UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
- --- ACT OF 1934
For the quarterly period ended September 30, 2006
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
For the transition period from to
------------ ------------
COMMISSION FILE NUMBER 1-5735
PROVIDENT COMMUNITY BANCSHARES, INC.
------------------------------------
(Exact name of registrant as specified in its Charter)
Delaware 57-1001177
-------- ----------
(State or other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
203 West Main Street, Union, South Carolina 29379
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(Address of Principal Executive Offices)
(864) 429-1864
--------------
(Registrant's telephone number, including area code)
Not Applicable
--------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
by Section 13 or 15(d) of the 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. Yes X No
--- ---
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. (Check
one):
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 Exchange Act.) Yes No X
---
The Corporation had 1,838,906 shares, $0.01 par value, of common stock issued
and outstanding as of October 26, 2006.
PROVIDENT COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
INDEX
Part I. Financial Information Page
--------------------- ----
Item 1. Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets as of September 30, 2006
and December 31, 2005 3
Consolidated Statements of Income for the three
and nine months ended September 30, 2006 and 2005 4
Consolidated Statements of Cash Flows for the nine
months ended September 30, 2006 and 2005 5
Consolidated Statements of Shareholders' Equity for the
nine months ended September 30, 2006 and 2005 6
Notes to Consolidated Financial Statements 7-12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12-27
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 27-29
Item 4. Controls and Procedures 29
Part II. Other Information
-----------------
Item 1. Legal Proceedings 30
Item 1A. Risk Factors 30
Item 2. Unregistered Sales of Equity Securities and
Use of Proceeds 30
Item 3. Defaults Upon Senior Securities 31
Item 4. Submission of Matters to a Vote of Security Holders 31
Item 5. Other Information 31
Item 6. Exhibits 31
Signatures 32
Part 1. Financial Information
PROVIDENT COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
(FORMERLY UNION FINANCIAL BANCSHARES, INC.)
CONSOLIDATED BALANCE SHEETS
September 30, 2006 (unaudited) and December 31, 2005
September 30, December 31,
ASSETS 2006 2005
---------------- ---------------
(DOLLARS IN THOUSANDS)
Cash and due from banks $ 10,804 $ 8,380
Investment and mortgage-backed securities
Held to maturity 3,187 3,204
Available for sale 117,091 143,079
---------------- ---------------
Total investment and mortgage-backed securities 120,278 146,283
---------------- ---------------
Loans, net 217,429 192,577
Office properties and equipment, net 5,632 5,148
Federal Home Loan Bank Stock, at cost 3,663 3,976
Federal Reserve Stock, at cost 539 539
Accrued interest receivable 2,375 2,429
Intangible assets 3,100 3,576
Cash surrender value of life insurance 5,557 5,404
Other assets 2,858 2,730
---------------- ---------------
TOTAL ASSETS $ 372,235 $ 371,042
================ ===============
LIABILITIES
Deposits $ 240,007 $ 239,603
Advances from the Federal Home Loan Bank 66,900 75,715
Securities sold under agreements to repurchase 25,000 20,000
Floating rate junior subordinated deferrable interest
debentures 12,371 8,247
Accrued interest payable 716 520
Advances from borrowers for taxes and insurance 213 33
Other liabilities 1,619 1,591
---------------- ---------------
TOTAL LIABILITIES 346,826 345,709
---------------- ---------------
Commitments and contingencies-Note 4
SHAREHOLDERS' EQUITY
Serial preferred stock, no par value,
authorized - 500,000 shares, issued
and outstanding - None -- --
Common stock - $0.01 par value,
authorized - 5,000,000 shares,
issued and outstanding - 1,838,906 shares at
9/30/06 and 1,905,897 at 12/31/05 20 20
Additional paid-in capital 12,468 12,346
Accumulated other comprehensive loss (717) (612)
Retained earnings, substantially restricted 18,301 16,916
Treasury stock, at cost (4,663) (3,337)
---------------- ---------------
TOTAL SHAREHOLDERS' EQUITY 25,409 25,333
---------------- ---------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 372,235 $ 371,042
================ ===============
See notes to consolidated financial statements.
3
PROVIDENT COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
(FORMERLY UNION FINANCIAL BANCSHARES, INC.)
CONSOLIDATED STATEMENTS OF INCOME
Three and Nine Months Ended September 30, 2006 and 2005 (unaudited)
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2006 2005 2006 2005
---------------- ---------------- ---------------- ----------------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE)
Interest Income:
Loans $ 4,387 $ 3,243 $ 12,306 $ 9,108
Deposits and federal funds sold 9 37 38 109
Mortgage-backed securities 248 305 808 1,050
Interest and dividends on
investment securities 1,374 1,319 4,062 3,756
---------------- ---------------- ---------------- ----------------
Total Interest Income 6,018 4,904 17,214 14,023
---------------- ---------------- ---------------- ----------------
Interest Expense:
Deposit accounts 2,037 1,349 5,647 3,770
Floating rate junior subordinated deferrable
interest debentures 249 150 596 417
Advances from the FHLB and other borrowings 1,181 827 3,084 2,308
---------------- ---------------- ---------------- ----------------
Total Interest Expense 3,467 2,326 9,327 6,495
---------------- ---------------- ---------------- ----------------
Net Interest Income 2,551 2,578 7,887 7,528
Provision for loan losses 45 220 355 768
---------------- ---------------- ---------------- ----------------
Net Interest Income After
Provision for Loan Losses 2,506 2,358 7,532 6,760
---------------- ---------------- ---------------- ----------------
Non-Interest Income:
Fees for financial services 693 667 2,055 1,856
Other fees, net 24 25 88 81
Net gain (loss) on sale of investments 3 -- (10) 5
---------------- ---------------- ----------------
Total Non-Interest Income 720 692 2,133 1,942
---------------- ---------------- ---------------- ----------------
Non-Interest Expense:
Compensation and employee benefits 1,095 1,012 3,327 3,010
Occupancy and equipment 465 492 1,477 1,523
Deposit insurance premiums 8 8 23 24
Professional services 107 86 330 276
Advertising/public relations 118 46 214 106
Loan operations 30 101 60 179
Deposit premium intangible 159 159 477 477
Items processing 46 49 145 110
Telephone 38 50 128 135
Other 228 167 673 523
---------------- ---------------- ---------------- ----------------
Total Non-Interest Expense 2,294 2,170 6,854 6,363
---------------- ---------------- ---------------- ----------------
Income Before Income Taxes 932 880 2,811 2,339
Income tax expense 281 242 822 613
---------------- ---------------- ---------------- ----------------
Net Income $ 651 $ 638 $ 1,989 $ 1,726
================ ================ ================ ================
Basic Net Income Per Common Share $ 0.35 $ 0.33 $ 1.06 $ 0.90
================ ================ ================ ================
Diluted Net Income Per Common Share $ 0.35 $ 0.33 $ 1.05 $ 0.88
================ ================ ================ ================
Weighted Average Number of
Common Shares Outstanding
Basic 1,846,643 1,906,555 1,876,630 1,914,269
Diluted 1,876,417 1,952,840 1,901,830 1,971,592
See notes to consolidated financial statements.
