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, 2007
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
------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (919) 963-2177
--------------
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 |X| Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act): YES [ ] NO |X|
$108,252,293
------------
(Aggregate market 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, 2007)
6,207,191
---------
(Number of shares of Common Stock, par value $1.00 per share,
outstanding as of March 6, 2008)
Documents Incorporated by Reference Where Incorporated
- ----------------------------------- ------------------
(1) Proxy Statement for the 2007 Annual Part III
Meeting of Shareholders to be held April 28, 2008
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
business, economic and other risks and uncertainties, both known and unknown,
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.
Any forward looking statements contained in this Annual Report on Form
10-K are as of the date hereof and we undertake no duty to update them if our
view changes later. These forward looking statements should not be relied upon
as representing our view as of any date subsequent to the date hereof.
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. Our corporate offices and
banking offices are located in eastern North Carolina in the counties of
Johnston (our corporate headquarters), Wake, Sampson, Lee, Duplin and Harnett
counties. We have 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 $1,153,000 in securities available for sale.
In addition, we have an interest in Four Oaks Statutory Trust I, a
wholly owned Delaware statutory business trust (the "Trust"), for the sole
purpose of issuing trust preferred securities. The Trust is not consolidated
with our financial statements of the Company pursuant to the provisions of
Financial Accounting Standards Board ("FASB") Interpretation No. 46,
"Consolidation of Variable Interest Entities (revised December 2003) - an
interpretation of ARB No. 51" ("FIN 46R"). We formed the Trust for the sole
purpose of issuing $12.0 million of trust preferred securities (the "Trust
Preferred Securities"). The Trust has invested the net proceeds from the sale of
the Trust Preferred Securities in Junior Subordinated Deferrable Interest (the
"Debentures") issued by us and recorded in borrowings on the accompanying
consolidated balance sheet. The Trust Preferred Securities pay cumulative cash
distributions quarterly at an annual rate, reset quarterly, equal to three month
LIBOR plus 1.35%. The dividends paid to holders of the Trust Preferred
Securities, which are recorded as interest expense, are deductible for income
tax purposes.
As of December 31, 2007, we had assets of $708.3 million, net loans
outstanding of $538.6 million and deposits of $537.8 million. We have enjoyed
considerable growth over the past five (5) years as evidenced by a 122.5%
increase in assets, a 137.6% increase in net loans outstanding, and a 114.6%
increase in deposits since December 31, 2002. We had net income of $5.7 million
and $7.0 million and basic earnings per share of $.92 and $1.15 for the years
ended December 31, 2007 and 2006, respectively. Net income of $5.0 million and
basic earnings per share of $0.84 were recorded for the year ended December 31,
2005.
The bank continues to remain a community-focused bank engaging in
general commercial banking business to the communities we serve in Johnston,
Harnett, Wake, Sampson, Lee and Duplin counties of North Carolina. The bank
provides a full range of banking services, including such services as:
o checking accounts;
o savings accounts;
o individual retirement accounts;
2
o NOW accounts;
o money market accounts;
o certificates of deposit;
o a student checking and savings program;
o loans for businesses, agriculture, real estate, personal uses,
home improvement and automobiles;
o mortgage loans;
o equity lines of credit;
o credit cards;
o safe deposit boxes;
o electronic funds transfer services, including wire transfers;
internet banking and bill pay services;
o telephone banking;
o gift cards;
o cashier's checks;
o traveler's check cards; and
o 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. Through an arrangement with Jefferson Pilot Securities Corporation,
the Bank also makes available a complete line of insurance and investment
services, including financial strategies, mutual funds, annuities, insurance,
stock brokerage, IRA's, discount brokerage services, employee benefit plans,
401(K)'s and simplified employee pension plans. At present, the bank does not
provide the services of a trust department.
We maintain 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". We are registered as a bank holding company with the
Federal Reserve System. We are 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, Duplin, and Harnett. 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. Harnett County is contiguous
to Cumberland, Moore, Lee, Chatham, Wake, Johnston and Sampson counties.
From its headquarters located in Four Oaks and its fourteen locations
in Four Oaks, Clayton, Smithfield, Garner, Benson, Fuquay-Varina, Wallace, Holly
Springs, Harrells, Sanford, Zebulon, and Dunn, the bank serves a major portion
of Johnston County, and part of Wake, Harnett, Duplin, Sampson and Lee counties.
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 2006 was estimated
in excess of 152,000. As of June 2007, the bank ranked first in deposit market
share for Johnston County at 28%.
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 a
branch office 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 West Center Street, one in Harrells at 590 Tomahawk Highway, one
in Sanford at 830 Spring Lane, one in Zebulon at 130 North Arendell Avenue, and
one in Dunn at 604-A Erwin Road.
The majority of the bank's customers are individuals and small to
medium-size businesses located in Johnston, Wake, Sampson, Lee, Duplin and
Harnett 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.
3
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 has been immaterial over the past two years. At December
31, 2007, the bank employed 177 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, 2007, 2006 and 2005 derived from our audited
financial statements and notes. 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:
2007 2006 2005
------------ ------------ ------------
(In thousands, except ratios)
Net income $ 5,652 $ 7,017 $ 5,003
Average equity capital accounts $ 52,246 $ 45,541 $ 39,613
Ratio of net income to average equity capital accounts 10.82% 15.41% 12.63%
Average daily total deposits $ 505,494 $ 435,991 $ 355,214
Ratio of net income to average daily total deposits 1.12 1.61 1.41
Average daily loans (gross) $ 494,426 $ 426,768 $ 351,103
Ratio of average daily loans to average daily total deposits 97.81% 97.88% 98.84%
Proposed Merger with LongLeaf Community Bank
On December 10, 2007, we announced that we had entered into a
definitive agreement with LongLeaf Community Bank ("LongLeaf") pursuant to which
LongLeaf will merge with and into the bank. Under the terms of the Agreement,
each share of LongLeaf common stock will be automatically converted into the
right to receive either (i) $16.50 in cash, without interest, (ii) 1.0 share of
Company common stock multiplied by an exchange ratio or (iii) 0.60 shares of
Company common stock multiplied by the exchange ratio plus an amount equal to
$6.60 in cash, all on and subject to the terms and conditions contained in the
Agreement. The exchange ratio is equal to $16.50 divided by the volume weighted
average of the daily closing sales price of our common stock as quoted on the
OTC Bulletin Board during the 20 consecutive trading days ending three business
days prior to the closing date of the Merger (the "Average Closing Price").
Pursuant to the Agreement, the Average Closing Price can be no higher than
$19.3397452 per share and no lower than $14.2945943 per share. In addition, if
(a) as of the later of the date of receipt of the required approval of
regulatory authorities or the date of approval by LongLeaf shareholders, the
average closing price of our common stock is less than 75% of the Average
Closing Price as of the date the Agreement was executed and (b) we do not agree
to adjust the exchange ratio as permitted by the Agreement, then LongLeaf will
have a right to terminate the Agreement. Finally, certain allocation procedures
will be used to cause the stock consideration to be paid to LongLeaf
shareholders to be between 50% and 70% of the total merger consideration.
On January 30, 2008, we filed a Registration Statement on Form S-4
with the Securities and Exchange Commission (the "SEC") to register up to
708,461 shares of our common stock that could be issued in connection with the
proposed transaction. LongLeaf mailed the related proxy statement/prospectus to
its shareholders on or about February 28, 2008, setting forth matters relating
to the transaction to be voted upon at its upcoming special Meeting of
Shareholders to be held on April 10, 2008. The Form S-4 describes the proposed
transaction in detail and provides, among other things, highlights and terms of
the proposed merger and pro forma financial information. Subject to receipt of
approval by LongLeaf's shareholders and certain other closing conditions, we
plan to consummate the bank merger in the second quarter of 2008.
4
We believe that the proposed merger presents an important opportunity
for us to increase shareholder value by acquiring a well-respected community
bank in Richmond and Moore counties in North Carolina, both of which are
desirable markets for the bank. We believe these counties represent natural
extensions of the bank's existing market areas, as Moore County is contiguous to
Lee County where the bank is already located, and Richmond County is contiguous
to Moore County. The bank's existing Sanford office located in Lee County is
situated just off US 1 as are the two offices of LongLeaf. The bank also expects
to realize profitability improvements in the LongLeaf operations due to merging
its back office functions into those of the bank. We also believe that we will
be able to further leverage LongLeaf's existing customer base, branch network
and reputation as a method to implement and accelerate the bank's growth
strategy and objectives. In addition, we believe that customers of LongLeaf will
benefit from the combination by having access to a larger community bank that
offers a full array of products and services at competitive prices.
Competition
Commercial banking in North Carolina is extremely competitive due in
large part to North Carolina's early adoption of 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 2007, we operated
branches in Johnston, Wake, Sampson, Duplin, and Lee counties, North Carolina.
At that time in Johnston County, North Carolina, the bank's primary market,
there were a total of approximately $1.3 billion in deposits and 39 branches
represented by the top eleven financial institutions in the county based on
deposit share, all commercial banks. The bank operated seven of the 39 branches
with deposits of $352.3 million, placing the bank first in the top eleven 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 are 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.
5
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 of 1997 (the "CRA"), 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.
6
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 well 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, 2007, we had Tier 1 risk-adjusted, total regulatory
capital and leverage capital of approximately 11.70%, 12.87% and 10.16%,
respectively, all in excess of the minimum requirements to be considered
well-capitalized under prompt corrective action provisions.
Dividends. During 2007, we paid cash dividends of $.29 per share on our
common stock, a 20.8% increase over 2006. 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
federal 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.
7
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 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 Deposit Insurance
Fund (the "DIF") of the Federal Deposit Insurance Corporation (the "FDIC") up to
a maximum of one hundred thousand dollars ($100,000) per insured depositor, with
the exception of retirement accounts, which were increased to $250,000 by the
FDIC effective April 1, 2006. 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.
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, 2007, the bank had Tier 1 risk-adjusted,
total regulatory capital and leverage capital of approximately 10.71%, 11.88%
and 8.85%, respectively, in excess of the minimum requirements to be considered
well-capitalized under prompt corrective action provisions.
8
The bank is subject to insurance assessments imposed by the FDIC,
including a risk-based assessment schedule providing for annual assessment rates
ranging from 5 to 43 cents per $100 in assessable deposits, applicable to
institutions insured by the DIF. The FDIC may change the assessment schedule
quarterly. 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 DIF (Subgroup B) or whether such weaknesses pose a
substantial probability of loss to the DIF 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. In 2007, we received a one-time assessment credit of
approximately $197,000, which has been applied to payments due during the year.
FDIC deposit insurance expense was $57,000, $52,000, and $46,000 for the years
ended December 31, 2007, 2006 and 2005, respectively.
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," or
"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.
9
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 &
Year first Trust Company and business experience
Name Age employed during past five (5) years
- --------------------------------------------------------------------------------
Ayden R. Lee, Jr. 59 1980 Chief Executive Officer, President and
Chairman of the Board of Directors of
Four Oaks Fincorp, Inc. and Four Oaks
Bank & Trust Company. Previously
Director of Four Oaks Fincorp, Inc.
and Four Oaks Bank & Trust Company.
Clifton L. Painter 58 1986 Senior Executive Vice President, Chief
Operating Officer of Four Oaks
Fincorp, Inc. and Four Oaks Bank &
Trust Company.
Nancy S. Wise 52 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 40 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 51 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 of Four Oaks Bank and
Trust Company.
10
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, Harnett,
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
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 North Carolina's early adoption of 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
prices and interest rates. Our market risk stems primarily from interest rate
risk inherent in our lending and deposit-taking activities. Our policy allows
that we may 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, from time to time we may 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 use fixed rate time deposits, such as certificates of deposit, 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.
Technological Advances
The banking industry undergoes frequent technological changes with
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.
11
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 BHCA, the GLB, the IBBEA, the USA Patriot Act of 2001, the FDIC, the CRA,
the North Carolina Business Corporation Act, the Sarbanes-Oxley Act of 2002
("Sarbanes-Oxley"), and new SEC regulations to name a few.
Sarbanes-Oxley 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
Sarbanes-Oxley 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 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 payment of interest, interest rates on deposits;
o the possible expansion of branch offices; and/or
o our ability to make other financial services available.
We also are subject to capitalization guidelines set forth in federal
regulations, 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
regulations 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.
Our Proposed Transaction with LongLeaf Community Bank is Subject to
Uncertainties.
Our proposed transaction with LongLeaf is subject to customary closing
conditions, including shareholder approval by LongLeaf shareholders. If any of
the conditions to closing are not satisfied or waived, the proposed transaction
would not be completed. In addition, the merger agreement relating to the
proposed transaction can be terminated prior to completion of the transaction
under certain circumstances, including where LongLeaf receives an acquisition
proposal from a third party that its board believes is more favorable to its
shareholders than the proposed transaction (after following specific procedures
described in our merger agreement with LongLeaf). If the merger agreement is
terminated, the proposed transaction would not be completed, and, in certain
circumstances, LongLeaf could be required to pay us a termination fee of
$350,000. If the merger is not completed, the value of our common stock could
decline. We are currently targeting to close the proposed transaction, assuming
the satisfaction or waiver of all conditions, in the second quarter of 2008. The
closing of the proposed transaction could be delayed beyond the second quarter
of 2008 due to many factors, including factors beyond the control of either
party.
12
We May Not Be Able To Successfully Integrate Bank Mergers and Acquisitions,
Including the Merger of LongLeaf into the Bank.
Our proposed merger of the bank with LongLeaf involves the combination
of two banks that previously have operated independently. Difficulties may arise
in the integration of the business and operations of any banks that we acquire
and, as a result, we may not be able to achieve the cost savings and synergies
that we expect will result from such transactions. Achieving cost savings is
dependent on consolidating certain operational and functional areas, eliminating
duplicative positions and terminating certain agreements for outside services.
Additional operational savings are dependent upon the integration of the
acquired or merged entity's businesses with ours, the conversion of core
operating systems, data systems and products and the standardization of business
practices. Complications or difficulties in the conversion of the core operating
systems, data systems and products may result in the loss of customers, damage
to our reputation within the financial services industry, operational problems,
one-time costs currently not anticipated or reduced cost savings resulting from
such mergers or acquisitions. Annual cost savings in each such transaction may
be materially less than anticipated if the merger or acquisition is delayed
unexpectedly, the integration of operations is delayed beyond what is
anticipated or the conversion to a single data system is not accomplished on a
timely basis.
Difficulty in integrating an acquired company may cause us not to
realize expected revenue increases, cost savings, increases in geographic or
product presence and/or other projected benefits from the acquisition. The
integration could result in higher than expected deposit attrition, loss of key
employees, disruption of our businesses or the businesses of the acquired
company, or otherwise adversely affect our ability to maintain relationships
with customers and employees or achieve the anticipated benefits of the
acquisition.
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 compete effectively in this area by offering competitive
financial packages that include incentive-based compensation.
We Have a High Concentration of Loans Secured by Real Estate
A significant portion of our loan portfolio is dependent on real
estate. In addition to the financial strength and cash flow characteristics of
the borrower in each case, often loans are secured with real estate collateral.
At December 31, 2007, approximately 88.5% of our loans have real estate as a
primary or secondary component of collateral. The real estate in each case
provides an alternate source of repayment in the event of default by the
borrower and may deteriorate in value during the time the credit is extended. An
adverse change in the economy affecting values of real estate generally or in
our primary markets specifically could significantly impair the value of
collateral and our ability to sell the collateral upon foreclosure. Furthermore,
it is likely that, in a decreasing real estate market, we would be required to
increase our allowance for loan losses. If we are required to liquidate the
collateral securing a loan to satisfy the debt during a period of reduced real
estate values or to increase our allowance for loan losses, our profitability
and financial condition could be adversely impacted.
Our Allowance for Probable Loan Losses May Be Insufficient
We maintain an allowance for probable loan losses, which is a reserve
established through a provision for probable loan losses charged to expense.
