UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
| x | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended September 30, 2005
| ¨ | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE TRANSITION PERIOD FROM TO
Commission File Number 000-32951
CRESCENT FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
| NORTH CAROLINA | 56-2259050 | |
| (State or other jurisdiction of Incorporation or organization) |
(IRS Employer Identification Number) |
1005 HIGH HOUSE ROAD, CARY, NORTH CAROLINA
27513
(Address of principal executive offices)
(Zip Code)
(919) 460-7770
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
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
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.
Common Stock, $1.00 par value
4,975,694 shares outstanding as of November 5, 2005
| Page No. | ||||
| FINANCIAL INFORMATION |
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| Item 1 - |
Financial Statements (Unaudited) |
|||
| Consolidated Balance Sheets September 30, 2005 (unaudited) and December 31, 2004 |
3 | |||
| 4 | ||||
| Consolidated Statements of Cash Flows Nine Months Ended September 30, 2005 and 2004 (unaudited) |
5 | |||
| 6 - 8 | ||||
| Item 2 - |
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
9 – 27 | ||
| Item 3 - |
28 | |||
| Item 4 - |
28 | |||
| Part II. |
Other Information |
|||
| 29 | ||||
| Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds |
29 | |||
| 29 | ||||
| Item 4 – Submission of Matters to a Vote of Security Holders |
29 | |||
| 29 | ||||
| 29 | ||||
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Part I. FINANCIAL INFORMATION
Item 1 - Financial Statements
CRESCENT FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
| Sept 30, 2005 (Unaudited) |
December 31, 2004* |
|||||||
| ASSETS |
||||||||
| Cash and due from banks |
$ | 12,176,001 | $ | 5,633,865 | ||||
| Interest earning deposits with banks |
592,829 | 43,353 | ||||||
| Investment securities available for sale at fair value |
53,154,869 | 53,444,322 | ||||||
| Loans |
322,191,581 | 257,461,327 | ||||||
| Allowance for loan losses |
(4,293,000 | ) | (3,668,000 | ) | ||||
| NET LOANS |
317,898,581 | 253,793,327 | ||||||
| Interest receivable |
1,560,880 | 1,218,572 | ||||||
| FHLB Stock |
2,956,900 | 1,447,200 | ||||||
| Bank premises and equipment |
3,936,264 | 3,030,184 | ||||||
| Investment in life insurance |
5,433,715 | 5,283,263 | ||||||
| Goodwill |
3,600,298 | 3,600,298 | ||||||
| Other assets |
3,715,229 | 3,732,814 | ||||||
| TOTAL ASSETS |
$ | 405,025,566 | $ | 331,227,198 | ||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY |
||||||||
| LIABILITIES |
||||||||
| Deposits |
||||||||
| Demand |
$ | 52,920,145 | $ | 42,818,455 | ||||
| Savings |
7,072,052 | 3,036,774 | ||||||
| Money market and NOW |
82,636,058 | 74,113,646 | ||||||
| Time |
170,120,411 | 153,679,946 | ||||||
| TOTAL DEPOSITS |
312,748,666 | 273,648,821 | ||||||
| Short-term borrowings |
31,313,552 | 1,307,105 | ||||||
| Long-term debt |
30,248,000 | 28,248,000 | ||||||
| Accrued expenses and other liabilities |
1,536,829 | 1,245,858 | ||||||
| Commitments (Note B) |
||||||||
| TOTAL LIABILITIES |
375,847,047 | 304,449,784 | ||||||
| STOCKHOLDERS’ EQUITY |
||||||||
| Preferred stock, no par value, 5,000,000 shares authorized, none outstanding; |
— | — | ||||||
| Common stock, $1 par value, 20,000,000 shares authorized; |
||||||||
| 4,170,494 shares outstanding September 30, 2005; |
||||||||
| 3,566,889 shares outstanding December 31, 2004 |
4,170,494 | 3,566,889 | ||||||
| Additional paid-in capital |
18,573,456 | 18,654,492 | ||||||
| Retained earnings |
6,702,176 | 4,562,681 | ||||||
| Accumulated other comprehensive loss (Note D) |
(267,607 | ) | (6,648 | ) | ||||
| TOTAL STOCKHOLDERS’ EQUITY |
29,178,519 | 26,777,414 | ||||||
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY |
$ | 405,025,566 | $ | 331,227,198 | ||||
| * | Derived from audited consolidated financial statements. |
See accompanying notes
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CRESCENT FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three and Nine Months Ended September 30, 2005 and 2004
| Three-month Periods Ended September 30, |
Nine-month Periods Ended September 30, | |||||||||||
| 2005 |
2004 |
2005 |
2004 | |||||||||
| INTEREST INCOME |
||||||||||||
| Loans |
$ | 5,466,322 | $ | 3,599,096 | $ | 14,466,577 | $ | 10,097,111 | ||||
| Investment securities available for sale |
576,234 | 460,983 | 1,711,582 | 1,291,466 | ||||||||
| Fed funds sold and interest-bearing deposits |
16,588 | 11,031 | 39,382 | 28,746 | ||||||||
| TOTAL INTEREST INCOME |
6,059,144 | 4,071,110 | 16,217,541 | 11,417,323 | ||||||||
| INTEREST EXPENSE |
||||||||||||
| Deposits |
1,841,363 | 1,135,110 | 4,807,498 | 3,179,125 | ||||||||
| Short-term borrowings |
200,601 | 17,799 | 263,537 | 39,150 | ||||||||
| Long-term debt |
369,357 | 248,699 | 1,130,152 | 691,639 | ||||||||
| TOTAL INTEREST EXPENSE |
2,411,321 | 1,401,608 | 6,201,187 | 3,909,914 | ||||||||
| NET INTEREST INCOME |
3,647,823 | 2,669,502 | 10,016,354 | 7,507,409 | ||||||||
| PROVISION FOR LOAN LOSSES |
240,112 | 197,522 | 746,666 | 581,687 | ||||||||
| NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES |
3,407,711 | 2,471,980 | 9,269,688 | 6,925,722 | ||||||||
| NON INTEREST INCOME |
614,331 | 713,952 | 1,742,039 | 1,790,384 | ||||||||
| NON INTEREST EXPENSES |
||||||||||||
| Salaries and employee benefits |
1,509,207 | 1,124,558 | 4,181,421 | 3,233,569 | ||||||||
| Occupancy and equipment |
443,255 | 413,924 | 1,274,613 | 1,123,805 | ||||||||
| Data processing |
161,889 | 142,022 | 477,514 | 401,702 | ||||||||
| Other |
603,411 | 503,512 | 1,821,784 | 1,496,250 | ||||||||
| TOTAL NON-INTEREST EXPENSES |
2,717,762 | 2,184,016 | 7,755,332 | 6,255,326 | ||||||||
| INCOME BEFORE INCOME TAXES |
1,304,280 | 1,001,916 | 3,256,395 | 2,460,780 | ||||||||
| INCOME TAXES |
459,000 | 340,600 | 1,116,900 | 817,200 | ||||||||
| NET INCOME |
$ | 845,280 | $ | 661,316 | $ | 2,139,495 | $ | 1,643,580 | ||||
| NET INCOME PER COMMON SHARE |
||||||||||||
| Basic |
$ | 0.20 | $ | 0.16 | $ | 0.52 | $ | 0.41 | ||||
| Diluted |
$ | 0.19 | $ | 0.15 | $ | 0.49 | $ | 0.38 | ||||
| WEIGHTED AVERAGE COMMON SHARES OUTSTANDING |
||||||||||||
| Basic |
4,142,454 | 4,085,351 | 4,121,073 | 4,057,080 | ||||||||
| Diluted |
4,384,392 | 4,293,547 | 4,365,031 | 4,280,140 | ||||||||
See accompanying notes
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CRESCENT FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Nine Months Ended September 30, 2005 and 2004
| 2005 |
2004 |
|||||||
| CASH FLOWS FROM OPERATING ACTIVITIES |
||||||||
| Net income |
$ | 2,139,495 | $ | 1,643,580 | ||||
| Adjustments to reconcile net income to net cash provided cash provided by operating activities: |
||||||||
| Depreciation |
453,315 | 401,844 | ||||||
| Provision for loan losses |
746,666 | 581,687 | ||||||
| (Gain) loss on sale of securities |
16,422 | (57 | ) | |||||
| (Gain) loss on sale of assets |
9,564 | (8,365 | ) | |||||
| Net amortization of premiums on securities |
66,513 | 78,013 | ||||||
| Increase in cash value of life insurance |
(150,452 | ) | (162,177 | ) | ||||
| Change in assets and liabilities: |
||||||||
| Increase in accrued interest receivable |
(342,308 | ) | (159,015 | ) | ||||
| Increase in other assets |
(1,327,660 | ) | (552,081 | ) | ||||
| Increase (decrease) in accrued interest payable |
203,229 | (19,574 | ) | |||||
| Increase (decrease) in other liabilities |
902,741 | (223,926 | ) | |||||
