UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
-------------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2003
--------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 0-24626
COOPERATIVE BANKSHARES, INC.
-----------------------------------------------------
Exact name of registrant as specified in its charter)
North Carolina 56-1886527
-------------------------------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
201 Market Street, Wilmington, North Carolina 28401
--------------------------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (910) 343-0181
--------------
Former name, former address and former fiscal year, if
changed since last report.
N/A
--------------------------------------------------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
[X] Yes [ ] No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
[ ] Yes [X] No
APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding
of each of the issuer's classes of common stock, as of the latest practicable
date. 2,847,947 shares at July 30, 2003
---------------------------------
TABLE OF CONTENTS
Page
Part I Financial Information
Item 1 Financial Statements
Consolidated Statements of Financial Condition,
June 30, 2003 and December 31, 2002 3
Consolidated Statements of Operations, for the three
and six months ended June 30, 2003 and 2002 4
Consolidated Statement of Stockholders' Equity, for the
six months ended June 30, 2003 5
Consolidated Statements of Cash Flows, for the
six months ended June 30, 2003 and 2002 6-7
Notes to Consolidated Financial Statements 8-10
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 10-19
Item 3 Market Risk 19
Item 4 Controls and Procedures 19
Part II Other Information
Item 1 Legal Proceedings 20
Item 2 Changes in Securities and Use of Proceeds 20
Item 3 Defaults Upon Senior Securities 20
Item 4 Submission of Matters to a Vote of Security Holders 20
Item 5 Other Information 20
Item 6 Exhibits and Reports on Form 8-K 20
Signatures 21
Exhibit 31.1 22
Exhibit 31.2 23
Exhibit 32 24
PART 1-FINANCIAL INFORMATION-FINANCIAL STATEMENTS
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
JUNE 30, 2003 December 31, 2002*
------------- ------------------
(UNAUDITED)
ASSETS
Cash and due from banks, noninterest-bearing $ 21,179,075 $ 11,858,603
Interest-bearing deposits in other banks 6,858,501 --
------------ ------------
Total cash and cash equivalents 28,037,576 11,858,603
Securities:
Available for sale (amortized cost of $34,986,714 in June 2003
and $41,033,409 in December 2002) 35,741,698 42,075,212
Held to maturity (estimated market value of $6,779,302 in June
2003 and $8,009,087 in December 2002) 6,723,586 7,859,955
FHLB stock 4,004,600 4,054,700
Loans held for sale 27,502,596 25,659,935
Loans 397,656,444 393,812,940
Less allowance for loan losses 3,110,698 2,936,795
------------ ------------
Net loans 394,545,746 390,876,145
Other real estate owned 898,800 619,163
Accrued interest receivable 2,119,579 2,239,826
Premises and equipment, net 8,319,300 7,019,219
Other assets 14,109,088 11,946,819
------------ ------------
Total assets $522,002,569 $504,209,577
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $373,627,531 $357,254,096
Short-term borrowings 60,956,824 61,585,827
Escrow deposits 403,855 223,604
Accrued interest payable 248,681 284,568
Accrued expenses and other liabilities 2,653,813 3,320,629
Long-term obligations 43,090,214 43,092,592
------------ ------------
Total liabilities 480,980,918 465,761,316
------------ ------------
Stockholders' equity:
Preferred stock, $1 par value, 3,000,000 shares authorized,
no shares issued and outstanding -- --
Common stock, $1 par value, 7,000,000 shares authorized,
2,847,947 and 2,835,947 shares issued and outstanding 2,847,947 2,835,947
Additional paid-in capital 2,613,152 2,440,645
Accumulated other comprehensive income 498,289 635,500
Retained earnings 35,062,263 32,536,169
------------ ------------
Total stockholders' equity 41,021,651 38,448,261
------------ ------------
Total liabilities and stockholders' equity $522,002,569 $504,209,577
============ ============
Book value per common share $ 14.40 $ 13.56
============ ============
*Derived from audited consolidated financial statements. The accompanying notes
are an integral part of the consolidated financial statements.
