UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005
Commission File Number 000-22787
FOUR OAKS FINCORP, INC.
(Exact name of registrant as specified in its charter)
North Carolina 56-2028446
---------------- ----------
(State or other jurisdiction of (IRS Employer Identification
incorporation or organization) Number)
6114 U.S. 301 South
Four Oaks, North Carolina 27524
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (919) 963-2177
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Securities registered under Section 12(b) of the Act: NONE
Securities registered under Section 12(g)
of the Act:
Common Stock, par value $1.00 per share
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. Yes |_| No |X|
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes |_| No |X|
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days: |X|YES [ ]NO
Indicate by check mark whether disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |X|
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act:
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer |X|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act): [ ]YES |X|NO
72,548,403
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(Aggregate value of voting and non-voting common equity
held by non-affiliates of the registrant based on
the price at which the registrant's Common Stock,
par value $1.00 per share
was sold on June 30, 2005)
4,408,027
---------
(Number of shares of Common Stock, par value $1.00 per share, outstanding as of
March 15, 2006)
Documents Incorporated by Reference Where Incorporated
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(1) Proxy Statement for the 2006 Annual Part III
Meeting of Shareholders to be held April 24, 2006
-1-
Forward Looking Information
Information set forth in this Annual Report on Form 10-K under the
caption "Business" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contains various "forward looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
which statements represent our judgment concerning the future and are subject to
risks and uncertainties that could cause our actual operating results and
financial position to differ materially. Such forward looking statements can be
identified by the use of forward looking terminology, such as "may," "will,"
"expect," "anticipate," "estimate," or "continue" or the negative thereof or
other variations thereof or comparable terminology.
We caution that any such forward looking statements are further
qualified by important factors that could cause our actual operating results to
differ materially from those in the forward looking statements, including,
without limitation, the effects of future economic conditions, governmental
fiscal and monetary policies, legislative and regulatory changes, the risks of
changes in interest rates on the level and composition of deposits, the effects
of competition from other financial institutions, the failure of assumptions
underlying the establishment of the allowance for possible loan losses and the
low trading volume of our common stock and the risks discussed in Item 1A. Risk
Factors below.
PART I
Item 1 - Business.
Four Oaks Bank & Trust Company (referred to herein as the "bank") was
incorporated under the laws of the State of North Carolina in 1912. On February
5, 1997, the bank formed Four Oaks Fincorp, Inc. (referred to herein as the
"company"; references herein to "we," "us" and "our" refer to the company and
its consolidated subsidiaries, unless the context otherwise requires) for the
purpose of serving as a holding company for the bank. The company has no
significant assets other than cash, the capital stock of the bank and its
membership interest in Four Oaks Mortgage Services, L.L.C., as well as, $668,000
in securities available for sale. Our corporate offices and banking offices are
located in eastern North Carolina in the counties of Johnston (our corporate
headquarters), Wake, Sampson, Lee and Duplin counties.
As of December 31, 2005, we had assets of $522.4 million, net loans
outstanding of $392.1 million and deposits of $397.5 million. We have enjoyed
considerable growth over the past five (5) years as evidenced by a 102.2%
increase in assets, a 104.5% increase in net loans outstanding, and an 83.5%
increase in deposits since December 31, 2000. We had net income of $5.3 million
and $4.4 million and basic earnings per share of $1.23 and $1.03 for the years
ended December 31, 2005 and 2004, respectively. Net income of $2.9 million and
basic earnings per share of $.70 were recorded for the year ended December 31,
2003.
The bank continues to remain a community-focused bank engaging in
general commercial banking business to the communities we serve in Johnston,
Wake, Sampson, Lee and Duplin counties of North Carolina. The bank provides a
full range of banking services, including such services as checking accounts;
savings accounts; individual retirement accounts; NOW accounts; money market
accounts; certificates of deposit; a student checking and savings program; loans
for businesses, agriculture, real estate, personal uses, home improvement and
automobiles; mortgage loans; equity lines of credit; credit cards; safe deposit
boxes; electronic funds transfer services, including wire transfers; internet
banking and bill pay services; telephone banking; cashier's checks; traveler's
checks; and free notary services to all bank customers. The bank also provides
financial services, offering a complete line of insurance and investment
services, including financial strategies, mutual funds, annuities, insurance,
stock brokerage, IRAs, discount brokerage services, employee benefit plans,
401(k)'s and simplified employee pension plans. In addition, the bank provides
its customers access to automated teller machines ("ATMs) through its own ATMs
throughout its communities served as well as access to worldwide ATMs for cash
withdrawals through the services of the Star, Cirrus, or Visa networks by using
ATM or Visa check cards. The Visa check cards may also be used at merchant
locations worldwide through the Star, Cirrus, or Visa networks. In 2003, the
bank began issuing stored value cards which are marketed by independent sales
organizations and provide access to funds through the Visa, Plus, Interlink,
Mastercard, Maestro, Cirrus, and Star networks. At present, the bank does not
provide the services of a trust department.
2
The bank maintains a website at www.fouroaksbank.com where our periodic
reports on Form 10-Q and 10-K and our current reports on Form 8-K are available
under "Investor Relations". The company is registered as a bank holding company
with the Federal Reserve System. The bank is a state-chartered member of the
Federal Reserve System and the Federal Deposit Insurance Corporation (the
"FDIC") insures its deposits up to applicable limits. Our corporate offices are
located at 6114 US 301 South, Four Oaks, North Carolina, 27524. Our common stock
is traded on the OTC Bulletin Board under the symbol "FOFN".
Our market area is concentrated in the eastern North Carolina counties
of Johnston, Wake, Sampson, Lee and Duplin. Johnston County is contiguous to
Wake, Wayne, Wilson, Harnett, Sampson and Nash counties. Wake County is
contiguous to Johnston, Durham, Harnett, Nash, Franklin, Granville and Chatham
counties. Sampson County is contiguous to Duplin, Pender, Bladen, Harnett,
Cumberland, Johnston, and Wayne counties. Lee County is contiguous to Chatham,
Moore and Harnett counties. Duplin County is contiguous to Pender, Sampson,
Wayne, Lenoir, Jones and Onslow counties.
From its headquarters located in Four Oaks and its twelve locations in
Four Oaks, Clayton, Smithfield, Garner, Benson, Fuquay-Varina, Wallace, Holly
Springs, Harrells and a loan production office in Sanford, the bank serves a
major portion of Johnston County, part of Wake, Harnett, Duplin, Sampson and Lee
counties. In addition, in January 2006, the bank opened a loan production office
in Zebulon, located in Wake County. Johnston County has a diverse economy and is
not dependent on any one particular industry. The leading industries in the area
include retail trade, manufacturing, pharmaceuticals, government, services,
construction, wholesale trade and agriculture. The population for Johnston
County in 2004 was estimated in excess of 141,000. As of June 2005, the bank
ranked second in deposit market share for Johnston County at 25%.
The bank is a community bank engaged in general commercial banking
business. In Four Oaks, the main office is located at 6144 US 301 South and an
additional branch is located at 111 North Main Street. The bank also operates
North Carolina branch offices in Clayton at 102 East Main Street, two in
Smithfield at 128 North Second Street, and 403 South Brightleaf Boulevard, one
in Garner at 200 Glen Road, one in Benson at 200 East Church Street, one in
Fuquay-Varina at 325 North Judd Parkway Northeast, one in Wallace at 406 East
Main Street, one in Holly Springs at 101 Avent Ferry Road, and one in Harrells
at 590 Tomahawk Highway. In addition, the bank has a loan production office at
1100 South Horner Boulevard, Sanford, North Carolina. The bank plans to
transition the Sanford loan production office to a full service banking office
by mid-year 2006. In January 2006, the bank opened a loan production office in
Zebulon, North Carolina which it plans to expand to a full service office in
March 2006.
The majority of the bank's customers are individuals and small to
medium-size businesses located in Johnston, Wake, Sampson, Lee and Duplin
counties and surrounding areas. The deposits and loans are well diversified with
no material concentration in a single industry or group of related industries.
There are no seasonal factors that would have any material adverse effect on the
bank's business, and the bank does not rely on foreign sources of funds or
income.
In an effort to offer a more diversified and competitive product line
to better serve our customers and community, in 2003 we discontinued our
provision of secondary market-type mortgages through the bank and, through a
joint venture with Centex Corporation, formed Four Oaks Mortgage Company, L.P.
Since 2003, Four Oaks Mortgage Company, L.P. has provided secondary market-type
mortgages and has been the vehicle through which all of our mortgage business is
run. Four Oaks Mortgage Company, L.P. is owned 49.99% by our wholly-owned
subsidiary, Four Oaks Mortgage Services, L.L.C., and 50.01% by its general
partner, CTX Mortgage Ventures, LLC, a wholly-owned indirect subsidiary of
Centex Corporation.
Amounts spent on research activities relating to the development or
improvement of services have been immaterial over the past two years. At
December 31, 2005, the bank employed 135 full time equivalent employees. Our
employees are extremely important to our continued success and the bank
considers its relationship with its employees to be good. Management continually
seeks ways to improve upon their benefits and well being.
The following table sets forth certain of our financial data and ratios
for the years ended December 31, 2005, 2004 and 2003. This information should be
read in conjunction with and is qualified in its entirety by reference to the
more detailed audited financial statements and notes thereto included in this
report:
3
2005 2004 2003
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(In thousands, except ratios)
Net income $ 5,349 $ 4,375 $ 2,918
Average equity capital accounts $ 39,959 $ 35,135 $ 32,341
Ratio of net income to average equity capital accounts 13.39% 12.45% 9.02%
Average daily total deposits $ 354,406 $ 295,524 $ 255,038
Ratio of net income to average daily total deposits 1.51% 1.48% 1.14%
Average daily loans (gross) $ 351,103 $ 298,783 $ 249,240
Ratio of average daily loans to average daily total deposits 99.07% 101.10% 97.73%
Competition
Commercial banking in North Carolina is extremely competitive due in
large part to statewide branching. As a result, many commercial banks have
branches located in several communities. The bank competes in its market area
with some of the largest banking organizations in the state and the country and
other financial institutions, such as federally and state-chartered savings and
loan institutions. At June 2005, we operated branches in Johnston, Wake,
Sampson, Duplin, Harnett and Lee counties, North Carolina. At that time in
Johnston County, North Carolina, the bank's primary market, there were a total
of approximately $1.1 billion in deposits and 36 branches represented by the top
ten financial institutions in the county based on deposit share, all commercial
banks. The bank operated six of the 36 branches with deposits of $270.4 million,
placing the bank second in the top ten based on deposit share. Many of the
bank's competitors have broader geographic markets and higher lending limits
than those of the bank and are also able to provide more services and make
greater use of media advertising. Therefore, in our market area, the bank has
significant competition for deposits and loans from other depository
institutions. Other financial institutions such as credit unions, as well as
consumer finance companies, mortgage companies and other lenders engaged in the
business of extending credit with varying degrees of regulatory restrictions
also compete in our market area. Additionally, credit unions have been permitted
to expand their membership criteria and expand their loan services to include
traditional bank services such as commercial lending creating a greater
competitive disadvantage to tax-paying financial institutions.
The enactment of legislation authorizing interstate banking has caused
great increases in the size and financial resources of some of the bank's
competitors. See "Holding Company Regulation" below for a description of this
legislation. In addition, as a result of interstate banking, out-of-state
commercial banks may acquire North Carolina banks and heighten the competition
among banks in North Carolina.
Although the competition in its market areas is expected to continue to
be significant, the bank believes that it has certain competitive advantages
that distinguish it from its competition. The bank believes that its primary
competitive advantages are its strong local identity, its affiliation with the
community and its emphasis on providing specialized services to small and
medium-sized business enterprises, as well as professional and upper-income
individuals. The bank offers customers modern, high-tech banking without
forsaking community values such as prompt, personal service and friendliness.
The bank offers many personalized services and attracts and retains customers by
being responsive and sensitive to their individualized needs. The bank also
relies on goodwill and referrals from our shareholders and the bank's satisfied
customers, as well as traditional media, to attract new customers. To enhance a
positive image in the community, the bank supports and participates in local
events and its officers and directors serve on boards of local civic and
charitable organizations.
Governmental Regulation
Holding companies, banks and many of their non-bank affiliates are
extensively regulated under both federal and state law. The following is a brief
summary of certain statutes, rules and regulations affecting us and the bank.
This summary is qualified in its entirety by reference to the particular
statutory and regulatory provisions referred to below and is not intended to be
an exhaustive description of the statutes or regulations applicable to the
business of the company or bank. Supervision, regulation and examination of the
company and the bank by bank regulatory agencies is intended primarily for the
protection of the bank's depositors rather than the company's shareholders.
4
Holding Company Regulation
General. Four Oaks Fincorp, Inc. is a holding company registered with
the Board of Governors of the Federal Reserve System under the Bank Holding
Company Act of 1956 (the "BHCA"). As such, we are subject to the supervision,
examination and reporting requirements contained in the BHCA and the regulation
of the Federal Reserve. The bank is also subject to the BHCA. The BHCA requires
that a bank holding company obtain the prior approval of the Federal Reserve
before (i) acquiring direct or indirect ownership or control of more than five
percent of the voting shares of any bank, (ii) taking any action that causes a
bank to become a subsidiary of the bank holding company, (iii) acquiring all or
substantially all of the assets of any bank or (iv) merging or consolidating
with any other bank holding company.
The BHCA generally prohibits a bank holding company, with certain
exceptions, from engaging in activities other than banking, or managing or
controlling banks or other permissible subsidiaries, and from acquiring or
retaining direct or indirect control of any company engaged in any activities
other than those activities determined by the Federal Reserve to be closely
related to banking, or managing or controlling banks, as to be a proper incident
thereto. In determining whether a particular activity is permissible, the
Federal Reserve must consider whether the performance of such an activity can
reasonably be expected to produce benefits to the public, such as greater
convenience, increased competition or gains in efficiency, that outweigh
possible adverse effects, such as undue concentration of resources, decreased or
unfair competition, conflicts of interest or unsound banking practices. For
example, banking, operating a thrift institution, extending credit or servicing
loans, leasing real or personal property, providing securities brokerage
services, providing certain data processing services, acting as agent or broker
in selling credit life insurance and certain other types of insurance
underwriting activities have all been determined by regulations of the Federal
Reserve to be permissible activities.
Pursuant to delegated authority, the Federal Reserve Bank of Richmond
has authority to approve certain activities of holding companies within its
district, including us, provided the nature of the activity has been approved by
the Federal Reserve. Despite prior approval, the Federal Reserve has the power
to order a holding company or its subsidiaries to terminate any activity or to
terminate its ownership or control of any subsidiary when it believes that
continuation of such activity or such ownership or control constitutes a serious
risk to the financial safety, soundness or stability of any bank subsidiary of
that bank holding company.
Financial Holding Companies. The Gramm-Leach-Bliley Modernization Act
of 1999 (the "GLB"), which was enacted on November 12, 1999, allows bank holding
companies that meet certain new regulatory standards regarding management,
capital and the Community Reinvestment Act, to engage in a broader range of
non-banking activities than previously permissible, including insurance
underwriting and making merchant banking investments in commercial and financial
companies; allows insurers and other financial services companies to acquire
banks; removes various restrictions that applied to bank holding company
ownership of securities firms and mutual fund advisory companies; and
establishes the overall regulatory structure applicable to bank holding
companies that also engage in insurance and securities operations.
At the present time, we have elected to remain a bank holding company,
and therefore we remain subject to the same regulatory framework as before the
enactment of the GLB. However, the financial holding company structure created
by the GLB permits insurance companies or securities firms operating under the
financial holding company structure to acquire us, and, if we elect to become a
financial holding company in the future, we could acquire insurance companies or
securities firms.
In addition to creating the more flexible financial holding company
structure, the GLB introduced several additional customer privacy protections
that will apply to us and the bank. The GLB's privacy provisions require
financial institutions to, among other things, (i) establish and annually
disclose a privacy policy, (ii) give consumers the right to opt out of
disclosures to nonaffiliated third parties, with certain exceptions, (iii)
refuse to disclose consumer account information to third-party marketers and
(iv) follow regulatory standards to protect the security and confidentiality of
consumer information.
Pursuant to the GLB's rulemaking provisions, the Office of the
Comptroller of the Currency, the Board of Governors of the Federal Reserve
System, the Federal Deposit Insurance Corporation and the Office of Thrift
Supervision adopted regulations, establishing standards for safeguarding
customer information. Such regulations provide financial institutions guidance
in establishing and implementing administrative, technical and physical
safeguards to protect the security, confidentiality and integrity of customer
information.
5
Mergers and Acquisitions. The Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 (the "IBBEA") permits interstate acquisitions
of banks and bank holding companies without geographic limitation, subject to
any state requirement that the bank has been organized for a minimum period of
time, not to exceed five (5) years, and the requirement that the bank holding
company, prior to or following the proposed acquisition, controls no more than
ten percent (10%) of the total amount of deposits of insured depository
institutions in the U.S. and no more than thirty percent (30%) of such deposits
in any state (or such lesser or greater amount set by state law).
In addition, the IBBEA permits a bank to merge with a bank in another
state as long as neither of the states has opted out of the IBBEA prior to May
31, 1997. In 1995, the state of North Carolina "opted in" to such legislation.
In addition, a bank may establish and operate a de novo branch in a state in
which the bank does not maintain a branch if that state expressly permits de
novo interstate branching. As a result of North Carolina having opted-in,
unrestricted interstate de novo branching is permitted in North Carolina.
Additional Restrictions and Oversight. Subsidiary banks of a bank
holding company are subject to certain restrictions imposed by the Federal
Reserve on any extensions of credit to the bank holding company or any of its
subsidiaries, investments in the stock or securities thereof and the acceptance
of such stock or securities as collateral for loans to any borrower. A bank
holding company and its subsidiaries are also prevented from engaging in certain
tie-in arrangements in connection with any extension of credit, lease or sale of
property or furnishing of services. An example of a prohibited tie-in would be
any arrangement that would condition the provision or cost of services on a
customer obtaining additional services from the bank holding company or any of
its other subsidiaries.
The Federal Reserve may issue cease and desist orders against bank
holding companies and non-bank subsidiaries to stop actions believed to present
a serious threat to a subsidiary bank. The Federal Reserve also regulates
certain debt obligations, changes in control of bank holding companies and
capital requirements.
Under the provisions of the North Carolina law, we are registered with
and subject to supervision by the North Carolina Commissioner of Banks.
Capital Requirements. The Federal Reserve has established risk-based
capital guidelines for bank holding companies and state member banks. The
minimum standard for the ratio of capital to risk-weighted assets (including
certain off balance sheet obligations, such as standby letters of credit) is
eight percent (8%). At least half of this capital must consist of common equity,
retained earnings and a limited amount of perpetual preferred stock and minority
interests in the equity accounts of consolidated subsidiaries, less goodwill
items and certain other items ("Tier 1 capital"). The remainder ("Tier 2
capital") may consist of mandatory convertible debt securities and a limited
amount of other preferred stock, subordinated debt and loan loss reserves.
In addition, the Federal Reserve has established minimum leverage ratio
guidelines for bank holding companies. These guidelines provide for a minimum
leverage ratio of Tier 1 capital to adjusted average quarterly assets less
certain amounts ("Leverage Ratio") equal to three percent for bank holding
companies that meet certain specified criteria, including having the highest
regulatory rating. All other bank holding companies will generally be required
to maintain a Leverage Ratio of between four percent and five percent.
The guidelines also provide that bank holding companies experiencing
significant growth, whether through internal expansion or acquisitions, will be
expected to maintain strong capital ratios substantially above the minimum
supervisory levels without significant reliance on intangible assets. The same
heightened requirements apply to bank holding companies with supervisory,
financial, operational or managerial weaknesses, as well as to other banking
institutions if warranted by particular circumstances or the institution's risk
profile. Furthermore, the guidelines indicate that the Federal Reserve will
continue to consider a "tangible Tier 1 Leverage Ratio" (deducting all
intangibles) in evaluating proposals for expansion or new activity. The Federal
Reserve has not advised us of any specific minimum Leverage Ratio or tangible
Tier 1 Leverage Ratio applicable to us.
As of December 31, 2005, we had Tier 1 risk-adjusted, total regulatory
capital and leverage capital of approximately 10.40%, 11.61% and 8.66%,
respectively, all in excess of the minimum requirements to be considered
well-capitalized under prompt corrective action provisions.
6
Dividends. During 2005, we paid cash dividends of $.30 per share of our
common stock, a 15.4% increase over 2004. North Carolina banking law requires
that dividends be paid out of retained earnings as determined pursuant to North
Carolina General Statues Section 53-87. At present, the company has sufficient
cash from its operations to pay cash dividends on its common stock. In the
past, we have received cash dividends from our bank and may continue to do so
from time to time in the future as necessary for cash flow purposes. Also,
applicable banking law contains additional limitations and restrictions on the
payment of dividends by a bank holding company. Accordingly, shareholders
receive dividends from us only to the extent that funds are available from our
operations or the bank. In addition, the Federal Reserve generally prohibits
bank holding companies from paying dividends except out of operating earnings,
and the prospective rate of earnings retention appears consistent with the bank
holding company's capital needs, asset quality and overall financial condition.
USA Patriot Act of 2001. Title III of the USA Patriot Act of 2001
contains the International Money Laundering Abatement and Financial
Anti-Terrorism Act of 2001 (the "IMLAFA"). The anti-money laundering provisions
of IMLAFA impose affirmative obligations on a broad range of financial
institutions, including banks, brokers, and dealers. Among other requirements,
IMLAFA requires all financial institutions to establish anti-money laundering
programs that include, at minimum, internal policies, procedures, and controls;
specific designation of an anti-money laundering compliance officer; ongoing
employee training programs; and an independent audit function to test the
anti-money laundering program. IMLAFA requires financial institutions that
establish, maintain, administer, or manage private banking accounts for
non-United States persons or their representatives to establish appropriate,
specific, and, where necessary, enhanced due diligence policies, procedures, and
controls designed to detect and report money laundering. Additionally, IMLAFA
provides for the Department of Treasury to issue minimum standards with respect
to customer identification at the time new accounts are opened. As of the date
of this filing, we believe that IMLAFA has not had a material impact on the
bank's operations. The bank has established policies and procedures to ensure
compliance with the IMLAFA, which are overseen by an Anti-Money Laundering
Officer who was appointed by our Board of Directors.
Bank Regulation
The bank is subject to numerous state and federal statutes and
regulations that affect its business, activities, and operations, and is
supervised and examined by the North Carolina Commissioner of Banks and the
Federal Reserve. The Federal Reserve and the North Carolina Commissioner of
Banks regularly examine the operations of banks over which they exercise
jurisdiction. They have the authority to approve or disapprove the establishment
of branches, mergers, consolidations, and other similar corporate actions, and
to prevent the continuance or development of unsafe or unsound banking practices
and other violations of law. The Federal Reserve and the North Carolina
Commissioner of Banks regulate and monitor all areas of the operations of banks
and their subsidiaries, including loans, mortgages, issuances of securities,
capital adequacy, loss reserves, and compliance with the Community Reinvestment
Act of 1977 (the "CRA") as well as other laws and regulations. Interest and
certain other charges collected and contracted for by banks are also subject to
state usury laws and certain federal laws concerning interest rates.
