SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number: 0-25859
1st STATE BANCORP, INC.
------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Virginia 56-2130744
------------------------------- ----------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
445 S. Main Street, Burlington, North Carolina 27215
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(Address of Principal Executive Offices) (Zip Code)
Registrant' s Telephone Number, Including Area Code (336) 227-8861
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N/A
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Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report
Indicate by check mark whether the registrant: (1) has filed all reports
required 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. Yes X No
---- ----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of August 8, 2003, the issuer had 2,973,066 shares of common stock
issued and outstanding.
CONTENTS
PAGE
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PART I. FINANCIAL INFORMATION
---------------------
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2003 (unaudited)
and September 30, 2002...............................................3
Consolidated Statements of Income for the Three Months
Ended June 30, 2003 and 2002 (unaudited).............................4
Consolidated Statements of Income for the Nine Months
Ended June 30, 2003 and 2002 (unaudited).............................5
Consolidated Statements of Stockholders' Equity and
Comprehensive Income for the Nine Months Ended
June 30, 2003 and 2002 (unaudited)...................................6
Consolidated Statements of Cash Flows for the Nine Months
Ended June 30, 2003 and 2002 (unaudited).............................7
Notes to Consolidated Financial Statements............................9
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...........................................13
Item 3. Quantitative and Qualitative Disclosures About Market Risk...........24
Item 4. Controls and Procedures..............................................25
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings....................................................26
Item 2. Changes in Securities and Use of Proceeds............................26
Item 3. Defaults Upon Senior Securities......................................26
Item 4. Submission of Matters to a Vote of Security Holders..................26
Item 5. Other Information....................................................26
Item 6. Exhibits and Reports on Form 8-K.....................................26
SIGNATURES....................................................................27
2
1st STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
JUNE 30, 2003 AND SEPTEMBER 30, 2002
(In Thousands, except share data)
AT AT
JUNE 30, SEPTEMBER 30,
2003 2002
------------------ ---------------
(Unaudited)
ASSETS
Cash and cash equivalents $ 32,058 18,865
Investment securities:
Held to maturity (fair value of $15,527 and $11,558
at June 30, 2003 and September 30, 2002, respectively) 15,098 11,114
Available for sale (cost of $60,024 and $77,213
at June 30, 2003 and September 30, 2002, respectively) 60,739 78,572
Loans held for sale, at lower of cost or fair value 9,484 6,798
Loans receivable (net of allowance for loan losses of $3,902
and $3,732 at June 30, 2003 and September 30, 2002,
respectively) 223,661 220,047
Real estate owned 80 183
Federal Home Loan Bank stock, at cost 1,000 1,750
Premises and equipment 8,448 7,972
Accrued interest receivable 1,549 2,272
Other assets 2,803 2,896
----------- ----------
Total assets $ 354,920 350,469
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposit accounts 260,211 260,667
Advances from Federal Home Loan Bank 20,000 20,000
Advance payments by borrowers for property taxes and insurance 336 54
Dividend payable 297 241
Other liabilities 10,953 7,938
----------- ----------
Total liabilities 291,797 288,900
----------- ----------
Stockholders' Equity:
Preferred stock, $0.01 par value, 1,000,000 shares authorized;
none issued -- --
Common stock, $0.01 par value, 7,000,000 shares authorized;
2,975,600 and 3,008,682 shares issued and outstanding
at June 30, 2003 and September 30, 2002, respectively 33 33
Additional paid-in capital 35,730 35,623
Unallocated ESOP shares (3,291) (3,739)
Deferred compensation payable in treasury stock 5,466 5,466
Treasury stock (12,695) (11,899)
Retained income - substantially restricted 37,445 35,258
Accumulated other comprehensive income - net unrealized
gain on investment securities available for sale 435 827
----------- ----------
Total stockholders' equity 63,123 61,569
----------- ----------
Total liabilities and stockholders' equity $ 354,920 350,469
=========== ==========
See accompanying notes to the consolidated financial statements.
3
1st STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED JUNE 30, 2003 AND 2002
(In Thousands, Except per Share Data)
(UNAUDITED)
FOR THE THREE MONTHS ENDED
JUNE 30,
------------------------------
2003 2002
---------- -----------
Interest income:
Interest and fees on loans $ 3,097 3,502
Interest and dividends on investments 982 1,413
Overnight deposits 43 50
--------- ---------
Total interest income 4,122 4,965
--------- ---------
Interest expense:
Deposit accounts 1,040 1,475
Borrowings 273 281
--------- ---------
Total interest expense 1,313 1,756
--------- ---------
Net interest income 2,809 3,209
Provision for loan losses 60 60
--------- ---------
Net interest income after provision for loan losses 2,749 3,149
--------- ---------
Other income:
Customer service fees 218 209
Commissions from sales of annuities and mutual funds 100 131
Mortgage banking income, net 457 171
Securities gains, net 103 --
Other 65 47
--------- ---------
Total other income 943 558
--------- ---------
Operating expenses:
Compensation and related benefits 1,348 1,512
Occupancy and equipment 353 315
Real estate operations, net (2) (24)
Other expenses 443 376
--------- ---------
Total operating expenses 2,142 2,179
--------- ---------
Income before income taxes 1,550 1,528
Income taxes 562 542
--------- ---------
Net income $ 988 986
========= =========
Earnings per share:
Basic $ 0.35 $ 0.32
Diluted $ 0.34 $ 0.31
See accompanying notes to the consolidated financial statements.
4
1st STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE NINE MONTHS ENDED JUNE 30, 2003 AND 2002
(In Thousands, Except per Share Data)
(UNAUDITED)
FOR THE NINE MONTHS ENDED
JUNE 30,
----------------------------
2003 2002
---------- ---------
Interest income:
Interest and fees on loans $ 9,764 10,934
Interest and dividends on investments 3,194 3,993
Overnight deposits 128 191
--------- ---------
Total interest income 13,086 15,118
--------- ---------
Interest expense:
Deposit accounts 3,500 5,248
Borrowings 825 843
--------- ---------
Total interest expense 4,325 6,091
--------- ---------
Net interest income 8,761 9,027
Provision for loan losses 180 180
--------- ---------
Net interest income after provision for loan losses 8,581 8,847
--------- ---------
Other income:
Customer service fees 648 675
Commissions from sales of annuities and mutual funds 346 351
Mortgage banking income, net 1,350 950
Securities gains, net 103 47
Other 183 153
--------- ---------
Total other income 2,630 2,176
--------- ---------
Operating expenses:
Compensation and related benefits 4,149 4,660
Occupancy and equipment 1,088 929
Real estate operations, net 7 (56)
Other expenses 1,282 1,153
--------- ---------
Total operating expenses 6,526 6,686
--------- ---------
Income before income taxes 4,685 4,337
Income taxes 1,717 1,582
--------- ---------
Net income $ 2,968 2,755
========= =========
Earnings per share:
Basic $ 1.06 $ 0.91
Diluted $ 1.01 $ 0.87
See accompanying notes to the consolidated financial statements.