3
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
----------- ----------- ----------- -----------
INTEREST INCOME:
Loans $ 6,534,851 $ 6,653,357 $13,060,444 $13,248,903
Securities 528,897 673,851 1,131,988 1,369,739
Other 14,185 11,625 23,991 23,918
Dividends on FHLB stock 37,849 54,384 83,424 113,292
----------- ----------- ----------- -----------
Total interest income 7,115,782 7,393,217 14,299,847 14,755,852
----------- ----------- ----------- -----------
INTEREST EXPENSE:
Deposits 1,904,065 2,610,028 3,942,326 5,455,370
Borrowed funds 889,958 892,076 1,781,900 1,804,729
----------- ----------- ----------- -----------
Total interest expense 2,794,023 3,502,104 5,724,226 7,260,099
----------- ----------- ----------- -----------
NET INTEREST INCOME 4,321,759 3,891,113 8,575,621 7,495,753
Provision for loan losses 180,000 120,000 380,000 400,000
----------- ----------- ----------- -----------
Net interest income after provision for loan losses 4,141,759 3,771,113 8,195,621 7,095,753
----------- ----------- ----------- -----------
NONINTEREST INCOME:
Gain on sale of loans 1,232,322 79,388 2,259,078 97,668
Net gain on sale of securities -- 18,417 -- 135,182
Service charges and fees on loans 114,886 136,374 253,217 337,756
Deposit-related fees 376,644 262,693 633,515 510,929
Gain on sale of real estate -- -- -- 464,977
Bank-owned life insurance earnings 89,910 99,837 186,984 199,674
Other income, net 41,879 42,858 94,004 102,974
----------- ----------- ----------- -----------
Total noninterest income 1,855,641 639,567 3,426,798 1,849,160
----------- ----------- ----------- -----------
NONINTEREST EXPENSE:
Compensation and fringe benefits 2,485,805 1,570,690 4,760,062 3,006,544
Occupancy and equipment 660,138 549,184 1,307,569 1,067,395
Professional and examination fees 112,461 99,044 213,708 229,624
Advertising 145,541 66,317 266,097 136,820
Real estate owned 15,651 3,985 33,541 10,527
Other 460,138 357,980 917,024 746,361
----------- ----------- ----------- -----------
Total noninterest expenses 3,879,734 2,647,200 7,498,001 5,197,271
----------- ----------- ----------- -----------
Income before income taxes 2,117,666 1,763,480 4,124,418 3,747,642
Income tax expense 694,427 632,318 1,313,529 1,327,978
----------- ----------- ----------- -----------
NET INCOME $ 1,423,239 $ 1,131,162 $ 2,810,889 $ 2,419,664
=========== =========== =========== ===========
NET INCOME PER SHARE:
Basic $ 0.50 $ 0.40 $ 0.99 $ 0.85
=========== =========== =========== ===========
Diluted $ 0.49 $ 0.40 $ 0.97 $ 0.85
=========== =========== =========== ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic 2,847,947 2,835,508 2,846,313 2,835,478
=========== =========== =========== ===========
Diluted 2,895,190 2,861,143 2,891,285 2,853,202
=========== =========== =========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
4
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(UNAUDITED)
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN COMPREHENSIVE RETAINED STOCKHOLDERS'
STOCK CAPITAL INCOME EARNINGS EQUITY
------------ ------------ ------------ ------------ ------------
Balance, December 31, 2002 $ 2,835,947 $ 2,440,645 $ 635,500 $ 32,536,169 $ 38,448,261
Exercise of stock options 12,000 158,500 -- -- 170,500
Tax benefit of stock option exercise -- 14,007 -- -- 14,007
Other comprehensive
loss, net of taxes -- -- (137,211) -- (137,211)
Net income -- -- -- 2,810,889 2,810,889
Cash dividends ($.10 per share) -- -- -- (284,795) (284,795)
------------ ------------ ------------ ------------ ------------
Balance, June 30, 2003 $ 2,847,947 $ 2,613,152 $ 498,289 $ 35,062,263 $ 41,021,651
============ ============ ============ ============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
5
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
2003 2002
------------- -------------
OPERATING ACTIVITIES:
Net income $ 2,810,889 $ 2,419,664
Adjustments to reconcile net income to net cash
provided by operating activities:
Net accretion, amortization, and depreciation 648,648 464,730
Net gain on sale of securities -- (135,182)
Net gain on sale of loans (2,259,078) (97,668)
Provision for deferred income taxes (151,752) 107,938
Gain on sale of premises and equipment -- (464,977)
Gain on sales of foreclosed real estate 3,711 --
Valuation losses on foreclosed real estate 116,543 108,446
Provision for loan losses 380,000 400,000
Proceeds from sale of loans held for sale 136,366,033 5,826,611
Loan originations held for sale (136,047,055) (12,286,447)
Changes in assets and liabilities:
Accrued interest receivable 120,247 248,450
Prepaid expenses and other assets (1,060,909) (311,859)
Accrued interest payable (35,887) 3,052
Accrued expenses and other liabilities (1,466,816) 184,102
------------- -------------
Net cash provided (used) by operating activities (575,426) (3,533,140)
------------- -------------
INVESTING ACTIVITIES:
Purchases of securities available for sale (800,000) (21,882,903)
Purchase of Lumina Mortgage Company -- (772,610)
Proceeds from sale of securities available for sale -- 19,058,014
Proceeds from maturity of securities available for sale 850,100 --
Repayments of mortgage-backed securities available for sale 5,926,289 2,131,132
