalents 10,984 13,197
---------------- ---------------
Investment and mortgage-backed securities
Held to maturity 3,209 1,630
Available for sale 140,251 141,864
---------------- ---------------
Total investment and mortgage-backed securities 143,460 143,494
---------------- ---------------
Loans, net 181,441 171,094
Office properties and equipment, net 5,148 5,635
Federal Home Loan Bank Stock, at cost 3,561 3,522
Federal Reserve Stock, at cost 539 539
Accrued interest receivable 1,961 2,068
Intangible assets 3,735 4,212
Cash surrender value of life insurance 5,353 5,206
Other assets 3,071 2,631
---------------- ---------------
TOTAL ASSETS $ 359,253 $ 351,598
================ ===============
LIABILITIES
Deposit accounts $ 239,316 $ 227,589
Advances from the Federal Home Loan Bank and other borrowings 62,500 63,500
Securities sold under agreements to repurchase 20,000 24,000
Floating rate junior subordinated deferrable interest debentures 8,247 8,247
Accrued interest on deposits 506 333
Advances from borrowers for taxes and insurance 237 40
Other liabilities 2,911 1,870
---------------- ---------------
TOTAL LIABILITIES 333,717 325,579
---------------- ---------------
Commitments and contingencies-Note 4
SHAREHOLDERS' EQUITY
Serial preferred stock, no par value, authorized - 500,000 shares,
issued and outstanding - None -- --
Common stock - $0.01 par value, authorized - 5,000,000 shares,
issued and outstanding - 1,916,482 shares at 9/30/05 and 1,957,989
at 12/31/04 19 20
Additional paid-in capital 12,271 12,109
Accumulated other comprehensive gain (loss) (336) 109
Retained earnings, substantially restricted 16,371 15,221
Treasury stock, at cost (2,789) (1,440)
---------------- ---------------
TOTAL SHAREHOLDERS' EQUITY 25,536 26,019
---------------- ---------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 359,253 $ 351,598
================ ===============
See notes to consolidated financial statements.
3
UNION FINANCIAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
Three and Nine Months Ended September 30, 2005 and 2004 (unaudited)
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2005 2004 2005 2004
------------ ------------ ------------ -----------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE) (DOLLARS IN THOUSANDS EXCEPT PER SHARE)
Interest Income:
Loans $ 3,243 $ 2,643 $ 9,108 $ 7,599
Deposits and federal funds sold 37 5 109 20
Mortgage-backed securities 305 463 1,050 1,442
Interest and dividends on investment securities 1,319 1,172 3,756 3,464
------------ ------------ ------------ -----------
Total Interest Income 4,904 4,283 14,023 12,525
------------ ------------ ------------ -----------
Interest Expense:
Deposit accounts 1,349 960 3,770 2,881
Floating rate junior subordinated deferrable interest 150 109 417 308
Advances from the FHLB and other borrowings 827 745 2,308 2,191
------------ ------------ ------------ -----------
Total Interest Expense 2,326 1,814 6,495 5,380
------------ ------------ ------------ -----------
Net Interest Income Provision for loan losses 2,578 2,469 7,528 7,145
220 390 768 775
------------ ------------ ------------ -----------
Net Interest Income After Provision for Loan Losses 2,358 2,079 6,760 6,370
------------ ------------ ------------ -----------
Non-Interest Income:
Fees for financial services 667 601 1,856 1,811
Other fees 14 16 44 49
Net gain on sale of loans 11 30 37 72
Net gain (loss) on sale of investments -- (8) 5 (8)
Total Non-Interest Income 692 639 1,942 1,924
Non-Interest Expense:
Compensation and employee benefits 1,012 907 3,010 2,882
Occupancy and equipment 492 540 1,523 1,562
Deposit insurance premiums 8 8 24 24
Professional services 86 67 276 226
Advertising/Public relations 46 40 106 121
Loan operations 101 48 179 111
Deposit premium intangible 159 159 477 477
Items processing 49 67 110 190
Telephone 50 34 135 111
Other 167 181 523 515
------------ ------------ ------------ -----------
Total Non-Interest Expense 2,170 2,051 6,363 6,219
------------ ------------ ------------ -----------
Income Before Income Taxes 880 667 2,339 2,075
Income tax expense 242 159 613 510
------------ ------------ ------------ -----------
Net Income $ 638 $ 508 $ 1,726 $ 1,565
============ ============ ============ ===========
Basic Net Income Per Common Share $ 0.33 $ 0.26 $ 0.90 $ 0.80
============ ============ ============ ===========
Diluted Net Income Per Common Share $ 0.33 $ 0.25 $ 0.88 $ 0.76
============ ============ ============ ===========
Weighted Average Number of Common Shares Outstanding
Basic 1,906,555 1,954,680 1,914,269 1,957,055
Diluted 1,952,840 2,022,522 1,971,592 2,049,073
See notes to consolidated financial statements.
4
UNION FINANCIAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 2005 and 2004 (unaudited)
Nine Months Ended
September 30, September 30,
2005 2004
----------------- -----------------
(IN THOUSANDS)
OPERATING ACTIVITIES:
Net income $ 1,726 $ 1,565
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for loan losses 768 775
Amortization of intangibles 477 477
Depreciation expense 672 738
Recognition of deferred income, net of costs (272) (250)
Deferral of fee income, net of costs 238 262
Gain on investment transactions (42) (64)
Changes in operating assets and liabilities:
(Increase) decrease in accrued interest receivable 107 (152)
(Increase) decrease in other assets (587) 239
Increase in other liabilities 1,238 1,552
Increase in accrued interest payable 173 53
--------- ---------
Net cash provided by operating activities 4,498 5,195
--------- ---------
INVESTING ACTIVITIES:
Purchase of investment and mortgage-backed securities:
Available for sale (49,746) (96,907)
Held to maturity (4,605) --
Proceeds from sale of investment and mortgage-backed securities
Available for sale 10,911 4,702
Proceeds from maturity of investment and mortgage-backed securities:
Available for sale 31,705 46,939
Held to maturity 3,000 --
Principal repayments on mortgage-backed securities:
Available for sale 8,360 14,346
Net increase in loans (11,075) (15,040)
Purchase of FHLB stock (39) --
Redemption of FHLB stock -- 587
Purchase of office properties and equipment (185) (153)
--------- ---------
Net cash used by investing activities (11,674) (45,526)
--------- ---------
FINANCING ACTIVITIES:
Proceeds from the dividend reinvestment plan 78 84
Dividends paid in cash ($0.30 per share -2005
and $0.30 per share - 2004) (577) (587)
Proceeds from the exercise of stock options 84 72
Share repurchase program (1,349) (810)
Proceeds (repayment) of term borrowings (5,000) 16,500
Increase in deposit accounts 11,727 1,328
--------- ---------
Net cash provided by financing activities 4,963 16,587
--------- ---------
NET DECREASE IN CASH AND CASH EQUIVALENTS (2,213) (23,744)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 13,197 28,702
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $10,984 $ 4,958
========= =========
SUPPLEMENTAL DISCLOSURES:
Cash paid for:
Income taxes $ 1,652 $ 120
Interest 6,292 5,327
Non-cash transactions:
Loans foreclosed $ 54 $ 647
See notes to consolidated financial statements.