4
PROVIDENT COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
(FORMERLY UNION FINANCIAL BANCSHARES, INC.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 2006 and 2005 (unaudited)
Nine Months Ended
September 30, September 30,
2006 2005
----------------- -----------------
(DOLLARS IN THOUSANDS)
OPERATING ACTIVITIES:
Net income $1,989 $1,726
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for loan losses 355 768
Amortization of intangibles 477 477
Depreciation expense 456 672
Recognition of deferred income, net of costs (388) (272)
Deferral of fee income, net of costs 407 238
(Gain) loss on investment transactions 10 (42)
Changes in operating assets and liabilities:
Decrease in accrued interest receivable 54 107
Increase in other assets (281) (587)
Increase in other liabilities 208 1,238
Increase in accrued interest payable 196 173
----------------- -----------------
Net cash provided by operating activities 3,483 4,498
----------------- -----------------
INVESTING ACTIVITIES:
Purchase of investment and mortgage-backed securities:
Available for sale (9,218) (49,746)
Held to maturity -- (4,605)
Proceeds from sale of investment and mortgage-
backed securities 18,257 10,911
Proceeds from maturity of investment and mortgage-
backed securities:
Available for sale 12,126 31,705
Held to maturity -- 3,000
Principal repayments on mortgage-backed securities:
Available for sale 4,724 8,360
Net increase in loans (25,226) (11,075)
Purchase of FHLB stock -- (39)
Redemption of FHLB stock 313 --
Purchase of office properties and equipment (940) (185)
----------------- -----------------
Net cash (used) provided by investing activities 36 (11,674)
----------------- -----------------
FINANCING ACTIVITIES:
Proceeds from the dividend reinvestment plan 85 78
Dividends paid in cash ($0.32 per share -2006
and $0.30 per share - 2005) (604) (577)
Proceeds from the exercise of stock options 37 84
Share repurchase program (1,326) (1,349)
Proceeds from the issuance of trust preferred securities 4,124 --
Decrease in other borrowings (3,815) (5,000)
Increase in deposit accounts 404 11,727
----------------- -----------------
Net cash (used) provided by financing activities (1,095) 4,963
----------------- -----------------
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS 2,424 (2,213)
CASH AND CASH EQUIVALENTS
AT BEGINNING OF PERIOD 8,380 13,197
----------------- -----------------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $10,804 $10,984
================= =================
SUPPLEMENTAL DISCLOSURES:
Cash paid for:
Income taxes $791 $1,652
Interest 9,131 6,292
Non-cash transactions:
Loans foreclosed $188 $54
See notes to consolidated financial statements.
5
PROVIDENT COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
(FORMERLY UNION FINANCIAL BANCSHARES, INC.)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
Nine Months Ended September 30, 2006 and 2005 (unaudited)
Retained Accumulated
Additional Earnings, Other Treasury Total
Common Stock Paid-in Substantially Comprehensive Stock Shareholders'
Shares Amount Capital Restricted Income (loss) At Cost Equity
------ ------ ------- ---------- ------------- ------- ------
(Dollars in Thousands, Except Share Data)
BALANCE AT DECEMBER 31, 2004 1,957,989 $20 $12,109 $15,221 $109 ($1,440) $26,019
Net income 1,726 1,726
Other comprehensive income, net of tax
Unrealized holding losses on securities
available for sale arising during period,
net of tax effect of $185 (450) (450)
Reclassification adjustment for gains
included in net income, net of tax of $2 5 5
Comprehensive income 1,281
Stock option activity, net 35,044 84 84
Dividend reinvestment plan contributions 4,557 78 78
Share repurchase program (81,108) (1) 1 (1,349) (1,349)
Cash dividend ($.30 per share) (577) (577)
------------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 2005 1,916,482 $19 $12,271 $16,371 ($336) ($2,789) $25,536
====================================================================================
BALANCE AT DECEMBER 31, 2005 1,905,897 $20 $12,346 $16,916 ($612) ($3,337) $25,333
Net income 1,989 1,989
Other comprehensive income, net of tax
Unrealized holding losses on securities
available for sale arising during period,
net of tax effect of $386 (98) (98)
Reclassification adjustment for losses
included in net income, net of tax of $3 (7) (7)
Comprehensive income 1,084
Stock option activity, net 2,203 37 37
Dividend reinvestment plan contributions 4,864 85 85
Share repurchase program (74,058) (1,326) (1,326)
Cash dividend ($.32 per share) (604) (604)
------------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 2006 1,838,906 $20 $12,468 $18,301 ($717) ($4,663) $25,409
====================================================================================
6
PROVIDENT COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
(FORMERLY UNION FINANCIAL BANCSHARES, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Presentation of Consolidated Financial Statements
-------------------------------------------------
The accompanying unaudited consolidated financial statements of Provident
Community Bancshares, Inc. (the "Corporation" or "Provident") were prepared in
accordance with instructions for Form 10-Q and, therefore, do not include all
disclosures necessary for a complete presentation of consolidated financial
condition, results of operations, and cash flows in conformity with accounting
principles generally accepted in the United States of America. However, all
adjustments which are, in the opinion of management, necessary for the fair
presentation of the interim consolidated financial statements have been
included. All such adjustments are of a normal and recurring nature. The results
of operations for the nine months ended September 30, 2006 are not necessarily
indicative of the results which may be expected for the entire calendar year.
Certain amounts in the prior year's financial statements have been reclassified
to conform with current year classifications.
Recently Issued Accounting Standards
The following is a summary of recent authoritative pronouncements that affect
accounting, reporting, and disclosure of financial information by the
Corporation:
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid
Financial Instruments--an amendment of FASB Statements No. 133 and 140." This
Statement amends SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," and SFAS No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities." This Statement resolves
issues addressed in SFAS No. 133 Implementation Issue No. D1, "Application of
Statement 133 to Beneficial Interests in Securitized Financial Assets." SFAS No.
155 is effective for all financial instruments acquired or issued after the
beginning of an entity's first fiscal year that begins after September 15, 2006.
The Corporation does not believe that the adoption of SFAS No. 155 will have a
material impact on its financial position, results of operations and cash flows.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets--an amendment of FASB Statement No. 140." This Statement amends
FASB No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," with respect to the accounting for separately
recognized servicing assets and servicing liabilities. SFAS No. 156 requires an
entity to recognize a servicing asset or servicing liability each time it
undertakes an obligation to service a financial asset by entering into a
servicing contract; requires all separately recognized servicing assets and
servicing liabilities to be initially measured at fair value, if practicable;
permits an entity to choose its subsequent measurement methods for each class of
separately recognized servicing assets and servicing liabilities; at its initial
7
adoption, permits a one-time reclassification of available-for-sale securities
to trading securities by entities with recognized servicing rights, without
calling into question the treatment of other available-for-sale securities under
Statement 115, provided that the available-for-sale securities are identified in
some manner as offsetting the entity's exposure to changes in fair value of
servicing assets or servicing liabilities that a servicer elects to subsequently
measure at fair value; and requires separate presentation of servicing assets
and servicing liabilities subsequently measured at fair value in the statement
of financial position and additional disclosures for all separately recognized
servicing assets and servicing liabilities. An entity should adopt SFAS No. 156
as of the beginning of its first fiscal year that begins after September 15,
2006. The Corporation believes the adoption of SFAS No. 156 will not have a
material impact on its financial position, results of operations or cash flows.
In July 2006, the FASB issued FASB Interpretation No. 48 ("FIN 48"), "Accounting
for Uncertainty in Income Taxes". FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an enterprises' financial statements
in accordance with FASB Statement No. 109, "Accounting for Income Taxes". FIN 48
prescribes a recognition threshold and measurement attributable for the
financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosures and transitions. FIN 48 is effective for fiscal years
beginning after December 15, 2006. The Corporation is currently analyzing the
effects of FIN 48.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." SFAS
157 defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles, and expands disclosures about fair
value measurements. SFAS 157 is effective for the Corporation on January 1, 2008
and is not expected to have a significant impact on the Corporation's financial
statements.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans" ("SFAS 158"), which
amends SFAS 87 and SFAS 106 to require recognition of the overfunded or
underfunded status of pension and other postretirement benefit plans on the
balance sheet. Under SFAS 158, gains and losses, prior service costs and
credits, and any remaining transition amounts under SFAS 87 and SFAS 106 that
have not yet been recognized through net periodic benefit cost will be
recognized in accumulated other comprehensive income, net of tax effects, until
they are amortized as a component of net periodic cost. The measurement date --
the date at which the benefit obligation and plan assets are measured -- is
required to be the company's fiscal year end. SFAS 158 is effective for
publiclyaheld companies for fiscal years ending after December 15, 2006, except
for the measurement date provisions, which are effective for fiscal years ending
after December 15, 2008. The Corporation is currently analyzing the effects of
SFAS 158 but does not expect its implementation will have a significant impact
on the Corporation's financial conditions or results of operations.
In September, 2006, The FASB ratified the consensuses reached by the FASB's
Emerging Issues Task Force (EITF) relating to EITF 06-4 "Accounting for the
Deferred Compensation and Postretirement Benefit Aspects of Endorsement
Split-Dollar Life Insurance Arrangements". EITF 06-4 addresses employer
accounting for endorsement split-dollar life insurance arrangements that provide
a benefit to an employee that extends to postretirement periods should recognize
a liability for future benefits in accordance with FASB Statement of Financial
8
Accounting Standards (SFAS) No. 106, "Employers' Accounting for Postretirement
Benefits Other Than Pensions", or Accounting Principles Board (APB) Opinion No.