Repayments of mortgage-backed securities held to maturity 1,052,741 304,379
Loan originations, net of principal repayments (4,431,624) (12,450,903)
Proceeds from disposals of foreclosed real estate 87,807 101,908
Additions to other real estate owned (8,236) (96,455)
Purchases of premises and equipment (1,746,387) (466,744)
Proceeds from sale of premises and equipment 1,691 499,070
------------- -------------
Net cash used in investing activities 932,381 (13,575,112)
------------- -------------
FINANCING ACTIVITIES:
Net increase in deposits 16,373,435 20,705,686
Net change in short-term borrowings (629,003) (2,166,409)
Repayments on long-term obligations (2,378) (2,251)
Proceeds from issuance of common stock 184,508 5,424
Dividends paid (284,795) (283,544)
Net change in escrow deposits 180,251 427,323
------------- -------------
Net cash provided by financing activities 15,822,018 18,686,229
------------- -------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 16,178,973 1,577,977
CASH AND CASH EQUIVALENTS:
BEGINNING OF PERIOD 11,858,603 12,295,578
------------- -------------
END OF PERIOD $ 28,037,576 $ 13,873,555
============= =============
(Continued)
6
COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
SIX MONTHS ENDED
JUNE 30,
2003 2002
------------ ------------
Cash paid for:
Interest $ 5,760,113 $ 7,257,047
Income taxes 1,537,652 1,192,763
Summary of noncash investing and financing activities:
Transfer from loans to foreclosed real estate 479,462 637,668
Unrealized gain (loss) on securities available for sale,
net of taxes (137,211) 15,790
Reclassifications between long-term obligations
and short-term borrowings 10,000,000 10,000,000
The accompanying notes are an integral part of the consolidated financial
statements.
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Accounting Policies: The significant accounting policies followed by
--------------------
Cooperative Bankshares, Inc. (the "Company") for interim financial
reporting are consistent with the accounting policies followed for annual
financial reporting. These unaudited consolidated financial statements have
been prepared in accordance with Rule 10-01 of Regulation S-X, and, in
management's opinion, all adjustments of a normal recurring nature
necessary for a fair presentation have been included. The accompanying
consolidated financial statements do not purport to contain all the
necessary financial disclosures that might otherwise be necessary in the
circumstances and should be read in conjunction with the consolidated
financial statements and notes thereto in the Company's annual report for
the year ended December 31, 2002 (the "Annual Report"). The results of
operations for the six-month period ended June 30, 2003 are not necessarily
indicative of the results to be expected for the full year.
2. Basis of Presentation: The accompanying unaudited consolidated financial
---------------------
statements include the accounts of Cooperative Bankshares, Inc.,
Cooperative Bank (the "Bank") and its wholly owned subsidiaries, Lumina
Mortgage Company, Inc. ("Lumina") and CS&L Holdings, Inc. ("Holdings"), and
Holdings' majority owned subsidiary, CS&L Real Estate Trust, Inc. (the
"REIT"). All significant intercompany items have been eliminated. Certain
items for prior periods have been reclassified to conform to the current
period presentation. These reclassifications have no effect on the net
income or stockholders' equity as previously reported.
3. Earnings Per Share: Earnings per share (EPS) are calculated by dividing net
------------------
income by the weighted average number of common shares outstanding (basic
EPS) and the sum of the weighted average number of common shares
outstanding and potential common stock (diluted EPS). Potential common
stock consists of stock options issued and outstanding. In determining the
number of shares of potential common stock, the treasury stock method was
applied. This method assumes that the number of shares issuable upon
exercise of the stock options is reduced by the number of common shares
assumed purchased at market prices with the proceeds from the assumed
exercise of the common stock options plus any tax benefits received as a
result of the assumed exercise. The following table provides a
reconciliation of income available to common stockholders and the average
number of shares outstanding for the periods below:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
----------------------- -----------------------
Net income (numerator) $1,423,239 $1,131,162 $2,810,889 $2,419,664
Shares for basic EPS (denominator) 2,847,947 2,835,508 2,846,313 2,835,478
Dilutive effect of stock options 47,243 25,635 44,972 17,724
-------------------------------------------------
Shares for diluted EPS (denominator) 2,895,190 2,861,143 2,891,285 2,853,202
=================================================
For the six months ended June 30, 2003 and 2002, there were 4,204 and 14,204
options outstanding respectively that were antidilutive since the exercise price
exceeds the average market price. The options have been omitted from the
calculation of the dilutive effect of stock options.