| Payment of income taxes |
(815,000 | ) | (133,000 | ) | ||||
| TOTAL ADJUSTMENTS |
(236,972 | ) | (196,651 | ) | ||||
| NET CASH PROVIDED BY OPERATING ACTIVITIES |
1,902,525 | 1,446,929 | ||||||
| CASH FLOWS FROM INVESTING ACTIVITIES |
||||||||
| Purchases of securities available for sale |
(8,790,967 | ) | (22,229,562 | ) | ||||
| Proceeds from disposals of securities available for sale |
3,845,156 | 5,848,357 | ||||||
| Maturities of available for sale securities |
— | 1,645,000 | ||||||
| Principal repayments of securities available for sale |
4,726,917 | 4,790,015 | ||||||
| Net increases in loans |
(64,851,920 | ) | (37,393,747 | ) | ||||
| Purchases of premises and equipment |
(1,368,958 | ) | (720,306 | ) | ||||
| NET CASH USED BY INVESTING ACTIVITIES |
(66,439,772 | ) | (48,060,243 | ) | ||||
| CASH FLOWS FROM FINANCING ACTIVITIES |
||||||||
| Net increase in deposits |
||||||||
| Non-interest bearing |
10,101,690 | 9,029,859 | ||||||
| Savings |
4,035,277 | 827,505 | ||||||
| Money market and NOW |
8,522,413 | 10,050,342 | ||||||
| Time Deposits |
16,440,465 | 36,191,118 | ||||||
| Net increase (decrease) in short-term borrowings |
30,006,447 | (8,443,097 | ) | |||||
| Net increase in long-term debt |
2,000,000 | 8,000,000 | ||||||
| Proceeds from stock options exercised |
522,567 | 412,446 | ||||||
| NET CASH PROVIDED BY FINANCING ACTIVITIES |
71,628,859 | 56,068,173 | ||||||
| NET INCREASE IN CASH AND CASH EQUIVALENTS |
7,091,612 | 9,454,859 | ||||||
| CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD |
5,677,218 | 7,051,157 | ||||||
| CASH AND CASH EQUIVALENTS, END OF PERIOD |
$ | 12,768,830 | $ | 16,506,016 | ||||
See accompanying notes.
- 5 -
CRESCENT FINANCIAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
NOTE A - BASIS OF PRESENTATION
In management’s opinion, the financial information, which is unaudited, reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of and for the three and nine-month periods ended September 30, 2005 and 2004, in conformity with accounting principles generally accepted in the United States of America. The financial statements include the accounts of Crescent Financial Corporation (the “Company”) and its wholly owned subsidiary, Crescent State Bank (the “Bank”). All significant inter-company transactions and balances are eliminated in consolidation. Operating results for the three and nine-month periods ended September 30, 2005 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2005.
The organization and business of the Company, accounting policies followed by the Company and other information are contained in the notes to the consolidated financial statements filed as part of the Company’s 2004 annual report on Form 10-KSB. This quarterly report should be read in conjunction with such annual report.
NOTE B – COMMITMENTS
At September 30, 2005, commitments are as follows
| Undisbursed lines of credit |
$ | 81,134,000 | |
| Stand-by letters of credit |
2,610,000 | ||
| Undisbursed commitment to purchase additional investment in Small Business Investment Corporation |
250,000 |
NOTE C – PER SHARE RESULTS
The Company effected a stock split in the form of a 15% stock dividend paid on April 27, 2005 to stockholders of record April 14, 2005. Share and per share data for the periods presented have been adjusted to reflect the effects of the stock split. Basic and diluted net income per common share have been computed by dividing net income for each period by the weighted average number of shares of common stock outstanding during each period after retroactively adjusting for this stock split.
Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the company relate solely to outstanding stock options and are determined using the treasury stock method.
- 6 -
CRESCENT FINANCIAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
| Three months ended September 30, |
Nine months ended September 30, | |||||||
| 2005 |
2004 |
2005 |
2004 | |||||
| Weighted average number of shares used in computing basic net income per share |
4,142,454 | 4,085,351 | 4,121,073 | 4,057,080 | ||||
| Effect of dilutive stock options |
241,938 | 208,196 | 243,958 | 223,060 | ||||
| Weighted average number of shares used in computing diluted net income per share |
4,384,392 | 4,293,547 | 4,365,031 | 4,280,140 | ||||
For the three-month period ended September 30, 2005 there were no options that were anti-dilutive. For the nine-month period ended September 30, 2005 there were 3,132 options that were anti-dilutive. There were 6,325 and 4,409 options that were anti-dilutive for the three and nine-month periods ended September 30, 2004, respectively.
NOTE D – COMPREHENSIVE INCOME
For the three months ended September 30, 2005 and 2004, total comprehensive income or (loss), consisting of net income and unrealized securities gains and losses, net of taxes, was $631,280 and $1,393,000, respectively.
For the nine months ended September 30, 2005 and 2004, total comprehensive income or (loss), consisting of net income and unrealized securities gains and losses, net of taxes, was $1,879,000 and $1,247,000, respectively.
NOTE E – STOCK COMPENSATION PLANS
In December 2004, the FASB issued SFAS No. 123(R), Accounting for Stock-Based Compensation (SFAS No. 123(R)). SFAS No. 123(R) establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123(R) requires that the fair value of such equity instruments be recognized as an expense in the historical financial statements as services are performed. Prior to SFAS No. 123(R), only certain pro forma disclosures of fair value were required. For the Company the provisions of this Statement are effective for the first interim reporting period that begins after December 15, 2005. Accordingly, we will adopt SFAS No. 123(R) commencing with the quarter ending March 31, 2006.
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CRESCENT FINANCIAL CORPORATION AND SUBSIDIARY
Notes to Consolidated Financial Statements
Presented below are the pro forma disclosures of net income and earnings per share and other disclosures as if the fair value based method of accounting had been applied.
| Three Months Ended September 30, |
Nine Months Ended September 30, | |||||||||||
| 2005 |
2004 |
2005 |
2004 | |||||||||
| (Amounts in thousands, except per share data) | ||||||||||||
| Net income: |
||||||||||||
| As reported |
$ | 845 | $ | 661 | $ | 2,139 | $ | 1,644 | ||||
| Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects |
22 | 18 | 64 | 57 | ||||||||
| Pro forma |
$ | 823 | $ | 643 | $ | 2,075 | $ | 1,587 | ||||
| Basic earnings per share: |
||||||||||||
| As reported |
$ | .20 | $ | .16 | $ | .52 | $ | .41 | ||||
| Pro forma |
.20 | .16 | .50 | .39 | ||||||||
| Diluted earnings per share: |
||||||||||||
| As reported |
$ | .19 | $ | .15 | $ | .49 | $ | .38 | ||||
| Pro forma |
.19 | .15 | .48 | .37 | ||||||||
NOTE F – SUBSEQUENT EVENTS
On October 27, 2005, the Company entered into an underwriting agreement with Ryan Beck & Co., Inc. for the sale of 805,000 shares of common stock at a price of $15.00 per share. The shares sold by the Company are expected to raise net proceeds of approximately $11.1 million after offering expenses and underwriting commissions. The underwriter for the offering was granted an option, exercisable for a period of 30 days, to purchase up to an additional 120,750 shares of common stock to cover over-allotments, if any. The offering proceeds will be used for general corporate purposes and to fund continued growth and expansion of the franchise.