12, "Omnibus Opinion--1967". EITF 06-4 is effective for fiscal years beginning
after December 15, 2006. Entities should recognize the effects of applying this
Issue through either (a) a change in accounting principle through a
cumulative-effect adjustment to retained earnings or to other components of
equity or net assets in the statement of financial position as of the beginning
of the year of adoption or (b) a change in accounting principle through
retrospective application to all prior periods. The Corporation does not believe
the adoption of EITF 06-4 will have a material impact on its financial position,
results of operations and cash flows.
On September 13, 2006, the SEC issued Staff Accounting Bulleting No. 108 ("SAB
108"). SAB 108 provides interpretive guidance on how the effects of the
carryover or reversal of prior year misstatements should be considered in
quantifying a potential current year misstatement. Prior to SAB 108, Companies
might evaluate the materiality of financial statement misstatements using either
the income statement or balance sheet approach, with the income statement
approach focusing on new misstatements added in the current year, and the
balance sheet approach focusing on the cumulative amount of misstatement present
in a company's balance sheet. Misstatements that would be material under one
approach could be viewed as immaterial under another approach, and not be
corrected. SAB 108 now requires that companies view financial statement
misstatements as material if they are material according to either the income
statement or balance sheet approach. The Corporation has analyzed SAB 108 and
determined that upon adoption it will have no impact on the reported results of
operations or financial conditions.
Other accounting standards that have been issued or proposed by the FASB or
other standards-setting bodies that do not require adoption until a future date
are not expected to have a material impact on the consolidated financial
statements upon adoption.
2. Income Per Share
----------------
Basic income per share amounts for the three and nine months ended September 30,
2006 and 2005 were computed based on the weighted average number of common
shares outstanding during the period. Diluted income per share adjusts for the
dilutive effect of outstanding common stock options during the periods utilizing
the treasury stock method. Common stock equivalents included in the diluted
earnings per share calculation for the nine months ended September 30, 2006 and
2005 were 25,200 and 57,323, respectively.
3. Assets Pledged
-------------
Approximately $65,858,000 and $83,170,000 of debt securities at September 30,
2006 and December 31, 2005, respectively, were pledged by Provident Community
Bank, N.A. (the "Bank") as collateral to secure deposits of the State of South
Carolina, and Union, Laurens and York counties along with additional borrowings
and repurchase agreements. The Bank pledges as collateral for Federal Home Loan
Bank advances the Bank's Federal Home Loan Bank stock and has entered into a
blanket collateral agreement with the Federal Home Loan Bank whereby the Bank
maintains, free of other encumbrances, qualifying mortgages (as defined) with
unpaid principal balances equal to, when discounted at 75% of the unpaid
9
principal balances, 100% of total advances. As part of the total assets pledged,
the Bank will also pledge securities to cover additional advances from the
Federal Home Loan Bank that exceed the qualifying mortgages balance along with
security repurchase lines with various brokerage houses.
4. Contingencies and Loan Commitments
----------------------------------
In the ordinary course of business, the Bank enters into financial instruments
with off-balance-sheet risk to meet the financing needs of its customers. These
instruments expose the Bank to credit risk in excess of the amount recognized on
the balance sheet.
The Bank's exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit is
represented by the contractual amount of those instruments. The Bank uses the
same credit policies in making commitments and conditional obligations as it
does for on-balance-sheet instruments. Total credit exposure at September 30,
2006 related to these items is summarized below:
Loan Commitments: Contract Amount
Approved loan commitments $ 2,545,000
Unadvanced portions of loans and credit lines 45,787,000
----------
Total loan commitments $48,332,000
==========
Loan commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract. Loan
commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. The Bank evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained upon
extension of credit is based on management's credit evaluation of the counter
party. Collateral held is primarily residential and commercial property.
Commitments outstanding at September 30, 2006 consisted of fixed and adjustable
rate loans at rates ranging from 6.5% to 8.5%. Commitments to originate loans
generally expire within 30 to 60 days.
Commitments to fund loans, including credit lines (principally variable rate,
consumer lines secured by real estate and overdraft protection) totaled
approximately $110,052,000 at September 30, 2006. Of these lines, the
outstanding loan balances totaled approximately $64,265,000.
5. Fixed/Floating Rate Junior Subordinated Deferrable Interest Debentures
----------------------------------------------------------------------
On July 21, 2006, the Corporation completed a private placement of $4 million in
trust preferred securities. In connection with the sale of the trust preferred
securities, the Corporation issued $4,124,000 aggregate principal amount of
Fixed/Floating Rate Junior Subordinated Debt Securities due 2036. The Company
intends to use the proceeds from the issuance of the trust preferred securities
for general corporate purposes and to increase the regulatory capital of the
Bank. The trust preferred securities will bear a rate equal to 7.393% for the
first five years following the offering. After the first five years, the
securities will bear a rate equal to 174 basis points over the three-month
LIBOR. The Subordinated Debt Securities bear an identical interest rate. The
trust preferred securities were issued by a statutory business trust formed by
the Corporation and were sold in a private placement pursuant to an applicable
exemption from registration under the Securities Act of 1933, as amended.
10
A summary of the Subordinated Deferrable Interest Debentures issued and
outstanding follows:
- --------------------------------------------------------------------------------------------------------------------
Amount Outstanding Distribution
at Prepayment Payment
September 30, Option Date Maturity Frequency
- --------------------------------------------------------------------------------------------------------------------
Name 2006 2005 Rate
- --------------------------------------------------------------------------------------------------------------------
Union Financial Statutory $8,000,000 $8,000,000 8.99% December 18, 2006 December 18, 2031 Quarterly
Trust I
- --------------------------------------------------------------------------------------------------------------------
Provident Community 4,000,000 - 7.39% October 1, 2011 October 1, 2036 Quarterly
Bancshares Capital Trust I
- --------------------------------------------------------------------------------------------------------------------
Total $12,000,000
6. Stock-Based Compensation
------------------------
On January 1, 2006, the Company adopted the fair value recognition
provisions of Financial Accounting Standards Board ("FASB") Statement of
Financial Accounting Standards ("SFAS") No. 123(R), Accounting for Stock-Based
Compensation, to account for compensation costs under its stock option plans.
The Company previously utilized the intrinsic value method under Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (as
amended) ("APB 25"). Under the intrinsic value method prescribed by APB 25, no
compensation costs were recognized for the Company's stock options because the
option exercise price in its plans equals the market price on the date of grant.
Prior to January 1, 2006, the Company only disclosed the pro forma effects on
net income and earnings per share as if the fair value recognition provisions of
SFAS 123(R) had been utilized.
In adopting SFAS No. 123(R), the Company elected to use the modified prospective
method to account for the transition from the intrinsic value method to the fair
value recognition method. Under the modified prospective method, compensation
cost is recognized from the adoption date forward for all new stock options
granted and for any outstanding unvested awards as if the fair value method had
been applied to those awards as of the date of grant. The following table
illustrates the effect on net income and earnings per share as if the fair value
based method had been applied to all outstanding and unvested awards in each
period (in thousands, except per share amounts).
11
Nine Months Ended
September 30,
2006 2005
-----------------------------
Net income as reported $1,989 $1,726
Add: Stock-based employee compensation expense included in reported
net income, net of related tax effects. 34 --
Deduct: Total stock-based employee compensation expense determined
under fair value based method for all awards, net of related tax
effects (34) (144)
Pro forma net income including stock-based compensation cost based
on fair-value method $1,989 $1,582
============ =============
Earnings per share:
Basic--as reported $ 1.06 $ 0.90
============ =============
Basic--pro forma $ 1.06 $ 0.83
============ =============
Diluted--as reported $ 1.05 $ 0.88
============ =============
Diluted--pro forma $ 1.05 $ 0.80
============ =============
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Critical Accounting Policies
- ----------------------------
The Corporation has adopted various accounting policies which govern the
application of accounting principles generally accepted in the United States of
America in the preparation of financial statements.
