UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2008
Commission File Number 000-22787
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FOUR OAKS FINCORP, INC.
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(Exact name of registrant as specified in its charter)
NORTH CAROLINA 56-2028446
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(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
6114 U.S. 301 SOUTH, FOUR OAKS, NC 27524
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(Address of principal executive office, including zip code)
(919) 963-2177
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(Registrant's telephone number, including area code)
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 the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definition of "large accelerated filer", "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer |X|
Non-accelerated filer [ ] (Do not check if a smaller reporting company) Smaller reporting company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act): [ ]YES |X|NO
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common Stock, 6,899,376
par value $1.00 per share (Number of shares outstanding
(Title of Class) as of August 4, 2008)
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TABLE OF CONTENTS Page No.
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Part I. FINANCIAL INFORMATION
Item 1 - Financial Statements (Unaudited)
Consolidated Balance Sheets
June 30, 2008 (Unaudited) and December 31, 2007.................................. 3
Consolidated Statements of Income (Unaudited)
Three Months and Six Months Ended June 30, 2008 and 2007......................... 4
Consolidated Statements of Comprehensive Income (Unaudited)
Three Months and Six Months Ended June 30, 2008 and 2007......................... 5
Consolidated Statement of Shareholders' Equity (Unaudited)
Six Months Ended June 30, 2008................................................... 6
Consolidated Statements of Cash Flows (Unaudited)
Six Months Ended June 30, 2008 and 2007.......................................... 7
Notes to Consolidated Financial Statements (Unaudited)........................... 8
Item 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................................ 14
Item 3 - Quantitative and Qualitative Disclosures About Market Risk........................... 18
Item 4 - Controls and Procedures.............................................................. 18
Part II. OTHER INFORMATION
Item 1A.- Risk Factors......................................................................... 18
Item 4 - Submission of Matters to a Vote of Security Holders.................................. 19
Item 6 - Exhibits............................................................................. 19
-2-
Part I. FINANCIAL INFORMATION
Item 1 - Financial Statements
FOUR OAKS FINCORP, INC.
CONSOLIDATED BALANCE SHEETS
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June 30, 2008 December 31,
(Unaudited) 2007*
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ASSETS (Amounts in thousands)
Cash and due from banks $ 14,339 $ 14,394
Interest-earning deposits 15,552 3,881
Federal funds sold 1,695 -
Investment securities available for sale 144,762 114,301
Loans 640,300 545,270
Allowance for loan losses (8,384) (6,653)
---------------- ---------------
Net loans 631,916 538,617
Accrued interest receivable 3,898 3,564
Bank premises and equipment, net 16,721 12,627
FHLB stock 6,529 5,010
Investment in life insurance 10,304 10,041
Goodwill 6,240 -
Other assets 8,326 5,868
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Total assets $ 860,282 $ 708,303
================ ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing demand $ 79,646 $ 74,687
Money market and NOW accounts 128,947 126,300
Savings 29,554 28,041
Time deposits, $100,000 and over 233,595 172,513
Other time deposits 175,479 136,222
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Total deposits 647,221 537,763
Borrowings 126,500 97,000
Subordinated debentures 12,372 12,372
Accrued interest payable 3,461 4,055
Other liabilities 6,155 2,483
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Total liabilities 795,709 653,673
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Shareholders' equity:
Common stock; $1.00 par value, 20,000,000 shares
authorized; 6,873,470 and 6,165,197 and shares issued
and outstanding at June 30, 2008 and December 31,
2007, respectively 6,873 6,165
Additional paid-in capital 30,504 21,545
Retained earnings 27,731 26,477
Accumulated other comprehensive income (loss) (535) 443
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Total shareholders' equity 64,573 54,630
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Total liabilities and shareholders' equity $ 860,282 $ 708,303
================ ===============
* Derived from audited consolidated financial statements.
The accompanying notes are an integral part of the consolidated financial statements.
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FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
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Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
2008 2007 2008 2007
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(In thousands, except per share data)
Interest and dividend income:
Loans, including fees $ 10,250 $ 9,925 $ 20,636 $ 19,605
Investment securities:
Taxable 1,758 1,520 3,271 2,837
Tax-exempt 71 42 128 85
Dividends 146 94 304 169
Interest-earning deposits 14 13 31 26
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Total interest and dividend income 12,239 11,594 24,370 22,722
---------- ---------- --------- -----------
Interest expense:
Deposits 4,869 4,814 9,567 9,227
Borrowings 1,343 1,077 2,611 2,135
---------- ---------- --------- -----------
Total interest expense 6,212 5,891 12,177 11,362
---------- ---------- --------- -----------
Net interest income 6,027 5,703 12,193 11,360
Provision for loan losses 954 232 1,242 494
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Net interest income after provision for loan losses 5,073 5,471 10,951 10,866
---------- ---------- --------- -----------
Non-interest income:
Service charges on deposit accounts 576 524 1,107 1,013
Other service charges, commissions and fees 439 409 820 760
Gain (loss) on sale of investment securities 163 (30) 296 (29)
Gain (loss) on sale of loans 41 (72) 46 26
Gain (loss) on hedges - (186) 97 (160)
Merchant fees 138 159 248 226
Income (expense) from investment in bank-owned life
insurance 131 (54) 263 (19)
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Total non-interest income 1,487 750 2,877 1,817
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Non-interest expenses:
Salaries 2,574 2,139 4,906 4,188
Employee benefits 521 415 1,039 863
Occupancy expense 247 194 469 381
Equipment expense 400 342 779 661
Professional and consulting fees 347 413 728 726
Other taxes and licenses 135 80 210 132
Merchant processing expense 120 134 211 192
Other operating expense 1,210 890 2,180 1,726
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Total non-interest expenses 5,554 4,607 10,521 8,869
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Income before income taxes 1,006 1,614 3,307 3,814
Provision for income taxes 202 565 1,006 1,315
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Net income $ 804 $ 1,049 $ 2,301 $ 2,499
========== ========== ========= ===========
Basic net income per common share $ 0.13 $ 0.17 $ 0.37 $ 0.41
========== ========== ========= ===========
Diluted net income per common share $ 0.13 $ 0.17 $ 0.37 $ 0.40
========== ========== ========= ===========
The accompanying notes are an integral part of the consolidated financial statements.
