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| FSBK > SEC Filings for FSBK > Form 10-Q on 5-Nov-2008 | All Recent SEC Filings |
5-Nov-2008
Quarterly Report
Comparison of Financial Condition at September 30, 2008 and December 31, 2007. Total assets were $888.6 million at September 30, 2008 compared to $909.3 million at December 31, 2007. Earning assets were $817.8 million at September 30, 2008 compared to $850.7 million at December 31, 2007, reflecting the net change in the composition of earning assets, as further discussed below. Earning assets were 92.0% of total assets at September 30, 2008 compared to 93.6% at December 31, 2007.
Interest-bearing overnight deposits in financial institutions were $3.4 million at September 30, 2008, compared to $1.8 million at December 31, 2007. Overnight funds are available to fund loan originations, liquidity management activities and daily operations of the Bank.
Investment securities available for sale were $41.1 million at September 30, 2008 and $49.1 million at December 31, 2007. There were no maturities of investment securities available for sale during the three months ended September 30, 2008 and $8.0 million during the nine months ended September 30, 2008. Proceeds were used to fund liquidity management and daily operations of the Bank. No investment securities available for sale were sold during the three and nine months ended September 30, 2008 or 2007.
Mortgage-backed securities available for sale were $28.2 million at September 30, 2008 and $37.8 million at December 31, 2007. The Bank may sell mortgage-backed securities during favorable interest rate windows and may also securitize mortgage loans held for sale into mortgage-backed securities to maintain sufficient liquidity levels. During the three months and nine ended September 30, 2008, the Bank sold $1.1 and $4.0 million of mortgage-backed securities available for sale and recorded gains of $28,000 and $98,000, respectively. No mortgage loans were securitized in to mortgage-backed securities during the three months ended September 30, 2008 or 2007. During the nine months ended September 30, 2008, $3.4 million of mortgage loans held for sale were securitized into mortgage-backed securities held for investment, compared to $5.5 million securitized into mortgage-backed securities held for sale during the nine months ended September 30, 2007. Mortgage-backed securities held for investment were $4.3 million at September 30, 2008 and $1.3 million at December 31, 2007, reflecting the $3.4 million securitization discussed above, net of scheduled principal payments.
Based on current market prices, investment and mortgage-backed securities available for sale declined in value by a net of $113,000 at September 30, 2008 from December 31, 2007. See "Note 4. Comprehensive Income" of "Notes to Consolidated Financial Statements (Unaudited)" for additional information.
Loans held for sale were $3.4 million at September 30, 2008 compared to $7.5 million at December 31, 2007. Proceeds from loan sales were $10.1 million and $33.5 million for the three and nine months ended September 30, 2008, compared to $851,000 and $19.9 million sold during both the three and nine months ended September 30, 2007. These sale transactions were executed to support a more balanced sensitivity to future interest rate changes. The proceeds from loans sold during the three and nine months ended September 30, 2008 were used to fund new loan originations and to fund the decline in deposits, as discussed below. Loans serviced for others were $259.3 million at September 30, 2008, compared to $254.7 million at December 31, 2007. As discussed above, $3.4 million of held for sale mortgage loans were securitized into mortgage-backed securities held for investment to support liquidity management.
Net loans and leases receivable held for investment declined to $746.3 million at September 30, 2008 from $757.6 million at December 31, 2007. During the three and nine months ended September 30, 2008, certain loans held for investment were subjects of foreclosure and transferred to other real estate owned, as discussed below. In addition, a portion of the proceeds from principal repayments on loans held for investment was used to fund the decline in deposits.
Non-performing loans increased to $12.5 million at September 30, 2008 from $10.4 million at the end of the preceding quarter ended June 30, 2008. Significant non-performing loans consist primarily of six commercial and residential real estate borrowers with total exposure of $9.0 million at September 30, 2008. The increase in non-performing loans is a result of the economy moving into a recessionary environment and placing pressure on the housing and real estate markets, significantly impacting property values in the Bank's market area and credit quality of certain borrowers. Management believes it has thoroughly evaluated its non-performing loans and they are either well collateralized or adequately reserved. However, there can be no assurance in the future that regulators, increased risks in its loans portfolio, changes in economic conditions or other factors will not require further adjustments to the allowance for credit losses.