Certain accounting policies involve significant judgments and assumptions by
management which could have a material impact on the carrying value of certain
assets and liabilities. Management considers such accounting policies to be
critical accounting policies. The judgments and assumptions used by management
are based on historical experience and other factors, which are believed to be
reasonable under the circumstances. Because of the nature of the judgments and
assumptions made by management, actual results could differ from these judgments
and estimates which could have a material impact on the carrying values of
assets and liabilities and the results of operations of the Corporation.
The Corporation believes the allowance for loan losses is a critical accounting
policy that requires significant judgments and estimates used in the preparation
of consolidated financial statements. Management reviews the level of the
allowance on a monthly basis and establishes the provision for loan losses based
on the nature and volume of the loan portfolio, overall portfolio quality,
delinquency levels, a review of specific problem loans, loss experience,
economic conditions, and other factors related to the collectibility of the loan
portfolio. A portion of the allowance is established by segregating the loans by
residential mortgage, commercial and consumer loans and assigning allocation
percentages based on historical loss experience and delinquency trends. The
applied allocation percentages are reevaluated at least annually to ensure their
relevance in the current economic environment. Accordingly, increases in the
size of the loan portfolio and the increased emphasis on commercial real estate
and commercial business loans, which carry a higher degree of risk of default
and, thus, a higher allocation percentage, increases the allowance.
Additionally, a portion of the allowance is established based on the level of
classified assets.
12
Although the Corporation believes that it uses the best information available to
establish the allowance for loan losses, future additions to the allowance may
be necessary based on estimates that are susceptible to change as a result of
changes in economic conditions and other factors. In addition, the Office of the
Comptroller of the Currency, as an integral part of its examination process,
will periodically review the Corporation's allowance for loan losses. Such
agency may require the Corporation to recognize adjustments to the allowance
based on its judgments about information available to it at the time of its
examination.
Forward Looking Statements
- --------------------------
Management's discussion and analysis of financial condition and results of
operations and other portions of this Form 10-Q may contain certain
"forward-looking statements" concerning the future operations of the Corporation
and the Bank. These forward-looking statements are generally identified by the
use of the words "believe," "expect," "intend," "anticipate," "estimate,"
"project," or similar expressions. Management intends to take advantage of the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995
and is including this statement for the express purpose of availing the
Corporation of the protections of such safe harbor with respect to all
forward-looking statements contained in this report to describe future plans and
strategies. Management's ability to predict results or the effect of future
plans or strategies is inherently uncertain. Factors which could effect actual
results include interest rate trends, the general economic climate in the
Corporation's and the Bank's market area and the country as a whole, the ability
of the Corporation and the Bank to control costs and expenses, competitive
products and pricing, loan delinquency rates, the quality and composition of the
loan and investment portfolios, changes in accounting principles and guidelines
and changes in federal and state regulation. These factors should be considered
in evaluating the forward-looking statements, and undue reliance should not be
placed on such statements.
Except as required by applicable law or regulation, the Corporation does not
undertake, and specifically disclaims any obligation, to release publicly the
result of any revisions that may be made to any forward looking statements to
reflect events or circumstances after the date of these statements or to reflect
the occurrence of anticipated or unanticipated events.
Financial Condition
- -------------------
Assets
- ------
Total assets of the Corporation increased $1,193,000, or 0.32%, to $372,235,000
at September 30, 2006 from $371,042,000 at December 31, 2005. Investments and
mortgage-backed securities decreased approximately $26,005,000, or 17.78%, from
December 31, 2005 to September 30, 2006, due to the sale and maturity of
securities. Proceeds from the maturity and sale of investment securities were
utilized to fund growth in higher-yielding loans.
13
Investment and Mortgage-backed Securities
- -----------------------------------------
Held to Maturity-Securities classified as held to maturity consisted of the
following (in thousands):
September 30, 2006 December 31, 2005
------------------- ------------------
Fair Amortized Fair Amortized
Cost Value Cost Value
------ ------ ------ ------
Municipal Securities $3,187 $3,236 $3,204 $3,247
====== ====== ====== ======
Available for Sale-Securities classified as available for sale consisted of the
following (in thousands):
September 30, 2006 December 31, 2005
------------------ -----------------
Fair Amortized Fair Amortized
Cost Value Cost Value
------ ------ ------ ------
Investment Securities:
U.S. Agency Obligations $70,474 $69,501 $84,631 $83,443
Municipal Securities 10,598 10,966 17,328 18,180
Other 15,302 15,395 14,530 14,621
------ ------ ------ ------
Total Investment Securities 96,374 95,862 116,489 116,244
------ ------ ------ ------
Mortgage-backed Securities:
Fannie Mae 13,786 13,298 17,370 16,771
Ginnie Mae 57 59 67 69
Freddie Mac 3,390 3,398 4,572 4,579
Collateralized Mortgage Obligations 4,586 4,474 5,523 5,416
------ ------ ------ ------
Total Mortgage-backed Securities 21,819 21,229 27,532 26,835
------ ------ ------ ------
Total Available for Sale $118,193 $117,091 $144,021 $143,079
====== ====== ====== ======
Loans
- -----
Loans increased $24,852,000, or 12.90%, to $217,429,000 at September 30, 2006.
The Corporation continues to focus on consumer and commercial lending with
specialized loan officers and products.
14
Loans receivable consisted of the following (in thousands):
September 30, December 31,
2006 2005
------------- ------------
Mortgage loans:
Fixed rate residential $19,560 $23,859
Adjustable-rate residential 9,906 12,701
Commercial real estate 56,281 45,665
Construction 6,655 4,842
------ ------
Total mortgage loans 92,402 87,067
Commercial loans:
Commercial non-real estate 37,779 39,453
Commercial lines of credit 47,519 31,215
------ ------
Total commercial loans 85,298 70,668
------ ------
Consumer loans:
Home equity 16,374 16,427
Consumer and installment 28,991 23,067
Consumer lines of credit 372 382
------ ------
Total consumer loans 45,737 39,876
------ ------
Total loans 223,437 197,611
------ ------
Less:
Undisbursed portion of interim
construction loans (2,842) (1,980)
Unamortized loan discount (631) (764)
Allowance for loan losses (2,615) (2,394)
Net deferred loan origination costs 80 104
------ ------
Total, net $217,429 $192,577
====== ======
Weighted-average interest rate of loans 7.99% 7.64%
Liabilities
- -----------
Total liabilities increased $1,117,000, or 0.32%, to $346,826,000 at September
30, 2006 from $345,709,000 at December 31, 2005. Deposits increased $404,000, or
0.17%, to $240,007,000 at September 30, 2006 from $239,603,000 at December 31,
2005. The increase was due primarily to growth in lower cost demand accounts
offset by a reduction in higher cost certificates of deposit accounts. The
Corporation continues to target lower cost demand deposit accounts through media
advertising.