5
1st STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
FOR THE NINE MONTHS ENDED JUNE 30, 2003 AND 2002 (UNAUDITED)
(In Thousands)
Deferred
compensation
Additional Unallocated Unearned payable in
Common paid-in ESOP Compensation treasury
stock capital shares MRP stock
----- ------- ------ --- ------
Balance at September 30, 2001 $33 35,588 (4,373) (518) 4,173
Comprehensive income:
Net income -- -- -- -- --
Other comprehensive loss-unrealized
loss on securities available-for-sale
net of income taxes of $22 -- -- -- -- --
Total comprehensive income
Allocation of ESOP shares -- 22 478 -- --
Deferred compensation -- -- -- -- 298
Acquisition of treasury shares -- -- -- -- --
Vesting of MRP shares -- -- -- 518 --
Cash dividends declared ($0.24 per share) -- -- -- -- --
Cash dividends on unallocated ESOP shares
and unvested MRP shares -- -- -- -- --
--- ------ ------- ----- -----
Balance at June 30, 2002 $33 35,610 (3,895) -- 4,471
=== ====== ======= ===== =====
Balance at September 30, 2002 $33 35,623 (3,739) -- 5,466
Comprehensive income:
Net income -- -- -- -- --
Other comprehensive loss-unrealized
loss on securities available-for-sale
net of income taxes of $252 -- -- -- -- --
Total comprehensive income
Allocation of ESOP shares -- 107 448 -- --
Acquisition of treasury shares -- -- -- -- --
Cash dividends declared ($0.28 per share) -- -- -- -- --
Cash dividends on unallocated ESOP shares -- -- -- -- --
--- ------ ------- ----- -----
Balance at June 30, 2003 $33 35,730 (3,291) -- 5,466
=== ====== ======= ===== =====
Accumulated
other Total
Treasury Retained comprehensive stockholders'
stock Income income (loss) equity
------ ------ ------------- ------
Balance at September 30, 2001 (4,173) 32,404 510 63,644
Comprehensive income:
Net income -- 2,755 -- 2,755
Other comprehensive loss-unrealized
loss on securities available-for-sale
net of income taxes of $22 -- -- (32) (32)
------
Total comprehensive income 2,723
Allocation of ESOP shares -- -- -- 500
Deferred compensation -- -- -- 298
Acquisition of treasury shares (298) -- -- (298)
Vesting of MRP shares -- -- -- 518
Cash dividends declared ($0.24 per share) -- (790) -- (790)
Cash dividends on unallocated ESOP shares
and unvested MRP shares -- 69 -- 69
-------- ------ --- ------
Balance at June 30, 2002 (4,471) 34,438 478 66,664
======== ====== === ======
Balance at September 30, 2002 (11,899) 35,258 827 61,569
Comprehensive income:
Net income -- 2,968 -- 2,968
Other comprehensive loss-unrealized
loss on securities available-for-sale net
of income taxes of $252 -- -- (392) (392)
------
Total comprehensive income
2,576
Allocation of ESOP shares -- -- -- 555
Acquisition of treasury shares (796) -- -- (796)
Cash dividends declared ($0.28 per share) -- (834) -- (834)
Cash dividends on unallocated ESOP shares -- 53 -- 53
-------- ------ --- ------
Balance at June 30, 2003 (12,695) 37,445 435 63,123
======== ====== === ======
See accompanying notes to the consolidated financial statements.
6
1st STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED JUNE 30, 2003 AND 2002
(UNAUDITED)
(In Thousands)
FOR THE NINE MONTHS ENDED
JUNE 30,
2003 2002
--------- -----------
Cash flows from operating activities:
Net income $ 2,968 2,755
Adjustment to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 180 180
Depreciation 557 474
Deferred tax expense 137 495
Amortization of premiums and discounts, net (34) (23)
Deferred compensation 180 236
Release of ESOP shares 555 500
Vesting of MRP shares and dividends on unvested MRP shares -- 712
Loan origination fees and unearned discounts
deferred, net of current amortization (66) (63)
Loss (gain) on sale of other real estate 11 (4)
Securities gains, net (103) (47)
Net (gain) loss on sale of loans (302) 227
Proceeds from loans held for sale 73,457 49,134
Originations of loans held for sale (75,841) (47,264)
Decrease (increase) in other assets 208 (41)
Decrease in accrued interest receivable 723 371
Increase in other liabilities 2,835 713
---------- ---------
Net cash provided by operating activities 5,465 8,355
---------- ---------
Cash flows provided by (used in) investing activities:
Purchase of FHLB stock (268) (100)
Proceeds from redemption of FHLB stock 1,018 --
Purchases of investment securities held to maturity (5,998) (3,958)
Purchases of investment securities available for sale (80,239) (78,127)
Proceeds from sales of investment securities available for sale 1,103 1,811
Proceeds from maturities and issuer calls of investment securities
available for sale 96,473 42,923
Proceeds from maturities and issuer calls of investment securities
held to maturity 2,003 6,004
Net decrease (increase) in loans receivable (3,728) 6,646
Proceeds from disposal of real estate acquired in
settlement of loans 92 107
Purchases of premises and equipment (1,033) (134)
---------- ---------
Net cash provided by (used in) investing activities 9,423 (24,828)
---------- ---------
(Continued)
7
1st STATE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
FOR THE NINE MONTHS ENDED JUNE 30, 2003 AND 2002
(UNAUDITED)
(In Thousands)
FOR THE NINE MONTHS ENDED
JUNE 30,
2003 2002
----------- -------------
Cash flows from financing activities:
Net increase (decrease) in deposits $ (456) $ 10,877
Advances from the Federal Home Loan Bank 13,000 29,000
Repayments of advances from the Federal Home Loan Bank (13,000) (29,000)
Purchase of treasury stock (796) (298)
Dividends paid on common stock (725) (721)
Increase in advance payments by borrowers for
property taxes and insurance 282 573
---------- ---------
Net cash provided by (used in) financing activities (1,695) 10,431
---------- ---------
Net increase (decrease) in cash and cash equivalents 13,193 (6,042)
Cash and cash equivalents at beginning of period 18,865 25,981
---------- ---------
Cash and cash equivalents at end of period $ 32,058 $ 19,939
========== =========
Payments are shown below for the following:
Interest $ 4,343 $ 6,085
========== =========
Income taxes $ 1,133 $ 1,534
========== =========
Noncash investing and financing activities:
Deferred compensation to be settled in Company's stock $ -- $ 298
========== =========
Unrealized losses on investment securities
available for sale $ (644) $ (54)
========== =========
Cash dividends declared but not paid $ 278 $ 244
========== =========
Cash dividends on unallocated ESOP shares $ 53 $ 69
========== =========
Transfer from loans to real estate acquired in settlement of loans $ -- $ 347
========== =========
See accompanying notes to consolidated financial statements.
8
1st STATE BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003 (UNAUDITED) AND SEPTEMBER 30, 2002
NOTE 1. NATURE OF BUSINESS
1st State Bancorp, Inc. (the "Company") was incorporated under the laws of
the Commonwealth of Virginia for the purpose of becoming the holding company for
1st State Bank (the "Bank") in connection with the Bank's conversion from a
North Carolina-chartered mutual savings bank to a North Carolina-chartered stock
savings bank (the "Converted Bank") pursuant to its Plan of Conversion (the
"Stock Conversion"). Upon completion of the Stock Conversion, the Converted Bank
converted from a North Carolina-chartered stock savings bank to a North Carolina
commercial bank (the "Bank Conversion"), retaining the name 1st State Bank (the
"Commercial Bank"), and the Commercial Bank succeeded to all of the assets and
liabilities of the Converted Bank. The Stock Conversion and the Bank Conversion
were consummated on April 23, 1999. The common stock of the Company began
trading on the Nasdaq National Market System under the symbol "FSBC" on April
26, 1999.
NOTE 2. BASIS OF PRESENTATION
The accompanying consolidated financial statements (which are unaudited,
except for the consolidated balance sheet at September 30, 2002, which is
derived from the September 30, 2002 audited consolidated financial statements)
have been prepared in accordance with accounting principles generally accepted
in the United States of America for interim financial information and with the
rules and regulations of the Securities and Exchange Commission. Accordingly,
they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. In the opinion of management, all adjustments (none of
which were other than normal recurring accruals) necessary for a fair
presentation of the financial position and results of operations for the periods
presented have been included.
The results of operations for the three and nine month periods ended June
30, 2003 are not necessarily indicative of the results of operations that may be
expected for the year ended September 30, 2003. The preparation of consolidated
financial statements in accordance with accounting principles generally accepted
in the United States of America requires management to make certain estimates.
These amounts may be revised in future periods because of changes in the facts
and circumstances underlying their estimation.
Certain amounts in the June 30, 2002 consolidated financial statements have
been reclassified to conform with the presentation adopted in 2003. Such
reclassifications did not change net income or stockholders' equity as
previously reported.