Other real estate owned increased to $7.0 million at September 30, 2008 from $4.0 million at the end of the preceding quarter ended June 30, 2008, reflecting foreclosures of certain non-performing loans. At September 30, 2008, other real estate owned consisted of fifteen single family residential properties, one partially developed residential subdivision and fourteen developed lots. During the three and nine months ended September 30, 2008, the Bank recorded $462,000 and $533,000 of fair value adjustments to other real estate owned. The Bank believes the adjusted carrying values of these properties are representative of their fair market values, although there can be no assurances that the ultimate sales will be equal to or greater than the carrying values. See "Note 6. Assets and Liabilities - Fair Value Information" of "Notes to Consolidated Financial Statements (Unaudited)" for additional information.
Deposits were $722.9 million at September 30, 2008, compared to $761.4 million at December 31, 2007. Demand accounts (personal and business checking accounts and money market accounts) declined to $229.3 million at September 30, 2008 from $243.6 million at December 31, 2007. The number of demand accounts was constant at 40,117 at September 30, 2008 and 40,142 at December 31, 2007, indicating customers are maintaining lower average balances in the current economic environment. Time deposits declined to $475.4 million at September 30, 2008 from $500.2 million at December 31, 2007. During the three and nine months ended September 30, 2008, and amid competitive pressure on interest rates, the Bank chose to not match higher time deposit rates being offered by certain competitive financial institutions in its market area, in order to control its time deposit cost. The Bank also began repricing certain new and maturing time deposits at lower rates, and combined with the growth of lower costing checking accounts, is attempting to effectively manage its deposit cost.
Borrowed money consisting of FHLB advances and repurchase agreements increased to $57.8 million at September 30, 2008 from $42.1 million at December 31, 2007. FHLB advances increased to $45.0 million at September 30, 2008 from $35.0 million at December 31, 2007, as the Bank repaid $35.0 million of daily rate credit advances from the Federal Home Loan Bank of Atlanta, and borrowed $45.0 million of fixed rated advances at terms ranging from 18 to 36 months at a weighted average cost of 3.01%, in order to reduce its cost of funds. Repurchase agreements (cash management accounts for commercial banking customers) increased to $12.8 million at September 30, 2008 from $7.1 million at December 31, 2007.
Stockholders' equity was $86.8 million at September 30, 2008 and $86.0 million at December 31, 2007. The equity to assets ratio was 9.8% At September 30, 2008, compared to 9.5% at December 31, 2007, reflecting the net effect of year-to-date earnings, dividend payments, stock option exercises, common stock purchases, the change in accumulated other comprehensive income and the change in the volume of assets. See "Consolidated Statements of Stockholders' Equity" for additional information.
Accumulated other comprehensive income was $264,000 at September 30, 2008 compared to $377,000 at December 31, 2007, reflecting the change in net market value of the investment portfolio based on current market prices. See "Note 4. Comprehensive Income" of "Notes to Consolidated Financial Statements (Unaudited)" for additional information.
As a North Carolina chartered commercial bank, the Bank must meet various capital standards required by federal and state banking regulatory agencies. The Bank's stand-alone capital was $85.7 million at September 30, 2008 and in excess of all regulatory capital requirements. See "Liquidity and Capital Resources" below for additional information.
On September 25, 2008, the Company declared a cash dividend of $0.20 per share, payable October 23, 2008 to stockholders of record as of October 10, 2008. This dividend payment represents a 95.2% payout ratio of the basic earnings per share for the quarter ended September 30, 2008, and is the Company's forty-sixth consecutive quarterly cash dividend.
During the three and nine months ended September 30, 2008, the Company acquired 15,000 and 140,241 shares of its common stock, respectively, through private and open market purchases pursuant to a stock repurchase plan adopted by the board of directors. The repurchase of its common stock allows the Company to minimize the dilutive effect of future stock option exercises and provides an effective means of leveraging its capital. Shares acquired via the stock repurchase plan are held as treasury stock, at cost. At September 30, 2008, there were 1,516,126 treasury shares held totaling $32.2 million, compared to 1,445,567 shares held at December 31, 2007 totaling $30.9 million.
There were no shares issued from the exercise of stock options during the three months and 90,499 issued nine months ended September 30, 2008, compared to 2,396 and 292,491 shares issued during the three and nine months ended September 30, 2007. During the three and nine months ended September 30, 2008, there were no shares and 20,817 shares, respectively, tendered by stock option plan participants to pay for the exercise price of stock options being exercised and income taxes incident to such option exercises, compared to 1,281 and 35,326 tendered during the three and nine months ended September 30, 2007.