This allowance represents management's best estimate of probable losses that
have been incurred within the existing portfolio of loans. The allowance, in the
judgment of management, is necessary to reserve for estimated loan losses and
risks inherent in the loan portfolio. The level of the allowance reflects
management's continuing evaluation of industry concentrations; specific credit
risks; loan loss experience; current loan portfolio quality; present economic,
political and regulatory conditions and unidentified losses inherent in the
current loan portfolio. The determination of the appropriate level of the
allowance for probable loan losses inherently involves a high degree of
subjectivity and requires us to make significant estimates and assumptions
regarding current credit risks and future trends, all of which may undergo
material changes. Changes in economic conditions affecting borrowers, new
information regarding existing loans, identification of additional problem loans
and other factors, both within and outside our control, may require an increase
in the allowance for probable loan losses. In addition, bank regulatory agencies
periodically review our allowance for loan losses and may require an increase in
the provision for probable loan losses or the recognition of further loan
charge-offs, based on judgments different than those of management. In addition,
if charge-offs in future periods exceed the allowance for probable loan losses;
we will need additional provisions to increase the allowance for probable loan
losses. Any increases in the allowance for probable loan losses will result in a
decrease in net income and, possibly, capital, and may have a material adverse
effect on our financial condition and results of operations. See Item 7,
Management's Discussion and Analysis of Financial Condition and Results of
Operations for further discussion related to our process for determining the
appropriate level of the allowance for probable loan losses.
13
We Are Subject To Environmental Liability Risk Associated With Lending
Activities
A significant portion of our loan portfolio is secured by real
property. During the ordinary course of business, we may foreclose on and take
title to properties securing certain loans. In doing so, there is a risk that
hazardous or toxic substances could be found on these properties. If hazardous
or toxic substances are found, we may be liable for remediation costs, as well
as for personal injury and property damage. Environmental laws may require us to
incur substantial expenses and may materially reduce the affected property's
value or limit our ability to use or sell the affected property. In addition,
future laws or more stringent interpretations or enforcement policies with
respect to existing laws may increase our exposure to environmental liability.
Although we have policies and procedures to perform an environmental review
before initiating any foreclosure action on nonresidential real property, these
reviews may not be sufficient to detect all potential environmental hazards. The
remediation costs and any other financial liabilities associated with an
environmental hazard could have a material adverse effect on our financial
condition and results of operations.
Our Controls and Procedures May Fail or Be Circumvented
Management regularly reviews and updates our internal controls,
disclosure controls and procedures, and corporate governance policies and
procedures. Any system of controls, however well designed and operated, is based
in part on certain assumptions and can provide only reasonable, not absolute,
assurances that the objectives of the system are met. Any failure or
circumvention of our controls and procedures or failure to comply with
regulations related to controls and procedures could have a material adverse
effect on our business, results of operations and financial condition.
The Holders of Our Subordinated Debentures Have Rights That Are Senior to Those
of Our Shareholders
As described below, we have issued $12.0 million of subordinated
debentures in connection with a trust preferred securities issuance by our
subsidiary, the Trust. We unconditionally guarantee payments of the principal
and interest on the trust preferred securities. Our subordinated debentures are
senior to our shares of common stock. As a result, we must make payments on the
subordinated debentures (and the related trust preferred securities) before any
dividends can be paid on our common stock and, in the event of bankruptcy,
dissolution or liquidation, the holders of the debentures must be satisfied
before any distributions can be made to the holders of common stock.
Our Information Systems May Experience an Interruption or Breach in Security
We rely heavily on communications and information systems to conduct
our business. Any failure, interruption or breach in security of these systems
could result in failures or disruptions in our customer relationship management,
general ledger, deposit, loan and other systems. While we have policies and
procedures designed to prevent or limit the effect of the failure, interruption
or security breach of our information systems, there can be no assurance that we
can prevent any such failures, interruptions or security breaches or, if they do
occur, that they will be adequately addressed. The occurrence of any failures,
interruptions or security breaches of our information systems could damage our
reputation, result in a loss of customer business, subject us to additional
regulatory scrutiny, or expose us to civil litigation and possible financial
liability, any of which could have a material adverse effect on our financial
condition and results of operations.
An Investment in Our Common Stock Is Not an Insured Deposit
Our common stock is not a bank deposit and, therefore, is not insured
against loss by the FDIC, any other deposit insurance fund or by any other
public or private entity. Investment in our common stock is inherently risky for
the reasons described in this "Risk Factors" section and elsewhere in this
report and is subject to the same market forces that affect the price of common
stock in any company. As a result, if you acquire our common stock, you may lose
some or all of your investment.
14
Consumers May Decide Not To Use Banks to Complete Their Financial Transactions
Technology and other changes are allowing parties to complete financial
transactions that historically have involved banks through alternative methods.
For example, consumers can now maintain funds that historically would have been
held as bank deposits in brokerage accounts or mutual funds. Consumers can also
complete transactions such as paying bills and/or transferring funds directly
without the assistance of banks. The process of eliminating banks as
intermediaries could result in the loss of fee income, as well as the loss of
customer deposits and the related income generated from those deposits. The loss
of these revenue streams and the lower cost deposits as a source of funds could
have a material adverse effect on our financial condition and results of
operations.
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 a former director of the company as well as a former
director of the bank. Under the terms of the lease, which the bank believes to
be arms-length, the bank paid $995 per month in rent in 2007. 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 West Center Street, Holly Springs, North
Carolina. Under the terms of the lease, the bank will pay $2,500 per month for a
period of five years ending April 1, 2008, with a 3% increase per year for the
next 5 years until March 31, 2013.
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 a period of four years ending December 31, 2009. In addition, the
bank has entered into a ten-year lease on its Sanford office located at 830
Spring Lane Sanford, North Carolina. Under the terms of the lease, the bank will
pay $7,170 each month with an annual rate increase not to exceed 2.5% over a 10
year period. On September 17, 2007, the bank entered into a two year lease on
its Dunn office located at 604-A Erwin Road, Dunn, North Carolina. Under the
terms of the lease, the bank will pay $1,500 each month for the period beginning
September 17, 2007 and ending August 31, 2009. 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:
15
Location Year Built Present Function Square Feet
- -------- ---------- ---------------- -----------
102 East Main Street
Clayton, North Carolina 1986 Branch Office 4,900
200 East Church Street
Benson, North Carolina 1987 Branch Office 2,300
128 North Second Street
Smithfield, North Carolina 1991 Branch Office 5,500
403 South Brightleaf Boulevard
Smithfield, North Carolina 1995 Limited-Service 860
Facility
200 Glen Road
Garner, North Carolina 1996 Branch Office 3,500
325 North Judd Parkway Northeast
Fuquay-Varina, North Carolina 2002 Branch Office 8,900
406 East Main Street
Wallace, North Carolina 2006 Branch Office 9,300
805 N. Arendell Avenue
Zebulon, North Carolina 2007 Branch Office 6,100
Management believes each of the properties referenced above is adequately
covered by insurance. In addition to the above locations, we have one ATM
located inside Blackmon's Country store in Four Oaks and 15 ATMs in 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 $12.6 million at December 31, 2007. Additional information
disclosed in Note D "Bank Premises and Equipment" to our consolidated financial
statements presented under Item 8 of Part II of this Form 10-K.
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 Stockholder 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, adjusted for stock splits, is as follows (prices reflect
inter-dealer prices, without retail mark-up, mark-down or commissions and may
not necessarily represent actual transactions):
16
Fiscal Year Ended December 31,
------------------------------
2006 2007
---------------------- ----------------------
High Low High Low
---------- ---------- ---------- ----------
First quarter $ 18.00 $ 16.00 $ 24.77 $ 23.64
Second quarter 23.25 17.64 23.64 20.00
Third quarter 21.82 18.00 20.00 18.82
Fourth quarter 24.55 21.45 19.09 15.50
As of March 6, 2008, the approximate number of holders of record of our
common stock was 1,700. 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 2007 and 2006, after giving effect to the 10% stock
dividend in 2007 and a 5-for-4 stock split during 2006 were $0.29 and $0.24 per
share, respectively.
We did not sell any securities in 2007 that were not registered under
the Securities Act of 1933 as amended. During 2007, we repurchased 75,807 shares
of our equity securities registered pursuant to Section 12 of the Securities
Exchange Act of 1934, as amended. The following table provides information with
respect to purchases made by or on behalf of the Company or any "affiliated
purchaser" (as defined in Rule 10b-18(a)(3) under the Exchange Act) of the
Company's common stock during the three months ended December 31, 2007:
Total Number of Shares Maximum Number of
Total Number Purchased as Part of a Shares That May Yet
of Shares Average Price Paid Publicly Announced Be Purchased Under
Purchased (1) Per Share Program (2) the Program (2)
-----------------------------------------------------------------------------------
October 1, 2007 to
October 31, 2007 - - - 390,969
-----------------------------------------------------------------------------------
November 1, 2007 to
November 30, 2007 - - - 390,969
-----------------------------------------------------------------------------------
December 1, 2007 to
December 31, 2007 1,100 15.95 40,000 350,969
-----------------------------------------------------------------------------------
Total 1,100 15.95 40,000 350,969
-----------------------------------------------------------------------------------
(1) This represents purchases of stock by the company on behalf of the
Employee Stock Ownership Plan.
(2) The company is authorized to repurchase shares of its common stock
through a program first approved by its board of directors in 2001.
The program currently approved by the company's board of directors
extends through December 31, 2008 and allows the company to repurchase
up to an aggregate of 500,000 shares, with the limit aggregated from
2001 through December 31, 2008. The company repurchased 40,000 shares
of stock under the program during the three months ended December 31,
2007. As of December 31, 2007, of the 500,000 authorized shares of its
common stock designated for repurchase an aggregate of 149,031 shares
have already been repurchased and 350,969 shares remained authorized
for repurchase under the program.
Item 6 - Selected Financial Data
The following table sets forth certain historical consolidated
financial data for the periods indicated. The selected historical annual
consolidated statement of operations and balance sheet data as of each of the
fiscal years ended December 31, 2007 and 2006 and are derived from, and are
qualified in their entirety by, our audited consolidated financial statements
included elsewhere in this report. The selected historical annual consolidated
statement of operations data for each of the years ended December 31, 2004 and
2003 and balance sheet date as of each of the years ended December 31, 2005,
2004 and 2003 are derived from audited consolidated financial statements not
included herein. 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 audited consolidated
financial statements and the related notes appearing in "Item 8. Financial
Statements." (dollars in thousands, except per share data).
17
As of and for the Year Ended December 31,
--------------------------------------------------------------------
2007 2006 2005 2004 2003
------------ ------------ ------------ ------------ ------------
Operating Data:
Total interest income $ 47,513 $ 40,556 $ 29,404 $ 21,748 $ 18,943
Total interest expense 23,699 17,817 9,983 5,811 5,922
------------ ------------ ------------ ------------ ------------
Net interest income 23,814 22,739 19,421 15,937 13,021
Provision for loan losses 1,362 873 1,403 1,596 1,373
------------ ------------ ------------ ------------ ------------
Net interest income after provision 22,452 21,866 18,018 14,341 11,648
Noninterest income 4,071 4,337 3,077 3,849 3,470
Noninterest expense 17,684 15,559 13,354 11,507 10,588
------------ ------------ ------------ ------------ ------------
Income before income taxes 8,839 10,644 7,741 6,683 4,530
Provision for income taxes 3,187 3,627 2,738 2,308 1,612
------------ ------------ ------------ ------------ ------------
Net income $ 5,652 $ 7,017 $ 5,003 $ 4,375 $ 2,918
============ ============ ============ ============ ============
Per Share Data: (Note A)
Earnings per share - basic $ 0.92 $ 1.15 $ 0.84 $ 0.75 $ 0.51
Earnings per share - diluted 0.91 1.14 0.83 0.75 0.50
Cash dividends declared 0.29 0.24 0.22 0.19 0.16
Market price
High 24.77 28.00 25.00 20.00 16.64
Low 15.50 17.40 17.60 13.44 11.26
Close 15.75 26.75 22.61 17.60 13.44
Book value 8.86 8.04 6.91 6.31 5.72
Weighted average shares outstanding
Basic 6,170,140 6,080,778 5,972,073 5,839,186 5,768,245
Diluted 6,192,559 6,137,222 6,016,319 5,872,418 5,788,820
Selected Year-End Balance Sheet Data:
Total assets $ 708,303 $ 608,137 $ 522,872 $ 398,500 $ 341,721
Loans 545,270 461,763 397,094 312,815 272,623
Allowance for loan losses 6,653 5,566 4,965 4,055 3,430
Deposits 537,763 466,868 398,341 315,307 272,918
Short-term borrowings 97,000 73,400 74,140 43,160 33,160
Subordinated Debentures 12,372 12,372 - - -
Shareholders' equity 54,630 49,323 41,612 37,295 32,880
Selected Average Balances:
Total assets $ 655,157 $ 560,689 $ 449,462 $ 376,422 $ 324,222
Loans 494,426 426,768 351,103 298,783 249,240
Total interest-earning assets 619,340 528,056 419,307 349,596 300,672
Deposits 505,494 435,991 355,214 295,524 255,038
Total interest-bearing liabilities 521,957 435,131 340,798 282,743 244,024
Shareholders' Equity 52,246 45,541 39,613 35,135 32,341
Selected Performance Ratios:
Return on average assets 0.86% 1.25% 1.11% 1.16% 0.90%
Return on average equity 10.82% 15.41% 12.63% 12.45% 9.02%
Net interest spread 3.13% 3.59% 4.08% 4.16% 3.87%
Net interest margin (yield) 3.84% 4.31% 4.63% 4.56% 4.33%
Net Income to average daily deposits 1.12% 1.61% 1.41% 1.48% 1.14%
Noninterest income to total revenue 7.89% 9.66% 9.47% 15.04% 15.48%
Noninterest income to average assets 0.62% 0.77% 0.68% 1.02% 1.07%
Noninterest expense to average assets 2.70% 2.77% 2.97% 3.06% 3.27%
Efficiency ratio 63.49% 57.43% 58.51% 58.58% 66.15%
Dividend payout ratio 31.66% 20.80% 26.26% 25.36% 31.63%
18
2007 2006 2005 2004 2003
------------ ------------ ------------ ------------ ------------
Asset Quality Ratios:
Nonperforming loans to period-end loans 0.23% 0.18% 0.25% 0.30% 0.39%
Allowance for loan losses to period-end loans 1.22% 1.21% 1.25% 1.30% 1.26%
Allowance for loan losses to nonperforming loans 530.54% 663.41% 497.99% 429.56% 323.89%
Nonperforming assets to total assets 0.42% 0.20% 0.25% 0.39% 0.52%
Net loan charge-offs to average loans 0.06% 0.06% 0.14% 0.32% 0.32%
Capital Ratios:
Total risk-based capital - Bank 10.71% 11.63% 10.40% 11.80% 12.30%
Tier 1 risk-based capital - Bank 11.88% 12.79% 9.19% 10.60% 11.10%
Leverage ratio - Bank 8.85% 9.31% 7.66% 8.60% 9.00%
Equity to assets ratio 7.71% 8.11% 7.96% 9.36% 9.62%
Equity to assets ratio (averages) 7.97% 8.12% 8.81% 9.33% 9.97%
Average interest earning assets to average total
assets 94.53% 94.18% 93.29% 92.87% 92.74%
Average loans to average total deposits 97.81% 97.88% 98.84% 101.10% 97.73%
Average interest bearing liabilities to average
interest earning assets 84.28% 82.40% 81.28% 80.88% 81.16%
Other Data:
Number of banking offices 14 13 12 10 10
Number of full time equivalent employees 177 156 135 131 126
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 audited
consolidated financial statements and notes thereto which are contained in this
report. Additional discussion and analysis related to fiscal year 2007 is
contained in our Quarterly Reports on Form 10-Q for the fiscal quarters ended
March 31, 2007, June 30, 2007 and September 30, 2007, 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 customers' 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 $341.7 million at December 31, 2003 to
$708.3 million at December 31, 2007, primarily due to increased loan demand,
while our total deposits have increased from $272.9 million to $537.8 million
over that same period. In addition, for 71 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 2007 were
10.82% and .86%, respectively, decreasing from returns of 15.41% and 1.25%,
respectively, for 2006.
We set interest rates on deposits and loans at competitive rates. We
have maintained spreads of 3.13% and 3.59% in 2007 and 2006, 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 $272.6 million at December 31, 2003 to $545.3 million at December 31, 2007;
while our average net annual charge-offs over the same period were approximately
$563,000. The sustained growth provided by operations resulted in increases in
total assets of 16.5%, 16.3%, and 31.2%, for 2007, 2006 and 2005, respectively.
Our gross loans grew 18.1% and 16.3% in 2007 and 2006, respectively.
Our total investments (including interest-earning deposits and FHLB stock)
increased 12.7% and 16.9% in 2007 and 2006, respectively, due to the decision to
build the portfolio as yields have continued to improve throughout 2006 and
2007. We closely monitor changes in the financial markets in order to maximize
the yield on our assets. The growth in loans for 2007 and 2006 was funded by
deposit growth of 15.2% and 17.2%, respectively. Earnings decreased in 2007,
ending the year with net income of $5.7 million, a decrease of 19.5% over 2006's
net income of $7.0 million, as a result of a challenging economic environment.