The deposit accounts of the bank are insured by the Bank Insurance Fund
(the "BIF") of the Federal Deposit Insurance Corporation (the "FDIC") up to a
maximum of one hundred thousand dollars ($100,000) per insured depositor. Any
insured bank that is not operated in accordance with or does not conform to FDIC
regulations, policies, and directives may be sanctioned for noncompliance. Civil
and criminal proceedings may be instituted against any insured bank or any
director, officer or employee of such bank for the violation of applicable laws
and regulations, breaches of fiduciary duties or engaging in any unsafe or
unsound practice. The FDIC has the authority to terminate insurance of accounts
pursuant to procedures established for that purpose.
Under the North Carolina Business Corporation Act, we may not pay a
dividend or distribution, if after giving it effect we would not be able to pay
our debts as they become due in the usual course of business or our total assets
would be less than our liabilities. All dividends paid by the bank are paid to
us, the sole shareholder of the bank. In general, our ability to pay cash
dividends is dependent in part upon the amount of dividends paid to us by the
bank. The ability of the bank to pay dividends to us is subject to statutory and
regulatory restrictions on the payment of cash dividends, including the
requirement under the North Carolina banking laws that cash dividends be paid
only out of undivided profits and only if the bank has surplus of a specified
level. The Federal Reserve also imposes limits on the bank's payment of
dividends. The amount of future dividends paid to us by the bank will in general
be a function of the profitability of the bank, which cannot be accurately
estimated or assured. We expect the bank will continue to pay us dividends in
the foreseeable future from time to time as needed to pay cash dividends to our
shareholders.
7
Like us, the bank is required by federal regulations to maintain
certain minimum capital levels. The levels required of the bank are the same as
those required of us. At December 31, 2005, the bank had Tier 1 risk-adjusted,
total regulatory capital and leverage capital of approximately 9.28%, 10.49% and
7.73%, respectively, in excess of the minimum requirements to be considered
well-capitalized under prompt corrective action provisions.
The bank is subject to insurance assessments imposed by the FDIC,
including a risk-based assessment schedule providing for annual assessment rates
ranging from 0% to .27% of an institution's average assessment base, applicable
to institutions insured by both the BIF and the Savings Association Insurance
Fund ("SAIF"). The actual assessment to be paid by each insured institution is
based on the institution's assessment risk classification, which focuses on
whether the institution is considered "well capitalized," "adequately
capitalized" or "under capitalized," as such terms are defined in the applicable
federal regulations. Within each of these three risk classifications, each
institution will be assigned to one of three subgroups based on supervisory risk
factors. In particular, regulators will assess supervisory risk based on whether
the institution is financially sound with only a few minor weaknesses (Subgroup
A), whether it has weaknesses which, if not corrected, could result in an
increased risk of loss to the BIF (Subgroup B) or whether such weaknesses pose a
substantial probability of loss to the BIF unless effective corrective action is
taken (Subgroup C). The FDIC also is authorized to impose one or more special
assessments in an amount deemed necessary to enable repayment of amounts
borrowed by the FDIC from the United States Treasury Department and, beginning
in 1997, all banks are required to pay additional annual assessments as set by
the Financing Corporation, which was established by the Competitive Equality
Banking Act of 1987.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") provides for, among other things, (i) publicly available annual
financial condition and management reports for certain financial institutions,
including audits by independent accountants, (ii) the establishment of uniform
accounting standards by federal banking agencies, (iii) the establishment of a
"prompt corrective action" system of regulatory supervision and intervention,
based on capitalization levels, with greater scrutiny and restrictions placed on
depository institutions with lower levels of capital, (iv) additional grounds
for the appointment of a conservator or receiver and (v) restrictions or
prohibitions on accepting brokered deposits, except for institutions which
significantly exceed minimum capital requirements. FDICIA also provides for
increased funding of the FDIC insurance funds and the implementation of
risk-based premiums.
A central feature of FDICIA is the requirement that the federal banking
agencies take "prompt corrective action" with respect to depository institutions
that do not meet minimum capital requirements. Pursuant to FDICIA, the federal
bank regulatory authorities have adopted regulations setting forth a five-tiered
system for measuring the capital adequacy of the depository institutions that
they supervise. Under these regulations, a depository institution is classified
in one of the following capital categories: "well capitalized," "adequately
capitalized," "under capitalized," "significantly undercapitalized," and
"critically undercapitalized." An institution may be deemed by the regulators to
be in a capitalization category that is lower than is indicated by its actual
capital position if, among other things, it receives an unsatisfactory
examination rating with respect to asset quality, management, earnings or
liquidity. FDICIA provides the federal banking agencies with significantly
expanded powers to take enforcement action against institutions which fail to
comply with capital or other standards. Such action may include the termination
of deposit insurance by the FDIC or the appointment of a receiver or conservator
for the institution.
Banks are also subject to the CRA, which requires the appropriate
federal bank regulatory agency, in connection with its examination of a bank, to
assess such bank's record in meeting the credit needs of the community served by
that bank, including low and moderate-income neighborhoods. Each institution is
assigned one of the following four ratings of its record in meeting community
credit needs: "outstanding," "satisfactory," "needs to improve" or "substantial
noncompliance." The regulatory agency's assessment of the bank's record is made
available to the public. Further, such assessment is required of any bank which
has applied to (i) charter a national bank, (ii) obtain deposit insurance
coverage for a newly chartered institution, (iii) establish a new branch office
that will accept deposits, (iv) relocate an office or (v) merge or consolidate
with, or acquire the assets or assume the liabilities of, a federally regulated
financial institution. In the case of a bank holding company applying for
approval to acquire a bank or other bank holding company, the Federal Reserve
will assess the record of each subsidiary bank of the applicant bank holding
company, and such records may be the basis for denying the application.
In addition, the GLB's "CRA Sunshine Requirements" call for financial
institutions to disclose publicly certain written agreements made in fulfillment
of the CRA. Banks that are parties to such agreements also must report to
federal regulators the amount and use of any funds expended under such
agreements on an annual basis, along with such other information as regulators
may require. This annual reporting requirement is effective for any agreements
made after May 12, 2000.
8
Monetary Policy and Economic Controls
Both the company and the bank are directly affected by governmental
policies and regulatory measures affecting the banking industry in general. Of
primary importance is the Federal Reserve Board, whose actions directly affect
the money supply which, in turn, affects banks' lending abilities by increasing
or decreasing the cost and availability of funds to banks. The Federal Reserve
Board regulates the availability of bank credit in order to combat recession and
curb inflationary pressures in the economy by open market operations in United
States government securities, changes in the discount rate on member bank
borrowings, changes in reserve requirements against bank deposits, and
limitations on interest rates that banks may pay on time and savings deposits.
Deregulation of interest rates paid by banks on deposits and the types
of deposits that may be offered by banks have eliminated minimum balance
requirements and rate ceilings on various types of time deposit accounts. The
effect of these specific actions and, in general, the deregulation of deposit
interest rates has generally increased banks' cost of funds and made them more
sensitive to fluctuations in money market rates. In view of the changing
conditions in the national economy and money markets, as well as the effect of
actions by monetary and fiscal authorities, no prediction can be made as to
possible future changes in interest rates, deposit levels, or loan demand on our
business and earnings or those of the bank. As a result, banks, including the
bank, face a significant challenge to maintain acceptable net interest margins.
Our Executive Officers
The following table sets forth certain information with respect to our
executive officers:
Positions and offices with Four Oaks
Fincorp, Inc. and Four Oaks Bank & Trust
Year first Company and business experience during
Name Age employed past five (5) years
- ------------------------------------------------------------------------------------------------------------------------------------
Ayden R. Lee, Jr. 57 1980 Chief Executive Officer, President and Director
of Four Oaks Fincorp, Inc. and Four Oaks Bank
& Trust Company.
Clifton L. Painter 56 1986 Senior Executive Vice President, Chief Operating
Officer of Four Oaks Fincorp, Inc. and Four Oaks
Bank & Trust Company.
Nancy S. Wise 50 1991 Executive Vice President, Chief Financial Officer of Four Oaks
Fincorp, Inc. and Four Oaks Bank & Trust Company. Previously,
Senior Vice President, Chief Financial Officer of Four Oaks
Fincorp, Inc. and Four Oaks Bank & Trust Company.
W. Leon Hiatt, III 38 1994 Executive Vice President of Four Oaks Fincorp, Inc. and Four Oaks
Bank & Trust Company, Chief Administrative Officer of Four Oaks
Bank & Trust Company. Previously, Senior Vice President Four
Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company, Loan
Administrator of Four Oaks Bank & Trust Company.
Jeff D. Pope 49 1991 Executive Vice President of Four Oaks Fincorp, Inc. and Four Oaks
Bank & Trust Company, Branch Administrator of Four Oaks Bank &
Trust Company. Previously, Senior Vice President, Loan Officer
and Regional/Branch Administrator Four Oaks Bank and Trust
Company.
9
Item 1A. Risk Factors
Our Results Are Impacted by the Economic Conditions of Our Principal Operating
Regions
The majority of our customers are individuals and small to medium-size
businesses located in North Carolina's Johnston, Wake, Duplin, Sampson and Lee
Counties and surrounding areas. As a result of this geographic concentration,
our results may correlate to the economic conditions in these areas. Declines in
these markets' economic conditions may adversely affect the quality of our loan
portfolio and the demand for our products and services, and accordingly, our
results of operations.
We Are Exposed to Risks in Connection with the Loans We Make
A significant source of risk for us arises from the possibility that
loan losses will be sustained because borrowers, guarantors and related parties
may fail to perform in accordance with the terms of their loans. Our policy
dictates that we maintain an allowance for loan losses. The amount of the
allowance is based on management's evaluation of our loan portfolio, the
financial condition of the borrowers, current economic conditions, past and
expected loan loss experience, and other factors management deems appropriate.
Such policies and procedures, however, may not prevent unexpected losses that
could adversely affect our results of operations.
We Compete with Larger Companies for Business
Commercial banking in North Carolina is extremely competitive due in
large part to statewide branching. The bank competes in the North Carolina
market area with some of the largest banking organizations in the state and the
country and other financial institutions, such as federally and state-chartered
savings and loan institutions and credit unions, as well as consumer finance
companies, mortgage companies and other lenders engaged in the business of
extending credit. Many of these competitors have broader geographic markets,
higher lending limits, more services, and more media advertising. We may not be
able to compete effectively in our markets, and our results of operations could
be adversely affected by the nature or pace of change in competition.
We Are Exposed to Certain Market Risks
Like most financial institutions, our most significant market risk
exposure is the risk of economic loss resulting from adverse changes in market
price and interest rates. Our market risk stems primarily from interest rate
risk inherent in our lending and deposit-taking activities. Our policy dictates
that we maintain derivative financial instruments, such as interest rate swap
agreements, to manage such risk.
To manage the risk of potentially decreasing interest rates for our
variable rate loan portfolio, we use an interest rate swap agreement whereby we
contract to receive fixed rate payments and in turn, we agree to make variable
interest payments for a defined time period. In addition, we used fixed rate
time deposits, such as certificates of deposits, for use in our lending and
investment activities. If the interest rates decline, we face the risk of being
committed to pay a fixed rated that is higher than the fair value rate of such
deposits. To manage this risk, we use interest rate swaps whereby we contract to
make a series of floating rate payments in exchange for receiving a series of
fixed rate payments.
Because the value of derivative contracts is tied to an independent
instrument, index or reference rate, the contracts are written in abstract
amounts that only provide the basis for calculating payments between
counterparties, i.e., notional amounts. Credit risk arises when amounts
receivable from the counterparty exceed amounts payable, or when the
counterparty fails to pay. The counterparties to these contracts are primarily
large commercial banks and investment banks. We control our risk of loss on
derivative contracts by subjecting each contracting counterparty to credit
reviews and approvals similar to those used in making loans and other extensions
of credit, and we continuously monitor these agreements. Other risks include the
effect on fixed rate positions during periods of changing interest rates, e.g.,
when interest rates fall, the notional amounts decrease more rapidly, whereas
when interest rates rise, the notional amounts decrease more slowly.
10
Technological Advances
The banking industry is undergoing technological changes with frequent
introductions of new technology-driven products and services. In addition to
improving customer services, the effective use of technology increases
efficiency and enables financial institutions to reduce costs. Our future
success will depend, in part, on our ability to address the needs of our
customers by using technology to provide products and services that will satisfy
customer demands for convenience as well as to create additional efficiencies in
our operations. Many of our competitors, however, have substantially greater
resources to invest in technological improvements.
Compliance with Changing Laws, Regulations and Standards May Result in
Additional Risks and Expenses
We are subject to changing laws, regulations and standards, including
the Bank Holding Company Act of 1956, the Gramm-Leach-Bliley Modernization Act
of 1999, the Riegle-Neal Interstate Banking and Branching Efficiency Act of
1994, the USA Patriot Act of 2001, the Federal Deposit Insurance Corporation
Improvement Act of 1991, the Community Reinvestment Act of 1977, the North
Carolina Business Corporation Act, the Sarbanes-Oxley Act of 2002 and new SEC
regulations to name a few.
The Sarbanes-Oxley Act and new SEC regulations, in particular, are
creating uncertainty for companies such as ours because they are subject to
varying interpretations in many cases. As a result, their application in
practice may evolve over time as new guidance is provided by regulatory and
governing bodies, which could result in continuing uncertainty regarding
compliance matters and higher costs necessitated by ongoing revisions to
disclosure and governance practices. We are committed to maintaining high
standards of corporate governance and public disclosure. As a result, our
efforts to comply with evolving laws, regulations and standards have resulted
in, and are likely to continue to result in, increased expenses and a diversion
of management time and attention. Specifically, our efforts to comply with
Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations
regarding management's required assessment of our internal control over
financial reporting and our external auditors' audit of that assessment has
required the commitment of significant financial and managerial resources. We
expect these efforts to require the continued commitment of significant
resources. Further, the members of our Board of Directors, members of the Audit
or Compensation committees, our Chief Executive Officer, our Chief Financial
Officer and certain other of our executive officers could face an increased risk
of personal liability in connection with the performance of their duties. In
addition, it may become more difficult and more expensive to obtain director and
officer liability insurance. As a result, our ability to attract and retain
executive officers and qualified Board and committee members could be more
difficult.
Government Regulations May Prevent or Impair Our Ability to Pay Dividends,
Engage in Acquisitions or Operate in Other Ways
Current and future legislation and the policies established by federal
and state regulatory authorities will affect our operations. We are subject to
supervision and a periodic examination by the Federal Reserve Bank and the North
Carolina State Banking Commission. Banking regulations, designed primarily for
the protection of depositors, may limit our growth and the return to you, our
investors, by restricting certain of our activities, such as:
o The payment of dividends to our shareholders;
o Possible mergers with or acquisitions of or by other
institutions;
o Our desired investments;
o Loans and interest rates on loans;
o Interest rates paid on deposits;
o The possible expansion of branch offices; and/or
o Our ability to provide securities or trust services.
We also are subject to capitalization guidelines set forth in federal
legislation, and could be subject to enforcement actions to the extent that we
are found by regulatory examiners to be undercapitalized. We cannot predict what
changes, if any, will be made to existing federal and state legislation and
regulators or the effect that such changes may have on our future business and
earnings prospects. The cost of compliance with regulatory requirements
including those imposed by the SEC may adversely affect our ability to operate
profitably.
11
We Depend Heavily on our Key Management Personnel
Our success depends in part on our ability to retain key executives and
to attract and retain additional qualified management personnel who have
experience both in sophisticated banking matters and in operating a small to
mid-size bank. Competition for such personnel is strong in the banking industry
and we may not be successful in attracting or retaining the personnel we
require. We expect to effectively compete in this area by offering competitive
financial packages that include incentive-based compensation.
Item 1B - Unresolved Staff Comments.
Not applicable.
Item 2 - Properties.
The bank owns its main office, which is located at 6144 US 301 South,
Four Oaks, North Carolina. The main office, which was constructed by the bank in
1985, is a 12,000 square foot facility on 1.64 acres of land. The bank leases a
limited-service facility in downtown Four Oaks located at 111 North Main Street
from M.S. Canaday, who is one of our directors as well as a director of the
bank. Under the terms of the lease, which the bank believes to be arms-length,
the bank paid $938 per month in rent in 2005. The lease is month-to-month and we
review its terms on an annual basis. The bank also leases a branch office
located at 101 Avent Ferry Road, Holly Springs, North Carolina. Under the terms
of the lease, the bank will pay $2,508 per month for a period of five years
ending April 1, 2008. The bank's Harrells office located at 590 Tomahawk
Highway, Harrells, North Carolina is under a lease with terms specifying the
bank will pay $600 each month for the period beginning January 1, 2006 and
ending December 31, 2009. In addition, the bank has entered into a yearly lease
with an annual option to renew on its Sanford office located at 1100 South
Horner Boulevard, Sanford, North Carolina. Under the terms of the lease, the
bank will pay $1,300 each month. Late in December 2005, the bank signed a yearly
lease with an annual option to renew for its new Zebulon office located at 130
North Arendell Avenue, Zebulon, North Carolina for $1,000 per month beginning
January 1, 2006. The bank owns a 5,000 square foot facility renovated in 1992 on
1.15 acres of land located at 5987 US 301 South, Four Oaks, North Carolina which
houses its training center. The bank also owns a 15,000 square foot facility
built in 2000 located at 6114 US 301 South, Four Oaks, North Carolina, which
houses its administrative offices, data operations, loan operations and wide
area network central link. In addition, the bank owns the following:
Location Year Built Present Function Square Feet
-------- ---------- ---------------- -----------
102 East Main Street
Clayton, North Carolina 1986 Branch Office 4,700
200 East Church Street
Benson, North Carolina 1987 Branch Office 2,000
128 North Second Street
Smithfield, North Carolina 1991 Branch Office 5,000
403 South Brightleaf Boulevard
Smithfield, North Carolina 1995 Limited-Service Facility 720
200 Glen Road
Garner, North Carolina 1996 Branch Office 3,600
325 North Judd Parkway Northeast
Fuquay-Varina, North Carolina 2002 Branch Office 8,900
406 East Main Street
Wallace, North Carolina 2003 Branch Office (modular) 2,800
Management believes each of the properties referenced above is adequately
covered by insurance. In addition to the above locations, we have 14 ATMs
located inside Food Lion grocery stores in the cities and towns of Clayton,
Benson, Sanford, Wallace, Fuquay-Varina, Holly Springs, Garner, Zebulon and
Wendell, North Carolina. The net book value for our properties, including land,
buildings, and furniture and equipment was $9.7 million at December 31, 2005.
Additional information disclosed in Note D "Bank Premises and Equipment" to our
consolidated financial statements presented under Item 8 of Part III of this
Form 10-K.
12
Item 3 - Legal Proceedings.
We are not involved in any material legal proceedings at the present
time.
Item 4 - Submission of Matters to a Vote of Security Holders.
None.
PART II
Item 5 - Market for Registrant's Common Equity, Related Shareholder Matters and
Issuer Purchases of Equity Securities.
Our common stock trades on the OTC Bulletin Board under the symbol
"FOFN." The range of high and low bid prices of our common stock for each
quarter during the two most recent fiscal years, as published by the OTC
Bulletin Board, is as follows (prices reflect inter-dealer prices, without
retail mark-up, mark-down or commissions and may not necessarily represent
actual transactions):
Fiscal Year Ended December 31,
2004 2005
------------------------------- --------------------------------
High Low High Low
---- --- ---- ---
First quarter $ 16.64 $ 13.44 $ 19.20 $ 17.60
Second quarter 15.68 14.08 23.20 18.64
Third quarter 14.72 14.08 24.00 19.80
Fourth quarter 20.00 14.88 25.00 19.80
As of March 15, 2006 , the approximate number of holders of record of
our common stock was 1,400. We have no other class of equity securities. The
bank's ability to declare a dividend to us and the company's ability to pay
dividends are subject to the restrictions of the North Carolina Business
Corporation Act. There also are state banking laws that require a surplus of at
least 50% of paid-in capital stock be maintained in order for the bank to
declare a dividend to the company. Subject to the legal availability of funds to
pay dividends, cash dividends paid by us in 2005 and 2004, after giving effect
to the 5-for-4 stock splits during 2005 and 2004, were $.30 and $.26 per share,
respectively.
We did not sell any securities in 2005 that were not registered under
the Securities Act of 1933 as amended. We did not make any purchases of our
equity securities registered pursuant to Section 12 of the Securities Exchange
Act of 1934, as amended during the fourth quarter of 2005.
