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| CRFN > SEC Filings for CRFN > Form 10-Q on 6-Nov-2008 | All Recent SEC Filings |
6-Nov-2008
Quarterly Report
Management's discussion and analysis is intended to assist readers in the understanding and evaluation of the financial condition and consolidated results of operations of Crescent Financial Corporation (the "Company"). The analysis includes detailed discussions for each of the factors affecting Crescent Financial Corporation's operating results and financial condition for the periods ended September 30, 2008 and 2007. It should be read in conjunction with the audited consolidated financial statements at and for the year ended December 31, 2007 and accompanying notes included in this report and the supplemental financial data appearing throughout this discussion and analysis. Because the Company has no operations and conducts no business on its own other than owning Crescent State Bank, the discussion contained in this Management's Discussion and Analysis concerns primarily the business of the Bank. However, for ease of reading and because the financial statements are presented on a consolidated basis, the Company and the Bank are collectively referred to herein as the Company unless otherwise noted. All significant intercompany transactions and balances are eliminated in consolidation.
Total assets at September 30, 2008 are $955.5 million compared with $835.5 million at December 31, 2007. Earning assets are 92% of total assets at both dates with $882.5 million at September 30, 2008 and $773.8 million at December 31, 2007. Components of earning assets at September 30, 2008 are $769.1 million in gross loans, $103.3 million in investment securities and Federal Home Loan Bank (FHLB) stock, $9.5 million in Federal funds sold and $639,000 in overnight investments and interest bearing deposits with correspondent banks. Earning assets at December 31, 2007 consisted of $675.9 million in gross loans, $97.5 million in investment securities and FHLB stock and $309,000 in overnight investments and interest bearing deposits. Total deposits, borrowings and stockholders' equity at September 30, 2008 were $711.6 million, $145.7 million and $94.1 million, respectively, compared to $605.4 million, $135.0 million and $91.7 million at December 31, 2007.
Gross loans outstanding increased by $93.1 million or 14% over the nine-month period. All categories of loans experienced net increases with the commercial real estate mortgage category experiencing the most significant dollar growth increasing $80.2 million or 23% from $350.4 million to $430.6 million. Commercial and industrial loans increased by $10.3 million or 14% from $72.9 million to $83.2 million. Home equity lines and loans increased by $9.3 million or 20% to $54.5 million, residential real estate loans increased $702,000 or 4% to $18.9 million and consumer loans increased by $216,000 or 4% to $5.7 million. The construction and acquisition and development category has experienced a decline of $7.6 million or 4% since the end of 2007. The decline reflects a general slowdown in the residential building and development industry as well as shifting of completed commercial construction loans into the permanent commercial real estate mortgage category. The composition of the loan portfolio, by category, as of September 30, 2008 is 56% commercial mortgage loans, 23% construction loans, 11% commercial loans, 7% home equity loans and lines, 2% residential mortgage loans and 1% consumer loans. The composition of the loan portfolio, by category, as of December 31, 2007 was 52% commercial mortgage loans, 27% construction loans, 11% commercial loans, 6% home equity loans and lines, 3% residential real estate mortgage loans and 1% consumer loans.
The Company had an allowance for loan losses at September 30, 2008 of $10.0 million or 1.30% of outstanding loans compared to $8.3 million or 1.24% at December 31, 2007. At September 30, 2008, there were eight loans totaling $2.8 million in non-accrual status. There were no loans past due 90 days or more and still accruing interest at September 30, 2008. Non-performing loans as a percentage of total loans at September 30, 2008 were 0.36%. At December 31, 2007, there were twelve loans totaling $2.7 million in non accrual status, no loans past due 90 days or more and still accruing interest and non-performing loans as a percentage of total loans at December 31, 2007 were 0.40%. For a more detailed discussion, see the section entitled Non-Performing Assets.
The Company has investment securities with an amortized cost of $97.6 million at September 30, 2008. All investments are accounted for as available for sale and are presented at their fair market value of $96.0 million compared with $90.8 million at year-end 2007. The Company's investment in available for sale securities at September 30, 2008, consists of U.S. Government agency securities, collateralized mortgage obligations, mortgage-backed securities, municipal bonds and marketable equity securities. The Company does not own any equity investments in the Federal Home Loan Mortgage Corporation (Freddie Mac) or the Federal National Mortgage Association (Fannie Mae). The increase during the first nine months of 2008 was the net result of $19.2 million in new purchases and $67,000 in net accretion of discounts, less $10.8 million in principal re-payments and called principal, the sale of $1.5 million of securities and a $1.6 million decrease in fair value. The Company has performed an analysis at September 30th and believes all unrealized losses within its securities portfolio are temporary in nature.