19
During 2007 and 2006, Four Oaks Mortgage Company, L.P. provided
secondary market-type mortgages which contributed $112,000 and $135,000 to our
revenue for the years 2007 and 2006, 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 attempted to monitor and control increases
in overhead expenses while being committed to developing the skills and
enhancing the professionalism of our employees. Employee turnover has been
minimal historically, while the number of our full-time equivalent employees has
increased from 126 at December 31, 2003 to 177 at December 31, 2007.
As described in more detail in the Business section of this Annual
Report on Form 10-K, on December 10, 2008, we announced that we had entered into
a definitive agreement with LongLeaf pursuant to which LongLeaf will merge with
and into the bank. Subject to receipt of approval by LongLeaf's shareholders and
certain other closing conditions, we plan to consummate the bank merger in the
second quarter of 2008. While the proposed merger will likely dilute our
earnings per share for the period in which it is completed, subject to the
amount and timing of projected cost savings that the proposed merger realizes
and to the amount of merger-related expenses charged against our earnings, it is
expected that the proposed merger will be accretive to its earnings in future
periods.
Results of Operations
Comparison of Financial Condition at December 31, 2007 and 2006
During 2007, our total assets increased by $100.2 million, or 16.5%,
from $608.1 million at December 31, 2006 to $708.3 million at December 31, 2007.
This increase in our total assets resulted primarily from growth in our net
loans, which increased from $456.2 million at December 31, 2006 to $538.6
million at December 31, 2007, an increase of $82.4 million, or 18.1%. The
sustained 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
suburban focus. Loans secured by real estate at December 31, 2007 of which $58.0
million was related to construction and land development loans, grew $78.4
million over 2006. In addition to loan growth, our securities portfolio
increased $12.9 million to $114.3 million at December 31, 2007 from $101.4
million at December 31, 2006. Our loan growth and increases in our securities
portfolio were primarily funded by deposit growth of $70.9 million, or 15.2%,
during 2007 to $537.8 million at December 31, 2007 compared with $466.9 million
at December 31, 2006. 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 $65.6 million
of the December 31, 2007 increase in deposits over December 31, 2006, and with
the remaining $5.3 million increase coming from deposits outside our local
customer base. We believe the growth in deposits was encouraged by targeted
deposit campaigns and branch calling efforts within our competitive market, in
spite of the national prime decrease from 8.25% at January 1, 2007 to 7.25% at
December 31, 2007.
Shareholders' equity increased by $5.3 million as of December 31, 2007
as compared to December 31, 2006. This increase resulted from our net income of
$5.7 million, dividend reinvestment plan proceeds of $1.3 million, proceeds from
the exercise of stock options of $362,000 and employee stock purchase plan
proceeds of $141,000, net of dividends paid of $1.8 million, stock repurchase
expenses of $1.5 million and other comprehensive gain of $855,000 comprised of
unrealized gains on securities available for sale of $613,000, net of tax and
unrealized gains on cash flow hedging activities of $242,000 net of tax.
20
Comparison of Operating Results for the Years Ended December 31, 2007 and 2006
Net Income
During 2007, we earned net income of $5.7 million, or $.92 basic net
income per share, which was a 19.5% decrease over 2006 net income of $7.0
million, or $1.15 basic net income per share. Increased competition for deposits
in our local markets caused interest expense to increase, causing a decline in
our net interest margin. The resulting $1.1 million, or 4.7%, increase in
interest income failed to absorb a 13.7% increase in non-interest expense for
2007 over 2006. A full year of opening and operating two new full-service
offices during 2007 contributed to increased salaries and benefits, occupancy
and equipment and other operating costs, along with costs associated with the
completion of the new building for Zebulon and the upfitting of the new Dunn
location. In addition to the new offices, rising costs in employee salaries
contributed to increased personnel expense in 2007. Compliance costs related to
the Sarbanes-Oxley Act of 2002 increased costs for outside professional services
for 2007.
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 by $1.1 million to $23.8 million in 2007,
with a net yield of 3.84% compared to $22.7 million and a net yield of 4.31% in
2006. However, the yield for 2007 decreased overall 47 basis points from 2006
due to the increasing costs of deposits and borrowings. The increase in net
interest income primarily was generated by an increased volume of $5.4 million
in average net interest-earning assets, which produced $1.1 million in net
interest income. The additional interest income over interest expense was driven
by steady loan growth, acquisition of higher yielding investments as well as an
increase of $2.1 million in average non-interest-bearing demand deposits. 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
decreased 100 basis points during 2007 to 7.25% at December 31, 2007 from 8.25%
at January 1, 2007. Prime rate decreased three times in late 2007, which
accounts for the decrease in net interest margin for 2007.
On average, our interest-earning assets grew $91.3 million during 2007
over 2006. A substantial portion of the increase in interest-earning assets was
achieved through increased loan demand. Average loans increased by $67.7 million
during 2007 over 2006 to $494.4 million, generating additional interest income
of $5.5 million. An increase in volume of interest-bearing liabilities of $85.8
million in 2007 resulted in additional interest expense of $3.7 million, while
increased competition for deposits in our local markets resulted in increased
interest expense of $2.2 million. The increase in interest expense in 2007
primarily resulted from a $27.0 million increase in more expensive other time
deposits at an average rate paid on these deposits of 5.02%, which was an
increase of 77 basis points over 2006. However, an increase of $36.7 million in
less expensive NOW and money market deposits at an average rate paid of 3.59%
and an increase of $2.1 million in interest free demand deposits in 2007
partially offset the increased cost of other time deposits. Interest expense on
subordinated debt associated with our Trust Preferred Securities increased from
$626,000 in 2006 to $850,000 in 2007. The average outstanding balance of
subordinated debt increased from $9.4 million in 2006 to $12.4 million in 2007,
as we completed a $12 million offering of Trust Preferred Securities in late
March 2006. The Trust Preferred Securities pay cumulative cash distributions
quarterly at an annual rate, reset quarterly, equal to three month LIBOR plus
1.35%.
Provision for Loan Losses and Asset Quality
Our provision for loan losses was $1.4 million during 2007 and $873,000
million during 2006. Net charge-offs in 2007 increased to $275,000 compared to
$272,000 in 2006. As a percent of average loans, net charge-offs were 0.06%, the
lowest level in the past five years and unchanged from 2006. The lower level of
net-charge-offs and nonperforming assets is attributable to continued efforts to
improve asset quality, including improved underwriting.
21
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. 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
Disclosures. Under these standards, a loan is considered impaired, based on
current information and events, if it is probable that we 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.
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, increased to $3.0 million at December 31, 2007 from $1.3 million at
December 31, 2006. This increase was primarily due to properties valued at
approximately $2.6 million being added to other real estate owned during 2007,
and to a lesser degree, the contraction of the housing market and subsequent
slowdown of real estate construction. Our allowance for loan losses, expressed
as a percentage of gross loans, was 1.22% and 1.21% at December 31, 2007 and
2006, respectively. At December 31, 2007, the allowance for loan losses amounted
to $6.7 million, which management believes is adequate to absorb losses inherent
in our loan portfolio.
Non-interest Income
Non-interest income before gains and losses on sales of securities,
hedging activity and loans decreased $744,000, or 16.1%, from $4.6 million
during 2006 to $3.9 million in 2007. Our non-interest income is comprised
primarily of service charges on deposit accounts, financial services
commissions, merchant fees, changes in the value of bank-owned life insurance
and various other sources of miscellaneous operating income. Net gains of
$512,000 on sales of investment securities and interest rate hedging activity
were recognized in 2007. The primary component of the decrease in non-interest
income is a loss on the surrender of the previous bank-owned life insurance
policy and the subsequent purchase of a new policy, resulting in a net loss of
$205,000 for the year ended December 31, 2007, as compared to a net gain of
$549,000 in 2006.
Non-interest Expense
Our non-interest expense increased from $15.5 million in 2006 to $17.7
million in 2007, an increase of $2.2 million. Although our non-interest expense
has continued to increase, our non-interest expense as a percent of our average
assets has declined over the last five years, down to 2.70% for 2007, our lowest
level in the last five years. Approximately 70.3% of the $2.2 million increase
in non-interest expense over 2006 was due to increases in salaries and benefits.
Salaries increased 17.9% while employee benefits increased 14.4%, primarily due
a 13.5% increase in the number of employees in 2007 over 2006. 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 156 employees for
the year 2006 to 177 employees for the year 2007. The increased personnel costs
reflect the costs of additional personnel for the new Dunn loan production
office as well as increased staffing for the administration and operations
departments. In addition to personnel costs, additional costs during 2007 were
incurred for occupancy expense. For 2007, occupancy expense increased $118,000
over 2006. 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 2007, contributing to an increase of $80,000 over 2006.
The primary increases in other non-interest expense for 2007 over 2006 included
advertising expense, up $28,000, printing and office supplies, up $21,000, auto
expense, up $17,000, meals, entertainment and travel, up $30,000, donations and
charities expense, up $58,000, ATM expense, up $77,000, postage, up $32,000, and
expenses relating to the collection of non-performing loans and sale of
repossessed assets, up $34,000. There were no other significant increases in the
remaining other non-interest expense categories.
22
Comparison of Operating Results for the Years Ended December 31, 2006 and 2005
Net Income
During 2006, we earned net income of $7.0 million, or $1.15 basic net
income per share, which was a 40.3% increase over 2005 net income of $5.0
million, or $0.84 basic net income per share. 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 $3.3 million, or 17.1%, increase in
net interest income absorbed a 16.5% increase in non-interest expense for 2006
over 2005. A full year of opening and operating two new full-service offices
during 2006 contributed to increased salaries and benefits, occupancy and
equipment and other operating costs, along with costs associated with the
completion of the new building for Wallace and the upfitting of the new Sanford
location. In addition to the new offices, rising costs in employee benefits
contributed to increased personnel expense. Compliance costs related to
Sarbanes-Oxley increased costs for outside professional services.
Net Interest Income
Net interest income increased by $3.3 million to $22.7 million in 2006,
with a net yield of 4.31% compared to $19.4 million and a net yield of 4.63% in
2005. However, the 2006 yield decreased an overall 32 basis points from 2005 due
to the increasing costs of deposits and borrowings. The increase in net interest
income primarily was generated by an increased volume of $14.4 million in
average net interest-earning assets, which produced $3.3 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 $7.6 million in average
non-interest-bearing demand deposits. 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 100 basis points during 2006 to 8.25% at
December 31, 2006 from 7.25% at January 1, 2006. Since the last prime rate
increase was June 29, 2006, our loan repricing leveled off in the latter part of
2006, while our deposits continued to reprice upwards as they reached maturity,
which accounts for the decrease in net interest margin for 2006.
On average, interest-earning assets grew $108.7 million during 2006
over 2005. A substantial portion of the increase in interest-earning assets was
achieved through increased loan demand. Average loans increased $75.7 million
during 2006 over 2005 to $426.8 million, generating additional interest income
of $3.6 million. Rising interest rates generated additional interest income of
$2.8 million on the bank's loan portfolio. An increase in volume of
interest-bearing liabilities of $94.3 million resulted in additional interest
expense of $3.6 million while repricing due to rising interest rates increased
interest expense by $4.2 million. The increase in interest expense primarily
resulted from a $33.2 million increase in higher costing jumbo time deposits at
an average rate paid on these deposits of 4.42% an increase of 113 basis points
over 2005. However, an increase of $24.5 million in lower costing NOW and money
market deposits at an average rate paid of 2.89% and an increase of $7.6 million
in interest free demand deposits partially offset the increased cost of the
jumbo time deposits. Interest expense on subordinated debt associated with our
offering of the Trust Preferred Securities increased from zero in 2005 to
$626,000 in 2006. The average outstanding balance of subordinated debt increased
from zero in 2005 to $9.4 million in 2006, as we completed a $12 million
offering of Trust Preferred Securities in late March 2006. The Trust Preferred
Securities pay cumulative cash distributions quarterly at an annual rate, reset
quarterly, equal to three month LIBOR plus 1.35%.
Provision for Loan Losses and Asset Quality
Our provision for loan losses was $873,000 during 2006 and $1.4 million
during 2005. Net charge-offs in 2006 declined to $272,000 compared to $493,000
in 2005. As a percent of average loans, net charge-offs were 0.06%, 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.
23
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. 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
Disclosures. Under these standards, a loan is considered impaired, based on
current information and events, if it is probable that we 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.
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, remained unchanged at $1.3 million at December 31, 2005 and December 31,
2006. Our allowance for loan losses, expressed as a percentage of gross loans,
was 1.21% and 1.25% at December 31, 2006 and 2005, respectively. At December 31,
2006, the allowance for loan losses amounted to $5.6 million, which management
believes is adequate to absorb losses inherent in our loan portfolio.
Non-interest Income
Non-interest income before gains and losses on sales of securities,
hedging activity and loans increased $756,000, or 19.9%, from $3.8 million
during 2005 to $4.6 million in 2006. 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, increased $178,000 for 2006 compared
to 2005, primarily due to an increase in overdraft charges. Merchant fees
increased $13,000 from $389,000 during 2005 to $402,000 in 2006, primarily due
to increased customer use of debit cards. During the same period, other service
charges, commissions and fees increased $316,000, of which $29,000 was
attributable to increased profits from our investment in Four Oaks Mortgage
Company, L.P., $117,000 was attributable to increased commissions from our
financial services department, $235,000 was attributable to the return on
investment in the Triangle Mezzanine Fund and $19,000 from the equity earnings
in The Four Oaks Statutory Trust. Income from bank-owned life insurance
increased $249,000. Net gains of $400,000 on sales of investment securities and
interest rate hedging activity were recognized in 2006. Our net gains on sales
of loans increased to $103,000 in 2006 from $61,000 recorded in 2005. The
increase in loan sales was driven by strong loan demand in a rising rate
environment.
24
Non-interest Expense
Our non-interest expense increased from $13.4 million in 2005 to $15.5
million in 2006, an increase of $2.1 million. Although our non-interest expense
has continued to increase, our non-interest expense as a percent of our average
assets has declined over the last five years, down to 2.76% for 2006, our lowest
level in the last five years. Approximately 60.7% of the $2.1 million increase
in non-interest expense over 2005 was due to increases in salaries and benefits.
Salaries increased 18.7% while employee benefits increased 13.0%, primarily due
a 15.6% increase in the number of employees in 2006 over 2005. 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 135 employees for
the year 2005 to 156 employees for the year 2006. The increased personnel costs
reflect the costs of a full year of staffing for our new Zebulon office which
opened in January 2006, and the increased staffing in Sanford when we converted
that office from a loan production office to a full-service branch. In addition
to personnel costs, additional costs during 2006 were incurred in occupancy and
equipment due to the additional staff, operating new offices, as well as general
upgrades in technology throughout the bank. For 2006, occupancy and equipment
expense increased $132,000 and $125,000, respectively, over 2005. 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
2006, contributing to an increase of $218,000 in professional and consulting
fees over 2005. The primary increases in other non-interest expense for 2006
over 2005 included advertising expense, up $111,000, printing and office
supplies, up $42,000, telephone expense, up $15,000, auto expense, up $18,000,
directors fees, up $26,000, meals, entertainment and travel, up $24,000,
donations and charities expense up, $21,000, ATM expense, up $20,000, and
servicing expense, up $16,000. There were no other significant increases in the
remaining other non-interest expense categories.
(The remainder of this page left blank.)
25
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, 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, to obtain wholesale deposits, and
repurchase agreements. At December 31, 2007, the bank had available lines of
credit totaling $54.7 million with the FHLB and $22.7 million lines of credit
from various financial institutions to purchase federal funds. As of December
31, 2007, we have no outstanding commitments for facility construction.
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 $54.6 million, or 7.71% of total assets
at December 31, 2007, and $49.3 million or 8.11% of total assets at December 31,
2006.
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, 2007, 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 $144.1 million. Additional detail regarding
the bank's off-balance sheet risk exposure is presented in Note J and K 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, 2007 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).