NOTE 3. EARNINGS PER SHARE
For purposes of computing basic and diluted earnings per share, weighted
average shares outstanding excludes unallocated ESOP shares that have not been
committed to be released. The deferred compensation obligation discussed in note
5 that is fully funded with shares of the Company's common stock has no net
impact on the Company's earnings per share computations. Diluted earnings per
share includes the potentially dilutive effects of the Company's stock-based
benefit plans. There were no antidilutive stock options for the three and nine
months ended June 30, 2003 and 2002. A reconciliation of the denominators of the
basic and diluted earnings per share computations is as follows:
9
THREE MONTHS ENDED
JUNE 30,
2003 2002
---------- -----------
Average shares issued and outstanding 2,976,652 3,289,607
Less: Unvested MRP shares -- (31,038)
Less: Unallocated ESOP shares (176,174) (216,108)
----------- -----------
Average basic shares for earnings per share 2,800,478 3,042,461
Add: Unvested MRP shares -- 31,038
Add: Potential common stock pursuant to stock option plan 123,595 90,660
----------- -----------
Average dilutive shares for earnings per share 2,924,073 3,164,159
=========== ===========
NINE MONTHS ENDED
JUNE 30,
2003 2002
---------- -----------
Average shares issued and outstanding 2,991,761 3,289,607
Less: Unvested MRP shares issued -- (38,464)
Less: Unallocated ESOP shares (181,034) (224,280)
----------- -----------
Average basic shares for earnings per share 2,810,727 3,026,863
Add: Unvested MRP shares -- 38,464
Add: Potential common stock pursuant to stock option plan 124,192 88,561
----------- -----------
Average dilutive shares for earnings per share 2,934,919 3,153,888
=========== ===========
NOTE 4. EMPLOYEE STOCK OWNERSHIP PLAN ("ESOP")
The Company sponsors an employee stock ownership plan (the "ESOP") whereby
an aggregate number of shares amounting to 253,050 or 8% of the stock issued in
the conversion was purchased for future allocation to employees. The ESOP was
funded by an 11 year term loan from the Company in the amount of $4,899,000. The
loan is secured by the shares of stock purchased by the ESOP. During the three
and nine months ended June 30, 2003 and 2002, 7,644 and 7,179 and 22,932 and
24,382 shares of stock were committed to be released and approximately $185,000
and $172,000 and $555,000 and $500,000 of compensation expense was recognized,
respectively.
NOTE 5. DEFERRED COMPENSATION
Directors and certain executive officers participate in a deferred
compensation plan, which was approved by the Board of Directors on September 24,
1997. This plan generally provides for fixed payments beginning after the
participant retires. Each participant is fully vested in his account balance
under the plan. Directors may elect to defer their directors' fees and executive
officers may elect to defer 25% of their salary and 100% of bonus compensation.
Prior to the Conversion, amounts deferred by each participant accumulated
interest at a rate equal to the highest rate of interest paid on the Bank's
one-year certificates of deposit. In connection with the Conversion,
participants in the plan were given the opportunity to prospectively elect to
have their deferred compensation balance earn a rate of return equal to the
total return of the Company's stock. All participants elected this option
concurrent with the Conversion, so the Company purchases its common stock to
fund this obligation. Refer to the Company's notes to consolidated financial
statements, incorporated by reference in the Company's 2002 Annual Report on
Form 10-K for a discussion of the Company's accounting policy with respect to
this deferred compensation plan and the related treasury stock purchased by the
Company to fund this obligation.
10
The expense related to this plan for the three and nine months ended June
30, 2003 and 2002 was $60,000 and $72,000 and $180,000 and $236,000,
respectively. This expense is included in compensation expense.
NOTE 6. MANAGEMENT RECOGNITION PLAN
The Company has a Management Recognition Plan ("MRP") which serves as a
means of providing existing directors and officers of the Bank with an ownership
interest in the Company. On June 6, 2000, restricted stock awards of 126,482
shares were granted. The shares awarded under the MRP were issued from
authorized but unissued shares of common stock at no cost to the recipients. The
shares vest at a rate of 33 1/3% per year with a one-third immediate vest on the
date of the grant and annually thereafter. The Company recorded no compensation
expense associated with the MRP during the three and nine months ended June 30,
2003 as all shares became fully vested in June 2002. Compensation expense of
$192,000 and $712,000 associated with the MRP was recorded during the three and
nine months ended June 30, 2002, respectively.
NOTE 7. STOCK OPTION AND INCENTIVE PLAN
On June 6, 2000 the Company's stockholders approved the 1st State Bancorp,
Inc. 2000 Stock Option and Incentive Plan (the "Plan"). The purpose of this plan
is to advance the interests of the Company through providing select key
employees and directors of the Bank with the opportunity to acquire shares. By
encouraging such stock ownership, the Company seeks to attract, retain and
motivate the best available personnel for positions of substantial
responsibility and to provide incentives to the key employees and directors.
Under the Plan, the Company granted 316,312 options to purchase its $0.01 par
value common stock in fiscal year 2000. The exercise price per share is equal to
the fair market value per share on the date of the grant of the option. Options
granted under the Stock Option Plan are 100% vested on the date of the grant,
and all options expire 10 years from the date of the grant. As a result of the
one-time cash dividend of $5.17 paid on October 2, 2000, the exercise price for
the options repriced from $18.44 to $14.71. No options were exercised or granted
during the three and nine months ended June 31, 2003 and 2002. At June 30, 2003,
316,312 options are outstanding, all of which are exercisable.
In December 2002, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 148 "Accounting for Stock-Based
Compensation - Transition and Disclosure" (SFAS 148) an amendment of FASB
Statement No. 123, "Accounting for Stock-Based Compensation" (SFAS 123), which
provides alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require
prominent disclosure in both annual and interim financial statements about the
method of accounting for stock-based compensation and the effect of the method
on reported results. The Company does not have any plans to change its method of
accounting for stock-based employee compensation. There is no pro forma impact
for any of the periods presented or for either of the two prior fiscal years.
NOTE 8. MORTGAGE SERVICING RIGHTS
The rights to service mortgage loans for others are included in other
assets on the consolidated balance sheet. Mortgage servicing rights ("MSRs") are
capitalized based on the allocated cost which is determined when the underlying
loans are sold. MSRs are amortized over a period which approximates the life of
the underlying loans as an adjustment of income. Impairment reviews of MSRs are
performed on a quarterly basis. As of June 30, 2003 and September 30, 2002 MSRs
totaled $526,000 and $370,000, respectively, and no valuation allowance was
required.
Amortization expense totaled $126,000 and $43,000 for the nine months ended
June 30, 2003 and 2002, respectively.
11
NOTE 9. STANDBY LETTERS OF CREDIT
In November 2002, the FASB issued Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others", which addressed the disclosure
to be made by a guarantor in its interim and annual financial statements about
its obligations under guarantees. FIN 45 requires the guarantor to recognize a
liability for the non-contingent component of the guarantee, such as the
obligation to stand ready to perform in the event that specified triggering
events or conditions occur. The initial measurement of this liability is the
fair value of the guarantee at inception. The recognition of the liability is
required even if it is not probable that payments will be required under the
guarantee or if the guarantee was issued with a premium payment or as part of a
transaction with multiple events. The initial recognition and measurement
provisions are effective for all guarantees within the scope of FIN 45 issued or
modified after December 31, 2002. The Company issues standby letters of credit
whereby the Company guarantees performance if a specified triggering event or
condition occurs (primarily nonperformance under construction contracts entered
into by construction customers). The guarantees generally expire within one year
and may be automatically renewed depending on the terms of the guarantee. The
maximum potential amount of undiscounted future payments related to standby
letters of credit at June 30, 2003 is $276,000. At June 30, 2003 the Company has
recorded no liability for the current carrying amount of the obligation to
perform as a guarantor and no contingent liability is considered necessary as
such amounts are deemed immaterial. Substantially all standby letters of credit
are secured by real estate and/or guaranteed by third parties in the event the
Company had to advance funds to fulfill the guarantee.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
When used in this Form 10-Q, the words or phrases "will likely result,"
"are expected to," "will continue," "is anticipated," "estimate," "project" or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties including changes in
economic conditions in our market area, changes in policies by regulatory
agencies, fluctuations in interest rates, demand for loans in our market area,
and competition that could cause actual results to differ materially from
historical earnings and those presently anticipated or projected. We wish to
caution you not to place undue reliance on any such forward-looking statements,
which speak only as of the date made. We wish to advise you that the factors
listed above could affect our financial performance and could cause our actual
results for future periods to differ materially from any opinions or statements
expressed with respect to future periods in any current statements.