-4-
FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
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Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
2008 2007 2008 2007
--------- ----------- --------- -----------
(Amounts in thousands)
Net income $ 804 $ 1,049 $ 2,301 $ 2,499
--------- ----------- --------- -----------
Other comprehensive income:
Securities available for sale:
Unrealized holding losses on available for sale
securities (1,886) (1,091) (1,122) (1,102)
Tax effect 713 436 322 440
Reclassification of (gains) losses recognized in net
income (163) 30 (296) 160
Tax effect 65 (12) 118 (64)
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Net of tax amount (1,271) (637) (978) (566)
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Cash flow hedging activities:
Unrealized holding gains on cash flow hedging
activities - 205 - 332
Tax effect - (82) - (132)
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Net of tax amount - 123 - 200
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Total other comprehensive income (1,271) (514) (978) (366)
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Comprehensive income (loss) $ (467) $ 535 $ 1,323 $ 2,133
========= =========== ========= ===========
The accompanying notes are an integral part of the consolidated financial statements.
-5-
FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (UNAUDITED)
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Accumulated
Common stock Additional other Total
---------------------- paid-in Retained comprehensive shareholders'
Shares Amount capital earnings income (loss) equity
---------- ----------- ------------ ----------- ------------- -------------
(Amounts in thousands, except share and per share data)
BALANCE AT DECEMBER 31, 2007 6,165,197 $ 6,165 $ 21,545 $ 26,477 $ 443 $ 54,630
Net income - - - 2,301 - 2,301
Other comprehensive income - - - - (978) (978)
Effect of Merger with LongLeaf
Community Bank 609,770 609 7,601 - - 8,210
Issuance of common stock 98,503 99 1,166 - - 1,265
Current income tax benefit - - 102 - - 102
Stock based compensation - - 90 - - 90
Cash dividends of $ .08 per share - - - (1,047) - (1,047)
---------- ----------- ------------ ----------- ------------- -------------
BALANCE AT JUNE 30, 2008 6,873,470 $ 6,873 $ 30,504 $ 27,731 $ (535) $ 64,573
========== =========== ============ =========== ============= =============
The accompanying notes are an integral part of the consolidated financial statements.
-6-
FOUR OAKS FINCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
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Six Months Ended
June 30,
------------------------------------
2008 2007
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(Amounts in thousands)
Cash flows from operating activities:
Net income $ 2,301 $ 2,499
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 1,242 494
Provision for depreciation and amortization 574 487
Net amortization of bond premiums and discounts 6 19
Stock based compensation 90 112
(Gain) loss on sale of investment securities (296) 29
(Gain) on sale of loans (46) (26)
Loss on disposition of premises and equipment 4 71
Loss on sale of foreclosed assets 65 27
(Income) loss from investment in life insurance (263) 19
(Gain) loss on hedges (97) 160
Changes in assets and liabilities:
Other assets (536) (88)
Interest receivable (92) (400)
Other liabilities 2,623 1,520
Interest payable (699) 556
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Net cash provided by operating activities 4,876 5,479
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Cash flows from investing activities:
Proceeds from sales and calls of investment securities
available for sale 77,848 23,375
Purchases of investment securities available for sale (105,225) (49,838)
Purchase of FHLB stock (2,452) (418)
Redemption of FHLB Stock 1,212 504
Net increase in loans (47,318) (29,470)
Purchase of bank premises and equipment (979) (1,148)
Proceeds from sales of foreclosed assets 36 362
Net expenditures on foreclosed assets (32) (11)
Net cash provided by business combination 3,167 -
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Net cash used by investing activities (73,743) (56,644)
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Cash flow from financing activities:
Net proceeds from borrowings 26,914 2,300
Net increase in deposit accounts 54,944 48,891
Proceeds from issuance of common stock 1,265 1,027
Excess tax benefits from stock options 102 197
Purchase and retirement of common stock - (671)
Cash dividends paid (1,047) (840)
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Net cash provided by financing activities 82,178 50,904
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Net increase (decrease) in cash and cash
equivalents 13,311 (261)
Cash and cash equivalents at beginning of period 18,275 17,711
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Cash and cash equivalents at end of the period $ 31,586 $ 17,450
================ ================
The accompanying notes are an integral part of the consolidated financial statements.