26
Interest Rate Sensitivity as of December 31, 2007
----------------------------------------------------------------------------
3 Months Over 3 Months Total Within Over 12
or Less to 12 Months 12 Months Months Total
------------ ------------ ------------ ------------ ------------
Interest-earning assets:
Loans $ 269,976 $ 51,052 $ 321,028 $ 224,242 $ 545,270
Securities available for sale - 590 590 113,711 114,301
Other earning assets 3,881 - 3,881 5,010 8,891
------------ ------------ ------------ ------------ ------------
Total interest-earning assets $ 273,857 $ 51,642 $ 325,499 $ 342,963 $ 668,462
============ ============ ============ ============ ============
Percent of total interest-earning assets 40.97% 7.73% 48.69% 51.31% 100.00%
Cumulative percent of total interest-
earning assets 40.97% 48.69% 48.69% 100.00% 100.00%
Interest-bearing liabilities
Fixed maturity deposits $ 84,481 $ 176,709 $ 261,190 $ 47,545 $ 308,735
All other deposits 154,341 - 154,341 - 154,341
Borrowings 10,000 10,000 20,000 77,000 97,000
------------ ------------ ------------ ------------ ------------
Total interest-bearing liabilities $ 248,822 $ 186,709 $ 435,531 $ 124,545 $ 560,076
============ ============ ============ ============ ============
Percent of total interest-bearing liabilities 44.43% 33.34% 77.76% 22.24% 100.00%
Cumulative percent of total interest-
bearing liabilities 44.43% 77.76% 77.76% 100.00% 100.00%
Interest sensitivity gap $ 25,035 $ (135,067) $ (110,032) $ 218,418 $ 108,386
Cumulative interest sensitivity gap 25,035 (110,032) (110,032) 108,386 108,386
Cumulative interest sensitivity gap as a
percent of total interest-earning assets 3.75% -16.46% -16.46% 16.21% 16.21%
Cumulative ratio of interest-sensitive assets
to interest-sensitive liabilities 110.06% 74.74% 74.74% 119.35% 119.35%
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, 2007 (in thousands):
Payments Due by Period
----------------------------------------------------------------------------
Less than 1 More than
Total year 1-3 years 3-5 years 5 years
------------ ------------ ------------ ------------ ------------
Borrowings $ 97,000 $ 20,000 $ 10,000 $ - $ 67,000
Subordinated debentures 12,372 - - - $ 12,372
Operating leases 1,106 144 265 256 441
Deposits 308,736 261,462 43,723 3,551 -
------------ ------------ ------------ ------------ ------------
Total $ 419,214 $ 281,606 $ 53,988 $ 3,807 $ 79,813
============ ============ ============ ============ ============
27
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, 2007 (in thousands):
Amount of Commitment Expiration Per Period
----------------------------------------------------------------------------
Less than 1 More than
Total year 1-3 years 3-5 years 5 years
------------ ------------ ------------ ------------ ------------
Undisbursed lines of credit $ 33,757 $ 3,509 $ 9,644 $ 1,149 $ 19,455
Other commitments to extend 30,860 22,872 7,302 686 -
Undisbursed portion of construction loans 76,894 65,097 10,479 1,134 183
Stand-by letters of credit 2,611 2,399 72 140 -
------------ ------------ ------------ ------------ ------------
Total $ 144,122 $ 93,877 $ 27,497 $ 3,109 $ 19,638
============ ============ ============ ============ ============
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 2007
and 2006 were 36.06% and 34.08%, 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.
28
Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rates and
Interest Differential
The following schedule presents average balance sheet information for
the years 2007, 2006 and 2005, 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,
--------------------------------------------------------------------------------------------
2007 2006 2005
------------------------------ ------------------------------ ------------------------------
Average Average Average Average Average Average
Balance Interest Rate Balance Interest Rate Balance Interest Rate
---------- ---------- ------ ---------- ---------- ------ ---------- ---------- ------
(dollars in thousands)
Interest-earning assets:
Loans $ 494,426 $ 40,967 8.29% $ 426,768 $ 35,457 8.31% $ 351,103 $ 26,612 7.58%
Investment securities - taxable 111,837 5,873 5.25% 89,195 4,503 5.05% 57,242 2,389 4.17%
Investment securities - tax exempt 4,846 178 3.68% 4,123 152 3.69% 3,175 118 3.72%
Other interest-earning assets 8,231 495 6.01% 7,970 444 5.57% 7,787 285 3.66%
---------- ---------- ------ ---------- ---------- ------ ---------- ---------- ------
Total interest-earning assets 619,340 47,513 7.67% 528,056 40,556 7.68% 419,307 29,404 7.01%
---------- ------ ---------- ------ ---------- ------
Other assets 35,817 32,633 30,155
---------- ---------- ----------
Total assets $ 655,157 $ 560,689 $ 449,462
========== ========== ==========
Interest-bearing liabilities:
Deposits:
NOW and money market deposits $ 107,520 $ 3,860 3.59% $ 71,981 $ 2,079 2.89% $ 57,928 $ 808 1.39%
Savings deposits 30,068 800 2.66% 37,304 1,079 2.89% 26,858 599 2.23%
Time deposits, $100,000 and over 166,744 8,164 4.90% 157,497 6,961 4.42% 124,248 4,066 3.27%
Other time deposits 125,875 6,317 5.02% 96,058 4,083 4.25% 80,610 2,350 2.92%
Borrowed funds 79,378 3,708 4.67% 63,885 2,989 4.68% 51,154 2,160 4.22%
Subordinated debentures 12,372 850 6.87% 9,389 626 6.67% - - 0.00%
---------- ---------- ------ ---------- ---------- ------ ---------- ---------- ------
Total interest-bearing
liabilities 521,958 23,699 4.54% 436,114 17,817 4.09% 340,798 9,983 2.93%
---------- ------ ---------- ------ ---------- ------
Noninterest-bearing deposits 75,286 73,151 65,570
Other liabilities 5,668 5,883 3,481
Stockholders' equity 52,246 45,541 39,613
---------- ---------- ----------
Total liabilities and
stockholders' equity $ 655,157 $ 560,689 $ 449,462
========== ========== ==========
Net interest income and interest
rate spread $ 23,814 3.13% $ 22,739 3.59% $ 19,421 4.08%
========== ====== ========== ====== ========== ======
Net yield on average interest-
earning assets 3.84% 4.31% 4.63%
====== ====== ======
Ratio of average interest-
earning assets to average
interest-bearing liabilities 118.66% 121.08% 123.04%
========== ========== ==========
29
The following table shows changes in interest income and expense by
category and rate/volume variances for the years ended December 31, 2007 and
2006. The changes due to rate and volume were allocated on their absolute
values:
Year Ended Year Ended
December 31, 2007 vs. 2006 December 31, 2006 vs. 2005
---------------------------------- ----------------------------------
Increase (Decrease) Due to Increase (Decrease) Due to
---------------------------------- ----------------------------------
Volume Rate Total Volume Rate Total
---------- ---------- ---------- ---------- ---------- ----------
(In thousands)
Interest income:
Loans $ 5,614 $ (103) $ 5,511 $ 6,011 $ 2,834 $ 8,845
Investment securities - taxable 1,166 204 1,370 1,473 641 2,114
Investment securities - tax exempt 26 - 26 35 (1) 34
Other interest-earning assets 17 34 51 10 149 159
---------- ---------- ---------- ---------- ---------- ----------
Total interest income 6,823 135 6,958 7,529 3,623 11,152
---------- ---------- ---------- ---------- ---------- ----------
Interest expense:
Deposits
NOW and money market deposits 1,151 630 1,781 301 970 1,271
Savings deposits (202) (77) (279) 268 212 480
Time deposits over $100,000 431 772 1,203 1,279 1,615 2,894
Other time deposits 1,383 851 2,234 552 1,182 1,735
Borrowed funds 725 (6) 719 567 262 829
Subordinated Debentures 202 22 224 626 - 626
---------- ---------- ---------- ---------- ---------- ----------
Total interest expense 3,690 2,192 5,882 3,593 4,241 7,835
---------- ---------- ---------- ---------- ---------- ----------
Net interest income increase (decrease) $ 3,133 $ (2,057) $ 1,076 $ 3,936 $ (618) $ 3,317
========== ========== ========== ========== ========== ==========
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, 2007. Loans
include nonaccrual loans but not the allowance for loan losses. (dollars in
thousands).
30
Beyond Five Average Estimated
2008 2009 2010 2011 2012 Years Total Interest Rate Fair Value
---- ---- ---- ---- ---- ---------- -------- ------------- ------------
Financial Assets
Loans:
Fixed rate $ 66,072 $ 55,974 $ 57,708 $ 46,845 $ 53,950 $ 9,837 $290,386 7.38% $289,967
Variable Rate 254,884 - - - - - 254,884 7.99% 254,517
Securities available
for sale 587 276 12,103 3,524 4,346 92,727 113,561 5.24% 114,301
Other earning assets 3,881 - - - - - 3,881 5.51% 3,881
-------- -------- -------- -------- -------- -------- -------- ----- --------
Total $325,424 $ 56,250 $ 69,811 $ 50,368 $ 58,296 $102,563 $662,712 7.24% $662,666
======== ======== ======== ======== ======== ======== ======== ========
Financial Liabilities
Money market, NOW and
savings deposits $154,341 - - - - - $154,341 2.05% $156,641
Time deposits 261,468 16,605 27,111 1,459 2,092 - 308,735 5.03% 301,102
Borrowings 20,000 - 10,000 - - 67,000 97,000 4.67% 99,095
Subordinated
debentures - - - 12,372 - - 12,372 6.87% 12,381
-------- -------- -------- -------- -------- -------- -------- ----- --------
Total $435,809 $ 16,605 $ 37,111 $ 13,831 $ 2,092 $ 67,000 $572,448 4.20% $569,219
======== ======== ======== ======== ======== ======== ======== ========
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, 2007, swap derivatives with a total notional value of $33.3
million, with remaining terms ranging up to three 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, 2007, our interest rate swaps
reflected a net unrealized loss of $16,000.
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, 2007, 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.
31
A discussion of derivatives is presented in Note J to our consolidated
financial statements, which are presented under Item 8 of Part II 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).
Year Ended December 31, 2007 Year Ended December 31, 2006
------------------------------------------ -------------------------------------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
----------- --------- --------- ---------- ---------- --------- ---------- -----------
Operating Data:
Total interest income $ 12,480 $ 12,310 $ 11,594 $ 11,128 $ 11,097 $ 10,547 $ 9,673 $ 9,239
Total interest expense 6,203 6,134 5,891 5,471 5,283 4,762 4,176 3,596
----------- --------- --------- ---------- ---------- --------- ---------- -----------
Net interest income 6,277 6,176 5,703 5,657 5,814 5,785 5,497 5,643
Provision for loan losses 587 280 232 262 187 332 168 186
----------- --------- --------- ---------- ---------- --------- ---------- -----------
Net interest income after
provision 5,690 5,896 5,471 5,395 5,627 5,453 5,329 5,457
Noninterest income 1,037 1,218 750 1,067 835 1,656 861 923
Noninterest expense 4,510 4,306 4,607 4,262 4,313 3,889 3,786 3,509
----------- --------- --------- ---------- ---------- --------- ---------- -----------
Income before income taxes 2,218 2,808 1,614 2,200 2,149 3,220 2,404 2,871
Provision for income taxes 876 996 565 750 653 1,074 869 1,031
----------- --------- --------- ---------- ---------- --------- ---------- -----------
Net income $ 1,341 $ 1,812 $ 1,050 $ 1,450 $ 1,496 $ 2,146 $ 1,535 $ 1,840
=========== ========= ========= ========== ========== ========= ========== ===========
Per Share Data:
Net income:
Basic $ 0.22 $ 0.27 $ 0.17 $ 0.24 $ 0.25 $ 0.35 $ 0.25 $ 0.30
Diluted 0.22 0.27 0.17 0.24 0.24 0.35 0.25 0.30
Cash dividends declared 0.08 0.08 0.07 0.06 0.07 0.06 0.06 0.06
Common stock price:
High $ 19.09 $ 20.00 $ 23.64 $ 24.77 $ 24.55 $ 21.82 $ 23.25 $ 18.00
Low 15.50 18.82 20.00 23.64 21.45 18.00 17.64 16.00
32
Investment Portfolio
The valuations of investment securities at December 31, 2007, 2006 and
2005, respectively, were as follows (in thousands):
Available for Sale
--------------------------------------------------------------------------
2007 2006 2005
----------------------------- ---------------------- -------------------
Amortized cost Estimated Amortized Estimated Amortized Estimated
fair value cost fair cost fair
value value
--------------- -------------- ------------- --------- --------- ---------
U.S. Government and agency
securities $ 92,651 $ 93,208 $ 85,730 $ 85,247 $69,108 $68,431
State and municipal securities 6,136 6,148 4,623 4,609 3,963 3,910
Mortgage-backed securities 12,985 13,087 9,882 9,860 7,003 6,904
Other 1,789 1,858 1,441 1,677 685 964
-------------- ------------- ------------ -------- -------- ---------
Total securities $ 113,561 $ 114,301 $ 101,676 $101,393 $80,759 $80,209
============== ============= ============ ======== ======== =========
Pledged securities $ 98,540 $ 69,239 $65,159
============= ======== =========
The following table sets forth the carrying value of our available for
sale investment portfolio at December 31, 2007 (in thousands):
Carrying Value
------------------------------------------------------------------
1 year After 1 year After 5 After 10 Total
through 5 years years years
through 10
years
------------ ----------------- ------------ ------------ ---------
U.S. Government and agency
securities - $ 17,100 $ 69,115 $ 6,994 $ 93,208
State and municipal securities - 1,527 1,413 3,208 6,148
Mortgage-backed securities $ 590 1,682 - 10,815 13,087
Other - - - 1,858 1,858
------------ ---------------- ----------- ----------- ---------
Total $ 590 $ 20,309 $ 70,528 $ 22,874 $114,301
============ ================ =========== =========== =========
The following table sets forth the weighted average yield by maturity
of our available for sale investment portfolio at December 31, 2007 amortized
cost:
Weighted Average Yields
-----------------------------------------------------------------
1 year After 1 year After 5 After 10 Total
through 5 years years years
through 10
years
----------- ---------------- ----------- ----------- ---------
U.S. Government and agency
securities - 4.59% 5.59% 5.62% 5.41%
State and municipal securities - 4.12% 4.14% 4.27% 4.20%
Mortgage-backed securities 4.27% 4.29% - 5.20% 5.04%
Other - - - 4.63% 4.63%
----------- ---------------- ----------- ----------- ---------
Total weighted average yields 4.27% 4.53% 5.56% 5.01% 5.24%
=========== ================ =========== =========== =========
33
Loan Portfolio
2007 2006 2005 2004 2003
------------ ------------- ---------- ---------- ------------
Loans secured by real estate:
Construction and land development $ 252,449 $ 194,460 $142,592 $ 90,742 $ 66,242
Secured by farmland 12,700 12,326 11,650 15,203 13,384
Secured by 1-4 family residential properties:
Revolving open-end loans & lines of credit 24,579 22,868 23,581 23,295 18,879
All other 76,776 68,196 66,140 58,158 55,113
Secured by multifamily residential properties 5,123 3,913 4,085 5,088 3,634
Secured by nonfarm nonresidential properties 110,769 102,217 84,189 72,611 63,372
Loans to finance agricultural production and
other loans to farmers 3,119 2,724 3,729 4,020 5,084
Commercial and industrial loans 45,653 37,622 34,166 26,005 27,872
Loans to individuals for household, family and
other personal expenditures
Credit cards and related plans 4,331 4,778 3,933 3,807 3,574
Other 8,235 11,840 22,438 13,400 14,458
Obligations of states and political subdivisions in
the U.S.:
Tax exempt obligations 744 199 113 225 332
All other loans 1,030 897 787 628 836
Lease financing receivables 5 5 9 12 13
Deferred cost (unearned income) on loans (243) (283) (318) (379) (170)
------------ ------------- ---------- ---------- ------------
Total loans 545,270 461,763 397,094 312,815 272,623
Allowance for loan losses (6,653) (5,566) (4,965) (4,055) (3,430)
------------ ------------- ---------- ---------- ------------
Net loans $ 538,617 $ 456,197 $392,129 $308,760 $ 269,193
============ ============= ========== ========== ============
Commitments and contingencies:
Commitments to make loans 141,511 140,539 97,183 89,377 68,731
Standby letters of credit 2,611 4,711 4,796 1,726 1,003
34
Certain Loan Maturities
The maturities and carrying amounts of certain loans as of December 31,
2007 are summarized as follows (in thousands):
Commerical Real Estate
Financial Construction
and and Land
Agricultural Development Total
------------- ------------ -----------
Due within one year $ 44,695 $ 165,523 $ 210,218
Due after one year to five years:
Fixed rate 89,350 65,392 154,743
Variable rate 24,130 17,520 41,650
Due after five years:
Fixed rate 5,299 1,481 6,780
Variable rate 4,426 - 4,426
------------- ------------ -----------
Total $ 167,900 $ 249,916 $ 417,816
============ ============ ===========
Risk Elements
Past due and nonaccrual loans, as extracted from the Call Reports of
December 31, 2007, 2006, 2005, 2004 and 2003 were as follows (in thousands):
2007 2006 2005 2004 2003
--------- ---------- ---------- ---------- ---------
Nonaccrual loans:
Real estate loans $ 1,038 $ 859 $ 535 $ 614 $ 739
Installment loans 40 58 114 80 96
Commercial and all other loans 176 50 348 250 224
--------- ---------- ---------- ---------- ---------
Total $ 1,254 $ 967 $ 997 $ 944 $ 1,059
========= ========== ========== ====================
Agricultural loans included above $ 164 $ - $ 252 $ 197 $ 110
========= ========== ========== ========== =========
Past due 90 days or more and still
accruing:
Real estate loans $ 30 $ 33 $ 64 $ 188 $ 597
Installment loans - - - 1 5
Credit cards and related plans 22 - 10 11 18
Commercial and all other loans - - - 26 15
--------- ---------- ---------- ---------- ---------
Total $ 52 $ 33 $ 74 $ 226 $ 635
========= ========== ========== ========== =========
Agricultural loans included above $ - $ - $ - $ 26 $ -
========= ========== ========== ========== =========
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. The gross interest income that would have been recorded for loans
accounted for on a nonaccrual basis at December 31, 2007 was approximately
$88,000. This amount represents interest income that would have been recorded if
the loans had been current in accordance with their original terms and had been
outstanding throughout the period or since origination, if held for part of
period.