We do not undertake, and specifically disclaim any obligation, to publicly
release the result of any revisions which may be made to any forward-looking
statements to reflect events or circumstances after the date of such statements
or to reflect the occurrence of anticipated or unanticipated events.
GENERAL
1st State Bancorp, Inc. was formed in November 1998 and became the holding
company for 1st State Bank on April 23, 1999.
Our business consists principally of attracting deposits from the general
public and investing these funds in loans secured by single-family residential
and commercial real estate, secured and unsecured commercial loans and consumer
loans. Our profitability depends primarily on our net interest income, which is
the difference between the income we receive on our loan and investment
securities portfolios and our cost of funds, which consists of interest paid on
deposits and borrowed funds. Net interest income also is affected by the
relative amounts of interest-earning assets and interest-bearing liabilities.
When interest-earning assets approximate or exceed interest-bearing liabilities,
any positive interest rate spread will generate net interest income. Our
profitability is also affected by the level of other income and operating
expenses. Other income consists of miscellaneous fees related to our loans and
deposits, mortgage banking income and commissions from sales of annuities and
mutual funds. Operating expenses consist of compensation and benefits, occupancy
related expenses, federal deposit insurance premiums, data processing,
advertising and other expenses.
Our operations are influenced significantly by local economic conditions
and by policies of financial institution regulatory authorities. Our cost of
funds is influenced by interest rates on competing investments and by rates
offered on similar investments by competing financial institutions in our market
area, as well as general market interest rates. These factors can cause
fluctuations in our net interest income and other income. Lending activities are
affected by the demand for financing of real estate and other types of loans,
which in turn is affected by the interest rates at which such financing may be
offered. In addition, local economic conditions can impact the credit risk of
our loan portfolio, in that local employers may be required to eliminate
employment positions of many of our borrowers, and small businesses and other
commercial borrowers may experience a downturn in their operating performance
and become unable to make timely payments on their loans. Management evaluates
these factors in estimating its allowance for loan losses, and changes in these
economic conditions could result in increases or decreases to the provision for
loan losses.
Our business emphasis has been to operate as a well-capitalized, profitable
and independent community-oriented financial institution dedicated to providing
quality customer service. We are committed to meeting the financial needs of the
communities in which we operate. We believe that we can be more effective in
servicing our customers than many of our nonlocal competitors because of our
ability to quickly and effectively provide senior management responses to
customer needs and inquiries. Our ability to provide these services is enhanced
by the stability of our senior management team.
13
Over the years, we have sought to gradually increase the percentage of our
assets invested in commercial real estate loans, commercial loans and consumer
loans, which have shorter terms and adjust more frequently to changes in
interest rates than single-family residential mortgage loans. These loans
generally carry added risk when compared to a single family residential mortgage
loan, so we have concurrently increased our allowance for loan losses as we have
originated these loans.
CRITICAL ACCOUNTING POLICIES
The Company's significant accounting policies are set forth in note 1 of
the consolidated financial statements as of September 30, 2002 which was filed
on Form 10-K. Of these significant accounting policies, the Company considers
its policy regarding the allowance for loan losses to be its most critical
accounting policy, because it requires management's most subjective and complex
judgments. In addition, changes in economic conditions can have a significant
impact on the allowance for loan losses and therefore the provision for loan
losses and results of operations. The Company has developed appropriate policies
and procedures for assessing the adequacy of the allowance for loan losses,
recognizing that this process requires a number of assumptions and estimates
with respect to its loan portfolio. The Company's assessments may be impacted in
future periods by changes in economic conditions, the impact of regulatory
examinations, and the discovery of information with respect to borrowers which
is not known to management at the time of the issuance of the consolidated
financial statements.
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 2003 AND SEPTEMBER 30, 2002
Total assets increased by $4.4 million or 1.3% from $350.5 million at
September 30, 2002 to $354.9 million at June 30, 2003. As market rates remained
low during the nine months ended June 30, 2003, many of the Company's callable
investments were called by the issuers. The proceeds from investment maturities
and calls totaled $98.5 million for the nine months ended June 30, 2003 compared
with investment purchases of $86.2 million; therefore, total investment
securities decreased from September 30, 2002. Cash and cash equivalents
increased $13.2 million from $18.9 million at September 30, 2002 to $32.1
million at June 30, 2003 as a result of the decrease in investment securities.
Loans receivable, net and loans held for sale increased by $3.7 million and $2.7
million, respectively. Deposits decreased by $456,000 from $260.7 million at
September 30, 2002 to $260.2 million at June 30, 2003.
Investment securities available for sale decreased $17.9 million from $78.6
million at September 30, 2002 to $60.7 million at June 30, 2003. During the nine
months ended June 30, 2003, we purchased $80.2 million of securities available
for sale and received $96.5 million in proceeds from maturities and issuer calls
of investment securities available for sale. Investment securities held to
maturity increased from $11.1 million at September 30, 2002 to $15.1 million at
June 30, 2003 as $6.0 million of investment securities held to maturity were
purchased during this period, and $2.0 million were called by the issuers.
Loans held for sale increased by $2.7 million from $6.8 million at
September 30, 2002 to $9.5 million at June 30, 2003. Loans receivable, net
increased $3.7 million from $220.0 million at September 30, 2002 to $223.7
million at June 30, 2003. The increase in loans held for sale resulted from
timing differences in the funding of loan sales. During the nine months ended
June 30, 2003 our mortgage originations and prepayments continued at record
levels. Mortgage rates declined to record low levels during this period, and
many borrowers took advantage of this opportunity to refinance their existing
mortgage loans. Mortgage loans secured by single family dwellings decreased by
$16.8 million during this period as a result of the tremendous refinancing
activity. During this same period, increases in commercial and home equity line
loans more than offset this single family mortgage loan decrease.
Stockholders' equity increased by $1.5 million from $61.6 million at
September 30, 2002 to $63.1 million at June 30, 2003 as a result of net income
of $3.0 million and release of ESOP shares of $555,000. These increases were
offset by cash dividends to stockholders declared of $781,000, purchases of
treasury stock of $796,000 and a net decrease in unrealized gain on available
for sale securities of $392,000.
14
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED JUNE 30, 2003
AND 2002
Net Income. We recorded net income of $988,000 for the quarter ended June
30, 2003, as compared to $986,000 for the quarter ended June 30, 2002,
representing an increase of $2,000, or 0.2%. For the three months ended June 30,
2003, basic and diluted earnings per share were $0.35 and $0.34, respectively,
compared to the basic and diluted earnings per share for the quarter ended June
30, 2002 of $0.32 and $0.31, respectively. The increase in net income resulted
primarily from increased other income and decreased operating expenses that were
offset partially by decreased net interest income and increased income tax
expense. The decrease in net interest income resulted from lower net interest
margins. The average prime interest rate for the quarter ended June 30, 2003 was
4.24%, a decrease of 51 basis points from 4.75% which was the average prime for
the quarter ended June 30, 2002. The repricing of certificates of deposits,
savings and money market investment accounts decreased the Company's cost of
funds to partially offset the decrease in asset yield which resulted from the
lower prevailing interest rates during the quarter ended June 30, 2003. Basic
and diluted earnings per share was favorably impacted by the Company's stock
repurchase plan which was approved in August 2002.
Net Interest Income. Net interest income, the difference between interest
earned on loans and investments and interest paid on interest-bearing
liabilities, decreased by $400,000 or 12.7% for the three months ended June 30,
2003, compared to the same quarter in the prior year. This decrease results from
a $843,000 decrease in interest income that was offset in part by the $443,000
decrease in total interest expense. The net interest income as a percentage of
average earning assets decreased 44 basis points from 3.90% for the three months
ended June 30, 2002 to 3.46% for the quarter ended June 30, 2003.
Interest Income. The decrease in interest income for the three months ended
June 30, 2003 was the result of a decrease in yield on interest-earning assets
of 95 basis points from 6.03% for the three months ended June 30, 2002 to 5.08%
for the three months ended June 30, 2003 and a $5.0 million decrease in average
interest earning assets. Average loans receivable increased $13.1 million from
$214.3 million for the quarter ended June 30, 2002 to $227.4 million for the
quarter ended June 30, 2003. Average investment securities decreased $19.6
million for the quarter compared to the prior year. Average interest-bearing
overnight funds increased $1.6 million for the quarter compared to the prior
year. The decrease in asset yield resulted from the lower rates prevailing in
the marketplace. The decrease in average interest earning assets decreased
interest income by approximately $53,000 and the decrease in the average yield
on interest earning assets decreased interest income by approximately $790,000.