8
4. Comprehensive Income: Comprehensive income includes net income and all
---------------------
other changes to the Company's equity, with the exception of transactions
with shareholders ("other comprehensive income"). The Company's only
components of other comprehensive income relate to unrealized gains and
losses on available for sale securities. The following table sets forth the
components of other comprehensive income and total comprehensive income for
the three and six months ended June 30:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net income $ 1,423,239 $ 1,131,162 $ 2,810,889 $ 2,419,664
Other comprehensive income
Reclassification to realized gains -- (18,417) -- (135,182)
Unrealized gain (losses) on available for sale securities (114,400) 1,064,830 (286,820) 161,067
Income tax (expense) benefit 38,896 (408,101) 149,609 (10,095)
----------- ----------- ----------- -----------
Other comprehensive income (loss) (75,504) 638,312 (137,211) 15,790
----------- ----------- ----------- -----------
Comprehensive income $ 1,347,735 $ 1,769,474 $ 2,673,678 $ 2,435,454
=========== =========== =========== ===========
5. Stock-Based Compensation: On January 1, 1996 the Company adopted SFAS No.
-------------------------
123, "Accounting for Stock-Based Compensation". As permitted by SFAS No.
123, the Company has chosen to continue to apply APB Opinion No. 25,
"Accounting for Stock Issued to Employees" and related interpretations. The
option exercise price is the market price of the common stock on the date
the option is granted. Accordingly, no compensation cost has been
recognized for options granted under the Option Plan. Had compensation cost
for the Company's Option Plan been determined based on the fair value at
the grant dates for awards under the option plan consistent with the method
of SFAS No. 123, the Company's net income and net income per share would
have been reduced to the pro forma amounts indicated below.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- ----------------------------
2003 2002 2003 2002
------------ ----------- ------------ -------------
Net income, as reported $ 1,423,239 $ 1,131,162 $ 2,810,889 $ 2,419,664
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects -- -- -- (60,543)
------------ ----------- ------------ -------------
Pro forma net income $ 1,423,239 $ 1,131,162 $ 2,810,889 $ 2,359,121
============ =========== ============ =============
Earnings per share:
Basic-as reported
$ 0.50 $ 0.40 $ 0.99 $ 0.85
============ =========== ============ =============
Basic-pro forma $ 0.50 $ 0.40 $ 0.99 $ 0.83
============ =========== ============ =============
Diluted-as reported $ 0.49 $ 0.40 $ 0.97 $ 0.85
============ =========== ============ =============
Diluted-pro forma $ 0.49 $ 0.40 $ 0.97 $ 0.83
============ =========== ============ =============
9
6. Acquisition: On May 31, 2002, the Bank acquired the operating assets of
-----------
Wilmington-based Lumina Mortgage Company. The purchase price was $740,000
in cash with two future contingent payments based on loan origination
volume and meeting certain profitability goals of Lumina. The agreement was
subsequently amended to change the contingent payments into two payments of
$400,000 each payable on July 31, 2003 and 2004. These payments are
considered additional purchase price and accordingly, goodwill related to
this acquisition was increased by $800,000.
7. New Accounting Pronouncements: On January 1, 2003, the Company adopted SFAS
-----------------------------
No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities". SFAS No. 146 addresses financial accounting and reporting for
costs associated with exit or disposal activities and nullifies Emerging
Issues Task Force (EITF) Issue 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity." The
adoption of SFAS No. 146 did not have a material effect on the Company's
consolidated financial statements.
In November 2002, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an
interpretation of FASB Statements No. 5, 57 and 107 and a rescission of
FASB Interpretation No. 34." This Interpretation elaborates on the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under guarantees issued. The
Interpretation also clarifies that a guarantor is required to recognize, at
inception of a guarantee, a liability for the fair value of the obligation
undertaken. The initial recognition and measurement provisions of the
Interpretation are applicable to guarantees issued or modified after
December 31, 2002 and did not have a material effect on the Company's
consolidated financial statements. The disclosure requirements are
effective for financial statements of interim and annual periods ending
after December 15, 2002.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51". This
Interpretation addresses the consolidation by business enterprises of
variable interest entities as defined in the Interpretation. The
Interpretation applies immediately to variable interests in variable
interest entities created after January 31, 2003, and to variable interests
in variable interest entities obtained after January 31, 2003. For public
enterprises with a variable interest in a variable interest equity created
before February 1, 2003, the interpretation applies to that enterprise no
later than the beginning of the first interim or annual reporting period
beginning after June 15, 2003. The application of this Interpretation did
not have a material effect on the Company's consolidated financial
statements. The Interpretation requires certain disclosures in financial
statements issued after January 31, 2003 if it is reasonably possible that
the Company will consolidate or disclose information about variable
interest entities when the Interpretation becomes effective.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Cooperative Bankshares, Inc. (the "Company") is a registered bank holding
company incorporated in North Carolina in 1994. The Company is the parent
company of Cooperative Bank (the "Bank"); a North Carolina chartered commercial
bank. Cooperative Bank, headquartered in Wilmington, North Carolina, was
chartered in 1898. The Bank provides financial services through 19 financial
centers in Eastern North Carolina. One of the Bank's subsidiaries, Lumina
Mortgage Company, Inc. ("Lumina") is a mortgage banking firm originating and
selling residential mortgage loans through offices in Wilmington, North
Carolina; North Myrtle Beach, South Carolina; and Virginia Beach, Virginia. The
Bank's other subsidiary, CS&L Holdings, Inc. ("Holdings"), is a holding company
for CS&L Real Estate Trust, Inc. (the "REIT"), which is a real estate investment
trust.