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements
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NOTE 1 - BASIS OF PRESENTATION
In management's opinion, the financial information contained in the accompanying
unaudited consolidated financial statements reflects all adjustments (consisting
solely of normal recurring adjustments) necessary for a fair presentation of the
financial information as of and for the three and six-month periods ended June
30, 2008 and 2007, in conformity with accounting principles generally accepted
in the United States of America. The consolidated financial statements include
the accounts of Four Oaks Fincorp, Inc. (the "Company") and its wholly-owned
subsidiaries, Four Oaks Bank & Trust Company (the "Bank") and Four Oaks Mortgage
Services, LLC, a mortgage origination subsidiary. All significant intercompany
transactions and balances have been eliminated in consolidation. Operating
results for the three and six-month periods ended June 30, 2008 are not
necessarily indicative of the results that may be expected for the fiscal year
ending December 31, 2008.
The organization and business of the Company, accounting policies followed by
the Company and other information are contained in the notes to the consolidated
financial statements filed as part of the Company's Annual Report on Form 10-K
for the year ended December 31, 2007. This Quarterly Report should be read in
conjunction with such Annual Report.
NOTE 2 - NET INCOME PER SHARE
Basic and diluted net income per common share are computed based on the weighted
average number of shares outstanding during each period. Diluted net income per
common share reflects the potential dilution that could occur if securities or
other contracts to issue common stock were exercised or converted into common
stock or resulted in the issuance of common stock that would then share in the
net income of the Company.
Basic and diluted net income per common share have been computed based upon net
income as presented in the accompanying consolidated statements of income
divided by the weighted average number of common shares outstanding or assumed
to be outstanding as summarized below:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
2008 2007 2008 2007
----------- ---------- ---------- ----------
Weighted average number of common shares
used in computing basic net income per share 6,248,016 6,166,557 6,220,661 6,157,719
Effect of dilutive stock options 15,585 22,477 16,595 28,101
----------- ---------- ---------- ----------
Weighted average number of common shares and
dilutive potential common shares used in
computing diluted net income per share 6,263,601 6,189,034 6,237,256 6,185,820
=========== ========== ========== ==========
FAs of June 30, 2008 there were 137,328 antidilutive stock options outstanding.
At June 30, 2007, there were no antidilutive stock options outstanding.
-8-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements
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NOTE 3 - COMMITMENTS
At June 30, 2008, loan commitments were as follows (in thousands):
Commitments to extend credit $ 119,169
Undisbursed lines of credit 34,921
Letters of credit 2,835
NOTE 4- FAIR VALUE MEASUREMENT
On January 1, 2008, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 157, "Fair Value Measurements," which defines fair value,
establishes a framework for measuring fair value under accounting principles
generally accepted in the United States, and enhances disclosures about fair
value measurements. The Company elected not to delay the application of SFAS No.
157 to nonfinancial assets and nonfinancial liabilities, as allowed by Financial
Accounting Standards Board ("FASB") Staff Position SFAS 157-2. SFAS No. 157
applies whenever other standards require (or permit) assets or liabilities to be
measured at fair value and, therefore, does not expand the use of fair value in
any new circumstances. Fair value is defined as the exchange price that would be
received to sell an asset or paid to transfer a liability in the principal or
most advantageous market for the asset or liability in an orderly transaction
between market participants on the measurement date. SFAS No. 157 clarifies that
fair value should be based on the assumptions market participants would use when
pricing an asset or liability and establishes a fair value hierarchy that
prioritizes the information used to develop those assumptions. The fair value
hierarchy gives the highest priority to quoted prices in active markets and the
lowest priority to unobservable data. SFAS No. 157 requires fair value
measurements to be separately disclosed by level within the fair value
hierarchy. Under SFAS No. 157, the Company bases fair values on the price that
would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. For assets and
liabilities recorded at fair value, it is the Company's policy to maximize the
use of observable inputs and minimize the use of unobservable inputs when
developing fair value measurements, in accordance with the fair value hierarchy
in SFAS No. 157.
Fair value measurements for assets and liabilities where there exists limited or
no observable market data and, therefore, are based primarily upon estimates,
are often calculated based on the economic and competitive environment, the
characteristics of the asset or liability and other factors. Therefore, the
results cannot be determined with precision and may not be realized in an actual
sale or immediate settlement of the asset or liability. Additionally, there may
be inherent weaknesses in any calculation technique, and changes in the
underlying assumptions used, including discount rates and estimates of future
cash flows, could significantly affect the results of current or future values.
The Company utilizes fair value measurements to record fair value adjustments to
certain assets and liabilities and to determine fair value disclosures.
Securities available-for-sale are recorded at fair value on a recurring basis.
Additionally, from time to time, the Company may be required to record at fair
value other assets on a nonrecurring basis. These nonrecurring fair value
adjustments typically would involve application of lower of cost or market
accounting or write-downs of individual assets.