Interest Expense. Interest expense decreased in the three months ended June
30, 2003 due to a decrease in the cost of interest-bearing liabilities of 60
basis points from 2.61% for the three months ended June 30, 2002 to 2.01% for
the three months ended June 30, 2003. Average interest-bearing deposits
decreased by $6.5 million while average FHLB advances decreased $1.6 million for
the three months ended June 30, 2003 compared to the same quarter in the prior
year. The decrease in the average rate of interest-bearing liabilities decreased
interest expense by approximately $385,000 and the decrease in the average
interest-bearing liabilities decreased interest expense by approximately
$58,000.
15
The following table presents average balances and average rates earned/paid
by the Company for the quarter ended June 30, 2003 compared to the quarter ended
June 30, 2002.
THREE MONTHS ENDED THREE MONTHS ENDED
JUNE 30, 2003 JUNE 30, 2002
DOLLARS IN THOUSANDS
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST YIELD/COST BALANCE INTEREST YIELD/COST
Assets:
Loans receivable (1) $227,367 $3,097 5.45% $214,339 $3,502 6.54%
Investment securities (2) 82,245 982 4.78 101,822 1,413 5.55
Interest-bearing overnight deposits 14,687 43 1.16 13,174 50 1.51
-------- ------ ---- -------- ------ ----
Total interest-earning assets (4) 324,299 4,122 5.08 329,335 4,965 6.03
Non interest-earning assets 20,109 22,601
-------- --------
Total assets $344,408 $351,936
======== ========
Liabilities and stockholders' equity
Interest-bearing checking $34,322 27 0.31 $32,836 38 0.47
Money market investment accounts 23,876 55 0.92 26,232 83 1.26
Passbook and statement savings 30,823 65 0.85 28,457 102 1.44
Certificates of deposit 151,748 894 2.36 159,727 1,252 3.14
FHLB advances 20,000 272 5.45 21,593 281 5.20
-------- ------ ---- -------- --- ----
Total interest-bearing liabilities 260,769 1,313 2.01 268,845 1,756 2.61
Non interest-bearing liabilities 20,797 17,450
-------- --------
Total liabilities 281,566 286,295
Stockholders' equity 62,842 65,641
-------- --------
Total liabilities and stockholders' equity $344,408 $351,936
======== ========
Net interest income $2,809 $3,209
====== ======
Interest rate spread 3.07% 3.42%
Net interest margin (3) 3.46% 3.90%
Ratio of average interest-earning assets
to average interest-bearing liabilities 124.36% 122.50%
--------
(1) Includes nonaccrual loans and loans held for sale, net of discounts
and allowance for loan losses.
(2) Includes FHLB of Atlanta stock.
(3) Represents net interest income divided by the average balance of
interest-earning assets.
(4) Due to immateriality, the interest income and yields related to certain tax
exempt assets have not been adjusted to reflect a fully taxable equivalent
yield.
Provision for Loan Losses. We charge provisions for loan losses to earnings
to maintain the total allowance for loan losses at a level we consider adequate
to provide for probable loan losses, based on existing loan levels and types of
loans outstanding, nonperforming loans, prior loss experience, general economic
conditions and other factors. We estimate the allowance using an allowance for
loan losses model which takes into consideration all of these factors. Our
policies require the review of assets on a regular basis, and we assign risk
grades to loans based on the relative risk of the credit, considering such
factors as repayment experience, value of collateral, guarantors, etc. Our
credit management systems have resulted in low loss experience; however, there
can be no assurances that such experience will continue. We believe we use the
best information available to make a determination with respect to the allowance
for loan losses, recognizing that future adjustments may be necessary depending
upon a change in economic conditions. The provision for loan losses was $60,000
and net charge-offs were $8,000 for the quarter ended June 30, 2003 compared
with a provision of $60,000, and net charge-offs of $0 for the quarter ended
June 30, 2002. Nonperforming loans were $4.5 million at June 30, 2003 and $4.2
million September 30, 2002. The
16
majority of the non-performing loans resulted from two unrelated, unique credits
which are not necessarily indicative of the credit quality of the entire
portfolio. There was no significant impact on the provision for the periods
presented as a result of these loans as these loans are well secured by property
and equipment. The provision for the quarter ended June 30, 2003 reflects the
shift in the loan portfolio to commercial loans which receive higher allocations
in the allowance for loan losses model. The Company made no significant changes
to the allowance for loan losses methodology during the period which impacted
the provision for loan losses.
During the quarters ended June 30, 2003 and 2002 commercial and home equity
loans continued to increase as well as the percentages of these loans to the
total portfolio. Although these loans normally have a relatively short maturity
management believes that there is greater risk inherent in these loans than the
typical one-to-four family residential mortgage loan. Therefore, management
assigns these types of loans a higher risk weighting in the analysis of the loan
loss reserve. The commercial loans that have been originated are loans made to
businesses to either produce a product, sell a product or provide a service.
Many of these loans are asset-based loans which are loans where repayment is
based primarily on the cash flow from operations and secondarily on, the
liquidation of assets such as inventory and accounts receivable.
Other Income. Other income increased $385,000, or 69%, from $558,000 for
the quarter ended June 30, 2002 to $943,000 for the quarter ended June 30, 2003.
Commissions from sales of annuities and mutual funds decreased $31,000, or 23.7%
from $131,000 for the quarter ended June 30, 2002 to $100,000 for the quarter
ended June 30, 2003. This decrease results from lower sales of annuities and
mutual funds. Mortgage banking income, net increased $286,000 from $171,000 for
the quarter ended June 30, 2002 to $457,000 for the quarter ended June 30, 2003
as a result of higher loan sales. Proceeds from the sale of mortgage loans
totaled $24.7 million for the quarter ended June 30, 2003 as compared to $7.2
million for the quarter ended June 30, 2002. The increased loan activity
resulted from heavy mortgage loan refinancing activity which resulted from the
attractive mortgage loan rates available in the marketplace. The Company
recorded gains on the sale of investments of $103,000 for the quarter ended June
30, 2003 which were not present in the prior quarter.
Operating Expenses. Total operating expenses were $2.1 million for the
quarter ended June 30, 2003 and $2.2 million for the quarter ended June 30,
2002. Compensation and related benefits expense decreased $200,000 from $1.5
million for the quarter ended June 30, 2002 to $1.3 million for the quarter
ended June 30, 2003. Compensation and related benefits expense for the quarter
ended June 30, 2002 included $192,000 of expense related to the vesting of the
restricted stock awards which was not present in 2003 as the final vesting date
for the restricted stock awards was June 6, 2002. Occupancy and equipment
expense increased $38,000, or 12.1% from $315,000 for the quarter ended June 30,
2002 to $353,000 for the quarter ended June 30, 2003. This increase was
primarily the result of increased depreciation on new equipment. During the
quarter ended June 30, 2003, the rent receipts on real estate owned properties
exceeded operating expenses by $2,000, compared with $24,000 in the prior year.
Income Tax Expense. Income tax expense increased $20,000 from tax expense
of $542,000 for the quarter ended June 30, 2002 to $562,000 for the quarter
ended June 30, 2003. The effective tax rates were 36.3% and 35.5% for the
quarters ended June 30, 2003 and 2002, respectively. The increase in the
effective rate was primarily due to an increase in non-deductible expenses over
the prior period.
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTHS ENDED JUNE 30, 2003 AND 2002
Net Income. We recorded net income of $3.0 million for the nine months
ended June 30, 2003, an increase of $200,000, or 7.1% over the $2.8 million
reported in the nine months ended June 30, 2002. For the nine months ended June
30, 2003, basic and diluted earnings per share were $1.06 and $1.01,
respectively. The Company reported basic and diluted earnings per share for the
nine months ended June 30, 2002 of $0.91 and $0.87,
17
respectively. The increase in net income resulted primarily from increased other
income and decreased operating expenses. These increases in income were
partially offset by decreased net interest income and increased income taxes.
