UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
September 30, 2006
-----------------------
Commission File Number 0-15572
FIRST BANCORP
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(Exact Name of Registrant as Specified in its Charter)
North Carolina 56-1421916
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
341 North Main Street, Troy, North Carolina 27371-0508
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(Address of Principal Executive Offices) (Zip Code)
(Registrant's telephone number, including area code) (910) 576-6171
----------------------
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 twelve months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] YES [ ] NO
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer.
[ ] Large Accelerated Filer [X] Accelerated Filer [ ] Non-Accelerated Filer
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). [ ] YES [X] NO
The number of shares of the registrant's Common Stock outstanding on November 1,
2006 was 14,325,735.
================================================================================
INDEX
FIRST BANCORP AND SUBSIDIARIES
Page
Part I. Financial Information
Item 1 - Financial Statements
Consolidated Balance Sheets -
September 30, 2006 and 2005
(With Comparative Amounts at December 31, 2005) 3
Consolidated Statements of Income -
For the Periods Ended September 30, 2006 and 2005 4
Consolidated Statements of Comprehensive Income -
For the Periods Ended September 30, 2006 and 2005 5
Consolidated Statements of Shareholders' Equity -
For the Periods Ended September 30, 2006 and 2005 6
Consolidated Statements of Cash Flows -
For the Periods Ended September 30, 2006 and 2005 7
Notes to Consolidated Financial Statements 8
Item 2 - Management's Discussion and Analysis of Consolidated
Results of Operations and Financial Condition 18
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 32
Item 4 - Controls and Procedures 33
Part II. Other Information
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds 34
Item 6 - Exhibits 34
Signatures 35
Page 2
Part I. Financial Information
Item 1 - Financial Statements
First Bancorp and Subsidiaries
Consolidated Balance Sheets
September 30, December 31, September 30,
($ in thousands-unaudited) 2006 2005 (audited) 2005
------------------------------------------------------------------------------------------------
ASSETS
Cash & due from banks, noninterest-bearing $ 35,931 32,985 21,853
Due from banks, interest-bearing 83,571 41,655 47,402
Federal funds sold 24,212 28,883 28,586
----------- ----------- -----------
Total cash and cash equivalents 143,714 103,523 97,841
----------- ----------- -----------
Securities available for sale (costs of $127,353,
$114,662, and $115,686) 125,950 113,613 115,622
Securities held to maturity (fair values of $14,326,
$14,321, and $12,820) 14,270 14,172 12,799
Presold mortgages in process of settlement 3,145 3,347 3,586
Loans 1,696,835 1,482,611 1,446,185
Less: Allowance for loan losses (18,465) (15,716) (15,879)
----------- ----------- -----------
Net loans 1,678,370 1,466,895 1,430,306
----------- ----------- -----------
Premises and equipment 43,207 34,840 33,395
Accrued interest receivable 11,368 8,947 7,779
Goodwill 49,489 47,247 47,247
Other intangible assets 2,229 1,980 2,053
Other 6,716 6,486 7,406
----------- ----------- -----------
Total assets $ 2,078,458 1,801,050 1,758,034
=========== =========== ===========
LIABILITIES
Deposits: Demand - noninterest-bearing $ 212,509 194,051 192,399
Savings, NOW, and money market 497,097 458,221 460,709
Time deposits of $100,000 or more 411,178 356,281 349,620
Other time deposits 544,118 486,024 472,800
----------- ----------- -----------
Total deposits 1,664,902 1,494,577 1,475,528
Repurchase agreements 32,804 33,530 12,409
Borrowings 200,013 100,239 101,239
Accrued interest payable 5,382 3,835 3,543
Other liabilities 12,268 13,141 14,386
----------- ----------- -----------
Total liabilities 1,915,369 1,645,322 1,607,105
----------- ----------- -----------
SHAREHOLDERS' EQUITY
Common stock, No par value per share
Issued and outstanding: 14,310,335,
14,229,148, and 14,196,987 shares 55,394 54,121 53,574
Retained earnings 108,803 102,507 97,655
Accumulated other comprehensive income (loss) (1,108) (900) (300)
----------- ----------- -----------
Total shareholders' equity 163,089 155,728 150,929
----------- ----------- -----------
Total liabilities and shareholders' equity $ 2,078,458 1,801,050 1,758,034
=========== =========== ===========
See notes to consolidated financial statements.
Page 3
First Bancorp and Subsidiaries
Consolidated Statements of Income
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
($ in thousands, except share data-unaudited) 2006 2005 2006 2005
-------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Interest and fees on loans $ 31,727 24,240 87,704 68,331
Interest on investment securities:
Taxable interest income 1,456 1,315 4,187 3,881
Tax-exempt interest income 140 114 394 360
Other, principally overnight investments 584 398 1,652 1,117
------------ ------------ ------------ ------------
Total interest income 33,907 26,067 93,937 73,689
------------ ------------ ------------ ------------
INTEREST EXPENSE
Savings, NOW and money market 1,976 1,042 4,944 2,881
Time deposits of $100,000 or more 4,668 3,015 12,519 8,085
Other time deposits 5,646 3,532 15,082 9,013
Other, primarily borrowings 2,576 1,126 6,054 3,066
------------ ------------ ------------ ------------
Total interest expense 14,866 8,715 38,599 23,045
------------ ------------ ------------ ------------
Net interest income 19,041 17,352 55,338 50,644
Provision for loan losses 1,215 690 3,630 2,115
------------ ------------ ------------ ------------
Net interest income after provision
for loan losses 17,826 16,662 51,708 48,529
------------ ------------ ------------ ------------
NONINTEREST INCOME
Service charges on deposit accounts 2,323 2,180 6,622 6,333
Other service charges, commissions and fees 1,102 961 3,426 2,950
Fees from presold mortgages 278 328 789 851
Commissions from sales of insurance and financial products 357 388 1,121 997
Data processing fees 40 38 113 243
Securities gains -- -- 205 2
Other gains (losses) (1,646) (116) (2,024) (175)
------------ ------------ ------------ ------------
Total noninterest income 2,454 3,779 10,252 11,201
------------ ------------ ------------ ------------
NONINTEREST EXPENSES
Salaries 6,062 5,402 17,581 16,167
Employee benefits 1,892 1,407 5,459 4,712
------------ ------------ ------------ ------------
Total personnel expense 7,954 6,809 23,040 20,879
Net occupancy expense 895 797 2,569 2,259
Equipment related expenses 877 744 2,506 2,207
Intangibles amortization 100 71 221 217
Other operating expenses 3,709 3,065 10,992 9,899
------------ ------------ ------------ ------------
Total noninterest expenses 13,535 11,486 39,328 35,461
------------ ------------ ------------ ------------
Income before income taxes 6,745 8,955 22,632 24,269
Income taxes 2,373 9,646 8,474 15,592
------------ ------------ ------------ ------------
NET INCOME (LOSS) $ 4,372 (691) 14,158 8,677
============ ============ ============ ============
Earnings (loss) per share:
Basic $ 0.31 (0.05) 0.99 0.61
Diluted 0.30 (0.05) 0.98 0.60
Weighted average common shares outstanding:
Basic 14,294,948 14,186,887 14,281,964 14,150,527
Diluted 14,421,380 14,186,887 14,425,347 14,353,169
See notes to consolidated financial statements.
Page 4
First Bancorp and Subsidiaries
Consolidated Statements of Comprehensive Income
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
($ in thousands-unaudited) 2006 2005 2006 2005
---------------------------------------------------------------------------------------------
Net income (loss) $ 4,372 (691) 14,158 8,677
------- ------- ------- -------
Other comprehensive income (loss):
Unrealized gains (losses) on securities
available for sale:
Unrealized holding gains (losses) arising
during the period, pretax 1,568 (824) (149) (1,252)
Tax benefit (expense) (613) 322 57 491
Reclassification to realized gains -- -- (205) (2)
Tax expense -- -- 79 1
Adjustment to minimum pension liability:
Additional pension charge related to unfunded
pension liability -- -- 16 (90)
Tax benefit (expense) -- -- (6) 35
------- ------- ------- -------
Other comprehensive income (loss) 955 (502) (208) (817)
------- ------- ------- -------
Comprehensive income (loss) $ 5,327 (1,193) 13,950 7,860
======= ======= ======= =======
See notes to consolidated financial statements.
Page 5
First Bancorp and Subsidiaries
Consolidated Statements of Shareholders' Equity
Accumulated
Common Stock Other Share-
---------------------------- Retained Comprehensive holders'
(In thousands, except per share - unaudited) Shares Amount Earnings Income (Loss) Equity
-----------------------------------------------------------------------------------------------------------------------
Balances, January 1, 2005 14,084 $ 51,614 96,347 517 148,478
Net income 8,677 8,677
Cash dividends declared ($0.52 per share) (7,369) (7,369)
Common stock issued under
stock option plan 58 656 656
Common stock issued into
dividend reinvestment plan 55 1,204 1,204
Tax benefit realized from exercise of
nonqualified stock options -- 100 100
Other comprehensive loss (817) (817)
------------ ------------ ------------ ------------ ------------
Balances, September 30, 2005 14,197 $ 53,574 97,655 (300) 150,929
============ ============ ============ ============ ============
Balances, January 1, 2006 14,229 $ 54,121 102,507 (900) 155,728
Net income 14,158 14,158
Cash dividends declared ($0.55 per share) (7,862) (7,862)
Common stock issued under
stock option plan 77 758 758
Common stock issued into
dividend reinvestment plan 57 1,219 1,219
Purchases and retirement of common stock (53) (1,112) (1,112)
Tax benefit realized from exercise of
nonqualified stock options -- 94 94
Stock-based compensation -- 314 314
Other comprehensive loss (208) (208)
------------ ------------ ------------ ------------ ------------
Balances, September 30, 2006 14,310 $ 55,394 108,803 (1,108) 163,089
============ ============ ============ ============ ============
See notes to consolidated financial statements.
Page 6
First Bancorp and Subsidiaries
Consolidated Statements of Cash Flows
Nine Months Ended
September 30,
----------------------
($ in thousands-unaudited) 2006 2005
---------------------------------------------------------------------------------------------------
Cash Flows From Operating Activities
Net income $ 14,158 8,677
Reconciliation of net income to net cash provided by operating activities:
Provision for loan losses 3,630 2,115
Net security premium amortization 69 83
Gain on sale of securities available for sale (205) (2)
Other losses 124 175
Net loan origination fees (costs) deferred 263 (288)
Depreciation of premises and equipment 2,118 2,005
Tax benefit from exercise of nonqualified stock options -- 100
Stock-based compensation expense 314 --
Amortization of intangible assets 221 217
Deferred income tax benefit (1,555) (224)
Originations of presold mortgages in process of settlement (48,413) (54,838)
Proceeds from sales of presold mortgages in process of settlement 48,615 53,023
Increase in accrued interest receivable (2,386) (947)
Decrease in other assets 2,849 1,912
Increase in accrued interest payable 1,469 866
Increase (decrease) in other liabilities (1,005) 7,196
--------- ---------
Net cash provided by operating activities 20,266 20,070
--------- ---------
Cash Flows From Investing Activities
Purchases of securities available for sale (45,182) (47,755)
Purchases of securities held to maturity (3,468) --
Proceeds from maturities/issuer calls of securities available for sale 31,004 19,355
Proceeds from maturities/issuer calls of securities held to maturity 3,192 1,171
Proceeds from sales of securities available for sale 1,575 8
Net increase in loans (210,973) (82,150)
Purchases of premises and equipment (9,779) (5,082)
Net cash received in purchase of branches 34,915 --
--------- ---------
Net cash used by investing activities (198,716) (114,453)
--------- ---------
Cash Flows From Financing Activities
Net increase in deposits and repurchase agreements 125,622 99,169
Proceeds from borrowings, net 99,774 9,000
Cash dividends paid (7,714) (7,206)
Proceeds from issuance of common stock 1,977 1,860
Purchases and retirement of common stock (1,112) --
Tax benefit from exercise of nonqualified stock options 94 --
--------- ---------
Net cash provided by financing activities 218,641 102,823
--------- ---------
Increase in Cash and Cash Equivalents 40,191 8,440
Cash and Cash Equivalents, Beginning of Period 103,523 89,401
--------- ---------
Cash and Cash Equivalents, End of Period $ 143,714 97,841
========= =========
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest $ 37,130 22,179
Income taxes 10,915 8,931
Non-cash transactions:
Unrealized loss on securities available for sale, net of taxes (218) (762)
Foreclosed loans transferred to other real estate 1,302 2,353
See notes to consolidated financial statements.