All of our mortgage-backed and collateralized mortgage obligation securities are issued through either a Government Sponsored Enterprise (GSE) such as Freddie Mac and Fannie Mae or the government-owned Government National Mortgage Association (Ginnie Mae). Prior to September 7, 2008, only those securities issued by Ginnie Mae were backed by the full faith of the US Government. There was an implied guarantee on securities issued through the other two GSEs, but not an explicit guarantee. On September 7, 2008, the US Department of Treasury and the Federal Housing Finance Agency announced that Freddie Mac and Fannie Mae were being placed into conservatorship. As a result, the US Government effectively has guaranteed the securities issued by the GSEs. Therefore, the credit risk associated with owning debt securities issued through these two entities has been significantly mitigated.
The Company owns $7.3 million of Federal Home Loan Bank stock at September 30, 2008 compared to $6.8 million at December 31, 2007.
There is $9.5 million in Federal funds sold at September 30, 2008 compared to $97,000 at December 31, 2007. Federal funds sold are a source of short-term liquidity typically used to fund loans and cover deposit fluctuations.
Interest-earning deposits held at correspondent banks increased by approximately $427,000 from $212,000 at December 31, 2007 to $639,000 at September 31, 2008.
Non-earning and other assets increased by approximately $12.7 million between December 31, 2007 and September 30, 2008. The Company purchased an additional $7.0 million of bank owned life insurance in May. The earnings from increased cash value on the bank owned life insurance is used to help offset certain employee and supplemental retirement benefits. There was a net increase in bank premises and equipment increased of $2.2 million as we purchased land for a future branch location and are incurring construction costs on a branch expected to open in 2009. The Company had three foreclosed properties totaling $272,000 at December 31, 2007. During 2008, we foreclosed on seven additional properties and moved $2.4 million in net realizable values to other real estate owned. Four of those properties have been disposed of, at a combined loss of $75,000, leaving a balance of other real estate owned of $1.9 million. Non-interest earning cash due from banks, the majority of which represents checks in the process of being collected through the Federal Reserve payment system, increased by $273,000. For more details regarding the increase in cash and cash equivalents, see the Consolidated Statements of Cash Flows.
Total deposits increased by $106.2 million between December 31, 2007 and September 30, 2008 from $605.4 million to $711.6 million. The largest dollar increase occurred in the time deposit category, which grew by $112.2 million or 32% to $457.4 million at September 30, 2008 from $645.2 million at year end 2007. Other categories experiencing growth include money market deposits increasing by $36.6 million or 76% to $84.9 million, interest-bearing demand deposit balances increasing by $3.6 million or 11% to $35.5 million and non-interest bearing demand deposits increasing $226,000 to $69.6 million. Due largely to the expected distribution of $20.4 million from an escrow account and migration toward an introductory money market product, savings account balances declined by $46.3 million to $64.2 million.
The composition of the deposit base, by category, at September 30, 2008 is as follows: 64% time deposits, 12% money market accounts, 10% non-interest-bearing demand deposits, 9% savings accounts and 5% interest-bearing demand deposits. The composition of the deposit base, by category, at December 31, 2007 was 57% time deposits, 18% in statement savings, 12% non-interest-bearing demand deposits, 8% money market and 5% in interest-bearing demand deposits. Over the past 12 months, short-term interest rates have fallen by 325 basis points. Rates on non-maturity deposit products such as interest bearing demand, savings and money market accounts have moved down accordingly. Due to fierce market competition and some irrational pricing by banks experiencing liquidity issues, the rates on time deposits have not dropped to the extent anticipated. This has caused a significant shift in our deposit mix from the lower cost non-maturity products into the time deposit category.
Time deposits of $100,000 or more totaled $367.1 million at September 30, 2008 compared to $276.6 million at December 31, 2007. The Company uses brokered certificates of deposit as an alternative funding source. Brokered deposits represent a source of fixed rate funds priced competitively with FHLB borrowings, but do not require collateralization like FHLB borrowings. Brokered deposits were $266.9 million at September 30, 2008 compared with $166.6 million at December 31, 2007.