5
UNION FINANCIAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Nine Months Ended September 30, 2005 and 2004 (unaudited)
Retained Accumulated Total
Additional Earnings, Other Treasury Share-
Common Stock Paid-in Substantially Comprehensive Stock holders'
Shares Amount Capital Restricted Income At Cost Equity
---------------------------------------------------------------------------------
(Dollars in Thousands, Except Share Data)
BALANCE AT DECEMBER 31, 2003 1,969,770 $20 $11,906 $13,848 $ 99 ($366) $25,507
Net income 1,565 1,565
Other comprehensive income, net of tax:
Unrealized holding gains on securities
available for sale arising during period,
net of tax effect of $171 thousand 220 220
-------
Comprehensive income 1,785
Stock option activity 40,043 1 71 72
Dividend reinvestment plan
contributions 5,280 84 84
Share repurchase program (47,832) (810) (810)
Cash dividend ($.30 per share) (587) (587)
---------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 2004 1,967,261 $21 $12,061 $14,826 $ 319 ($1,176) $26,051
=================================================================================
BALANCE AT DECEMBER 31, 2004 1,957,989 $20 $12,109 $15,221 $ 109 ($1,440) $26,019
Net income 1,726 1,726
Other comprehensive income, net of tax
Unrealized holding losses on securities
available for sale arising during period,
net of tax effect of $181 thousand (450) (450)
Reclassification adjustment for gains 5 5
included in net income ------ -------
Comprehensive loss 1,281
Stock option activity 35,044 84 84
Dividend reinvestment plan
contributions 4,557 78 78
Share repurchase program (81,108) (1) 1 (1,349) (1,349)
Cash dividend ($.30 per share) (577) (577)
---------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 2005 1,916,482 $19 $12,271 $16,371 ($336) ($2,789) $25,536
=================================================================================
6
UNION FINANCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Presentation of Consolidated Financial Statements
-------------------------------------------------
The accompanying unaudited consolidated financial statements of Union
Financial Bancshares, Inc. (the "Corporation" or "Union Financial") were
prepared in accordance with instructions for Form 10-Q and, therefore, do
not include all disclosures necessary for a complete presentation of
consolidated financial condition, results of operations, and cash flows in
conformity with accounting principles generally accepted in the United
States of America. However, all adjustments which are, in the opinion of
management, necessary for the fair presentation of the interim consolidated
financial statements have been included. All such adjustments are of a
normal and recurring nature. The results of operations for the nine months
ended September 30, 2005 are not necessarily indicative of the results
which may be expected for the entire calendar year. Certain amounts in the
prior year's financial statements have been reclassified to conform with
current year classifications.
Recently Issued Accounting Standards
The following is a summary of recent authoritative pronouncements that
affect accounting, reporting, and disclosure of financial information by
the Corporation:
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 123 (revised
2004), "Share-Based Payment" ("SFAS No. 123(R))"). SFAS No. 123(R)) will
require companies to measure all employee stock-based compensation awards
using a fair value method and record such expense in its financial
statements. In addition, the adoption of SFAS No. 123(R)) requires
additional accounting and disclosure related to the income tax and cash
flow effects resulting from share-based payment arrangements. SFAS No.
123(R)) is effective beginning as of the first interim or annual reporting
period beginning after December 15, 2006. The Corporation is currently
evaluating the impact that the adoption of SFAS No. 123(R)) will have on
its financial position, results of operations and cash flows. The
cumulative effect of adoption, if any, will be measured and recognized in
the statement of income on the date of adoption.
In April 2005, the Securities and Exchange Commission's Office of the Chief
Accountant and its Division of Corporation Finance has released Staff
Accounting Bulletin ("SAB") No.107 to provide guidance regarding the
application of SFAS No.123 (revised 2004), "Share-Based Payment". SFAS
No.123(R)) covers a wide range of share-based compensation arrangements
including share options, restricted share plans, performance-based awards,
share appreciation rights, and employee share purchase plans. SAB No. 107
provides interpretive guidance related to the interaction between SFAS
No.123(R)) and certain SEC rules and regulations, as well as the staff's
views regarding the valuation of share-based payment arrangements for
public companies. SAB No. 107 also reminds public companies of the
importance of including disclosures within filings made with the SEC
relating to the accounting for share-based payment transactions,
particularly during the transition to SFAS No.123(R)).
7
In May 2005, the FASB issued Statement of Financial Accounting Standards
No. 154, "Accounting Changes and Error Corrections - a replacement of APB
Opinion No. 20 and FASB Statement No. 3" ("SFAS No. 154"). SFAS No. 154
establishes retrospective application as the required method for reporting
a change in accounting principle, unless it is impracticable, in which case
the changes should be applied to the latest practicable date presented.
SFAS No. 154 also requires that a correction of an error be reported as a
prior period adjustment by restating prior period financial statements.
SFAS No. 154 is effective for accounting changes and corrections of errors
made in fiscal years beginning after December 15, 2005.
Additional accounting standards that have been issued or proposed by the
FASB or other standards-setting bodies that do not require adoption until a
future date are not expected to have a material impact on the consolidated
financial statements upon adoption.