35
Foreclosed assets (included in other assets) were $1.7 million,
$327,000, $247,000, $404,000, and $75,000, at December 31, 2007, 2006, 2005,
2004, and 2003, respectively. The amount of interest recognized on impaired
loans during the portion of 2007 that they were impaired was not material.
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.
We evaluate our loan portfolio in accordance with 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 are 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.
36
The following table summarizes the bank's loan loss experience for the
years ending December 31, 2007, 2006, 2005, 2004 and 2003 (in thousands, except
ratios):
2007 2006 2005 2004 2003
------------ ------------ ------------ ------------ ------------
Balance at beginning of period $ 5,566 $ 4,965 $ 4,055 $ 3,430 $ 2,860
Charge-offs:
Commercial and other 104 135 245 417 311
Real estate 144 87 158 395 342
Installment loans to
individuals 217 178 198 237 396
Credit cards and related
plans 39 58 95 297 88
------------ ------------ ------------ ------------ ------------
504 458 696 1,346 1,137
------------ ------------ ------------ ------------ ------------
Recoveries:
Commercial and other 26 49 49 206 31
Real estate 71 32 19 27 134
Installment loans 88 65 69 56 159
Credit cards and related
plans 44 40 66 86 10
------------ ------------ ------------ ------------ ------------
229 186 203 375 334
------------ ------------ ------------ ------------ ------------
Net charge-offs 275 272 493 971 803
------------ ------------ ------------ ------------ ------------
Additions charged to operations 1,362 873 1,403 1,596 1,373
------------ ------------ ------------ ------------ ------------
Balance at end of year $ 6,653 $ 5,566 $ 4,965 $ 4,055 $ 3,430
============ ============ ============ ============ ============
Ratio of net charge-offs during
the
year to average gross loans
outstanding during the year 0.06% 0.06% 0.14% 0.32% 0.32%
The following table summarizes the bank's allocation of allowance for
loan losses at December 31, 2007, 2006, 2005, 2004 and 2003 (in thousands,
except ratios):
At December 31,
-----------------------------------------------------------------------
2007 2006 2005
------------------------- ------------------------ --------------------
Amount % of Total Amount % of Total Amount % of Total
Loans (1) Loans (1) Loans (1)
-----------------------------------------------------------------------
Real estate loans $ 5,883 88% $ 4,866 87% $ 4,150 84%
Commercial and industrial loans 595 9% 486 9% 474 10%
Installment loans 153 2% 200 4% 330 7%
Unallocated 22 0% 14 0% 11 0%
------------ ------------ ------------ ----------- --------- ----------
Total $ 6,653 100% $ 5,566 100% $ 4,965 100%
============ ============ ============ =========== ========= ==========
37
At December 31,
----------------------------------------------
2004 2003
-------------------- ---------------------
% of Total Amount % of Total
Amount Loans (1) Loans (1)
-------------------- ---------------------
Real estate loans $ 3,432 85% $ 2,773 81%
Commercial and industrial
loans 389 10% 415 12%
Installment loans 223 6% 227 7%
Unallocated 11 0% 15 0%
--------- ---------- ---------- ----------
Total $ 4,055 100% $ 3,430 100%
========= ========== ========== ==========
- ------------------------------------------
(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, 2007 by maturity were as follows (in thousands):
Three months or less $ 42,167
Over three months through six months 51,296
Over six months through twelve months 39,506
Over twelve months through three years 37,671
Over three years 1,873
-----------
Total $ 172,513
===========
Borrowings
The bank borrows funds principally from the FHLB. Information regarding
such borrowings is as follows (in thousands, except rates):
2007 2006 2005
----------- ----------- ------------
Balance outstanding at December 31 $ 97,000 $ 70,000 $ 63,000
Weighted average rate at December 31 4.44% 4.65% 4.44%
Maximum borrowings during the year $ 97,000 $ 70,000 $ 63,000
Average amounts outstanding during year $ 78,405 $ 62,103 $ 48,945
Weighted average rate during year 4.73% 4.65% 4.23%
There were no short-term advances outstanding from the FHLB at December
31, 2007 and 2006. For 2007 and 2006, average outstanding short-term balances
were $973,000 and $1,221,000, respectively.
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 2007 and 2006,
average federal funds purchased were $3.6 million and $1.8 million,
respectively. At December 31, 2007 the bank had $10.0 million of federal funds
borrowings outstanding under these lines. At December 31, 2006, there were $3.4
million federal funds borrowings outstanding.
The bank completed a $12 million offering of Trust Preferred Securities
on March 30, 2006. Net proceeds from the sale of the Trust Preferred Securities
were invested in Junior Subordinated Deferrable Interest Debentures issued by
the Company.
38
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
The Emerging Issues Task Force ("EITF") reached a consensus at its
September 2006 meeting regarding EITF 06-4, Accounting for Deferred Compensation
and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance
Arrangements. The scope of EITF 06-4 is limited to the recognition of a
liability and related compensation costs for endorsement split-dollar life
insurance policies that provide a benefit to an employee that extends to
postretirement periods. Therefore, this EITF would not apply to a split-dollar
life insurance arrangement that provides a specified benefit to an employee that
is limited to the employee's active service period with an employer. This EITF
06-4 is effective for fiscal years beginning after December 15, 2007, with
earlier application permitted. We do not expect EITF 06-4 to have a material
impact on its financial position, results of operations or cash flows upon
adoption.
In September 2006, the FASB issued SFAS No. No. 157, Fair Value
Measurements, which defines fair value, establishes guidelines for measuring
fair value and expands disclosures regarding fair value measurements. SFAS No.
157 does not require any new fair value measurements but rather eliminates
inconsistencies in guidance found in various prior accounting pronouncements.
SFAS No. 157 is effective for fiscal years beginning after November 15, 2007.
However, on December 14, 2007, the FASB issued proposed FASB Staff Position
("FSP") SFAS 157-b ("FSP 157-b"), which would delay the effective date of SFAS
NO. 157 for all non-financial assets and non-financial liabilities, except those
that are recognized or disclosed at fair value in the financial statements on a
recurring basis (at least annually). FSP 157-b partially defers the effective
date of SFAS No. 157 to fiscal years beginning after November 15, 2008, and
interim periods within those fiscal years for items within the scope of FSP
157-b. We will adopt SFAS No. 157 during 2008, except as it applies to those
non-financial assets and non-financial liabilities as noted in proposed FSP
157-b. The partial adoption of SFAS No. 157 is not expected to have a material
impact on our financial position, results of operations or cash flows.
In July 2006, the FASB issued Financial Interpretation ("FIN") 48,
Accounting for Uncertainty in Income Taxes ("FIN 48"). FIN 48 is an
interpretation of SFAS No. 109, Accounting for Income Taxes. FIN 48 provides
interpretive guidance for the financial statement recognition and measurement of
a tax position taken, or expected to be taken, in a tax return. FIN 48 requires
the affirmative evaluation that it is more likely than not, based on the
technical merits of a tax position, that an enterprise is entitled to economic
benefits resulting from positions taken in income tax returns. If a tax position
does not meet the "more-likely-than-not" recognition threshold, the benefit of
that position is not recognized in the financial statements. FIN 48 also
requires companies to disclose additional quantitative and qualitative
information in their financial statements about uncertain tax positions. FIN 48
was effective for fiscal year beginning January 1, 2007. The adoption of FIN 48
did not have a material impact on our financial position, results of operations
or cash flows.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option
for Financial Assets and Financial Liabilities, Including an Amendment of FASB
Statement No. 115. SFAS No. 159 permits entities to choose to measure many
financial instruments and certain other items at fair value that are not
currently required to be measured at fair value and establishes presentation and
disclosure requirements designed to facilitate comparisons between entities that
choose different measurement attributes for similar types of assets and
liabilities. SFAS No. 159 is effective for financial statements issued for
fiscal years beginning after November 15, 2007. We do not expect SFAS No. 159 to
39
have a material impact on its financial position, results of operations or cash
flows upon adoption.
In November 2007, the SEC issued SAB No. 109, Written Loan Commitments
Recorded at Fair Value Through Earnings. SAB No. 109 supersedes guidance
provided by SAB No. 105, Loan Commitments Accounted for as Derivative
Instruments, and provides guidance on written loan commitments accounted for at
fair value through earnings. Specifically, SAB No. 109 addresses the inclusion
of expected net future cash flows related to the associated servicing of a loan
in the measurement of all written loan commitments accounted for at fair value
through earnings. In addition, SAB No. 109 retains the SEC's position on the
exclusion of internally-developed intangible assets as part of the fair value of
a derivative loan commitment originally established in SAB No.105. SAB No. 109
is effective for fiscal years ending after December 15, 2007. Our adoption of
SAB No. 109 did not have a material impact on our financial position, results of
operations or cash flows.
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 our consolidated financial statements
and monitors the status of changes to and proposed effective dates of exposure
drafts.
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 Analysis," "Market Risk," and "Derivative
Financial Instruments."
Item 8 - Financial Statements and Supplementary Data.
40
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, 2007 and 2006 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, 2007. 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. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as 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, 2007 and 2006, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2007 in conformity with accounting principles generally
accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness Four Oaks Fincorp,
Inc.'s internal control over financial reporting as of December 31, 2007, based
on criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission, and our report
dated March 12, 2008 expressed an unqualified opinion on the effectiveness of
the Company's internal control over financial reporting.
/s/ Dixon Hughes PLLC
Raleigh, North Carolina
March 12, 2008
41
Four Oaks Fincorp, Inc.
Consolidated Balance Sheets
December 31, 2007 and 2006
- --------------------------------------------------------------------------------
2007 2006
--------------------- ----------------------
(Amounts in thousands, except share data)
ASSETS
Cash and due from banks $ 14,394 $ 13,960
Interest-earning deposits 3,881 3,751
Investment securities available for sale, at fair value 114,301 101,393
Loans 545,270 461,763
Allowance for loan losses (6,653) (5,566)
--------------------- ----------------------
Net loans 538,617 456,197
Accrued interest receivable 3,564 3,614
Bank premises and equipment, net 12,627 11,630
FHLB stock 5,010 4,194
Investment in life insurance 10,041 8,424
Other assets 5,868 4,974
--------------------- ----------------------
Total assets $ 708,303 $ 608,137
===================== ======================
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand $ 74,687 $ 72,087
Money market and NOW accounts 126,300 89,615
Savings 28,041 31,424
Time deposits, $100,000 and over 172,513 164,497
Other time deposits 136,222 109,245
--------------------- ----------------------
Total deposits 537,763 466,868
Borrowings 97,000 73,400
Subordinated debentures 12,372 12,372
Accrued interest payable 4,055 3,258
Other liabilities 2,483 2,916
--------------------- ----------------------
Total liabilities 653,673 558,814
--------------------- ----------------------
Commitments and Contingencies (Notes C, J, K, N and S)
Shareholders' equity:
Common stock; $1.00 par value, 10,000,000 shares
authorized; 6,165,197 and 5,577,862 shares issued and
outstanding at December 31, 2007 and 2006,
respectively 6,165 5,578
Additional paid-in capital 21,545 10,016
Retained earnings 26,477 34,141
Accumulated other comprehensive income (loss) 443 (412)
--------------------- ----------------------
Total shareholders' equity 54,630 49,323
--------------------- ----------------------
Total liabilities and shareholders' equity $ 708,303 $ 608,137
===================== ======================
The accompanying notes are an integral part of these consolidated financial
statements.
42
Four Oaks Fincorp, Inc.
Consolidated Statements of Operations
For the Years Ended December 31, 2007, 2006 and 2005
- --------------------------------------------------------------------------------
2007 2006 2005
---------------- ---------------- ----------------
(Amounts in thousands, except per share data)
Interest and dividend income:
Loans, including fees $ 40,967 $ 35,457 $ 26,612
Investment securities:
Taxable 5,873 4,503 2,389
Tax-exempt 178 152 118
Dividends 390 287 155
Interest-earning deposits 105 157 130
---------------- ---------------- ----------------
Total interest and dividend income 47,513 40,556 29,404
---------------- ---------------- ----------------
Interest expense:
Deposits 19,142 14,202 7,823
Borrowings 4,557 3,615 2,160
---------------- ---------------- ----------------
Total interest expense 23,699 17,817 9,983
---------------- ---------------- ----------------
Net interest income 23,814 22,739 19,421
Provision for loan losses 1,362 873 1,403
---------------- ---------------- ----------------
Net interest income after provision for loan losses 22,452 21,866 18,018
---------------- ---------------- ----------------
Non-interest income:
Service charges on deposit accounts 2,098 2,053 1,875
Other service charges, commissions and fees 1,544 1,613 1,235
Losses on sale of investment securities (36) (121) (386)
Gains (losses) on hedges, net 165 (262) (397)
Gains on sale of loans 69 103 61
Merchant fees 436 402 389
Income (loss) from investment in life insurance (205) 549 300
---------------- ---------------- ----------------
Total non-interest income 4,071 4,337 3,077
---------------- ---------------- ----------------
Non-interest expenses:
Salaries 8,444 7,163 6,033
Employee benefits 1,690 1,477 1,306
Occupancy expenses 799 681 549
Equipment expenses 1,409 1,438 1,313
Professional and consulting fees 1,263 1,183 965
Other taxes and licenses 275 271 248
Merchant processing expenses 370 355 341
Other operating expenses 3,434 2,991 2,599
---------------- ---------------- ----------------
Total non-interest expenses 17,684 15,559 13,354
---------------- ---------------- ----------------
Income before income taxes 8,839 10,644 7,741
Provision for income taxes 3,187 3,627 2,738
---------------- ---------------- ----------------
Net income $ 5,652 $ 7,017 $ 5,003
================ ================ ================
Basic net income per common share $ 0.92 $ 1.15 $ 0.84
================ ================ ================
Diluted net income per common share $ 0.91 $ 1.14 $ 0.83
================ ================ ================
The accompanying notes are an integral part of these consolidated financial
statements.
43
Four Oaks Fincorp, Inc.
Consolidated Statements of Comprehensive Income
For the Years Ended December 31, 2007, 2006 and 2005
- --------------------------------------------------------------------------------
2007 2006 2005
----------------- ----------------- -----------------
(Amounts in thousands)
Net income $ 5,652 $ 7,017 $ 5,003
----------------- ----------------- -----------------
Other comprehensive income (loss):
Securities available for sale:
Unrealized holding gains (losses) on
available for sale securities 987 145 (1,326)
Tax effect (395) (57) 529
Reclassification of losses recognized
in net income 36 121 386
Tax effect (14) (48) (154)
----------------- ----------------- -----------------
Net of tax amount 613 161 (565)
----------------- ----------------- -----------------
Cash flow hedging activities:
Unrealized holding gains (losses) on
cash flow hedging activities 402 314 (290)
Tax effect (160) (127) 117
----------------- ----------------- -----------------
Net of tax amount 242 187 (173)
----------------- ----------------- -----------------
Total other comprehensive income (loss) 855 348 (738)
----------------- ----------------- -----------------
Comprehensive income $ 6,507 $ 7,365 $ 4,265
================= ================= =================
The accompanying notes are an integral part of these consolidated financial
statements.