15
Deposit accounts were as follows (in thousands):
September 30, 2006 December 31, 2005
-------------------------- -------------------------
Rate Balance % Rate Balance %
-------- ------- --- -------- ------- ---
Account Type
- ------------
NOW accounts:
Commercial non-interest-bearing -- $15,854 6.61% -- $14,651 6.11%
Non-commercial 2.62% 52,380 21.82% 1.93% 51,447 21.47%
Money market checking accounts 4.34% 14,818 6.17% 2.55% 14,414 6.02%
Regular savings 0.63% 15,447 6.44% 0.43% 16,733 6.98%
-------- -------- -------- --------
Total demand and savings deposits 2.33% 98,499 41.04% 1.50% 97,245 40.58%
-------- -------- -------- --------
Savings certificates:
Up to 3.00% 23,867 9.94% 55,105 23.00%
3.01 %- 4.00% 27,904 11.63% 56,033 23.38%
4.01 %- 5.00% 43,985 18.33% 23,862 9.96%
5.01 %- 6.00% 39,994 16.66% 2,720 1.13%
6.01 %- 7.00% 23 0.01% 23 0.02%
-------- -------- -------- --------
Total savings certificates 3.66% 135,773 56.57% 2.75% 137,743 57.49%
-------- -------- -------- --------
Sweep accounts 5.00% 5,735 2.39% 3.43% 4,615 1.93%
-------- -------- -------- --------
Total deposit accounts 3.07% $240,007 100.00% 2.57% $239,603 100.00%
======== ======== ======== ========
At September 30, 2006 and December 31, 2005, the Bank had $66,900,000 and
$75,715,000, respectively, of advances outstanding from the FHLB. The maturity
of the advances from the FHLB is as follows (in thousands):
September 30, 2006 December 31, 2005
Wtd Avg Rate Wtd Avg Rate
------------------ -----------------
Contractual Maturity:
Within one year - fixed rate $13,000 4.97% $10,000 2.35%
Within one year - adjustable rate 30,400 5.45% 23,215 4.08%
After one but within three years - fixed rate - -% 3,000 3.35%
After one but within three years - adjustable rate 12,500 5.30% 5,000 3.79%
After three but within five years - adjustable rate - -% 7,500 5.30%
Greater than five years - adjustable rate 11,000 4.16% 27,000 4.24%
------ ------
Total advances $66,900 5.12% $75,715 3.98%
====== ======
The Bank pledges as collateral for the advances its FHLB stock and investment
securities and has entered into a blanket collateral agreement with the FHLB
whereby the Bank maintains, free of other encumbrances, qualifying loans (as
defined) with unpaid principal balances equal to, when discounted at 50% to 75%
of the unpaid principal balances, 100% of total advances. Borrowings from the
Federal Home Loan Bank (the "FHLB") decreased $8,815,000, or 11.64%, to
$66,900,000 at September 30, 2006 from $75,715,000 at December 31, 2005.
Securities sold under agreement to repurchase increased $5,000,000 to
$25,000,000 at September 30, 2006 from $20,000,000 at December 31, 2005. During
this period, securities sold under agreement to repurchase provided a lower cost
16
funding alternative to Federal Home Loan Bank advances. Borrowings were reduced
with deposit growth and the proceeds from reductions in investments and
mortgage-backed securities. In addition, on July 21, 2006, the Corporation
completed a private placement of $4 million in trust preferred securities
thereby increasing outstanding balances to $12 million at September 30, 2006
compared to $8 million at September 30, 2005.
Shareholders' Equity
- --------------------
Shareholders' equity increased $76,000, or 0.30%, to $25,409,000 at September
30, 2006 from $25,333,000 at December 31, 2005 due to net income of $1,989,000
and $122,000 in additional paid-in capital due to stock option exercises and
shares issued under the dividend reinvestment plan, offset by the repurchase of
74,058 shares at a cost of $1,326,000, dividend payments of $0.32 per share at a
cost of $604,000 and a $105,000 increase in unrealized losses on securities
available for sale.
Liquidity
- ---------
Liquidity is the ability to meet demand for loan disbursements, deposit
withdrawals, repayment of debt, payment of interest on deposits and other
operating expenses. The primary sources of liquidity are deposits, loan
repayments, borrowings, maturity and sale of securities and interest payments.
While maturities and scheduled amortization of loans and securities are
predictable sources of funds, deposit outflows and mortgage prepayments are
greatly influenced by general interest rates, economic conditions and
competition. The primary investing activities of the Corporation are the
origination of commercial and consumer loans, and the purchase of investment and
mortgage-backed securities. These activities are funded primarily by principal
and interest payments on loans and investment securities, deposit growth,
securities sold under agreements to repurchase and the utilization of FHLB
advances.
At September 30, 2006, the Corporation's investment in marketable securities
totaled $120,278,000, nearly all of which is available for sale. Approximately
$65,858,000 and $83,170,000 of debt securities at September 30, 2006 and
December 31, 2005, respectively, were pledged by the Bank as collateral to
secure deposits of the State of South Carolina, and Union, Laurens and York
counties along with additional borrowings and repurchase agreements.
Additionally, outstanding loan commitments (including commitments to fund credit
lines) totaled $110,052,000 at September 30, 2006. Management of the Corporation
anticipates that it will have sufficient funds available to meet its current
loan commitments.
The Corporation closely monitors its liquidity position on a daily basis.
Certificates of deposit, which are scheduled to mature in one year or less from
September 30, 2006, totaled $104,004,000. The Corporation relies primarily on
competitive rates, customer service, and long-standing relationships with
customers to retain deposits. From time to time, the Corporation will also offer
special products to its customers to increase retention and to attract new
deposits. Based upon the Corporation's experience with deposit retention and
current retention strategies, management believes that, although it is not
17
possible to predict future terms and conditions upon renewal, a significant
portion of such deposits will remain with the Corporation. If the Corporation
requires funds beyond its ability to generate them internally, additional
sources of funds are available through FHLB advances, securities sold under
agreements to repurchase and lines of credit. At September 30, 2006, the
Corporation had outstanding $66,900,000 of FHLB borrowings and $25,000,000 of
securities sold under agreements to repurchase. At September 30, 2006, the
Corporation had unused short-term lines of credit to purchase federal funds from
unrelated banks totaling $19,000,000 and the ability to borrow an additional
$10,000,000 from FHLB and secured borrowing lines. Lines of credit are available
on a one-to-ten day basis for general purposes of the Corporation. All of the
lenders have reserved the right to withdraw these lines at their option.
Capital Management
- ------------------
The Bank and the Corporation are subject to various regulatory capital
requirements administered by banking regulators. Failure to meet minimum capital
requirements can initiate certain mandatory - and possibly additional
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on the Corporation's consolidated financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Bank must meet specific capital guidelines that involve quantitative
measures of the Bank's assets, liabilities, and certain off-balance-sheet items
as calculated under regulatory accounting practices. The Bank's capital amounts
and classifications are also subject to qualitative judgments by the regulators
about components, risk weights and other factors.
Quantitative measures established by regulations to ensure capital adequacy
require the Bank and the Corporation to maintain minimum amounts and ratios of
total and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to
average assets (as defined in the regulations). Management believes, as of
September 30, 2006, that the Bank and the Corporation meet the capital adequacy
requirements to which they are subject.
As of September 30, 2006, the Bank was "well capitalized" under the regulatory
framework for prompt corrective action based on its capital ratio calculations.
In order to be "well capitalized", the Bank must maintain minimum total
risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the
following table.
Under present regulations of the Office of the Comptroller of the Currency, the
Bank must have core capital (leverage requirement) equal to 4.0% of assets, of
which 1.5% must be tangible capital, excluding intangible assets. The Bank must
also maintain risk-based regulatory capital as a percent of risk weighted assets
at least equal to 8.0%. In measuring compliance with capital standards, certain
adjustments must be made to capital and total assets.
18
The following tables present the total risk-based, Tier 1 risk-based and Tier 1
leverage requirements for the Corporation and the Bank (dollars in thousands).
September 30, 2006
------------------
Actual Regulatory Minimum "Well Capitalized"
---------------- ------------------ ----------------
Amount Ratio Amount Ratio Amount Ratio
$ % $ % $ %
------ ----- ------ ----- ------ -----
Leverage ratio
Corporation 31,734 8.61% 14,736 4.00% n/a n/a
Bank 33,669 9.19% 14,654 4.00% 18,317 5.00%
Tier 1 capital ratio
Corporation 31,734 12.40% 10,221 4.00% n/a n/a
Bank 33,669 13.18% 10,222 4.00% 15,332 6.00%
Total risk-based capital ratio
Corporation 37,641 14.71% 20,443 8.00% n/a n/a
Bank 36,284 14.20% 20,443 8.00% 25,553 10.00%
19
During fiscal 2003, the Corporation implemented a share repurchase program under
which the Board of Directors of the Corporation authorized the repurchase of up
to 5% of the outstanding shares or 98,000 shares. The program was expanded by an
additional 5%, or 98,000 shares, in fiscal 2004, by an additional 5%, or 95,000
shares in fiscal 2005 and by an additional 5%, or 92,000 shares in fiscal 2006.
The shares are to be repurchased either through open market purchases or
privately negotiated transactions, depending on market conditions and other
factors. Repurchased shares will be held in treasury and will be available for
the Corporation's benefit plans. During the nine months ended September 30,
2006, the Corporation repurchased 74,058 shares. As of September 30, 2006, the
Corporation had repurchased a total of 265,611 shares under these authorizations
and had 117,389 shares available for repurchase under these authorizations.