10
Through its financial centers, the Bank provides a wide range of banking
products, including interest-bearing and non-interest-bearing checking accounts,
certificates of deposit and individual retirement accounts, which are insured up
to the applicable limits of the Federal Deposit Insurance Corporation ("FDIC").
It offers an array of loan products: overdraft protection, commercial, consumer,
agricultural, real estate, residential mortgage and home equity loans. Also
offered are safe deposit boxes, ATMs and Access24 Phone Banking. The bank began
offering online banking and bill payment on July 1, 2003. In addition, the Bank
offers discount brokerage services, annuity sales and mutual funds through a
third party arrangement with UVEST Investment Services. Lumina delivers a wide
range of mortgage loan products to its market area.
MISSION STATEMENT
It is the mission of the Company to provide the maximum in safety and security
for our depositors, an equitable rate of return for our stockholders, excellent
service for our customers, and to do so while operating in a fiscally sound and
conservative manner, with fair pricing of our products and services, good
working conditions, outstanding training and opportunities for our staff, along
with a high level of corporate citizenship.
MANAGEMENT STRATEGY
Cooperative Bank's lending activities have traditionally concentrated on the
origination of loans for the purpose of constructing, financing or refinancing
residential properties. In recent years however, the Bank has emphasized
origination of nonresidential real estate loans and secured and unsecured
consumer and business loans. As of June 30, 2003, approximately $268 million, or
68%, of the Bank's loan portfolio, which excludes loans held for sale, consisted
of loans secured by residential properties. This compared to approximately $268
million, or 69% at December 31, 2002. The Bank originates adjustable rate and
fixed rate loans. As of June 30, 2003, adjustable rate and fixed rate loans
totaled approximately 65.9% and 34.1%, respectively, of the Bank's total loan
portfolio.
The Bank has chosen to sell a larger percentage of its fixed rate mortgage loan
originations in the secondary market and through brokered arrangements. This
enables the Bank to reinvest these funds in commercial loans, while increasing
fee income. This is part of the continuing effort to restructure the balance
sheet and operations to be more reflective of a commercial bank.
The Bank opened additional branches in Wilmington, North Carolina on May 12,
2003 and Morehead City, North Carolina on July 1, 2003.
INTEREST RATE SENSITIVITY ANALYSIS
Interest rate sensitivity refers to the change in interest spread resulting from
changes in interest rates. To the extent that interest income and interest
expense do not respond equally to changes in interest rates, or that all rates
do not change uniformly, earnings will be affected. Interest rate sensitivity,
at a point in time, can be analyzed using a static gap analysis that measures
the match in balances subject to repricing between interest-earning assets and
interest-bearing liabilities. Gap is considered positive when the amount of
interest rate sensitive assets exceed the amount of interest rate sensitive
liabilities. Gap is considered negative when the amount of interest rate
sensitive liabilities exceed the amount of interest rate sensitive assets. At
June 30, 2003, Cooperative had a one-year positive gap position of 1.8%. During
a period of falling interest rates, a positive gap would tend to adversely
affect net interest income, while a negative gap would tend to result in an
increase in net interest income. During a period of rising interest rates, a
positive gap would tend to result in an increase in net interest income while a
negative gap would tend to adversely affect net interest income. It is important
to note that certain shortcomings are inherent in using a static gap analysis.
Although certain assets and liabilities may have similar maturities or periods
of repricing, they may react in different degrees to changes in market interest
rates. For example, a part of the Company's adjustable-rate mortgage loans are
indexed to the National Monthly Median Cost of Funds to SAIF-insured
institutions. This index is considered a lagging index that may lag behind
changes in market rates. The one-year or less interest-bearing liabilities also
include checking, savings, and money market deposit accounts. Experience has
shown that the Company sees relatively modest repricing of these transaction
accounts. Management takes this into consideration in determining acceptable
levels of interest rate risk.