The Company has $125.7 million of long-term debt outstanding at September 30, 2008 compared to $121.2 million at December 31, 2007. The long-term debt is comprised of $108.0 million in FHLB term advances, $15.7 million in junior subordinated debt and $2.0 million outstanding on a line of credit. Short-term borrowings increased by $6.2 million during 2008 to $20.0 million. Short-term borrowings consist of FHLB term advances with remaining maturities of less than one year
Accrued interest payable and other liabilities increased by $539,000 and are $4.0 million and $3.4 million at September 30, 2008 and December 31, 2007, respectively.
Between December 31, 2007 and September 30, 2008, total stockholders' equity increased by $2.5 million. The increase resulted primarily from net income for the first nine months of $2.8 million, $707,000 in new stock issued pursuant to the exercise of stock options and $160,000 due to the recognition of certain stock award expense. Total stockholders' equity decreased by $142,000 due to recording the cumulative effect of adopting EITF 06-04 and a decline in the net fair market value of available for sale securities of $1.1 million. The decline in the fair market value of securities available for sale is almost entirely due to the Company's municipal securities portfolio. Due to the credit crisis and the impact on municipal debt issuance, the market for these securities is illiquid. We believe the unrealized loss on the municipal portfolio is temporary and due to market inactivity rather than the credit quality of the underlying issuers.
COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTH PERIODS ENDED SEPTEMBER
Net Income. Net income for the three-month period ended September 30, 2008 is $746,000 compared to $1.6 million for the three-month period ended September 30, 2007. Diluted earnings per share for the current period are $.08 compared to $.16. Annualized return on average assets declined to 0.31% from 0.79% for the prior period. The decline is due to a net interest margin compression, strong loan growth funded by high cost money, an increase in the loan loss provision and higher non-interest expenses. Return on average equity for the current period is 3.12% compared to 7.04% for the prior period.
Net Interest Income. Net interest income decreased by $466,000 from $6.8 million for the prior three-month period to $6.3 million for the three-month period ended September 30, 2008. The additional interest income generated by a higher volume of earning assets was more than offset by the decline in net interest margin earned on those assets. Total interest expense from deposits and other borrowings increased as the cost of new interest bearing liabilities to fund earning asset growth was greater than the reduction experienced due to the lower interest rate environment. The Company's net interest margin decreased from 3.72% to 2.89% due to a greater dependency on interest-bearing liabilities and a lower interest rate environment which has reduced the average yield on earning assets to a greater extent than the reduction in the Company's cost of funds.
Total interest income decreased by $301,000 to $13.8 million for the current three-month period compared to $14.1 million for the prior year period. The net decline resulted from a $3.0 million decrease due to lower yields realized on earning assets and a $2.7 million increase in interest income due to the growth in total average earning assets. Total interest expense for the current period increased by $164,000 from $7.3 million to $7.6 million. The decrease was the net result of a $1.7 million decline due to the lower cost of money and a $1.8 million increase due to growth in interest-bearing funds.
Total average earning assets increased $146.3 million or 20% from an average of $725.4 million for the prior year three-month period to an average of $871.7 million for the three-month period ended September 30, 2008. The average balance of loans outstanding during the current quarter is $765.5 million, a $140.4 million or 22% increase over the $625.1 million of average outstanding loans for the prior year period. The average balance of the investment securities portfolio is $102.8 million, increasing by over $9.0 million or 10% compared to the prior period average of $93.7 million. The average balance of federal funds sold and other earning assets decreased to $3.4 million for the current three-month period compared to $6.5 million for the prior period.
Average interest-bearing liabilities increased by $152.9 million or 24% from $625.6 million for the quarter ended September 30, 2007 to $778.5 million for the current quarter. Total interest-bearing deposits increased by $95.5 million or 18% from $535.1 million to $630.6 million. Time deposits experienced the largest increase averaging $437.8 million during the current year period compared to $326.0 million for the prior period. Total borrowings increased by 63% or $57.4 million from $90.5 million to $147.9 million.
Net interest margin is interest income earned on loans, securities and other earning assets, less interest expense paid on deposits and borrowings, expressed as a percentage of total average earning assets. The net interest margin for the three-month period ended September 30, 2008 is 2.89% compared to 3.72% for the three-month period ended September 30, 2007. The average yield on earning assets for the current three-month period decreased 141 basis points to 6.30% compared with 7.71% for the prior year period, while the average cost of interest-bearing funds decreased by only 81 basis points to 3.81% from 4.62%. The interest rate spread, which is the difference between the average yield on earning assets and the cost of interest-bearing funds, decreased by 61 basis points from 3.10% for the quarter ended September 30, 2007 to 2.49% for the quarter ended September 30, 2008. The percentage of interest earning assets to average interest-bearing liabilities declined from 115.95% for the prior year period to 111.97% for the three months ended September 30, 2008. A decrease in the ratio of average earning assets to average interest-bearing liabilities indicates an increased dependency on interest-bearing forms of funding to meet the demand of earning asset growth.