The offering was made pursuant to a registration statement originally filed with the Securities and Exchange Commission on September 12, 2005.
- 8 -
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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, 2005 and 2004. It should be read in conjunction with the audited consolidated financial statements 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.
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2005 AND
DECEMBER 31, 2004
Total assets at September 30, 2005 were $405.0 million compared with $331.2 million at December 31, 2004. Earning assets represented 94% of total assets as of both dates and totaled $378.9 million at September 30, 2005 compared with $312.4 million at December 31, 2004. Components of earning assets at September 30, 2005 are $322.2 million in gross loans, $56.1 million in investment securities and Federal Home Loan Bank (FHLB) stock and $593,000 in interest bearing deposits with correspondent banks. Earning assets at December 31, 2004 included $257.5 million in gross loans, $54.9 million in investment securities and FHLB stock and $43,000 in overnight investments. Total deposits and stockholders’ equity at September 30, 2005 were $312.7 million and $29.2 million, respectively, compared to $273.6 million and $26.8 million at December 31, 2004.
Gross loans outstanding at September 30, 2005 increased by $64.7 million or 25% to $322.2 million compared to $257.5 million reported at December 31, 2004. The composition of the loan portfolio, by category, as of September 30, 2005 is 52% commercial mortgage loans, 18% commercial loans, 13% construction loans, 11% home equity loans and lines, 4% residential mortgage loans and 2% consumer loans. The commercial mortgage category showed the most growth increasing $47.1 million from $121.5 million at December 31, 2004 to $168.6 million at September 30, 2005. Construction and development loans experienced a net increase of $4.8 million, growing from $38.8 million at year end to $43.6 million at September 30, 2005. The commercial loan portfolio increased by $7.9 million from $48.7 million at year-end 2004 to $56.6 million at September 30, 2005. Home equity loans and lines increased by $2.0 million during the first nine months of 2005 from $31.0 million at December 31, 2004 to $33.0 million at September 30, 2005. Residential mortgage loans grew $2.8 million from $11.6 million to $14.4 million. The consumer loan portfolio increased by $140,000 during the nine-month period. The composition of the loan portfolio, by category, as of December 31, 2004 was 47% commercial mortgage loans, 19% commercial loans, 15% construction loans, 12% home equity loans and lines, 5% residential real estate mortgage loans and 2% consumer loans.
The Company had an allowance for loan losses at September 30, 2005 of $4.3 million or 1.33% of total outstanding loans compared to $3.7 million or 1.42% of total outstanding loans at December 31, 2004. At September 30, 2005, there were five loans totaling $222,000 in non- accrual status. There were no loans past due 90 days or more and still accruing interest at
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September 30, 2005. Non-performing loans as a percentage of total loans at September 30, 2005 were less than 0.07%. There were two loans totaling $5,000 in non accrual status at December 31, 2004. There were no loans past due 90 days or more and still accruing interest at December 31, 2004. Non-performing loans as a percentage of total loans at December 31, 2004 were less than 0.01%. For a more detailed discussion, see the section entitled Non-Performing Assets.
The Company has investment securities with an amortized cost of $53.6 million at September 30, 2005. All investments are accounted for as available for sale under Financial Accounting Standards Board (FASB) No. 115 and are presented at their fair market value of $53.2 million compared with $53.4 million at year-end 2004. The Company’s investment in debt securities at September 30, 2005, consists of U.S. Government agency securities, collateralized mortgage obligations, mortgage-backed securities, municipal bonds and trust preferred securities. The increase during the first nine months of 2005 was the net result of $8.8 million in new purchases less $4.7 million in principal re-payments, $3.8 million in proceeds on the sale of securities, a $16,000 gain on the sale of those securities, a $425,000 decline in the fair value of the portfolio and $66,000 in net amortization of premiums.
The Company owned $3.0 million of Federal Home Loan Bank stock at September 30, 2005 compared to $1.4 million at December 31, 2004.
There were no Federal funds sold at September 30, 2005 or December 31, 2004.
Interest-earning deposits held at correspondent banks increased by approximately $550,000 from $43,000 at December 31, 2004 to $593,000 at September 30, 2005. The increase represents principal and interest payments from the investment portfolio waiting to be re-invested.
Non-earning and other assets increased by approximately $7.9 million between December 31, 2004 and September 30, 2005. Non-interest bearing cash due from banks increased by $6.5 million during the nine months ended September 30, 2005. Cash and due from banks includes amounts represented by checks in the process of being collected through the Federal Reserve payment system. Funds represented by these checks were not yet collected and therefore could not be invested overnight. The outgoing cash letter in transit on September 30, 2005 was more than $7.7 million. For more details regarding the increase in cash and cash equivalents, see the Consolidated Statement of Cash Flows. Categories of other assets experiencing increases between December 31, 2004 and September 30, 2005 include interest receivable, bank premises and equipment, deferred tax asset and cash surrender value on bank owned life insurance.
Total deposits increased by $39.1 million between December 31, 2004 and September 30, 2005 from $273.6 million to $312.7 million. The largest increase occurred in the time deposit category, which grew by $16.4 million to $170.1 million at September 30, 2005 from $153.7 million at year end 2004. Increases to other deposit categories were as follows: money market account balances increased by $10.4 million from $33.3 million to $43.7 million, non-interest bearing demand deposits increased by $10.1 million from $42.8 million to $52.9 million and savings increased by $4.1 million from $3.0 million to $7.1 million. Interest-bearing demand deposits decreased by $1.9 million from $40.8 million to $38.9 million. The decline is due in part to the changes in interest rates over the past fifteen months causing a shift in deposit mix.
- 10 -
Prior to July 2004, the interest rate paid on our premium interest-bearing checking account product was actually higher than the rates paid on savings and money market accounts. Customers seeking to earn a higher rate on funds on liquid deposits shifted money from the traditional savings products to the interest-bearing checking product. As interest rates have increased, rates on the savings and money market product types have risen more sharply than the rate on the premium interest-bearing checking account. As a result, customers have begun shifting deposits back to the more traditional savings products.
The Company has several deposit relationships with real estate settlement attorneys. Due to the nature of these relationships, deposits balances for these accounts can increase significantly at each month end. The degree of account balance fluctuation is dependent on many factors such as the level of mortgage interest rates, the level of residential mortgage activity and the time of year. The balances in these real estate settlement deposit accounts were $13.6 million and $12.1 million at September 30, 2005 and December 31, 2004, respectively.
The composition of the deposit base, by category, at September 30, 2005 is as follows: 54% time deposits, 17% non-interest-bearing demand deposits, 13% interest-bearing demand deposits, 14% money market and 2% statement savings. The composition of the deposit base, by category, at December 31, 2004 was 56% time deposits, 16% non-interest-bearing demand deposits, 15% interest-bearing demand deposits, 12% money market and 1% statement savings. Time deposits of $100,000 or more totaled $110.0 million at September 30, 2005 compared to $97.5 million at December 31, 2004. 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 $63.5 million at September 30, 2005 compared with $49.5 million at December 31, 2004.
The Company had $30.2 million of long-term debt outstanding at September 30, 2005 compared to $28.2 million at December 31, 2004. The long-term debt is comprised of $22.0 million in FHLB term advances and $8.2 million in junior subordinated debt. Short-term borrowings increased by $30.0 million during the nine months of 2005 to $31.3 million from $1.3 million. Short-term borrowings consist of FHLB term advances with remaining maturities of less than one year, Federal funds purchased from correspondent banks and securities sold under a repurchase agreement. Securities sold under repurchase agreements generally mature within one to four days from the transaction date.
Accrued interest payable and other liabilities increased by $291,000 to $1.5 million at September 30, 2005 compared with $1.2 million at December 31, 2004. The increase is primarily the result of higher accrued interest due to rising interest rates and higher deposit and borrowing levels.
Between December 31, 2004 and September 30, 2005, total stockholders’ equity rose by $2.4 million. The increase resulted from net income for the first nine months of $2,1 million plus $523,000 in new stock issuance pursuant to the exercise of stock options less unrealized losses on available for sale securities of $261,000.