Off-Balance Sheet Risk
- ----------------------
In the normal course of operations, the Corporation engages in a variety of
financial transactions that, in accordance with generally accepted accounting
principles, are not recorded in its financial statements. These transactions
involve, to varying degrees, elements of credit, interest rate and liquidity
risk. Such transactions are used primarily to manage customer's requests for
funding and take the form of legally binding agreements to lend money to
customers at predetermined interest rates for a specified period of time.
Outstanding loan commitments (including commitments to fund credit lines)
totaled $110,052,000 at September 30, 2006. Each customer's credit worthiness is
evaluated on a case-by-case basis. The amount of collateral obtained, if deemed
necessary by the Corporation upon extension of credit, is based on the credit
evaluation of the borrower. Collateral varies but may include accounts
receivable, inventory, property, plant and equipment, commercial and residential
real estate. The credit risk on these commitments is managed by subjecting each
customer to normal underwriting and risk management processes.
For the period ended September 30, 2006, the Corporation did not engage in any
off-balance sheet transactions reasonably likely to have a material effect on
its financial condition, results of operation and cash flows.
Results of operations for the three months ended September 30, 2006 and 2005
- ----------------------------------------------------------------------------
General
- -------
Net income increased $13,000, or 2.04%, to $651,000 for the three months ended
September 30, 2006 as compared to $638,000 for the same period in 2005 as an
increase in non-interest income and a reduction in the provision for loan losses
were partially offset by an increase in non-interest expense and a reduction in
net interest income.
20
(dollars in thousands)
Three Months Ended September 30,
--------------------------------
2006 2005
---- ----
Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
------- -------- ---------- ------- -------- ----------
Interest-earning assets:
Loans (1) $212,063 $4,387 8.27% $182,194 $3,243 7.12%
Mortgage-backed securities 22,163 248 4.48% 31,065 305 3.93%
Investment securities 103,582 1,318 5.09% 116,058 1,276 4.40%
Other interest-earning assets 4,687 65 5.55% 10,663 80 3.00%
------- -------- ---------- ------- -------- ----------
Total interest-earning assets 342,495 6,018 7.03% 339,980 4,904 5.77%
-------- ========== -------- ==========
Non-interest-earning assets 28,890 25,572
------- -------
Total assets $371,385 $365,552
======= -------
Interest-bearing liabilities:
Deposits 239,522 2,037 3.40% 233,504 1,349 2.31%
Floating rate junior subordinated
deferrable interest debentures 11,475 249 8.68% 8,247 150 7.28%
FHLB advances and other borrowings 93,407 1,181 5.06% 95,242 827 3.47%
------- -------- ---------- ------- -------- ----------
Total interest-bearing liabilities 344,404 3,467 4.03% 336,993 2,326 2.76%
-------- ========== -------- ==========
Non-interest-bearing liabilities 2,626 2,168
------- -------
Total liabilities 347,030 339,161
Shareholders' equity 24,355 26,391
------- -------
Total liabilities and shareholders'
equity $371,385 $365,552
======= =======
Net interest income/spread $2,551 3.00% $2,578 3.01%
======== ========
Net yield on earning assets 2.98% 3.03%
(1) Average balances of loans include non-accrual loans.
21
Interest Income
- ---------------
Interest income increased $1,114,000, or 22.72%, to $6,018,000 for the three
months ended September 30, 2006 as compared to the same period in 2005. Interest
income on loans increased by 35.28%, or $1,144,000, to $4,387,000 for the three
months ended September 30, 2006 from $3,243,000 for the three months ended
September 30, 2005, due primarily to higher average rates due to increasing
market interest rates along with a higher average balance of loans and our
increased emphasis on commercial and consumer loan originations. Interest on
deposits and federal funds sold, combined with interest and dividends on
investment and mortgage-backed securities decreased $30,000, or 1.81%, for the
three months ended September 30, 2006 to $1,631,000 from $1,661,000 during the
same period in 2005 due to lower average balances offset by higher yields from
higher market interest rates.
Interest Expense
- ----------------
Interest expense increased $1,141,000, or 49.05%, to $3,467,000 for the three
months ended September 30, 2006 as compared to the three months ended September
30, 2005. Interest expense on deposit accounts increased $688,000, or 51.0%, to
$2,037,000 for the three months ended September 30, 2006 from $1,349,000 during
the same period in 2005 due to higher average balances and cost of deposits as a
result of higher market rates. The Corporation continues to target lower cost
demand deposit accounts versus traditional higher cost certificates of deposits
in order to reduce overall funding costs. Interest expense on borrowings
increased $354,000, or 42.81%, for the three months ended September 30, 2006 as
compared to the same period in the previous year due to higher market interest
rates. Interest expense on floating rate junior subordinated deferrable interest
debentures increased $99,000, or 66.0%, to $249,000 for the three months ended
September 30, 2006 from $150,000 during the same period in 2005 due to higher
market interest rates. In addition, on July 21, 2006, the Corporation completed
a private placement of $4 million in trust preferred securities thereby
increasing outstanding balances to $12 million at September 30, 2006 compared to
$8 million at September 30, 2005.
Provision for Loan Losses
- -------------------------
During the three months ended September 30, 2006, the provision for loan losses
was $45,000 as compared to $220,000 for the same period in the previous year
with a decrease in classified loans and net charge-offs, partially offset by
loan growth and an increase in nonperforming loans. Average classified loans
decreased $1,985,000 from $4,599,000 at September 30, 2005 to $2,614,000 at
September 30, 2006. The decrease from the previous year was due to the prior
year payoff for one commercial loan. Loans 30-89 days past due and still
accruing was $3,899,000 at September 30, 2006 compared to $3,442,000 at
September 30, 2005. During the three months ended September 30, 2006, bad debt
charge-offs, net of recoveries, was $4,000 as compared to $89,000 for the same
period in the previous year.
22
Non-Interest Income
- -------------------
Total non-interest income increased $28,000, or 4.05%, to $720,000 for the three
months ended September 30, 2006 from $692,000 for the same period in the
previous year. Fees from financial services increased $26,000, or 3.9%, to
$693,000 for the three months ended September 30, 2006 from $667,000 for the
same period in the previous year. The increase was from an increase in
transaction accounts along with higher loan fees from an increase in average
outstanding loan balances.
Non-Interest Expense
- --------------------
For the three months ended September 30, 2006, total non-interest expense
increased $124,000, or 5.71%, to $2,294,000 from $2,170,000 for the same period
in 2005. Compensation and employee benefits increased $83,000, or 8.20%, to
$1,095,000 for the three months ended September 30, 2006 from $1,012,000 for the
same period in 2005 due primarily to higher compensation and benefits costs for
normal merit salary increases and additional staff due to the opening of a new
banking center location in Simpsonville, South Carolina in March 2006. Occupancy
and equipment expense decreased $27,000, or 5.49%, to $465,000 for the three
months ended September 30, 2006 from $492,000 for the same period in 2005, due
primarily to lower depreciation expense. Professional services expense increased
$21,000, or 24.42%, to $107,000 for the three months ended September 30, 2006
from $86,000 for the same period in 2005, due to higher legal and audit fees.
Advertising/public relations expense increased $72,000, or 156.52%, to $118,000
for the three months ended September 30, 2006 from $46,000 for the same period
in 2005 due primarily to product and promotion expenses for the new banking
center location and product promotion expenses for business checking accounts.
Loan operations expense decreased $71,000, or 70.3%, to $30,000 for the three
months ended September 30, 2006 from $101,000 for the same period in 2005, due
to lower costs associated with loan foreclosures. Telephone expense decreased
$12,000, or 24.0%, to $38,000 for the three months ended September 30, 2006 from
$50,000 for the same period in 2005 due to new telephone contracts and vendor
credits. Other expense increased $61,000, or 36.53%, to $228,000 for the three
months ended September 30, 2006 from $167,000 for the same period in 2005 due to
higher general operating expense from two new banking center openings.
Results of operations for the nine months ended September 30, 2006 and 2005
- ---------------------------------------------------------------------------
General
- -------
Net income increased $263,000, or 15.24%, to $1,989,000 for the nine months
ended September 30, 2006 as compared to $1,726,000 for the same period in 2005
as increases in net interest income and non-interest income and a reduction in
the provision for loan losses were partially offset by an increase in
non-interest expense.