Page 7
First Bancorp and Subsidiaries
Notes to Consolidated Financial Statements
(unaudited) For the Periods Ended September 30, 2006 and 2005
--------------------------------------------------------------------------------
Note 1 - Basis of Presentation
In the opinion of the Company, the accompanying unaudited consolidated
financial statements contain all adjustments necessary to present fairly the
consolidated financial position of the Company as of September 30, 2006 and 2005
and the consolidated results of operations and consolidated cash flows for the
periods ended September 30, 2006 and 2005. All such adjustments were of a
normal, recurring nature. Reference is made to the 2005 Annual Report on Form
10-K filed with the SEC for a discussion of accounting policies and other
relevant information with respect to the financial statements. The results of
operations for the periods ended September 30, 2006 and 2005 are not necessarily
indicative of the results to be expected for the full year.
Note 2 - Accounting Policies
Note 1 to the 2005 Annual Report on Form 10-K filed with the SEC contains a
description of the accounting policies followed by the Company and discussion of
recent accounting pronouncements. The following paragraph updates that
information as necessary.
In September 2006, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 108 (SAB 108). SAB 108 provides guidance on the
consideration of the effects of prior year misstatements in quantifying current
year misstatements for the purpose of a materiality assessment. The bulletin is
effective for the first fiscal year ending after November 15, 2006. The Company
does not expect the adoption of SAB 108 to materially impact the Company's
consolidated financial statements.
In September 2006, the FASB issued Statement of Financial Accounting
Standards No. 157 (Statement 157), "Fair Value Measurements." Statement 157
provides enhanced guidance for using fair value to measure assets and
liabilities. The standard also requires expanded disclosures about the extent to
which companies measure assets and liabilities at fair value, the information
used to measure fair value, and the effect of fair value measurements on
earnings. Statement 157 is effective for financial statements issued for fiscal
years beginning after November 15, 2007, and interim periods within those fiscal
years. The Company does not expect the adoption of Statement 157 to materially
impact the Company's consolidated financial statements.
In September 2006, the FASB issued Statement of Financial Accounting
Standards No. 158 (Statement 158), "Employers' Accounting for Defined Benefit
Pension and Other Postretirement Plans (an amendment of FASB Statements No. 87,
88, 106, and 132R)." Statement 158 requires an employer to: (a) recognize in its
statement of financial position an asset for a plan's overfunded status or a
liability for a plan's underfunded status (b) measure a plan's assets and its
obligations that determine its funded status as of the end of the employer's
fiscal year (with limited exceptions) and (c) recognize changes in the funded
status of a defined benefit postretirement plan in the year in which the changes
occur. Those changes will be reported in comprehensive income. The requirement
to recognize the funded status of a benefit plan and the disclosure requirements
are effective as of the end of the fiscal year ending after December 15, 2006.
The Company has not fully assessed the impact of the adoption of Statement 158
at this time. However, if the provisions of Statement 158 had been applied as of
December 31, 2005, the Company's shareholders' equity would have been reduced by
approximately $6.8 million before tax and approximately $4.1 million after tax.
In July 2006, the Financial Accounting Standards Board (FASB) released FASB
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, an
interpretation of FASB Statement No. 109" (FIN 48). FIN 48 clarifies the
accounting and reporting for uncertainties in income tax law. FIN 48 prescribes
a comprehensive model for the financial statement recognition, measurement,
presentation and disclosure of uncertain tax positions taken or expected to be
taken in income tax returns. The Company will adopt FIN 48 in the first quarter
of 2007. The cumulative effect of applying the provisions of this interpretation
is required to be reported separately as an adjustment to the opening balance of
retained earnings in the year of adoption. The Company is in the process of
reviewing and evaluating FIN 48, and therefore the ultimate impact of its
adoption is not yet known.
Page 8
On January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123 (revised 2004) (Statement 123(R)), "Share-Based Payment."
Statement 123(R) replaces FASB Statement No. 123 (Statement 123), "Accounting
for Stock-Based Compensation," and supersedes Accounting Principles Board
Opinion No. 25 (Opinion 25), "Accounting for Stock Issued to Employees."
Statement 123(R) requires that the compensation cost relating to share-based
payment transactions be recognized in the financial statements. Statement 123(R)
permits public companies to adopt its requirements using one of two methods. The
"modified prospective" method recognizes compensation for all stock options
granted after the date of adoption and for all previously granted stock options
that become vested after the date of adoption. The "modified retrospective"
method includes the requirements of the "modified prospective" method described
above, but also permits entities to restate prior period results based on the
amounts previously presented under Statement 123 for purposes of pro-forma
disclosures. The Company has elected to adopt Statement 123(R) under the
"modified prospective" method and accordingly will not restate prior period
results. See Note 4 for a more detailed description the Company's adoption of
Statement 123(R).
In May 2005, the FASB issued Statement of Financial Accounting Standards
No. 154 (Statement 154), "Accounting Changes and Error Corrections, a
replacement of APB Opinion No. 20 and FASB Statement No. 3." Statement 154
applies to all voluntary changes in accounting principle as well as to changes
required by an accounting pronouncement that does not include specific
transition provisions. Statement 154 eliminates the previous requirement that
the cumulative effect of changes in accounting principle be reflected in the
income statement in the period of change. Instead, to enhance the comparability
of prior period financial statements, Statement 154 requires that changes in
accounting principle be retrospectively applied. Under retrospective
application, the new accounting principle is applied as of the beginning of the
first period presented, as if that principle had always been used. Statement 154
carries forward the requirement that an error be reported by restating prior
period financial statement as of the beginning of the first period. Statement
154 is effective for accounting changes and corrections of errors made in fiscal
years beginning after December 15, 2005. The initial adoption of Statement 154
did not have a material impact on the Company's financial statements; however
the adoption of this statement could result in a material change to the way the
Company reflects future changes in accounting principles, depending on the
nature of future changes in accounting principles and whether specific
transition provisions are included.
Note 3 - Reclassifications
Certain amounts reported in the period ended September 30, 2005 have been
reclassified to conform with the presentation for September 30, 2006. These
reclassifications had no effect on net income (loss) or shareholders' equity for
the periods presented, nor did they materially impact trends in financial
information.
Note 4 - Equity-Based Compensation Plans
At September 30, 2006, the Company had the following equity-based
compensation plans, all of which are stock option plans: the First Bancorp 2004
Stock Option Plan, the First Bancorp 1994 Stock Option Plan, and four plans that
were assumed from acquired entities, which are all described below. The
Company's shareholders approved all equity-based compensation plans, except for
those assumed from acquired companies. As of September 30, 2006, the First
Bancorp 2004 Stock Option Plan was the only plan that had shares available for
future grants.
The First Bancorp 2004 Stock Option Plan and its predecessor plan, the
First Bancorp 1994 Stock Option Plan, were intended to serve as a means of
attracting, retaining and motivating key employees and directors and to
associate the interests of the plans' participants with those of the Company and
its shareholders. Stock option grants to non-employee directors have
historically had no vesting requirements, whereas, except as discussed below,
stock option grants to employees have generally had five-year vesting schedules
(20% vesting each year).
Page 9
In April 2004, the Company granted 128,000 options to employees with no vesting
requirements. These options were granted without any vesting requirements for
two reasons - 1) the options were granted primarily as a reward for past
performance and therefore had already been "earned" in the view of the
Committee, and 2) to potentially minimize the impact that any change in
accounting standards for stock options could have on future years' reported net
income. Employee stock option grants since the April 2004 grant have reverted to
having five year vesting periods. The Company's options provide for immediate
vesting if there is a change in control (as defined in the plans). Under the
terms of these two plans, options can have a term of no longer than ten years,
and all options granted thus far under these plans have had a term of ten years.
Except for grants to directors (see below), the Company cannot estimate the
amount of future stock option grants at this time. In the past, stock option
grants to employees have been irregular, generally falling into three categories
- 1) to attract and retain new employees, 2) to recognize changes in
responsibilities of existing employees, and 3) to periodically reward exemplary
performance. As it relates to directors, the Company has historically granted
2,250 stock options to each of the Company's non-employee directors in June of
each year, and expects to continue doing so for the foreseeable future. At
September 30, 2006, there were 653,658 options outstanding related to these two
plans with exercise prices ranging from $7.83 to $22.12. At September 30, 2006,
there were 1,186,840 shares remaining available for grant under the First
Bancorp 2004 Stock Option Plan.
The Company also has four stock option plans as a result of assuming plans
of acquired companies. At September 30, 2006, there were 38,586 stock options
outstanding in connection with these plans, with option prices ranging from
$10.22 to $11.49.
The Company issues new shares when options are exercised.
Prior to January 1, 2006, the Company accounted for all of these plans
using the intrinsic value method prescribed by Opinion 25 and related
interpretations. Because all of the Company's stock options had an exercise
price equal to the market value of the underlying common stock on the date of
grant, no compensation cost had ever been recognized. On January 1, 2006, the
Company adopted Statement 123(R). Statement 123(R) supersedes Opinion 25 (and
related interpretations) and requires that the compensation cost relating to
share-based payment transactions be recognized in the financial statements.
Statement 123(R) permits public companies to adopt its requirements using one of
two methods. The "modified prospective" method recognizes compensation expense
for all stock options granted after the date of adoption and for all previously
granted stock options that become vested after the date of adoption. The
"modified retrospective" method includes the requirements of the "modified
prospective" method described above, but also permits entities to restate prior
period results based on the amounts previously presented under Statement 123 for
purposes of pro-forma disclosures. The Company has elected to adopt Statement
123(R) under the "modified prospective" method and accordingly will not restate
prior period results.
The Company measures the fair value of each option award on the date of
grant using the Black-Scholes option-pricing model. The Company determines the
assumptions used in the Black-Scholes option pricing model as follows: the
risk-free interest rate is based on the U.S. Treasury yield curve in effect at
the time of the grant; the dividend yield is based on the Company's dividend
yield at the time of the grant (subject to adjustment if the dividend yield on
the grant date is not expected to approximate the dividend yield over the
expected life of the option); the volatility factor is based on the historical
volatility of the Company's stock (subject to adjustment if historical
volatility is reasonably expected to differ from the past); the weighted-average
expected life is based on the historical behavior of employees related to
exercises, forfeitures and cancellations.
Page 10
As noted above, prior to the adoption of Statement 123(R), the Company
applied Opinion 25 to account for its stock options. The following table
illustrates the effect on net income and earnings per share had the Company
accounted for share-based compensation in accordance with Statement 123(R) for
the periods indicated:
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
(In thousands except per share data) 2006 2005 2006 2005
------------ ------------ ------------ ------------
Net income, as reported $ 4,372 (691) 14,158 8,677
Add: Stock-based employee compensation expense
included in reported net income, net of related
tax effects 22 -- 235 --
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (22) (52) (235) (284)
------------ ------------ ------------ ------------
Pro forma net income $ 4,372 (743) 14,158 8,393
============ ============ ============ ============
Earnings per share: Basic-As reported $ 0.31 (0.05) 0.99 0.61
Basic-Pro forma 0.31 (0.05) 0.99 0.59
Diluted-As reported 0.30 (0.05) 0.98 0.60
Diluted-Pro forma 0.30 (0.05) 0.98 0.58
For the three and nine month periods ended September 30, 2006, the Company
recorded stock-based compensation expense in the income statement of $22,000 and
$314,000, respectively, which reduced income before income taxes by those same
amounts for the respective periods. The Company recognized no income tax
benefits in the income statement related to stock-based compensation for the
three month period ended September 30, 2006. The Company recognized $79,000 of
income tax benefits in the income statement for the first nine months of 2006.