2. Income Per Share
----------------
Basic income per share amounts for the three and nine months ended
September 30, 2005 and 2004 were computed based on the weighted average
number of common shares outstanding during the period. Diluted income per
share adjusts for the dilutive effect of outstanding common stock options
during the periods utilizing the treasury stock method. Common stock
equivalents included in the diluted earnings per share calculation for the
three months ended September 30, 2005 and 2004 were 46,285 and 67,842,
respectively and for the nine months ended September 30, 2005 and 2004 were
57,323 and 92,018, respectively.
3. Assets Pledged
--------------
Approximately $77,675,000 and $62,396,000 of debt securities at September
30, 2005 and December 31, 2004, respectively, were pledged by Provident
Community Bank, N.A. (the "Bank") as collateral to secure deposits of the
State of South Carolina, and Union, Laurens and York counties along with
additional borrowings and repurchase agreements. The Bank pledges as
collateral for Federal Home Loan Bank advances the Bank's Federal Home Loan
Bank stock and has entered into a blanket collateral agreement with the
Federal Home Loan Bank whereby the Bank maintains, free of other
encumbrances, qualifying mortgages (as defined) with unpaid principal
balances equal to, when discounted at 75% of the unpaid principal balances,
100% of total advances. As part of the total assets pledged, the Bank will
also pledge securities to cover additional advances from the Federal Home
Loan Bank that exceed the qualifying mortgages balance along with security
repurchase lines with various brokerage houses.
4. Contingencies and Loan Commitments
----------------------------------
In the ordinary course of business, the Bank enters into financial
instruments with off-balance-sheet risk to meet the financing needs of its
customers. These instruments expose the Bank to credit risk in excess of
the amount recognized on the balance sheet.
8
The Bank'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 amount of those instruments. The Bank uses
the same credit policies in making commitments and conditional obligations
as it does for on-balance-sheet instruments. Total credit exposure at
September 30, 2005 related to these items is summarized below:
Loan Commitments: Contract Amount
Approved loan commitments $ 1,086,000
Unadvanced portions of loans and
credit lines 39,787,000
----------
Total loan commitments $ 40,873,000
==========
Loan commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Loan commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. The Bank evaluates each
customer's creditworthiness on a case-by-case basis. The amount of
collateral obtained upon extension of credit is based on management's
credit evaluation of the counter party. Collateral held is primarily
residential and commercial property.
Commitments outstanding at September 30, 2005 consisted of fixed and
adjustable rate loans at rates ranging from 5.0% to 6.5%. Commitments to
originate loans generally expire within 30 to 60 days.
Commitments to fund loans, including credit lines (principally variable
rate, consumer lines secured by real estate and overdraft protection)
totaled approximately $87,345,000 at September 30, 2005. Of these lines,
the outstanding loan balances totaled approximately $47,558,000.
5. Floating Rate Junior Subordinated Deferrable Interest Debentures
----------------------------------------------------------------
On December 18, 2001, Union Financial Statutory Trust I, (the "Trust")
issued $8,000,000 of floating rate capital securities through a pooled
trust preferred securities offering. The proceeds from this issuance, along
with the Corporation's $247,000 capital contribution for the Trust's common
securities, were used to acquire $8,247,000 aggregate principal amount of
the Corporation's floating rate junior subordinated deferrable interest
debentures due December 18, 2031 (the "Debentures"), which constitute the
sole asset of the Trust. The interest rate on the Debentures and the
capital securities is variable and adjustable quarterly at 3.60% over the
three-month LIBOR. A rate cap of 12.50% is effective through December 18,
2006. The Corporation has, through the Trust Agreement establishing the
Trust, the Guarantee Agreement, the notes and the related Debentures, taken
together, fully irrevocably and unconditionally guaranteed all of the
Trust's obligations under the capital securities.
9
A summary of the Trust securities issued and outstanding follows:
-------------------------------------------------------------------------------------------------------------------
Amount Distribution
Outstanding Prepayment Payment
September 30, Option Date Maturity Frequency
-------------------------------------------------------------------------------------------------------------------
Name 2005 2004 Rate
-------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------
Union Financial $8,000,000 $8,000,000 7.48% December 18, 2006 December 18, 2031 Quarterly
Statutory Trust I
-------------------------------------------------------------------------------------------------------------------
The stated maturity of the Debentures is December 18, 2031. In addition,
the Debentures are subject to redemption at par at the option of the
Corporation, subject to prior regulatory approval, in whole or in part on
any interest payment date after December 18, 2006. The Debentures are also
subject to redemption prior to December 18, 2006 at 107.5% of par after the
occurrence of certain events that would either have a negative tax effect
on the Trust or the Corporation or would result in the Trust being treated
as an investment company that is required to be registered under the
Investment Company Act of 1940.
The Corporation has the right, at one or more times, to defer interest
payments on the Debentures for up to twenty consecutive quarterly periods.
During any deferral period, each installment of interest that would
otherwise have been due and payable will bear additional interest (to the
extent payment of such interest would be legally enforceable) at the
applicable distribution rate, compounded quarterly. Additionally, during
any deferral period, the Corporation will be prohibited from declaring or
paying cash dividends on its common stock.
10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward Looking Statements
--------------------------
Management's discussion and analysis of financial condition and results of
operations and other portions of this Form 10-Q may contain certain
"forward-looking statements" concerning the future operations of the
Corporation and the Bank. These forward-looking statements are generally
identified by the use of the words "believe," "expect," "intend,"
"anticipate," "estimate," "project," or similar expressions. Management
intends to take advantage of the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995 and is including this statement
for the express purpose of availing the Corporation of the protections of
such safe harbor with respect to all forward-looking statements contained
in this report to describe future plans and strategies. Management's
ability to predict results or the effect of future plans or strategies is
inherently uncertain. Factors which could effect actual results include
interest rate trends, the general economic climate in the Corporation's and
the Bank's market area and the country as a whole, the ability of the
Corporation and the Bank to control costs and expenses, competitive
products and pricing, loan delinquency rates, the quality and composition
of the loan and investment portfolios, changes in accounting principles and
guidelines and changes in federal and state regulation. These factors
should be considered in evaluating the forward-looking statements, and
undue reliance should not be placed on such statements.
Except as required by applicable law or regulation, the Corporation does
not undertake, and specifically disclaims any obligation, to release
publicly the result of any revisions that may be made to any forward
looking statements to reflect events or circumstances after the date of
these statements or to reflect the occurrence of anticipated or
unanticipated events.