23
Average Yields and Rates
- ------------------------
(dollars in thousands)
Nine Months Ended September 30,
--------------------------------
2006 2005
---- ----
Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
------- -------- ---------- ------- -------- ----------
Interest-earning assets:
Loans (1) $205,247 $12,306 7.99% $176,034 $9,108 6.90%
Mortgage-backed securities 24,879 808 4.33% 34,390 1,050 4.07%
Investment securities 109,554 3,927 4.78% 113,294 3,756 4.42%
Other interest-earning assets 5,107 173 4.52% 7,576 109 1.92%
------- -------- ---------- ------- -------- ----------
Total interest-earning assets 344,787 17,214 6.66% 331,294 14,023 5.64%
-------- ========== -------- ==========
Non-interest-earning assets 26,734 23,885
------- -------
Total assets $371,521 $355,179
======= =======
Interest-bearing liabilities:
Deposits 245,057 5,647 3.07% 228,972 3,770 2.20%
Floating rate junior subordinated
deferrable interest debentures 9,335 596 8.51% 8,247 417 6.74%
FHLB advances and other borrowings 89,741 3,084 4.58% 89,480 2,308 3.44%
------- -------- ---------- ------- -------- ----------
Total interest-bearing liabilities 344,133 9,327 3.61% 326,699 6,495 2.65%
-------- ========== -------- ==========
Non-interest-bearing liabilities 2,319 3,012
------- -------
Total liabilities 346,452 329,711
Shareholders' equity 25,069 25,468
------- -------
Total liabilities and shareholders'
equity $371,521 $355,179
======= =======
Net interest income/spread $7,887 3.05% $7,528 2.99%
======== ========
Net yield on earning assets 3.05% 3.03%
(1) Average balances of loans include non-accrual loans.
Interest Income
- ---------------
Interest income increased $3,191,000, or 22.76%, to $17,214,000 for the nine
months ended September 30, 2006 as compared to the same period in 2005. Interest
income on loans increased by 35.11%, or $3,198,000, to $12,306,000 for the nine
months ended September 30, 2006 from $9,108,000 for the nine months ended
September 30, 2005, due primarily to a higher average rate due to increasing
market interest rates along with our increased emphasis on commercial and
consumer loan originations and a higher average balance of loans. Interest on
deposits and federal funds sold, combined with interest and dividends on
investment and mortgage-backed securities decreased $7,000, for the nine months
ended September 30, 2006 to $4,908,000 from $4,915,000 during the same period in
2005 due to higher yields, from higher market interest rates, offset by lower
average balances.
24
Interest Expense
- ----------------
Interest expense increased $2,832,000, or 43.60%, to $9,327,000 for the nine
months ended September 30, 2006 as compared to the nine months ended September
30, 2005. Interest expense on deposit accounts increased $1,877,000, or 49.79%,
to $5,647,000 for the nine months ended September 30, 2006 from $3,770,000
during the same period in 2005 due to higher averages balances and cost of
deposits as a result of higher market rates. The Corporation continues to target
lower cost demand deposit accounts versus traditional higher cost certificates
of deposits. Interest expense on borrowings increased $776,000, or 33.62%, for
the nine months ended September 30, 2006 as compared to the same period in the
previous year due to higher market interest rates. Interest expense on floating
rate junior subordinated deferrable interest debentures increased $179,000, or
42.93%, to $596,000 for the nine months ended September 30, 2006 from $417,000
during the same period in 2005 due to higher market interest rates. In addition,
on July 21, 2006, the Corporation completed a private placement of $4 million in
trust preferred securities thereby increasing outstanding balances to $12
million at September 30, 2006 compared to $8 million at September 30, 2005.
Provision for Loan Losses
- -------------------------
During the nine months ended September 30, 2006, the provision for loan losses
was $355,000 as compared to $768,000 for the same period in the previous year
due to a decrease in classified loans and charge-offs, partially offset by loan
growth and an increase in nonperforming loans. The provision also reflects the
Corporation's continued movement from longer term, fixed rate residential
mortgage loans to shorter term, floating rate consumer and commercial loans.
Consumer and commercial loans carry higher risk weighted rates in the reserve
calculation as compared to residential mortgage loans. Real estate acquired in
foreclosure and loans classified as substandard and doubtful decreased $303,000
from $3,164,000 at December 31, 2005 to $2,861,000 at September 30, 2006. During
the nine months ended September 30, 2006, bad debt charge-offs, net of
recoveries, was $134,000 as compared to $198,000 for the same period in the
previous year. The Corporation's loan loss allowance at September 30, 2006 was
approximately 1.20% of the Corporation's outstanding loan portfolio and 137.70%
of non-performing loans compared to 1.23% of the Corporation's outstanding loan
portfolio and 162.86% of non-performing loans at December 31, 2005.
The changes in the allowance for loan losses consisted of the following (in
thousands):
Balance at beginning of period $2,394
Provision for loan losses 355
Charge-offs, net (134)
======
Balance at end of period $2,615
25
The following table sets forth information with respect to the Bank's
non-performing assets at the dates indicated (dollars in thousands):
September 30, 2006 December 31, 2005
------------------ -----------------
Non-accruing loans which are
contractually past due 90 days
or more:
Real estate $ 367 $ 461
Commercial 1,029 436
Consumer 331 349
------ ------
Total $1,727 $1,246
====== ======
Percentage of loans receivable 0.77% 0.64%
------ ------
Percentage of allowance for loan losses
to total loans outstanding 1.20% 1.23%
------ ------
Allowance for loan losses $2,615 $2,394
====== ======
Real estate acquired through
foreclosure and repossessed assets $ 172 $ 224
------ ------
Non-performing loans for the nine months ended September 30, 2006 increased
$481,000 from December 31, 2005 due primarily to an increase in 3 delinquencies
for commercial loans. Since the quarter end, approximately $300,000 of the
commercial loans have been brought current. The allowance for loan loss
calculation includes a segmentation of loan categories subdivided by residential
mortgage, commercial and consumer loans. Each category is rated for all loans
including performing groups. The weight assigned to each performing group is
developed from previous loan loss experience and as the loss experience changes,
the category weight is adjusted accordingly. In addition to loan loss
experience, management's evaluation of the loan portfolio includes the market
value of the underlying collateral, growth and composition of the loan
portfolio, delinquency trends and economic conditions. Management evaluates the
carrying value of loans periodically and the allowance for loan loss calculation
will adjust accordingly.
Non-Interest Income
- -------------------
Total non-interest income increased $191,000, or 9.84%, to $2,133,000 for the
nine months ended September 30, 2006 from $1,942,000 for the same period in the
previous year. Fees from financial services increased $199,000, or 10.72%, to
$2,055,000 for the nine months ended September 30, 2006 from $1,856,000 for the
same period in the previous year. The increase was due to higher service fees as
a result of an increase in transaction accounts.
Non-Interest Expense
- --------------------
For the nine months ended September 30, 2006, total non-interest expense
increased $491,000, or 7.72%, to $6,854,000 from $6,363,000 for the same period
in 2005. Compensation and employee benefits increased $317,000, or 10.53%, to
$3,327,000 for the nine months ended September 30, 2006 from $3,010,000 for the
same period in 2005 due primarily to higher compensation and benefits costs for
26
normal merit salary increases and additional staff due to the opening of a new
banking center location in Simpsonville, South Carolina in March 2006. Occupancy
and equipment expense decreased $46,000, or 3.02%, to $1,477,000 for the nine
months ended September 30, 2006 from $1,523,000 for the same period in 2005 due
to primarily to lower depreciation expense. Professional services expense
increased $54,000, or 19.57%, to $330,000 for the nine months ended September
30, 2006 from $276,000 for the same period in 2005 due to higher legal expenses
primarily due to the changing the name of the holding company during the first
quarter of 2006. Advertising/public relations expense increased $108,000, or
101.89%, to $214,000 for the nine months ended September 30, 2006 from $106,000
for the same period in 2005 due primarily to product and promotion expenses for
the new banking center location and product promotion expenses for business
checking accounts. Loan operations expense decreased $119,000, or 66.48%, to
$60,000 for the nine months ended September 30, 2006 from $179,000 for the same
period in 2005, due to lower costs associated with foreclosures. Items
processing expense increased $35,000, or 31.82%, to $145,000 for the nine months
ended September 30, 2006 from $135,000 for the same period in 2005 due to an
increase in transaction accounts. Other expense increased $150,000, or 28.68%,
to $673,000 for the nine months ended September 30, 2006 from $523,000 for the
same period in 2005 due to higher loan expense from increased production and
higher forms and supplies expense from two new banking center openings.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
The Corporation is committed to following a program of asset and liability
management in an effort to manage the fluctuations in earnings caused by
movements in interest rates. A significant portion of the Corporation's income
results from the spread between the yield realized on its interest-earning
assets and the rate of interest paid on its deposits and other borrowings.