-9-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements
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NOTE 4 - FAIR VALUE MEASUREMENT (Continued)
Under SFAS 157, the Company groups assets and liabilities at fair value in three
levels, based on the markets in which the assets and liabilities are traded and
the reliability of the assumptions used to determine fair value. These levels
are:
Level 1 -- Valuations for assets and liabilities traded in active exchange
markets, such as the New York Stock Exchange.
Level 2 -- Valuations are obtained from readily available pricing sources via
independent providers for market transactions involving similar assets or
liabilities. The company's principal market for these securities is the
secondary institutional markets and valuations are based on observable market
data in those markets. Level 2 securities include U. S. Government agency
obligations, state and municipal bonds and mortgage-backed securities.
Level 3 -- Valuations for assets and liabilities that are derived from other
valuation methodologies, including option pricing models, discounted cash flow
models and similar techniques, and not based on market exchange, dealer, or
broker traded transactions. Level 3 valuations incorporate certain assumptions
and projections in determining the fair value assigned to such assets or
liabilities. Level 3 financial instruments consist of the Company's derivative
financial instruments. The Company obtains pricing for these instruments from
third parties who have experience in valuing these types of securities.
Following is a description of valuation methodologies used for assets and
liabilities recorded at fair value.
Investment Securities Available-for-Sale
- ----------------------------------------
Investment securities available-for-sale are recorded at fair value on a
recurring basis. Fair value measurement is based upon quoted prices, if
available. If quoted prices are not available, fair values are measured using
independent pricing models or other model-based valuation techniques such as the
present value of future cash flows, adjusted for the security's credit rating,
prepayment assumptions and other factors such as credit loss assumptions. Level
1 securities include those traded on an active exchange, such as the New York
Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers
in active over-the-counter markets and money market funds. Level 2 securities
include mortgage-backed securities issued by government sponsored entities,
municipal bonds and corporate debt securities. Securities classified as Level 3
include asset-backed securities in less liquid markets.
Loans
- -----
The Company does not record loans at fair value on a recurring basis. However,
from time to time, a loan is considered impaired and an allowance for loan
losses is established. Loans for which it is probable that payment of interest
and principal will not be made in accordance with the contractual terms of the
loan agreement are considered impaired. Once a loan is identified as
individually impaired, management measures impairment in accordance with SFAS
No. 114, "Accounting by Creditors for Impairment of a Loan." The fair value of
impaired loans is estimated using one of several methods, including collateral
value, market value of similar debt, enterprise value, liquidation value and
discounted cash flows. Those impaired loans not requiring an allowance represent
loans for which the fair value of the expected repayments or collateral exceed
the recorded investments in such loans. At June 30, 2008, none of the impaired
loans were evaluated based on the fair value of collateral. In accordance with
SFAS No. 157, impaired loans where an allowance is established based on the fair
value of collateral require classification in the fair value hierarchy. When the
fair value of the collateral is based on an observable market price or a current
appraised value, the Company would record the impaired loan as nonrecurring
Level 2. When an appraised value is not available or management determines the
fair value of the collateral is further impaired below the appraised value and
there is no observable market price, the Company would record the impaired loan
as nonrecurring Level 3.
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements
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NOTE 4 - FAIR VALUE MEASUREMENT (Continued)
Derivative Assets and Liabilities
- ---------------------------------
Derivative instruments held or issued by the Company for risk management
purposes are traded in over-the-counter markets where quoted market prices are
not readily available. For those derivatives, the Company measures fair value
using models that use primarily market observable inputs, such as yield curves
and option volatilities, and include the value associated with counterparty
credit risk. The Company classifies derivatives instruments held or issued for
risk management purposes as Level 2. As of June 30, 2008 the Company held no
derivative instruments.
Foreclosed Assets
- -----------------
Foreclosed assets are adjusted to fair value upon transfer of the loans to
foreclosed assets. Subsequently, foreclosed assets are carried at the lower of
carrying value or fair value. Fair value is based upon independent market
prices, appraised values of the collateral or management's estimation of the
value of the collateral. When the fair value of the collateral is based on an
observable market price or a current appraised value, the Company records the
foreclosed asset as nonrecurring Level 2. When an appraised value is not
available or management determines the fair value of the collateral is further
impaired below the appraised value and there is no observable market price, the
Company records the foreclosed asset as nonrecurring Level 3. There were no fair
value adjustments related to foreclosed real estate of $1.8 million at June 30,
2008.
Below is a table that presents information about certain assets and liabilities
measured at fair value on a recurring basis:
Fair Value Measurements at
June 30, 2008, Using
-----------------------------------------------------------
Total Carrying Amount Quoted Prices in Significant
in The Consolidated Assets Measured at Active Markets for Significant Other Unobservable
Balance Sheet Fair Value Identical Assets Observable Inputs Inputs
Description 6/30/2008 6/30/2008 (Level 1) (Level 2) (Level 3)
- ---------------------------------------- ------------------- ------------------- ------------------- -------------------
Available-for-sale
securities $ 144,762 $ 144,762 $ 2,797 $ 141,965 $ -
NOTE 5 - OTHER RECENT ACCOUNTING PRONOUNCEMENTS
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities." SFAS No. 159 allows entities to
measure financial instruments and certain other items at fair value that are not
currently required to be measured at fair value. Unrealized gains and losses on
items for which the fair value option has been elected must be reported in
earnings at each subsequent reporting date. The fair value option can be applied
instrument by instrument, however the election is irrevocable. The Company's
adoption of SFAS No. 159 on January 1, 2008 had no financial statement impact
because the Company did not elect the fair value option for any of its financial
assets or liabilities.