11
When Lumina gives a rate lock commitment to a customer, there is a concurrent
"lock in" for the loan with a secondary market investor under a best efforts
delivery mechanism. Therefore, interest rate risk is mitigated because any
commitments to fund a loan available for sale is concurrently hedged by a
commitment from an investor to purchase the loan under the same terms. Loans are
usually sold within 60 days after closing.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The Bank enters into agreements that obligate it to make future payments under
contracts, such as debt and lease agreements. In addition, the Bank commits to
lend funds in the future such as credit lines and loan commitments. Below is a
table of such contractual obligations and commitments at June 30, 2003 (in
thousands).
Payments Due by Period
--------------------------------------------------------------
Less
than 1 1-3 4-5 Over 5
Contractual Obligations Total year years years years
--------------------------------------------------------------
Borrowed Funds $ 104,047 $ 60,957 $ 10,000 $ 10,000 $ 23,090
Lease Obligations 2,885 305 410 253 1,917
Lumina Mortgage Company Purchase 800,000 400,000 400,000 -- --
Deposits 373,628 325,302 47,644 182 500
--------------------------------------------------------------
Total Contractual Cash Obligations $1,280,560 $ 786,564 $ 458,054 $ 10,435 $ 25,507
==============================================================
Amount of Commitment Expiration
Per Period
-----------------------------------------------
Total Less
Amounts than 1 1-3 4-5 Over 5
Other Commitments Committed year years years years
-----------------------------------------------
Undisbursed portion of home equity
collateralized primarily by junior liens
on 1-4 family properties $15,175 $ 1,205 $ 798 $ 576 $12,596
Other commitments and credit lines 13,605 4,383 6,331 71 2,820
Undisbursed portion of construction loans 31,318 31,318 -- -- --
Available for sale mortgage loan commitments 6,430 6,430 -- -- --
Fixed-rate mortgage loan commitments 2,535 2,535 -- -- --
Adjustable-rate mortgage loan
commitments 3,335 3,335 -- -- --
-----------------------------------------------
Total Commitments $72,398 $49,206 $ 7,129 $ 647 $15,416
===============================================
LIQUIDITY
The Company's goal is to maintain adequate liquidity to meet potential funding
needs of loan and deposit customers, pay operating expenses, and meet regulatory
liquidity requirements. Maturing securities, principal repayments of loans and
securities, deposits, income from operations and borrowings are the main sources
of liquidity. The Bank has been granted a line of credit by the Federal Home
Loan Bank of Atlanta ("FHLB") in an amount of up to 25% of the Bank's total
assets. At June 30, 2003, the Bank's borrowed funds from the FHLB equaled 16.0%
of its total assets. Scheduled loan repayments are a relatively predictable
source of funds, unlike deposits and loan prepayments that are significantly
influenced by general interest rates, economic conditions and competition.
12
At June 30, 2003, the estimated market value of liquid assets (cash, cash
equivalents, marketable securities and loans held for sale) was approximately
$98.1 million, which represents 20.5% of deposits and borrowed funds as compared
to $87.6 million or 19.0% of deposits and borrowed funds at December 31, 2002.
The increase in liquid assets was primarily due to an increase in cash and cash
equivalents.
The Company's primary uses of liquidity are to fund loans and to make
investments. At June 30, 2003, outstanding off-balance sheet commitments to
extend credit totaled $41.1 million, and the undisbursed portion of construction
loans was $31.3 million. Management considers current liquidity levels adequate
to meet the Company's cash flow requirements.
CAPITAL
Stockholders' equity at June 30, 2003, was $41.0 million, up 6.7% from $38.4
million at December 31, 2002. Stockholders' equity at June 30, 2003, includes an
unrealized gain net of tax, of $498,289 as compared to an unrealized gain net of
tax at December 31, 2002, of $635,500 on securities available for sale marked to
estimated fair market value.
Under the capital regulations of the FDIC, the Bank must satisfy minimum
leverage ratio requirements and risk-based capital requirements. Banks
supervised by the FDIC must maintain a minimum leverage ratio of core (Tier I)
capital to average adjusted assets ranging from 3% to 5%. At June 30, 2003, the
Bank's ratio of Tier I capital was 7.76%. The FDIC's risk-based capital rules
require banks supervised by the FDIC to maintain risk-based capital to
risk-weighted assets of at least 8.00%. Risk-based capital for the Bank is
defined as Tier I capital plus the balance of allowance for loan losses. At June
30, 2003, the Bank had a ratio of qualifying total capital to risk-weighted
assets of 11.22%.
The Company, as a bank holding company, is also subject, on a consolidated
basis, to the capital adequacy guidelines of the Board of Governors of the
Federal Reserve (the "Federal Reserve Board"). The capital requirements of the
Federal Reserve Board are similar to those of the FDIC governing the Bank. The
Company currently exceeds all of its capital requirements. Management expects
the Company to continue to exceed these capital requirements without altering
current operations or strategies.