Thus, the impact of stock-based compensation expense on net income for the three
months ended September 30, 2006 was to reduce it by $22,000, or less than one
cent basic and diluted earnings share. The impact of stock-based compensation
expense on net income for the nine months ended September 30, 2006 was to reduce
it by $235,000, or approximately 1.6 cents basic and diluted earnings share. The
2006 stock-based compensation expense related to the vesting of several stock
option grants made prior to January 1, 2006, as well as a grant of 29,250
options (2,250 options to each non-employee director of the Company) on June 1,
2006 with no vesting requirements. This compensation expense was reflected as an
adjustment to cash flows from operating activities on the Company's Consolidated
Statement of Cash Flows. At September 30, 2006, the Company had $68,000 of
unrecognized compensation costs related to unvested stock options. The cost is
expected to be amortized over a weighted-average life of 1.9 years, with $12,000
being expensed in the fourth quarter of 2006, $47,000 being expensed in 2007
equally distributed among each of the four quarters, and $3,000 being expensed
in each of 2008, 2009 and 2010, equally distributed among each of the four
quarters of each year. In addition, as discussed above, the Company granted
2,250 options, without vesting requirements, to each of its non-employee
directors on June 1, 2006 and expects to continue this grant on June 1 of each
year thereafter.
As noted above, certain of the Company's stock option grants contain terms
that provide for a graded vesting schedule whereby portions of the award vest in
increments over the requisite service period. As provided for under Statement
123(R), the Company has elected to recognize compensation expense for awards
with graded vesting schedules on a straight-line basis over the requisite
service period for the entire award. Statement 123(R) requires companies to
recognize compensation expense based on the estimated number of stock options
and awards for which service is to be rendered. Over the past five years, there
have only been four forfeitures or expirations, totaling 9,600 options, and
therefore the Company assumes that all options granted will become vested.
Page 11
The Company's only option grants for the first nine months of 2006 and 2005
were grants of 29,250 and 31,500 options to non-employee directors on June 1,
2006 and 2005, respectively (2,250 option per director). The per share
weighted-average fair value of options granted during the nine months ended
September 30, 2006 and September 30, 2005, was $6.79, and $6.68, respectively,
on the date of the grant using the following weighted-average assumptions:
Nine months ended Nine months ended
September 30, 2006 September 30, 2005
------------------ ------------------
Expected dividend yield 3.30% 3.07%
Risk-free interest rate 5.05% 3.84%
Expected life 7 years 7 years
Expected volatility 32.56% 32.99%
The following table presents information regarding the activity during the
first nine months of 2006 related to all of the Company's stock options
outstanding:
All Options Outstanding
------------------------------------------------------------
Weighted
Average
Weighted Remaining Aggregate
Number of Average Contractual Intrinsic Value
Nine months ended September 30, 2006 Shares Exercise Price Term ($000)
------------------------------------------ ------------ ------------ ------------ ------------
Outstanding at the beginning of the period 746,882 $ 15.75
Granted during the period 29,250 21.83
Exercised during the period 79,388 10.08
Forfeited or expired during the period 4,500 6.55
------------
Outstanding at end of period 692,244 $ 16.72 5.5 years $ 2,532
============ ============ ============ ============
Exercisable at September 30, 2006 671,744 $ 16.73 5.4 years $ 2,452
============ ============ ============ ============
The Company received $758,000 and $656,000 as a result of stock option
exercises during the nine months ended September 30, 2006 and 2005,
respectively. The intrinsic value of the stock options exercised during the nine
months ended September 30, 2006 and 2005 was $882,000 and $654,000,
respectively. The Company recorded $94,000 and $100,000 in associated tax
benefits from the exercise of nonqualified stock options during the nine months
ended September 30, 2006 and 2005, respectively. In accordance with Statement
123(R), this benefit is included as a financing activity in the accompanying
Statements of Cash Flows for periods subsequent to the adoption of Statement
123(R), but continues to be reported as an operating activity in periods prior
to its adoption.
The following table presents information regarding the activity during the
first nine months of 2006 related to the Company's stock options outstanding
that are nonvested:
Nonvested Options
----------------------------------
Weighted-Average
Number of Grant-Date
Nine months ended September 30, 2006 Shares Fair Value
------------------------------------------------------------ --------------- ---------------
Nonvested options outstanding at the beginning of the period 67,999 $ 4.75
Granted during the period -- --
Vested during the period (47,499) 4.60
Forfeited or expired during the period -- --
---------------
Nonvested options outstanding at end of period 20,500 $ 5.05
===============
Page 12
Note 5 - Earnings Per Share
Basic earnings per share were computed by dividing net income by the
weighted average common shares outstanding. Diluted earnings per share includes
the potentially dilutive effects of the Company's stock option plan. The
following is a reconciliation of the numerators and denominators used in
computing basic and diluted earnings per share:
For the Three Months Ended September 30,
----------------------------------------------------------------------------
2006 2005
------------------------------------ -------------------------------------
Income Shares Income Shares
($ in thousands except per (Numer- (Denom- Per Share (Numer- (Denom- Per Share
share amounts) ator) inator) Amount ator) inator) Amount
----------------------------- ---------- ---------- ---------- ---------- ---------- ----------
Basic EPS
Net income (loss) $ 4,372 14,294,948 $ 0.31 $ (691) 14,186,887 $ (0.05)
========== ==========
Effect of Dilutive Securities -- 126,432 -- --
---------- ---------- ---------- ----------
Diluted EPS $ 4,372 14,421,380 $ 0.30 $ (691) 14,186,887 $ (0.05)
========== ========== ========== ========== ========== ==========
For the Nine Months Ended September 30,
----------------------------------------------------------------------------
2006 2005
------------------------------------ -------------------------------------
Income Shares Income Shares
($ in thousands except per (Numer- (Denom- Per Share (Numer- (Denom- Per Share
share amounts) ator) inator) Amount ator) inator) Amount
----------------------------- ---------- ---------- ---------- ---------- ---------- ----------
Basic EPS
Net income $ 14,158 14,281,964 $ 0.99 $ 8,677 14,150,527 $ 0.61
========== ==========
Effect of Dilutive Securities -- 143,383 -- 202,642
---------- ---------- ---------- ----------
Diluted EPS $ 14,158 14,425,347 $ 0.98 $ 8,677 14,353,169 $ 0.60
========== ========== ========== ========== ========== ==========
For the three and nine months ended September 30, 2006, there were 220,980
options that were antidilutive because the exercise price exceeded the average
market price for the period. Because the Company reported a net loss for the
three months ended September 30, 2005, all options are considered to be
anti-dilutive. If the Company had reported net income for the three months ended
September 30, 2005, the "Effect of Dilutive Securities" in the table above would
have been 170,840 shares. There were no antidilutive options for the nine months
ended September 30, 2005. Antidilutive options have been omitted from the
calculation of diluted earnings per share for the respective periods.
Page 13
Note 6 - Asset Quality Information
Nonperforming assets are defined as nonaccrual loans, loans past due 90 or
more days and still accruing interest, restructured loans and other real estate.
Nonperforming assets are summarized as follows:
September 30, December 31, September 30,
($ in thousands) 2006 2005 2005
-------------------------------------------- ------------ ------------ ------------
Nonperforming loans:
Nonaccrual loans $ 5,170 1,640 3,330
Restructured loans 11 13 14
Accruing loans > 90 days past due -- -- --
------------ ------------ ------------
Total nonperforming loans 5,181 1,653 3,344
Other real estate 1,799 1,421 2,023
------------ ------------ ------------
Total nonperforming assets $ 6,980 3,074 5,367
============ ============ ============
Nonperforming loans to total loans 0.31% 0.11% 0.23%
Nonperforming assets as a percentage of loans
and other real estate 0.41% 0.21% 0.37%
Nonperforming assets to total assets 0.34% 0.17% 0.31%
Allowance for loan losses to total loans 1.09% 1.06% 1.10%
--------------------------------------------------------------------------------
Note 7 - Deferred Loan Fees
Loans are shown on the Consolidated Balance Sheets net of net deferred loan
costs (fees) of ($79,000), $184,000, and $75,000 at September 30, 2006, December
31, 2005, and September 30, 2005, respectively.
Note 8 - Goodwill and Other Intangible Assets
The following is a summary of the gross carrying amount and accumulated
amortization of amortizable intangible assets as of September 30, 2006, December
31, 2005, and September 30, 2005 and the carrying amount of unamortized
intangible assets as of those same dates.
September 30, 2006 December 31, 2005 September 30, 2005
--------------------------- --------------------------- ---------------------------
Gross Carrying Accumulated Gross Carrying Accumulated Gross Carrying Accumulated
($ in thousands) Amount Amortization Amount Amortization Amount Amortization
------------------------ ------------ ------------ ------------ ------------ ------------ ------------
Amortizable intangible
assets:
Customer lists $ 394 139 394 115 394 108
Noncompete agreements 50 50 50 50 50 50
Core deposit premiums 2,945 1,208 2,441 1,011 2,441 945
------------ ------------ ------------ ------------ ------------ ------------
Total $ 3,389 1,397 2,885 1,176 2,885 1,103
============ ============ ============ ============ ============ ============
Unamortizable intangible
assets:
Goodwill $ 49,489 47,247 47,247
============ ============ ============
Pension $ 237 273 273
============ ============ ============
Amortization expense totaled $100,000 and $71,000 for the three months
ended September 30, 2006 and 2005, respectively. Amortization expense totaled
$221,000 and $217,000 for the nine months ended September 30, 2006 and 2005,
respectively.
Page 14
The following table presents the estimated amortization expense for each of
the five calendar years ending December 31, 2010 and the estimated amount
amortizable thereafter. These estimates are subject to change in future periods
to the extent management determines it is necessary to make adjustments to the
carrying value or estimated useful lives of amortized intangible assets.
Estimated Amortization
(Dollars in thousands) Expense
---------------------- ----------------------
2006 $ 323
2007 374
2008 316
2009 279
2010 262
Thereafter 658
-----------
Total $ 2,212
===========
Note 9 - Pension Plans
The Company sponsors two defined benefit pension plans - a qualified
retirement plan (the "Pension Plan") which is generally available to all
employees, and a Supplemental Executive Retirement Plan (the "SERP Plan"), which
is for the benefit of certain senior management executives of the Company.
The Company recorded pension expense totaling $808,000 and $447,000 for the
three months ended September 30, 2006 and 2005, respectively, related to the
Pension Plan and the SERP Plan. The following table contains the components of
the pension expense for the three months ended September 30, 2006 and 2005.
For the Three Months Ended September 30,
------------------------------------------------------------------------------
2006 2005 2006 2005 2006 Total 2005 Total
(in thousands) Pension Plan Pension Plan SERP Plan SERP Plan Both Plans Both Plans
---------- ---------- ---------- ---------- ---------- ----------
Service cost - benefits earned during the
period $ 359 284 217 62 576 346
Interest cost on projected benefit obligation 222 192 111 38 333 230
Expected return on plan assets (242) (237) -- -- (242) (237)
Net amortization and deferral 57 86 84 22 141 108
---------- ---------- ---------- ---------- ---------- ----------
Net periodic pension cost $ 396 325 412 122 808 447
========== ========== ========== ========== ========== ==========
The Company recorded pension expense totaling $1,970,000 and $1,341,000 for
the nine months ended September 30, 2006 and 2005, respectively, related to the
Pension Plan and the SERP Plan. The following table contains the components of
the pension expense for the nine months ended September 30, 2006 and 2005.
For the Nine Months Ended September 30,
------------------------------------------------------------------------------
2006 2005 2006 2005 2006 Total 2005 Total
(in thousands) Pension Plan Pension Plan SERP Plan SERP Plan Both Plans Both Plans
---------- ---------- ---------- ---------- ---------- ----------
Service cost - benefits earned during the
period $ 1,041 852 375 186 1,416 1,038
Interest cost on projected benefit obligation 676 576 215 114 891 690
Expected return on plan assets (778) (711) -- -- (778) (711)
Net amortization and deferral 295 258 146 66 441 324
---------- ---------- ---------- ---------- ---------- ----------
Net periodic pension cost $ 1,234 975 736 366 1,970 1,341
========== ========== ========== ========== ========== ==========
The Company's contributions to the Pension Plan are based on computations
by independent actuarial consultants and are intended to ensure that the Pension
Plan exceeds minimum funding standards at all times according to standards
established by the Internal Revenue Service. The contributions are invested to
provide for benefits under the Pension Plan. The Company estimates that its
contribution to the Pension Plan will be $1,500,000 during 2006.