The decrease in the net interest income resulted from lower net interest
margins. The average prime interest rate for the nine months ended June 30, 2003
was 4.32%, a decrease of 57 basis points from 4.89%, which was the average prime
for the nine months ended June 30, 2002. The rate decrease caused a greater
reduction in the average rate paid on interest-bearing liabilities than the
average yield on earning assets. Basic and diluted earnings per share was
favorably impacted by the Company's stock repurchase plan which was approved in
August 2002.
Net Interest Income. Net interest income, the difference between interest
earned on loans and investments and interest paid on interest-bearing
liabilities, decreased by $266,000 or 2.9% for the nine months ended June 30,
2003, compared to the same nine months in the prior year. This increase reflects
a $2.0 million decrease in interest income that was partially offset by the $1.8
million decrease in total interest expense. The average net interest margin
decreased 10 basis points from 3.69% for the nine months ended June 30, 2002 to
3.59% for the nine months ended June 30, 2003.
Interest Income. The decrease in interest income for the nine months ended
June 30, 2003 was due to a decrease in the yield on interest-earning assets of
80 basis points from 6.17% for the nine months ended June 30, 2002 to 5.37% for
the nine months ended June 30, 2003 as well as a decrease of $1.5 million in
average interest-earning assets compared to the same period in the prior year.
The decreased volume of average interest-earning assets decreased interest
income by approximately $69,000 and the decreased yield decreased interest
income by approximately $2.0 million. Average loans receivable increased $9.8
million for the nine months ended June 30, 2003 compared with the prior year.
This increase was offset in part by a decrease in average investment securities
of $11.2 million and a decrease of $9,000 in average interest bearing overnight
funds.
Interest Expense. Interest expense decreased in the nine months ended June
30, 2003 due to a decrease in average interest-bearing liabilities of $3.4
million and a decrease in the cost of interest-bearing liabilities of 85 basis
points from 3.05% for the nine months ended June 30, 2002 to 2.20% for the nine
months ended June 30, 2003. Average deposits decreased by $2.4 million and
average FHLB advances decreased $1.0 million for the nine months ended June 30,
2003 compared to the same nine months in the prior year. The decrease in average
interest-bearing liabilities decreased interest expense by approximately $79,000
and the decrease in the average cost of interest-bearing liabilities decreased
interest expense by approximately $1.7 million.
18
The following table presents average balances and average rates earned/paid
by the Company for the nine months ended June 30, 2003 compared to the nine
months ended June 30, 2002.
NINE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, 2003 JUNE 30, 2002
DOLLARS IN THOUSANDS
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST YIELD/COST BALANCE INTEREST YIELD/COST
Assets:
Loans receivable (5) $227,694 $9,764 5.72% $217,934 $10,934 6.69%
Investment securities (6) 83,352 3,194 5.11 94,589 3,993 5.63
Interest-bearing overnight deposits 14,088 128 1.21 14,097 191 1.81
-------- ------ ---- -------- ------- ----
Total interest-earning assets (8) 325,134 13,086 5.37 326,620 15,118 6.17
Non interest-earning assets 20,094 22,270
-------- --------
Total assets $345,228 $348,890
======== ========
Liabilities and stockholders' equity
Interest-bearing checking $33,686 101 0.40 $ 31,658 115 0.48
Money market investment accounts 22,649 167 0.98 27,504 288 1.39
Passbook and statement savings 29,784 227 1.01 27,232 316 1.55
Certificates of deposit 155,675 3,005 2.57 157,852 4,530 3.83
FHLB advances 20,718 825 5.31 21,697 842 5.18
-------- ------ ---- -------- ------ ----
Total interest-earning liabilities 262,512 4,325 2.20 265,943 6,091 3.05
Non interest-earning liabilities 20,517 18,176
-------- --------
Total liabilities 283,029 284,119
Stockholders' equity 62,199 64,771
-------- --------
Total liabilities and stockholders' equity $345,228 $348,890
======== ========
Net interest income $8,761 $ 9,027
====== =======
Interest rate spread 3.17% 3.12%
Net interest margin (7) 3.59% 3.69%
Ratio of average interest-earning assets to
average interest-bearing liabilities 123.85% 122.82%
(5) Includes nonaccrual loans and loans held for sale, net of discounts and
allowance for loan losses.
(6) Includes FHLB of Atlanta stock.
(7) Represents net interest income divided by the average balance of
interest-earning assets.
(8) Due to immateriality, the interest income and yields related to certain tax
exempt assets have not been adjusted to reflect a fully taxable equivalent
yield.
Provision for Loan Losses. The provision for loan losses is charged to
earnings to maintain the total allowance for loan losses at a level considered
adequate to absorb estimated probable losses inherent in the loan portfolio
based on existing loan levels and types of loans outstanding, nonperforming
loans, prior loan loss experience, general economic conditions and other
factors. Provisions for loan losses totaled $180,000 for both the nine months
ended June 30, 2003 and 2002. The provision for loan losses in both periods was
impacted by the continued shift in the portfolio to commercial loans which
require a larger allocation of allowance for loan losses.
Other Income. Other income increased $400,000, 18.2%, from $2.2 million for
the nine months ended June 30, 2002 to $2.6 million for the nine months ended
June 30, 2003. Mortgage banking income, net increased $400,000 from $950,000 for
the nine months ended June 30, 2002 to $1.4 million for the nine months ended
June 30, 2003. During the nine months ended June 30, 2003, we sold fixed-rate
mortgage loans held for sale of $73.5 million compared with loan sales of $49.1
million for the nine months ended June 30, 2002. Gains on sales of
19
investment securities of $103,000 were recognized during the nine months ended
June 30, 2003 while gains on sales of investment securities of $47,000 were
recognized during the nine months ended June 30, 2002. The non-interest income
recognized in fiscal 2003 was positively impacted by the relatively low interest
rates which increased the mortgage banking income and gains on investments over
the prior year.
Operating Expenses. Total operating expenses were $6.5 million for the nine
months ended June 30, 2003, a decrease of $200,000, or 3.0% from the $6.7
million recorded for the nine months ended June 30, 2002. Compensation and
related benefits expense decreased $500,000, or 10.6% from $4.7 million for the
nine months ended June 30, 2002 to $4.2 million for the nine months ended June
30, 2003. Compensation and related benefits for the nine months ended June 30,
2002 included $712,000 of expense related to the vesting of restricted stock
awards which was not present in 2003 as the final vesting date for the
restricted stock awards was June 6, 2002. Partially offsetting this decrease was
increased personnel expense related to the increased number of employees and
increased salary and benefit costs. The Company recognized income from real
estate operations of $56,000 during the nine months ended June 30, 2002 compared
to expenses of $7,000 in the nine months ended June 30, 2003.
Income Tax Expense. Income tax expense increased $100,000 from tax expense
of $1.6 million for the nine months ended June 30, 2002 to $1.7 million for the
nine months ended June 30, 2003. The increase resulted from a $348,000 increase
in income before income taxes. The effective tax rates were 36.7% and 36.5% for
the nine months ended June 30, 2003 and 2002, respectively.
COMMITMENTS, CONTINGENCIES AND OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet risk
including commitments to extend credit under existing lines of credit and
commitments to sell loans. These instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the consolidated balance sheets.
Off-balance sheet financial instruments whose contract amount represents
credit and interest rate risk are summarized as follows:
June 30, 2003 September 30, 2002
------------- ------------------
(dollars in thousands)
Commitments to originate new loans $ 1,421 $ 1,435
Commitments to originate new loans held for sale 881 --
Unfunded commitments to extend credit under existing
equity line and commercial lines of credit 56,060 56,200
Commercial letters of credit 276 266
Commitments to sell loans held for sale 20,169 16,371
The Company does not have any special purpose entities or other similar
forms of off-balance sheet financing arrangements.