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FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements
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NOTE 5 - OTHER RECENT ACCOUNTING PRONOUNCEMENTS (Continued)
In December 2007, the FASB issued SFAS No. 141(revised 2007), "Business
Combinations," ("SFAS No. 141(R)"), which replaces SFAS No. 141. SFAS No. 141(R)
establishes principles and requirements for recognition and measurement of
assets, liabilities and any noncontrolling interest acquired due to a business
combination. SFAS No. 141(R) expands the definitions of a business and a
business combination, resulting in an increased number of transactions or other
events that will qualify as business combinations. Under SFAS No. 141(R) the
entity that acquires the business (the "acquirer") will record 100 percent of
all assets and liabilities of the acquired business, including goodwill,
generally at their fair values. As such, an acquirer will not be permitted to
recognize the allowance for loan losses of the acquiree. SFAS No. 141(R)
requires the acquirer to recognize goodwill as of the acquisition date, measured
as a residual. In most business combinations, goodwill will be recognized to the
extent that the consideration transferred plus the fair value of any
noncontrolling interests in the acquiree at the acquisition date exceeds the
fair values of the identifiable net assets acquired. Under SFAS No. 141(R),
acquisition-related transaction and restructuring costs will be expensed as
incurred rather than treated as part of the cost of the acquisition and included
in the amount recorded for assets acquired. SFAS No. 141(R) is effective for
fiscal years beginning after December 15, 2008. Accordingly, for acquisitions
completed after December 31, 2008, the Company will apply the provisions of SFAS
No. 141(R).
In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No. 133."
SFAS No. 161 applies to all derivative instruments and related hedged items
accounted for under SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities." SFAS No. 161 requires entities to provide greater
transparency about (a) how and why an entity uses derivative instruments, (b)
how derivative instruments and related hedged items are accounted for under SFAS
No. 133 and its related interpretations, and (c) how derivative instruments and
related hedged items affect an entity's financial position, results of
operations and cash flows. To meet those objectives, SFAS No. 161 requires (1)
qualitative disclosures about objectives for using derivatives by primary
underlying risk exposure (e.g., interest rate, credit or foreign exchange rate)
and by purpose or strategy (fair value hedge, cash flow hedge, net investment
hedge, and non-hedges), (2) information about the volume of derivative activity
in a flexible format that the preparer believes is the most relevant and
practicable, (3) tabular disclosures about balance sheet location and gross fair
value amounts of derivative instruments, income statement and other
comprehensive income location of gain and loss amounts on derivative instruments
by type of contract, and (4) disclosures about credit-risk related contingent
features in derivative agreements. SFAS No. 161 is effective for financial
statements issued for fiscal years and interim periods beginning after November
15, 2008. Accordingly, the Company will adopt the provisions of SFAS No. 161 in
the first quarter 2009. The Company does not expect the adoption of the
provisions of SFAS No. 161 to have a material effect on its financial condition
and results of operations.
Other accounting standards that have been issued or proposed by the FASB or
other standards-setting bodies are not expected to have a material impact on the
Company's financial position, results of operations and cash flows.
-12-
FOUR OAKS FINCORP, INC.
Notes to Consolidated Financial Statements
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NOTE 6 - MERGER WITH LONGLEAF COMMUNITY BANK
On April 17, 2008, the Company completed the merger of LongLeaf Community Bank
("LongLeaf") headquartered in Rockingham, North Carolina. Under the terms of the
merger agreement, each share of LongLeaf common stock was converted into the
right to receive either (i) $16.50 in cash, without interest, (ii) 1.0 share of
the Company's common stock multiplied by an exchange ratio of 1.1542825 or (iii)
0.60 shares of the Company's common stock multiplied by an exchange ratio of
1.1542825 plus an amount equal to $6.60 in cash. As a result of the acquisition,
the Company paid $4.9 million in cash and has issued 609,770 additional shares
of common stock. The merger was accounted for using the purchase method of
accounting, with the operating results of LongLeaf subsequent to April 17, 2008
included in the Company's financial statements.
An unaudited summary of the total purchase price of the transaction is as
follows:
(In thousands)
Fair value of common stock issued $ 7,554
Fair value of common stock options issued 656
Cash paid for shares 4,265
Transaction costs paid in cash 606
---------------
Total purchase price $ 13,081
===============
An unaudited summary of the estimated fair value of the assets acquired and
liabilities assumed is as follows:
(In thousands)
Cash and due from banks $ 1,690
Interest-earning deposits 1,763
Federal funds sold 4,585
Investment securities available for sale 4,212
Loans, net 47,248
Accrued interest receivable 242
FHLB stock 279
Bank premises and equipment, net 3,678
Deferred tax assets, net 886
Core deposit intangible 470
Goodwill 6,240
Other assets 139
Deposits (54,514)
FHLB Advances (2,586)
Accrued interest payable (105)
Other liabilities (1,146)
---------------
Net assets acquired $ 13,081
===============
-13-
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion provides information about the major components of the
financial condition and results of operations of the Company and its
subsidiaries and should be read in conjunction with the Company's Consolidated
Financial Statements and Notes thereto in Part I, Item 1 of this Quarterly
Report.