Item 6 - Selected Financial Data
The following table sets forth our historical consolidated financial
data for the periods indicated. The selected historical annual consolidated
statement of operations and balance sheet data as of and for each of the five
fiscal years presented are derived from, and are qualified in their entirety by,
our consolidated financial statements. Historical results are not necessarily
indicative of the results to be expected in the future. You should read the
following data together with "Item 1. Business," "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
our consolidated financial statements and the related notes appearing in "Item
8. Financial Statements." (Dollars in thousands, except per share data).
13
As of and for the Year Ended December 31,
----------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
Operating Data:
Total interest income $ 29,404 $ 21,748 $ 18,943 $ 19,785 $21,462
Total interest expense 9,817 5,811 5,922 7,640 10,167
------- ------- ------- ------- -------
Net interest income 19,587 15,937 13,021 12,145 11,295
Provision for loan losses 1,403 1,596 1,373 1,248 834
------- ------- ------- ------- -------
Net interest income after provision for
loan losses 18,184 14,341 11,648 10,897 10,461
Noninterest income 3,474 3,849 3,470 2,810 2,284
Noninterest expense 13,354 11,507 10,588 9,485 8,834
------- ------- ------- ------- -------
Income before income taxes 8,304 6,683 4,530 4,222 3,911
Provision for income taxes 2,955 2,308 1,612 1,306 1,255
------- ------- ------- ------- -------
Net income $ 5,349 $ 4,375 $ 2,918 $ 2,916 $ 2,656
======= ======= ======= ======= =======
Per Share Data:
Earnings per share - basic $ 1.23 $ 1.03 $ 0.70 $ 0.70 $ 0.65
Earnings per share - diluted 1.22 1.02 0.69 0.70 0.65
Cash dividends declared 0.30 0.26 0.23 0.21 0.18
Market price
High 25.00 20.00 16.64 12.03 12.80
Low 17.60 13.44 11.26 10.50 9.22
Close 22.61 17.60 13.44 12.03 10.45
Book value 9.58 8.68 7.86 7.45 6.81
Weighted average shares outstanding
Basic 4,343,326 4,246,681 4,195,088 4,157,450 4,083,146
Diluted 4,375,505 4,270,850 4,210,052 4,171,083 4,104,604
Selected Year-End Balance Sheet Data:
Total assets $522,410 $398,500 $341,721 $318,289 $299,970
Loans 397,094 312,815 272,623 229,570 209,822
Allowance for loan losses 4,965 4,055 3,430 2,860 2,650
Deposits 397,533 315,307 272,918 250,573 235,604
Borrowings 74,140 43,160 33,160 33,160 33,173
Shareholders' equity 41,958 37,295 32,880 31,193 28,025
Selected Average Balances:
Total assets $449,000 $376,422 $324,222 $308,334 $274,054
Loans 351,103 298,783 249,240 216,620 202,500
Total interest-earning assets 419,307 349,596 300,672 290,294 256,476
Deposits 354,406 295,524 255,038 242,878 226,476
Total interest-bearing liabilities 339,990 282,743 244,024 236,661 208,381
Shareholders' Equity 39,959 35,135 32,341 29,931 27,306
Selected Performance Ratios:
Return on average assets 1.19% 1.16% 0.90% 0.95% 0.97%
Return on average equity 13.39% 12.45% 9.02% 9.74% 9.73%
Net interest spread 4.12% 4.16% 3.87% 3.59% 3.49%
Net interest margin 4.67% 4.56% 4.33% 4.18% 4.40%
Non-interest income to total revenue 15.06% 19.45% 21.04% 18.79% 16.82%
Non-interest income to average assets 0.77% 1.02% 1.07% 0.91% 0.83%
Non-interest expense to average assets 2.97% 3.06% 3.27% 3.08% 3.22%
Efficiency ratio 57.10% 58.58% 66.15% 64.14% 64.68%
Dividend payout ratio 24.39% 24.81% 33.33% 29.55% 31.50%
Asset Quality Ratios:
Nonperforming loans to period-end loans 0.25% 0.30% 0.39% 0.67% 0.97%
Allowance for loan losses to period-end
loans 1.25% 1.30% 1.26% 1.25% 1.26%
Allowance for loan losses to
nonperforming loans 497.99% 429.56% 323.89% 186.08% 129.65%
Nonperforming assets to total assets 0.25% 0.39% 0.52% 0.65% 0.78%
Net loan charge-offs to average loans 0.14% 0.32% 0.32% 0.48% 0.47%
14
As of and for the Year Ended December 31,
----------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
Capital Ratios:
Total risk-based capital - Bank 10.49% 11.80% 12.30% 14.00% 14.10%
Tier 1 risk-based capital - Bank 9.28% 10.60% 11.10% 12.80% 13.90%
Leverage ratio - Bank 7.73% 8.60% 9.00% 9.70% 9.50%
Equity to assets ratio 8.03% 9.36% 9.62% 9.80% 9.34%
Equity to assets ratio (averages) 8.90% 9.33% 9.97% 9.71% 9.96%
Average interest earning assets to
average tot assets 93.39% 92.87% 92.74% 94.15% 93.59%
Average loans to average total deposits 99.07% 101.10% 97.73% 89.19% 89.41%
Average interest- bearing liabilities to
avg int earn asset 81.08% 80.88% 81.16% 81.52% 81.25%
Other Data:
Number of banking offices 12 10 10 9 8
Number of full time equivalent employees 135 131 126 122 112
Item 7 - Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion and analysis provides information about the
major components of our results of operations and financial condition, liquidity
and capital resources and should be read in conjunction with our Consolidated
Financial Statements and Notes thereto which are contained in this report.
Additional discussion and analysis related to fiscal 2005 is contained in our
Quarterly Reports on Form 10-Q for the fiscal quarters ended March 31, 2005,
June 30, 2005 and September 30, 2005, respectively.
Overview
As a community focused commercial bank our primary business consists of
providing a full range of banking services to our customers with an emphasis on
quality personal service. Our core products consist of loans secured by real
estate and commercial and consumer loans as well as various deposit products to
meet our customer's needs. Our primary source of income is generated from net
interest income, the difference between interest income received on our loans
and securities and interest expense paid on deposits and borrowings. Our income
is also affected by our ability to price our products competitively and maximize
the interest rate spread between the interest yield on loans and securities and
the interest rate paid on deposits and borrowings. Our products also generate
other income through product related fees and commissions. We incur operating
expenses consisting primarily of salaries and benefits, occupancy and equipment
and other professional and miscellaneous expenses.
Our assets have increased from $300.0 million at December 31, 2001 to
$522.4 million at December 31, 2005, primarily through loan demand, while our
total deposits have increased from $235.6 million to $397.5 million over that
same period. In addition, for 70 consecutive years, we have paid dividends
(prior to 1997 when we reorganized into a holding company, it was our wholly
owned subsidiary, Four Oaks Bank & Trust Company, which paid dividends). For the
past five years, dividends have averaged 26.4% of our average net income. Return
on average equity and return on average assets for 2005 were 13.39% and 1.19%,
respectively, up over returns of 12.45% and 1.16%, respectively, for 2004.
We set interest rates on deposits and loans at competitive rates while
maintaining spreads of 4.12% and 4.16% in 2005 and 2004, respectively, between
interest earned on average loans and investments and interest paid on average
interest-bearing deposits and borrowings. Our gross loans have increased from
$209.8 million at December 31, 2001 to $397.1 million at December 31, 2005,
while our average net annual charge-offs over the same period were approximately
$852,000. The sustained growth provided by operations resulted in increases in
total assets of 31.1%, 16.6% and 7.4% for 2005, 2004 and 2003, respectively.
15
Our gross loans grew 26.9% and 14.7% in 2005 and 2004, respectively.
Our total investments (including interest-earning deposits and FHLB stock)
increased 59.7% and 29.0% in 2005 and 2004, respectively, due to the decision to
build the portfolio as yields have continued to improve throughout 2004 and
2005. We closely monitor changes in the financial markets in order to maximize
the yield on our assets. The growth in loans for 2005 and 2004 was funded
respectively by deposit growth of 26.1% and 15.6%, increased borrowings of $31.0
million and $10.0 million, and net income of $5.3 million and $4.4 million,
respectively, for 2005 and 2004. Improved earnings trends continued during 2005,
ending the year with earnings of $5.3 million, an increase of 22.3% over 2004's
net income of $4.4 million. This increase was primarily due to an increase in
net interest income. Strategic pricing of both loans and deposits and improved
yields in our investment portfolio provided improvement in our net interest
margin for 2005.
During 2005 and 2004, Four Oaks Mortgage Company, L.P. provided
secondary market-type mortgages which contributed $106,000 and $76,000 in income
for the years 2005 and 2004, respectively. Four Oaks Mortgage Company, L.P. is
owned 49.99% by our wholly owned subsidiary, Four Oaks Mortgage Services,
L.L.C., and 50.01% by its general partner, CTX Mortgage Ventures, LLC, a wholly
owned indirect subsidiary of Centex Corporation.
In December 2004, we added the Retail Real Estate Lending division,
which works with individuals, developers and contractors involved in real estate
acquisition and development.
Management historically has monitored and controlled increases in
overhead expenses while being committed to developing the skills and enhancing
the professionalism of our employees. Employee turnover has been minimal, while
the number of full-time equivalent employees has increased from 112 at December
31, 2001 to 135 at December 31, 2005.
Results of Operations
Comparison of Financial Condition at December 31, 2005 and 2004
During 2005, our total assets increased by $123.9 million, or 31.1%,
from $398.5 million at December 31, 2004 to $522.4 million at December 31, 2005.
This increase in our total assets resulted primarily from growth in our net
loans, which increased from $308.8 million at December 31, 2004 to $392.1
million at December 31, 2005, an increase of $83.4 million, or 26.9%. The
substantial growth in our loan portfolio continues to reflect a trend towards
growth in commercial real estate lending primarily in real estate construction
as a result of a continued shift in our markets from an agricultural focus to a
surburban focus. Loans secured by real estate at December 31, 2005, grew $67.1
million over the prior year of which $51.9 million was related to construction
and land development loans. In addition to loan growth, our securities portfolio
increased $27.9 million to $80.2 million at December 31, 2005 and other earning
assets (interest-earning deposits and FHLB stock) increased $7.1 million over
the prior year. Our loan growth, increases in our securities portfolio and other
earning assets was primarily funded by deposit growth of $82.2 million, or
26.1%, during 2005 to $397.5 million at December 31, 2005 compared with $315.3
million at December 31, 2004. Our local market customers continue to be our
primary source for deposit growth, funding deposit growth predominantly in
savings and time deposits. Deposits from our local market customers provided
$60.4 million of the December 31, 2005 increase in deposits over December 31,
2004 while deposits outside our local customer base provided the remaining $21.8
million. The growth in deposits was encouraged by increased deposit rates as the
national prime increased from 5.25% at January 1, 2005 to 7.25% at December 31,
2005 and successful deposit campaigns and branch calling efforts within our
competitive market.
Shareholders' equity increased by $4.7 million during 2005. This
increase resulted from our net income of $5.3 million, dividend reinvestment
plan proceeds of $671,000, proceeds from the exercise of stock options of
$536,000 and employee stock purchase plan proceeds of $124,000, net of dividends
paid of $1.3 million and other comprehensive loss of $738,000 comprised of
unrealized losses on securities available for sale of $565,000, net of tax and
unrealized losses on cash flow hedging activities of $173,000 net of tax.
Comparison of Operating Results for the Years Ended December 31, 2005 and 2004
Net Income
We earned net income of $5.3 million, or $1.23 basic net income per
share for 2005, which was a 22.3% increase over net income of $4.4 million or
$1.03 basic net income per share for 2004. We believe strategic pricing of both
our loans and deposits improved our net interest margin by managing our overall
cost of funds and allowing us to attract the higher balance, higher quality
loans in our markets. The resulting $3.7 million, or 22.9%, increase in net
interest income absorbed a 16.1% increase in non-interest expense for 2005 over
the prior year. A full year of operating two new offices contributed to
increased salaries and benefits, occupancy and equipment and other operating
costs. In addition to the new offices, rising costs in employee benefits also
contributed to increased personnel expense. Compliance costs related to the
Sarbanes-Oxley Act of 2002 also increased costs for outside professional
services.
16
Net Interest Income
Like most financial institutions, the primary component of earnings for
the bank is net interest income. Net interest income is the difference between
interest income, principally from loan and investment securities, and interest
expense, principally on customer deposits and borrowings. Changes in net
interest income result from changes in volume, spread and margin. For this
purpose, volume refers to the average dollar level of interest-earning assets
and interest-bearing liabilities, spread refers to the difference between the
average yield on interest-earning assets and the average cost of
interest-bearing liabilities, and margin refers to net interest income divided
by average interest-earning assets. Margin is influenced by the level and
relative mix of interest-earning assets and interest-bearing liabilities, as
well as by levels of non-interest-bearing liabilities and capital.
Net interest income increased to $19.6 million in 2005, with a net
yield of 4.67%, compared to $15.9 million and a net yield of 4.56% in 2004,
which was an increase of $3.7 million, or 11 basis points, from 2004. The
increase in net interest income primarily was generated by an increased volume
of $12.5 million in average net interest-earning assets, which produced $3.0
million in net interest income. The additional interest income over interest
expense was driven by strong loan demand in a rising rate environment,
acquisition of higher yielding investments as well as an increase of $10.0
million in average non-interest-bearing demand deposits. Also contributing to
the increase in net interest income was the positive results of repricing our
interest-earning assets faster than our interest-bearing funds in a rising rate
environment, producing an additional $630,000 in net interest income. The rates
earned on a substantial portion of our loans reprice to correspond with each
prime rate increase. Most of our interest-bearing liabilities, however, have
fixed interest rates until maturity and as a result do not reprice as quickly or
in the same increments as our loan portfolio. The national prime increased 200
basis points during 2005 to 7.25% at December 31, 2005 from 5.25% at January 1,
2005.
On average, interest-earning assets grew $69.7 million during 2005 over
the prior year period. A substantial portion of the increase in interest-earning
assets was achieved through increased loan demand. Average loans increased $52.3
million during 2005 over the prior year to $351.1 million, generating additional
interest income of $3.7 million. Rising interest rates generated additional
interest income of $2.9 million on the bank's loan portfolio. An increase in
volume of interest-bearing liabilities of $57.2 million resulted in additional
interest expense of $1.4 million while repricing due to rising interest rates
increased interest expense by $2.6 million. The increase in interest expense
primarily resulted from a $29.1 million increase in higher costing jumbo time
deposits at an average rate paid on these deposits of 3.16%. However, an
increase of $12.9 million in lower costing savings deposits at an average rate
paid of 2.23% and an increase of $10.0 million in interest free demand deposits
partially offset the increased cost of the jumbo time deposits.
Provision for Loan Losses and Asset Quality
Our provision for loan losses was $1.4 million during 2005 and $1.6
million during 2004. Net charge-offs in 2005 declined to $493,000 compared to
$971,000 in 2004. As a percent of average loans, net charge-offs were 0.14%, the
lowest level in the past five years. The lower level of net-charge-offs and
nonperforming assets is attributable to continued efforts to improve asset
quality, including improved underwriting.
The provision for loan losses is charged to bring the allowance for
loan losses to the level deemed appropriate by management after adjusting for
recoveries of amounts previously charged off. Loans are charged against the
allowance for loan losses when management believes that the uncollectibility of
a loan balance is confirmed. The allowance for loan losses is maintained at a
level deemed adequate to absorb probable losses inherent in the loan portfolio
and results from management's consideration of such factors as the financial
condition of borrowers, past and expected loss experience, current economic
conditions, and other factors management feels deserve recognition in
establishing an appropriate reserve. Although management attempts to maintain
the allowance at a level deemed adequate, future additions to the allowance may
be necessary based upon changes in market conditions or the status of the loans
included in the loan portfolio. In addition, various regulatory agencies
periodically review our allowance for loan losses. These agencies may require us
to make adjustments based upon their judgments about information available to
them at the time of their examination. See "Allowance for Loan Losses and
Summary of Loan Loss Experience" below. The Company evaluates its loan portfolio
in accordance with Statement of Financial Accounting Standards ("SFAS") No. 114,
Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118,
Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosure. Under these standards, a loan is considered impaired, based on
current information and events, if it is probable that the Company will be
unable to collect the scheduled payments of principal and interest when due
according to the contractual terms of the loan agreement. Uncollateralized loans
are measured for impairment based on the present value of expected future cash
flows discounted at the historical effective interest rate or the loan's
observable market price, while all collateral-dependent loans are measured for
impairment based on the fair value of the collateral. If the recorded investment
in the loan exceeds the measure of fair value, a valuation allowance is
established as a component of the allowance for loan losses. This evaluation is
inherently subjective as it requires material estimates that may be susceptible
to significant change.
17
Our non-performing assets, which consist of loans past due 90 days or
more, real estate acquired in the settlement of loans, and loans in nonaccrual
status, decreased from $1.6 million at December 31, 2004 to $1.3 million at
December 31, 2005. Our allowance for loan losses, expressed as a percentage of
gross loans, was 1.25% and 1.30% at December 31, 2005 and 2004, respectively. At
December 31, 2005, the allowance for loan losses amounted to $5.0 million, which
management believes is adequate to absorb losses inherent in its loan portfolio.
Non-interest Income
Non-interest income before gains and losses on sales of securities and
loans increased $93,000, or 2.5%, from $3.7 million during 2004 to $3.8 million
in 2005. Our non-interest income is comprised primarily of service charges on
deposit accounts, financial services commissions, merchant fees, bank-owned life
insurance income and various other sources of miscellaneous operating income.
Fees charged on deposit accounts, our largest component of non-interest income,
declined $66,000 for 2005 compared to 2004. These fees have been trending
downward as competition for deposits by offering lower fees on deposit accounts
continues among banking institutions in our market areas. Merchant fees
increased $42,000 from $347,000 during 2004 to $389,000 in 2005. During the same
period, other service charges, commissions and fees increased $211,000, of which
$31,000 was attributable to increased profits from our investment in Four Oaks
Mortgage Company, L.P., $39,000 was attributable to increased commissions from
our financial services department and $81,000 was attributable to increased
credit card interchange and stored value card fees. Income from bank-owned life
insurance decreased $94,000. Net losses of $386,000 on sales of investment
securities were recognized in 2005 in efforts to position our investment
portfolio for higher yielding securities in a rising interest rate environment.
Net gains of $71,000 from sales of investment securities were recognized during
2004. Our net gains on sales of loans continued to trend downward during 2005
with net gains of $61,000 recorded compared to $72,000 during 2004 and $212,000
during 2003. The decline in loan sales was attributable to a slow down in
funding of government-backed loans.
Non-interest Expense
Our non-interest expense increased from $11.5 million in 2004 to $13.4
million in 2005, an increase of $1.8 million. Although non-interest expense
continues to increase, our non-interest expense as a percent of our average
assets has declined over the last five years, down to below 3.0% for 2005, our
lowest level in the last five years. Approximately 51.3% of the $1.8 million
increase in non-interest expense over 2004 was due to increases in salaries and
benefits. Salaries increased 12.7% while employee benefits increased 25.9%,
primarily due to increased employee insurance costs. In addition to normal
salary increases and increased costs for employee benefits overall, personnel
costs grew due to additional staffing needs throughout the bank. In total, our
number of full time equivalent employees grew from 126 for the year 2003, to 131
employees for the year 2004, up to 135 employees for the year 2005. The
increased personnel costs reflect the costs of a full year of staffing two new
offices which opened in January 2005. In addition to personnel costs, additional
costs during the year were incurred in occupancy and equipment due to the
additional staff, the opening of the new offices, as well as general upgrades in
technology throughout the bank. For 2005, occupancy and equipment expense
increased $41,000 and $90,000, respectively, over the prior year. Additional
testing and documentation required for compliance with the Sarbanes-Oxley Act of
2002 continued to increase our fees paid for outside professional services in
2005, contributing to an increase of $218,000 in professional and consulting
fees over 2004. Other operating expenses were up due to general asset growth and
the increased costs due to additional staffing and new offices opened. The
primary increases in other non-interest expense for 2005 over the prior year
period included materials, training and seminars, up $40,000, advertising
expense, up $62,000, printing and office supplies, up $39,000, postage and
freight up $62,000, telephone expense up $13,000, checks, forgery and other
losses up $46,000, auto expense up $35,000, waived charges up $73,000 and
directors fees up $52,000. There were no other significant increases in the
remaining other non-interest expense categories.
18
Comparison of Operating Results for the Years Ended December 31, 2004 and 2003
Net Income
We earned net income of $4.4 million or $1.03 basic net income per
share for 2004, which was a 49.9% increase over net income of $2.9 million or
$.70 basic net income per share for 2003. We believe strategic pricing of both
our loans and deposits improved our net interest margin by lowering our overall
cost of funds and allowing us to attract the higher balance, higher quality
loans in our markets. Cost containment initiatives that began in prior years
continue to positively impact our overhead levels. We incurred only a moderate
increase in non-interest expense of 8.7% in 2004 over the prior year despite
expenses incurred in preparation of the opening of two new offices in January
2005. Non-interest expense increased 11.6% for the year 2003 over the prior year
when one new branch was opened and one branch was permanently relocated from
temporary quarters.
Net Interest Income
Net interest income increased to $15.9 million in 2004, with a net
yield of 4.56%, compared to $13.0 million and a net yield of 4.33% in 2003,
which was an increase of $2.9 million, or 23 basis points, from 2003. Our level
of average interest-earning assets increased from $300.7 million for 2003 to
$349.6 million for 2004. Although the average rate we earned on these assets
dropped 8 basis points from 6.30% in 2003 to 6.22% in 2004, the average growth
in volume of earning assets, primarily loans, provided additional interest
income of $3.4 million offsetting the $546,000 decrease due to decline in
yields. Interest paid on interest-bearing liabilities declined $111,000 for 2004
due to declines in rates paid on interest-bearing funds. Our average
interest-bearing liabilities, primarily time deposits, grew 15.9% to $282.7
million for 2004 resulting in an increase in interest expense of $828,000.
However, declines in rates paid on interest-bearing funds provided a decrease in
interest expense of $939,000, primarily in time deposits where the average rates
paid for time deposits greater than $100,000 declined 56 basis points and other
time deposits declined 32 basis points. The growth in our non-interest-bearing
demand deposits of 22.9% also contributed to our increase in net interest
income.
Provision for Loan Losses and Asset Quality
Our provision for loan losses was $1.6 million during 2004 and $1.4
million during 2003. Net charge-offs in 2004 were $971,000 compared to $803,000
in 2003. This increase resulted primarily from the growth in our loan portfolio
during the year.
Our non-performing assets, which consist of loans past due 90 days or
more, real estate acquired in the settlement of loans, and loans in nonaccrual
status, decreased from $1.8 million at December 31, 2003 to $1.6 million at
December 31, 2004. Our allowance for loan losses, expressed as a percentage of
gross loans, was 1.30% and 1.26% at December 31, 2004 and 2003, respectively. At
December 31, 2004, the allowance for loan losses amounted to $4.1 million, which
management believes is adequate to absorb losses inherent in its loan portfolio.
Non-interest Income
Non-interest income increased 10.9% from $3.5 million during 2003 to
$3.8 million during 2004. The $379,000 increase in non-interest income from 2003
to 2004 primarily resulted from increases in service charges on deposits
accounts of $74,000, merchant fees of $23,000, other service charges of
$389,000, as well as increases in income from bank-owned life insurance of
$235,000, all of which were in part offset by declines in net gains from sales
of securities and loans. Our net gains on sales of loans declined $140,000 in
2004 compared to the previous year primarily due to a slow down in funding of
government-backed loans, which generated net gains of $212,000 during 2003.
Non-interest Expense
Our non-interest expense increased from $10.6 million in 2003 to $11.5
million in 2004, an increase of $919,000. Approximately 48.9% of this increase
was due to increases in salaries and benefits. In addition to normal salary
increases and increased benefits costs, we opened two new offices in January
2005, incurring additional expense during the fourth quarter of 2004 in
preparation for these two new locations. Professional fees increased due to our
preparation for compliance with the Sarbanes-Oxley Act of 2002.
19
Liquidity and Capital Resources
Our liquidity position is primarily dependent upon the bank's need to
respond to loan demand, the short-term demand for funds caused by withdrawals
from deposit accounts (other than time deposits) and the liquidity of its
assets. The bank's primary liquidity sources include cash and amounts due from
other banks, federal funds sold, and U.S. Government Agency and other short-term
investment securities. In addition, the bank has the ability to borrow funds
from the Federal Reserve Bank and the Federal Home Loan Bank of Atlanta
("FHLB"), to purchase federal funds from other financial institutions and to
obtain wholesale deposits. At December 31, 2005, the bank had available lines of
credit totaling $104.5 million with the FHLB and $32.7 million lines of credit
from various financial institutions to purchase federal funds. Our management
believes that our liquidity sources are adequate to meet our operating needs and
the operating needs of the bank for the next eighteen months. Total
shareholders' equity was $42.0 million, or 8.03% of total assets at December 31,
2005, and $37.3 million or 9.36% of total assets at December 31, 2004.