Commitments to originate new loans or to extend credit are agreements to
lend to a customer as long as there is no violation of any condition established
in the contract. Loan commitments generally expire within 30 to 45 days. Most
equity line commitments are for a term of 15 years, and commercial lines of
credit are generally renewable on an annual basis. Commitments generally have
fixed expiration dates or other termination clauses and may require payment of a
fee. Since many of the commitments are expected to expire without being drawn
upon, the total commitment amounts do not necessarily represent future cash
requirements. The Company evaluates each customer's creditworthiness on a
case-by-case basis. The amounts of collateral obtained, if deemed necessary by
the Company upon extension of credit, is based on management's credit evaluation
of the borrower.
Commitments to sell loans held for sale are agreements to sell loans to a
third party at an agreed upon price. At June 30, 2003, the agreed-upon price of
these commitments exceeded the book value of the loans to be sold. The fair
value of these commitments at June 30, 2003 was not considered material.
20
CONTRACTUAL OBLIGATIONS
As of June 30, 2003
Payments due by period
----------------------
(Dollars in thousands)
----------------------
Less than
1 year 1-3 years 4-5 years Over 5 years Total
----------------- --------- --------- ------------ -----
Deposits $ 229,410 20,883 9,918 -- 260,211
Long-term borrowings -- -- 20,000 -- 20,000
Lease obligations 19 56 42 38 155
-------------- ------ ------ ------ -------
Total contractual cash
obligations $ 229,429 20,939 29,960 38 280,366
============== ====== ====== ====== =======
ASSET QUALITY
At June 30, 2003, we had approximately $4.6 million in non-performing
assets (nonaccrual loans and real estate owned) or 1.30% of total assets. At
September 30, 2002, non-performing assets were $4.4 million or 1.25% of total
assets. At June 30, 2003 and September 30, 2002, impaired loans totaled $3.8
million and $3.7 million, respectively, as defined by Statement of Financial
Accounting Standards No. 114, "Accounting by Creditors for Impairment of a
Loan." The impaired loans at June 30, 2003 result from three unrelated
commercial loan customers, all of which have loans secured by commercial real
estate and business assets in Alamance County. At June 30, 2003, the entire $3.8
million of the impaired loans were on non-accrual status, and their related
reserve for loan losses totaled $210,000. The average carrying value of impaired
loans was $3.8 million and $3.7 million during the three and nine months ended
June 30, 2003, respectively. Interest income of $42,000 and $159,000 has been
recorded on impaired loans on a cash basis in the three and nine months ended
June 30, 2003, respectively. The Bank's net charge-offs for the three and nine
months ended June 30, 2003 were $8,000 and $10,000, respectively. The Bank's
allowance for loan losses was $3.9 million at June 30, 2003 compared with $3.7
million at September 30, 2002 and $3.7 million at June 30, 2002. As a result of
our continued , gradual shift toward commercial, construction, consumer and home
equity loans, the recent decrease in residential mortgage loans, the modest
increase in non-performing loans as a percentage of total loans as well as the
continued decline in the local and regional economy, the ratio of the allowance
for loan losses to total loans, net of loans in process and deferred loan fees
increased to 1.71% at June 30, 2003 compared to 1.67% at September 30, 2002.
The following table presents an analysis of our nonperforming assets:
(Dollars in thousands)
At At At
June 30, September 30, June 30,
2003 2002 2002
---- ---- ----
Nonperforming loans:
Nonaccrual loans $4,501 $ 4,204 $ 3,728
Loans 90 days past due and accruing -- -- --
Restructured loans -- -- --
------ -------- --------
Total nonperforming loans 4,501
4,204 3,728
Other real estate 80 183 2,226
------ -------- --------
Total nonperforming assets $4,581 $ 4,387 $ 5,954
====== ======== ========
Nonperforming loans to loans receivable, net 2.01% 1.91% 1.73%
Nonperforming assets as a percentage
of loans and other real estate owned 2.05% 1.99% 2.74%
Nonperforming assets to total assets 1.29% 1.25% 1.69%
21
Regulations require that we classify our assets on a regular basis. There
are three classifications for problem assets: substandard, doubtful and loss. We
regularly review our assets to determine whether any assets require
classification or re-classification. At June 30, 2003, we had $5.0 million in
classified assets consisting of $4.9 million in substandard and loss loans and
$80,000 in real estate owned. At September 30, 2002, we had $5.1 million in
substandard assets consisting of $4.9 million in loans and $183,000 million in
real estate owned.
In addition to regulatory classifications, we also classify as "special
mention" and "watch" assets that are currently performing in accordance with
their contractual terms but may become classified or nonperforming assets in the
future. At June 30, 2003, we have identified approximately $1.1 million in
assets classified as special mention and $36.5 million as watch. Included in the
watch asset total are six loans with an aggregate outstanding balance of $4.5
million at June 30, 2003 to entities affiliated with one of our directors. In
addition, the director has the ability to borrow an additional $403,000 from us
under line of credits. All the loans are secured by a first lien on all company
assets, including accounts receivable, inventory, equipment, furniture and real
property occupied by the borrower. In addition, the director has personally
guaranteed repayment of the loans. At June 30, 2003, such loans were current
with respect to their payment terms and were performing in accordance with the
related loan agreements. Based on an analysis of the borrower's current
financial statements received in July 2003, management has concerns that the
borrower may have difficulty in complying with the present loan repayment terms
on an ongoing basis. Accordingly, these loans may become a nonperforming asset
in future periods. Management will continue to closely monitor the performance
of these loans in future periods.
LIQUIDITY AND CAPITAL RESOURCES
The Bank must meet certain liquidity requirements established by the State
of North Carolina Office of the Commissioner of Banks (the "Commissioner"). At
June 30, 2003, the Bank's liquidity ratio exceeded such requirements. 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 loan commitments, maintain adequate
reserve requirements, pay operating expenses, provide funds for debt service,
pay dividends to stockholders and meet other general commitments.
Our primary sources of funds are deposits, principal and interest payments
on loans, proceeds from the sale of loans, and to a lesser extent, advances from
the FHLB of Atlanta. While maturities and scheduled amortization of loans are
predictable sources of funds, deposit flows and mortgage prepayments are greatly
influenced by general interest rates, economic conditions and local competition.
Our most liquid assets are cash and cash equivalents. The levels of these
assets are dependent on our operating, financing, lending and investing
activities during any given period. At June 30, 2003, cash and cash equivalents
totaled $32.0 million. We have other sources of liquidity should we need
additional funds. During the three and nine months ended June 30, 2003, we sold
loans totaling $24.7 million and $73.5 million, respectively. Additional sources
of funds include FHLB of Atlanta advances. Other sources of liquidity include
loans and investment securities designated as available for sale, which totaled
$70.2 million at June 30, 2003.
We anticipate that we will have sufficient funds available to meet our
current commitments. At June 30, 2003, we had $2.3 million in commitments to
originate new loans, $53.9 million in unfunded commitments to extend credit
under existing equity lines and commercial lines of credit and $276,000 in
standby letters of credit. At June 30, 2003, certificates of deposit, which are
scheduled to mature within one year, totaled $125.3 million. We believe that a
significant portion of such deposits will remain with us.
The FDIC requires the Bank to meet a minimum leverage capital requirement
of Tier I capital 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 4% must be in
the form of Tier I capital. The Commissioner requires the Bank at all times to
maintain certain minimum capital levels. The Bank was in compliance with all
capital requirements of the FDIC and the Commissioner at June 30, 2003 and is
deemed to be "well capitalized."
22
The Federal Reserve also mandates capital requirements on all bank holding
companies, including 1st State Bancorp, Inc. These capital requirements are
similar to those imposed by the FDIC on the Bank. At June 30, 2003, the Company
was in compliance with the capital requirements of the Federal Reserve.
On October 2, 2000, the Company paid a one-time special cash distribution
of $5.17 per share to its stockholders. The distribution was made to manage the
Company's capital and enhance shareholder value. Returning capital to the
stockholders reduced the Company's equity to asset ratio from 21.2% to 17.2%.
The Company's equity to asset ratio at June 30, 2003 was 17.8%. The Company's
capital level is sufficient to support future growth.
The Company has declared cash dividends per common share of $0.10, $0.08
and $0.08 for each of the three months ended June 30, 2003, September 30, 2002
and June 30, 2002, respectively. The Company's ability to pay dividends is
dependent upon earnings. The Company's dividend payout ratio for the three
months ended June 30, 2003, September 30, 2002 and June 30, 2002 was 29.4%,
26.4% and 25.8%, respectively.