Comparison of Financial Condition at
June 30, 2008 and December 31, 2007
The Company's total assets grew from $708.3 million at December 31, 2007 to
$860.3 million at June 30, 2008, an increase of $152.0 million or 21.5%. The
Company's liquid assets, consisting of cash and cash equivalents and investment
securities available for sale, increased $43.8 million during the six months
ended June 30, 2008 compared to liquid assets as of December 31, 2007, primarily
from increases in investment securities of $30.5 million. Additional funds
available from deposit growth provided the Company with an opportunity to
increase investment securities available for sale during the first six months of
2008. Gross loans increased by $95.0 million or 17.6% from $545.3 million at
December 31, 2007 to $640.3 million at June 30, 2008. The acquisition of
LongLeaf Community Bank ("LongLeaf") on April 17, 2008 contributed $47.2 million
of the total loan growth, with the majority of the remaining growth due to
growth in loans secured by real estate. The Company's loan portfolio continues
to reflect a trend towards growth in commercial real estate lending and
construction loans. Deposits grew $109.5 million or 20.4% from $537.8 million at
December 31, 2007 to $647.2 million at June 30, 2008. Deposits from the
Company's local market continued to be its primary funding source, increasing by
$71.6 million in the first six months of 2008 compared to deposits from the
local market as of December 31, 2007, while wholesale deposits increased by
$37.9 million for the same period. The LongLeaf acquisition accounts for $54.5
million of the total deposit growth, with the remaining due primarily to growth
in the Company's time deposit accounts.
Total shareholders' equity increased approximately $10.0 million from $54.6
million at December 31, 2007 to $64.6 million at June 30, 2008. This increase in
shareholders' equity resulted principally from shares of common stock valued at
$7.6 million issued and stock options valued at $656,000 in connection with the
merger with LongLeaf, income from operations of $2.3 million, net proceeds from
the issuance of common stock from stock option exercises and employee stock
purchases of $753,000, dividend reinvestment in the amount of $614,000, and
stock compensation expense of $90,000. Offsetting these increases were dividends
paid to the Company's shareholders of $1.0 million and other comprehensive
losses of $978,000. At June 30, 2008, both the Company and the Bank were
considered to be well capitalized as such term is defined in applicable federal
regulations.
Results of Operations for the Three Months Ended
June 30, 2008 and 2007
Net Income. Net income for the three months ended June 30, 2008 was $804,000, or
$.13 basic net income per share, as compared with net income of $1,049,000, or
$.17 basic net income per share, for the three months ended June 30, 2007, a
decrease of $245,000, or $.04 basic net income per share. Net income declined
primarily due to lower margins and increased operating costs related to the
Company's recent expansion and increased provision for loan losses.
-14-
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 portfolios, 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 for the three months ended June 30, 2008 was $6.0 million,
an increase of $324,000 compared to the three months ended June 30, 2007, which
was primarily due to increases in the loan and investment securities portfolios.
Average interest-earning assets increased $163.1 million for the quarter. The
increase of $158.3 million in average interest-bearing liabilities resulted in
higher interest expense. The margins decreased as yields on assets and
liabilities fell resulting in a decrease in the Company's net interest margin by
62 basis points from 3.76% during the three months ended June 30, 2007 to 3.14%
during the three months ended June 30, 2008.
Provision for Loan Losses. The provision for loan losses was $954,000 and
$232,000 for the three months ended June 30, 2008 and 2007, respectively, an
increase of $722,000. Net charge-offs of $768,000 were recorded for the three
months ended June 30, 2008 compared to net charge offs of $58,000 during the
three months ended June 30, 2007. Non-performing assets aggregated $7.1 million
at June 30, 2008, an increase of $2.3 million from the $4.8 million at March 31,
2008, while the allowance for loan losses, expressed as a percentage of gross
loans, was 1.31% at June 30, 2008 and 1.20% at March 31, 2008. The increase in
non-performing assets was due primarily to $1.3 million of non-performing loans
acquired in the merger. The remaining increase resulted from additions to our
loans in nonaccrual and 90 days or more past due. Management believes that the
allowance is adequate to absorb probable losses inherent in the loan portfolio.
Non-Interest Income. Non-interest income increased $737,000 for the three months
ended June 30, 2008 to $1.5 million as compared to $750,000 for the same period
in 2007. The increase is primarily due to an increase in value in the cash
surrender value of the bank-owned life insurance of $185,000, realized gains on
the sale of investment securities of $193,000, gains on sale of loans of
$113,000, gains on hedges of $186,000, and an increase in service charge income
of $52,000.