On June 18, 2003, the Company's Board of Directors approved a quarterly cash
dividend of $.05 per share. The dividend was paid on July 16, 2003 to
stockholders of record as of July 1, 2003. This brings the total dividend for
the year to $.10 per share. Any future payment of dividends is dependent on the
financial condition and capital needs of the Company, requirements of regulatory
agencies, and economic conditions in the marketplace.
CRITICAL ACCOUNTING POLICY
The Bank's most significant critical accounting policy is the determination of
its allowance for loan losses. A critical accounting policy is one that is both
very important to the portrayal of the Bank's financial condition and results,
and requires management's most difficult, subjective or complex judgments. What
makes these judgments inherently difficult, subjective and/or complex is the
need to make estimates about the effects of matters that are inherently
uncertain. For further information on the allowance for loan losses, see the
"Financial Condition" in Management's Discussion and Analysis and Note 3 of
"Notes to Consolidated Financial Statements" included in the Annual Report.
FINANCIAL CONDITION AT JUNE 30, 2003, COMPARED TO DECEMBER 31, 2002
The Company's total assets increased 3.5% to $522.0 million at June 30, 2003, as
compared to $504.2 million at December 31, 2002. The major change in the assets
is an increase of $16.2 million (136.4%) in cash and cash equivalents, which was
caused by an increase in deposits of $16.4 million (4.6%). The increase in
deposits was mainly in the six and fifteen month certificates, due to the
customers' desire to stay short term in the current rate environment, and
non-interest-bearing checking accounts due to the emphasis of the Bank on
obtaining business accounts. The Bank also attracted an additional $7.9 million
in internet deposits because the rates were competitive with the Bank's local
markets. Internet deposits are usually obtained from other financial
institutions with terms
13
primarily of one or two years. The decrease in available for sale securities of
$6.3 million (15.1%) enabled the Bank to fund an increase in loans of $3.8
million (1.0%) and loans held for sale of $1.8 million (7.2%) as well as repay
$1.0 million of borrowed funds from the FHLB. Borrowed funds, collateralized
through an agreement with the FHLB for advances, are secured by the Bank's
investment in FHLB stock and qualifying first mortgage loans. Securities
available for sale decreased during the first six months of 2003 due to payments
of mortgage backed securities. The increase of $1.3 million in premises and
equipment, during this same period, is primarily due to the building of two new
branches. Other assets increased $2.2 million (18.1%) due to an increase of $1.2
million being held by attorneys to fund loan closings and an increase of
$800,000 in goodwill. The increase of funds held by attorneys was the result of
a backlog of loan closings created by high demand. The additional goodwill was
created by amending the purchase agreement of Lumina Mortgage Company from two
contingent payments into two payments of $400,000 each payable on July 31, 2003
and 2004.
The Company's non-performing assets (loans 90 days or more delinquent and
foreclosed real estate) were $1.5 million, or .29% of assets, at June 30, 2003,
compared to $1.2 million, or 0.24% of assets, at December 31, 2002. Foreclosed
real estate increased to $898,800 at June 30, 2003, from $619,163 at December
31, 2002, but only 3 properties make up this balance. The Company assumes an
aggressive position in collecting delinquent loans and disposing of foreclosed
assets to minimize balances of non-performing assets and continues to evaluate
the loan and real estate portfolios to provide loss reserves as considered
necessary. For further information see "Comparison of Operating Results -
Provision and Allowance for Loan Losses".
COMPARISON OF OPERATING RESULTS
OVERVIEW
The net income of the Company depends primarily upon net interest income. Net
interest income is the difference between the interest earned on loans, the
securities portfolio and interest-earning deposits and the cost of funds,
consisting principally of the interest paid on deposits and borrowings. The
Company's operations are materially affected by general economic conditions, the
monetary and fiscal policies of the Federal government, and the policies of
regulatory authorities. Yields and costs have declined because of the actions
the Federal Reserve has taken since 2001 to reduce interest rates in hopes of
spurring the economy.
NET INCOME
Net income for the three and six-month periods ended June 30, 2003, increased
25.8% to $1.4 million and 16.2% to $2.8 million respectively, as compared to the
same periods last year. The increase in net income for the six-month period
ended June 30, 2003 can be attributed to increases in net interest income of
$1.1 million and non-interest income of $1.6 million. These changes were
partially offset by an increase in non-interest expense of $2.3 million during
the same period.
INTEREST INCOME
For the three-month period ended June 30, 2003, interest income decreased 3.8%
as compared to the same period a year ago. The average balance of
interest-earning assets increased 9.7% but the average yield decreased 84 basis
points as compared to the same period a year ago. Interest income decreased 3.1%
for the six-month period ended June 30, 2003, as compared to the same period a
year ago. The decrease in interest income can be attributed to the yield on
average interest-earning assets decreasing to 6.00% as compared to 6.82% for the
same period a year ago. The average balance of interest-earning assets increased
10.0% for the six month period ended June 30, 2003, as compared to the same
period a year ago. The increase in the average balance of interest-earning
assets had a positive effect on interest income while the reduction in yield had
a negative impact on interest income.