Financial Condition
-------------------
Assets
------
Total assets of the Corporation increased $7,655,000, or 2.18%, to
$359,253,000 at September 30, 2005 from $351,598,000 at December 31, 2004.
Loans increased $10,347,000, or 6.05%, to $181,441,000 at September 30,
2005. The Corporation continues to focus on consumer and commercial lending
with specialized loan officers and products. Short term interest earning
deposits decreased $8,250,000, or 71.05%, to $3,361,000, from December 31,
2004 to September 30, 2005, as these deposits were used to fund growth in
loans. Other assets increased $440,000, or 16.72%, to $3,071,000, from
December 31, 2004 to September 30, 2005, due to an increase in a net
deferred tax receivable that was related to the mark to market adjustment
for investments available for sale.
11
Liabilities
-----------
Total liabilities increased $8,138,000, or 2.50%, to $333,717,000 at
September 30, 2005 from $325,579,000 at December 31, 2004. Deposits
increased $11,727,000, or 5.15%, to $239,316,000 at September 30, 2005 from
$227,589,000 at December 31, 2004. The increase was due primarily to growth
in lower cost demand accounts partially offset by a reduction in higher
cost certificates of deposit accounts. The Corporation continues to target
lower cost demand deposit accounts through media advertising versus
traditional higher cost certificates of deposits.
Borrowings from the Federal Home Loan Bank (the "FHLB") decreased
$1,000,000, or 1.57%, to $62,500,000 at September 30, 2005 from $63,500,000
at December 31, 2004. Securities sold under agreement to repurchase
decreased $4,000,000 to $20,000,000 at September 30, 2005 from $24,000,000
at December 31, 2004. Borrowings were reduced with deposit growth and
reductions in short term interest earning deposits. Other liabilities
increased $1,041,000 to $2,911,000 at September 30, 2005 from $1,870,000 at
December 31, 2004, due primarily to an increase in outstanding loan
fundings.
Shareholders' Equity
--------------------
Shareholders' equity decreased $483,000, or 1.86%, to $25,536,000 at
September 30, 2005 from $26,019,000 at December 31, 2004 due to the
repurchase of 81,108 shares at a cost of $1,349,000, dividend payments of
$0.30 per share at a cost of $577,000 and a $445,000 increase in unrealized
losses on securities available for sale, offset by net income of
$1,726,000.
Liquidity
---------
Liquidity is the ability to meet demand for loan disbursements, deposit
withdrawals, repayment of debt, payment of interest on deposits and other
operating expenses. The primary sources of liquidity are deposits, loan
repayments, borrowings, maturity of securities and interest payments.
While maturities and scheduled amortization of loans and securities are
predictable sources of funds, deposit outflows and mortgage prepayments are
greatly influenced by general interest rates, economic conditions and
competition. The primary investing activities of the Corporation are the
origination of commercial and consumer loans, and the purchase of
investment, and mortgage-backed securities. These activities are funded
primarily by principal and interest payments on loans and investment
securities, deposit growth, securities sold under agreements to repurchase
and the utilization of FHLB advances.
During the nine months ended September 30, 2005, the Corporation's loan
originations totaled $55,589,000. At September 30, 2005, the Corporation's
investment in agency and mortgage-backed securities totaled $143,460,000,
nearly all of which is available for sale. Approximately $77,675,000 and
$62,396,000 of debt securities at September 30, 2005 and December 31, 2004,
respectively, were pledged by Provident Community Bank, N.A. (the "Bank")
as collateral to secure deposits of the State of South Carolina, and Union,
Laurens and York counties along with additional borrowings and repurchase
agreements.
12
Additionally, outstanding loan commitments (including commitments to fund
credit lines) totaled $40,873,000 at September 30, 2005. Management of the
Corporation anticipates that it will have sufficient funds available to
meet its current loan commitments.
During the nine months ended September 30, 2005, total deposits increased
$11,727,000. The Corporation closely monitors its liquidity position on a
daily basis. Certificates of deposit, which are scheduled to mature in one
year or less from September 30, 2005, totaled $93,985,000. The Corporation
relies primarily on competitive rates, customer service, and long-standing
relationships with customers to retain deposits. From time to time, the
Corporation will also offer special products to its customers to increase
retention and to attract new deposits. Based upon the Corporation's
experience with deposit retention and current retention strategies,
management believes that, although it is not possible to predict future
terms and conditions upon renewal, a significant portion of such deposits
will remain with the Corporation. If the Corporation requires funds beyond
its ability to generate them internally, additional sources of funds are
available through FHLB advances and lines of credit. At September 30, 2005,
the Corporation had outstanding $62,500,000 of FHLB borrowings and
$20,000,000 of securities sold under agreements to repurchase. At September
30, 2005, the Corporation had unused short-term lines of credit to purchase
federal funds from unrelated banks totaling $17,000,000 and the ability to
borrow an additional $22,000,000 from secured borrowing lines. Lines of
credit are available on a one-to-ten day basis for general purposes of the
Corporation. All of the lenders have reserved the right to withdraw these
lines at their option.
Capital Management
------------------
The Bank and the Corporation are subject to various regulatory capital
requirements administered by banking regulators. Failure to meet minimum
capital requirements can initiate certain mandatory - and possibly
additional discretionary - actions by regulators that, if undertaken, could
have a direct material effect on the Corporation's consolidated financial
statements. Under capital adequacy guidelines and the regulatory framework
for prompt corrective action, the Bank must meet specific capital
guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Bank's capital amounts and
classifications are also subject to qualitative judgments by the regulators
about components, risk weights and other factors.
Quantitative measures established by regulations to ensure capital adequacy
require the Bank and the Corporation to maintain minimum amounts and ratios
of total and Tier 1 capital to risk-weighted assets, and of Tier 1 capital
to average assets (as defined in the regulations). Management believes, as
of September 30, 2005, that the Bank and the Corporation meet the capital
adequacy requirements to which they are subject.