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COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTH PERIODS ENDED
SEPTEMBER 30, 2005 AND 2004
Net Income. Net income for the three-month period ending September 30, 2005 was $845,000 or $0.19 per diluted share compared with $661,000 or $0.15 per diluted share for the three-month period ended September 30, 2004. Annualized return on average assets was 0.86% and 0.83% for the two periods ended September 30, 2005 and 2004, respectively. The improvement in return on average assets is primarily due to the increase in earnings resulting from a higher volume of earning assets and the rising interest rate environment. Return on average equity for the current period was 11.62% compared to 10.27% for the prior period. Return on average equity for the current period increased due to improved earnings and the more efficient leveraging of capital.
Net Interest Income. Net interest income increased by $978,000 or 37% from $2.7 million for the prior three-month period to $3.6 million for the three-month period ended September 30, 2005. Total interest income for the current three month period benefited from a higher volume of earning assets and a higher yield earned on those assets. Total interest expense from deposits and other borrowings increased due to growth in interest-bearing liabilities needed to fund the higher volume of assets and an increase in short-term interest rates. The Company’s net interest margin increased due to a rising interest rate environment which improved the spread between the yield on earning assets and the cost of interest-bearing liabilities.
Total average earning assets increased $71.9 million or 24% from an average of $295.6 million for the prior year three-month period to an average of $367.4 million for the three-month period ended September 30, 2005. The average balance of loans outstanding during the current quarter was $309.8 million, a 25% increase over the $248.0 million of average outstanding loans for the prior period. The average balance of the investment securities portfolio for the three-month period ended September 30, 2005 was $55.6 million, increasing by $11.3 million or 26% compared to an average of $44.3 million at September 30, 2004. The average balance of federal funds sold and other earning assets decreased to $2.0 million for the current three-month period compared to $3.1 million for the prior period. Average interest-bearing liabilities increased by $63.4 million or 25% from $252.3 million for the quarter ended September 30, 2004 to $315.7 million for the current quarter. Total interest-bearing deposits increased by $38.9 million or 17% from $224.3 million to $263.2 million. Time deposits experienced the largest increase averaging $172.0 million during the current year period compared to $147.2 million for the prior period. Total borrowings increased by 87% or $24.4 million from $28.1 million to $52.5 million.
Total interest income increased by $2.0 million for the current three-month period compared to the same period from the prior year. The increase was the result of an additional $1.1 million due to the growth in total average earning assets and a $880,000 increase due to higher yields realized on earning assets. Total interest expense for the current period rose by $1.0 million compared to prior period. The increase was the result of a $496,000 increase due to growth in interest-bearing funds and a $513,000 increase due to the higher interest rate environment.
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, 2005 was 3.93% compared to 3.59% for the three-month period ended September 30, 2004. The average yield on earning assets for the current three-month period increased 106 basis points to 6.54% compared with 5.48% for the prior year period, while the average cost of interest-bearing funds increased by 82 basis points to 3.03% from 2.21%. The interest rate spread,
- 12 -
which is the difference between the average yield on earning assets and the cost of interest-bearing funds, increased by 24 basis points from 3.27% for the quarter ended September 30, 2004 to 3.51% for the quarter ended September 30, 2005. The percentage of interest earning assets to average interest-bearing liabilities declined from 117.12% for the prior year period to 116.37% for the three months ended September 30, 2005.
Between July 1, 2004 and September 30, 2005, the Federal Reserve (the “Fed”) increased short-term interest rates 275 basis points. Initially the increases were designed to achieve a more neutral monetary policy than had existed during the thirty months prior to June 30, 2004 and current increases are aimed at controlling certain inflationary pressures in the economy. Prior to the increases, the Company had made an effort to structure its balance sheet to take advantage of a rising interest rate environment. While the current rate environment has resulted in an increase in the net interest margin, the magnitude of the increase has been less than we would have anticipated. Approximately 62% of the Company’s loan portfolio carries variable rate pricing based on the Prime lending rate. Each time the Fed increases rates, the rate on 62% of the Company’s loan balances increases. However, as short-term interest rates have risen, intermediate and long-term rates have not risen to the same extent. This has resulted in a flattening of the interest rate yield curve. The volume of new loan originations has outpaced the generation of lower cost core deposits causing the Company to rely more heavily on borrowed funds and brokered certificates of deposit. Of the $64.7 million increase in loan outstandings since December 31, 2004, $47.0 million has come in the commercial real estate category. Due to the nature of the collateral and the competitive marketplace, this type of loan typically receives very favorable fixed-rate pricing off the intermediate to long end of the yield curve. Therefore, interest rates on new commercial real estate loans are only slightly higher than one year ago, but because of the flatness of the yield curve, the cost to fund these loans is significantly higher. The Company should continue to experience marginal benefit from a moderately rising rate environment.
Provision for Loan Losses. The Company’s provision for loan losses for the three-month period ended September 30, 2005 was $240,000 compared to $198,000 for the same period in 2004. 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 primarily due to loan growth in the third quarter of 2005, although the analysis discussion outlines additional factors impacting the provision. The allowance for loan losses was $4.3 million at September 30, 2005, representing 1.33% of total outstanding loans.
Non-Interest Income. For the three-month period ended September 30, 2005, non-interest income declined by $100,000 to $614,000 compared to $714,000 for the same period in 2004. Non-interest income for the prior year period included $203,000 of distributions from our membership interest in a mortgage origination company. In late 2004, the Company sold its membership interest and no longer enjoys that distribution stream.
Total mortgage origination fees increased by $94,000 to $237,000 for the current period from $143,000 for the prior period. Customer service fees on deposit accounts increased by $37,000 from $188,000 to $225,000. Fees from brokerage referrals declined by $8,000, earnings from increases in cash value on life insurance decreased by $5,000 and service charges earned on deposit accounts were $3,000 less than the prior year period. The decline in service charge income is due primarily to the increase in the earnings credit rate paid on compensating balances on commercial demand deposit accounts. We incurred a $17,000 loss on the sale of available for sale securities during the third quarter of 2005.
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Non-Interest Expenses. Non-interest expenses were $2.7 million for the three-month period ended September 30, 2005 compared with $2.2 million for the same period ended September 30, 2004. The largest component of non-interest expense for the current period was personnel expense. Salaries and benefits expense increased by $385,000 or 34% to $1.5 million for the current year period compared to $1.1 million for the same period in the prior year. The expansion into the Sanford, Garner and Raleigh, North Carolina markets and the addition of certain support staff has increased personnel costs. Management anticipates personnel expense to continue to increase as we identify new opportunities for expansion.
Occupancy and equipment expenses increased by $29,000 or 7% from $414,000 for the three-month period ended September 30, 2004 to $443,000 for the current year period. Branch offices were opened in two new markets, and a new Operations Center was opened in Cary, North Carolina. Data processing costs increased by $20,000 or 14% to $162,000 for the current period from $142,000 for the prior year period. The Company outsources its data processing and expenses are closely tied to transaction and account volumes. The added costs of installing and maintaining data communications lines to the new branch and operations facilities are also considered data processing expenses. As the Company continues to grow in accordance with its strategic plan, management expects both occupancy and data processing costs to increase.
Other non-interest expenses increased by $100,000 to $603,000 for the third quarter of 2005 compared with $504,000 for the prior year quarter. The increase was primarily a result of the Company’s continued growth. The largest components of other non-interest expenses include professional fees and services, office supplies and printing, advertising, and loan related fees. Management expects that as the complexity and size of the Company increases, expenses associated with these categories will continue to increase.
Provision for Income Taxes. The Company recorded income tax expense of $459,000 for the three-months ended September 30, 2005 compared with $341,000 for the prior year period. The effective tax rate for the three-month period ended September 30, 2005 was 35.2% compared with 34.0% for the prior year period. The increase in the effective tax rate is attributable to a smaller percentage of income coming from tax exempt sources.