Between mid September 2007 and April 30, 2008, the Federal Reserve (the "Fed") decreased short-term interest rates seven times for a total of 325 basis points. Unlike the slow, measured approach to increasing interest rates between July 2004 and July 2006, when each increase was in 25 basis point increments, four of the seven decreases came in the 50 to 75 basis point range. The interest rate cuts were in response to weakness being experienced in the US economy. Approximately 50% of the Company's loan portfolio has variable rate pricing based on the Prime lending rate or LIBOR (London Inter Bank Offering Rate). As short-term rates have declined, variable rate loans have repriced downward resulting in a lower yield on average earning assets. While the yield on the variable portion of existing loans was falling with rate decreases, rates on new fixed rate loans were experiencing significant downward pressure due to loan competition in our high growth markets. On the liability side of the balance sheet, while we have decreased rates on our non-maturity deposits categories, our time deposits have fixed rates and are subject to contractual maturities and therefore reprice at a slower rate. Irrational time deposit pricing in our markets by banks experiencing liquidity problems have not permitted us to lower offering rates on new time deposits to the extent we would have anticipated in the falling rate environment. For these reasons, net interest margin has fallen over the past year.
Since the Company began almost ten years ago, we have focused on asset growth as the main driver of value. We are in the process of implementing a new strategic initiative which will focus our efforts towards becoming a high performing bank in terms of earnings and profitability measures. As a result of this new strategy, where risk-based loan pricing and core deposit generation play a more prevalent role, the rate of asset growth is likely to decline from our historical percentage growth rates. We would expect that over time, this strategy will yield higher net interest margins due to better loan pricing and a reduced reliance on high cost forms of funding. However, subsequent to September 30th, the Fed lowered short-term interest rates by another 50 basis point which is likely to have an unfavorable impact on net interest margin in the short run.
Provision for Loan Losses. The Company's provision for loan losses for the three-month period ended September 30, 2008 is $1.3 million compared to $666,000 for the same period in 2007. Provision for loan losses is charged to income to bring the allowance for loan losses to a level deemed appropriate by management based on factors discussed under "Analysis of Allowance for Loan Losses." The increase in the loan loss provision is due in part to the increase in loans outstanding during the quarter and specific reserves identified for individual credits whose quality showed some deterioration. The allowance for loan losses was $10.0 million at September 30, 2008, representing 1.30% of total outstanding loans.
Non-Interest Income. For the three-month period ended September 30, 2008, non-interest income increased by $367,000 or 53% to $1.1 million compared to $689,000 for the same period in 2007. Categories experiencing increases over the prior period include earnings on cash value of bank owned life insurance, customer service fees and mortgage loan origination fees. There are $121,000 of miscellaneous non-recurring fees included in other non-interest income.
Non-Interest Expenses. For the current three-month period, non-interest expenses increased by $664,000 or 15% from $4.4 million to $5.1 million. The personnel and occupancy expense categories attribute $532,000 of the total increase reflecting the costs associated with branch expansion and additional lending and support staff. The Company has opened two new branch offices during the past year and moved one office to a more visible location. Salaries and benefits expense increased by $405,000 or 16% to $2.9 million for the current year period compared to $2.5 million, and occupancy increased by $127,000 or 22% to $709,000 from $582,000.
Provision for Income Taxes. The Company has income tax expense of $306,000 for the three-months ended September 30, 2008 compared with $868,000 for the prior year period. The effective tax rate for the three-month period ended September 30, 2008 was 29.1% compared with 35.7% for the prior year period. The decrease in the effective tax rate is attributable to a larger percentage of tax exempt income compared with pre-tax income in the current quarter.
Net Income. Net income for the nine-month period ended September 30, 2008 is $2.8 million or $.29 per diluted share compared to $4.5 million or $0.47 per diluted share for the nine-month period ended September 30, 2007. Annualized return on average assets is 0.41% and 0.79% for the two periods ended September 30, 2008 and 2007, respectively. The decline in return on assets is primarily attributed to the effects of a lower interest rate environment, the narrowing of spread between pricing on new loans and the cost to fund the loan growth and an increase in non-interest expenses. Return on average equity for the current period is 3.94% compared to 6.94% for the prior period. Return on average equity decreased due to a lower return on average assets.