13
As of September 30, 2005, the Bank was "well capitalized" under the
regulatory framework for prompt corrective action based on its capital
ratio calculations. In order to be "well capitalized", the Bank must
maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage
ratios as set forth in the following table. Under present regulations of
the Office of the Comptroller of the Currency, the Bank must have core
capital (leverage requirement) equal to 4.0% of assets, of which 1.5% must
be tangible capital, excluding intangible assets. The Bank must also
maintain risk-based regulatory capital as a percent of risk weighted assets
at least equal to 8.0%. In measuring compliance with capital standards,
certain adjustments must be made to capital and total assets.
The following tables present the total risk-based, Tier 1 risk-based and
Tier 1 leverage requirements for the Corporation and the Bank (dollars in
thousands).
September 30, 2005
------------------
Actual Regulatory Minimum "Well Capitalized"
----------------- ------------------ ------------------
Amount Ratio Amount Ratio Amount Ratio
- -----------------------------------------------------------------------------------------------
$ % $ % $ %
- -----------------------------------------------------------------------------------------------
Leverage ratio
- -----------------------------------------------------------------------------------------------
Corporation 30,054 8.31% 14,469 4.00% n/a n/a
- -----------------------------------------------------------------------------------------------
Bank 29,294 8.10% 14,469 4.00% 18,086 5.00%
- -----------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------
Tier 1 capital ratio
- -----------------------------------------------------------------------------------------------
Corporation 30,054 13.71% 8,770 4.00% n/a n/a
- -----------------------------------------------------------------------------------------------
Bank 29,294 13.35% 8,776 4.00% 13,164 6.00%
- -----------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------
Total risk-based
capital ratio
- -----------------------------------------------------------------------------------------------
Corporation 32,652 14.89% 17,541 8.00% n/a n/a
- -----------------------------------------------------------------------------------------------
Bank 31,891 14.54% 17,552 8.00% 21,940 10.00%
- -----------------------------------------------------------------------------------------------
14
During fiscal 2003, the Corporation implemented a share repurchase program
under which the Board of Directors of the Corporation authorized the
repurchase of up to 5% of the outstanding shares or 98,000 shares. The
program was expanded by an additional 5%, or 98,000 shares, in fiscal 2004
and by an additional 5%, or 95,000 shares in fiscal 2005. The shares are to
be repurchased either through open market purchases or privately negotiated
transactions and will be made from time to time depending on market
conditions and other factors. Repurchased shares will be held in treasury
and will be available for the Corporation's benefit plans. The repurchase
program is expected to improve the Corporation's operating performance on a
per share basis and enhance, in the long term, the market price per share
of the Corporation's common stock. During the three and nine months ended
September 30, 2005, the Corporation repurchased 17,140 and 81,108 shares,
respectively. As of September 30, 2005, the Corporation had repurchased a
total of 164,093 shares under these authorizations. Of the three
authorizations, 32,000 shares remain to be purchased under the second
authorization.
Off-Balance Sheet Risk
----------------------
In the normal course of operations, the Corporation engages in a variety of
financial transactions that, in accordance with generally accepted
accounting principles, are not recorded in its financial statements. These
transactions involve, to varying degrees, elements of credit, interest rate
and liquidity risk. Such transactions are used primarily to manage
customer's requests for funding and take the form of legally binding
agreements to lend money to customers at predetermined interest rates for a
specified period of time. Outstanding loan commitments (including
commitments to fund credit lines) totaled $47,558,000 at September 30,
2005. Each customer's credit worthiness is evaluated on a case-by-case
basis. The amount of collateral obtained, if deemed necessary by the
Corporation upon extension of credit, is based on the credit evaluation of
the borrower. Collateral varies but may include accounts receivable,
inventory, property, plant and equipment, commercial and residential real
estate. The credit risk on these commitments is managed by subjecting each
customer to normal underwriting and risk management processes.
For the period ended September 30, 2005, the Corporation did not engage in
any off-balance sheet transactions reasonably likely to have a material
effect on its financial condition, results of operation and cash flows.
15
Results of operations for the three months ended September 30, 2005 and
---------------------------------------------------------------------------
2004
----
General
-------
Net income increased $130,000, or 25.59%, to $638,000 for the three months
ended September 30, 2005 as compared to $508,000 for the same period in
2004 as increases in net interest income and non-interest income and
reductions in the provision for loan losses were partially offset by an
increase in non-interest expense.
Interest Income
---------------
Interest income increased $621,000, or 14.50%, to $4,904,000 for the three
months ended September 30, 2005 as compared to the same period in 2004.
Interest income on loans increased by 22.70%, or $600,000, to $3,243,000
for the three months ended September 30, 2005 from $2,643,000 for the three
months ended September 30, 2004, due primarily to increasing market
interest rates along with a higher average balance of loans with a higher
average rate due to our increased emphasis on commercial and consumer loan
originations. Interest on deposits and federal funds sold, combined with
interest and dividends on investment and mortgage-backed securities
increased $21,000, or 1.28%, for the three months ended September 30, 2005
to $1,661,000 from $1,640,000 during the same period in 2004 due to higher
yields, due to higher market interest rates, offset by lower average
balances.
Interest Expense
----------------
Interest expense increased $512,000, or 28.22%, to $2,326,000 for the three
months ended September 30, 2005 as compared to the three months ended
September 30, 2004. Interest expense on deposit accounts increased
$389,000, or 40.52%, to $1,349,000 for the three months ended September 30,
2005 from $960,000 during the same period in 2004 due to higher cost of
deposits as a result of higher market rates offset by growth in lower
costing transaction accounts. The Corporation continues to target lower
cost demand deposit accounts versus traditional higher cost certificates of
deposits. Interest expense on borrowings increased $82,000, or 11.01%, for
the three months ended September 30, 2005 as compared to the same period in
the previous year due to lower borrowing levels offset by higher market
interest rates. Interest expense on floating rate junior subordinated
deferrable interest debentures increased $41,000, or 37.61%, to $150,000
for the three months ended September 30, 2005 from $109,000 during the same
period in 2004 due to higher market interest rates.