Off-Balance Sheet Arrangements
As part of its normal course of business to meet the financing needs of
its customers, the bank is at times a party to financial instruments with
off-balance sheet credit risk. Such instruments include commitments to extend
credit and standby letters of credit. At December 31, 2005, the bank's
outstanding commitments to extend credit consisted of undisbursed lines of
credit, other commitments to extend, undisbursed portion of construction loans
and stand-by letters of credit of $102.0 million. Additional detail regarding
the bank's off-balance sheet risk exposure is presented in Note J to the
accompanying consolidated financial statements.
Interest Rate Sensitivity Analysis
As a part of our interest rate risk management policy, we periodically
perform an interest rate sensitivity analysis. Interest rate sensitivity
analysis is a common, though imperfect, measure of interest rate risk, which
measures the relative dollar amounts of interest-earning assets and
interest-bearing liabilities that reprice within a specific time period, either
through maturity or rate adjustment. Any resulting interest rate "gap" is the
difference between the amounts of such assets and liabilities that are subject
to repricing. A positive gap for a given period means that the amount of
interest-earning assets maturing or otherwise repricing within that period
exceeds the amount of interest-bearing liabilities maturing or otherwise
repricing within the same period. Accordingly, in a declining interest rate
environment, an institution with a positive gap would generally be expected,
absent the effects of other factors, to experience a decrease in the yield on
its assets greater than the decrease in the cost of its liabilities, and its net
interest income should be negatively affected. Conversely, the yield on its
assets for an institution with a positive gap would generally be expected to
increase more quickly than the cost of funds in a rising interest rate
environment, and such institution's net interest income generally would be
expected to be positively affected by rising interest rates. Changes in interest
rates generally have the opposite effect on an institution with a negative gap.
The table below sets forth the amounts of our interest-earning assets
and interest-bearing liabilities outstanding as of December 31, 2005 that are
projected to reprice or mature in each of the future time periods shown. Except
as stated below, the amounts of assets and liabilities shown that reprice or
mature within a particular period were determined in accordance with the
contractual terms of the assets or liabilities. Loans with adjustable rates are
shown as being due at the end of the next upcoming adjustment period. Money
market deposit accounts and negotiable order of withdrawal or other transaction
accounts are assumed to be subject to immediate repricing and depositor
availability and have been placed in the shortest period. In making the gap
computations, none of the traditional assumptions regarding prepayment rates and
deposit decay rates have been used for any interest-earning assets or
interest-bearing liabilities. In addition, the table does not reflect scheduled
principal payments that will be received throughout the lives of the loans or
investments. The interest rate sensitivity of our assets and liabilities
illustrated in the following table would vary substantially if different
assumptions were used or if actual experience differs from that indicated by
such assumptions. (Dollars in thousands).
20
Interest Rate Sensitivity as of December 31, 2005
--------------------------------------------------------------
3 Months Over 3 Months Total Within Over 12
or Less to 12 Months 12 Months Months Total
------- ------------ --------- ------ -----
Interest-earning assets:
Loans $224,889 $ 16,950 $241,839 $155,255 $397,094
Securities available for sale 2 2,011 2,013 78,196 80,209
Other earning assets 9,704 - 9,704 3,655 13,359
-------- -------- -------- -------- --------
Total interest-earning assets $234,595 $ 18,961 $253,556 $237,106 $490,662
======== ======== ======== ======== ========
Percent of total interest-earning
assets 47.81% 3.86% 51.68% 48.32% 100.00%
Cumulative percent of total interest-
earning assets 47.81% 51.68% 51.68% 100.00% 100.00%
Interest-bearing liabilities:
Fixed maturity deposits $ 58,836 $ 90,524 $149,360 $ 76,029 $225,389
All other deposits 103,151 - 103,151 - 103,151
Borrowings 20,980 160 21,140 53,000 74,140
-------- -------- -------- -------- --------
Total interest-bearing liabilities $182,967 $ 90,684 $273,651 $129,029 $402,680
======== ======== ======== ======== ========
Percent of total interest-bearing
liabilities 45.44% 22.52% 67.96% 32.04% 100.00%
Cumulative percent of total interest-
bearing liabilities 45.44% 67.96% 67.96% 100.00% 100.00%
Interest sensitivity gap $ 51,628 $(71,723) $(20,095) $108,077 $ 87,982
Cumulative interest sensitivity gap 51,628 (20,095) (20,095) 87,982 87,982
Cumulative interest sensitivity gap as a
percent of total interest-earning
assets 10.52% (4.10%) (4.10%) 17.93% 17.93%
Cumulative ratio of interest-sensitive
assets to interest-sensitive
liabilities 128.22% 92.66% 92.66% 121.85% 121.85%
Contractual Obligations and Commitments
In the normal course of business there are various outstanding
contractual obligations that require future cash outflows. The following table
shows our expected contractual obligations and future operating lease
commitments as of December 31, 2005 (in thousands):
Payments Due by Period
-------------------------------------------------------------------------
Less than More than
Total 1 year 2-3 years 4-5 years 5 years
------------ ------------ ------------ ------------- ------------
Borrowings $ 74,140 $ 21,140 $ - $ 10,000 $ 43,000
Operating leases 122 62 53 7 -
Building obligation 1,032 1,032 - - -
Deposits 225,389 149,360 49,108 12,921 14,000
Purchase obligations 500 500 - - -
------------ ------------ ------------ ------------- ------------
Total $ 301,183 $ 172,094 $ 49,161 $ 22,928 $ 57,000
============ ============ ============ ============= ============
The following table shows our undisbursed lines of credit, other
commitments to extend, undisbursed portion of construction loans and stand-by
letters of credit as of December 31, 2005 (in thousands):
Amount of Commitment Expiration Per Period
-------------------------------------------------------------------------
Less than More than
Total 1 year 2-3 years 4-5 years 5 years
------------ ------------ ------------ ------------- ------------
Undisbursed lines of credit $ 25,299 $ 187 $ 7,736 $ 365 $ 17,011
Other commitments to extend 30,227 21,028 7,330 481 1,388
Undisbursed portion of construction loans 41,657 37,870 3,775 12 -
Stand-by letters of credit 4,796 2,225 2,534 37 -
------------ ------------ ------------ ------------- ------------
Total $ 101,979 $ 61,310 $ 21,375 $ 895 $ 18,399
============ ============ ============ ============= ============
21
Inflation
The effect of inflation on financial institutions differs somewhat from
the effect it has on other businesses. The performances of banks, with assets
and liabilities that are primarily monetary in nature, are affected more by
changes in interest rates than by inflation. Interest rates generally increase
as the rate of inflation increases, but the magnitude of the change in rates may
not be the same. During periods of high inflation, there are normally
corresponding increases in the money supply, and banks will normally experience
above average growth in assets, loans and deposits. Also, general increases in
the price of goods and services will generally result in increased operating
expenses.
Income Taxes
Income taxes, as a percentage of income before income taxes, for 2005
and 2004 were 35.59% and 34.54%, respectively. The increase was the result of
management's redirection of funds between loans and different types of taxable
and tax exempt interest-bearing assets in response to economic conditions and
the bank's liquidity requirements.
Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rates and
Interest Differential
The following schedule presents average balance sheet information for
the years 2005, 2004 and 2003, along with related interest earned and average
yields for interest-earning assets and the interest paid and average rates for
interest-bearing liabilities. Nonaccrual notes are included in loan amounts.
Average Daily Balances, Interest Income/Expense, Average Yield/Rate
For the Years Ended December 31,
----------------------------------------------------------------------------------
2005 2004 2003
------------------------- ------------------------- -------------------------
Average Average Average Average Average Average
balance Interest rate balance Interest Rate balance Interest Rate
------- -------- ---- ------- -------- ---- ------- -------- ----
(Dollars in thousands)
Interest-earning assets:
Loans $351,103 $26,612 7.58% $298,783 $19,968 6.68% $249,240 $17,318 6.95%
Investment securities - taxable 57,242 2,389 4.17% 40,729 1,470 3.61% 40,691 1,272 3.13%
Investment securities - tax-exempt 3,175 118 3.72% 4,278 162 3.79% 4,968 212 4.27%
Other 7,787 285 3.66% 5,806 148 2.55% 5,773 141 2.44%
-------- ------- -------- ------- -------- ------- ----
Total interest-earning assets 419,307 29,404 7.01% 349,596 21,748 6.22% 300,672 18,943 6.30%
------- ---- ------- ---- ------- ----
Other assets 29,693 26,826 23,550
-------- -------- --------
Total assets $449,000 $376,422 $324,222
======== ======== ========
Interest-bearing liabilities:
Deposits:
NOW and money market $ 57,928 808 1.39% $52,677 361 .69% $ 39,313 238 .61%
Savings 26,858 599 2.23% 13,967 59 .42% 12,659 63 .50%
Time deposits greater
than $100,000 123,440 3,901 3.16% 94,313 1,978 2.10% 70,567 1,878 2.66%
Other time deposits 80,610 2,349 2.91% 78,987 1,725 2.18% 87,285 2,186 2.50%
Borrowings 51,154 2,160 4.22% 42,799 1,688 3.94% 34,200 1,557 4.55%
-------- ------- -------- ------- -------- ------- ----
Total interest-bearing
liabilities 339,990 9,817 2.89% 282,743 5,811 2.06% 244,024 5,922 2.43%
------- ----- ------- ------ ------- ----
Non-interest-bearing deposits 65,570 55,580 45,214
Other liabilities 3,481 2,964 2,643
Shareholders' equity 39,959 35,135 32,341
-------- -------- --------
Total liabilities and
shareholders' equity $449,000 $376,422 $324,222
======== ======== ========
Net interest income and
interest rate spread $19,587 4.12% $15,937 4.16% $13,021 3.87%
======= ===== ======= ===== ======= =====
Net yield on average interest-
earning assets 4.67% 4.56% 4.33%
===== ===== =====
Ratio of average interest-earning
assets to average interest-bearing
liabilities 123.33% 123.64% 123.21%
======= ======= =======
22
The following table shows changes in interest income and expense by
category and rate/volume variances for the years ended December 31, 2005 and
2004. The changes due to rate and volume were allocated on their absolute
values:
Year Ended Year Ended
December 31, 2005 vs. 2004 December 31, 2004 vs. 2003
---------------------------------- ----------------------------------
Increase (Decrease) Due to Increase (Decrease) Due to
---------------------------------- ----------------------------------
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
(In thousands)
Interest income:
Loans $ 3,730 $ 2,914 $ 6,644 $ 3,377 $ (727) $ 2,650
Investment securities - taxable 643 276 919 1 197 198
Investment securities - tax-exempt (41) (3) (44) (28) (22) (50)
Other 62 75 137 1 6 7
----------- ---------- ----------- ----------- ----------- -----------
Total interest income 4,394 3,262 7,656 3,351 (546) 2,805
----------- ---------- ----------- ----------- ------------ -----------
Interest expense:
Deposits:
NOW and money market 55 392 447 86 37 123
Savings 171 369 540 6 (10) (4)
Time deposits greater
than $100,000 766 1,157 1,923 566 (466) 100
Other time deposits 41 583 624 (195) (266) (461)
Borrowings 341 131 472 365 (234) 131
----------- ---------- ----------- ----------- ------------ -----------
Total interest expense 1,374 2,632 4,006 828 (939) (111)
----------- ---------- ----------- ----------- ------------ ------------
Net interest income increase $ 3,020 $ 630 $ 3,650 $ 2,523 $ 393 $ 2,916
=========== ========== =========== =========== =========== ===========
Market Risk
Like most financial institutions, our most significant market risk
exposure is the risk of economic loss resulting from adverse changes in market
price and interest rates. This risk of loss can be reflected in diminished
current market values and/or reduced potential net interest income in future
periods. Our market risk arises primarily from interest rate risk inherent in
our lending and deposit-taking activities. The structure of our loan and deposit
portfolios is such that a significant decline in interest rates may adversely
impact net market values and net interest income. We do not maintain a trading
account nor are we subject to currency exchange risk or commodity price risk.
Interest rate risk is monitored as part of the bank's asset/liability management
function. The following table presents information about the contractual
maturities, average interest rates and estimated fair values of our financial
instruments we considered market risk sensitive as of December 31, 2005. Loans
include nonaccrual loans but not the allowance for loan losses. (Dollars in
thousands).
Five Interest Fair
2006 2007 2008 2009 2010 Years Total Rate Value
---- ---- ---- ---- ---- ----- ----- ---- -----
Financial assets:
Loans:
Fixed rate $ 29,699 $29,986 $39,866 $44,138 $31,443 $9,540 $184,672 7.19% $182,991
Variable Rate 212,422 - - - - - 212,422 7.80% 210,489
Securities available for sale 2,013 3,958 5,921 10,090 29,453 28,774 80,209 4.50% 80,209
Other earning assets 9,704 - - - - - 9,704 4.09% 9,704
-------- ------- ------- ------- ------- ------- -------- --------
Total $253,838 $33,944 $45,787 $54,228 $60,896 $38,314 $487,007 6.95% $483,393
======== ======= ======= ======= ======= ======= ======== ========
Financial liabilities:
Money market, NOW and savings deposits $103,151 - - - - - $103,151 1.32% $90,850
Time deposits 149,360 $23,220 $6,830 $19,058 $26,921 - 225,389 3.66% 226,455
Borrowings 21,140 - - - 10,000 $43,000 74,140 4.43% 73,651
-------- ------- ------- ------- ------- ------- -------- --------
Total $273,651 $23,220 $6,830 $19,058 $36,921 $43,000 $402,680 3.20% $390,956
======== ======= ======= ======= ======= ======= ======== ========
23
Derivative Financial Instruments
A derivative is a financial instrument that derives its cash flows,
and therefore its value, by reference to an underlying instrument, index or
reference rate. These instruments primarily consist of interest rate swaps,
caps, floors, financial forward and futures contracts and options written or
purchased. Derivative contracts are written in amounts referred to as notional
amounts. Notional amounts only provide the basis for calculating payments
between counterparties and do not represent amounts to be exchanged between
parties and are not a measure of financial risk. Credit risk arises when amounts
receivable from a counterparty exceed amounts payable. We control our risk of
loss on derivative contracts by subjecting counterparties to credit reviews and
approvals similar to those used in making loans and other extensions of credit.
We have used interest rate swaps in the management of interest rate
risk. Interest rate swaps are contractual agreements between two parties to
exchange a series of cash flows representing interest payments. A swap allows
both parties to alter the repricing characteristics of assets or liabilities
without affecting the underlying principal positions. Through the use of a swap,
assets and liabilities may be transformed from fixed to floating rates, from
floating rates to fixed rates, or from one type of floating rate to another. At
December 31, 2005, swap derivatives with a total notional value of $63.7
million, with terms ranging up to five years, were outstanding.
Although off-balance sheet derivative financial instruments do not
expose us to credit risk equal to the notional amount, such agreements generate
credit risk to the extent of the fair value gain in an off-balance sheet
derivative financial instrument if the counterparty fails to perform. We
minimize such risk by evaluating the creditworthiness of the counterparties and
consistently monitoring these agreements. The counterparties to these
arrangements are primarily large commercial banks and investment banks. Where
appropriate, master netting agreements are arranged or collateral is obtained in
the form of rights to securities. At December 31, 2005, our interest rate swaps
reflected a net unrealized loss of $1.0 million.
Other risks associated with interest-sensitive derivatives include the
effect on fixed rate positions during periods of changing interest rates.
Indexed amortizing swaps' notional amounts and maturities change based on
certain interest rate indices. Generally, as rates fall the notional amounts
decline more rapidly, and as rates increase notional amounts decline more
slowly. As of December 31, 2005, we had no indexed amortizing swaps outstanding.
Under unusual circumstances, financial derivatives also increase liquidity risk,
which could result from an environment of rising interest rates in which
derivatives produce negative cash flows while being offset by increased cash
flows from variable rate loans. We consider such risk to be insignificant due to
the relatively small derivative positions we hold.
A discussion of derivatives is presented in Note I to our consolidated
financial statements, which are presented under Item 8 of Part III in this Form
10-K.
Quarterly Financial Information
The following table, sets forth, for the periods indicated, certain of
our consolidated quarterly financial information. This information is derived
from our unaudited financial statements, which include, in the opinion of
management, all normal recurring adjustments that management considers necessary
for a fair presentation of the results for such periods. This information should
be read in conjunction with our consolidated financial statements included under
Item 8 of Part II in this Form 10-K. The results for any quarter are not
necessarily indicative of results for any future period. (Dollars in thousands,
except per share data).
24
Year Ended December 31, 2005 Year Ended December 31, 2004
---------------------------------------- ----------------------------------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- ------- -------
Operating Data:
Total interest income $8,507 $7,766 $6,908 $6,223 $5,856 $5,609 $5,215 $5,068
Total interest expense 3,163 2,696 2,153 1,805 1,567 1,505 1,401 1,338
----- ----- ----- ----- ----- ----- ----- -----
Net interest income 5,344 5,070 4,755 4,418 4,289 4,104 3,814 3,730
Provision for loan losses 527 498 191 187 205 401 422 568
----- ----- ----- ----- ----- ----- ----- -----
Net interest income after
provision 4,817 4,572 4,564 4,231 4,084 3,703 3,392 3,162
Non-interest income 720 1,110 882 762 938 1,071 982 858
Non-interest expense 3,393 3,358 3,408 3,195 3,068 2,789 2,860 2,790
----- ----- ----- ----- ----- ----- ----- -----
Income before income taxes 2,144 2,324 2,038 1,798 1,954 1,985 1,514 1,230
Provision for income taxes 755 857 721 622 691 654 532 431
----- ----- ----- ----- ----- ----- ----- -----
Net income $1,389 $1,467 $1,317 $1,176 $1,263 $1,331 $ 982 $ 799
====== ====== ====== ====== ====== ====== ====== ======
Per Share Data:
Net income:
Basic $ 0.32 $ 0.34 $ 0.30 $ 0.27 $ 0.30 $ 0.31 $ 0.23 $ 0.19
Diluted 0.32 0.33 0.30 0.27 0.30 0.31 0.23 0.19
Cash dividends declared $ 0.08 $ 0.07 $ 0.07 $ 0.07 $ 0.06 $ 0.06 $ 0.06 $ 0.06
Common stock price:
High $25.00 $24.00 $23.20 $19.20 $20.00 $14.72 $15.68 $16.64
Low 19.80 19.80 18.64 17.60 14.88 14.08 14.08 13.44
Investment Portfolio
The valuations of investment securities at December 31, 2005, 2004 and
2003, respectively, were as follows (in thousands):
Available for Sale
-------------------------------------------------------------------------------
2005 2004 2003
------------------------ ------------------------- -------------------------
Amortized Estimated Amortized Estimated Amortized Estimated
cost fair value cost fair value cost fair value
----------- ---------- ----------- ----------- ----------- -----------
U.S. Government and agency
securities $ 69,108 $ 68,431 $ 34,991 $ 34,958 $ 15,866 $ 15,914
State and municipal securities 3,963 3,910 3,573 3,632 4,664 4,955
Mortgage-backed securities 7,003 6,904 12,759 12,775 16,535 16,502
Other 685 964 628 977 567 832
----------- ---------- ----------- ----------- ----------- -----------
Total securities $ 80,759 $ 80,209 $ 51,951 $ 52,342 $ 37,632 $ 38,203
=========== ========== =========== =========== =========== ===========
Pledged securities $ 65,159 $ 33,408 $ 12,329
========== =========== ===========
The following table sets forth the carrying value of our available for
sale investment portfolio at December 31, 2005 (in thousands):
Carrying Value
--------------------------------------------------------------------------
After 1 year After 5 years
through through After
1 year 5 years 10 years 10 years Total
------------ ------------ ------------ ------------- ------------
U.S. Government and agency
securities $ 1,000 $ 47,810 $ 19,621 $ - $ 68,431
State and municipal securities - 339 1,436 2,135 3,910
Mortgage-backed securities - 1,546 904 4,454 6,904
Other - - - 964 964
------------ ------------ ------------ ------------- ------------
Total $ 1,000 $ 49,695 $ 21,961 $ 7,553 $ 80,209
============ ============= ============ ============= ============
25
The following table sets forth the weighted average yield by maturity
of our available for sale investment portfolio at December 31, 2005 amortized
cost:
Weighted Average Yields
--------------------------------------------------------------------------
After 1 year After 5 years
through through After
1 year 5 years 10 years 10 years Total
------------ ------------ ------------ ------------- ------------
U.S. Government and agency
securities 5.50% 4.57% 4.40% - 4.54%
State and municipal securities - 5.29% 3.32% 3.63% 3.65%
Mortgage-backed securities - 4.12% 5.24% 4.91% 4.77%
Other - - - 4.53% 4.53%
------------ ------------ ------------ ------------- ------------
Total weighted average yields 5.50% 4.57% 4.36% 4.49% 4.52%
============ ============ ============ ============= ============
Loan Portfolio
Loans consisted of the following, as extracted from the Call Reports of
December 31, 2005, 2004, 2003, 2002 and 2001 (in thousands):
2005 2004 2003 2002 2001
------------ ------------ ------------ ------------- ------------
Loans receivable:
Loans secured by real estate:
Construction and land development $ 142,592 $ 90,742 $ 66,242 $ 56,780 $ 44,770
Secured by farmland 11,650 15,203 13,384 8,290 7,171
Secured by 1-4 family residential properties:
Revolving open-end loans & lines
of credit 23,581 23,295 18,879 16,569 14,603
All other 66,140 58,158 55,113 43,821 48,190
Secured by multifamily residential
properties 4,085 5,088 3,634 3,265 2,621
Secured by nonfarm nonresidential
properties 84,189 72,611 63,372 42,941 38,446
Loans to finance agricultural production
and other loans to farmers 3,729 4,020 5,084 6,277 6,329
Commercial and industrial loans 34,166 26,005 27,872 29,908 26,420
Loans to individuals for household,
family and other personal expenditures:
Credit cards and related plans 3,933 3,807 3,574 3,527 2,917
Other 22,438 13,400 14,458 17,177 17,169
Obligations of states and political
subdivisions in the U.S.:
Tax exempt obligations 113 225 332 - 202
All other loans 787 628 836 921 953
Lease financing receivables 9 12 13 14 20
Deferred cost (unearned income) on loans 318 379 170 (80) (11)
------------ ------------ ------------ -------------- -------------
Total loans 397,094 312,815 272,623 229,570 209,822
Allowance for loan losses (4,965) (4,055) (3,430) (2,860) (2,650)
------------- ------------- ------------ ------------- ------------
Net loans $ 392,129 $ 308,760 $ 269,193 $ 226,710 $ 207,172
============ ============ ============ ============= ============
Commitments and contingencies:
Commitments to make loans $ 97,183 $ 89,377 $ 68,731 $ 44,525 $ 45,510
Standby letters of credit $ 4,796 $ 1,726 $ 1,003 $ 2,408 $ 653
26
Certain Loan Maturities
The maturities and carrying amounts of certain loans as of December 31,
2005 are summarized as follows (in thousands):
Real Estate
Commercial Construction
Financial and and Land
Agricultural Development Total
------------ ----------- -----
Due within one year $ 40,213 $ 84,519 $ 124,732
Due after one year to five years:
Fixed rate 47,645 39,937 87,582
Variable rate 36,486 13,341 49,827
Due after five years:
Fixed rate 3,611 1,601 5,212
Variable rate 5,495 3,194 8,689
--------------- ------------------ -----------------
Total $ 133,450 $ 142,592 $ 276,042
=============== ================== =================
Risk Elements
Past due and nonaccrual loans, as extracted from the Call Reports of
December 31, 2005, 2004, 2003, 2002 and 2001 were as follows (in thousands):
2005 2004 2003 2002 2001
------------ ------------ ------------ ------------- ------------
Nonaccrual loans:
Real estate loans $ 535 $ 614 $ 739 $ 1,059 $ 1,651
Installment loans 114 80 96 191 62
Commercial and all other loans 348 250 224 287 331
------------ ------------ ------------ ------------- ------------
Total $ 997 $ 944 $ 1,059 $ 1,537 $ 2,044
============ ============ ============ ============= ============
Agricultural loans included above $ 252 $ 197 $ 110 $ 163 $ 82
============ ============ ============ ============= ============
Past due 90 days or more and still accruing:
Real estate loans $ 64 $ 188 $ 597 $ - $ 24
Installment loans - 1 5 36 19
Credit cards and related plans 10 11 18 17 9
Commercial and all other loans - 26 15 30 65
------------ ------------ ------------ ------------- ------------
Total $ 74 $ 226 $ 635 $ 83 $ 117
============ ============ ============ ============= ============
Agricultural loans included above $ - $ 26 $ - $ 17 $ 65
============ ============ ============ ============= ============
Foreclosed assets (included in other assets) were $247,000, $404,000,
$75,000, $442,000, and $170,000, at December 31, 2005, 2004, 2003, 2002, and
2001, respectively.