Page 15
The Company's funding policy with respect to the SERP Plan is to fund the
related benefits primarily from the operating cash flow of the Company. The
Company estimates that its payments to participants in the SERP Plan will be
$25,000 in 2006.
Note 2 includes discussion of a newly issued accounting standard that will
impact the Company's accounting for its two defined benefit penion plans.
Note 10 - Contingency
The Company recorded a loss amount of $6,320,000, or $0.44 per diluted
share, in the third quarter of 2005 to accrue for contingent tax loss exposure
involving the North Carolina Department of Revenue. In February 2006, the North
Carolina Department of Revenue announced a "Settlement Initiative" that offered
companies with certain transactions that had been challenged by the North
Carolina Department of Revenue the opportunity to resolve such matters with
reduced penalties by agreeing to participate in the initiative by June 15, 2006.
Although the Company believed that its tax returns complied with the relevant
statutes, the Board of Directors of the Company decided that it was in the best
interests of the Company to settle this matter by participating in the
initiative. Based on the terms of the initiative, the Company estimated that its
total liability to settle the matter will be approximately $4.3 million, net of
the federal tax benefit, or $2.0 million less than the amount that was
originally accrued. Accordingly, in March 2006, the Company adjusted its
originally reported 2005 earnings to reflect the impact of this subsequent event
by reducing originally reported tax expense for the three and twelve months
ended December 31, 2005 by $1,982,000, or $0.14 per diluted share. The Company
believes it has fully reserved for this liability and does not have any
additional state income tax exposure other than the ongoing interest that will
continue to accrue ($65,000 per quarter on an after-tax basis) until the
Settlement Initiative is completed and the Company pays the amounts due in
accordance with the settlement, which is expected to occur in the first quarter
of 2007.
Note 11 - Completed Acquisitions
The Company completed two branch acquisitions in the third quarter of 2006
as follows:
(a) On July 7, 2006, the Company completed the purchase of a branch of
First Citizens Bank located in Dublin, Virginia. The Company assumed the
branch's $21 million in deposits and did not purchase any loans in this
transaction. The primary reason for this acquisition was to increase the
Company's presence in southwestern Virginia, a market in which the Company
already had three branches with a large customer base. The Company paid a
deposit premium for the branch of approximately $994,000, all of which is
deductible for tax purposes. The identifiable intangible asset associated with
the fair value of the core deposit base, as determined by an independent
consulting firm, was determined to be $269,000 and is being amortized as expense
on an accelerated basis over an eight year period based on an amortization
schedule provided by the consulting firm. The remaining intangible asset of
$725,000 has been classified as goodwill, and thus is not being systematically
amortized, but rather is subject to an annual impairment test. The primary
factors that contributed to a purchase price that resulted in recognition of
goodwill were the Company's desire to expand its presence in southwestern
Virginia with facilities, operations and experienced staff in place. This
branch's operations are included in the accompanying Consolidated Statements of
Income beginning on the acquisition date of July 7, 2006. Historical pro forma
information is not presented due to the immateriality of this transaction to the
overall consolidated financial statements of the Company.
(b) On September 1, 2006, the Company completed the purchase of a branch of
Bank of the Carolinas in Carthage, North Carolina. The Company assumed the
branch's $24 million in deposits and $6 million in loans. The primary reason for
this acquisition was to increase the Company's presence in Moore County, a
market in which the Company already had ten branches with a large customer base.
The Company paid a deposit premium for the branch of approximately $1,754,000,
all of which is deductible for tax purposes. The identifiable intangible asset
associated with the fair value of the core deposit base, as determined by an
independent consulting firm, was determined to be approximately $235,000 and is
being amortized as expense on an accelerated basis over a ten year period based
on an amortization schedule provided by the consulting firm. The remaining
intangible asset of $1,519,000 has been classified as goodwill, and thus is not
being systematically amortized, but rather is subject to an annual impairment
test. The primary factors that contributed to a purchase price that resulted in
recognition of goodwill were the Company's desire to expand in an existing
high-growth market with facilities, operations and
Page 16
experienced staff in place. This branch's operations are included in the
accompanying Consolidated Statements of Income beginning on the acquisition date
of September 1, 2006. Historical pro forma information is not presented due to
the immateriality of this transaction to the overall consolidated financial
statements of the Company.
Page 17
Item 2 - Management's Discussion and Analysis of Consolidated Results of
Operations and Financial Condition
CRITICAL ACCOUNTING POLICIES
The accounting principles followed by the Company and the methods of
applying these principles conform with accounting principles generally accepted
in the United States of America and with general practices followed by the
banking industry. Certain of these principles involve a significant amount of
judgment and/or use of estimates based on the Company's best assumptions at the
time of the estimation. The Company has identified three policies as being more
sensitive in terms of judgments and estimates, taking into account their overall
potential impact to the Company's consolidated financial statements - 1) the
allowance for loan losses, 2) tax uncertainties, and 3) intangible assets.
Allowance for Loan Losses
Due to the estimation process and the potential materiality of the amounts
involved, the Company has identified the accounting for the allowance for loan
losses and the related provision for loan losses as an accounting policy
critical to the Company's consolidated financial statements. The provision for
loan losses charged to operations is an amount sufficient to bring the allowance
for loan losses to an estimated balance considered adequate to absorb losses
inherent in the portfolio.
Management's determination of the adequacy of the allowance is based
primarily on a mathematical model that estimates the appropriate allowance for
loan losses. This model has two components. The first component involves the
estimation of losses on loans defined as "impaired loans." A loan is considered
to be impaired when, based on current information and events, it is probable the
Company will be unable to collect all amounts due according to the contractual
terms of the loan agreement. The estimated valuation allowance is the
difference, if any, between the loan balance outstanding and the value of the
impaired loan as determined by either 1) an estimate of the cash flows that the
Company expects to receive from the borrower discounted at the loan's effective
rate, or 2) in the case of a collateral-dependent loan, the fair value of the
collateral.
The second component of the allowance model is to estimate losses for all
loans not considered to be impaired loans. First, loans that have been risk
graded by the Company as having more than "standard" risk but are not considered
to be impaired are assigned estimated loss percentages generally accepted in the
banking industry. Loans that are classified by the Company as having normal
credit risk are segregated by loan type, and estimated loss percentages are
assigned to each loan type, based on the historical losses, current economic
conditions, and operational conditions specific to each loan type.
The reserve estimated for impaired loans is then added to the reserve
estimated for all other loans. This becomes the Company's "allocated allowance."
In addition to the allocated allowance derived from the model, management also
evaluates other data such as the ratio of the allowance for loan losses to total
loans, net loan growth information, nonperforming asset levels and trends in
such data. Based on this additional analysis, the Company may determine that an
additional amount of allowance for loan losses is necessary to reserve for
probable losses. This additional amount, if any, is the Company's "unallocated
allowance." The sum of the allocated allowance and the unallocated allowance is
compared to the actual allowance for loan losses recorded on the books of the
Company and any adjustment necessary for the recorded allowance to equal the
computed allowance is recorded as a provision for loan losses. The provision for
loan losses is a direct charge to earnings in the period recorded.
Although management uses the best information available to make
evaluations, future adjustments may be necessary if economic, operational, or
other conditions change. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the Company's
allowance for loan losses. Such agencies may require the Company to recognize
additions to the allowance based on the examiners' judgment about information
available to them at the time of their examinations.
Page 18
For further discussion, see "Nonperforming Assets" and "Summary of Loan
Loss Experience" below.
Tax Uncertainties
The Company reserves for tax uncertainties in instances when it has taken a
position on a tax return that may differ from the opinion of the applicable
taxing authority. In accounting for tax contingencies, the Company assesses the
relative merits and risks of certain tax transactions, taking into account
statutory, judicial and regulatory guidance in the context of the Company's tax
position. For those matters where it is probable that the Company will have to
pay additional taxes, interest or penalties and a loss or range of losses can be
reasonably estimated, the Company records reserves in the consolidated financial
statements. For those matters where it is reasonably possible but not probable
that the Company will have to pay additional taxes, interest or penalties and
the loss or range of losses can be reasonably estimated, the Company only makes
disclosures in the notes and does not record reserves in the consolidated
financial statements. The process of concluding that a loss is reasonably
possible or probable and estimating the amount of loss or range of losses and
related tax reserves is inherently subjective and future changes to the reserve
may be necessary based on changes in management's intent, tax law or related
interpretations, or other functions.
See Note 10 to the Consolidated Financial Statements above for information
related to a tax loss contingency accrual that was recorded in 2005.
Intangible Assets
Due to the estimation process and the potential materiality of the amounts
involved, the Company has also identified the accounting for intangible assets
as an accounting policy critical to the Company's consolidated financial
statements.
When the Company completes an acquisition transaction, the excess of the
purchase price over the amount by which the fair market value of assets acquired
exceeds the fair market value of liabilities assumed represents an intangible
asset. The Company must then determine the identifiable portions of the
intangible asset, with any remaining amount classified as goodwill. Identifiable
intangible assets associated with these acquisitions are generally amortized
over the estimated life of the related asset, whereas goodwill is tested
annually for impairment, but not systematically amortized. Assuming no goodwill
impairment, it is beneficial to the Company's future earnings to have a lower
amount assigned to identifiable intangible assets and higher amount of goodwill
as opposed to having a higher amount considered to be identifiable intangible
assets and a lower amount classified as goodwill.
For the Company, the primary identifiable intangible asset typically
recorded in connection with a whole-bank or bank branch acquisition is the value
of the core deposit intangible, whereas when the Company acquires an insurance
agency, the primary identifiable intangible asset is the value of the acquired
customer list. Determining the amount of identifiable intangible assets and
their average lives involves multiple assumptions and estimates and is typically
determined by performing a discounted cash flow analysis, which involves a
combination of any or all of the following assumptions: customer
attrition/runoff, alternative funding costs, deposit servicing costs, and
discount rates. The Company typically engages a third party consultant to assist
in each analysis. For the whole-bank and bank branch transactions recorded to
date, the core deposit intangible in each case has been estimated to have
approximately a ten year life, with an accelerated rate of amortization. For
insurance agency acquisitions, the identifiable intangible assets related to the
customer lists were determined to have a life of ten to fifteen years, with
amortization occurring on a straight-line basis.
Subsequent to the initial recording of the identifiable intangible assets
and goodwill, the Company amortizes the identifiable intangible assets over
their estimated average lives, as discussed above. In addition, on at least an
annual basis, goodwill is evaluated for impairment by comparing the fair value
of the Company's reporting units to their related carrying value, including
goodwill (the Company's community banking operation is its only material
reporting unit). At its last evaluation, the fair value of the Company's
community banking operation exceeded its
Page 19
carrying value, including goodwill. If the carrying value of a reporting unit
were ever to exceed its fair value, the Company would determine whether the
implied fair value of the goodwill, using a discounted cash flow analysis,
exceeded the carrying value of the goodwill. If the carrying value of the
goodwill exceeded the implied fair value of the goodwill, an impairment loss
would be recorded in an amount equal to that excess. Performing such a
discounted cash flow analysis would involve the significant use of estimates and
assumptions.
The Company reviews identifiable intangible assets for impairment whenever
events or changes in circumstances indicate that the carrying value may not be
recoverable. The Company's policy is that an impairment loss is recognized,
equal to the difference between the asset's carrying amount and its fair value,
if the sum of the expected undiscounted future cash flows is less than the
carrying amount of the asset. Estimating future cash flows involves the use of
multiple estimates and assumptions, such as those listed above.
Current Accounting Matters
See Note 2 to the Consolidated Financial Statements above as it relates to
accounting standards that have been recently adopted by the Company.
RESULTS OF OPERATIONS
Overview
The Company recorded net income of $4,372,000, or $0.30 per diluted share
for the three months ended September 30, 2006, compared to a net loss of
$691,000, or $0.05 per diluted share, recorded in the third quarter of 2005. Net
income for the nine months ended September 30, 2006 was $14,158,000, or $0.98
per diluted share, a 63.3% increase in diluted earnings per share from the net
income of $8,677,000, or $0.60 per diluted share, reported for the nine months
ended September 30, 2005.