COMPARISON OF RESULTS OF OPERATIONS FOR THE NINE-MONTH PERIODS ENDED
SEPTEMBER 30, 2005 AND 2004
Net Income. Net income for the nine-month period ended September 30, 2005 was $2,139,000 or $0.49 per diluted share compared with $1,644,000 or $0.38 per diluted share for the nine-month period ended September 30, 2004. Annualized return on average assets was 0.78% and 0.73% for the two periods ended September 30, 2005 and 2004, respectively. The improvement in return on assets was primarily attributed higher earnings resulting from a rising interest rate environment and strong growth in earning assets. Return on average equity for the current period was 10.21% compared to 8.75% for the prior period. Return on average equity improved as a result of increased net income and a more efficient leveraging of capital.
Results of operations for the nine-month period ended September 30, 2005, when compared with the period ended September 30, 2004, were positively impacted by strong earning asset growth over the past twelve months and a rising interest rate environment. Non-interest income declined slightly due to the loss of a significant recurring revenue stream; however, other components of non-interest income improved to help mitigate the impact. Non interest expense increased during
- 14 -
the current nine-month period as the Company continues to expand its branch network into new markets.
Net Interest Income. Net interest income increased by $2.5 million or 33% from $7.5 million for the nine-month period ended September 30, 2004 to $10.0 million for the current period. Growth in both earning assets and interest bearing liabilities, coupled with the rising interest rate environment, resulted in increases in both total interest income and total interest expense in the current period compared with the prior year period.
Total interest income was $16.2 million for the nine-month period ended September 30, 2005 compared to $11.7 million for the prior year period, an increase of $4.8 million or 42%. The total increase was the result of a $2.0 million increase due to growth in average earning assets and a $2.8 million increase due to the rising average yield earned on those assets. Total interest expense increased by $2.3 million from $3.9 million for the prior year period to $6.2 million for the current period. The increase was the result of an $1.3 million increase due to growth in interest-bearing liabilities and a $1.0 million increase due to the rising cost of funds.
Total average earning assets increased $62.8 million or 22% from an average of $281.4 million as of September 30, 2004 to an average of $344.2 million for the nine-month period ended September 30, 2005. The average of loans outstanding during the current nine-month period was $287.6 million reflecting a $52.0 million or 22% increase over the $235.6 million for the prior year period. The average balance of the investment securities portfolio for the current period was $54.8 million, increasing by $12.8 million or 30% compared to an average of $42.0 million at September 30, 2004. The average balance of federal funds sold and other earning assets decreased to $1.7 million for the nine-month period ended September 30, 2005 compared to $3.8 million for the prior period.
Total average interest-bearing liabilities increased by $57.8 million or 24% from an average of $237.4 million for the period ended September 30, 2004 to $295.2 million for the current nine-month period. Total average interest-bearing deposits increased by $36.9 million or 17% growing from $212.6 million at September 30, 2004 to $249.5 million at September 30, 2005. Total average borrowings increased by $20.8 million or 84% to $45.7 million for the current nine-month period from $24.9 million for the prior year period.
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 nine-month period ended September 30, 2005 was 3.89% compared to 3.56% for the nine-month period ended September 30, 2004. The average yield on earning assets for the current nine-month period increased by 88 basis points to 6.30% compared with 5.42% for the prior year period, while the average cost of interest-bearing funds increased by 61 basis points to 2.81% from 2.20%. The spread between the rates paid on earning assets and the cost of interest-bearing funds increased by 27 basis points from 3.22% to 3.49%. The Company’s reliance on interest-bearing liabilities to fund earning asset growth continued to increase as the percentage of interest earning assets to interest bearing liabilities fell from 118.51% to 116.59%.
The Company’s balance sheet is currently asset sensitive over a twelve-month period, meaning that a higher volume of earning assets is subject to repricing than that of interest bearing liabilities. Other outside influences being equal, an asset sensitive balance sheet should enhance net interest income in a rising rate environment. The asset sensitivity of the balance sheet is largely due to the composition of the loan portfolio. The loan portfolio is split between
- 15 -
62% floating rates loans and 38% fixed rate loans. While the investment portfolio is predominately comprised of fixed income securities, it has very stable principal re-payment characteristics designed to allow those cash flows to be reinvested at higher rates or deployed to fund loan growth. The risk of an asset sensitive balance sheet is a falling rate environment, therefore the balance sheet will need to be repositioned in the future to reduce the inherent risks of the next falling rate environment. The timing and execution of that repositioning is subject to the judgment of management and the Asset Liability Committee.
Provision for Loan Losses. The Company’s provision for loan losses for the nine-month period ended September 30, 2005 was $747,000 compared to $582,000 for the same period in 2004. 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 sharp increase in the loan portfolio, but other factors also influence the amount charged against earnings. See the section entitled “Non Performing Assets” for more details. The allowance for loan losses was $4.3 million at September 30, 2005, representing 1.33% of total outstanding loans.
Non-Interest Income. For the nine-month period ended September 30, 2005, non-interest income was $1.7 million decreasing by $48,000 or 3%. During the prior year period, the Company had a membership interest in a mortgage loan origination company and received distributions of $287,000. That membership interest was sold during the fourth quarter of 2004 and therefore, no distributions have been received in 2005. The largest components of non-interest income in the first nine months of 2005 were $617,000 in customer service fees, $569,000 in mortgage loan origination fees, $170,000 increase in cash surrender value on life insurance, $138,000 in brokerage referral fees and $131,000 in service charges and fees on deposit accounts. For the current nine-month period, revenue was partially offset by a $16,000 loss on the sale of available for sale securities and a $10,000 loss on the sale of assets.
For the nine-month period ended September 30, 2004, non-interest income included $533,000 in customer service fees, $453,000 in mortgage loan origination fees, $181,000 increase in cash value on life insurance, $112,000 in investment referral fees and $141,000 in service charges and fees on deposit accounts. The Company also recognized $8,000 in gains on the sale of assets.
Most categories of non-interest income experienced increases over the prior year period with the exception of service charge income and increases in cash value on life insurance. As short-term interest rates have increased, the earnings credit rate paid on commercial checking accounts to offset service charges has increased and lowered actual services charges. The interest rate paid on life insurance investments tends to lag the general market and are lower than a year ago.
Non-Interest Expenses. Non-interest expenses increased by $1.5 million or 24% to $7.8 million for the nine-month period ended September 30, 2005 compared with $6.3 million for the same period ended September 30, 2004. The largest component of non-interest expense for the current period was personnel expense. Salaries and benefits expense increased by 948,000 or 29% to $4.2 million for the current nine-month period compared to $3.2 million for the same period in the prior year. Due to branch and administrative expansion, the number of employees has increased over the past twelve months. Management anticipates personnel expense to continue to increase as opportunities to hire quality employees present themselves and we expand into new markets.
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Occupancy and equipment expenses increased by $151,000 or 13% from $1.1 million for the nine-month period ended September 30, 2004 to $1.3 million for the current year period. Occupancy expenses have risen due to the opening of two new branch locations and an Operations Center. Data processing costs increased from $402,000 for the prior year nine-month period to $478,000 for the current period. The Company outsources its data processing and expenses are closely tied to transaction and account volumes, and include the monthly costs associated with data line connectivity between offices. As the Company continues to grow in accordance with its strategic plan, management expects both occupancy and data processing costs to increase.
Other non-interest expenses increased by $326,000 to $1.8 million for the 2005 period compared with $1.5 million for the prior year period. The increase was primarily a result of the Company’s continued growth. The largest components of other non-interest expenses include professional fees and services, office supplies and printing, advertising, and loan related fees. Management expects that as the complexity and size of the Company increases, expenses associated with these categories will continue to increase.
Provision for Income Taxes. The Company recorded income tax expense of $1,117,000 during the nine-months ended September 30, 2005 compared to $817,000 for the prior year period. The effective tax rates for the two periods were 34.3% and 33.2%, respectively. The increase is due to a smaller percentage of income earned from tax exempt sources.
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NET INTEREST INCOME
Net interest income represents the difference between income derived from interest-earning assets and interest expense incurred on interest-bearing liabilities. Net interest income is affected by both (1) the difference between the rates of interest earned on interest-earning assets and the rates paid on interest-bearing liabilities (“interest rate spread”) and (2) the relative amounts of interest-earning assets and interest-bearing liabilities (“net interest-earning balance”). The following tables set forth information relating to average balances of the Company’s assets and liabilities for the three and nine-month periods ended September 30, 2005 and 2004. The tables reflect the average yield on interest-earning assets and the average cost of interest-bearing liabilities (derived by dividing income or expense by the daily average balance of interest-earning assets or interest-bearing liabilities, respectively) as well as the net interest margin. In preparing the tables, non-accrual loans are included, when applicable, in the average loan balance.