Allowance for Loan Losses and Summary of Loan Loss Experience
As a matter of policy, the bank maintains an allowance for loan losses.
The allowance for loan losses is created by direct charges to income and by
recoveries of amounts previously charged off. The allowance is reduced as losses
on loans are charged against the allowance when realized.
27
We evaluate our loan portfolio in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 114, Accounting by Creditors for
Impairment of a Loan, as amended by SFAS No. 118, Accounting by Creditors for
Impairment of a Loan - Income Recognition and Disclosure. Under these standards,
a loan is considered impaired, based on current information and events, if it is
probable that the company will be unable to collect the scheduled payments of
principal and interest when due according to the contractual terms of the loan
agreement. Uncollateralized loans are measured for impairment based on the
present value of expected future cash flows discounted at the historical
effective interest rate or the loan's observable market price, while all
collateral-dependent loans are measured for impairment based on the fair value
of the collateral. If the recorded investment in the loan exceeds the measure of
fair value, a valuation allowance is established as a component of the allowance
for loan losses. This evaluation is inherently subjective as it requires
material estimates that may be susceptible to significant change.
The loan portfolio and the adequacy of the allowance is evaluated by
management at least quarterly. In addition, our Loan Committee reviews our loan
portfolio and credit quality quarterly. The amount of the allowance is based on
management's evaluation of the loan portfolio including trends in composition,
growth and terms, historical and expected loan loss experience, economic
conditions and conditions that may affect the borrowers' ability to pay, and
other factors management deems appropriate. In addition, regulatory examiners
may require the bank to recognize changes to the allowance for loan losses based
on their judgments about information available to them at the time of their
examination. The bank's management believes its allowance for loan losses is
adequate under existing economic conditions to absorb loan losses inherent in
its loan portfolio. Although management attempts to maintain the allowance at a
level deemed adequate, future additions to the allowance may be necessary based
upon changes in market conditions or the status of the loans included in the
loan portfolio.
The allowance for loan losses is established as losses are estimated to
have occurred through a provision for loan losses charged to earnings. Loans are
charged against the allowance for loan losses when management believes that the
uncollectibility of a loan balance is confirmed. In addition to the review of
loans considered impaired as discussed above, the allowance for loan losses is
also based upon such factors as changes in the trends in volumes and terms of
loans, levels and trends of charge-offs and recoveries, national and local
economic trends and conditions that may affect the borrowers' ability to pay,
effects of changes in risk selection and underwriting standards as well as
overall portfolio quality. If conditions change substantially from the
assumptions used to evaluate the allowance for loan losses, it is possible that
management's assessment of the allowance may change.
The following table summarizes the bank's loan loss experience for the
years ending December 31, 2005, 2004, 2003, 2002 and 2001 (in thousands, except
ratios):
2005 2004 2003 2002 2001
------------ ------------ ------------ ------------- ------------
Balance at beginning of period $ 4,055 $ 3,430 $ 2,860 $ 2,650 $ 2,770
Charge-offs:
Commercial and other 245 417 311 604 668
Real estate 158 395 342 240 174
Installment loans to individuals 198 237 396 283 176
Credit cards and related plans 95 297 88 72 60
------------ ------------ ------------ ------------- ------------
696 1,346 1,137 1,199 1,078
------------ ------------ ------------ ------------- ------------
Recoveries:
Commercial and other 49 206 31 74 38
Real estate 19 27 134 13 24
Installment loans 69 56 159 62 53
Credit cards and related plans 66 86 10 12 9
------------ ------------ ------------ ------------- ------------
203 375 334 161 124
------------ ------------ ------------ ------------- ------------
Net charge-offs 493 971 803 1,038 954
------------ ------------ ------------ ------------- ------------
Additions charged to operations 1,403 1,596 1,373 1,248 834
------------ ------------ ------------ ------------- ------------
Balance at end of year $ 4,965 $ 4,055 $ 3,430 $ 2,860 $ 2,650
============ ============ ============ ============= ============
Ratio of net charge-offs during
the year to average gross loans
outstanding during the year .14% .32% .32% .48% .47%
28
The following table summarizes the bank's allocation of allowance for
loan losses at December 31, 2005, 2004, 2003, 2002 and 2001 (in thousands,
except ratios):
At December 31,
--------------------------------------------------------------------------
2005 2004 2003
----------------------- ----------------------- -----------------------
% of Total % of Total % of Total
Amount Loans (1) Amount Loans (1) Amount Loans (1)
------ --------- ------ --------- ------ ---------
Real estate loans $ 4,150 84% $ 3,432 84% $ 2,773 81%
Commercial and industrial loans 474 10% 389 10% 415 12%
Installment loans 330 6% 223 6% 227 7%
Unallocated 11 -% 11 -% 15 -%
---------- ---------- ----------- ---------- ---------- -----------
Total $ 4,965 100% $ 4,055 100% $ 3,430 100%
========== ========== =========== ========== ========== ===========
At December 31,
------------------------------------------------
2002 2001
----------------------- -----------------------
% of Total % of Total
Amount Loans (1) Amount Loans (1)
------ --------- ------ ---------
Real estate loans $ 2,139 75% $ 1,967 74%
Commercial and industrial loans 451 16% 414 16%
Installment loans 258 9% 254 10%
Unallocated 12 -% 15 -%
---------- ----------- ---------- ----------
Total $ 2,860 100% $ 2,650 100%
========== =========== ========== ==========
- --------------------------------------------
(1) Represents total of all outstanding loans in each category as a percentage
of total loans outstanding.
Deposits
Time certificates in amounts of $100,000 or more outstanding at
December 31, 2005 by maturity were as follows (in thousands):
Three months or less $ 31,072
Over three months through twelve months 51,946
Over twelve months through three years 33,102
Over three years 25,069
---------------
Total $ 141,189
===============
Borrowings
The bank borrows funds principally from the Federal Home Loan Bank of
Atlanta. Information regarding such borrowings is as follows (in thousands,
except rates):
2005 2004 2003
---------------- --------------- ----------------
Balance outstanding at December 31 $ 63,000 $ 43,000 $ 33,000
Weighted average rate at December 31 4.44% 3.86% 4.58%
Maximum borrowings during the year $ 63,000 $ 43,000 $ 35,760
Average amounts outstanding during year $ 48,945 $ 42,799 $ 34,200
Weighted average rate during year 4.23% 3.94% 4.55%
In addition, short-term advances of $480,000 were outstanding from the
Federal Home Loan Bank at December 31, 2005. For 2005 and 2004, average
outstanding short-term balances were $148,000 and $638,000, respectively. At
December 31, 2004, there were no short-term Federal Home Loan Bank advances
outstanding.
29
In addition, the bank may purchase federal funds through unsecured
federal funds lines of credit with various banks aggregating $32.7 million.
These lines are intended for short-term borrowings and are payable on demand and
bear interest based upon the daily federal funds rate. For 2005 and 2004,
average federal funds purchased were $1.9 million and $1.1 million,
respectively. At December 31, 2005 the bank had $10.5 million of federal funds
borrowings outstanding under these lines. At December 31, 2004, there were no
federal funds borrowings outstanding.
Also included with the bank's borrowings at December 31, 2005 and
2004, is an outstanding promissory note for $160,000 for the purchase of
property. The note matures June 2006 and bears interest at 7.50%.
Critical Accounting Estimates and Policies
We prepare our consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America. The
preparation of these financial statements requires us to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amount of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Critical accounting estimates and policies are those we believe are
both most important to the portrayal of our financial condition and results, and
require our most difficult, subjective or complex judgments, often as a result
of the need to make estimates about the effect of matters that are inherently
uncertain. Judgments and uncertainties affecting the application of those
policies may result in materially different amounts being reported under
different conditions or using different assumptions. We believe that the
allowance for loan losses represents a particularly sensitive accounting
estimate. The amount of the allowance is based on management's evaluation of the
collectibility of the loan portfolio, including the maturity of the loan
portfolio, credit concentration, trends in historical loss experience, specific
impaired loans and general economic conditions. See Note A to the consolidated
financial statements for a comprehensive discussion of our accounting policy for
the allowance for loan losses.
New Accounting Standards
In December 2004, the FASB issued SFAS 123 (revised 2004), Share-Based
Payment, ("SFAS No. 123(R)"), which is a revision of SFAS No. 123, Accounting
for Stock-Based Compensation. SFAS No. 123(R) supersedes Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"),
and amends SFAS No. 95 Statement of Cash Flows. SFAS No. 123(R) establishes
standards for the accounting for transactions in which an entity exchanges its
equity instruments for goods or services. This Statement focuses primarily on
accounting for transactions in which an entity obtains employee services in
share-based payment transactions. SFAS No. 123(R) requires that the fair value
of such equity instruments be recognized as an expense in the historical
financial statements as services are performed. Prior to SFAS No. 123(R), only
certain proforma disclosures of fair value were required. The provisions of this
Statement are effective for the first annual reporting period that begins after
June 15, 2005. Accordingly, we will adopt SFAS No. 123(R) commencing with the
quarter ending March 31, 2006. If we had included the cost of employee stock
option compensation in our consolidated financial statements, our net income for
the fiscal years ended December 31, 2005, 2004, and 2003 would have decreased by
approximately $88,000, $64,000, and $68,000, respectively. Accordingly, the
adoption of SFAS No. 123(R) is not expected to have a material effect on our
consolidated financial statements.
Item 7A - Quantitative and Qualitative Disclosures About Market Risk.
This information is included under Item 7 of this report under the
captions "Interest Rate Sensitivity," "Market Risk," and "Derivative Financial
Instruments."
Item 8 - Financial Statements.
30
[DIXON HUGHES CORPORATE LOGO]
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
Four Oaks Fincorp,Inc.
Four Oaks, North Carolina
We have audited the accompanying consolidated balance sheets of Four Oaks
Fincorp, Inc. and Subsidiaries as of December 31, 2005 and 2004 and the related
consolidated statements of operations, comprehensive income, shareholders'
equity and cash flows for each of the years in the three-year period ended
December 31, 2005. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. We were not engaged to perform an
audit of the Company's internal control over financial reporting. Our audit
included consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Four Oaks Fincorp,
Inc. and Subsidiaries as of December 31, 2005 and 2004, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2005 in conformity with accounting principles generally
accepted in the United States of America.
/s/ Dixon Hughes PLLC
- -----------------------
Sanford, North Carolina
March 15, 2006
31
Four Oaks Fincorp, Inc.
Consolidated Balance Sheets
December 31, 2005 and 2004
- ---------------------------------------------------------------------------------------------------------------------
2005 2004
------------------- -------------------
(Amounts in thousands except share data)
ASSETS
Cash and due from banks $ 13,211 $ 10,634
Interest-earning deposits 9,704 3,615
Investment securities available for sale, at fair value 80,209 52,342
Loans 397,094 312,815
Allowance for loan losses (4,965) (4,055)
--------------------- -----------------
Net loans 392,129 308,760
Accrued interest receivable 2,950 2,210
Bank premises and equipment, net 9,683 10,149
FHLB stock 3,655 2,621
Investment in life insurance 7,875 6,054
Other assets 2,994 2,115
------------------ -----------------
Total assets $ 522,410 $ 398,500
================== =================
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Non-interest-bearing demand $ 68,993 $ 59,528
Money market and NOW accounts 59,251 55,467
Savings 43,900 14,900
Time deposits, $100,000 and over 141,189 108,655
Other time deposits 84,200 76,757
------------------ -----------------
Total deposits 397,533 315,307
Borrowings 74,140 43,160
Accrued interest payable 2,255 1,201
Other liabilities 6,524 1,537
------------------ -----------------
Total liabilities 480,452 361,205
------------------ -----------------
Commitments and Contingencies (Notes I, J and M)
Shareholders' equity:
Common stock; $1.00 par value, 10,000,000
shares authorized; 4,379,258 and 3,438,107 shares issued
and outstanding at December 31, 2005 and 2004, respectively 4,379 3,438
Additional paid-in capital 9,178 8,788
Retained earnings 29,161 25,091
Accumulated other comprehensive loss (760) (22)
------------------ -----------------
Total shareholders' equity 41,958 37,295
------------------ -----------------
Total liabilities and shareholders' equity $ 522,410 $ 398,500
================== =================
- ---------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements.
32
Four Oaks Fincorp, Inc.
Consolidated Statements of Operations
For the Years Ended December 31, 2005, 2004 and 2003
- ---------------------------------------------------------------------------------------------------------------------
2005 2004 2003
-------------- --------------- --------------
(Amounts in thousands, except per share data)
Interest and dividend income:
Loans, including fees $ 26,612 $ 19,968 $ 17,318
Investment securities:
Taxable 2,389 1,470 1,272
Tax-exempt 118 162 212
Dividends 155 109 88
Interest-earning deposits 130 39 53
-------------- --------------- --------------
Total interest and dividend income 29,404 21,748 18,943
-------------- --------------- --------------
Interest expense:
Deposits 7,657 4,123 4,365
Borrowings 2,160 1,688 1,557
-------------- --------------- --------------
Total interest expense 9,817 5,811 5,922
-------------- --------------- --------------
Net interest income 19,587 15,937 13,021
Provision for loan losses 1,403 1,596 1,373
-------------- --------------- --------------
Net interest income after provision for loan losses 18,184 14,341 11,648
-------------- --------------- --------------
Non-interest income:
Service charges on deposit accounts 1,875 1,941 1,867
Other service charges, commissions and fees 1,235 1,024 635
Gains (losses) on sale of investment securities (386) 71 273
Gains on sale of loans 61 72 212
Merchant fees 389 347 324
Income from investment in bank-owned life insurance 300 394 159
-------------- --------------- --------------
Total non-interest income 3,474 3,849 3,470
-------------- --------------- --------------
Non-interest expenses:
Salaries 6,033 5,354 4,934
Employee benefits 1,306 1,037 1,008
Occupancy expenses 549 508 493
Equipment expenses 1,313 1,223 1,124
Professional and consulting fees 965 747 664
Other taxes and licenses 248 251 251
Merchant processing expenses 341 304 277
Other operating expenses 2,599 2,083 1,837
-------------- --------------- --------------
Total non-interest expenses 13,354 11,507 10,588
-------------- --------------- --------------
Income before income taxes 8,304 6,683 4,530
Provision for income taxes 2,955 2,308 1,612
-------------- --------------- --------------
Net income $ 5,349 $ 4,375 $ 2,918
============== =============== ==============
Basic net income per common share $ 1.23 $ 1.03 $ .70
============== =============== ==============
Diluted net income per common share $ 1.22 $ 1.02 $ .69
============== =============== ==============
- ---------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements.
33
Four Oaks Fincorp, Inc.
Consolidated Statements of Comprehensive Income
For the Years Ended December 31, 2005, 2004 and 2003
- ---------------------------------------------------------------------------------------------------------------------
2005 2004 2003
-------------- --------------- --------------
(Amounts in thousands)
Net income $ 5,349 $ 4,375 $ 2,918
--------------- --------------- --------------
Other comprehensive income:
Securities available for sale:
Unrealized holding gains (losses) on
available for sale securities (1,326) (109) 40
Tax effect 529 44 (17)
Reclassification of (gains) losses recognized in
net income 386 (71) (273)
Tax effect (154) 28 109
--------------- --------------- --------------
Net of tax amount (565) (108) (141)
-------------- --------------- --------------
Cash flow hedging activities:
Unrealized holding losses on cash flow
hedging activities (290) (370) (56)
Tax effect 117 148 22
-------------- --------------- --------------
Net of tax amount (173) (222) (34)
-------------- --------------- --------------
Total other comprehensive loss (738) (330) (175)
-------------- --------------- --------------
Comprehensive income $ 4,611 $ 4,045 $ 2,743
============== =============== ==============
- ---------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements.
34
Four Oaks Fincorp, Inc.
Consolidated Statements of Shareholders' Equity
For the Years Ended December 31, 2005, 2004 and 2003
- ---------------------------------------------------------------------------------------------------------------------
Accumulated
Additional other Total
Common stock paid-in Retained comprehensive shareholders'
Shares Amount capital earnings income (loss) equity
--------- ----------- ------------ ------------ ---------------- --------------
(Amounts in thousands, except share data)
BALANCE, DECEMBER 31, 2002 2,144,211 $ 2,144 $ 7,716 $ 20,850 $ 483 $ 31,193
Net income - - - 2,918 - 2,918
Other comprehensive loss - - - - (175) (175)
Effect of 5-for-4 stock split 533,706 534 (542) - - (8)
Issuance of common stock 42,014 42 837 - - 879
Current income tax benefit - - 18 - - 18
Purchases and retirement
of common stock (43,668) (44) - (949) - (993)
Cash dividends of $.23 per share - - - (952) - (952)
----------- ----------- ------------ ------------ ------------ ---------
BALANCE, DECEMBER 31, 2003 2,676,263 2,676 8,029 21,867 308 32,880
Net income - - - 4,375 - 4,375
Other comprehensive loss - - - - (330) (330)
Effect of 5-for-4 stock split 682,474 683 (683) - - -
Issuance of common stock 82,170 82 1,348 - - 1,430
Current income tax benefit - - 94 - - 94
Purchases and retirement
of common stock (2,800) (3) - (62) - (65)
Cash dividends of $.26 per share - - - (1,089) - (1,089)
----------- ----------- ------------ ------------ ------------ ---------
BALANCE, DECEMBER 31, 2004 3,438,107 3,438 8,788 25,091 (22) 37,295
Net income - - - 5,349 - 5,349
Other comprehensive loss - - - - (738) (738)
Effect of 5-for-4 stock split 872,060 872 (872) - - -
Issuance of common stock 69,091 69 1,161 - - 1,230
Current income tax benefit - - 101 - - 101
Cash dividends of $.30 per share - - - (1,279) - (1,279)
----------- ----------- ------------ ------------ ------------ ---------
BALANCE, DECEMBER 31, 2005 4,379,258 $ 4,379 $ 9,178 $ 29,161 $ (760) $ 41,958
============ =========== ============ ============ ============ ==========
- ---------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements.
35
Four Oaks Fincorp, Inc.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2005, 2004 and 2003
- ---------------------------------------------------------------------------------------------------------------------
2005 2004 2003
-------------- --------------- --------------
(Amounts in thousands)
Cash flows from operating activities:
Net income $ 5,349 $ 4,375 $ 2,918
Adjustments to reconcile net income to net cash
provided by operations:
Provision for loan losses 1,403 1,596 1,373
Provision for depreciation and amortization 1,038 1,008 946
Deferred income tax benefit (455) (188) (129)
Net amortization of bond premiums and discounts 18 109 595
Gain on sale of loans (61) (72) (212)
(Gain) loss on sale of investment securities 386 (71) (273)
Loss on sale of foreclosed assets - 25 15
(Gain) loss on disposition of premises and equipment - 7 -
Increase in cash surrender value of life insurance (300) (394) (159)
Changes in assets and liabilities:
Other assets (102) 545 (130)
Interest receivable (740) (317) (122)
Other liabilities 4,797 52 (155)
Interest payable 1,054 (83) (501)
-------------- --------------- ---------------
Net cash provided by operating activities 12,387 6,592 4,166
-------------- --------------- ---------------
Cash flows from investing activities:
Proceeds from sales and calls of investment
securities available for sale 36,783 41,422 44,835
Proceeds from maturities of investment
securities available for sale - - 10,516
Purchase of investment securities available for sale (65,994) (55,779) (37,320)
Purchase of FHLB stock (1,034) (698) (273)
Net increase in loans (85,142) (42,305) (43,811)
Additions to premises and equipment (558) (568) (848)
Purchases of bank-owned life insurance (1,521) (3,552) (2,896)
Proceeds from sale of foreclosed assets 589 860 521
Expenditures on foreclosed assets (1) - (2)
--------------- --------------- ---------------
Net cash used by investing activities (116,878) (60,620) (29,278)
-------------- --------------- ---------------
Cash flows from financing activities:
Net proceeds from borrowings 30,980 10,000 -
Net increase in deposit accounts 82,226 42,176 22,345
Proceeds from issuance of common stock 1,230 1,430 879
Purchases and retirement of common stock - (65) (993)
Cash dividends paid (1,279) (1,089) (960)
-------------- --------------- ---------------
Net cash provided by financing activities 113,157 52,452 21,271
-------------- --------------- ---------------
Net increase (decrease) in cash and cash equivalents 8,666 (1,576) (3,841)
Cash and cash equivalents at beginning of year 14,249 15,825 19,666
-------------- --------------- ---------------
Cash and cash equivalents at end of year $ 22,915 $ 14,249 $ 15,825
============== =============== ===============
- ---------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements.
36
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements include the accounts and transactions of
Four Oaks Fincorp, Inc. (the "Company"), a bank holding company incorporated
under the laws of the State of North Carolina, and its wholly owned
subsidiaries, Four Oaks Bank & Trust Company, Inc. (the "Bank") and Four Oaks
Mortgage Services, LLC, the Company's mortgage origination subsidiary. All
significant intercompany transactions have been eliminated.
Nature of Operations
The Company was incorporated under the laws of the State of North Carolina on
February 5, 1997. The Company's primary function is to serve as the holding
company for its wholly owned subsidiary, the Bank. The Bank operates twelve
offices in eastern and central North Carolina, and its primary source of revenue
is derived from loans to customers and from its securities portfolio. The loan
portfolio is comprised mainly of real estate, commercial and consumer loans.