Results for 2006 include the write-off loss of a merchant credit card
receivable amounting to $1,900,000, of which $230,000 was recorded in the second
quarter of 2006 and the remaining $1,670,000 was recorded in the third quarter
of 2006. The after-tax impact on net income for the second quarter of 2006 was
$139,000, or $0.01 per diluted share, and the after-tax impact on net income for
the third quarter of 2006 was $1,010,000, or $0.07 per diluted share. Results
for 2005 include a loss accrual related to income tax exposure amounting to
$6,320,000 (after-tax), or $0.44 per diluted share, which was recorded in the
third quarter of 2005. Both of these items are discussed in more detail below.
Growth in loans and deposits was the primary reason for the increases in
the Company's net interest income when comparing the three and nine month
periods in 2006 to the comparable periods of 2005. Net interest income for the
third quarter of 2006 amounted to $19.0 million, a 9.7% increase over the $17.4
million recorded in the third quarter of 2005. Net interest income for the nine
months ended September 30, 2006 amounted to $55.3 million, a 9.3% increase over
the $50.6 million recorded in the same nine month period in 2005.
The impact of the growth in loans and deposits on the Company's net
interest income was partially offset by declines in the Company's net interest
margin (tax-equivalent net interest income divided by average earning assets).
The Company's net interest margin for the third quarter of 2006 was 4.12%
compared to 4.32% for the third quarter of 2005. The Company's net interest
margin for the first nine months of 2006 was 4.22% compared to 4.32% for the
same nine months of 2005. The 4.12% net interest margin realized in the third
quarter of 2006 was a 10 basis point decrease from the second quarter of 2006
net interest margin of 4.22%, and a 21 basis point decrease from the first
quarter of 2006 net interest margin of 4.33%. The compressing margin is
primarily due to deposit rates paid by the Company rising by more than loan and
investment yields, which is associated with the flat interest rate yield curve
currently prevailing in the marketplace. The Company has also been negatively
impacted by customers shifting their funds from low cost deposits to higher cost
deposits as rates have risen.
Page 20
The Company's provision for loan losses amounted to $1,215,000 in the third
quarter of 2006, an increase of 76.1% over the $690,000 recorded in the third
quarter of 2005. The provision for loan losses for the first nine months of 2006
was $3,630,000, an increase of 71.6% over the $2,115,000 recorded in first nine
months of 2005. The higher provisions are a result of the strong loan growth
realized in 2006, as asset quality ratios have remained stable and compare
favorably to peers. Net internal loan growth was $55 million in the third
quarter of 2006 compared to $20 million in the third quarter of 2005, while net
internal loan growth was $208 million for the first nine months of 2006 compared
to $79 million for the first nine months of 2005. The Company's ratios of
annualized net charge-offs to average loans were 11 basis points and 8 basis
points for the three and nine month periods in 2006, respectively, compared to
12 basis points and 9 basis points for the three and nine month periods in 2005,
respectively. The Company's ratio of nonperforming assets to total assets was
0.34% at September 30, 2006 compared to 0.31% a year earlier.
Noninterest income amounted to $2,454,000 for the third quarter of 2006, a
35.1% decrease from the $3,779,000 recorded in the third quarter of 2005.
Noninterest income for the nine months ended September 30, 2006 amounted to
$10,252,000, a decrease of 8.5% from the $11,201,000 recorded in the first nine
months of 2005. The decreases in 2006 were caused by the write-off loss of a
merchant credit card receivable that is discussed in more detail below.
Noninterest expenses amounted to $13.5 million in the third quarter of
2006, a 17.8% increase over the $11.5 million recorded in the third quarter of
2005. Noninterest expenses for the nine months ended September 30, 2006 amounted
to $39.3 million, a 10.9% increase from the $35.5 million recorded in the first
nine months of 2005. The increase in noninterest expenses is primarily
attributable to costs associated with the Company's overall growth in loans,
deposits and branch network.
The Company's effective tax rate was approximately 35% and 37% for the
three and nine month periods ended September 30, 2006, respectively. The Company
recorded a tax benefit of $182,000 in the third quarter of 2006 related to
several nonrecurring adjustments that reduced otherwise reported income tax
expense. The Company's income tax expense for the three and nine months ended
September 30, 2005 included a loss accrual related to income tax exposure
amounting to $6,320,000 (after-tax), or $0.44 per diluted share, which was
recorded in the third quarter of 2005 and is discussed in more detail below.
The Company's annualized return on average assets for the third quarter of
2006 was 0.88% compared to (0.16%) for the third quarter of 2005. The Company's
annualized return on average assets for the nine months ended September 30, 2006
was 1.00% compared to 0.69% for the comparable period of 2005.
The Company's annualized return on average equity for the third quarter of
2006 was 10.54% compared to (1.73%) for the third quarter of 2005. The Company's
annualized return on average equity for the nine months ended September 30, 2006
was 11.70% compared to 7.49% for the first nine months of 2005.
Components of Earnings
Net interest income is the largest component of earnings, representing the
difference between interest and fees generated from earning assets and the
interest costs of deposits and other funds needed to support those assets.
Net interest income for the three month period ended September 30, 2006
amounted to $19,041,000, an increase of $1,689,000, or 9.7%, from the
$17,352,000 recorded in the third quarter of 2005. Net interest income on a
taxable equivalent basis for the three months ended September 30, 2006, amounted
to $19,174,000, an increase of $1,711,000, or 9.8%, from the $17,463,000
recorded in the third quarter of 2005. Management believes that analysis of net
interest income on a tax-equivalent basis is useful and appropriate because it
allows a comparison of net interest income amounts in different periods without
taking into account the different mix of taxable versus non-taxable investments
that may have existed during those periods.
Net interest income for the nine months ended September 30, 2006 amounted
to $55,338,000 an increase of
Page 21
$4,694,000, or 9.3%, from the $50,644,000 recorded in the first nine months of
2005. Net interest income on a taxable equivalent basis for the nine months
ended September 30, 2006 amounted to $55,722,000, an increase of $4,743,000, or
9.3%, from the $50,979,000 recorded in the first nine months of 2005.
There are two primary factors that cause changes in the amount of net
interest income recorded by the Company - 1) growth in loans and deposits, and
2) the Company's net interest margin. For the three and nine month periods ended
September 30, 2006, growth in loans and deposits were the primary causes for the
increases in net interest income, as the Company's net interest margins in 2006
were lower than those realized in 2005.
For internal purposes and in the discussion that follows, the Company
evaluates its net interest income on a tax-equivalent basis by adding the tax
benefit realized from tax-exempt securities to reported interest income. The
following tables present net interest income analysis on a taxable-equivalent
basis.
For the Three Months Ended September 30,
-----------------------------------------------------------------------------
2006 2005
------------------------------------- -------------------------------------
Interest Interest
Average Average Earned Average Average Earned
($ in thousands) Volume Rate or Paid Volume Rate or Paid
---------- ---------- ---------- ---------- ---------- ----------
Assets
Loans (1) $1,669,423 7.54% $ 31,727 $1,433,874 6.71% $ 24,240
Taxable securities 123,168 4.69% 1,456 118,927 4.39% 1,315
Non-taxable securities (2) 10,668 10.15% 273 10,438 8.55% 225
Short-term investments 41,301 5.61% 584 41,144 3.84% 398
---------- ---------- ---------- ----------
Total interest-earning assets 1,844,560 7.32% 34,040 1,604,383 6.47% 26,178
---------- ----------
Liabilities
Savings, NOW and money
market deposits $ 491,630 1.59% $ 1,976 $ 465,089 0.89% $ 1,042
Time deposits >$100,000 397,393 4.66% 4,668 347,057 3.45% 3,015
Other time deposits 529,120 4.23% 5,646 468,170 2.99% 3,532
---------- ---------- ---------- ----------
Total interest-bearing deposits 1,418,143 3.44% 12,290 1,280,316 2.35% 7,589
Securities sold under agreements
to repurchase 28,712 3.81% 276 6,276 2.59% 41
Borrowings 136,972 6.66% 2,300 79,367 5.42% 1,085
---------- ---------- ---------- ----------
Total interest-bearing liabilities 1,583,827 3.72% 14,866 1,365,959 2.53% 8,715
---------- ----------
Non-interest-bearing deposits 205,462 186,867
Net yield on interest-earning
assets and net interest income 4.12% $ 19,174 4.32% $ 17,463
========== ==========
Interest rate spread 3.60% 3.94%
Average prime rate 8.25% 6.42%
--------------------------------------------------------------------------------
(1) Average loans include nonaccruing loans, the effect of which is to lower the
average rate shown.
(2) Includes tax-equivalent adjustments of $133,000 and $111,000 in 2006 and
2005, respectively, to reflect the tax benefit that the Company receives
related to its tax-exempt securities, which carry interest rates lower than
similar taxable investments due to their tax exempt status. This amount has
been computed assuming a 39% tax rate and is reduced by the related
nondeductible portion of interest expense.
--------------------------------------------------------------------------------
Page 22
For the Nine Months Ended September 30,
-----------------------------------------------------------------------------
2006 2005
------------------------------------- -------------------------------------
Interest Interest
Average Average Earned Average Average Earned
($ in thousands) Volume Rate or Paid Volume Rate or Paid
---------- ---------- ---------- ---------- ---------- ----------
Assets
Loans (1) $1,592,983 7.36% $ 87,704 $1,408,736 6.49% $ 68,331
Taxable securities 118,750 4.71% 4,187 113,785 4.56% 3,881
Non-taxable securities (2) 11,516 9.03% 778 10,830 8.58% 695
Short-term investments 40,525 5.45% 1,652 44,780 3.34% 1,117
---------- ---------- ---------- ----------
Total interest-earning assets 1,763,774 7.15% 94,321 1,578,131 6.27% 74,024
---------- ----------
Liabilities
Savings, NOW and money
market deposits $ 478,316 1.38% $ 4,944 $ 472,361 0.82% $ 2,881
Time deposits >$100,000 381,029 4.39% 12,519 349,677 3.09% 8,085
Other time deposits 510,442 3.95% 15,082 446,894 2.70% 9,013
---------- ---------- ---------- ----------
Total interest-bearing deposits 1,369,787 3.18% 32,545 1,268,932 2.11% 19,979
Securities sold under agreements
to repurchase 29,376 3.69% 811 2,232 2.58% 43
Other, principally borrowings 106,648 6.57% 5,243 77,521 5.21% 3,023
---------- ---------- ---------- ----------
Total interest-bearing liabilities 1,505,811 3.43% 38,599 1,348,685 2.28% 23,045
---------- ----------
Non-interest-bearing deposits 203,064 180,667
Net yield on interest-earning
assets and net interest income 4.22% $ 55,722 4.32% $ 50,979
========== ==========
Interest rate spread 3.72% 3.99%
Average prime rate 7.86% 5.93%
--------------------------------------------------------------------------------
(1) Average loans include nonaccruing loans, the effect of which is to lower the
average rate shown.
(2) Includes tax-equivalent adjustments of $384,000 and $335,000 in 2006 and
2005, respectively, to reflect the tax benefit that the Company receives
related to its tax-exempt securities, which carry interest rates lower than
similar taxable investments due to their tax exempt status. This amount has
been computed assuming a 39% tax rate and is reduced by the related
nondeductible portion of interest expense.
--------------------------------------------------------------------------------
Average loans outstanding for the third quarter of 2006 were $1.669
billion, which was 16.4% higher than the average loans outstanding for the third
quarter of 2005 ($1.434 billion). Average loans outstanding for the nine months
ended September 30, 2006 were $1.593 billion, which was 13.1% higher than the
average loans outstanding for the nine months ended September 30, 2005 ($1.409
billion).
The mix of the Company's loan portfolio remained substantially the same at
September 30, 2006 compared to December 31, 2005, with approximately 87% of the
Company's loans being real estate loans, 9% being commercial, financial, and
agricultural loans, and the remaining 4% being consumer installment loans. The
majority of the Company's real estate loans are personal and commercial loans
where real estate provides additional security for the loan.