44
Four Oaks Fincorp, Inc.
Consolidated Statements of Shareholders' Equity
For the Years Ended December 31, 2007, 2006 and 2005
- --------------------------------------------------------------------------------
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, 2004 3,438,107 $ 3,438 $ 8,788 $ 25,091 $ (22) $ 37,295
Net income - - - 5,003 - 5,003
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 $.22 per share - - - (1,279) - (1,279)
------------ ---------- ---------- ----------- ------------- ------------
BALANCE, DECEMBER 31, 2005 4,379,258 $ 4,379 $ 9,178 $ 28,815 $ (760) $ 41,612
Net income - - - 7,017 - 7,017
Other comprehensive income - - - - 348 348
Effect of 5-for-4 stock split 1,109,543 1,110 (1,110) - - -
Issuance of common stock 98,896 98 1,511 - - 1,609
Current income tax benefit - - 293 - - 293
Stock based compensation - - 144 - - 144
Purchases and retirement of
common stock (9,835) (9) - (243) - (252)
Cash dividends of $.24 per share - - - (1,448) - (1,448)
------------ ---------- ---------- ----------- ------------- -----------
BALANCE, DECEMBER 31, 2006 5,577,862 $ 5,578 $ 10,016 $ 34,141 $ (412) $ 49,323
Net income - - - 5,652 - 5,652
Other comprehensive income - - - - 855 855
Effect of 10% stock dividend 562,345 562 9,532 (10,094) - -
Issuance of common stock 100,797 100 1,565 - - 1,665
Current income tax benefit - - 203 - - 203
Stock based compensation - - 229 - - 229
Purchases and retirement of
common stock (75,807) (76) - (1,437) - (1,513)
Cash dividends of $.29 per share - - - (1,784) - (1,784)
------------ ---------- ---------- ----------- ------------- -----------
BALANCE, DECEMBER 31, 2007 6,165,197 $ 6,165 $ 21,545 $ 26,477 $ 443 $ 54,630
============ ========== ========== =========== ============= ===========
The accompanying notes are an integral part of these consolidated financial
statements.
45
Four Oaks Fincorp, Inc.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2007, 2006 and 2005
- --------------------------------------------------------------------------------
2007 2006 2005
------------ ------------ ------------
(Amounts in thousands)
Cash flows from operating activities:
Net income $ 5,652 $ 7,017 $ 5,003
Adjustments to reconcile net income to net cash
provided by operations:
Provision for loan losses 1,362 873 1,403
Provision for depreciation and amortization 1,009 1,022 1,038
Deferred income tax benefit (523) (319) (672)
Net amortization of bond premiums and discounts 32 (28) 18
Stock based compensation 229 144 -
Gain on sale of loans (69) (103) (61)
(Gain) loss on sale of investment securities 36 121 386
(Gain) loss on sale of foreclosed assets 20 (2) -
Loss on disposition of premises and equipment 77 73 -
(Income) loss from investment in life insurance 205 (549) (300)
(Gain) loss on hedges (165) 262 397
Changes in assets and liabilities:
Other assets 407 (1,365) 50
Interest receivable 50 (664) (740)
Other liabilities 134 (3,556) 4,003
Interest payable 797 1,003 1,054
------------ ------------ ------------
Net cash provided by operating activities 9,253 3,929 11,579
------------ ------------ ------------
Cash flows from investing activities:
Proceeds from sales and calls of investment
securities available for sale 78,027 36,759 36,783
Proceeds from maturities of investment
securities available for sale 2,000 275 -
Purchase of investment securities available for sale (91,980) (58,045) (65,994)
Purchase of FHLB stock (1,320) (1,825) (1,034)
Redemption of FHLB stock 504 1,286 -
Net increase in loans (86,283) (65,107) (85,142)
Purchases of bank premises and equipment (2,070) (3,028) (558)
Purchases of bank-owned life insurance (1,822) - (1,521)
Proceeds from sale of foreclosed assets 1,299 193 589
Expenditures on foreclosed assets (110) (1) (1)
------------ ------------ ------------
Net cash used by investing activities (101,755) (89,493) (116,878)
------------ ------------ ------------
Cash flows from financing activities:
Net proceeds from borrowings 23,600 (740) 30,980
Net increase in deposit accounts 70,895 68,526 83,034
Proceeds from subordinated debentures - 12,372 -
Proceeds from issuance of common stock 1,665 1,609 1,230
Excess tax benefits from stock options 203 293 -
Purchases and retirement of common stock (1,513) (252) -
Cash dividends paid (1,784) (1,448) (1,279)
------------ ------------ ------------
Net cash provided by financing activities 93,066 80,360 113,965
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents 564 (5,204) 8,666
Cash and cash equivalents at beginning of year 17,711 22,915 14,249
------------ ------------ ------------
Cash and cash equivalents at end of year $ 18,275 $ 17,711 $ 22,915
============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
46
Four Oaks Fincorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005
- --------------------------------------------------------------------------------
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. In March 2006, the
Company formed Four Oaks Statutory Trust I, a wholly owned Delaware statutory
business trust (the "Trust"), for the sole purpose of issuing Trust Preferred
Securities (as defined in Note G below). The Trust is not included in the
consolidated financial statements of the Company, in accordance with Financial
Accounting Standards Board ("FASB") Interpretation No. 46, "Consolidation of
Variable Interest Entities (revised December 2003) - an interpretation of ARB
No. 51" ("FIN 46R").
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 subsidiaries, the bank and Four Oaks Mortgage
Services, LLC. The bank operates fourteen 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, 2007, the
daily average gross reserve requirement was $3.1 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
47
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(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.
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.
48
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
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. Buildings, furniture 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 buildings. Expenditures
for repairs and maintenance are charged to expense as incurred.
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 carry-forwards.
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 FHLB of
Atlanta. 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, 2007.
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.
49
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
Accumulated other comprehensive income at December 31, 2007 and 2006 consists of
the following:
2007 2006
------- -------
(Amounts in thousands)
Unrealized holding gains (losses) - investment securities
available for sale $ 740 $ (283)
Deferred income taxes (297) 113
------- -------
Net unrealized holding gains (losses) - investment
securities available for sale 443 (170)
------- -------
Unrealized holding losses - cash flow hedge instruments - (402)
Deferred income taxes - 160
------- -------
Net unrealized holding losses - cash flow hedge
instruments - (242)
------- -------
Total accumulated other comprehensive income (loss) $ 443 $ (412)
======= =======
Stock Compensation Plans
Effective January 1, 2006, the Company adopted SFAS No. 123 (revised 2004),
Share-Based Payment ("SFAS No. 123R"), which was issued by the FASB in December
2004. SFAS No. 123R revises SFAS No. 123 Accounting for Stock Based
Compensation, and supersedes Accounting Principles Board Opinion ("APB") No. 25,
Accounting for Stock Issued to Employees, and its related interpretations. SFAS
No. 123R requires recognition of the cost of employee services received in
exchange for an award of equity instruments in the financial statements over the
period the employee is required to perform the services in exchange for the
award (usually the vesting period). SFAS No. 123R also requires measurement of
the cost of employee services received in exchange for an award based on the
grant-date fair value of the award. SFAS No. 123R also amends SFAS No. 95,
Statement of Cash Flows, to require that excess tax benefits be reported as
financing cash inflows, rather than as a reduction of taxes paid, which is
included within operating cash flows.
The Company adopted SFAS No. 123R using the modified prospective application as
permitted under SFAS No. 123R. Accordingly, prior period amounts have not been
restated. Under this application, the Company is required to record compensation
expense for all awards granted after the date of adoption and for the unvested
portion of previously granted awards that remain outstanding at the date of
adoption. Prior to the adoption of SFAS No. 123R, the Company used the intrinsic
value method as prescribed by APB No. 25 and thus recognized no compensation
expense for options granted with exercise prices equal to the fair market value
of the Company's common stock on the date of grant.
The following table illustrates the effect on net income and earnings per share
if the Company had applied the fair value recognition provisions of SFAS No.
123R to options granted under the Company's stock option plans for the year
ended December 31, 2005. For purposes of this pro forma disclosure, the value of
the options is estimated using the Black-Scholes option-pricing model and
amortized to expense over the options' vesting periods.
50
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
For the Year Ended
December 31, 2005
(Dollars in thousands)
----------------------
Net income:
As reported $ 5,003
Deduct: Total stock-based employee
compensation expense determined under
fair value method for all awards, net
of related tax effects (88)
--------
Pro forma $ 4,915
========
Basic earnings per share:
As reported $ .84
Pro forma $ .82
Diluted earnings per share:
As reported $ .83
Pro forma $ .82
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.
All references to net income per share, weighted average shares outstanding, and
dividends per share have been retroactively adjusted for a 10% stock dividend
issued on October 3, 2007 and five for four stock splits distributed in the form
of 25% stock dividend on November 10, 2006, November 25, 2005, and October 29,
51
2004. Potential common shares that may be issued by the Company relate solely to
outstanding stock options.
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:
2007 2006 2005
-------------- -------------- --------------
Weighted average number of common shares used in
computing basic net income per share 6,170,140 6,080,778 5,972,073
Effect of dilutive stock options 22,419 56,444 44,246
-------------- -------------- --------------
Weighted average number of commons shares and
dilutive potential common shares used in
computing diluted net income per share 6,192,559 6,137,222 6,016,319
============== ============== ==============
There were no antidilutive shares outstanding for the years ended December 31,
2007, 2006 and 2005.
52
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
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.
New Accounting Standards
The Emerging Issues Task Force ("EITF") reached a consensus at its September
2006 meeting regarding EITF 06-4, Accounting for Deferred Compensation and
Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance
Arrangements. The scope of EITF 06-4 is limited to the recognition of a
liability and related compensation costs for endorsement split-dollar life
insurance policies that provide a benefit to an employee that extends to
postretirement periods. Therefore, this EITF would not apply to a split-dollar
life insurance arrangement that provides a specified benefit to an employee that
is limited to the employee's active service period with an employer. This EITF
06-4 is effective for fiscal years beginning after December 15, 2007, with
earlier application permitted. The Company does not expect EITF 06-4 to have a
material impact on its financial position, results of operations or cash flows
upon adoption.
In September 2006, the FASB issued SFAS No. No. 157, Fair Value Measurements,
which defines fair value, establishes guidelines for measuring fair value and
expands disclosures regarding fair value measurements. SFAS No. 157 does not
require any new fair value measurements but rather eliminates inconsistencies in
guidance found in various prior accounting pronouncements. SFAS No. 157 is
effective for fiscal years beginning after November 15, 2007. However, on
December 14, 2007, the FASB issued proposed FASB Staff Position ("FSP") SFAS
157-b ("FSP 157-b"), which would delay the effective date of SFAS No. 157 for
all non-financial assets and non-financial liabilities, except those that are
recognized or disclosed at fair value in the financial statements on a recurring
basis (at least annually). FSP 157-b partially defers the effective date of SFAS
No. 157 to fiscal years beginning after November 15, 2008, and interim periods
within those fiscal years for items within the scope of FSP 157-b. The Company
will adopt SFAS No. 157 during 2008, except as it applies to those non-financial
assets and non-financial liabilities as noted in proposed FSP 157-b. The partial
adoption of SFAS No. 157 is not expected to have a material impact on the
Company's financial position, results of operations or cash flows.
53
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
The Company adopted the provisions of Financial Accounting Standards Board
("FASB") Interpretation No. 48 ("FIN 48"), Accounting for Uncertainty in Income
Taxes - an Interpretation of FASB Statement No. 109, on April 1, 2007. The
Company has analyzed filing positions in all of the federal and state
jurisdictions where it is required to file income tax returns, as well as all
open tax years in these jurisdictions. The periods subject to examination for
the Company's federal return are the fiscal 2006 and 2007 tax years. The company
did not have any unrecognized tax benefits and there was no effect on our
financial condition or results of operations as a result of implementing FIN 48.
It is the Company policy to recognize interest and penalties accrued on any
unrecognized tax benefits as a component of income tax expense. As of the date
of adoption of FIN 48, the Company did not have any accrued interest or
penalties associated with any unrecognized tax benefits, nor was any interest
expense recognized during the quarter.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities, Including an Amendment of FASB
Statement No. 115. SFAS No. 159 permits entities to choose to measure many
financial instruments and certain other items at fair value that are not
currently required to be measured at fair value and establishes presentation and
disclosure requirements designed to facilitate comparisons between entities that
choose different measurement attributes for similar types of assets and
liabilities. SFAS No. 159 is effective for financial statements issued for
fiscal years beginning after November 15, 2007. The Company does not expect SFAS
No. 159 to have a material impact on its financial position, results of
operations or cash flows upon adoption.
In November 2007, the SEC issued SAB No. 109, Written Loan Commitments Recorded
at Fair Value Through Earnings. SAB No. 109 supersedes guidance provided by SAB
No. 105, Loan Commitments Accounted for as Derivative Instruments, and provides
guidance on written loan commitments accounted for at fair value through
earnings. Specifically, SAB No. 109 addresses the inclusion of expected net
future cash flows related to the associated servicing of a loan in the
measurement of all written loan commitments accounted for at fair value through
earnings. In addition, SAB No. 109 retains the SEC's position on the exclusion
of internally-developed intangible assets as part of the fair value of a
derivative loan commitment originally established in SAB No.105. SAB No. 109 is
effective for fiscal years ending after December 15, 2007. The Company adoption
of SAB No. 109 did not have a material impact on its financial position, results
of operations or cash flows.
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.
Reclassifications
Certain items included in the 2006 and 2005 consolidated financial statements
have been reclassified to conform to the 2007 presentation. These
reclassifications have no effect on the net income or shareholders' equity
previously reported.
54
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, 2007 and 2006 are as
follows:
Amortized Gross Unrealized Gross Unrealized
Cost Gains Losses Fair Value
--------------- --------------- --------------- ---------------
(Amounts in thousands)
2007:
U.S. government and agency securities $ 92,651 $ 559 $ 2 $ 93,208
State and municipal securities 6,136 17 5 $ 6,148
Mortgage-backed securities 12,985 122 20 $ 13,087
Other 1,789 69 - $ 1,858
--------------- --------------- --------------- ---------------
$ 113,561 $ 767 $ 27 $ 114,301
=============== =============== =============== ===============
Amortized Gross Unrealized Gross Unrealized
Cost Gains Losses Fair Value
--------------- --------------- --------------- ---------------
(Amounts in thousands)
2006:
U.S. government and agency securities $ 85,730 $ 83 $ 566 $ 85,247
State and municipal securities 4,623 16 30 $ 4,609
Mortgage-backed securities 9,882 52 74 $ 9,860
Other 1,441 236 - $ 1,677
--------------- --------------- --------------- ---------------
$ 101,676 $ 387 $ 670 $ 101,393
=============== =============== =============== ===============
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, 2007 and 2006. As of December 31, 2007, the unrealized losses
relate to eight U.S. government agency securities, three mortgage-backed
securities and five municipal securities. Four of the municipal securities and
three of the mortgage backed 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.
55
NOTE B - INVESTMENT SECURITIES (Continued)
2007
----------------------------------------------------------------------------------
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 $ 14,983 $ 2 $ - $ - $ 14,983 $ 2
State and municipal securities 139 - 1,519 5 1,658 5
Mortgage-backed securities - - 2,439 20 2,439 20
------------ ------------ ------------ ------------ ------------ ------------
Total temporarily impaired
securities $ 15,122 $ 2 $ 3,958 $ 25 $ 19,080 $ 27
============ ============ ============ ============ ============ ============
2006
----------------------------------------------------------------------------------
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 $ 11,967 $ 22 $ 48,225 $ 544 $ 60,192 $ 566
State and municipal securities 138 - 2,349 30 2,487 30
Mortgage-backed securities 549 - 4,320 74 4,869 74
------------ ------------ ------------ ------------ ------------ ------------
Total temporarily impaired
securities $ 12,654 $ 22 $ 54,894 $ 648 $ 67,548 $ 670
============ ============ ============ ============ ============ ============
The amortized cost and fair value of available for sale securities at December
31, 2007 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 $ 587 $ 590
Due after one year through five years 20,248 20,309
Due after five years through ten years 70,028 70,528
Due after ten years 22,699 22,874
---------------- ----------------
$ 113,561 $ 114,301
================ ================
56
NOTE B - INVESTMENT SECURITIES (Continued)
Securities with a carrying value of approximately $98.5 million and $69.2
million at December 31, 2007 and 2006, respectively, were pledged to secure
public deposits and for other purposes required or permitted by law.