Non-Interest Expense. Non-interest expense increased $947,000 to $5.6 million
for the three months ended June 30, 2008 compared to $4.6 million for the three
months ended June 30, 2007. This increase was due in part to increases in
salaries and employee benefits of $541,000, which resulted from normal salary
adjustments, rising benefits costs, additional staffing, and the merger with
LongLeaf. For the three months ended June 30, 2008, net occupancy and equipment
expenses increased $111,000, other taxes and licenses of $55,000 and other
operating expenses increased $452,000. The primary increases in other
non-interest expense for the three months ended June 30, 2008 included an
increase in the FDIC insurance premium of $95,000, printing and office supplies
of $34,000, advertising expense of $50,000, meals, entertainment and travel
expenses of $24,000. There were no other significant increases in any of the
remaining non-interest expenses.
Provision for Income Taxes. The Company's provision for income taxes, as a
percentage of income before income taxes, was 20.1% and 35.0% for the three
months ended June 30, 2008 and 2007, respectively. The percentage decreased for
the current quarter because tax exempt interest and nontaxable income from
bank-owned life insurance represented a much larger component of income before
income taxes.
-15-
Results of Operations for the Six Months Ended
June 30, 2008 and 2007
Net Income. Net income for the six months ended June 30, 2008 was $2.3 million,
or $.37 basic net income per share, as compared with net income of $2.5 million
or $.41 basic net income per share for the six months ended June 30, 2006, a
decrease of $198,000 or $.04 per share. Net income declined primarily due to
lower margins, increased operating costs related to the Company's recent
expansion and increased provision for loan losses.
Net Interest Income. Net interest income was $12.2 million and $11.4 million for
the six month periods ended June 30, 2008 and June 30, 2007, respectively.
Interest and dividend income was $24.4 million and $22.7 million for the six
months ended June 30, 2008 and 2007, respectively. This increase in interest and
dividend income was offset by an increase in interest expense on deposits and
borrowings of $815,000 to $12.2 million for the six months ended June 30, 2008
from $11.4 million for the six months ended June 30, 2007. This increase in
interest expense was primarily due to average deposit growth of $86.7 million
and an average increase in borrowings of $41.0 million during the six months
ended June 30, 2008. Margins decreased as the yields on assets fell faster than
the cost of liabilities, resulting in a decrease in the Company's net interest
margin by 48 basis points from 3.84% in the first half of 2007 to 3.36% in the
first half of 2008.
Provision for Loan Losses. The Company's provision for loan losses was $1.2
million and $494,000 for the six months ended June 30, 2008 and 2007,
respectively, an increase of $748,000. Net charge-offs of $909,000 were recorded
during the first six months of 2008, compared to $130,000 for the first six
months of 2007. Non-performing assets aggregated $7.1 million at June 30, 2008,
increasing $4.3 million from the $2.8 million at June 30, 2007, while the
allowance for loan losses, expressed as a percentage of gross loans, was 1.31%
at June 30, 2008 and 1.21% at June 30, 2007. This increase was primarily due to
$1.5 million added to nonaccrual loans for one commercial relationship, as well
as $1.3 million acquired as a result of the merger with LongLeaf. The remaining
increase is due to increases in loans 90 days or more past due and other real
estate owned of approximately $1.5 million. Management believes that the
allowance is adequate to absorb probable losses inherent in the loan portfolio.
Non-Interest Income. Non-interest income increased $1.1 million to $2.9 million
for the six months ended June 30, 2008 compared to $1.8 million for the six
month period ended June 30, 2007. This increase is primarily due to an increase
of $325,000 in the sale of investment securities, a $257,000 increase from the
interest rate swaps and a $282,000 increase in the cash surrender value of the
bank owned life insurance, gains on sales of loans of $206,000, and an increase
in service charges for deposit accounts of $94,000 due to the growth in deposit
accounts. There were no other significant changes in any of the categories of
income that comprise the Company's total non-interest income.
Non-Interest Expense. Non-interest expense increased $1.7 million to $10.5
million for the six months ended June 30, 2008 compared to $8.9 million for the
six months ended June 30, 2007. The increase was due in part to an increase in
salaries and employee benefits of $894,000, which resulted from normal salary
adjustments, rising benefit costs, additional staffing due to the merger with
LongLeaf and rising insurance costs. In addition, net occupancy and equipment
expenses increased $206,000, other taxes and licenses increased $78,000, and
other operating expenses increased $584,000. The primary increases in other
non-interest expense for the first six months of 2008 included ATM operating
fees of $29,000, advertising expense of $96,000, printing and office supply
expenses of $53,000, meals and entertainment expenses of $33,000, an increase in
the FDIC insurance premium of $81,000. There were no other significant increases
in any of the remaining non-interest expenses which grew due to the Company's
overall asset growth.
-16-
Provision for Income Taxes. The Company's provision for income taxes, as a
percentage of income before income taxes, was 30.4% and 34.5% for the six months
ended June 30, 2008 and 2007, respectively. The percentage decreased for the
current six month period because tax exempt interest and nontaxable income from
bank-owned life insurance represented a much larger component of income before
income taxes.