Average total deposits outstanding for the third quarter of 2006 were
$1.624 billion, which was 10.7% higher than the average deposits outstanding for
the third quarter of 2005 ($1.467 billion). Average deposits outstanding for the
nine months ended September 30, 2006 were $1.573 billion, which was 8.5% higher
than the average deposits outstanding for the nine months ended September 30,
2005 ($1.450 billion). Generally, the Company can reinvest funds from deposits
at higher yields than the interest rate being paid on those deposits, and
therefore increases in deposits typically result in higher amounts of net
interest income for the Company.
See additional discussion regarding the nature of the growth in loans and
deposits in the section entitled "Financial Condition" below. The effect of the
higher amounts of average loans and deposits was to increase net interest income
in 2006.
Page 23
As derived from the tables above, yields on interest earning assets and
liabilities are higher for the periods presented in 2006 compared to 2005, which
is a result of the rising rate environment that began in the third quarter of
2004. From July 1, 2004 to September 30, 2006, the Federal Reserve raised
short-term interest rates 17 times totaling 425 basis points. The tables also
indicate that the interest-bearing liability rates paid by the Company have
risen by more than yields realized on interest-earning assets. For each of the
three and nine month periods ended September 30, 2006, interest-earning asset
yields have increased by 85-88 basis points, whereas the average rate paid on
interest-bearing liabilities has risen by 115-119 basis points. This narrowing
spread was caused by rates paid on most of the Company's categories of
interest-bearing liabilities increasing by more than the increases in yields
realized on most of the Company's earning assets, which was primarily caused by
the flat interest rate yield curve prevailing in the marketplace. The spread has
also been negatively impacted by customers shifting their funds from low cost
deposits to high cost deposits as rates have risen. As a result of the narrowed
interest rate spread, the Company's net interest margin (tax-equivalent net
interest income divided by average earning assets) has declined in 2006, with
the Company's net interest margin amounting to 4.12% in the third quarter of
2006 compared to 4.32% in the third quarter of 2005, and the Company's net
interest margin amounting to 4.22% for the nine months ended September 30, 2006
compared to 4.32% for the same nine months of 2005.
See additional information regarding net interest income in the section
entitled "Interest Rate Risk" (Item 3 below).
The provision for loan losses amounted to $1,215,000 in the third quarter
of 2006 compared to $690,000 in the third quarter of 2005, and the provision for
loan losses for the first nine months of 2006 was $3,630,000 compared to
$2,115,000 for the first nine months of 2005. The higher provisions for loan
losses in 2006 compared to 2005 are a result of the strong loan growth realized
in 2006, as asset quality ratios have remained stable and compare favorably to
peers. Net internal loan growth was $55 million in the third quarter of 2006
compared to $20 million in the third quarter of 2005, while net internal loan
growth was $208 million for the first nine months of 2006 compared to $79
million for the first nine months of 2005. The Company's ratios of annualized
net charge-offs to average loans were 11 basis points and 8 basis points for the
three and nine month periods in 2006, respectively, compared to 12 basis points
and 9 basis points for the three and nine month periods in 2005, respectively.
The Company's level of nonperforming assets to total assets was 0.34% at
September 30, 2006 compared to 0.31% a year earlier
Noninterest income amounted to $2,454,000 for the third quarter of 2006, a
35.1% decrease from $3,779,000 recorded in the third quarter of 2005.
Noninterest income for the nine months ended September 30, 2006 amounted to
$10,252,000, a decrease of 8.5% from the $11,201,000 recorded in the first nine
months of 2005. The decreases in 2006 were caused by the write-off loss of a
merchant credit card receivable. During the second quarter of 2006, the Company
discovered that it had liability associated with a customer that sold furniture
over the internet. The furniture store did not deliver furniture that its
customers had ordered and paid for, and was unable to immediately refund their
credit card purchases. As the furniture store's credit card processor, the
Company became liable for the amounts that were required to be refunded. During
the second quarter of 2006, the furniture store changed management, stated its
intention to repay the Company for all funds advanced, and began making
repayments to the Company. At June 30, 2006, the Company recorded a $230,000
loss to reserve for this situation. During the third quarter of 2006, the
furniture store's financial condition deteriorated significantly. Accordingly,
the Company determined that it should fully reserve for the entire $1.9 million
exposure associated with this situation, which resulted in recording an
additional loss of $1,670,000. The owners of the furniture store continue to
state their intent to repay the Company, but at this time their ability to do so
is uncertain. During the third quarter of 2006, the Company completed a review
of all merchant credit card customers and concluded that this situation appears
to be an isolated event that is not likely to recur.
Noninterest income was positively impacted in 2006 as a result of higher
"other service charges, commissions, and fees." This category of noninterest
income includes items such as credit card interchange income related to
merchants and customers, debit card interchange income, ATM charges, safety
deposit box rentals, fees from sales of personalized checks, and check cashing
fees. This category of income grew primarily because of increases in these
activity-related fee services as a result of the increased acceptance and
popularity of debit cards, as well as the overall growth in the Company's total
customer base. Other service charges, commissions and fees amounted to
$1,102,000 in the third quarter of 2006, a
Page 24
14.7% increase from the $961,000 recorded in the third quarter of 2005. Other
service charges, commissions and fees amounted to $3,426,000 for the first nine
months of 2006, a 16.1% increase from the $2,950,000 recorded through September
30, 2005.
Noninterest income for the nine months ended September 30, 2006 was
negatively impacted by a decrease in data processing income, which declined by
$130,000 when comparing the first nine months of 2006 to the comparable period
in 2005. At January 1, 2005, the Company had five community bank customers using
this service. Three of these customers terminated their contracts with the
Company in the latter half of 2005, which resulted in the decrease in data
processing fee income. The Company intends to continue to market this service to
area banks, but does not currently have any near-term prospects for additional
business.
Also impacting noninterest income were securities gains in the amount of
$205,000 in 2006 and $2,000 in 2005, each of which was recorded in the second
quarter of the respective year.
Noninterest expenses amounted to $13.5 million in the third quarter of
2006, a 17.8% increase over the $11.5 million recorded in the third quarter of
2005. Noninterest expenses for the nine months ended September 30, 2006 amounted
to $39.3 million, a 10.9% increase from the $35.5 million recorded in the first
nine months of 2005. The increase in noninterest expenses is primarily
attributable to costs associated with the Company's overall growth in loans,
deposits and branch network. Since January 1, 2005, the Company's loans and
deposits have increased by 24% and 20%, respectively. Additionally, in
accordance with the new accounting requirements regarding stock-based
compensation (FASB Statement 123(R)) that were effective on January 1, 2006, the
Company recorded stock option expense of $22,000 ($22,000 after-tax effect) and
$314,000 ($235,000 after-tax effect) for the three and nine month periods ended
September 30, 2006, respectively. As permitted by previous accounting standards,
no stock option expense was recorded by the Company in 2005, or any prior
periods. Noninterest expenses for the nine months ended September 30, 2005 were
also impacted by approximately $500,000 in the following miscellaneous expenses,
all of which were recorded in the second quarter of 2005: immediately vested
post-retirement benefits granted to the Company's CEO totaling $196,000,
external Sarbanes-Oxley costs related to the prior year Sarbanes-Oxley
certification of $181,000, and public relation expenses of $123,000 associated
with the Company's sponsorship of the 2005 U.S. Open Golf Tournament that was
held in the Company's largest market - Moore County, North Carolina.
The Company's effective tax rate was approximately 35% and 37% for the
three and nine month periods ended September 30, 2006, respectively. The Company
recorded a tax benefit of $182,000 in the third quarter of 2006 related to
several nonrecurring adjustments that reduced otherwise reported income tax
expense. The Company's income tax expense for the three and nine months ended
September 30, 2005 includes a loss accrual related to income tax exposure
amounting to $6,320,000 (after-tax), or $0.44 per diluted share, which was
recorded in the third quarter of 2005. As discussed more fully in the Company's
2005 Form 10-K filed with the Securities and Exchange Commission, during the
third quarter of 2005, the Company recorded a $6,320,000 loss accrual to reserve
for an audit issue raised by the North Carolina Department of Revenue related to
the Company's operating structure that the Department of Revenue deemed to
result in improper "income shifting." This reserve was subsequently reduced in
the fourth quarter of 2005 by $1,982,000, or $0.14 per diluted share, as a
result of a "Settlement Initiative" offered by the North Carolina Department of
Revenue that offered companies with certain transactions, including those that
applied to the Company, the opportunity to resolve such matters with reduced
penalties by agreeing to participate in the initiative. The Company continues to
participate in the initiative and expects the matter to be resolved and all
amounts paid by March 15, 2007. The aspects of the Company's operating structure
that gave rise to this issue were discontinued effective January 1, 2005, and
thus the Company does not believe it has any additional exposure related to this
item beyond the amount of the accrual, other than ongoing interest on the unpaid
taxes amounting to $65,000 per quarter (after-tax).
The Consolidated Statements of Comprehensive Income reflect "Other
Comprehensive Income" of $955,000 during the third quarter of 2006 and "Other
Comprehensive Loss" of $208,000 for the nine months ended September 30, 2006,
compared to "Other Comprehensive Loss" of $502,000 for the third quarter of 2005
and "Other Comprehensive Loss" of $817,000 for the nine months ended September
30, 2005. The primary
Page 25
component of other comprehensive income/loss for the periods presented relates
to changes in unrealized holding gains/losses of the Company's available for
sale securities. The Company's available for sale securities portfolio is
predominantly comprised of fixed rate bonds that increase in value when market
yields for fixed rate bonds decrease and decline in value when market yields for
fixed rate bonds increase.
FINANCIAL CONDITION
Total assets at September 30, 2006 amounted to $2.08 billion, 18.2% higher
than a year earlier. Total loans at September 30, 2006 amounted to $1.70
billion, a 17.3% increase from a year earlier, and total deposits amounted to
$1.66 billion at September 30, 2006, a 12.8% increase from a year earlier.
The following tables present information regarding the nature of the
Company's growth since September 30, 2005.
Balance at Balance at Total Percentage growth,
October 1, 2005 to beginning of Internal Growth from end of percentage excluding
September 30, 2006 period Growth Acquisitions period growth acquisitions
------------------------------ ------------ ------------ ------------ ------------ ------------ --------------
($ in thousands)
Loans $ 1,446,185 244,901 5,749 1,696,835 17.3% 16.9%
============ ============ ============ ============
Deposits - Noninterest bearing $ 192,399 15,136 4,974 212,509 10.5% 7.9%
Deposits - Savings, NOW, and
Money Market 460,709 24,497 11,891 497,097 7.9% 5.3%
Deposits - Time>$100,000 349,620 56,759 4,799 411,178 17.6% 16.2%
Deposits - Time<$100,000 472,800 49,005 22,313 544,118 15.1% 10.4%
------------ ------------ ------------ ------------
Total deposits $ 1,475,528 145,397 43,977 1,664,902 12.8% 9.9%
============ ============ ============ ============
January 1, 2006 to
September 30, 2006
------------------------------
Loans $ 1,482,611 208,475 5,749 1,696,835 14.4% 14.1%
============ ============ ============ ============
Deposits - Noninterest bearing $ 194,051 13,484 4,974 212,509 9.5% 6.9%
Deposits - Savings, NOW, and
Money Market 458,221 26,985 11,891 497,097 8.5% 5.9%
Deposits - Time>$100,000 356,281 50,098 4,799 411,178 15.4% 14.1%
Deposits - Time<$100,000 486,024 35,781 22,313 544,118 12.0% 7.4%
------------ ------------ ------------ ------------
Total deposits $ 1,494,577 126,348 43,977 1,664,902 11.4% 8.5%
============ ============ ============ ============
As noted in the tables above, a portion of the loan and deposit growth can
be attributed to the two branch acquisitions that were completed during the
third quarter of 2006. The Company obtained a total of $44 million in deposits
and $6 million in loans from the two branch acquisitions.