ACCOUNTING MATTERS
On October 3, 2001, the FASB issued Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" (SFAS No. 144), which addresses financial accounting and reporting for
the impairment or disposal of long-lived assets. While SFAS No. 144 supercedes
SFAS No. 121 ("Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of"), it retains many of the fundamental
provisions of SFAS No. 121. SFAS No. 144 also supersedes the accounting and
reporting provisions of Accounting Principles Board Opinion No. 30 (Reporting
the Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions) for the disposal of a segment of a business. However, it retains
the requirement in Opinion No. 30 to report separately discontinued operations
and extends the reporting to a component of an entity that either has been
disposed of (by sale, abandonment, or in a distribution to owners) or is
classified as held for sale. The provisions of SFAS No. 144 are effective for
financial statements issued for fiscal years beginning after December 15, 2001,
and interim periods within those fiscal years. Adoption of SFAS No. 144 on
October 1, 2002 did not have a material impact on the Company's consolidated
financial statements.
In June 2002, the FASB issued Statement of Financial Accounting Standards
No. 146 (SFAS No. 146), "Accounting for Costs Associated with Exit or Disposal
Activities," which addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." This Statement applies to costs associated
with an exit activity that does not involve an entity newly acquired in a
business combination or with a disposal activity covered by SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets." Those costs
include, but are not limited to, the following: a) termination benefits provided
to current employees that are involuntarily terminated under the terms of a
benefit arrangement that, in substance, is not an ongoing benefit arrangement or
an individual deferred compensation contract (hereinafter referred to as
one-time termination benefits), b) costs to terminate a contract that is not a
capital lease and c) costs to consolidate facilities or relocate employees. This
Statement does not apply to costs associated with the retirement of a long-lived
asset covered by FASB Statement No. 143, "Accounting for Asset Retirement
Obligations." A liability for a cost associated with an exit or disposal
activity shall be recognized and measured initially at its fair value in the
period in which the liability is incurred. A liability for a cost associated
with an exit or disposal activity is incurred when the definition of a liability
is met. The provisions of this Statement are effective for exit or disposal
activities that are initiated after December 31, 2002, with early application
encouraged. This statement will impact the Company to the extent it engages in
exit or disposal activities in future periods.
In November 2002, the FASB issued Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others", which addresses the disclosure
to be made by a guarantor in its interim and annual financial statements about
its obligations under guarantees. FIN 45 requires the guarantor to recognize a
liability for the non-contingent component of the guarantee, such as the
obligation to stand ready to perform in the event that specified triggering
events or conditions occur. The
23
initial measurement of this liability is the fair value of the guarantee at
inception. The recognition of the liability is required even if it is not
probable that payments will be required under the guarantee or if the guarantee
was issued with a premium payment or as part of a transaction with multiple
events. The disclosure requirements are effective for interim and annual
financial statements ending after December 15, 2002. The initial recognition and
measurement provisions are effective for all guarantees within the scope of FIN
45 issued or modified after December 31, 2002. The Company issues standby
letters of credit whereby the Company guarantees performance if a specified
triggering event or condition occurs (primarily nonperformance under
construction contracts entered into by construction customers.) The guarantees
generally expire within one year and may be automatically renewed depending on
the terms of the guarantee. The maximum potential amount of undiscounted future
payments related to standby letters of credit at June 30, 2003 is $276,000. At
June 30, 2003, the Company has recorded no liability for the current carrying
amount of the obligation to perform as a guarantor and no contingent liability
is considered necessary, as such amounts are deemed immaterial. Substantially
all standby letters of credit are secured by real estate and/or guaranteed by
third parties in the event the Company had to advance funds to fulfill the
guarantee.
In December 2002, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure' (SFAS 148) an amendment of FASB
Statement No. 123, Accounting for Stock-Based Compensation (SFAS 123), which
provides alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The transition provisions of the statement are
effective for financial statements for fiscal years ending after December 15,
2002 while the disclosure requirements are effective for interim periods
beginning after December 15, 2002, with early application encouraged. The
adoption of SFAS 148 have resulted in enhanced disclosures for the Company's
stock-based employee compensation plan effective January 1, 2003.
In April 2003, the FASB issued Statement of Financial Accounting Standards
No. 149 (SFAS No. 149), "Amendment of Statement 133 on Derivative Instruments
and Hedging Activities," which amends and clarifies financial accounting and
reporting for derivative instruments and for hedging activities under Statement
of Financial Accounting Standards No. 133 (SFAS No. 133). This statement
clarifies when a contract with an initial net investment meets the
characteristic of a derivative, clarifies when a derivative instrument contains
a financing component, amends the definition of an underlying to conform it to
language used in Financial Accounting Standards Board Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others", and amends certain other
existing pronouncements. This Statement requires that contracts with comparable
characteristics be accounted for similarly. This Statement is effective for most
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. For contracts with forward
purchases or sales of TBA-type securities or other securities that do not yet
exist, this Statement is effective for both existing contracts and new contracts
entered into after June 30, 2003. All provisions of this Statement should be
applied prospectively. Adoption of SFAS No. 149 on July 1, 2003 did not have a
material effect on the Company's consolidated financial statements.
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150 (SFAS No. 150), "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity", which establishes standards for
how an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability (or an
asset in some circumstances). This Statement is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. It is to be implemented by reporting the cumulative effect of a change in
accounting principle for financial instruments created before the issuance date
of the Statement and still existing at the beginning of the interim period of
adoption. Adoption of SFAS No. 150 on July 1, 2003 did not have a material
effect on the Company's consolidated financial statements.
24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the possible chance of loss from unfavorable changes in
market prices and rates. These changes may result in a reduction of current and
future period net interest income, which is the favorable spread earned from the
excess of interest income on interest-earning assets over interest expense on
interest-bearing liabilities.
The Company considers interest rate risk to be its most significant market
risk, which could potentially have the greatest impact on operating earnings.
The structure of the Company's loan and deposit portfolios is such that a
significant decline in interest rates may adversely impact net market values and
net interest income.
The Company monitors whether material changes in market risk have occurred
since September 30, 2002. The Company does not believe that any material adverse
changes in market risk exposures occurred since September 30, 2002.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, management of the
Company carried out an evaluation, under the supervision and with the
participation of the Company's principal executive officer and principal
financial officer, of the effectiveness of the Company's disclosure controls and
procedures. Based on this evaluation, the Company's principal executive officer
and principal financial officer concluded that the Company's disclosure controls
and procedures are effective in ensuring that information required to be
disclosed by the Company in reports that it files or submits under the
Securities Exchange Act of 1934, as amended, is recorded, processed, summarized
and reported, within the time periods specified in the Securities and Exchange
Commission's rules and forms. It should be noted that the design of the
Company's disclosure controls and procedures is based in part upon certain
reasonable assumptions about the likelihood of future events, and there can be
no reasonable assurance that any design of disclosure controls and procedures
will succeed in achieving its stated goals under all potential future
conditions, regardless of how remote, but the Company's principal executive and
financial officers have concluded that the Company's disclosure controls and
procedures are, in fact, effective at a reasonable assurance level.
In addition, there have been no changes in the Company's internal control
over financial reporting identified in connection with the evaluation described
in the above paragraph that occurred during the Company's last fiscal quarter,
that has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
25
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a.) Exhibits.
--------
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
32 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
(b.) Reports on Form 8-K.
-------------------
The Registrant filed the following Current Reports on Form 8-K during the
quarter ended June 30, 2003:
DATE OF REPORT ITEM(S) REPORTED FINANCIAL STATEMENTS FILED
-------------- ---------------- --------------------------
January 28, 2003 7, 12 N/A
26
SIGNATURES
Pursuant to the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
1st STATE BANCORP, INC.
Date: August 14, 2003 /s/James C. McGill
--------------------------------------------
James C. McGill
President and Chief Executive Officer
(Principal Executive Officer)
Date: August 14, 2003 /s/A. Christine Baker
--------------------------------------------
A. Christine Baker
Executive Vice President
Treasurer and Secretary
(Principal Financial and Accounting Officer)
27