Liquidity and Capital Resources
Our liquidity position is primarily dependent upon the Bank's need to respond to
loan demand, the short-term demand for funds caused by withdrawals from deposit
accounts (other than time deposits) and the liquidity of its assets. The Bank's
primary liquidity sources include cash and amounts due from other banks, federal
funds sold, and U.S. Government Agency and other marketable investment
securities. The Bank also has the ability to borrow funds from the Federal
Reserve Bank and the Federal Home Loan Bank of Atlanta and to purchase federal
funds from other financial institutions. Management believes that the Bank's
liquidity sources are adequate to meet its operating needs and the operating
needs of the Bank for the next eighteen months. Total shareholders' equity was
$64.6 million or 7.5% of total assets at June 30, 2008 and $54.6 million or 7.7%
of total assets at December 31, 2007.
Forward-looking Information
Information set forth in this Quarterly Report on Form 10-Q, under the caption
"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 (the "Exchange Act"), which
statements represent the Company's judgment concerning the future and are
subject to risks and uncertainties that could cause its 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.
The Company cautions that any such forward-looking statements are further
qualified by important factors that could cause its actual operating results to
differ materially from those anticipated 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 loan losses, the
low trading volume of the Company's common stock, other considerations described
in connection with specific forward-looking statements and other cautionary
elements specified in the Company's periodic filings with the Securities and
Exchange Commission (the "Commission"), including without limitation, its Annual
Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form
8-K.
-17-
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company believes there has not been any material change in information or in
the overall analysis of financial instruments considered market risk sensitive,
as measured by the factors of contractual maturities, average interest rates and
the difference between estimated fair values and book values, since the analysis
prepared and presented in conjunction with its Annual Report on Form 10-K for
the fiscal year ended December 31, 2007.
ITEM 4 - CONTROLS AND PROCEDURES
As required by paragraph (b) of Rule 13a-15 under 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 Quarterly 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 Commission'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. During the course of their evaluation, the officers
discovered that, as a result of human error, the Company failed to timely file a
Form 8-K pursuant to Item 5.02 (Departure of Directors or Certain Officers;
Election of Directors; Appointment of Certain Officers; Compensatory
Arrangements of Certain Officers) in connection with the appointment of a new
director. 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 Quarterly 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 Commission's rules and forms.
There have been no changes in the Company's internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) during the period covered by this Quarterly Report that the
Company believes have materially affected, or are reasonably likely to
materially affect, its internal control over financial reporting.
Part II. OTHER INFORMATION
ITEM 1A - RISK FACTORS
There have been no material changes in the Company's risk factors from those
disclosed in its Annual Report on Form 10-K for the year ended December 31,
2007.
-18-
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On April 28, 2008, the Company held its Annual Meeting of Shareholders. Of
6,207,191 shares entitled to vote at the meeting, 4,250,477 shares voted. The
following proposals were submitted to the shareholders and voted on at the
meeting:
Proposal: To elect eight nominees to the Company's Board of Directors to serve
until the 2009 Annual Meeting of Shareholders or until their successors are
elected and qualified. The votes were cast as follows:
For Withheld
--------------- ---------------
Ayden R. Lee, Jr. 4,205,623 44,854
Percy Y. Lee 4,228,966 21,512
Warren L. Grimes 4,228,233 22,243
William J. Edwards 4,227,414 23,063
Dr. R. Max Raynor 4,225,987 24,489
William Ashley Turner 4,102,063 148,413
Paula Canaday Bowman 4,221,656 28,820
Michael A. Weeks 4,228,560 21,916
ITEM 6 EXHIBITS
Exhibit Description
- ------- -----------
3.1 Articles of Incorporation of Four Oaks FinCorp, Inc. including
Articles of Amendment to Articles of Incorporation of Four Oaks
FinCorp, Inc., dated April 26, 2004 and July 8, 2008
10.1 Consulting Agreement Between Four Oaks Bank & Trust Company and
John W. Bullard, dated April 17, 2008
31.1 Certification of the Chief Executive Officer pursuant to Rule
13a-14(a) or Rule 15d-4(a) as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
31.2 Certification of the Chief Financial Officer pursuant to Rule
13a-14(a) or Rule 15d-14(a) as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
32.1 Certification by the Chief Executive Officer pursuant to 18
U.S.C. 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification by the Chief Financial Officer pursuant to 18
U.S.C. 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
-19-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FOUR OAKS FINCORP, INC.
Date: August 11, 2008 By: /s/ Ayden R. Lee, Jr.
-------------------------------------
Ayden R. Lee, Jr.
President and Chief Executive Officer
Date: August 11, 2008 By: /s/ Nancy S. Wise
-------------------------------------
Nancy S. Wise
Executive Vice President and
Chief Financial Officer
-20-
Exhibit Index
Exhibit Description
- ------- -----------
3.1 Articles of Incorporation of Four Oaks FinCorp, Inc. including
Articles of Amendment to Articles of Incorporation of Four Oaks
FinCorp, Inc., dated April 26, 2004 and July 8, 2008
10.1 Consulting Agreement Between Four Oaks Bank & Trust Company and
John W. Bullard, dated April 17, 2008
31.1 Certification of the Chief Executive Officer pursuant to Rule
13a-14(a) or Rule 15d-4(a) as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
31.2 Certification of the Chief Financial Officer pursuant to Rule
13a-14(a) or Rule 15d-14(a) as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
32.1 Certification by the Chief Executive Officer pursuant to 18
U.S.C. 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification by the Chief Financial Officer pursuant to 18
U.S.C. 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002