16
Provision for Loan Losses
-------------------------
During the three months ended September 30, 2005, the provision for loan
losses was $220,000 as compared to $390,000 for the same period in the
previous year, due to lower charge-offs and non-accrual loans, offset by
the growth in the loan portfolio and the increase in commercial and
consumer loans with greater risk. Commercial and consumer loans accounted
for 67.18% of the loan portfolio at September 30, 2005 compared to 63.00%
for the same period in 2004. During the three months ended September 30,
2005, bad debt charge-offs, net of recoveries, were $89,000 as compared to
$178,000 in net bad debt charge-offs for the same period in the previous
year. During the three months ended September 30, 2005, non-accrual loans
decreased $2,516,000 from $4,001,000 at June 30, 2005 to $1,485,000 at
September 30, 2005. This compares to non-accrual loans at September 30,
2004 of $1,286,000. The decrease in non-accrual loans for the quarter
ending September 30, 2005 included one commercial loan for $2.4 million
that was paid off. Management believes the Corporation's loan loss
allowance is adequate to absorb possible loan losses inherent in the
portfolio.
The allowance for loan loss calculation includes a segmentation of loan
categories subdivided by residential mortgage, commercial and consumer
loans. Each category is rated for all loans including performing groups.
The weight assigned to each performing group is developed from previous
loan loss experience and as the loss experience changes, the category
weight is adjusted accordingly. In addition to loan loss experience,
management's evaluation of the loan portfolio includes the market value of
the underlying collateral, growth and composition of the loan portfolio,
delinquency trends and economic conditions. Management evaluates the
carrying value of loans periodically and the allowance for loan loss
calculation will adjust accordingly.
Non-Interest Income
-------------------
Total non-interest income increased $53,000, or 8.29%, to $692,000 for the
three months ended September 30, 2005 from $639,000 for the same period in
the previous year. Fees from financial services increased $66,000, or
10.98%, to $667,000 for the three months ended September 30, 2005 from
$601,000 for the same period in the previous year. The increase was from an
increase in transaction accounts that was offset by lower fees generated
from third party investment brokerage and financing receivables programs
due to a reduction in product volumes. Gain on sale of loans for the three
months ended September 30, 2005 was $11,000 compared to $30,000 for the
same period in the previous year due to lower residential loan originations
as a result of the rising interest rate environment along with the
Corporation's shift in focus to consumer/commercial loans. The sales
represent loans funded and sold through a third party on a servicing
released basis.
Non-Interest Expense
--------------------
For the three months ended September 30, 2005, total non-interest expense
increased $119,000, or 5.80%, to $2,170,000 from $2,051,000 for the same
period in 2004. Compensation and employee benefits increased $105,000, or
11.58%, to $1,012,000 for the three months ended September 30, 2005 from
$907,000 for the same period in 2004 due primarily to higher amortization
expense for deferred compensation contracts. Occupancy and equipment
expense decreased $48,000, or 8.89%, to $492,000 for the three months ended
September 30, 2005 from $540,000 for the same period in 2004 due to
primarily to lower depreciation expense. Professional services expense
17
increased $19,000, or 28.36%, to $86,000 for the three months ended
September 30, 2005 from $67,000 for the same period in 2004 due to higher
consultant expense utilized to implement improved loan documentation
policies and procedures. Loan operations expense increased $53,000, or
110.42%, to $101,000 for the three months ended September 30, 2005 from
$48,000 for the same period in 2004, due to higher costs associated with
foreclosures. Items processing expense decreased $18,000, or 26.87%, to
$49,000 for the three months ended September 30, 2005 from $67,000 for the
same period in 2004. The Corporation entered into a new items processing
contract that was effective January 1, 2005 that reduced the long term
expense for demand accounts. Telephone expense increased $16,000, or
47.06%, to $50,000 for the three months ended September 30, 2005 from
$34,000 for the same period in 2004 due to prior year expense credits
received with the purchase of a new system.
Results of operations for the nine months ended September 30, 2005 and 2004
---------------------------------------------------------------------------
General
-------
Net income increased $161,000, or 10.29%, to $1,726,000 for the nine months
ended September 30, 2005 as compared to the same period in 2004 as an
increase in net interest income was partially offset by an increase in
non-interest expense.
Interest Income
---------------
Interest income increased $1,498,000, or 11.96%, to $14,023,000 for the
nine months ended September 30, 2005 as compared to the same period in
2004. Interest income on loans increased by 19.86%, or $1,509,000, to
$9,108,000 for the nine months ended September 30, 2005 from $7,599,000 for
the nine months ended September 30, 2004, due primarily to increasing
market interest rates along with a higher average balance of loans with a
higher average rate due to our increased emphasis on commercial and
consumer loan originations. Interest on deposits and federal funds sold,
combined with interest and dividends on investment and mortgage-backed
securities decreased $11,000, or 0.22%, for the nine months ended September
30, 2005 to $4,915,000 from $4,926,000 during the same period in 2004 due
to lower average balances, offset by higher yields. Proceeds from the
maturity and sale of investment securities were utilized to fund growth in
higher yielding loans.
Interest Expense
----------------
Interest expense increased $1,115,000, or 20.72%, to $6,495,000 for the
nine months ended September 30, 2005 as compared to the nine months ended
September 30, 2004. Interest expense on deposit accounts increased
$889,000, or 30.86%, to $3,770,000 for the nine months ended September 30,
2005 from $2,881,000 during the same period in 2004 due to higher cost of
deposits as a result of higher market rates offset by growth in lower
costing transaction accounts. The Corporation continues to target lower
cost demand deposit accounts versus traditional higher cost certificates of
deposits. Interest expense on borrowings increased $117,000, or 5.34%, for
the nine months ended September 30, 2005 as compared to the same period in
the previous year due to lower borrowing levels offset by higher market
interest rates. Interest expense on floating rate junior subordinated
deferrable interest debentures increased $109,000, or 35.39%, to $417,000
for the nine months ended September 30, 2005 from $308,000 during the same
period in 2004 due to higher market interest rates.
18
Provision for Loan Losses
-------------------------
During the nine months ended September 30, 2005, the provision for loan
losses was $768,000 as compared to $775,000 for the same period in the
previous year, which reflected loan growth along with an increase in
non-accrual loans, offset by a decrease in net charge-offs. The provision
also reflects the Corporation's continued movement from longer term, fixed
rate residential mortgage loans to shorter term, floating rate consumer and
commercial loans. Consumer and commercial loans carry higher risk weighted
rates in the reserve calculation as compared to residential mortgage loans.