These loans are primarily collateralized by residential and commercial
properties, commercial equipment, and personal property.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
Preparing consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates. Material estimates that are particularly susceptible to significant
change relate to the determination of the allowance for loan losses.
Cash and Cash Equivalents
For the purpose of presentation in the consolidated statements of cash flows,
cash and cash equivalents are defined as those amounts included in the balance
sheet captions cash and due from banks and interest-earning deposits.
Federal regulations require institutions to set aside specified amounts of cash
as reserves against transactions and time deposits. As of December 31, 2005, the
daily average gross reserve requirement was $6.5 million.
Investment Securities
Investment securities are classified into three categories:
(1) Held to Maturity - Debt securities that the Company has the positive intent
and the ability to hold to maturity are classified as held to maturity and
reported at amortized cost;
(2) Trading - Debt and equity securities that are bought and held principally
for the purpose of selling them in the near term are classified as trading
securities and reported at fair value, with unrealized gains and losses included
in earnings; and
- --------------------------------------------------------------------------------
37
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
Investment Securities (Continued)
(3) Available for Sale - Debt and equity securities not classified as either
securities held to maturity or trading securities are reported at fair value,
with unrealized gains and losses excluded from earnings and reported, net of
income taxes, as other comprehensive income, a separate component of
shareholders' equity.
The Company has historically classified all securities as available for sale.
Gains and losses on sales of securities, computed based on specific
identification of adjusted cost of each security, are included in income at the
time of the sale. Premiums and discounts are amortized into interest income
using a method that approximates the interest method over the period to
maturity.
Loans and Allowance for Loan Losses
Loans are stated at the amount of unpaid principal, reduced by an allowance for
loan losses. Interest on loans is calculated by using the simple interest method
on daily balances of the principal amount outstanding.
Loan origination fees are deferred, as well as certain direct loan origination
costs. Such costs and fees are recognized as an adjustment to yield over the
contractual lives of the related loans utilizing the interest method.
The Company evaluates its loan portfolio in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 114, Accounting by Creditors for
Impairment of a Loan, as amended by SFAS No. 118, Accounting by Creditors for
Impairment of a Loan - Income Recognition and Disclosure. Under these standards,
a loan is considered impaired, based on current information and events, if it is
probable that the Company will be unable to collect the scheduled payments of
principal and interest when due according to the contractual terms of the loan
agreement. Uncollateralized loans are measured for impairment based on the
present value of expected future cash flows discounted at the historical
effective interest rate or the loan's observable market price, while all
collateral-dependent loans are measured for impairment based on the fair value
of the collateral. If the recorded investment in the loan exceeds the measure of
fair value, a valuation allowance is established as a component of the allowance
for loan losses.
The allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to earnings. Loans are
charged against the allowance for loan losses when management believes that the
uncollectibility of a loan balance is confirmed. In addition to the review of
loans considered impaired as discussed above, the allowance for loan losses is
also based upon such factors as changes in the trends in volumes and terms of
loans, levels and trends of charge-offs and recoveries, national and local
economic trends and conditions that may affect the borrowers' ability to pay,
effects of changes in risk selection and underwriting standards as well as
overall portfolio quality. If conditions change substantially from the
assumptions used to evaluate the allowance for loan losses, it is possible that
management's assessment of the allowance may change. In addition, regulatory
examiners may require the Bank to recognize changes to the allowance for loan
losses based on their judgments about information available to them at the time
of their examination.
- --------------------------------------------------------------------------------
38
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
Income Recognition on Impaired and Nonaccrual Loans
Loans, including impaired loans, are generally classified as nonaccrual if they
are past due as to maturity or payment of principal or interest for a period of
more than 90 days, unless such loans are well-secured and in the process of
collection. If a loan or a portion of a loan is classified as doubtful or is
partially charged-off, the loan is generally classified as nonaccrual. Loans
that are on a current payment status or past due less than 90 days may also be
classified as nonaccrual if repayment in full of principal and/or interest is in
doubt.
Loans may be returned to accrual status when all principal and interest amounts
contractually due (including arrearages) are reasonably assured of repayment
within an acceptable period of time and there is a sustained period of repayment
performance (generally a minimum of six months) by the borrower, in accordance
with the contractual terms.
While a loan is classified as nonaccrual and the future collectibility of the
recorded loan balance is doubtful, collections of interest and principal are
generally applied as a reduction to the principal outstanding, except in the
case of loans with scheduled amortizations where the payment is generally
applied to the oldest payment due. When the future collectibility of the
recorded loan balance is expected, interest income may be recognized on a cash
basis. In the case where a nonaccrual loan had been partially charged-off,
recognition of interest on a cash basis is limited to that which would have been
recognized on the recorded loan balance at the contractual interest rate.
Receipts in excess of that amount are recorded as recoveries to the allowance
for loan losses until prior charge-offs have been fully recovered.
Foreclosed Assets
Assets acquired as a result of foreclosure are valued at fair value at the date
of foreclosure establishing a new cost basis. After foreclosure, valuations of
the property are periodically performed by management and the assets are carried
at the lower of cost or fair value minus estimated costs to sell. Losses from
the acquisition of property in full or partial satisfaction of debt are treated
as credit losses. Routine holding costs, subsequent declines in value, and gains
or losses on disposition are included in other income and expense.
Bank Premises and Equipment
Land is carried at cost. Bank premises and equipment are stated at cost less
accumulated depreciation. Depreciation is computed using the straight-line
method based on the estimated useful lives of assets. Useful lives range from 5
to 10 years for furniture and equipment and 40 years for premises. Expenditures
for repairs and maintenance are charged to expense as incurred.
- --------------------------------------------------------------------------------
39
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
Income Taxes
Deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the tax bases of assets and
liabilities and their carrying amounts for financial reporting purposes.
Deferred tax assets are also recognized for operating loss carryforwards.
Deferred tax assets and liabilities are measured using enacted tax rates in
effect for the year in which the temporary differences are expected to be
recovered or settled. Deferred tax assets are reduced by a valuation allowance
if it is more likely than not that the tax benefits will not be realized.
Stock in Federal Home Loan Bank of Atlanta
As a requirement for membership, the Company invests in stock of the Federal
Home Loan Bank of Atlanta ("FHLB"). This investment is carried at cost. Due to
the redemptive provisions of the FHLB, the Company estimated that fair value
equals cost and that this investment was not impaired as of December 31, 2005.
Comprehensive Income
Comprehensive income is defined as the change in equity during a period for
non-owner transactions and is divided into net income and other comprehensive
income. Other comprehensive income includes revenues, expenses, gains, and
losses that are excluded from earnings under current accounting standards.
Components of other comprehensive income for the Company consist of the
unrealized gains and losses, net of taxes, in the Company's available for sale
securities portfolio and unrealized gains and losses, net of taxes, in the
Company's cash flow hedge instruments.
Accumulated other comprehensive income at December 31, 2005, 2004 and 2003
consists of the following:
2005 2004 2003
-------------- --------------- --------------
(Amounts in thousands)
Unrealized holding gains (losses) - investment securities
available for sale $ (550) $ 391 $ 571
Deferred income taxes 219 (157) (229)
-------------- --------------- --------------
Net unrealized holding gains - investment securities
available for sale (331) 234 342
--------------- --------------- --------------
Unrealized holding losses - cash flow hedge instruments (716) (426) (56)
Deferred income taxes 287 170 22
-------------- --------------- --------------
Net unrealized holding losses - cash flow hedge
instruments (429) (256) (34)
-------------- --------------- --------------
Total accumulated other comprehensive income (loss) $ (760) $ (22) $ 308
============== =============== ==============
- --------------------------------------------------------------------------------
40
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
Stock Compensation Plans
SFAS No. 123, Accounting for Stock-Based Compensation, encourages all entities
to adopt a fair value based method of accounting for employee stock compensation
plans, whereby compensation cost is measured at the grant date based on the
value of the award and is recognized over the service period, which is usually
the vesting period. However, it also allows an entity to continue to measure
compensation cost for those plans using the intrinsic value based method of
accounting prescribed by Accounting Principles Board ("APB") Opinion No. 25,
Accounting for Stock Issued to Employees, whereby compensation cost is the
excess, if any, of the quoted market price of the stock at the grant date (or
other measurement date) over the amount an employee must pay to acquire the
stock. Stock options issued under the Company's stock option plans have no
intrinsic value at the grant date and, under APB Opinion No. 25, no compensation
cost is recognized for them. The Company has elected to continue with the
accounting methodology in APB No. 25 and, as a result, has provided pro forma
disclosures of net income and earnings per share and other disclosures as if the
fair value based method of accounting had been applied.
2005 2004 2003
-------------- --------------- --------------
(Amounts in thousands, except per share data)
Net income:
As reported $ 5,349 $ 4,375 $ 2,918
Deduct: Total stock-based employee compensation
expense determined under fair value method
for all awards, net of related tax effects (88) (64) (68)
--------------- --------------- --------------
Pro forma $ 5,261 $ 4,311 $ 2,850
============== =============== ==============
Basic earnings per share:
As reported $ 1.23 $ 1.03 $ .70
Pro forma 1.21 1.02 .68
Diluted earnings per share:
As reported $ 1.22 $ 1.02 $ .69
Pro forma 1.20 1.01 .68
Net Income Per Common Share and Common Shares Outstanding
Basic earnings per share represents income available to common shareholders
divided by the weighted average number of common shares outstanding during the
period. Diluted earnings per share reflect additional common shares that would
have been outstanding if dilutive potential common shares had been issued, as
well as any adjustment to income that would result from the assumed issuance.
The weighted average number of shares outstanding during each period have been
retroactively adjusted for a five for four stock split distributed November 25,
2005, October 29, 2004 and November 10, 2003. Potential common shares that may
be issued by the Company relate solely to outstanding stock options.
- --------------------------------------------------------------------------------
41
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
Net Income Per Common Share and Common Shares Outstanding (Continued)
Basic and diluted net income per common share have been computed based upon net
income as presented in the accompanying consolidated statements of operations
divided by the weighted average number of common shares outstanding or assumed
to be outstanding as summarized below:
2005 2004 2003
-------------- --------------- --------------
Weighted average number of common shares used
in computing basic net income per common share 4,343,326 4,246,681 4,195,088
Effect of dilutive stock options 32,179 24,169 14,964
-------------- --------------- --------------
Weighted average number of common shares and
dilutive potential common shares used in computing
diluted net income per common share 4,375,505 4,270,850 4,210,052
============== =============== ==============
There were no antidilutive shares outstanding for the years ended December 31,
2005, 2004 and 2003.
Derivative Instruments
The Company utilizes interest rate swaps in the management of interest rate
risk. Interest rate swaps are contractual agreements between two parties to
exchange a series of cash flows representing interest payments. A swap allows
both parties to alter the repricing characteristics of assets or liabilities
without affecting the underlying principal positions. Through the use of a swap,
assets and liabilities may be transformed from fixed to floating rates, from
floating rates to fixed rates, or from one type of floating rate to another.
Swap terms generally range from one year to ten years depending on the need.
The net interest payable or receivable on interest rate swaps that are
designated as hedges is accrued and recognized as an adjustment to the interest
income or expense of the related asset or liability. Gains and losses from early
terminations of derivatives are deferred and amortized as yield adjustments over
the shorter of the remaining term of the hedged asset or liability or the
remaining term of the derivative instrument. Upon disposition or settlement of
the asset or liability being hedged, deferral accounting is discontinued and any
gains or losses are recognized in income. Unrealized holding gains and losses on
derivatives designated as cash flow hedges are reported, net of applicable
income tax effect, in accumulated other comprehensive income.
Derivative financial instruments that fail to qualify as a hedge are carried at
fair value with gains and losses recognized in current earnings.
- --------------------------------------------------------------------------------
42
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
New Accounting Standards
On March 9, 2004, the SEC Staff issued Staff Accounting Bulletin No. 105,
Application of Accounting Principles to Loan Commitments ("SAB 105"). SAB 105
clarifies existing accounting practices relating to the valuation of issued loan
commitments, including interest rate lock commitments ("IRLC"), subject to SFAS
No. 149 and Derivative Implementation Group Issue C13, Scope Exceptions: When a
Loan Commitment is included in the Scope of Statement 133. Furthermore, SAB 105
disallows the inclusion of the values of a servicing component and other
internally developed intangible assets in the initial and subsequent IRLC
valuation. The provisions of SAB 105 were effective for loan commitments entered
into after March 31, 2004. The adoption of SAB 105 did not have a material
impact on the Company's consolidated financial statements.
In March 2004, the Emerging Issues Task Force ("EITF") released EITF Issue
03-01, The Meaning of Other-Than-Temporary Impairment and its Application to
Certain Investments ("Issue 03-01"). Issue 03-01 provides guidance for
determining whether an investment is other-than-temporarily impaired and
requires certain disclosures with respect to these investments. The recognition
and measurement guidance for other-than-temporary impairment has been delayed by
the issuance of FASB Staff Position EITF 03-1-1 on September 30, 2004. The
adoption of Issue 03-1 did not result in any other-than-temporary impairment of
the Company's investments.
In November 2003, the Emerging Issues Task Force ("EITF") issued EITF Issue No.
03-01, The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments ("EITF 03- 01"). EITF 03-01 provided guidance for evaluating
whether an investment is other-than-temporarily impaired and requires certain
disclosures with respect to these investments. In September 2004, the Financial
Accounting Standards Board ("FASB") issued a FASB Staff Position ("FSP EITF
03-1-b") to delay the requirement to record impairment losses EITF 03-1. The
guidance also included accounting considerations subsequent to the recognition
of an other-than-temporary impairment and requirements for disclosures about
unrealized losses that have not been recognized as other-than-temporary
impairments. In November 2005, the FASB issued FSP FAS 115-1 and FAS 124-1,
which addresses the determination as to when an investment is considered
impaired. This FSP nullifies certain requirements of EITF 03-01 and supersedes
EITF Topic No. D-44, Recognition of Other-Than-Temporary Impairment upon the
Planned Sale of a Security Whose Cost Exceeds Fair Value. This FSP is to be
applied to reporting periods beginning after December 15, 2005. The Company is
in process of evaluating the impact of this FSP.
In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 123(r), Share-Based Payments, which is a revision of SFAS No. 123 Accounting
for Stock-Based Compensation and supersedes Accounting Principles Board ("APB")
Opinion No. 25 Accounting for Stock Issued to Employees. SFAS No. 123(r)
requires companies to recognize in the income statement the grant-date fair
value of stock options and other equity-based compensation issued to employees
over the period during which an employee is required to provide service in
exchange for the award, which will often be the shorter of the vesting period of
the period the employee will be retirement eligible. SFAS No. 123(r) sets
accounting requirements for "share-based" compensation to employees, including
employee-stock purchase plans ("ESPPs"). Awards to most nonemployee directors
will be accounted for as employee awards. This Statement was to be effective for
public companies that do not file as small business issuers as of the beginning
of interim or annual reporting periods beginning after June 15, 2005. In April
- --------------------------------------------------------------------------------
43
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
New Accounting Standards (Continued)
2005, the Securities and Exchange Commission ("SEC") issued Release No. 2005-57,
which defers the effective date of SFAS No. 123(r) for many registrants.
Registrants that do not file as small business users must adopt SFAS No. 123(r)
as of the beginning of their first annual period beginning after June 15, 2005.
Accordingly, the Company will adopt SFAS No. 123(r) on January 1, 2006, and is
currently evaluating the effect on its consolidated financial statements.
In March 2005, the SEC issued Staff Accounting Bulletin No. 107 ("SAB 107"),
which contains guidance on applying the requirements in SFAS No. 123(r). SAB 107
provides guidance on valuation techniques, development of assumptions used in
valuing employee share options and related MD&A disclosures. SAB 107 is
effective for the period in which SFAS No. 123(r) is adopted. The Company will
adopt SAB 107 on January 1, 2006, and is currently evaluating the effect on its
consolidated financial statements.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error
Corrections, which replaces APB Opinion No. 20 Accounting Changes and SFAS No. 3
Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154
changes the requirements for the accounting for and reporting of a change in an
accounting principle. SFAS No. 154 requires retrospective application for
voluntary changes in an accounting principle unless it is impracticable to do
so. SFAS No. 154 is effective for accounting changes made in fiscal years
beginning after December 15, 2005. The Company will adopt SFAS No. 154 on
January 1, 2006 with no expected material effect on its consolidated financial
statements.
From time to time the FASB issues exposure drafts for proposed statements of
financial accounting standards. Such exposure drafts are subject to comment from
the public, to revisions by the FASB and to final issuance by the FASB as
statements of financial accounting standards. Management considers the effect of
the proposed statements on the consolidated financial statements of the Company
and monitors the status of changes to and proposed effective dates of exposure
drafts.
In December 2004, the FASB issued SFAS 123 (revised 2004), Share-Based Payment,
("SFAS No. 123(R)"), which is a revision of SFAS No. 123, Accounting for
Stock-Based Compensation. SFAS No. 123(R) supersedes Accounting Principles Board
(APB) Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"), and
amends SFAS No. 95 Statement of Cash Flows. SFAS No. 123(R) establishes
standards for the accounting for transactions in which an entity exchanges its
equity instruments for goods or services. This Statement focuses primarily on
accounting for transactions in which an entity obtains employee services in
share-based payment transactions. SFAS No. 123(R) requires that the fair value
of such equity instruments be recognized as an expense in the historical
financial statements as services are performed. Prior to SFAS No. 123(R), only
certain pro forma disclosures of fair value were required. The provisions of
this Statement are effective for the first annual reporting period that begins
after June 15, 2005. Accordingly, we will adopt SFAS No. 123(R) commencing with
the quarter ending March 31, 2006. If we had included the cost of employee stock
option compensation in our consolidated financial statements, our net income for
the fiscal years ended December 31, 2005, 2004 and 2003 would have decreased by
approximately $88,000, $64,000, and $68,000, respectively. Accordingly, the
adoption of SFAS No. 123(R) is not expected to have a material effect on our
consolidated financial statements.
- --------------------------------------------------------------------------------
44
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
Reclassifications
Certain items included in the 2004 and 2003 consolidated financial
statements have been reclassified to conform to the 2005 presentation. These
reclassifications have no effect on the net income or shareholders' equity
previously reported.
NOTE B - INVESTMENT SECURITIES
The amortized cost, gross unrealized gains, gross unrealized losses and fair
values of securities available for sale as of December 31, 2005 and 2004 are as
follows:
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
------------- ----------- ----------- -------------
(Amounts in thousands)
2005:
U.S. Government and agency securities $ 69,108 $ 21 $ 698 $ 68,431
State and municipal securities 3,963 15 68 3,910
Mortgage-backed securities 7,003 3 102 6,904
Other 685 279 - 964
------------- ------------- ------------- --------------
$ 80,759 $ 318 $ 868 $ 80,209
============= ============= ============= ==============
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
------------- ----------- ----------- -------------
(Amounts in thousands)
2004:
U.S. Government and agency securities $ 34,991 $ 57 $ 90 $ 34,958
State and municipal securities 3,573 72 13 3,632
Mortgage-backed securities 12,759 53 37 12,775
Other 628 349 - 977
------------- ------------- ------------- --------------
$ 51,951 $ 531 $ 140 $ 52,342
============= ============= ============= ==============
The following table shows gross unrealized losses and fair values of investment
securities, aggregated by investment category and length of time that the
individual securities have been in a continuous unrealized loss position, at
December 31, 2005 and 2004. As of December 31, 2005, the unrealized losses
relate to thirty-five U.S. government agency securities, five mortgage-backed
securities and twelve municipal securities. Four of the U.S. government agency
securities and three of the municipal securities had continuous unrealized
losses for more than twelve months. The unrealized losses relate to debt
securities that have incurred fair value reductions due to higher market
interest rates since the securities were purchased. The unrealized losses are
not likely to reverse unless and until market interest rates decline to the
levels that existed when the securities were purchased. Since none of the
unrealized losses relate to the marketability of the securities or the issuer's
ability to honor redemption obligations, none of the securities are deemed to be
other than temporarily impaired.
- --------------------------------------------------------------------------------
45
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE B - INVESTMENT SECURITIES (Continued)
2005
------------------------------------------------------------------------------
Less Than 12 Months 12 Months or More Total
------------------- ------------------------- ------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
value losses value losses value losses
----- ------ ----- ------ ----- ------
(Amounts in thousands)
Securities available for sale:
U.S. government and
agency securities $ 50,622 $ 546 $ 7,840 $ 152 $ 58,462 $ 698
State and municipal securities 2,810 53 626 15 3,436 68
Mortgage-backed securities 5,004 102 - - 5,004 102
----------- ----------- ---------- ----------- ----------- -----------
Total temporarily impaired
securities $ 58,436 $ 701 $ 8,466 $ 167 $ 66,902 $ 868
=========== =========== ========== =========== =========== ===========
2004
------------------------------------------------------------------------------
Less Than 12 Months 12 Months or More Total
------------------- ------------------------- ------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
value losses value losses value losses
----- ------ ----- ------ ----- ------
(Amounts in thousands)
Securities available for sale:
U.S. government and
agency securities $ 18,892 $ 90 $ - $ - $ 18,892 $ 90
State and municipal securities 1,968 13 - - 1,968 13
Mortgage-backed securities 2,056 15 2,924 22 4,980 37
----------- ----------- ---------- ----------- ----------- -----------
Total temporarily impaired
securities $ 22,916 $ 118 $ 2,924 $ 22 $ 25,840 $ 140
=========== =========== ========== =========== =========== ===========
The amortized cost and fair value of debt securities at December 31, 2005 by
contractual maturities are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
Amortized
Cost Fair Value
---- ----------
(Amounts in thousands)
Due within one year $ 1,000 $ 1,000
Due after one year through five years 50,176 49,695
Due after five years through ten years 22,207 21,961
Due after ten years 7,376 7,553
--------------- ---------------
$ 80,759 $ 80,209
=============== ===============
Securities with a carrying value of approximately $65.2 million and $33.4
million at December 31, 2005 and 2004, respectively, were pledged to secure
public deposits and for other purposes required or permitted by law.
- --------------------------------------------------------------------------------
46
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE B - INVESTMENT SECURITIES (Continued)
Sales and calls of securities available for sale during 2005 and 2004 generated
gross realized gains of $73,717 and $224,000, respectively. Gross realized
losses amounted to $460,142 and $153,000, respectively.
NOTE C - LOANS AND ALLOWANCE FOR LOAN LOSSES
Major classifications of loans as of December 31, 2005 and 2004 are summarized
as follows:
2005 2004
------------ ----------------
(Amounts in thousands)
Real estate - residential and other $ 177,995 $ 159,152
Real estate - agricultural 11,650 15,203
Construction and land development 142,592 90,742
Other agricultural 3,729 4,020
Consumer loans 26,371 17,207
Commercial loans 34,166 26,005
Other loans 909 865
---------------- ----------------
397,412 313,194
Less:
Net deferred loan costs (318) (379)
Allowance for loan losses (4,965) (4,055)
----------------- ----------------
$ 392,129 $ 308,760
================= ================
Nonperforming assets at December 31, 2005 and 2004 consist of the following:
2005 2004
------------ ----------------
(Amounts in thousands)
Loans past due ninety days or more $ 74 $ 226
Nonaccrual loans 997 944
Foreclosed assets (included in other assets) 247 404
---------------- ----------------
$ 1,318 $ 1,574
================ ================
During 2005, the Company revised its SFAS 114 methodology for reporting loans.