The Company experienced solid internal loan and deposit growth during the
first nine months of 2006, with loans increasing by $208 million, or 18.7% on an
annualized basis, and deposits increasing by $126 million, or 11.3% on an
annualized basis. For the twelve months ended September 30, 2006, the Company's
loans grew internally by $245 million, or 16.9%, and deposits increased
internally by $145 million, or 9.9%. The Company opened two de novo branches and
two loan production offices in 2005, while in the first half of 2006, the
Company opened one loan production office and upgraded one loan production
office to a full service branch. Each of these new offices has contributed to
the internal growth. In the fourth quarter of 2006, the Company plans to convert
two loan production offices to full service branches and to open two additional
full service branches, with all four new branches being located in the
southeastern coastal region of North Carolina.
The mix of the Company's loan portfolio remains substantially the same at
September 30, 2006 compared to
Page 26
December 31, 2005, with approximately 87% of the Company's loans being real
estate loans, 9% being commercial, financial, and agricultural loans, and the
remaining 4% being consumer installment loans. The majority of the Company's
real estate loans are personal and commercial loans where real estate provides
additional security for the loan.
Nonperforming Assets
Nonperforming assets are defined as nonaccrual loans, loans past due 90 or
more days and still accruing interest, restructured loans and other real estate.
Nonperforming assets are summarized as follows:
September 30, December 31, September 30,
($ in thousands) 2006 2005 2005
-----------------------------------------------------------------------------------------------
Nonperforming loans:
Nonaccrual loans $ 5,170 1,640 3,330
Restructured loans 11 13 14
Accruing loans > 90 days past due -- -- --
------------- ------------- -------------
Total nonperforming loans 5,181 1,653 3,344
Other real estate 1,799 1,421 2,023
------------- ------------- -------------
Total nonperforming assets $ 6,980 3,074 5,367
============= ============= =============
Nonperforming loans to total loans 0.31% 0.11% 0.23%
Nonperforming assets as a percentage of loans
and other real estate 0.41% 0.21% 0.37%
Nonperforming assets to total assets 0.34% 0.17% 0.31%
Allowance for loan losses to total loans 1.09% 1.06% 1.10%
Management has reviewed the collateral for the nonperforming assets,
including nonaccrual loans, and has included this review among the factors
considered in the evaluation of the allowance for loan losses discussed below.
Nonperforming loans (which includes nonaccrual loans and restructured
loans) as of September 30, 2006, December 31, 2005, and September 30, 2005
totaled $5,181,000, $1,653,000, and $3,344,000, respectively. Nonperforming
loans as a percentage of total loans amounted to 0.31%, 0.11%, and 0.23%, at
September 30, 2006, December 31, 2005, and September 30, 2005, respectively. The
variances in the dollar amount of nonperforming loans among the periods has been
primarily due to changes in nonaccrual loans, as restructured loans have not
changed significantly. In the fourth quarter of 2005, the collection process for
several of the Company's largest nonaccrual loan relationships reached a
conclusion and their principal balances were reduced to zero either as a result
of cash received or the recording of a charge-off. This resulted in the amount
of the Company's nonperforming loans at December 31, 2005 reaching its lowest
level in over five years. In 2006, the Company has experienced more typical
activity within its nonaccrual loan category, and the amount of nonaccrual loans
increased to more normal levels. The largest nonaccrual relationship at
September 30, 2006 amounted to $461,000.
At September 30, 2006, December 31, 2005, and September 30, 2005, the
recorded investment in loans considered to be impaired was $1,591,000, $338,000,
and $1,364,000, respectively, all of which were on nonaccrual status. At
September 30, 2006, December 31, 2005, and September 30, 2005, the related
allowance for loan losses for all impaired loans was $291,000, $100,000, and
$620,000, respectively. At September 30, 2006, December 31, 2005, and September
30, 2005, there was $844,000, $0, and $182,000 in impaired loans for which there
was no related allowance. The average recorded investments in impaired loans
during the nine month period ended September 30, 2006, the year ended December
31, 2005, and the nine months ended September 30, 2005 were approximately
$1,090,000 $1,474,000, and $1,758,000, respectively. For the same periods, the
Company recognized no interest income on those loans during the period that they
were considered to be impaired.
The Company's other real estate owned did not vary materially among the
periods presented, amounting to
Page 27
$1,799,000, $1,421,000, and $2,023,000 at September 30, 2006, December 31, 2005
and September 30, 2005, respectively. The Company's management has reviewed
recent appraisals of its other real estate and believes that their fair values,
less estimated costs to sell, equal or exceed their respective carrying values
at the dates presented.
Summary of Loan Loss Experience
The allowance for loan losses is created by direct charges to operations.
Losses on loans are charged against the allowance in the period in which such
loans, in management's opinion, become uncollectible. The recoveries realized
during the period are credited to this allowance.
The Company has no foreign loans, few agricultural loans and does not
engage in significant lease financing or highly leveraged transactions.
Commercial loans are diversified among a variety of industries. The majority of
the Company's real estate loans are primarily various personal and commercial
loans where real estate provides additional security for the loan. Collateral
for virtually all of these loans is located within the Company's principal
market area.
The provision for loan losses recorded by the Company for the three and
nine months ended September 30, 2006, amounted to $1,215,000 in the third
quarter of 2006 compared to $690,000 in the third quarter of 2005, and
$3,630,000 for the first nine months of 2006 compared to $2,115,000 for the
first nine months of 2005. The higher provisions for loan losses in 2006
compared to 2005 are a result of the strong loan growth realized in 2006, as
asset quality ratios have remained stable and compare favorably to peers. Net
internal loan growth was $55 million in the third quarter of 2006 compared to
$20 million in the third quarter of 2005, while net internal loan growth was
$208 million for the first nine months of 2006 compared to $79 million for the
first nine months of 2005. The Company's ratios of annualized net charge-offs to
average loans were 11 basis points and 8 basis points for the three and nine
month periods in 2006, respectively, compared to 12 basis points and 9 basis
points for the three and nine month periods in 2005, respectively. The Company's
level of nonperforming assets to total assets was 0.34% at September 30, 2006
compared to 0.31% a year earlier.
At September 30, 2006, the allowance for loan losses amounted to
$18,465,000, compared to $15,716,000 at December 31, 2005 and $15,879,000 at
September 30, 2005. The allowance for loan losses as a percentage of total loans
did not vary significantly among the periods presented, amounting to 1.09% at
September 30, 2006, 1.06% at December 31, 2005, and 1.10% at September 30, 2005.
Management believes the Company's reserve levels are adequate to cover
probable loan losses on the loans outstanding as of each reporting date. It must
be emphasized, however, that the determination of the reserve using the
Company's procedures and methods rests upon various judgments and assumptions
about economic conditions and other factors affecting loans. No assurance can be
given that the Company will not in any particular period sustain loan losses
that are sizable in relation to the amounts reserved or that subsequent
evaluations of the loan portfolio, in light of conditions and factors then
prevailing, will not require significant changes in the allowance for loan
losses or future charges to earnings. See "Critical Accounting Policies -
Allowance for Loan Losses" above.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for loan losses
and value of other real estate. Such agencies may require the Company to
recognize adjustments to the allowance or the carrying value of other real
estate based on their judgments about information available at the time of their
examinations.
Page 28
For the periods indicated, the following table summarizes the Company's
balances of loans outstanding, average loans outstanding, changes in the
allowance for loan losses arising from charge-offs and recoveries, and additions
to the allowance for loan losses that have been charged to expense.
Nine Months Twelve Months Nine Months
Ended Ended Ended
September 30, December 31, September 30,
($ in thousands) 2006 2005 2005
------------ ------------ ------------
Loans outstanding at end of period $ 1,696,835 1,482,611 1,446,185
============ ============ ============
Average amount of loans outstanding $ 1,592,983 1,422,419 1,408,736
============ ============ ============
Allowance for loan losses, at
beginning of period $ 15,716 14,717 14,717
Total charge-offs (1,135) (2,363) (1,171)
Total recoveries 202 322 218
------------ ------------ ------------
Net charge-offs (933) (2,041) (953)
------------ ------------ ------------
Additions recorded related to loans
acquired in branch purchase 52 -- --
Additions to the allowance charged to expense 3,630 3,040 2,115
------------ ------------ ------------
Allowance for loan losses, at end of period $ 18,465 15,716 15,879
============ ============ ============
Ratios:
Net charge-offs (annualized) as a percent of average loans 0.08% 0.14% 0.09%
Allowance for loan losses as a
percent of loans at end of period 1.09% 1.06% 1.10%
Based on the results of the Company's loan analysis and grading program and
management's evaluation of the allowance for loan losses at September 30, 2006,
there have been no material changes to the allocation of the allowance for loan
losses among the various categories of loans since December 31, 2005.
Liquidity, Commitments, and Contingencies
The Company's liquidity is determined by its ability to convert assets to
cash or acquire alternative sources of funds to meet the needs of its customers
who are withdrawing or borrowing funds, and to maintain required reserve levels,
pay expenses and operate the Company on an ongoing basis. The Company's primary
liquidity sources are net income from operations, cash and due from banks,
federal funds sold and other short-term investments. The Company's securities
portfolio is comprised almost entirely of readily marketable securities, which
could also be sold to provide cash.
In addition to internally generated liquidity sources, the Company has the
ability to obtain borrowings from the following three sources - 1) an
approximately $415 million line of credit with the Federal Home Loan Bank (of
which $133 million was outstanding at September 30, 2006), 2) a $50 million
overnight federal funds line of credit with a correspondent bank (none of which
was outstanding at September 30, 2006), and 3) an approximately $72 million line
of credit through the Federal Reserve Bank of Richmond's discount window (none
of which was outstanding at September 30, 2006).
The Company's liquidity decreased slightly from December 31, 2005 to
September 30, 2006, as a result of loan growth that exceeded deposit growth
during the first nine months of the year. Loans increased during the first nine
months of 2006 by $214 million compared to deposit growth of $170 million. The
Company's loan to deposit ratio was 101.9% at September 30, 2006 compared to
99.2% at December 31, 2005. The higher growth in loans
Page 29
compared to deposits is the primary factor in the Company increasing its
outstanding borrowings from $100 million at December 31, 2005 to $200 million at
September 30, 2006.
The Company's management believes its liquidity sources, including unused
lines of credit, are at an acceptable level and remain adequate to meet its
operating needs in the foreseeable future. The Company will continue to monitor
its liquidity position carefully and will explore and implement strategies to
increase liquidity if deemed appropriate.
The amount and timing of the Company's contractual obligations and
commercial commitments has not changed materially since December 31, 2005,
detail of which is presented in Table 18 on page 56 of the Company's 2005 Form
10-K.
See Note 10 to the Consolidated Financial Statements above for information
related to a tax contingency.
The Company is not involved in any legal proceedings that, in management's
opinion, could have a material effect on the consolidated financial position of
the Company.
Off-Balance Sheet Arrangements and Derivative Financial Instruments
Off-balance sheet arrangements include transactions, agreements, or other
contractual arrangements in which the Company has obligations or provides
guarantees on behalf of an unconsolidated entity. The Company has no off-balance
sheet arrangements of this kind other than repayment guarantees associated with
trust preferred securities.
Derivative financial instruments include futures, forwards, interest rate
swaps, options contracts, and other financial instruments with similar
characteristics. The Company has not engaged in derivative activities through
September 30, 2006, and has no current plans to do so.
Capital Resources
The Company is regulated by the Board of Governors of the Federal Reserve
Board (FED) and is subject to securities registration and public reporting
regulations of the Securities and Exchange Commission. The Company's banking
subsidiary is regulated by the Federal Deposit Insurance Corporation (FDIC) and
the North Carolina Office of the Commissioner of Banks. The Company is not aware
of any recommendations of regulatory authorities or otherwise which, if they
were to be implemented, would have a material effect on its liquidity, capital
resources, or operations.