Differences in the timing and volume of repricing assets versus the timing and
volume of repricing liabilities expose the Corporation to interest rate risk.
Management's policies are directed at minimizing the impact on earnings of
movements in interest rates.
The Corporation's Asset/Liability Committee makes pricing and marketing
decisions on deposit and loan products in conjunction with managing the
Corporation's interest rate risk. In addition, the Asset/Liability Committee
reviews the Corporation's securities portfolio, FHLB advances and other
borrowings as well as the Corporation's asset and liability policies.
The primary objective of Asset/Liability management at the Corporation is to
manage interest rate risk and achieve reasonable stability in net interest
income throughout interest rate cycles in order to maintain adequate liquidity.
This is achieved by maintaining the proper balance of rate-sensitive earning
assets and rate-sensitive costing liabilities. The relationship of
rate-sensitive earning assets to rate-sensitive costing liabilities is the
principal factor in projecting the effect that fluctuating interest rates will
have on future net interest income. Rate-sensitive assets and interest-bearing
liabilities are those that can be repriced to current market rates within a
relatively short time period. Management monitors the rate sensitivity of
earning assets and interest-bearing liabilities over the entire life of these
instruments.
27
The Corporation has established policies and monitors results to control
interest rate sensitivity. Although the Corporation utilizes measures such as
static gap, which is simply the measurement of the difference between
interest-sensitive assets and interest-sensitive liabilities repricing for a
particular time period, just as important a process is the evaluation of how
particular assets and liabilities are impacted by changes in interest rates or
selected indices as they reprice. Asset/liability modeling techniques are
utilized by the Corporation to assess varying interest rate and balance sheet
mix assumptions.
Net Interest Income Simulation Analysis. We analyze our interest rate
sensitivity position to manage the risk associated with interest rate movements
through the use of interest income simulation. The matching of assets and
liabilities may be analyzed by examining the extent to which such assets and
liabilities are "interest sensitive." An asset or liability is said to be
interest rate sensitive within a specific time period if it will mature or
reprice within that time period.
Our goal is to manage asset and liability positions to moderate the effects of
interest rate fluctuations on net interest income. Interest income simulations
utilizing interest rate shocks are completed quarterly and presented to the
Asset/Liability Committee. The simulations provide an estimate of the impact of
changes in interest rates on net interest income under a range of assumptions.
The interest rate shocks are compared to board approved policy limits and are
reviewed by the Asset/Liability Committee on a quarterly basis. The simulation
incorporates assumptions regarding the potential timing in the repricing of
certain assets and liabilities when market rates change and the changes in
spreads between different market rates. The simulation analysis incorporates
management's current assessment of the risk that pricing margins will change
adversely over time due to competition or other factors.
Simulation analysis is only an estimate of our interest rate risk exposure at a
particular point in time. We continually review the potential effect changes in
interest rates could have on the repayment of rate sensitive assets and funding
requirements of rate sensitive liabilities.
The table below sets forth an approximation of our exposure as a percentage of
estimated net interest income for the next twelve month period using interest
income simulation. The simulation uses projected repricing of assets and
liabilities on the basis of contractual maturities, anticipated repayments and
scheduled rate adjustments. Prepayment rates can have a significant impact on
interest income simulation. When interest rates rise, prepayments tend to slow.
When interest rates fall, prepayments tend to rise.
28
The following table reflects changes in estimated net interest income from rate
shocks of (+) or (-) 100 and 200 basis points in a rising and falling interest
rate environment for the Corporation.
At At
September 30, December 31,
Change in Rates (Basis Points) 2006 2005
- ------------------------------ ---- ----
+200
+6.95% +5.88%
+100
+3.63% +3.24%
-100
-3.91% -4.97%
-200
-7.27% -7.72%
The Corporation improved slightly in rising interest rate environments for the
period ending September 30, 2006 as compared to the period ending December 31,
2005 due primarily to significant growth in prime based loan products.
The 200 and 100 basis point change in rates in the above table is assumed to
occur evenly over the following twelve months. Based on the scenario above, net
interest income would be positively affected in the twelve-month periods if
rates rose by 100 and 200 basis points, but would be adversely affected if rates
declined by 100 and 200 basis points.
Item 4. Controls and Procedures
-----------------------
The Corporation's management, including the Corporation's principal executive
officer and principal financial officer, have evaluated the effectiveness of the
Corporation's "disclosure controls and procedures," as such term is defined in
Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as
amended, (the "Exchange Act"). Based upon their evaluation, the principal
executive officer and principal financial officer concluded that, as of the end
of the period covered by this report, the Corporation's disclosure controls and
procedures were effective for the purpose of ensuring that the information
required to be disclosed in the reports that the Corporation files or submits
under the Exchange Act with the Securities and Exchange Commission (the "SEC")
(1) is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms, and (2) is accumulated and communicated
to the Corporation's management, including its principal executive and principal
financial officers, as appropriate to allow timely decisions regarding required
disclosure.
There has been no change in the Corporation's internal control over financial
reporting identified in connection with the evaluation required by Rule
13(a)-15(e) that occurred during the Corporation's last fiscal quarter that has
materially affected or is reasonably likely to materially affect, the
Corporation's internal control over financial reporting.
29
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
The Corporation is not involved in any legal proceedings. The Bank is involved
in various claims and legal actions arising in the normal course of business.
Management believes that these proceedings are immaterial to the Corporation's
financial condition and results of operations.
Item 1A. Risk Factors
------------
In addition to the other information set forth in this report, you should
carefully consider the factors discussed in Part I, "Item 1A. Risk Factors" in
our Annual Report on Form 10-K for the year ended December 31, 2005, which could
materially affect our business, financial condition or future results. The risks
described in our Annual Report on Form 10-K are not the only risks that we face.
Additional risks and uncertainties not currently known to us or that we
currently deem to be immaterial also may materially adversely affect our
business, financial condition and/or operating results.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------
The following table provides certain information with regard to shares
repurchased by the Corporation during the third quarter of 2006.
(c)
(a) Total Number of (d)
(b) Shares Purchased Maximum Number of
Total Number Average as part of Publicly Shares that may
of Shares Price Paid Announced be purchased under
Period Purchased per share Programs Program
- ------------------ --------------- ----------- ------------------- --------------------
July 1, 2006 through 10,243 $17.64 10,243 44,631
July 31, 2006
August 1, 2006 through 18,963 $18.41 18,963 117,668
August 31, 2006
September 1, 2006 279 $18.10 279 117,389
through September 30, 2006
Total 29,485 $18.14 29,485 N/A
In May 2005, the Corporation implemented a share repurchase program under which
the Corporation may repurchase up to 5% of the outstanding shares or 98,000
shares. In August 2006, the program was expanded by an additional 5% or 92,000
shares. The repurchase program will continue until it is completed or terminated
by the Board of Directors.
30
Item 3. Defaults upon Senior Securities
-------------------------------
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
None
Item 5. Other Information
-----------------
None
Item 6. Exhibits
--------
31(a) Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31(b) Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32(a) Chief Executive Officer Certification Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
32(b) Chief Financial Officer Certification Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
31
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PROVIDENT COMMUNITY BANCSHARES, INC.
------------------------------------
(Registrant)
Date: 11/07/2006 By: /s/ Dwight V. Neese
---------- -------------------
Dwight V. Neese, CEO
Date: 11/07/2006 By: /s/ Richard H. Flake
---------- --------------------
Richard H. Flake, CFO
32