Comparison of Operating Results - Three and Nine months ended September 30, 2008 and 2007. Net income for the three and nine months ended September 30, 2008 was $2.1 million and $9.0 million, compared to $4.3 million and $12.9 million for the three and nine months ended September 30, 2007. Diluted earnings per share were $0.21 and $0.93 per share for the three and nine months ended September 30, 2008, compared to $0.42 and $1.28 per share for the three and nine months ended September 30, 2007.
The decline in net earnings during the three and nine months ended September 30, 2008 results primarily from increased provisions for credit losses, write downs of other real estate owned and the decline in net interest margin, significantly influenced by the Federal Reserve's 325 basis point rate cuts since September 2007. Like many financial institutions in the Bank's market area, current period earnings have been influenced by an economy moving towards a recessionary environment. Economic pressure on the housing and real estate markets is impacting property values and credit quality issues. Competitive pressure continues impact slow loan growth, deposit flows and rates paid for loans and deposits
Many banks have been challenged by issues relating to sub-prime lending and Fannie Mae and Freddie Mac stock ownership. First South Bank does not have any sub-prime loan exposure and does not hold any equity shares of either Fannie Mae or Freddie Mac. The Bank faces challenges due to the weakening housing and real estate market, and it is monitoring and evaluating all significant loans in its portfolio. The Bank will continue to manage its credit risk exposure while waiting for the stabilization of the real estate market. Management believes competition and pricing pressures will continue on both deposits and loans during the remainder of 2008 and into 2009. The amount and timing of any future Federal Reserve rate cuts remains uncertain, and may further impact the Bank, particularly if those cuts are significant.
Key performance ratios are return on average assets (ROA), return on average equity (ROE), and efficiency. ROA was .9% and 1.3% for the three and nine months ended September 30, 2008, compared to 1.9% for both the three and nine months ended September 30, 2007. ROE was 9.4% and 13.7% for the three and nine months ended September 30, 2008, compared to 20.1% and 20.7% for the three and nine months ended September 30, 2007. The efficiency ratio was 55.3% and 50.9% for the three and nine months ended September 30, 2008, compared to 45.4% and 44.2% for the three and nine months ended September 30, 2007.
Interest Income. Interest income was $14.4 million and $46.0 million for the three and nine months ended September 30, 2008, compared to $17.6 million and $52.5 million for the three and nine months ended September 30, 2007. This decline is due to the recent decline in interest rates due to the Federal Reserve rate cuts and a decline in the volume of average interest-earning assets. Average interest-earning assets were $830.8 million and $846.9 million for the three and nine months ended September 30, 2008, compared to $845.2 million and $847.2 million for the three and nine months ended September 30, 2007, reflecting the maturities of investment securities, sales or mortgage backed securities, the amount of foreclosed loans transferred to other real estate owned and the increased volume of non-performing loans discussed above. The yield on average interest-earning assets was 6.9% and 7.2% for the three and nine months ended September 30, 2008, compared to 8.4% and 8.3% for the three and nine months ended September 30, 2007. The yield on average interest-earning has been directly impacted by the Federal Reserve rate cuts and the decline in average interest-earning assets discussed above.
Interest Expense. Interest expense declined to $5.4 million and $18.2 million for the three and nine months ended September 30, 2008, compared to $7.3 million and $21.8 million for the three and nine months ended September 30, 2007, reflecting a decline in interest rates between the respective periods and a decline in the volume of average interest-bearing liabilities. The effective cost of funds was 2.7% and 3.0% for the three and nine months ended September 30, 2008, compared to 3.6% for both the three and nine months ended September 30, 2007. The Company was able to improve its cost of funds by the combination of deposit repricing, and the rollover of time deposits and the repositioning of borrowings within the lower interest rate environment. Average deposits and borrowings were $799.7 million and $811.9 million for the three and nine months ended September 30, 2008, compared to $810.1 million and $811.0 million for the three and nine months ended September 30, 2007.