Sales and calls of securities available for sale during 2007, 2006 and 2005
generated gross realized gains of $82,000, $15,000, and $74,000, respectively
and gross realized losses of $119,000, $135,000, and $460,000, respectively.
NOTE C - LOANS AND ALLOWANCE FOR LOAN LOSSES
Major classifications of loans as of December 31, 2007 and 2006 are summarized
as follows:
2007 2006
---------- ----------
(Amounts in thousands)
Real estate - residential and other $ 217,247 $ 197,195
Real estate - agricultural 12,700 12,326
Construction and land development 252,449 194,460
Other agricultural 3,119 2,724
Consumer loans 12,566 16,618
Commercial loans 45,653 37,622
Other loans 1,779 1,101
---------- ----------
545,513 462,046
Less:
Net deferred loan costs (243) (283)
Allowance for loan losses (6,653) (5,566)
---------- ----------
$ 538,617 $ 456,197
========== ==========
Nonperforming assets at December 31, 2007 and 2006 consist of the following:
2007 2006
---------- ----------
(Amounts in thousands)
Loans past due ninety days or more $ 52 $ 33
Nonaccrual loans 1,254 967
Foreclosed assets (included in other assets) 1,688 327
---------- ----------
$ 2,994 $ 1,327
========== ==========
At December 31, 2007, the recorded investment in loans considered impaired in
accordance with SFAS No. 114 totaled $5.6 million. This amount consisted of both
accrual and nonaccrual loans in the amount of $4.4 million and $1.2 million,
respectively. At December 31, 2006, the investment in loans considered impaired
consisted of both accrual and nonaccrual loans in the amount of $4.4 million and
$1.0 million, respectively. Impaired loans of $4.4 million and $4.4 million had
related allowances for loan losses of $2.2 million and $1.7 million at December
31, 2007 and 2006, respectively. For the years ended December 31, 2007 and 2006,
the average recorded investment in impaired loans was approximately $5.0 million
and $4.9 million, respectively. The amount of interest recognized on impaired
loans during the portion of the year that they were impaired was not material.
57
NOTE C - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
A summary of the allowance for loan losses for the years ended December 31,
2007, 2006 and 2005 is as follows:
2007 2006 2005
---------- ---------- ---------
(Amounts in thousands)
Balance, beginning $ 5,566 $ 4,965 $ 4,055
Provision for loan losses 1,362 873 1,403
Loans charged-off (504) (458) (696)
Recoveries of loans previously charged-off 229 186 203
---------- ---------- ---------
Balance, ending $ 6,653 $ 5,566 $ 4,965
========== ========== =========
The Company 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, 2006 $ 7,254
New loans 2,752
Principal repayments (3,060)
---------
Balance at December 31, 2007 $ 6,946
=========
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, 2007, the Company had pre-approved but unused
lines of credit totaling $1.4 million to executive officers, directors and their
affiliates.
58
NOTE D - BANK PREMISES AND EQUIPMENT
Company premises and equipment at December 31, 2007 and 2006 are as follows:
2007 2006
---------- ----------
(Amounts in thousands)
Land $ 2,815 2,814
Buildings 9,501 8,410
Furniture and equipment 9,159 8,383
---------- ----------
21,475 19,607
Less accumulated depreciation (8,848) (7,977)
---------- ----------
$ 12,627 $ 11,630
========== ==========
Depreciation expense for the years ended December 31, 2007, 2006 and 2005
amounted to $1.0 million for each year.
NOTE E - DEPOSITS
At December 31, 2007, the scheduled maturities of time deposits are as follows
(amounts in thousands):
Less than $100,000 Total
$100,000 more
----------------------------------
Within one year $ 128,493 $ 132,969 $ 261,462
Over one year through three years 6,052 37,671 43,723
Over three years 1,677 1,873 3,550
---------- ---------- ----------
$ 136,222 $ 172,513 $ 308,735
========== ========== ==========
59
NOTE F - BORROWINGS
At December 31, 2007 and 2006, borrowed funds included the following FHLB
advances (amounts in thousands):
Maturity Interest Rate 2007 2006
- ----------------- --------------------- ----------- ---------
June 27, 2008 4.40% Variable 10,000 10,000
July 19, 2010 5.75% Fixed 10,000 10,000
November 16, 2011 5.39% Variable - 8,000
August 12, 2015 3.77% Fixed - 10,000
May 25, 2016 4.46% Fixed 5,000 5,000
October 3, 2016 4.01% Fixed - 10,000
October 19, 2016 4.13% Fixed - 5,000
November 17, 2016 4.11% Fixed 5,000 5,000
November 30, 2016 4.09% Fixed 7,000 7,000
June 5, 2017 4.35% Fixed 10,000 -
July 3, 2017 4.36% Fixed 13,000 -
July 24, 2017 4.34% Fixed 5,000 -
July 31, 2017 4.35% Fixed 5,000 -
August 14, 2017 4.08% Fixed 5,000 -
August 14, 2017 3.94% Fixed 5,000 -
October 4, 2017 3.95% Fixed 7,000 -
----------- ---------
$ 87,000 $70,000
=========== =========
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, 2007, the Company has available lines of credit totaling $141.7
million with the FHLB for borrowing dependent on adequate collateralization. The
weighted average rates for the above borrowings at December 31, 2007 and 2006
were 4.73% and 4.65%, respectively. The Company has no short-term FHLB advances
outstanding as of December 31, 2007 and 2006.
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 $10.0 million outstanding as of December 31,
2007. The Company had $3.4 million outstanding as of December 31, 2006.
60
NOTE G - TRUST PREFERRED SECURITIES
On March 30, 2006, $12.0 million of trust preferred securities ("Trust Preferred
Securities") were placed through the Trust. The Trust has invested the net
proceeds from the sale of the Trust Preferred Securities in Junior Subordinated
Deferrable Interest Debentures (the "Debentures") issued by the Company and
recorded in borrowings on the accompanying consolidated balance sheet. The Trust
Preferred Securities pay cumulative cash distributions quarterly at an annual
rate, reset quarterly, equal to three month LIBOR plus 1.35%. The dividends paid
to holders of the Trust Preferred Securities, which will be recorded as interest
expense, are deductible for income tax purposes. The Trust Preferred Securities
are redeemable on June 15, 2011 or afterwards in whole or in part, on any June
15, September 15, December 15 or March 15. Redemption is mandatory by June 15,
2036. The Company has fully and unconditionally guaranteed the Trust Preferred
Securities through the combined operation of the Debentures and other related
documents. The Company's obligation under the guarantee is unsecured and
subordinate to senior and subordinated indebtedness of the Company. The Trust
Preferred Securities qualify as Tier I capital for regulatory capital purposes
subject to certain limitations.
NOTE H - INCOME TAXES
Allocation of income tax expense between current and deferred portions is as
follows:
Years Ended December 31,
--------------------------
2007 2006 2005
-------- -------- --------
(Amounts in thousands)
Current tax expense:
Federal $3,384 $3,513 $2,947
State 326 433 463
-------- -------- --------
3,710 3,946 3,410
-------- -------- --------
Deferred tax expense:
Federal (426) (269) (559)
State (97) (50) (113)
-------- -------- --------
(523) (319) (672)
-------- -------- --------
$3,187 $3,627 $2,738
======== ======== ========
The reconciliation of expected income tax at the statutory federal rate of
34% with income tax expense is as follows:
Years Ended December 31,
--------------------------
2007 2006 2005
-------- -------- --------
(Amounts in thousands)
Expense computed at statutory rate of 34% $3,005 $3,619 $2,631
Effect of state income taxes, net of federal
benefit 151 253 232
Tax exempt income (59) (51) (36)
(Income) loss from investment in life insurance 70 (187) (102)
Other, net 20 (7) 13
-------- -------- --------
$3,187 $3,627 $2,738
======== ======== ========
61
NOTE H - INCOME TAXES (Continued)
Deferred income taxes consist of the following:
Years Ended December 31,
------------------------
2007 2006
-------- --------
(Amounts in thousands)
Deferred tax assets:
Allowance for loan losses $ 2,520 $ 2,101
Non-qualified stock options 148 60
Unamortized investment premiums 15 1
Net deferred loan fees 94 109
Other comprehensive loss - 273
Other 97 57
-------- --------
Total deferred tax assets 2,874 2,601
-------- --------
Deferred tax liabilities:
Property and equipment $ 640 641
Unrealized gain on securities 297 -
Prepaid expense 132 105
Unaccreted investment discounts - 20
Other 16 -
-------- --------
Total deferred tax liabilities 1,085 766
-------- --------
Net deferred tax asset included in
other assets $ 1,789 $ 1,835
======== ========
NOTE I - 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, 2007, 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, 2007, that the Bank meets all capital adequacy
requirements to which it is subject.
As of December 31, 2007, 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.
62
NOTE I - REGULATORY RESTRICTIONS (Continued)
The Bank's actual capital amounts and ratios are also presented in the table
below (dollars in thousands):
Actual Minimum for Capital Minimum To Be Well
Adequacy Purposes Capitalized Under
Prompt Corrective
Action Provisions
--------------------------------------- -------------------
Amount Ratio Amount Ratio Amount Ratio
--------------------------------------- -------------------
As of December 31, 2007:
- ---------------------------------
Total Capital (to Risk Weighted
Assets) $67,505 11.9% $45,458 8.0% $56,822 10.0%
Tier I Capital (to Risk Weighted
Assets) 60,852 10.7% 22,729 4.0% 34,093 6.0%
Tier I Capital (to Average
Assets) 60,852 8.9% 27,501 4.0% 34,376 5.0%
As of December 31, 2006:
- ---------------------------------
Total Capital (to Risk Weighted
Assets) $61,618 12.8% $38,543 8.0% $48,179 10.0%
Tier I Capital (to Risk Weighted
Assets) 56,052 11.6% 19,272 4.0% 28,908 6.0%
Tier I Capital (to Average
Assets) 56,052 9.3% 24,070 4.0% 30,090 5.0%
The Company is also subject to these capital requirements. At December 31, 2007
and 2006, the Company's total capital to risk weighted assets, Tier 1 capital to
risk weighted assets and Tier 1 capital to average assets were 11.7%, 12.9%, and
10.2%, and 12.9%, 14.0%, and 10.3%, respectively.
NOTE J - 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.
63
NOTE J - DERIVATIVES (Continued)
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.
At December 31, 2007 there were no outstanding interest rate swap agreements
used to hedge variable rate loans. At December 31, 2006, the information
pertaining to an outstanding interest rate swap agreement used to hedge variable
rate loans is as follows (dollars in thousands):
Notional amount $ 25,000
Weighted average pay rate 7.96%
Weighted average receive rate 5.85%
Weighted average maturity in years 0.7
Unrealized loss relating to interest rate swaps $ (402)
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, 2006, the Company's interest rate swap used to hedge variable
rate loans reflected an unrealized loss of $402,000. The unrealized loss is
included in other comprehensive income, net of tax, in the accompanying
consolidated balance sheet.
Risk management results for the year ended December 31, 2006 related to the
balance sheet hedging of variable rate loans indicate that the hedge was 100%
effective and that there was no component of the derivative instrument's gain or
loss which was excluded from the assessment of hedge effectiveness.
At December 31, 2006 the unrealized loss relating to use of the interest rate
swap 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.
64
NOTE J - DERIVATIVES (Continued)
Interest Rate Risk Management - Fair Value Hedging Instruments
The Company uses funds from fixed rate time deposits in its lending and
investment activities and for 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, 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, 2007 and 2006, the information pertaining to outstanding
interest rate swap agreements used to hedge fixed-rate funding is as follows
(dollars in thousands):
2007 2006
------- -------
Notional amount $33,301 $38,611
Weighted average pay rate 4.93% 5.32%
Weighted average receive rate 4.25% 3.90%
Weighted average maturity in years 2.2 3.1
Unrealized gain (loss) relating to interest rate swaps $ (16) $ (145)
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.
The interest rate swap agreement used to hedge variable rate loans expired July
30, 2007. No other interest rate swaps were terminated during 2007 or 2006. At
December 31, 2007 and 2006, the Company's interest rate swaps used to hedge
fixed-rate funding reflected an unrealized loss of $16,000 and $145,000,
respectively. For the years ended December 31, 2007 and 2006, the Company's
interest rate swaps not designated as a fair value hedge reflected a gain of
$165,000 and a loss of $262,000, respectively. The above interest rate swaps are
recorded in other liabilities in the accompanying consolidated balance sheet.
NOTE K - COMMITMENTS AND CONTINGENCIES
The Company 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
Company uses the same credit policies in making commitments and conditional
obligations as it does for on-balance-sheet instruments.
65
NOTE K - COMMITMENTS AND CONTINGENCIES (Continued)
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 Company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Company, 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, 2007 is as follows (dollars in thousands):
Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit $ 110,651
Undisbursed lines of credit 30,860
Financial stand-by letters of credit 575
Performance stand-by letters of credit 2,036
NOTE L - 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 1,342,773 shares of
common stock. Options are granted at the discretion of the Company's Board of
Directors at an exercise price approximating market value, 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 option activity under the Plan for the year ended December 31,
2007, after giving retroactive effect to the 10% stock dividend, is presented
below:
66
NOTE L - STOCK OPTION PLAN (Continued)
Weighted-
Average
Remaining Aggregate
Option Price Contractual Intrinsic
Shares Per Share Term Value
--------- ------------ ------------- ------------
Outstanding at January 1, 2007 177,309 $ 12.05
Granted 41,140 24.41
Exercised (42,237) 8.65
Forfeited (2,578) 13.24
Expired (7,606) 6.76
---------
Balance December 31, 2007 166,028 $ 16.20 1.67 $ 601,000
========= ============ ============= ============
Excercisable at December 31, 2007 124,888 $ 13.50 1.18 $ 281,000
========= ============ ============= ============
The weighted average exercise price of all exercisable options at December 31,
2007 is $13.50. There were 419,271 shares reserved for future issuance at
December 31, 2007.
As of December 31, 2007, there was $20,000 of unrecognized compensation cost
related to non-vested share-based compensation arrangements. That cost is
expected to be recognized in 2008.
Additional information concerning the Company's stock options at December 31,
2007 is as follows:
Remaining
Exercise Price Number Contractual Number
Outstanding Life Exercisable
- --------------------------------------------------------------------------
$10.24 41,791 0.15 years 41,791
$13.24 37,860 1.15 years 37,860
$16.73 45,237 2.15 years 45,237
$24.41 41,140 3.16 years -
----------- ------------
166,028 124,888
=========== ============
67
NOTE L - STOCK OPTION PLAN (Continued)
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 2007, 2006 and 2005:
2007 2006 2005
-------------- -------------- -------------
Dividend yield 1.20% 1.53% 1.84%
Expected volatility 23.76% 20.72% 24.31%
Risk free interest rate 4.65% 4.73% 3.75%
Expected life 4 years 4 years 4 years
The weighted average fair value of options granted during 2007, 2006 and 2005
was $5.76, $3.84, and $3.04, respectively.
NOTE M - 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. SERP 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 SERP plan amounts to $175,000 and $147,000 at December 31, 2007 and
2006, respectively. During 2007, 2006, and 2005, the expense attributable to the
SERP amounted to $28,000, $25,000, and $23,000, 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 and key employees 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.
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 $15,500 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, 2007, 2006 and 2005 were $97,000,
$66,000, and $79,000, respectively. Contributions under the plan are made at the
discretion of the Company's Board of Directors.
68
NOTE M - OTHER EMPLOYEE BENEFITS (Continued)
Employee Stock Ownership Plan
The Company sponsors an employee stock ownership plan (ESOP) which makes the
employees of the 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 the years ended 2007, 2006, and 2005 were $300,000, $249,000, and
$223,000, 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, 2007, 268,555 shares of the Company's common stock had been
reserved for issuance under the Purchase Plan, and 170,388 shares had been
purchased. During the years ended December 31, 2007 and 2006, 5,785 and 8,554
shares, respectively, were purchased under the Purchase Plan.
NOTE N - LEASES
The Company 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):
2008 $ 144
2009 142
2010 123
2011 127
2012 129
2013 and beyond 441
----------
$ 1,106
==========
In addition, the Company has leased a building from one of its former directors
for approximately $1,000 per month in 2007 and 2006, under an operating lease on
a month-to-month basis.
Total rental expense under operating leases for the years ended December 31,
2007, 2006 and 2005 amounted to $152,000, $116,000 and $57,000, respectively.