Net Interest Income. Net interest income is $19.2 million for the current nine-month period compared to $19.9 million for the prior period. Increased interest income that would be expected from strong growth in earning assets has been offset by both the lower interest rate environment and the increased volume of high cost deposits to fund the asset growth.
Total interest income is $40.7 million for the current nine-month period compared to $40.5 million for the prior year period, an increase of $239,000 or less than 1%. The increase is comprised of a $7.6 million increase due to growth in average earning assets and a $7.4 million decrease due to the lower average yield earned on those assets. Total interest expense increased by $702,000 or 3% from $20.8 million for the prior year period to $21.5 million for the current period. The increase is the result of a $5.0 million increase due to growth in interest-bearing liabilities and a $4.3 million decrease due to the lower interest rate environment.
Total average earning assets increased $136.1 million or 19% from an average of $698.6 million as of September 30, 2007 to an average of $834.7 million for the nine-month period ended September 30, 2008. The average balance of loans outstanding during the current nine-month period is $728.9 million reflecting a $131.9 million or 22% increase over the $597.0 million for the prior year period. The average balance of the investment securities portfolio for the current period is $101.9 million, increasing by $10.6 million or 12% compared to an average of $91.3 million at September 30, 2007. The average balance of federal funds sold and other earning assets decreased to $3.9 million for the nine-month period ended September 30, 2008 compared to $10.3 million for the prior period.
Total average interest-bearing liabilities increased by $138.0 million or 23% from an average of $600.3 million for the period ended September 30, 2007 to $738.3 million for the current nine-month period. Average interest-bearing deposits increased by $78.3 million or 15% growing from $519.2 million at September 30, 2007 to $597.5 million at September 30, 2008. Total average borrowings increased by $59.7 million or 74% to $140.7 million for the current nine-month period from $81.0 million for the prior year period.
The net interest margin for the nine-month period ended September 30, 2008 is 3.07% compared to 3.76% for the prior year nine-month period. The average yield on earning assets for the current nine-month period decline by 125 basis points to 6.49% compared with 7.74% for the prior year period, while the average cost of interest-bearing funds decreased by only 74 basis points to 3.90% from 4.64%. The spread between the rates paid on earning assets and the cost of interest-bearing funds decreased by 50 basis points from 3.10% to 2.60%. The Company's reliance on interest-bearing liabilities to fund earning asset growth increased as the percentage of interest earning assets to interest bearing liabilities declined from 116.39% to 113.07%.
Provision for Loan Losses. The Company's provision for loan losses for the nine-month period ended September 30, 2008 is $2.5 million compared to $1.3 million for the same period in 2007. Provision for loan losses is charged to income to bring the allowance for loan losses to a level deemed appropriate by management based on factors discussed under "Analysis of Allowance for Loan Losses." The increased loan loss provision for the current nine-month period is primarily due to the increase in net loan growth and reserves for specific credits experiencing quality deterioration. See the section entitled "Non Performing Assets" for more details.
Non-Interest Income. For the nine-month period ended September 30, 2008, non-interest income increased by $717,000 to $2.7 million. The largest components of non-interest income are $996,000 in customer service fees, $512,000 in mortgage loan origination fees, $431,000 in earnings on cash value of bank owned life insurance and $181,000 in deposit service charges. For the prior nine-month period, we recorded $829,000 in customer service fees, $396,000 in mortgage loan origination fees, $281,000 increase in cash surrender value on life insurance, and $177,000 in service charges and fees on deposit accounts. Other non interest income increased by $339,000 of which $238,000 represents non-recurring revenue.
Non-Interest Expenses. Non-interest expenses increased by 15% to $15.2 million for the nine-month period ended September 30, 2008 compared with $13.2 million for the same period ended September 30, 2007. The Company has added two branch locations, moved one office to a more visible location and increased both lending and support staff during the past twelve months. Increases in personnel and occupancy expenses account for 79% of the total rise in non-interest expenses. Salaries and benefits expense increased by $1.2 million or 16% to $8.6 million for the current nine-month period compared to $7.4 million for the prior year. Occupancy and equipment expenses increased by $334,000 or 19% to $2.0 for the current period compared to $1.7 million for the prior year period. Management anticipates both personnel and occupancy expense to increase in early to mid 2009 as we plan to open two new locations in Raleigh, North Carolina. Data processing costs increased by only $7,000 to $802,000.
Other non-interest expenses increased by $407,000 to $3.7 million for the first nine months of 2008 compared with $3.3 million for the prior year. The largest . . .
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