Net Interest Income. Net interest income was $9.0 million and $27.8 million for the three and nine months ended September 30, 2008, compared to $10.3 million and $30.7 million for the three and nine months ended September 30, 2007. The interest rate spread (the difference between the effective yield on average earning assets and the effective cost of average deposits and borrowings) was 4.2% and 4.3% for the three and nine months ended September 30, 2008, compared to 4.8% and 4.7% for the three and nine months ended September 30, 2007. The net yield on interest-earning assets (net interest income divided by average interest-earning assets) was 4.3% and 4.4% for the three and nine months ended September 30, 2008, compared to 4.9% and 4.8% for the three and nine months ended September 30, 2007. The decline in interest rate spread and net yield on interest-earning assets is caused by the same events impacting interest income and interest expense, as discussed above.
Provision for Credit Losses. The Bank's methodology for determining its provision for credit losses includes amounts specifically allocated to credits that are individually determined to be impaired, as well as general provisions allocated to groups of loans that have not been individually assessed for impairment. The Bank recorded $1.7 million and $2.9 million of provisions for credit losses in the three and nine months ended September 30, 2008, compared to $100,000 and $200,000 in the three and nine months ended September 30, 2007, reflecting the current volume of non-performing loans as previously discussed.
Allowance for Credit Losses. The Bank maintains general and specific allowances for loan and lease losses and unfunded loan commitments (collectively the "allowance for credit losses") at levels the Bank believes is adequate to absorb probable losses inherent in the loan and lease portfolio and in unfunded loan commitments. The Bank has developed policies and procedures for assessing the adequacy of the allowance for credit losses that reflect the assessment of credit risk. This assessment includes an analysis of qualitative and quantitative trends in the levels of classified loans. In developing this analysis, the Bank relies on estimates and exercises judgment in assessing credit risk. Future assessments of credit risk may yield different results, depending on changes in the qualitative and quantitative trends, which may require increases or decreases in the allowance for credit losses.
The Bank uses a variety of modeling and estimation tools for measuring its credit risk, which are used in developing the allowance for credit losses. The factors supporting these allowances do not diminish the fact that the entire allowance for credit losses is available to absorb probable losses in both the loan and leases portfolio and in unfunded loan commitments. The Bank's principal focus is on the adequacy of the total allowance for credit losses. Based on the overall credit quality of the loan and lease receivable portfolio, the Bank believes it has established the allowance for credit losses pursuant to generally accepted accounting principles, and has taken into account the views of its regulators and the current economic environment. However, there can be no assurance in the future that regulators, increased risks in its loans and leases portfolio, changes in economic conditions and other factors will not require additional adjustments to the allowance for credit losses.
The Bank's allowances for loan and leases losses were $11.3 million at September 30, 2008, compared to $9.5 million December 31, 2007. The allowance for unfunded loan commitments was $378,000 at September 30, 2008, compared to $403,000 at December 31, 2007. The ratio of the allowance for credit losses to net loans and leases was 1.5% at September 30, 2008 and 1.2% December 31, 2007. See "Note 3. Allowance for Credit Losses" of "Notes to Consolidated Financial Statements (Unaudited)" and "Critical Accounting Policies" below for additional information.
Noninterest Income. Noninterest income was $2.4 million and $7.9 million for the three and nine months ended September 30, 2008, compared to $2.5 million and $7.4 million for the three and nine months ended September 30, 2007. Noninterest income consists of fees, service charges and servicing fees earned on loans, service charges and insufficient funds fees collected on deposit accounts, gains from loan sales and other miscellaneous income. Fees, service charges and servicing fees collected were $2.1 million and $6.4 million for the three and nine months ended September 30, 2008, compared to $2.0 million and $6.0 million for the three and nine months ended September 30, 2007. Fees, service charges and servicing fees collected during each period depends on the collection of fees and service charges related loan and deposit account transactions processed during each period, and servicing fees earned on loans serviced for others.
The Bank recorded $108,000 and $513,000 of gains from loan sales during the three and nine months ended September 30, 2008, compared to $26,000 and $279,000 during the three and nine months ended September 30, 2007. Fixed-rate residential mortgage loans were sold to better manage market risk exposure for a more balanced sensitivity to future interest rate changes. During the three and nine months ended September 30, 2008, other income consisting of real estate owned and mortgage backed securities sales, credit card income, brokerage commissions and other miscellaneous income was $270,000 and $1.1 million, compared to $518,000 and $1.2 million for the three and nine months ended September 30, 2007.