Average Balances, Interest and Average Yields/Cost
(Dollars in Thousands)
| For the Three Months Ended September 30, |
||||||||||||||||||
| 2005 |
2004 |
|||||||||||||||||
| Average Balance |
Interest |
Average Yield/Cost |
Average Balance |
Interest |
Average Yield/Cost |
|||||||||||||
| (Dollars in thousands) | ||||||||||||||||||
| Interest-earnings assets |
||||||||||||||||||
| Loan portfolio |
$ | 309,800 | $ | 5,466 | 7.00 | % | $ | 248,039 | $ | 3,599 | 5.77 | % | ||||||
| Investment securities |
55,621 | 576 | 4.14 | % | 44,340 | 461 | 4.16 | % | ||||||||||
| Fed funds and other interest-earning assets |
1,996 | 17 | 3.38 | % | 3,176 | 11 | 1.38 | % | ||||||||||
| Total interest-earning assets |
367,417 | 6,059 | 6.54 | % | 295,555 | 4,071 | 5.48 | % | ||||||||||
| Noninterest-bearing assets |
23,000 | 20,118 | ||||||||||||||||
| Total Assets |
$ | 390,417 | $ | 315,673 | ||||||||||||||
| Interest-bearing liabilities |
||||||||||||||||||
| Interest-bearing NOW |
$ | 41,811 | 117 | 1.11 | % | $ | 41,724 | 83 | 0.79 | % | ||||||||
| Money market and savings |
49,386 | 274 | 2.20 | % | 35,392 | 95 | 1.07 | % | ||||||||||
| Time deposits |
172,033 | 1,450 | 3.34 | % | 147,179 | 957 | 2.59 | % | ||||||||||
| Short-term borrowings |
20,524 | 201 | 3.89 | % | 1,713 | 18 | 4.18 | % | ||||||||||
| Long-term debt |
31,987 | 369 | 4.58 | % | 26,348 | 249 | 3.76 | % | ||||||||||
| Total interest-bearing liabilities |
315,741 | 2,411 | 3.03 | % | 252,356 | 1,402 | 2.21 | % | ||||||||||
| Non-interest bearing deposits |
44,564 | 36,559 | ||||||||||||||||
| Other liabilities |
1,242 | 1,218 | ||||||||||||||||
| Total Liabilities |
361,547 | 290,133 | ||||||||||||||||
| Stockholders’ Equity |
28,870 | 25,540 | ||||||||||||||||
| Total Liabilities & Stockholders’ Equity |
$ | 390,417 | $ | 315,673 | ||||||||||||||
| Net interest income |
$ | 3,648 | $ | 2,669 | ||||||||||||||
| Interest rate spread |
3.51 | % | 3.27 | % | ||||||||||||||
| Net interest-margin |
3.93 | % | 3.59 | % | ||||||||||||||
| Percentage of average interest-earning assets to average interest-bearing liabilities |
116.37 | % | 117.12 | % | ||||||||||||||
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Average Balances, Interest and Average Yields/Cost
(Dollars in Thousands)
| For the Nine Months Ended September 30, |
||||||||||||||||||
| 2005 |
2004 |
|||||||||||||||||
| Average Balance |
Interest |
Average Yield/Cost |
Average Balance |
Interest |
Average Yield/Cost |
|||||||||||||
| Interest-earnings assets |
||||||||||||||||||
| Loan portfolio |
$ | 287,633 | $ | 14,466 | 6.72 | % | $ | 235,630 | $ | 10,097 | 5.72 | % | ||||||
| Investment securities |
54,813 | 1,712 | 4.16 | % | 42,012 | 1,291 | 4.10 | % | ||||||||||
| Fed funds and other interest-earning assets |
1,780 | 39 | 2.93 | % | 3,767 | 29 | 1.03 | % | ||||||||||
| Total earning assets |
344,226 | 16,217 | 6.30 | % | 281,409 | 11,417 | 5.42 | % | ||||||||||
| Noninterest-bearing assets |
21,890 | 19,554 | ||||||||||||||||
| Total Assets |
$ | 366,116 | $ | 300,963 | ||||||||||||||
| Interest-bearing liabilities |
||||||||||||||||||
| Interest-bearing NOW |
$ | 39,733 | 293 | 0.99 | % | $ | 40,838 | 242 | 0.79 | % | ||||||||
| Money market and savings |
43,805 | 628 | 1.92 | % | 33,123 | 277 | 1.12 | % | ||||||||||
| Time deposits |
165,986 | 3,886 | 3.13 | % | 138,617 | 2,660 | 2.56 | % | ||||||||||
| Short-term borrowings |
9,612 | 264 | 3.67 | % | 2,739 | 39 | 1.90 | % | ||||||||||
| Long-term debt |
36,101 | 1,130 | 4.18 | % | 22,131 | 692 | 4.18 | % | ||||||||||
| Total interest-bearing liabilities |
295,237 | 6,201 | 2.81 | % | 237,448 | 3,910 | 2.20 | % | ||||||||||
| Non interest-bearing deposits |
41,756 | 37,061 | ||||||||||||||||
| Other liabilities |
1,101 | 1,360 | ||||||||||||||||
| Total Liabilities |
338,094 | 275,869 | ||||||||||||||||
| Stockholders’ Equity |
28,022 | 25,094 | ||||||||||||||||
| Total Liabilities & Stockholders’ Equity |
$ | 366,116 | $ | 300,963 | ||||||||||||||
| Net interest income |
$ | 10,016 | $ | 7,507 | ||||||||||||||
| Interest rate spread |
3.49 | % | 3.22 | % | ||||||||||||||
| Net margin |
3.89 | % | 3.56 | % | ||||||||||||||
| Percentage of average interest-earning assets to average interest bearing liabilities |
116.59 | % | 118.51 | % | ||||||||||||||
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VOLUME/RATE VARIANCE ANALYSIS
The following tables analyze the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities for the three and nine-month periods ended September 30, 2005 and 2004. The table distinguishes between (i) changes attributable to volume (changes in volume multiplied by the prior period’s rate), (ii) changes attributable to rate (changes in rate multiplied by the prior period’s volume), and (iii) net change (the sum of the previous columns). The change attributable to both rate and volume (changes in rate multiplied by changes in volume) has been allocated proportionately to both the changes attributable to volume and the changes attributable to rate.
Rate/Volume Analysis
| Three Months Ended September 30, (in Thousands) | ||||||||
| Increase (Decrease) Due to | ||||||||
| Volume |
Rate |
Total | ||||||
| Interest Income |
||||||||
| Loan portfolio |
1,000 | 867 | 1,867 | |||||
| Investment Securities |
115 | (0 | ) | 115 | ||||
| Fed funds and other interest-earning assets |
(7 | ) | 13 | 6 | ||||
| Total interest-earning assets |
1,108 | 880 | 1,988 | |||||
| Interest Expense |
||||||||
| Interest-bearing NOW |
0 | 34 | 34 | |||||
| Money market and savings |
58 | 121 | 179 | |||||
| Time deposits |
187 | 306 | 493 | |||||
| Short-term borrowings |
191 | (8 | ) | 183 | ||||
| Long-term debt |
60 | 60 | 120 | |||||
| Total interest-bearing liabilities |
496 | 513 | 1,009 | |||||
| Net interest income |
612 | 367 | 979 | |||||
- 20 -
Rate/Volume Analysis
| Nine Months Ended September 30, (in Thousands) | |||||||
| Increase (Decrease) Due to | |||||||
| Volume |
Rate |
Total | |||||
| Interest Income |
|||||||
| Loan portfolio |
2,416 | 1,953 | 4,369 | ||||
| Investment Securities |
(356 | ) | 777 | 421 | |||
| Fed funds and other interest-earning assets |
(30 | ) | 40 | 10 | |||
| Total interest-earning assets |
2,030 | 2,770 | 4,800 | ||||
| Interest Expense |
|||||||
| Interest-bearing NOW |
(8 | ) | 59 | 51 | |||
| Money market and savings |
121 | 230 | 351 | ||||
| Time deposits |
581 | 645 | 1,226 | ||||
| Short-term borrowings |
144 | 81 | 225 | ||||
| Long-term debt |
437 | 1 | 438 | ||||
| Total interest-bearing liabilities |
1,275 | 1,016 | 2,291 | ||||
| Net interest income |
755 | 1,754 | 2,509 | ||||
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NONPERFORMING ASSETS
The table below sets forth, for the period indicated, information about our nonaccrual loans, restructured loans, total nonperforming loans (nonaccrual loans plus restructured loans), and total nonperforming assets.