Non-performing loans increased $735,000 from $750,000 at December 31, 2004
to $1,485,000 at September 30, 2005. The increase in non-accrual loans for
the nine months ending September 30, 2005 includes one commercial loan for
$380,000 that was downgraded as a result of an analysis of the underlying
collateral. Loans 30-89 days past due and still accruing was $3,442,000 at
September 30, 2005 compared to $7,214,000 at December 31, 2004. The
reduction in delinquent loans is a result of increased emphasis and focus
from the Credit Administration area of the Bank that was developed with the
utilization of outside loan consultants. During the nine months ended
September 30, 2005, bad debt charge-offs, net of recoveries, was $197,000
as compared to $1,058,000 for the same period in the previous year. The
previous year bad debt charge-offs included approximately $737,000 from two
commercial loans that were written down due to a reduction in the market
value of the supporting loan collateral. The Corporation's loan loss
allowance at September 30, 2005 was approximately 1.44% of the
Corporation's outstanding loan portfolio and 174.88% of non-performing
loans compared to 1.18% of the Corporation's outstanding loan portfolio and
270.13% of non-performing loans at December 31, 2004.
The changes in the allowance for loan losses consisted of the following (in
thousands):
Balance at beginning of year $2,026
Provision for loan losses 768
Charge-offs, net (197)
--------------
Balance at end of quarter $2,597
===============
19
The following table sets forth information with respect to the Bank's
non-performing assets at the dates indicated (dollars in thousands):
September 30, 2005 December 31, 2004
------------------ -----------------
Non-accruing loans which are
contractually past due 90 days
or more:
Real estate $ 406 $ 217
Commercial 802 142
Consumer 277 391
------ ------
Total $1,485 $ 750
====== ======
Percentage of loans receivable, net 0.81% 0.44%
====== ======
Percentage of allowance for loan losses
to total loans outstanding 1.44% 1.18%
====== ======
Allowance for loan losses $2,597 $2,026
====== ======
Real estate acquired through
foreclosure and repossessed
assets $ 223 $ 373
====== ======
Non-Interest Income
-------------------
Total non-interest income increased $18,000, or 0.94%, to $1,942,000 for
the nine months ended September 30, 2005 from $1,924,000 for the same
period in the previous year. Fees from financial services increased
$45,000, or 2.48%, to $1,856,000 for the nine months ended September 30,
2005 from $1,811,000 for the same period in the previous year. The increase
was due primarily to higher fees for financial services as a result of an
increase in demand deposit accounts offset by lower fees generated from
third party investment brokerage and financing receivables programs due to
a reduction in product volumes. Gain on sale of loans for the nine months
ended September 30, 2005 was $37,000 compared to $72,000 for the same
period in the previous year due to lower sales of fixed-rate mortgage loans
because of lower residential loan originations as a result of the rising
interest rate environment along with the Corporation's shift in focus to
consumer/commercial loans. The sales represent loans funded and sold
through a third party on a servicing released basis.
Non-Interest Expense
--------------------
For the nine months ended September 30, 2005, total non-interest expense
increased $144,000, or 2.32%, to $6,363,000 from $6,219,000 for the same
period in 2004. Compensation and employee benefits increased $128,000, or
4.44% to $3,010,000 for the nine month period ended September 30, 2005 from
$2,882,000 for the same period in 2004, due to normal merit salary
increases along with higher amortization expense for deferred compensation
contracts. Occupancy and equipment expense decreased $39,000, or 2.50%, to
$1,523,000 for the nine months ended September 30, 2005 from $1,562,000 for
20
the same period in 2004 due primarily to lower depreciation expense.
Professional services expense increased $50,000, or 22.12%, to $276,000 for
the nine months ended September 30, 2005 from $226,000 for the same period
in 2004 due to higher consultant expense utilized to implement improved
loan documentation procedures and higher audit fees. Advertising expense
decreased $15,000, or 12.40%, to $106,000 for the nine months ended
September 30, 2005 from $121,000 for the same period in 2004, due to
reductions in media advertising in slower growth markets. Loan operations
costs increased $68,000, or 61.26%, to $179,000 for the nine months ended
September 30, 2005 from $111,000 for the same period in 2004, due to higher
costs associated with foreclosures. Items processing expense decreased
$80,000, or 42.11%, to $110,000 for the nine months ended September 30,
2005 from $190,000 for the same period in 2004. The Corporation entered
into a new items processing contract that was effective January 1, 2005
that reduced the long term expense for demand accounts. Telephone expense
increased $24,000, or 21.62%, to $135,000 for the nine months ended
September 30, 2005 from $111,000 for the same period in 2004, due to
installation charges incurred for two new banking center systems and prior
year expense credits received on the purchase of new equipment.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
-----------------------------------------------------------------
The Corporation is committed to following a program of asset and liability
management in an effort to manage the fluctuations in earnings caused by
movements in interest rates. A significant portion of the Corporation's
income results from the spread between the yield realized on its
interest-earning assets and the rate of interest paid on its deposits and
other borrowings. Differences in the timing and volume of repricing assets
versus the timing and volume of repricing liabilities expose the
Corporation to interest rate risk. Management's policies are directed at
minimizing the impact on earnings of movements in interest rates.
The Corporation's Asset/Liability Committee makes pricing and marketing
decisions on deposit and loan products in conjunction with managing the
Corporation's interest rate risk. In addition, the Asset/Liability
Committee reviews the Corporation's securities portfolio, FHLB advances and
other borrowings as well as the Corporation's asset and liability policies.
The primary objective of Asset/Liability management at the Corporation is
to manage interest rate risk and achieve reasonable stability in net
interest income throughout interest rate cycles in order to maintain
adequate liquidity. This is achieved by maintaining the proper balance of
rate-sensitive earning assets and rate-sensitive costing liabilities. The
relationship of rate-sensitive earning assets to rate-sensitive costing
liabilities is the principal factor in projecting the effect that
fluctuating interest rates will have on future net interest income.
Rate-sensitive assets and interest-bearing liabilities are those that can
be repriced to current market rates within a relatively short time period.
Management monitors the rate sensitivity of earning assets and
interest-bearing liabilities over the entire life of these instruments.