69
NOTE O - PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information of Four Oaks Fincorp, Inc., the parent company,
at December 31, 2007 and 2006 and for the years ended December 31, 2007, 2006
and 2005 is presented below:
2007 2006
----------- -------
(Amounts in thousands)
Condensed Balance Sheets
Assets:
Cash and cash equivalents $3,686 $4,409
Equity investment in subsidiaries 62,187 56,324
Securities available for sale 1,153 1,015
Other assets 33 76
----------- -------
Total assets $67,059 $61,824
=========== =======
Liabilities and Shareholders' Equity:
Other liabilities $57 $129
Subordinated debentures 12,372 12,372
Shareholders' equity 54,630 49,323
----------- -------
Total liabilities and shareholders' equity $67,059 $61,824
=========== =======
70
NOTE O - PARENT COMPANY FINANCIAL INFORMATION (Continued)
For the Years Ended
December 31,
------------------------
2007 2006 2005
------- -------- -------
(Amounts in thousands)
Condensed Statements of Operations
Dividends received from bank subsidiary $1,784 $1,448 $937
Equity in undistributed earnings of
subsidiaries 4,464 6,021 4,035
Interest income 228 187 81
Other income 83 65 17
Other expenses (907) (704) (67)
------- -------- -------
Net income $5,652 $7,017 $5,003
======= ======== =======
2007 2006 2005
------- -------- -------
(Amounts in thousands)
Condensed Statements of Cash Flows
Operating activities:
Net income $5,652 $7,017 $5,003
Equity in undistributed earnings of
subsidiaries (4,464) (6,021) (4,035)
Decrease (increase) in other assets 43 (76) -
(Decrease) increase in other liabilities (72) 17 -
------- -------- -------
Net cash provided by operating activities 1,159 937 968
------- -------- -------
Investing activities:
Investment in subsidiaries (315) (12,695) -
Purchase of securities available for sale (138) (347) (53)
------- -------- -------
Net cash used by investing activities (453) (13,042) (53)
------- -------- -------
Financing activities:
Proceeds from issuance of common stock 1,665 1,609 1,230
Excess tax benefits from stock options 203 293 -
Proceeds from issuance of subordinated
debentures - 12,372 -
Purchases and retirements of common stock (1,513) (252) -
Dividends paid (1,784) (1,448) (1,279)
------- -------- -------
Net cash (used) provided by financing
activities (1,429) 12,574 (49)
------- -------- -------
Net (decrease) increase in cash and cash
equivalents (723) 469 866
Cash and cash equivalents, beginning of year 4,409 3,940 3,074
------- -------- -------
Cash and cash equivalents, end of year $3,686 $4,409 $3,940
======= ======== =======
71
NOTE P - 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 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 and Subordinated Debentures
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.
72
NOTE P - 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, 2007 and 2006
2007 2006
------------------------------- --------------------------------
Carrying Value Estimated Fair Carrying Value Estimated Fair
Value Value
--------------- -------------- -------------- --------------
Financial assets:
Cash and cash equivalents $ 18,275 $ 18,275 $ 17,711 $ 17,711
Securities available for sale 114,301 114,301 101,393 101,393
Loans, net 538,617 537,831 456,197 449,550
FHLB stock 5,010 5,010 4,194 4,194
Investment in life insurance 10,041 10,041 8,424 8,424
Accrued interest receivable 3,564 3,564 3,614 3,614
Financial liabilities:
Deposits $ 537,763 $ 522,212 $ 466,868 $ 449,771
Subordinated debentures 12,372 12,381 12,372 12,384
Borrowings 97,000 99,905 73,400 74,042
Accrued interest payable 4,055 4,055 3,258 3,258
Derivative financial instruments:
Interest rate swap agreements:
Liabilities, net loss 80 80 1,108 1,108
73
NOTE Q - CASH FLOW SUPPLEMENTAL DISCLOSURES
The following information is supplemental information regarding the cash flows
for the years ended December 31, 2007, 2006 and 2005:
2007 2006 2005
----------- ------------ ------------
(Amounts in thousands)
Cash paid for:
Interest on deposits and borrowings $ 22,902 $ 16,814 $ 8,929
Income taxes 2,981 4,057 3,684
Summary of noncash investing and financing activities:
Transfer from loans to foreclosed assets 2,570 269 431
Tax benefit from the exercise of non-qualified stock options 203 293 101
Increase (decrease) in fair value of securities available for sale,
net of tax 613 161 (565)
Increase (decrease) in fair value of cash flow hedge, net of tax 242 187 (173)
74
NOTE R - 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. On December
20, 2006, the Board of Directors increased the purchase authorization to 200,000
shares. On November 26, 2007 the Board of Directors increased the purchase
authorization to 500,000 shares and on December 17, 2007 authorized the
extension of the Company's Stock Purchase Program through December 31, 2008.
During 2007, the Company purchased 75,807 shares at an average cost of $19.97.
At December 31, 2007, there were 350,969 share available for repurchase.
NOTE S - PROPOSED MERGER WITH LONGLEAF COMMUNITY BANK
On December 10, 2007, the Company announced that it had entered into a
definitive agreement (the "Agreement") with LongLeaf Community Bank ("LongLeaf")
pursuant to which LongLeaf will merge with and into the Bank. Under the terms of
the Agreement, each share of LongLeaf common stock will be automatically
converted into the right to receive either (i) $16.50 in cash, without interest,
(ii) 1.0 share of Company common stock multiplied by an exchange ratio or (iii)
0.60 shares of Company common stock multiplied by the exchange ratio plus an
amount equal to $6.60 in cash, all on and subject to the terms and conditions
contained in the Agreement. The exchange ratio is equal to $16.50 divided by the
volume weighted average of the daily closing sales price of the Company's common
stock as quoted on the OTC Bulletin Board during the 20 consecutive trading days
ending three business days prior to the closing date of the Merger (the "Average
Closing Price"). Pursuant to the Agreement, the Average Closing Price can be no
higher than $19.3397452 per share and no lower than $14.2945943 per share. In
addition, if (a) as of the later of the date of receipt of the required approval
of regulatory authorities or the date of approval by LongLeaf shareholders, the
average closing price of the Company's common stock is less than 75% of the
Average Closing Price as of the date the Agreement was executed and (b) the
Company and Four Oaks do not agree to adjust the exchange ratio as permitted by
the Agreement, then LongLeaf will have a right to terminate the Agreement.
Finally, certain allocation procedures will be used to cause the stock
consideration to be paid to LongLeaf shareholders to be between 50% and 70% of
the total merger consideration.
On January 30, 2008, the Company filed a Registration Statement on Form S-4 with
the Securities and Exchange Commission to register up to 708,461 shares of its
common stock that could be issued in connection with the proposed transaction.
LongLeaf mailed the related proxy statement/prospectus to its shareholders on or
about February 28, 2008, setting forth matters relating to the transaction to be
voted upon at its upcoming Special Meeting of Shareholders to be held on April
10, 2008. The Form S-4 describes the proposed transaction in detail and
provides, among other things, highlights and terms of the proposed merger and
pro forma financial information. Subject to receipt of approval by LongLeaf's
shareholders and certain other closing conditions, the Company plans to
consummate the bank merger in the second quarter of 2008.
75
Item 9 - Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not Applicable.
Item 9A - Controls and Procedures.
Disclosure 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 the Company's
management, including its Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the Company's disclosure controls and procedures (as
defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of
the period covered by this Annual Report. As defined in Rule 13a-15(e) and
15d-15(e) under the Exchange Act, the term disclosure controls and procedures
means controls and other procedures of an issuer that are designed to ensure
that information required to be disclosed by the issuer in the reports that it
files or submits under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the Securities and Exchange
Commission's (the "SEC's") rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed by an issuer in the reports that it files
or submits under the Exchange Act is accumulated and communicated to the
issuer's management, including its principal executive and principal financial
officers, or persons performing similar functions, as appropriate to allow
timely decisions regarding required disclosure. Based on their evaluation, the
Chief Executive Officer and Chief Financial Officer have concluded that as of
the end of the period covered by this Annual Report, the Company's disclosure
controls and procedures are effective, in that they provide reasonable
assurances that information required to be disclosed by the Company in the
reports that it files or submits under the Exchange Act is recorded, processed,
summarized and reported, within the time periods required by the SEC's rules and
forms.
Management's Report on Internal Control Over Financial Reporting
The management of the Company is responsible for establishing and
maintaining adequate internal control over financial reporting. The Company's
internal control system was designed to provide reasonable assurance to its
management and board of directors regarding the preparation and fair
presentation of published financial statements.
All internal control systems, no matter how well designed, have
inherent limitations. Therefore, even those systems determined to be effective
can provide only reasonable assurance with respect to financial statement
preparation and presentation.
The Company's management assessed the effectiveness of the Company's
internal control over financial reporting as of December 31, 2007. In making
this assessment, management used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control
- - Integrated Framework. Based on that assessment, we believe that, as of
December 31, 2007, the Company maintained effective internal control over
financial reporting based on those criteria.
Four Oaks' independent auditors have issued an audit report on our
assessment and on the Company's internal control over financial reporting. This
report appears on page 77.
Changes in Internal Control Over Financial Reporting
There have been no changes in the Company's internal control over
financial reporting (as such term is defined in Rules 13d-15(f) and 15(d)-15(f)
under the Exchange Act) that occurred during the fourth quarter of 2007 that the
Company believes have materially affected or is likely to materially affect, its
internal control over financial reporting.
76
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Four Oaks Fincorp, Inc. and Subsidiaries
We have audited Four Oaks Fincorp, Inc. and Subsidiaries (the
"Company")'s internal control over financial reporting as of December 31, 2007
based on criteria established in Internal Control--Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission. The
Company's management is responsible for maintaining effective internal control
over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting, included in the accompanying Management's
Report on Internal Control Over Financial Reporting. Our responsibility is to
express an opinion on the Company's internal control over financial reporting
based on our audit.
We conducted our audit 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
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness
exists, and testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk. Our audit also included performing
such other procedures as we considered necessary in the circumstances. We
believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
In our opinion, Four Oaks Fincorp, Inc. and Subsidiaries maintained, in
all material respects, effective internal control over financial reporting as of
December 31, 2007, based on criteria established in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission.
We have also audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated financial
statements of Four Oaks Fincorp, Inc. and Subsidiaries as of and for the year
ended December 31, 2007, and our report dated March 12, 2008, expressed an
unqualified opinion on those consolidated financial statements.
/s/ Dixon Hughes PLLC
Raleigh, North Carolina
March 12, 2008
77
Item 9B - Other Information.
Not Applicable.
PART III
This Part incorporates certain information from the definitive proxy
statement (the "2008 Proxy Statement") for the Company's 2008 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, Executive Officers and Corporate Governance.
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 2008 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 2007 Proxy Statement. Information
about the procedures by which shareholder nominations to our board of directors
may be submitted, including material changes to such procedures, if any, is
incorporated by reference from the section entitled "Information About our Board
of Directors-- Board Committees--The Corporate Governance and Nominating
Committee" in the 2008 Proxy Statement. Information regarding the Company's
audit committee is hereby incorporated by reference from the section entitled
"Information About our Board of Directors--Board Committees--The Audit
Committee" in the 2008 Proxy Statement.
Item 11 - Executive Compensation.
This information is incorporated by reference from the section entitled
"Executive Compensation" and "Compensation Committee Interlocks and Insider
Participation" in the 2008 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 2008 Proxy
Statement.
Item 13 - Certain Relationships and Related Transactions, and Director
Independence.
Information about certain relationships and related transactions is
incorporated by reference from the section entitled "Certain Transactions" in
the 2008 Proxy Statement. Information about director independence is
incorporated by reference from the section entitled "Information About our Board
of Directors--General" in the 2008 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 2008 Proxy Statement.
78
Item 15 - Exhibits, Financial Statement Schedules.
(a)(1) Financial Statements. The following financial statements and
supplementary data are included in Item 8 of Part II of this Annual Report on
Form 10-K.
Form 10-K Page
Financial Statements
Report of Independent Registered Public Accounting Firm, Dixon Hughes PLLC, 41
dated March xx, 2008
Consolidated Balance Sheets as of December 31, 2007 and 2006 42
Consolidated Statements of Operations for the years ended December 31, 2007, 43
2006 and 2005
Consolidated Statements of Comprehensive Income for the years ended December 31, 44
2007, 2006 and 2005
Consolidated Statements of Shareholders' Equity for the years ended December 31, 45
2007, 2006 and 2005
Consolidated Statements of Cash Flows for the years ended December 31, 2007, 46
2006 and 2005
Notes to Consolidated Financial Statements 47
(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
2.1 Merger Agreement, dated as of December 10, 2007, by
and among Four Oaks Fincorp, Inc., Four Oaks Bank &
Trust Company and LongLeaf Community Bank
(incorporated by reference to Exhibit 2.1 to the
Company's Current Report on Form 8-K filed on
December 13, 2007)
2.2 List of Schedules Omitted from Merger Agreement
included as Exhibit 2.1 above (incorporated by
reference to Exhibit 2.2 to the Company's Current
Report on Form 8-K filed on December 13, 2007)
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)
79
Exhibit No. Description of Exhibit
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 Second 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 December 21, 2006)
(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)
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
80
(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)
10.18 Amended and Restated Declaration of Trust of Four
Oaks Statutory Trust I, dated as of March 30, 2006
(incorporated by reference to Exhibit 10.1 to the
Company's Current Report on Form 8-K filed with the
SEC on April 4, 2006)
10.19 Guarantee Agreement of Four Oaks Fincorp, Inc. dated
as of March 30, 2006 (incorporated by reference to
Exhibit 10.2 to the Company's Current Report on Form
8-K filed with the SEC on April 4, 2006)
10.20 Indenture, dated as of March 30, 2006 by and between
Four Oaks Fincorp, Inc. and Wilmington Trust Company,
as Trustee, relating to Junior Subordinated Debt
Securities due June 15, 2036 (incorporated by
reference to Exhibit 10.3 to the Company's Current
Report on Form 8-K filed with the SEC on April 4,
2006)
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.]
32.1 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.]
(b) See (a) (3) above.
(c) See (a) (2) above.
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 12, 2008 By: /s/ Ayden R. Lee, Jr.
---------------------
Ayden R. Lee, Jr.
Chairman, 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 12, 2008 /s/ Ayden R. Lee, Jr.
---------------------
Ayden R. Lee, Jr.
Chairman, President and Chief
Executive Officer
Date: March 12, 2008 /s/ Nancy S. Wise
-----------------
Nancy S. Wise
Executive Vice President and Chief
Financial Officer
Date: March 12, 2008 /s/ William J. Edwards
----------------------
William J. Edwards
Director
Date: March 12, 2008 /s/ Warren L. Grimes
--------------------
Warren L. Grimes
Director
Date: March 12, 2008 /s/ Dr. R. Max Raynor, Jr.
--------------------------
Dr. R. Max Raynor, Jr.
Director
Date: March 12, 2008 /s/ Percy Y. Lee
----------------
Percy Y. Lee
Director
Date: March 12, 2008 /s/ Paula C. Bowman
-------------------
Paula C. Bowman
Director
Date: March 12, 2008 /s/ William Ashley Turner
-------------------------
William Ashley Turner
Director
Date: March 12, 2008 /s/ Michael A. Weeks
--------------------
Michael A. Weeks
Director
82
Exhibit No. Description of Exhibit
2.1 Merger Agreement, dated as of December 10, 2007, by
and among Four Oaks Fincorp, Inc., Four Oaks Bank &
Trust Company and LongLeaf Community Bank
(incorporated by reference to Exhibit 2.1 to the
Company's Current Report on Form 8-K filed on
December 13, 2007)
2.2 List of Schedules Omitted from Merger Agreement
included as Exhibit 2.1 above (incorporated by
reference to Exhibit 2.2 to the Company's Current
Report on Form 8-K filed on December 13, 2007)
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 Second 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 December 21, 2006)
(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)
43
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)
10.18 Amended and Restated Declaration of Trust of Four
Oaks Statutory Trust I, dated as of March 30, 2006
(incorporated by reference to Exhibit 10.1 to the
Company's Current Report on Form 8-K filed with the
SEC on April 4, 2006)
10.19 Guarantee Agreement of Four Oaks Fincorp, Inc. dated
as of March 30, 2006 (incorporated by reference to
Exhibit 10.2 to the Company's Current Report on Form
8-K filed with the SEC on April 4, 2006)
10.20 Indenture, dated as of March 30, 2006 by and between
Four Oaks Fincorp, Inc. and Wilmington Trust Company,
as Trustee, relating to Junior Subordinated Debt
Securities due June 15, 2036 (incorporated by
reference to Exhibit 10.3 to the Company's Current
Report on Form 8-K filed with the SEC on April 4,
2006)
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.]
32.1 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.]