| At September 30, |
At December 31, |
|||||||||||||||
| 2005 |
2004 |
2004 |
2003 |
|||||||||||||
| (Dollars in thousands) | ||||||||||||||||
| Nonaccrual loans |
$ | 222 | $ | 262 | $ | 5 | $ | 159 | ||||||||
| Restructured loans |
— | — | — | — | ||||||||||||
| Total nonperforming loans |
222 | 262 | 5 | 159 | ||||||||||||
| Real estate owned |
— | 254 | 245 | — | ||||||||||||
| Repossessed assets |
— | 35 | 48 | — | ||||||||||||
| Total nonperforming assets |
$ | 222 | $ | 551 | $ | 298 | $ | 159 | ||||||||
| Accruing loans past due 90 days or more |
$ | — | $ | — | $ | — | $ | 647 | ||||||||
| Allowance for loan losses |
4,293 | 3,771 | 3,668 | 3,304 | ||||||||||||
| Nonperforming loans to period end loans |
0.07 | % | 0.10 | % | 0.00 | % | 0.07 | % | ||||||||
| Allowance for loan losses to period end loans |
1.33 | % | 1.48 | % | 1.42 | % | 1.52 | % | ||||||||
| Allowance for loan losses to nonperforming loans |
1,930.59 | % | 1,439.31 | % | 78,577.55 | % | 2,077.99 | % | ||||||||
| Nonperforming assets to total assets |
0.05 | % | 0.17 | % | 0.09 | % | 0.06 | % | ||||||||
| Nonperforming assets and loans past due 90 days or more to total assets |
0.05 | % | 0.17 | % | 0.09 | % | 0.29 | % | ||||||||
Our financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on loans, unless we place a loan on nonaccrual basis. We account for loans on a nonaccrual basis when we have serious doubts about the collectibility of principal or interest. Generally, our policy is to place a loan on nonaccrual status when the loan becomes past due 90 days. We also place loans on nonaccrual status in cases where we are uncertain whether the borrower can satisfy the contractual terms of the loan agreement. Amounts received on nonaccrual loans generally are applied first to principal and then to interest only after all principal has been collected. Restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal have been granted due to the borrower’s weakened financial condition. We accrue interest on restructured loans at the restructured rates when we anticipate that no loss of original principal will occur. Potential problem loans are loans which are currently performing and are not included as nonaccrual or restructured loans above, but about which we have serious doubts as to the borrower’s ability to comply with present repayment terms. These loans are likely to be included later in nonaccrual, past due or restructured loans, so they are considered by our management in assessing the adequacy of our allowance for loan losses. At September 30, 2005, we identified seven loans in the
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aggregate amount of $915,000 as potential problem loans. These secured loans will continue to be closely monitored and management does not anticipate any material losses.
There were no foreclosed or repossessed properties at September 30, 2005. At September 30, 2004, there two properties held in other real estate owned totaling $254,000 and one repossessed vehicle valued at $35,000. There were five non-accrual loans at September 30, 2005 in the aggregate amount of $222,000. Two loans in the aggregate amount of $198,000 are secured by real estate. The real estate is in the process of foreclosure and no material losses on the subsequent sales are anticipated. One loan is in the amount of $2,000 and the borrower is making payments in an agreed upon manner. Two loans totaling $22,000 are secured by personal property. The properties are being liquidated by the borrowers to repay the amounts due. We anticipate losing approximately half of the amount due. Interest foregone on nonaccrual loans for the nine-month period ended September 30, 2005 was approximately $5,000. Interest foregone on nonaccrual loans for the prior year period was approximately $8,000.
ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established through periodic charges to earnings in the form of a provision for loan losses. Increases to the allowance for loan losses occur as a result of provisions charged to operations and recoveries of amounts previously charged-off, and decreases to the allowance occur when loans are charged-off. Management evaluates the adequacy of our allowance for loan losses on a monthly basis. The evaluation of the adequacy of the allowance for loan losses involves the consideration of loan growth, loan portfolio composition and industry diversification, historical loan loss experience, current delinquency levels, adverse conditions that might affect a borrower’s ability to repay the loan, estimated value of underlying collateral, prevailing economic conditions and all other relevant factors derived from the Company’s history of operations. Additionally, as an important component of their periodic examination process, regulatory agencies review the allowance for loan losses and may require additional provisions for estimated losses based on judgments that differ from those of management.
The Company uses an internal grading system to assign the degree of inherent risk on each individual loan. The grade is initially assigned by the lending officer and reviewed by the Loan Administration function. The internal grading system is reviewed and tested periodically by an independent third party credit review firm. The testing process involves the evaluation of a sample of new loans, loans having been identified as possessing potential weakness in credit quality, past due loans and nonaccrual loans to determine the ongoing effectiveness of the internal grading system. The loan grading system is used to assess the adequacy of the allowance for loan losses.
Management has developed a model for evaluating the adequacy of the allowance for loan losses. The model distinguishes between loans that will be evaluated as a group by loan category and those loans to be evaluated individually. Using the various evaluation factors mentioned above, management predetermined allowance percentages for each major loan category. Loans that exhibit an acceptable level of risk per the internal loan grading system are grouped by loan category and multiplied by the associated allowance percentage to determine an adequate level of allowance for loan losses.
Based on the loan grading system, management maintains an internally classified watch list. Loans classified as watch list credits, and those loans that are not watch list credits but possess other characteristics which in the opinion of management suggest a higher degree of inherent risk, are evaluated individually, by loan category, using higher allowance percentages. Using
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the data gathered during the monthly evaluation process, the model calculates an acceptable range for allowance for loan losses. Management and the Board of Directors are responsible for determining the appropriate level of the allowance for loan losses within that range.
The primary reason for increases to the allowance for loan losses has been growth in total outstanding loans; however, there were other factors influencing the provision. For the nine-month period ended September 30, 2005, there were $122,000 net loan charge-offs and $222,000 in non-accrual loans compared with $115,000 in net loan charge-offs and $262,000 in non accrual loans at September 30, 2004. The allowance for loan losses at September 30, 2005 was $4.3 million, which represents 1.33% of total outstanding loans compared to $3.8 million and 1.48% for the prior year. The allowance for loan losses as a percentage of total outstanding loans declined from the prior year primarily due to improvement in the asset quality of the portfolio.
The allowance for loan losses represents management’s estimate of an amount adequate to provide for known and inherent losses in the loan portfolio in the normal course of business. While management believes the methodology used to establish the allowance for loan losses incorporates the best information available at the time, future adjustments to the level of the allowance may be necessary and the results of operations could be adversely affected should circumstances differ substantially from the assumptions initially used. We believe that the allowance for loan losses was established in conformity with generally accepted accounting principles; however, there can be no assurances that the regulatory agencies, after reviewing the loan portfolio, will not require management to increase the level of the allowance. Likewise, there can be no assurance that the existing allowance for loan losses is adequate should there be deterioration in the quality of any loans or changes in any of the factors discussed above. Any increases in the provision for loan losses resulting from such deterioration or change in condition could adversely affect the financial condition of the Company and results of its operations.
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The following table describes the allocation of the allowance for loan losses among various categories of loans for the dates indicated.