At December 31, 2005, the recorded investment in loans considered impaired in
accordance with SFAS No. 114 totaled $3.6 million. This amount consisted of both
accrual and nonaccrual loans in the amount of $2.6 million and $1.0 million,
respectively. At December 31, 2004, the investment in loans considered impaired
amounted to $944,000, which consisted entirely of nonaccrual loans. Impaired
loans of $3.6 million and $944,000 had related allowances for loan losses of
$1.2 million and $151,000 at December 31, 2005 and 2004, respectively. For the
years ended December 31, 2005 and 2004, the average recorded investment in
impaired loans was approximately $3.5 million and $1.5 million, respectively.
The amount of interest recognized on impaired loans during the portion of the
year that they were impaired was not material.
- --------------------------------------------------------------------------------
47
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE C - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
A summary of the allowance for loan losses for the years ended December 31,
2005, 2004 and 2003 is as follows:
2005 2004 2003
-------------- --------------- --------------
(Amounts in thousands)
Balance, beginning $ 4,055 $ 3,430 $ 2,860
Provision for loan losses 1,403 1,596 1,373
Loans charged-off (696) (1,346) (1,137)
Recoveries of loans previously charged-off 203 375 334
-------------- --------------- --------------
Balance, ending $ 4,965 $ 4,055 $ 3,430
============== =============== ==============
The Bank had loan and deposit relationships with most of its directors and
executive officers and with companies with which certain directors and executive
officers are associated. The following is a reconciliation of loans directly
outstanding to executive officers, directors, and their affiliates (amounts in
thousands):
Balance at December 31, 2004 $ 4,710
New loans 2,672
Principal repayments (3,281)
-----------------
Balance at December 31, 2005 $ 4,101
================
As a matter of policy, these loans and credit lines are approved by the
Company's Board of Directors and are made with interest rates, terms, and
collateral requirements comparable to those required of other borrowers. In the
opinion of management, these loans do not involve more than the normal risk of
collectibility. At December 31, 2005, the Company had pre-approved but unused
lines of credit totaling $1.6 million to executive officers, directors and their
affiliates.
NOTE D - BANK PREMISES AND EQUIPMENT
Bank premises and equipment at December 31, 2005 and 2004 are as follows:
2005 2004
------------ ----------------
(Amounts in thousands)
Land $ 2,237 $ 2,237
Building 7,183 7,042
Furniture and equipment 7,369 6,952
---------------- ----------------
16,789 16,231
Less accumulated depreciation (7,106) (6,082)
----------------- ----------------
$ 9,683 $ 10,149
================ ===============
Depreciation expense for the years ended December 31, 2005 and 2004 amounted to
$1.0 million and $994,000, respectively.
- --------------------------------------------------------------------------------
48
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE E - DEPOSITS
At December 31, 2005, the scheduled maturities of time deposits are as follows
(amounts in thousands):
Less than $100,000
$100,000 or more Total
----------- ----------- ---------------
Within one year $ 66,342 $ 83,018 $ 149,360
Over one year through three years 16,006 33,102 49,108
Over three years 1,852 25,069 26,921
------------- ------------- --------------
$ 84,200 $ 141,189 $ 225,389
============== ============= ==============
NOTE F - BORROWINGS
At December 31, 2005 and 2004, borrowed funds consisted of the following FHLB
advances (amounts in thousands):
Maturity Interest Rate 2005 2004
----------------- ---------------- ------------- --------------
March 2006 4.52% - Variable $ 10,000 $ 10,000
July 2010 5.75% - Fixed 10,000 10,000
July 2011 4.44% - Fixed 5,000 5,000
September 2011 4.38% - Fixed 3,000 3,000
October 2011 4.30% - Fixed 7,000 7,000
November 2011 4.56% - Variable 8,000 8,000
August 2015 3.77% - Fixed 10,000 -
October 2015 3.73% - Fixed 10,000 -
------------- --------------
$ 63,000 $ 43,000
============= ==============
The above advances are secured by a floating lien covering the Company's loan
portfolio of qualifying residential (1-4 units) first mortgage loans. At
December 31, 2005, the Company has available lines of credit totaling $104.5
million with the FHLB for borrowing dependent on adequate collateralization. The
weighted average rates for the above borrowings at December 31, 2005 and 2004
were 4.44% and 3.86%, respectively. In addition to the above advances, the
Company has short-term FHLB advances of $480,000 outstanding as of December 31,
2005.
In addition to the above advances, the Company has lines of credit of $32.7
million from various financial institutions to purchase federal funds on a
short-term basis. The Company has $10.5 million outstanding as of December 31,
2005. The Company did not have any federal funds as of December 31, 2004.
At December 31, 2005 and 2004, the Company was obligated under an outstanding
promissory note for $160,000 for the purchase of property. The note calls for
set monthly interest only payments, with a balloon payment at maturity on June
2006. The note bears interest at 7.50%.
- --------------------------------------------------------------------------------
49
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE G - INCOME TAXES
Allocation of income tax expense between current and deferred portions is as
follows:
Years Ended December 31,
-----------------------------------------------------
2005 2004 2003
-------------- --------------- --------------
(Amounts in thousands)
Current tax expense:
Federal $ 2,947 $ 2,086 $ 1,470
State 463 410 271
-------------- --------------- --------------
3,410 2,496 1,741
-------------- --------------- --------------
Deferred tax expense:
Federal (381) (161) (106)
State (74) (27) (23)
-------------- --------------- --------------
(455) (188) (129)
-------------- --------------- --------------
$ 2,955 $ 2,308 $ 1,612
============== =============== ==============
The reconciliation of expected income tax at the statutory federal rate of 34%
with income tax expense is as follows:
Years Ended December 31,
-----------------------------------------------------
2005 2004 2003
-------------- --------------- --------------
(Amounts in thousands)
Expense computed at statutory rate of 34% $ 2,823 $ 2,272 $ 1,540
Effect of state income taxes, net of federal benefit 257 304 164
Tax exempt income (36) (101) (123)
Bank owned life insurance income (102) (152) (61)
Other, net 13 (15) 92
-------------- ---------------- --------------
$ 2,955 $ 2,308 $ 1,612
============== =============== ==============
Deferred income taxes consist of the following:
Years Ended December 31,
-----------------------------------------------------
2005 2004 2003
-------------- --------------- --------------
(Amounts in thousands)
Deferred tax assets:
Allowance for loan losses $ 1,870 $ 1,518 $ 1,277
Unamortized investment premiums 5 49 44
Net deferred loan fees 123 146 66
Other 47 38 31
-------------- --------------- --------------
Total deferred tax assets 2,045 1,751 1,418
-------------- --------------- --------------
Deferred tax liabilities:
Property and equipment 718 857 818
Other comprehensive income (506) (13) 207
Prepaid expense 81 93 -
Unaccreted investment discounts 3 13 -
-------------- --------------- --------------
Total deferred tax liabilities 296 950 1,025
-------------- --------------- --------------
Net deferred tax assets $ 1,749 $ 801 $ 393
============== =============== ==============
- --------------------------------------------------------------------------------
50
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE H - REGULATORY RESTRICTIONS
The Bank, as a North Carolina banking corporation, may pay dividends to the
Company only out of undivided profits as determined pursuant to North Carolina
General Statutes Section 53-87. However, regulatory authorities may limit
payment of dividends by any bank when it is determined that such a limitation is
in the public interest and is necessary to ensure the financial soundness of the
bank.
Current Federal regulations require that the Bank maintain a minimum ratio of
total capital to risk weighted assets of 8%, with at least 4% being in the form
of Tier 1 capital, as defined in the regulations. In addition, the Bank must
maintain a leverage ratio of 4%. As of December 31, 2005, the Bank's capital
exceeded the current capital requirements. The Bank currently expects to
continue to exceed these minimums without altering current operations or
strategy.
The Bank is subject to various regulatory capital requirements administered by
the federal and state banking agencies. 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 Bank's financial statements. Quantitative measures
established by regulation to ensure capital adequacy require the Bank to
maintain minimum amounts and ratios, as set forth in the table below. Management
believes, as of December 31, 2005, that the Bank meets all capital adequacy
requirements to which it is subject.
As of December 31, 2005, the most recent notification from the FDIC categorized
the Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, the Bank must maintain
minimum amounts and ratios as set forth in the table below. There are no
conditions or events since that notification that management believes have
changed the Bank's category.
The Bank's actual capital amounts and ratios are also presented in the table
below (amounts in thousands, except ratios):
Minimum
To Be Well
Minimum Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------ ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of December 31, 2005:
Total Capital (to Risk Weighted Assets) $ 43,028 10.5% $ 32,800 8.0% $ 41,000 10.0%
Tier I Capital (to Risk Weighted Assets) 38,063 9.3% 16,400 4.0% 24,600 6.0%
Tier I Capital (to Average Assets) 38,063 7.7% 19,694 4.0% 24,617 5.0%
As of December 31, 2004:
Total Capital (to Risk Weighted Assets) $ 37,642 11.8% $ 25,427 8.0% $ 31,784 10.0%
Tier I Capital (to Risk Weighted Assets) 33,668 10.6% 12,714 4.0% 19,071 6.0%
Tier I Capital (to Average Assets) 33,668 8.6% 15,605 4.0% 19,506 5.0%
The Company is also subject to these capital requirements. At December 31, 2005
and 2004, the Company's total capital to risk weighted assets, Tier 1 capital to
risk weighted assets and Tier 1 capital to average assets were 11.6% and 13.0%,
10.4% and 11.7%, and 8.7% and 9.5%, respectively.
- --------------------------------------------------------------------------------
51
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE I - DERIVATIVES
Derivative Financial Instruments
The Company has stand-alone derivative financial instruments in the form of
interest rate swap agreements, which derive their value from underlying interest
rates. These transactions involve both credit and market risk. The notional
amounts are amounts on which calculations, payments, and the value of the
derivative are based. Notional amounts do not represent direct credit exposures.
Direct credit exposure is limited to the net difference between the calculated
amounts to be received and paid, if any. Such difference, which represents the
fair value of the derivative instruments, is reflected on the Company's
consolidated balance sheets as derivative assets and derivative liabilities.
The Company is exposed to credit-related losses in the event of nonperformance
by the counterparties to these agreements. The Company controls the credit risk
of its financial contracts through credit approvals, limits and monitoring
procedures, and does not expect any counterparties to fail their obligations.
The Company deals only with primary dealers.
Derivative instruments are generally either negotiated over-the-counter ("OTC")
contracts or standardized contracts executed on a recognized exchange.
Negotiated OTC derivative contracts are generally entered into between two
counterparties that negotiate specific agreements terms, including the
underlying instruments, amount, exercise prices and maturity.
Risk Management Policies - Hedging Instruments
The primary focus of the Company's asset/liability management program is to
monitor the sensitivity of the Company's net portfolio value and net income
under varying interest rate scenarios to take steps to control its risks. On a
quarterly basis, the Company simulates the net portfolio value and net income
expected to be earned over a twelve-month period following the date of
simulation. The simulation is based on a projection of market interest rates at
varying levels and estimates the impact of such market rates on the levels of
interest-earning assets and interest-bearing liabilities during the measurement
period. Based upon the outcome of the simulation analysis, the Company considers
the use of derivatives as a means of reducing the volatility of net portfolio
value and projected net income within certain ranges of projected changes in
interest rates. The Company evaluates the effectiveness of entering into any
derivative instrument agreement by measuring the cost of such an agreement in
relation to the reduction in net portfolio value and net income volatility
within an assumed range of interest rates.
Interest Rate Risk Management - Cash Flow Hedging Instruments
The Company originates variable rate loans for its loan portfolio. These loans
expose the Company to variability in cash flows, primarily from interest
receipts due to changes to interest rates. If interest rates increase, interest
income increases. Conversely, if interest rates decrease, interest income
decreases. Management believes it is prudent to limit the variability of a
portion of its cash flows on variable rate loans therefore, generally hedges a
portion of its variable-rate receipts. To meet this objective, management enters
into interest rate swap agreements whereby the Company receives fixed rate
payments and makes variable rate payments during the contract period.
- --------------------------------------------------------------------------------
52
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE I - DERIVATIVES (Continued)
At December 31, 2005 and 2004, the information pertaining to an outstanding
interest rate swap agreement used to hedge variable rate loans is as follows
(amounts in thousands):
2005 2004
------------ ---------
Notional amount $ 25,000 $ 25,000
Weighted average pay rate 6.09% 4.38%
Weighted average receive rate 5.85% 5.85%
Weighted average maturity in years 1.7 2.7
Unrealized loss relating to interest rate swaps $ (716) $ (426)
This agreement requires the Company to make payments at a variable rate
determined by a specified index (prime) in exchange for receiving payments at a
fixed rate.
At December 31, 2005 and 2004, the Company's interest rate swaps used to hedge
variable rate loans reflected an unrealized loss of $716,000 and $426,000,
respectively. The unrealized losses are included in other comprehensive income,
net of tax, in the accompanying consolidated balance sheet.
Risk management results for the year ended December 31, 2005 related to the
balance sheet hedging of variable rate loans indicate that the hedges were 100%
effective and that there was no component of the derivative instruments' gain or
loss which was excluded from the assessment of hedge effectiveness.
At December 31, 2005, the unrealized loss relating to use of interest rate swaps
was recorded in derivative liabilities in accordance with SFAS No. 133. Changes
in the fair value of interest rate swaps designated as hedging instruments of
the variability of cash flows associated with variable rate loans are reported
in other comprehensive income.
Interest Rate Risk Management - Fair Value Hedging Instruments
The Company uses fixed rate time deposits for use in its lending and investment
activities and other general purposes. These debt obligations expose the Company
to variability in their fair value due to changes in the level of interest
rates. Management believes that it is prudent to limit the variability in the
fair value of a portion of its fixed-rate funding. It is the Company's objective
to hedge the change in fair value of fixed-rate funding coverage levels that are
appropriate, given anticipated or existing interest rate levels and other market
considerations, as well as the relationship of change in this liability to other
liabilities of the Company. To meet this objective, on December 31, 2005, the
Company utilized interest rate swaps as an asset/liability management strategy
to hedge the change in value of the funding due to changes in expected interest
rate assumptions. These interest rate swap agreements are contracts to make a
series of floating rate payments in exchange for receiving a series of fixed
rate payments.
At December 31, 2005 and 2004, the information pertaining to outstanding
interest rate swap agreements used to hedge fixed-rate funding is as follows
(amounts in thousands):
2005 2004
------------ -------
Notional amount $ 38,711 $ 26,000
Weighted average pay rate 4.28% 2.30%
Weighted average receive rate 3.73% 3.66%
Weighted average maturity in years 5.4 5.6
Unrealized gain (loss) relating to interest rate swaps $ (1,049) $ 213
- --------------------------------------------------------------------------------
53
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE I - DERIVATIVES (Continued)
These agreements require the Company to make payments at variable-rate
determined by a specified index (LIBOR) in exchange for receiving payments at a
fixed-rate.
No interest rate swaps were terminated during 2005 or 2004. During 2004, an
interest rate swap was called at par, with no corresponding gain or loss
recognized. At December 31, 2005 and December 31, 2004, the Company's interest
rate swaps used to hedge fixed-rate funding reflected an unrealized loss of $1.0
million and an unrealized gain of $213,000, respectively, which are recorded in
other liabilities in the accompanying consolidated balance sheet.
NOTE J - COMMITMENTS AND CONTINGENCIES
The Bank is a party to financial instruments with off-balance sheet credit risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and letters of
credit. Those instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the balance sheet. The
contract or notional amounts of those instruments reflect the extent of
involvement the Bank has in particular classes of financial instruments. The
Bank uses the same credit policies in making commitments and conditional
obligations as it does for on-balance-sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of conditions established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since some of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. 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 management's
credit evaluation of the borrower. Collateral obtained varies but may include
real estate, stocks, bonds, and certificates of deposit.
Unfunded commitments under lines of credit are commitments for possible future
extensions of credit to existing customers. These lines of credit usually do not
contain a specified maturity date and may not be drawn upon to the total extent
to which the Bank is committed.
Stand-by letters of credit are conditional lending commitments issued by the
Bank to guarantee the performance of a customer to a third party. Those letters
of credit are primarily issued to support public and private borrowing
arrangements. Essentially all letters of credit issued have expiration dates
within one year. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
A summary of the contract amount of the Bank's exposure to off-balance sheet
credit risk as of December 31, 2005 is as follows (amounts in thousands):
Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit $ 71,884
Undisbursed lines of credit 25,299
Financial stand-by letters of credit 366
Performance stand-by letters of credit 4,430
- --------------------------------------------------------------------------------
54
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE K - STOCK OPTION PLAN
The Company has a non-qualified stock option plan for certain key employees
under which it is authorized to issue options for up to 976,563 shares of common
stock. Options are granted at the discretion of the Company's Board of Directors
at a price approximating market, as determined by a committee of Board members.
All options granted subsequent to a 1997 amendment will be 100% vested one year
from the grant date and will expire after such a period as is determined by the
Board at the time of grant. Options granted prior to the amendment have ten year
lives and a five year level vesting provision.
A summary of the status of the Company's stock options, after giving retroactive
effect to stock splits, as of December 31, 2005, 2004 and 2003, and changes
during the years ending on those dates is presented below:
Options Option Price
Outstanding Per Share
----------- ---------
Balance December 31, 2002 166,287 $5.91 - 10.58
Granted 56,349 $11.52
Exercised (30,570) $9.90
Forfeited - -
Expired (191) $9.90
--------------
Balance December 31, 2003 191,875 $5.91 - 11.26
Granted 42,344 $14.08
Exercised (77,328) $10.49
Forfeited (1) $10.24
Expired (9) $10.58
---------------
Balance December 31, 2004 156,881 $5.91 - 11.26
Granted 38,875 $18.20
Exercised (40,844) $10.69
Forfeited (3,321) $12.72
Expired (599) $10.24
---------------
Balance December 31, 2005 150,992 $13.45
==============
The weighted average exercise price of all exercisable options at December 31,
2005 is $11.81. There were 368,244 shares reserved for future issuance at
December 31, 2005.
- --------------------------------------------------------------------------------
55
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE K - STOCK OPTION PLAN (Continued)
Additional information concerning the Company's stock options at December 31,
2005 is as follows:
Remaining
Number Contractual Number
Exercise Price Outstanding Life Exercisable
- -------------- ----------- ---- -----------
$ 5.92 6,592 1.19 years 6,592
$10.24 23,413 .15 years 23,413
$11.52 43,362 1.16 years 43,362
$14.08 38,750 2.15 years 38,750
$18.20 38,875 3.15 years -
----------- -----------
150,992 112,117
========== ==========
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions used for
grants in 2005, 2004 and 2003:
2005 2004 2003
---------- ------------ -----------
Dividend yield 1.84% 2.06% 1.69%
Expected volatility 24.31% 21.92% 21.65%
Risk free interest rate 3.75% 3.00% 2.82%
Expected life 4 years 4 years 4 years
The weighted average fair value of options granted during 2005, 2004 and 2003
was $3.79, $2.46, and $2.57, respectively.
NOTE L - OTHER EMPLOYEE BENEFITS
Supplemental Retirement
In 1998, the Company's subsidiary, Four Oaks Bank & Trust Company, adopted a
Supplemental Executive Retirement Plan ("SERP") for its president. The Company
has purchased life insurance policies in order to provide future funding of
benefit payments. Plan benefits will accrue and vest during the period of
employment and will be paid in annual benefit payments over the officer's
remaining life commencing with the officer's retirement. The liability accrued
under the plan amounts to $122,000 and $99,000 at December 31, 2005 and 2004,
respectively. During 2005, 2004 and 2003, the expense attributable to this plan
amounted to $23,000, $20,000 and $18,000, respectively.
Employment Agreements
The Company has entered into employment agreements with certain of its executive
officers to ensure a stable and competent management base. The agreements
provide for benefits as spelled out in the contracts and cannot be terminated by
the Company's Board of Directors, except for cause, without prejudicing the
officers' rights to receive certain vested rights, including compensation. In
addition, the Company has entered into severance compensation agreements with
certain of its executive officers to provide them with severance pay benefits in
the event of a change in control of the Company, as outlined in the agreements,
the acquirer will be bound to the terms of the contracts.
- --------------------------------------------------------------------------------
56
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE L - OTHER EMPLOYEE BENEFITS (Continued)
Defined Contribution Plan
The Company sponsors a contributory profit-sharing plan in effect for
substantially all employees. Participants may make voluntary contributions
resulting in salary deferrals in accordance with Section 401(k) of the Internal
Revenue Code. The plans provide for employee contributions up to $14,000 of the
participant's annual salary and an employer contribution of 25% matching of the
first 6% of pre-tax salary contributed by each participant. Expenses related to
these plans for the years ended December 31, 2005, 2004 and 2003 were $79,000,
$47,000 and $56,000, respectively. Contributions under the plan are made at the
discretion of the Company's Board of Directors.
Employee Stock Ownership Plan
The Company sponsors an employee stock ownership plan (ESOP) which makes the
employees of a company, owners of stock in the company. The Four Oaks Bank &
Trust Company's Employee Stock Ownership Trust is available to full-time
employees at least 21 years of age after six months of service. Contributions
are voluntary by the Company and employees cannot contribute. Stock issued is
purchased on the open market and the Company does not issue new shares in
conjunction with this plan. Voluntary contributions are determined by the
Company's Board of Directors annually based on Company performance and are
allocated to employees based on annual compensation. Contribution expenses for
this plan for 2005, 2004, and 2003 were $223,000, $180,000, and $189,000,
respectively.
Employee Stock Purchase and Bonus Plan
The Employee Stock Purchase and Bonus Plan (the "Purchase Plan") is a voluntary
plan that enables full-time employees of the Company and its subsidiaries to
purchase shares of the Company's common stock. The Purchase Plan is administered
by a committee of the Board of Directors, which has broad discretionary
authority to administer the Purchase Plan. The Company's Board of Directors may
amend or terminate the Purchase Plan at any time. The Purchase Plan is not
intended to be qualified as an employee stock purchase plan under Section 423 of
the Internal Revenue Code of 1986, as amended.
Once a year, participants in the Purchase Plan purchase the Company's common
stock at fair market value. Participants are permitted to purchase shares under
the Purchase Plan up to (5%) of their compensation, with a maximum purchase
amount of $1,000 per year. The Company matches, in cash, fifty percent (50%) of
the amount of each participant's purchase, up to $500. After withholding for
income and employment taxes, participants use the balance of the Company's
matching grant to purchase shares of the Company's common stock.