Noninterest Expense. Noninterest expenses were $6.3 million and $18.2 million for the three and nine months ended September 30, 2008, compared to $5.8 million and $16.8 million for the three and nine months ended September 30, 2007. The largest component is compensation and fringe benefits at $3.4 million and $10.4 million for the three and nine months ended September 30, 2008, compared to $3.6 million and $10.2 million for the three and nine months ended September 30, 2007. In managing its compensation expense, the Bank has reduced its full time equivalent employees to 271 at September 30, 2008 from 287 at December 31, 2007. FDIC insurance premiums increased to $109,000 and $153,000 for the three and nine months ended September 30, 2008, compared to $23,000 and $71,000 the three and nine months ended September 30, 2007, as assessment credits received under the Federal Deposit Reform Act of 2005 have been exhausted. Other noninterest expenses including premises and equipment, advertising, data processing, repairs and maintenance, office supplies, professional fees, taxes and insurance, etc., have remained relatively flat during the respective periods. As discussed above, other real estate owned fair value write downs have increased as a result of the increase in volume of other real estate owned.
Income Taxes. Income tax expense was $1.3 million and $5.6 million for the three and nine months ended September 30, 2008, compared to $2.7 million and $8.2 million for the three and nine months ended September 30, 2007. The changes in the amounts of income tax provisions reflect the changes in pretax income and the estimated income tax rates in effect during each period. The effective income tax rates were 38.7% and 38.6% for the three and nine months ended September 30, 2008, compared to 38.9% for both the three and nine months ended September 30, 2007. See "Critical Accounting Policies" below for additional information.
Liquidity and Capital Resources. Liquidity generally refers to the Bank's ability to generate adequate amounts of funds to meet its cash needs. Adequate liquidity guarantees that sufficient funds are available to meet deposit withdrawals, fund future loan commitments, maintain adequate reserve requirements, pay operating expenses, provide funds for debt service, pay dividends to stockholders, and meet other general commitments. The Bank must maintain certain regulatory liquidity requirements of liquid assets to deposits and short-term borrowings. At September 30, 2008, the Bank had cash, deposits in banks, investment securities, mortgage-backed securities, FHLB stock and loans held for sale totaling $108.7 million, compared to $122.9 million at December 31, 2007, representing 14.6% and 15.3% of deposits and short-term borrowings for the respective periods.
The Bank believes it can meet future liquidity needs with existing funding sources. The Bank's primary sources of funds are deposits, payments on loans and mortgage-backed securities, maturities of investment securities, earnings and funds provided from operations, the ability to borrow from the FHLB of Atlanta and the availability of loans held for sale. While scheduled repayments of loans and mortgage-backed securities are relatively predictable sources of funds, deposit flows and general market interest rates, economic conditions and competition substantially influence loan prepayments. In addition, the Bank manages its deposit pricing in order to maintain a desired deposit mix.
The FDIC requires the Bank to meet a minimum leverage capital requirement of Tier I capital (consisting of retained earnings and common stockholder's equity, less any intangible assets) to assets ratio of 4%. The FDIC also requires the Bank to meet a ratio of total capital to risk-weighted assets of 8%, of which at least 4% must be in the form of Tier I capital. The North Carolina Office of the Commissioner of Banks requires the Bank to maintain a capital surplus of not less than 50% of common capital stock. The Bank was in compliance with all regulatory capital requirements at September 30, 2008 and December 31, 2007.
Critical Accounting Policies. The Company has identified the policies below as critical to its business operations and the understanding of its results of operations. The impact and any associated risks related to these policies on the Company's business operations is discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where such policies affect reported and expected financial results.
Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. Estimates 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 amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Loans Impairment, Allowance for Loan and Lease Losses and Unfunded Loan Commitments. A loan or lease is considered impaired, based on current information and events, if it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan or lease agreement. Uncollateralized loans are measured for impairment based on the present value of expected future cash flows discounted at the historical effective interest rate, while all collateral-dependent loans are measured for impairment based on the fair value of the collateral. The Bank uses several factors in determining if a loan or lease is impaired. The internal asset classification procedures include a thorough review of significant loans, leases and lending relationships and include the accumulation of related data. This data includes loan and lease payment status, borrowers' financial data and borrowers' operating factors such as cash flows, operating income or loss, etc.
The allowance for credit losses is increased by charges to income and decreased by charge-offs (net of recoveries). Management's periodic evaluation of the . . .
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