21
The Corporation has established policies and monitors results to control
interest rate sensitivity. Although the Corporation utilizes measures such
as static gap, which is simply the measurement of the difference between
interest-sensitive assets and interest-sensitive liabilities repricing for
a particular time period, just as important a process is the evaluation of
how particular assets and liabilities are impacted by changes in interest
rates or selected indices as they reprice. Asset/liability modeling
techniques are utilized by the Corporation to assess varying interest rate
and balance sheet mix assumptions.
Net Interest Income Simulation Analysis. We analyze our interest rate
sensitivity position to manage the risk associated with interest rate
movements through the use of interest income simulation. The matching of
assets and liabilities may be analyzed by examining the extent to which
such assets and liabilities are "interest sensitive." An asset or liability
is said to be interest rate sensitive within a specific time period if it
will mature or reprice within that time period.
Our goal is to manage asset and liability positions to moderate the effects
of interest rate fluctuations on net interest income. Interest income
simulations utilizing interest rate shocks are completed quarterly and
presented to the Asset/Liability Committee. The simulations provide an
estimate of the impact of changes in interest rates on net interest income
under a range of assumptions. The interest rate shocks are compared to
board approved policy limits and are reviewed by the Asset/Liability
Committee on a quarterly basis. The simulation incorporates assumptions
regarding the potential timing in the repricing of certain assets and
liabilities when market rates change and the changes in spreads between
different market rates. The simulation analysis incorporates management's
current assessment of the risk that pricing margins will change adversely
over time due to competition or other factors.
Simulation analysis is only an estimate of our interest rate risk exposure
at a particular point in time. We continually review the potential effect
changes in interest rates could have on the repayment of rate sensitive
assets and funding requirements of rate sensitive liabilities.
The table below sets forth an approximation of our exposure as a percentage
of estimated net interest income for the next twelve month period using
interest income simulation. The simulation uses projected repricing of
assets and liabilities on the basis of contractual maturities, anticipated
repayments and scheduled rate adjustments. Prepayment rates can have a
significant impact on interest income simulation. When interest rates rise,
prepayments tend to slow. When interest rates fall, prepayments tend to
rise.
The following table reflects changes in estimated net interest income from
rate shocks of (+) or (-) 1% and 2% in a rising and falling interest rate
environment for the Corporation. Management did not include a 200 basis
points decrease in the simulation model at December 31, 2004 as such a
change in interest rates at that time was a highly remote scenario.
22
At At
September 30, December 31,
2005 2004
---- ----
- --------------------------------------------------------------------------------
200 basis point increase in rates
6.26% 5.75%
- --------------------------------------------------------------------------------
100 basis point increase in rates
3.41% 3.12%
- --------------------------------------------------------------------------------
100 basis point decrease in rates
(4.50%) (3.22%)
- --------------------------------------------------------------------------------
200 basis point decrease in rates
(11.79%) N/A
- --------------------------------------------------------------------------------
The 200 and 100 basis point change in rates in the above table is assumed to
occur evenly over the following twelve months. Based on the scenario above, net
interest income would be positively affected in the twelve-month periods if
rates rose by 100 and 200 basis points, but would be adversely affected if rates
declined by 100 and 200 basis points.
Item 4. Controls and Procedures
-----------------------
The Corporation's management, including the Corporation's principal executive
officer and principal financial officer, have evaluated the effectiveness of the
Corporation's "disclosure controls and procedures," as such term is defined in
Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as
amended, (the "Exchange Act"). Based upon their evaluation, the principal
executive officer and principal financial officer concluded that, as of the end
of the period covered by this report, the Corporation's disclosure controls and
procedures were effective for the purpose of ensuring that the information
required to be disclosed in the reports that the Corporation files or submits
under the Exchange Act with the Securities and Exchange Commission (the "SEC")
(1) is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms, and (2) is accumulated and communicated
to the Corporation's management, including its principal executive and principal
financial officers, as appropriate to allow timely decisions regarding required
disclosure.
There has been no change in the Corporation's internal control over financial
reporting identified in connection with the evaluation required by Rule
13(a)-15(e) that occurred during the Corporation's last fiscal quarter that has
materially affected or is reasonably likely to materially affect, the
Corporation's internal control over financial reporting.
23
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
The Corporation is involved in various claims and legal actions arising in
the normal course of business. Management believes that these proceedings
are immaterial to the Corporation's financial condition and results of
operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------
The following table provides certain information with regard to shares
repurchased by the Corporation during the second quarter of 2005.
(c)
Total Number of (d)
(a) (b) Shares Purchased Maximum Number of
Total Number Average as part of Publicly Shares that may be
of Shares Price Paid Announced purchased under
Period Purchased per share Programs Program
- -------------------------------------------------------------------------------------------------------------
July 1, 2005 through
July 31, 2005 3,000 $18.01 3,000 141,422
- -------------------------------------------------------------------------------------------------------------
August 1, 2005 through
August 31, 2005 4,140 $18.02 4,140 137,282
- -------------------------------------------------------------------------------------------------------------
September 1, 2005 through
September 30, 2005 10,000 $18.04 10,000 127,282
- -------------------------------------------------------------------------------------------------------------
Total 17,140 $18.03 17,140 N/A
- -------------------------------------------------------------------------------------------------------------
In November 2004, the Corporation implemented a share repurchase program
under which the Corporation may repurchase up to 5% of the outstanding
shares or 98,000 shares. In May 2005, the program was expanded by an
additional 5% or 95,000 shares. The repurchase program will continue until
it is completed or terminated by the Board of Directors.
Item 3. Defaults upon Senior Securities
-------------------------------
Not applicable.
24
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
None
Item 5. Other Information
-----------------
None
Item 6. Exhibits
--------
31(a) Rule 13a-14(a)/15d-14(a) Certification of Chief Executive
Officer
31(b) Rule 13a-14(a)/15d-14(a) Certification of Chief Financial
Officer
32(a) Chief Executive Officer Certification Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
32(b) Chief Financial Officer Certification Pursuant to Section 906 of
the Sarbanes- Oxley Act of 2002
25
SIGNATURES
----------
Pursuant to the requirements of the Exchange Act, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
UNION FINANCIAL BANCSHARES, INC.
--------------------------------
(Registrant)
Date: November 7, 2005 By: /s/ Dwight V. Neese
---------------- --------------------
Dwight V. Neese, CEO
Date: November 7, 2005 By: /s/ Richard H. Flake
---------------- ----------------------
Richard H. Flake, CFO
26