The Company must comply with regulatory capital requirements established by
the FED and FDIC. Failure to meet minimum capital requirements can initiate
certain mandatory, and possibly additional discretionary, actions by regulators
that, if undertaken, could have a direct material effect on the Company's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Company must meet specific capital
guidelines that involve quantitative measures of the Company's assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The Company's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors. These capital standards require the Company to
maintain minimum ratios of "Tier 1" capital to total risk-weighted assets and
total capital to risk-weighted assets of 4.00% and 8.00%, respectively. Tier 1
capital is comprised of total shareholders' equity calculated in accordance with
generally accepted accounting principles, excluding accumulated other
comprehensive income (loss), less intangible assets, and total capital is
comprised of Tier 1 capital plus certain adjustments, the largest of which for
the Company is the allowance for loan losses. Risk-weighted assets refer to the
on- and off-balance sheet exposures of the Company, adjusted for their related
risk levels using formulas set forth in FED and FDIC regulations.
Page 30
In addition to the risk-based capital requirements described above, the
Company is subject to a leverage capital requirement, which calls for a minimum
ratio of Tier 1 capital (as defined above) to quarterly average total assets of
3.00% to 5.00%, depending upon the institution's composite ratings as determined
by its regulators. The FED has not advised the Company of any requirement
specifically applicable to it.
At September 30, 2006, the Company's capital ratios exceeded the regulatory
minimum ratios discussed above. The following table presents the Company's
capital ratios and the regulatory minimums discussed above for the periods
indicated.
September 30, December 31, September 30,
2006 2005 2005
-------------- -------------- --------------
Risk-based capital ratios:
Tier I capital to Tier I risk adjusted assets 10.13% 10.52% 10.42%
Minimum required Tier I capital 4.00% 4.00% 4.00%
Total risk-based capital to
Tier II risk-adjusted assets 11.77% 11.51% 11.46%
Minimum required total risk-based capital 8.00% 8.00% 8.00%
Leverage capital ratios:
Tier I leverage capital to
adjusted most recent quarter average assets 8.69% 8.62% 8.49%
Minimum required Tier I leverage capital 4.00% 4.00% 4.00%
In April 2006, the Company issued an additional $25 million in trust
preferred securities, which qualify as regulatory capital and helped maintain
the Company's regulatory capital ratios at acceptable levels during the recent
periods of high growth and the two branch purchases.
The Company's bank subsidiary is also subject to similar capital
requirements as those discussed above. The bank subsidiary's capital ratios do
not vary materially from the Company's capital ratios presented above. At
September 30, 2006, the Company's bank subsidiary exceeded the minimum ratios
established by the FED and FDIC.
SHARE REPURCHASES
During the second quarter of 2006, the Company repurchased 53,000 shares of
its common stock at an average price of $20.97 per share. The Company made no
share repurchases during the first or third quarters of 2006. At September 30,
2006, the Company had approximately 262,000 shares available for repurchase
under existing authority from its board of directors. The Company may repurchase
these shares in open market and privately negotiated transactions, as market
conditions and the Company's liquidity warrant, subject to compliance with
applicable regulations. See also Part II, Item 2 "Unregistered Sales of Equity
Securities and Use of Proceeds."
Page 31
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
INTEREST RATE RISK (INCLUDING QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK)
Net interest income is the Company's most significant component of
earnings. Notwithstanding changes in volumes of loans and deposits, the
Company's level of net interest income is continually at risk due to the effect
that changes in general market interest rate trends have on interest yields
earned and paid with respect to the various categories of earning assets and
interest-bearing liabilities. It is the Company's policy to maintain portfolios
of earning assets and interest-bearing liabilities with maturities and repricing
opportunities that will afford protection, to the extent practical, against wide
interest rate fluctuations. The Company's exposure to interest rate risk is
analyzed on a regular basis by management using standard GAP reports, maturity
reports, and an asset/liability software model that simulates future levels of
interest income and expense based on current interest rates, expected future
interest rates, and various intervals of "shock" interest rates. Over the years,
the Company has been able to maintain a fairly consistent yield on average
earning assets (net interest margin). Over the past five calendar years the
Company's net interest margin has ranged from a low of 4.23% (realized in 2001)
to a high of 4.58% (realized in 2002). During that five year period the prime
rate of interest has ranged from a low of 4.00% to a high of 9.50%.
Using stated maturities for all instruments except mortgage-backed
securities (which are allocated in the periods of their expected payback) and
securities and borrowings with call features that are expected to be called
(which are included in the period of their expected call), at September 30, 2006
the Company had $447 million more in interest-bearing liabilities that are
subject to interest rate changes within one year than earning assets. This
generally would indicate that net interest income would experience downward
pressure in a rising interest rate environment and would benefit from a
declining interest rate environment. However, this method of analyzing interest
sensitivity only measures the magnitude of the timing differences and does not
address earnings, market value, or management actions. Also, interest rates on
certain types of assets and liabilities may fluctuate in advance of changes in
market interest rates, while interest rates on other types may lag behind
changes in market rates. In addition to the effects of "when" various
rate-sensitive products reprice, market rate changes may not result in uniform
changes in rates among all products. For example, included in interest-bearing
liabilities at September 30, 2006 subject to interest rate changes within one
year are deposits totaling $497 million comprised of NOW, savings, and certain
types of money market deposits with interest rates set by management. These
types of deposits historically have not repriced coincidentally with or in the
same proportion as general market indicators. Interest rate caps and floors
which are in place for a portion of the Company's variable rate loans can also
impact its repricing characteristics.
Overall, the Company believes that in the near term (twelve months), net
interest income would not likely experience significant downward pressure from
rising interest rates. Similarly, management would not expect a significant
increase in near term net interest income from falling interest rates.
Generally, when rates change, the Company's interest-sensitive assets that are
subject to adjustment reprice immediately at the full amount of the change,
while the Company's interest-sensitive liabilities that are subject to
adjustment reprice at a lag to the rate change and typically not to the full
extent of the rate change. The net effect is that in the twelve month horizon,
as rates change, the impact of having a higher level of interest-sensitive
liabilities is substantially negated by the later and typically lower
proportionate change these liabilities experience compared to interest sensitive
assets. The general discussion in this paragraph applies most directly in a
"normal" interest rate environment in which longer term maturity instruments
carry higher interest rates than short term maturity instruments, and is less
applicable in periods in which there is a "flat" interest rate curve, which is
discussed in the following paragraph.
Since the second half of 2004, the Federal Reserve has increased the
discount rate 17 times totaling 425 basis points. However the impact of these
rate increases has not had an equal effect on short-term interest rates and
long-term interest rates in the marketplace. In the marketplace, short-term
rates have risen by a significantly higher amount than have longer-term interest
rates. For example, from June 30, 2004 to September 30, 2006, the interest rate
on three-month treasury bills rose by 331 basis points, whereas the interest
rate for seven-year treasury notes
Page 32
increased by just 25 basis points. This has resulted in what economists refer to
as a "flat yield curve", which means that short-term interest rates are
substantially the same as long-term interest rates. This is an unfavorable
interest rate environment for many banks, including the Company, as short-term
interest rates generally drive the Company's deposit pricing and longer-term
interest rates generally drive loan pricing. When these rates converge, as they
have recently (particularly in 2006), the "profit" spread the Company realizes
between loan yields and deposit rates narrows, which reduces the Company's net
interest margin.
In addition to the negative impact of the flat yield curve interest rate
environment, the Company's net interest margin has also been negatively impacted
by customers shifting their funds from low cost deposits to higher cost deposits
as rates have risen.
The factors just discussed are the primary reasons for the Company
experiencing a decline in its net interest margin for the third consecutive
quarter. The Company's net interest margin was 4.37% in the fourth quarter of
2005, 4.33% in the first quarter of 2006, 4.22% in the second quarter of 2006,
and 4.12% in the third quarter of 2006. Based on rate projections the Company
has reviewed, the Company expects its net interest margin to continue to
experience compression for the fourth quarter of 2006.
The Company has no market risk sensitive instruments held for trading
purposes, nor does it maintain any foreign currency positions.
See additional discussion of the Company's net interest margin in the
"Components of Earnings" section above.
Item 4 - Controls and Procedures
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our chief
executive officer and chief financial officer, of the effectiveness of the
design and operation of our disclosure controls and procedures, which are our
controls and other procedures that are designed to ensure that information
required to be disclosed in our periodic reports with the SEC is recorded,
processed, summarized and reported within the required time periods. Disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed is communicated to
our management to allow timely decisions regarding required disclosure. Based on
the evaluation, our chief executive officer and chief financial officer
concluded that our disclosure controls and procedures are effective in allowing
timely decisions regarding disclosure to be made about material information
required to be included in our periodic reports with the SEC. In addition, no
change in our internal control over financial reporting has occurred during, or
subsequent to, the period covered by this report that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting.
FORWARD-LOOKING STATEMENTS
Part I of this report contains statements that could be deemed
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934 and the Private Securities Litigation Reform Act, which
statements are inherently subject to risks and uncertainties. Forward-looking
statements are statements that include projections, predictions, expectations or
beliefs about future events or results or otherwise are not statements of
historical fact. Such statements are often characterized by the use of
qualifying words (and their derivatives) such as "expect," "believe,"
"estimate," "plan," "project," or other statements concerning opinions or
judgment of the Company and its management about future events. Factors that
could influence the accuracy of such forward-looking statements include, but are
not limited to, the financial success or changing strategies of the Company's
customers, the Company's level of success in integrating acquisitions, actions
of government regulators, the level of market interest rates, and general
economic conditions. For additional information that could affect the matters
discussed in this paragraph, see the "Risk Factor" section of the Company's 2005
Annual Report on Form 10-K.
Page 33
Part II. Other Information
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
------------------------------------------------------------------------------------------------------------------------------
Total Number of Shares Maximum Number of
Purchased as Part of Shares that May Yet Be
Total Number of Average Price Paid per Publicly Announced Purchased Under the
Period Shares Purchased Share Plans or Programs Plans or Programs (1)
---------------------------- --------------------- ----------------------- ----------------------- -----------------------
July 1, 2006 to July 31,
2006 -- -- -- 262,015
August 1, 2006 to August
31, 2006 -- -- -- 262,015
September 1, 2006 to
September 30, 2006 -- -- -- 262,015
--------------------- ----------------------- ----------------------- -----------------------
Total -- -- -- 262,015
===================== ======================= ======================= =======================
Footnotes to the Above Table
----------------------------
(1) All shares available for repurchase are pursuant to publicly announced
share repurchase authorizations. On July 30, 2004, the Company announced
that its Board of Directors had approved the repurchase of 375,000 shares
of the Company's common stock. The repurchase authorization does not have
an expiration date. There are no plans or programs the Company has
determined to terminate prior to expiration, or under which the Company
does not intend to make further purchases.
(2) The above table above does not include shares that were used by option
holders to satisfy the exercise price of the Company's call options issued
by the Company to its employees and directors pursuant to the Company's
stock option plans. There were no such options exercised during the periods
shown.
Item 6 - Exhibits
The following exhibits are filed with this report or, as noted, are
incorporated by reference. Management contracts, compensatory plans and
arrangements are marked with an asterisk (*).
3.a. Copy of Articles of Incorporation of the Company and amendments thereto
were filed as Exhibits 3.a.i through 3.a.v to the Company's Quarterly
Report on Form 10-Q for the period ended June 30, 2002, and are
incorporated herein by reference.
3.b Copy of the Amended and Restated Bylaws of the Company was filed as
Exhibit 3.b to the Company's Annual Report on Form 10-K for the year
ended December 31, 2003, and is incorporated herein by reference.
4 Form of Common Stock Certificate was filed as Exhibit 4 to the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30,
1999, and is incorporated herein by reference.
31.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 302(a) of the Sarbanes-Oxley Act of 2002.
31.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 302(a) of the Sarbanes-Oxley Act of 2002.
Page 34
32.1 Chief Executive Officer Certification Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2 Chief Financial Officer Certification Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
Copies of exhibits are available upon written request to: First Bancorp, Anna G.
Hollers, Executive Vice President, P.O. Box 508, Troy, NC 27371
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FIRST BANCORP
November 8, 2006 BY: James H. Garner
---------------------------
James H. Garner
President, Chief Executive
Officer
(Principal Executive Officer),
Treasurer and Director
November 8, 2006 BY: Anna G. Hollers
---------------------------
Anna G. Hollers
Executive Vice President,
Chief Operating Officer
and Secretary
November 8, 2006 BY: Eric P. Credle
---------------------------
Eric P. Credle
Senior Vice President
and Chief Financial Officer
Page 35