Allocation of Allowance for Loan Losses
| At September 30, |
At December 31, |
|||||||||||
| 2005 |
2004 |
|||||||||||
| Amount |
% of Total Loans (1) |
Amount |
% of Total Loans (1) |
|||||||||
| (Dollars in thousands) | ||||||||||||
| Residential real estate loans |
$ | 92 | 4.46 | % | $ | 44 | 4.50 | % | ||||
| Home equity loans and lines |
180 | 10.25 | % | 173 | 12.00 | % | ||||||
| Commercial mortgage loans |
1,798 | 52.32 | % | 1,290 | 47.24 | % | ||||||
| Construction loans |
691 | 13.55 | % | 718 | 15.09 | % | ||||||
| Commercial and industrial loans |
1,218 | 17.56 | % | 1,105 | 18.90 | % | ||||||
| Loans to individuals |
314 | 1.86 | % | 338 | 2.27 | % | ||||||
| Total loans |
$ | 4,293 | 100.00 | % | $ | 3,668 | 100.00 | % | ||||
| (1) | Represents total of all outstanding loans in each category as a percent of total loans outstanding |
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The following table presents information regarding changes in the allowance for loan losses for the periods indicated:
Changes in Allowance for Loan Losses
| For the Nine-Month Period Ended September 30, |
||||||||
| 2005 |
2004 |
|||||||
| (Dollars in thousands) | ||||||||
| Balance at the beginning of the year |
$ | 3,668 | $ | 3,304 | ||||
| Charge-offs: |
||||||||
| Commercial and industrial loans |
138 | 95 | ||||||
| Commercial real estate loans |
34 | 21 | ||||||
| Residential real estate loans |
— | 49 | ||||||
| Loans to individuals |
8 | 6 | ||||||
| Total charge-offs |
180 | 171 | ||||||
| Recoveries |
58 | 56 | ||||||
| Net charge-offs (recoveries) |
122 | 115 | ||||||
| Provision for loan losses |
747 | 582 | ||||||
| Balance at the end of the year |
$ | 4,293 | $ | 3,771 | ||||
| Total loans outstanding at period-end |
$ | 322,192 | $ | 254,025 | ||||
| Average loans outstanding for the period |
$ | 287,633 | $ | 235,630 | ||||
| Allowance for loan losses to total loans outstanding |
1.33 | % | 1.48 | % | ||||
| Ratio of net charge-offs to average loans outstanding |
0.04 | % | 0.05 | % | ||||
LIQUIDITY AND CAPITAL RESOURCES
Maintaining adequate liquidity while managing interest rate risk is the primary goal of the Company’s asset and liability management strategy. Liquidity is the ability to fund the needs of the Company’s borrowers and depositors, pay operating expenses, and meet regulatory liquidity requirements. Maturing investments, loan and mortgage-backed security principal repayments, deposit growth, brokered time deposits and borrowings from the Federal Home Loan Bank and other correspondent banks are presently the main sources of the Company’s liquidity. The Company’s primary uses of liquidity are to fund loans and to make investments.
As of September 30, 2005, liquid assets (cash and due from banks, interest-earning deposits with banks and investment securities available for sale) were approximately $65.9 million, which represents 16% of total assets and 21% of total deposits. Supplementing this liquidity, the Company has available lines of credit from various correspondent banks of approximately $105.8 million of which $52.9 million is outstanding at September 30, 2005. At September 30,
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2005, outstanding commitments for undisbursed lines of credit, letters of credit and undisbursed investment commitments amounted to approximately $83.7 million. Management intends to fund anticipated loan closings and operational needs through cash and cash equivalents on hand, brokered deposits, scheduled principal repayments from the loan and securities portfolios, and anticipated increases in deposits and borrowings. Certificates of deposits represented 54% of the Company’s total deposits at September 30, 2005 compared with 56% at December 31, 2004. The Company’s growth strategy will include marketing efforts focused at increasing the relative volume of low cost transaction deposit accounts; however, time deposits will continue to play an important role in the Company’s funding strategy. Certificates of deposit of $100,000 or more represented 35% and 36% of the Company’s total deposits at September 30, 2005 and December 31, 2004, respectively. While these deposits are generally considered rate sensitive and the Company will need to pay competitive rates to retain these deposits at maturity, there are other subjective factors that will determine the Company’s continued retention of those deposits.
Under federal capital regulations, Crescent State Bank must satisfy certain minimum leverage ratio requirements and risk-based capital requirements. At September 30, 2005, the Bank’s equity to asset ratio was 7.20%. All capital ratios place the Bank in excess of the minimum required to be deemed a well-capitalized bank by regulatory measures. The Bank’s ratios of Tier I capital to risk-weighted assets and total capital to risk-based assets at September 30, 2005 were 9.04% and 10.24%, respectively.
IMPACT OF INFLATION AND CHANGING PRICES
A commercial bank has an asset and liability composition that is distinctly different from that of a company with substantial investments in plant and inventory because the major portions of its assets are monetary in nature. As a result, a bank’s performance may be significantly influenced by changes in interest rates. Although the banking industry is more affected by changes in interest rates than by inflation in the prices of goods and services, inflation is a factor that may influence interest rates. However, the frequency and magnitude of interest rate fluctuations do not necessarily coincide with changes in the general inflation rate. Inflation does affect operating expenses in that personnel expenses and the cost of supplies and outside services tend to increase more during periods of high inflation.
FORWARD-LOOKING INFORMATION
This quarterly report to stockholders may contain, in addition to historical information, certain “forward-looking statements” that represent management’s judgment concerning the future and are subject to risks and uncertainties that could cause the Company’s actual operating results and financial position to differ materially from those projected in the forward-looking statements. Such forward-looking statements can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “anticipate,” “estimate” or “continue” or the negative thereof or other variations thereof or comparable terminology. Factors that could influence the estimates include changes in national, regional and local market conditions, legislative and regulatory conditions, and the interest rate environment.
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| Item 3. | Quantitative and Qualitative Disclosures about Market Risk |
The Company’s primary market risk is interest rate risk. Interest rate risk is the result of differing maturities or repricing intervals of interest earning assets and interest bearing liabilities and the fact that rates on these financial instruments do not change uniformly. These conditions may impact the earnings generated by the Company’s interest earning assets or the cost of its interest bearing liabilities, thus directly impacting the Company’s overall earnings. The Company’s management actively monitors and manages interest rate risk. One way this is accomplished is through the development of and adherence to the Company’s asset/liability policy. This policy sets forth management’s strategy for matching the risk characteristics of the Company’s interest earning assets and liabilities so as to mitigate the effect of changes in the rate environment. The Company’s market risk profile has not changed significantly since December 31, 2004.
| Item 4. | Controls and Procedures |
Crescent Financial Corporation’s management, with the participation of the Chief Executive Officer and Principal Financial Officer, has evaluated the effectiveness of the company’s disclosure controls and procedures as of September 30, 2005. Based on that evaluation, the company’s Chief Executive Officer and Principal Financial Officer concluded that the company’s disclosure controls and procedures were effective, as of September 30, 2005, to provide reasonable assurance that information required to be disclosed by the Company in the reports filed or submitted by it under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and to provide reasonable assurance that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
The Company assesses the adequacy of its internal control over financial reporting quarterly and enhances its controls in response to internal control assessments and internal and external audit and regulatory recommendations. No such control enhancements during the quarter ended September 30, 2005 or through the date of this Quarterly Report on Form 10-Q have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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Part II. OTHER INFORMATION
| Item 1. | Legal Proceedings. |
None.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. |
None.
| Item 3. | Defaults Upon Senior Debt. |
None.
| Item 4. | Submission of Matters to a Vote of Security Holders |
None.
| Item 5. | Other Information. |
None.
| Item 6. | Exhibits |
| (a) | Exhibits. |
| 31.1 | Certification of Principal Executive Officer pursuant to Rule 13a – 14(a) | |
| 31.2 | Certification of Principal Financial Officer pursuant to Rule 13a – 14(a) | |
| 32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
| 32.2 | Certification of Principal Financial Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
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SIGNATURES
Under the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| CRESCENT FINANCIAL CORPORATION | ||||||||
| Date: November 11, 2005 |
By: |
/s/ MICHAEL G. CARLTON | ||||||
| Michael G. Carlton | ||||||||
| President and Chief Executive | ||||||||
| Date: November 11, 2005 |
By: |
/s/ BRUCE W. ELDER | ||||||
| Bruce W. Elder | ||||||||
| Principal Financial Officer | ||||||||
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