As of December 31, 2005, 195,312 shares of the Company's common stock had been
reserved for issuance under the Purchase Plan, and 113,490 shares had been
purchased. During 2005, 6,872 shares were purchased under the Purchase Plan.
- --------------------------------------------------------------------------------
57
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE M - LEASES
The Bank has entered into non-cancelable operating leases for three branch
facilities. Future minimum lease payments under the leases for future years are
as follows (amounts in thousands):
2006 $ 62
2007 37
2008 16
2009 7
2010 -
----------------
$ 122
================
In addition, the Bank has leased a building from one of its directors for $938
and $908 per month in 2005 and 2004, respectively under an operating lease on a
month-to-month basis.
Total rental expense under operating leases for the years ended December 31,
2005, 2004 and 2003 amounted to $57,000 and $45,000 and $31,000, respectively.
NOTE N - PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information of Four Oaks Fincorp, Inc., the parent company,
at December 31, 2005 and 2004 and for the years ended December 31, 2005, 2004
and 2003 is presented below:
2005 2004
---------- -----------------
(Amounts in thousands)
Condensed Balance Sheets
Assets:
Cash and cash equivalents $ 3,940 $ 3,074
Equity investment in subsidiaries 37,462 33,665
Securities available for sale 668 695
---------------- --------------
Total assets $ 42,070 $ 37,434
================ ==============
Liabilities and Shareholders' Equity:
Liabilities:
Other liabilities $ 112 $ 139
Shareholders' equity 41,958 37,295
---------------- ---------------
Total liabilities and shareholders' equity $ 42,070 $ 37,434
================ ===============
- --------------------------------------------------------------------------------
58
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE N - PARENT COMPANY FINANCIAL INFORMATION (Continued)
2005 2004 2003
-------------- --------------- --------------
(Amounts in thousands)
Condensed Statements of Operations
Equity in earnings of subsidiaries $ 5,318 $ 4,361 $ 2,897
Interest income 81 30 22
Other investment income 17 15 17
Miscellaneous expenses (67) (31) (18)
-------------- --------------- --------------
Net income $ 5,349 $ 4,375 $ 2,918
============== =============== ==============
2005 2004 2003
-------------- --------------- --------------
(Amounts in thousands)
Condensed Statements of Cash Flows
Operating activities:
Net income $ 5,349 $ 4,375 $ 2,918
Equity in undistributed earnings of subsidiaries (5,318) (4,361) (2,897)
-------------- --------------- --------------
Cash flows provided by operating activities 31 14 21
-------------- --------------- --------------
Investing activities:
Purchase of securities available for sale (53) (14) (16)
Upstream dividend received from subsidiary 937 1,089 1,166
-------------- --------------- --------------
Cash flows provided by investing activities 884 1,075 1,150
-------------- --------------- --------------
Financing activities:
Proceeds from issuance of common stock 1,230 1,430 879
Purchases and retirements of common stock - (65) (993)
Dividends paid (1,279) (1,089) (960)
-------------- --------------- --------------
Cash flows used by financing activities (49) 276 (1,074)
--------------- --------------- --------------
Net increase in cash and cash equivalents 866 1,365 97
Cash and cash equivalents, beginning of year 3,074 1,709 1,612
-------------- --------------- --------------
Cash and cash equivalents, end of year $ 3,940 $ 3,074 $ 1,709
============== =============== ==============
NOTE O - FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, Disclosures about Fair Value of Financial Instruments,
requires the disclosure of estimated fair values for financial instruments.
Quoted market prices, if available, are utilized as an
- --------------------------------------------------------------------------------
59
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE O - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
estimate of the fair value of financial instruments. Because no quoted market
prices exist for a significant part of the Company's financial instruments, the
fair value of such instruments has been derived based on management's
assumptions with respect to future economic conditions, the amount and timing of
future cash flows and estimated discount rates. Different assumptions could
significantly affect these estimates. Accordingly, the net realizable value
could be materially different from the estimates presented below. In addition,
the estimates are only indicative of individual financial instruments' values
and should not be considered an indication of the fair value of the Company
taken as a whole. The following methods and assumptions were used to estimate
the fair value of each class of financial instrument.
Cash and Cash Equivalents
The carrying amounts of cash and cash equivalents are equal to the fair value
due to the liquid nature of the financial instruments.
Investment Securities Available for Sale
Fair values of investment securities available for sale are based on quoted
market prices. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities.
Loans
Fair values have been estimated by type of loan: residential real estate loans,
consumer loans, and commercial and other loans. For variable-rate loans that
reprice frequently and with no significant credit risk, fair values are based on
carrying values. The fair values of fixed rate loans are estimated by
discounting the future cash flows using the current rates at which loans with
similar terms would be made to borrowers with similar credit ratings and for the
same remaining maturities. The Company has assigned no fair value to off-balance
sheet financial instruments since they are either short term in nature or
subject to immediate repricing.
FHLB Stock
The carrying amount of FHLB stock approximates fair value.
Investment in Life Insurance
The carrying value of life insurance approximates fair value because this
investment is carried at cash surrender value, as determined by the insurer.
Deposits
The fair value of demand deposits, savings accounts and money market deposits is
the amount payable on demand at year-end. Fair value of time deposits is
estimated by discounting the future cash flows using the current rate offered
for similar deposits with the same maturities.
Borrowings
The fair values are based on discounting expected cash flows at the interest
rate for debt with the same or similar remaining maturities and collection
requirements.
- --------------------------------------------------------------------------------
60
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE O - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
Accrued Interest Receivable and Payable
The carrying amounts of accrued interest approximate fair value.
Derivative Financial Instruments
Fair values for interest rate swap agreements are based upon the amounts
required to settle the contracts.
The following table presents information for financial assets and liabilities as
of December 31, 2005 and 2004 (amounts in thousands):
2005 2004
---------------------------- ---------------------------------
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value
------ -------------- --------------- ---------------
Financial assets:
Cash and cash equivalents $ 22,915 $ 22,915 $ 14,249 $ 14,249
Securities available for sale 80,209 80,209 52,342 52,342
Loans, net 392,129 388,515 308,760 308,713
FHLB stock 3,655 3,655 2,621 2,621
Investment in life insurance 7,875 7,875 6,054 6,054
Accrued interest receivable 2,950 2,950 2,210 2,210
Financial liabilities:
Deposits $ 397,533 $ 375,517 $ 315,307 $ 309,801
Borrowings 74,140 73,651 43,160 41,651
Accrued interest payable 2,255 2,255 1,201 1,201
Derivative financial instruments:
Interest rate swap agreements:
Liabilities, net loss 1,765 1,765 213 213
- --------------------------------------------------------------------------------
61
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
- --------------------------------------------------------------------------------
NOTE P - CASH FLOW SUPPLEMENTAL DISCLOSURES
The following information is supplemental information regarding the cash flows
for the years ended December 31, 2005, 2004 and 2003:
2005 2004 2003
-------------- --------------- --------------
(Amounts in thousands)
Cash paid for:
Interest on deposits and borrowings $ 10,871 $ 5,895 $ 4,365
Income taxes 3,684 2,192 1,637
Summary of noncash investing and financing activities:
Transfer from loans to foreclosed assets 431 1,214 167
Loans to facilitate the sale of foreclosed assets - 393 111
Tax benefit from the exercise of non-qualified
stock options 101 94 18
Decrease in fair value of securities
available for sale, net of tax (565) (108) (141)
Decrease in fair value of cash flow hedge, net of tax (173) (222) (34)
NOTE Q - STOCK PURCHASE PLAN
On December 10, 2001, the Company's Board of Directors approved a Stock Purchase
Program authorizing the Company to purchase up to 100,000 shares, or
approximately 4.7% of the then outstanding shares of common stock. During 2004,
the Company purchased 2,800 shares at an average cost of $23.25 per share. The
2004 purchase amount does not reflect the five-for-four stock split during 2004
to shareholders of record as of October 15, 2004, payable on or after October
29, 2004 nor the five-for-four stock split to shareholders of record as of
November 9, 2005, payable on or after November 25, 2005. Effective December 31,
2005, the Company's Board of Directors extended this stock purchase plan until
December 31, 2006.
- --------------------------------------------------------------------------------
62
Item 9 - Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not Applicable.
Item 9A - Controls and Procedures.
As required by paragraph (b) of Rule 13a-15 under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), an evaluation was carried
out under the supervision and with the participation of our management,
including our Chief Executive Officer and our Chief Financial Officer of the
effectiveness of our disclosure controls and procedures (as such term is defined
in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the
period covered by this report. Based on such evaluation, our Chief Executive
Officer and our Chief Financial Officer have concluded that, as of the end of
the period covered by this report, our disclosure controls and procedures are
effective, in that they provide reasonable assurance that the information we are
required to disclose in the reports that we file or submit under the Exchange
Act is recorded, processed, summarized and reported within the time periods
required by the United States Securities and Exchange Commission's rules and
forms.
There have been no changes in our internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) during the fourth quarter of fiscal 2005 that we believe have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
Item 9B - Other Information.
Not Applicable.
PART III
This Part incorporates certain information from the definitive proxy
statement (the "2006 Proxy Statement") for the Company's 2006 Annual Meeting of
Shareholders, to be filed with the SEC within 120 days after the end of the
Company's fiscal year.
Item 10 - Directors and Executive Officers of the Registrant.
Director information is incorporated by reference from the sections
entitled "Information about Our Board of Directors," "Election of Directors,"
and under the section entitled "Section 16(a) Beneficial Ownership Reporting
Compliance," in the 2006 Proxy Statement. Information on our executive officers
is included under the caption "Our Executive Officers" on Page 9 of this report.
Information about our Code of Ethics is incorporated by reference from the
section entitled "Code of Ethics," in the 2006 Proxy Statement .
Item 11 - Executive Compensation.
This information is incorporated by reference from the sections
entitled "Executive Compensation," "Board Compensation Committee Report on
Executive Compensation," "Compensation Committee Interlocks and Insider
Participation" and "Comparison of Cumulative Total Return" in the 2006 Proxy
Statement.
Item 12 - Security Ownership of Certain Beneficial Owners and Management and
Related Shareholder Matters.
This information is incorporated by reference from the section entitled
"Security Ownership of Management and Certain Beneficial Owners" and the
sections entitled "Equity Compensation Plan Information," "Nonqualified Stock
Option Plan" and "Employee Stock Purchase and Bonus Plan" in the 2006 Proxy
Statement.
Item 13 - Certain Relationships and Related Transactions.
This information is incorporated by reference from the section entitled
"Certain Transactions" in the 2006 Proxy Statement.
Item 14 - Principal Accountant Fees and Services
Information regarding principal accountant fees and services is
incorporated by reference from the section entitled "Audit Firm Fee Summary" in
the 2006 Proxy Statement.
63
Item 15 - Exhibits, Financial Statement Schedules.
(a)(1) Financial Statements. The following financial statements and
supplementary data are included in Item 8 of this Annual Report on Form 10-K.
Form 10-K Page
--------------
Financial Statements
Report of Independent Registered Public Accounting Firm, Dixon Hughes PLLC, 31
dated March 15, 2006
Consolidated Balance Sheets as of December 31, 2005 and 2004 32
Consolidated Statements of Operations for the years ended December 31, 2005, 33
2004 and 2003
Consolidated Statements of Comprehensive Income for the years ended December 31, 34
2005, 2004 and 2003
Consolidated Statements of Shareholders' Equity for the years ended December 31, 35
2005, 2004 and 2003
Consolidated Statements of Cash Flows for the years ended December 31, 2005, 36
2004 and 2003
Notes to Consolidated Financial Statements 37
(a)(2) Financial Statement Schedules. All applicable financial
statement schedules required under Regulation S-X have been included in the
Notes to Consolidated Financial Statements.
(a)(3) Exhibits. The following exhibits are filed as part of this
Annual Report on Form 10-K.
Exhibit No. Description of Exhibit
----------- ----------------------
3.1 Articles of Incorporation of Four Oaks Fincorp, Inc. including Articles of Amendment to
Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 2004)
3.2 Bylaws of Four Oaks Fincorp, Inc. (incorporated by reference to Exhibit 3.2 to the
Company's Current Report on Form 8-K12G3 filed with the SEC on July 2, 1997)
4 Specimen of Certificate for Four Oaks Fincorp, Common Stock (incorporated by reference
to Exhibit 4 to the Company's Current Report on Form 8-K12G3 filed with the SEC on July
2, 1997)
10.1 Employment Agreement with Ayden R. Lee, Jr. (incorporated by reference to Exhibit 10.1
to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1997)
(management contract or compensatory plan, contract or arrangement)
10.2 Severance Compensation Agreement with Ayden R. Lee, Jr. (incorporated by reference to
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the period ended June
30, 1997) (management contract or compensatory plan, contract or arrangement)
10.3 Amended and Restated Nonqualified Stock Option Plan (incorporated by reference to
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the period ended June
30, 2004) (management contract or compensatory plan, contract or arrangement)
10.4 Amended and Restated Employee Stock Purchase and Bonus Plan (incorporated by reference to
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended June
30, 2004) (management contract or compensatory plan, contract or arrangement)
10.5 Amended and Restated Dividend Reinvestment and Stock Purchase Plan (incorporated by
reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC
on September 29, 2004) (management contract or compensatory plan, contract or
arrangement)
64
Exhibit No. Description of Exhibit
----------- ----------------------
10.6 Four Oaks Bank & Trust Company Supplemental Executive Retirement Plan (incorporated by
reference to Exhibit 10.6 to the Company's Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1998) (management contract or compensatory plan, contract or
arrangement)
10.7 Employment Agreement with Clifton L. Painter (incorporated by reference to Exhibit 10.7 to
the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 2001)
(management contract or compensatory plan, contract or arrangement)
10.8 Severance Compensation Agreement with Clifton L. Painter (incorporated by reference to
Exhibit 10.8 to the Company's Annual Report on Form 10-KSB for the period ended December
31, 2002) (management contract or compensatory plan, contract or arrangement)
10.9 Executive Employment Agreement with W. Leon Hiatt, III (incorporated by reference to
Exhibit 10.9 to the Company's Annual Report on Form 10-KSB for the period ended December
31, 2003) (management contract or compensatory plan, contract or arrangement)
10.10 Severance Compensation Agreement with W. Leon Hiatt, III (incorporated by reference to
Exhibit 10.10 to the Company's Annual Report on form 10-KSB for the period ended December
31, 2003) (management contract or compensatory plan, contract or arrangement)
10.11 Executive Employment Agreement with Nancy S. Wise (incorporated by reference to Exhibit
10.11 to the Company's Annual Report on Form 10-KSB for the period ended December 31,
2003) (management contract or compensatory plan, contract or arrangement)
10.12 Severance Compensation Agreement with Nancy S. Wise (incorporated by reference to Exhibit
10.12 to the Company's Annual Report on Form 10-KSB for the period ended December 31,
2003) (management contract or compensatory plan, contract or arrangement)
10.13 Form of Stock Option Agreement (Non-Employee Director) (incorporated by reference to
Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on March 1,
2005) (management contract or compensatory plan, contract or arrangement)
10.14 Form of Stock Option Agreement (Employee) (incorporated by reference to Exhibit 10.2 to
the Company's Current Report on Form 8-K filed with the SEC on March 1, 2005)
(management contract or compensatory plan, contract or arrangement)
10.15 Executive Employment Agreement with Jeff D. Pope (incorporated by reference to Exhibit
10.15 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31,
2004) (management contract or compensatory plan, contract or arrangement)
10.16 Severance Compensation Agreement with Jeff D. Pope (incorporated by reference to Exhibit
10.16 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31,
2004) (management contract or compensatory plan, contract or arrangement)
10.17 Summary of Non-Employee Director Compensation (incorporated by reference to Exhibit 10.1
to the Company's Current Report on Form 8-K filed with the SEC on January 25, 2006)
(management contract or compensatory plan, contract or arrangement)
21 Subsidiaries of Four Oaks Fincorp, Inc.
23 Consent of Dixon Hughes PLLC
31.1 Certification of Chief Executive Officer Pursuant to Rule 13a-14/15d-14 as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer Pursuant to Rule 13a-14/15d-14 as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. [This exhibit is
being furnished pursuant to Section 905 of the Sarbanes-Oxley Act of 2002 and shall not,
except to the extent required by that Act, be deemed to be incorporated by reference into
any document or filed herewith for the purposes of liability under the Securities
Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the
case may be.]
32.2 Certification of Chief Financial Officer to Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 [This exhibit is
being furnished pursuant to Section 905 of the Sarbanes-Oxley Act of 2002 and shall not,
except to the extent required by that Act, be deemed to be incorporated by reference into
any document or filed herewith for the purposes of liability under the Securities
Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the
case may be.]
65
(b) See (a)(3) above.
(c) See (a)(2) above.
66
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FOUR OAKS FINCORP, INC.
Date: March 27, 2006 By: /s/ Ayden R. Lee, Jr.
---------------------
Ayden R. Lee, Jr.
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
Date: March 27, 2006 /s/ Ayden R. Lee, Jr.
---------------------
Ayden R. Lee, Jr.
President, Chief Executive Officer
and Director
Date: March 27, 2006 /s/ Nancy S. Wise
---------------------
Nancy S. Wise
Executive Vice President and Chief
Financial Officer
Date: March 27, 2006 /s/ William J. Edwards
----------------------
William J. Edwards
Director
Date: March 27, 2006 /s/ Warren L. Grimes
---------------------
Warren L. Grimes
Director
Date: March 27, 2006 /s/ Dr. R. Max Raynor, Jr.
---------------------------
Dr. R. Max Raynor, Jr.
Director
Date: March 27, 2006 /s/ Percy Y. Lee
----------------------
Percy Y. Lee
Director
Date: March 27, 2006 /s/ Merwin S. Canaday
----------------------
Merwin S. Canaday
Director
Date: March 27, 2006 /s/ Paula C. Bowman
--------------------
Paula C. Bowman
Director
Date: March 27, 2006 /s/ William Ashley Turner
-------------------------
William Ashley Turner
Director
Date: March 27, 2006 /s/ Michael A. Weeks
--------------------
Michael A. Weeks
Director
67
EXHIBIT INDEX
Exhibit No. Description of Exhibit
----------- ----------------------
3.1 Articles of Incorporation of Four Oaks Fincorp, Inc. including Articles of Amendment to
Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 2004)
3.2 Bylaws of Four Oaks Fincorp, Inc. (incorporated by reference to Exhibit 3.2 to the
Company's Current Report on Form 8-K12G3 filed with the SEC on July 2, 1997)
4 Specimen of Certificate for Four Oaks Fincorp, Common Stock (incorporated by reference
to Exhibit 4 to the Company's Current Report on Form 8-K12G3 filed with the SEC on July
2, 1997)
10.1 Employment Agreement with Ayden R. Lee, Jr. (incorporated by reference to Exhibit 10.1
to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1997)
(management contract or compensatory plan, contract or arrangement)
10.2 Severance Compensation Agreement with Ayden R. Lee, Jr. (incorporated by reference to
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the period ended June
30, 1997) (management contract or compensatory plan, contract or arrangement)
10.3 Amended and Restated Nonqualified Stock Option Plan (incorporated by reference to
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the period ended June
30, 2004) (management contract or compensatory plan, contract or arrangement)
10.4 Amended and Restated Employee Stock Purchase and Bonus Plan (incorporated by reference to
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended June
30, 2004) (management contract or compensatory plan, contract or arrangement)
10.5 Amended and Restated Dividend Reinvestment and Stock Purchase Plan (incorporated by
reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC
on September 29, 2004) (management contract or compensatory plan, contract or
arrangement)
10.6 Four Oaks Bank & Trust Company Supplemental Executive Retirement Plan (incorporated by
reference to Exhibit 10.6 to the Company's Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1998) (management contract or compensatory plan, contract or
arrangement)
10.7 Employment Agreement with Clifton L. Painter (incorporated by reference to Exhibit 10.7 to
the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 2001)
(management contract or compensatory plan, contract or arrangement)
10.8 Severance Compensation Agreement with Clifton L. Painter (incorporated by reference to
Exhibit 10.8 to the Company's Annual Report on Form 10-KSB for the period ended December
31, 2002) (management contract or compensatory plan, contract or arrangement)
10.9 Executive Employment Agreement with W. Leon Hiatt, III (incorporated by reference to
Exhibit 10.9 to the Company's Annual Report on Form 10-KSB for the period ended December
31, 2003) (management contract or compensatory plan, contract or arrangement)
10.10 Severance Compensation Agreement with W. Leon Hiatt, III (incorporated by reference to
Exhibit 10.10 to the Company's Annual Report on form 10-KSB for the period ended December
31, 2003) (management contract or compensatory plan, contract or arrangement)
10.11 Executive Employment Agreement with Nancy S. Wise (incorporated by reference to Exhibit
10.11 to the Company's Annual Report on Form 10-KSB for the period ended December 31,
2003) (management contract or compensatory plan, contract or arrangement)
10.12 Severance Compensation Agreement with Nancy S. Wise (incorporated by reference to Exhibit
10.12 to the Company's Annual Report on Form 10-KSB for the period ended December 31,
2003) (management contract or compensatory plan, contract or arrangement)
10.13 Form of Stock Option Agreement (Non-Employee Director) (incorporated by reference to
Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on March 1,
2005) (management contract or compensatory plan, contract or arrangement)
68
Exhibit No. Description of Exhibit
----------- ----------------------
10.14 Form of Stock Option Agreement (Employee) (incorporated by reference to Exhibit 10.2 to
the Company's Current Report on Form 8-K filed with the SEC on March 1, 2005)
(management contract or compensatory plan, contract or arrangement)
10.15 Executive Employment Agreement with Jeff D. Pope (incorporated by reference to Exhibit
10.15 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31,
2004) (management contract or compensatory plan, contract or arrangement)
10.16 Severance Compensation Agreement with Jeff D. Pope (incorporated by reference to Exhibit
10.16 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31,
2004) (management contract or compensatory plan, contract or arrangement)
10.17 Summary of Non-Employee Director Compensation (incorporated by reference to Exhibit 10.1
to the Company's Current Report on Form 8-K filed with the SEC on January 25, 2006)
(management contract or compensatory plan, contract or arrangement)
21 Subsidiaries of Four Oaks Fincorp, Inc.
23 Consent of Dixon Hughes PLLC
31.1 Certification of Chief Executive Officer Pursuant to Rule 13a-14/15d-14 as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer Pursuant to Rule 13a-14/15d-14 as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. [This exhibit is
being furnished pursuant to Section 905 of the Sarbanes-Oxley Act of 2002 and shall not,
except to the extent required by that Act, be deemed to be incorporated by reference into
any document or filed herewith for the purposes of liability under the Securities
Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the
case may be.]
32.2 Certification of Chief Financial Officer to Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 [This exhibit is
being furnished pursuant to Section 905 of the Sarbanes-Oxley Act of 2002 and shall not,
except to the extent required by that Act, be deemed to be incorporated by reference into
any document or filed herewith for the purposes of liability under the Securities
Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the
case may be.]
69