14
INTEREST EXPENSE
Interest expense decreased 20.2% for the three-month period ended June 30, 2003,
as compared to the same period a year ago. This decrease was due to the average
cost of interest-bearing liabilities decreasing 88 basis points as compared to
the same period a year ago. In the six-month period ended June 30, 2003,
interest expense decreased 21.2% as compared to the same period a year ago. The
average balance of interest-bearing liabilities increased 7.8% as compared to
the same period a year ago. The cost of interest-bearing liabilities decreased
to 2.61% as compared to 3.57% for the same period last year.
NET INTEREST INCOME
Net interest income for the three and six-month periods ended June 30, 2003, as
compared to the same period a year ago, increased 11.1% and 14.4% respectively.
The increase was due to interest-earning assets increasing faster than
interest-bearing liabilities. In addition, there was a larger decrease in the
cost of liabilities versus the yield on assets, which can be attributed to the
fact that deposits continue to reprice at lower yields caused by the Federal
Reserve's previous rate reductions and the increased use of low cost borrowings
due to the Lumina purchase. See "Average Yield/Cost Analysis" table for further
information on interest income and interest expense.
15
AVERAGE YIELD/COST ANALYSIS
The following tables contain information relating to the Company's average
balance sheet and reflects the average yield on assets and average cost of
liabilities for the periods indicated. Such annualized yields and costs are
derived by dividing income or expense by the average balances of assets or
liabilities, respectively, for the periods presented. The average loan portfolio
balances include nonaccrual loans.
For the three months ended
JUNE 30, 2003 JUNE 30, 2002
----------------------------------- ---------------------------------
(DOLLARS IN THOUSANDS) Average Average
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
-------- ------- ------ -------- ------- ------
Interest-earning assets:
Interest-bearing deposits in other banks $ 4,983 $ 14 1.12% $ 2,604 $ 12 1.84%
Securities:
Available for sale 37,715 436 4.62% 41,171 559 5.43%
Held to maturity 7,254 93 5.13% 7,216 115 6.37%
FHLB stock 3,798 38 4.00% 4,155 54 5.20%
Loan portfolio 424,247 6,535 6.16% 380,417 6,653 7.00%
-------- ------- -------- -------
Total interest-earning assets 477,997 7,116 5.95% 435,563 7,393 6.79%
Non-interest earning assets 27,861 27,238
-------- --------
Total assets $505,858 $462,801
======== ========
Interest-bearing liabilities:
Deposits 348,301 1,904 2.19% 336,202 2,610 3.11%
Borrowed funds 90,803 890 3.92% 72,460 892 4.92%
-------- ------- -------- -------
Total interest-bearing liabilities 439,104 $ 2,794 2.55% 408,662 $ 3,502 3.43%
------- -------
Non-interest bearing liabilities 26,059 19,098
-------- --------
Total liabilities 465,163 427,760
Stockholders' equity 40,695 35,041
-------- --------
Total liabilities and stockholders' equity $505,858 $462,801
======== ========
Net interest income $ 4,322 $ 3,891
======= =======
Interest rate spread 3.40% 3.36%
===== =====
Net yield on interest-earning assets 3.62% 3.57%
Percentage of average interest-earning
assets to average interest-bearing
liabilities 108.9% 106.6%
===== =====
16
For the six months ended
JUNE 30, 2003 JUNE 30, 2002
---------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) Average Average
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
-------- ------- ------- -------- ------- -------
Interest-earning assets:
Interest-bearing deposits in other banks $ 4,269 $ 24 1.12% $ 2,707 $ 24 1.77%
Securities:
Available for sale 39,027 929 4.76% 42,285 1,166 5.51%
Held to maturity 7,519 202 5.37% 6,108 204 6.68%
FHLB stock 3,961 84 4.24% 4,155 113 5.44%
Loan portfolio 421,553 13,061 6.20% 377,682 13,249 7.02%
-------- ------- -------- -------
Total interest-earning assets 476,329 14,300 6.00% 432,937 14,756 6.82%
Non-interest earning assets 27,063 26,709
-------- --------
Total assets $503,392 $459,646
======== ========
Interest-bearing liabilities:
Deposits 346,573 3,942 2.27% 331,507 5,454 3.29%
Borrowed funds 92,138 1,782 3.87% 75,443 1,806 4.79%
-------- ------- -------- -------
Total interest-bearing liabilities 438,711 $ 5,724 2.61% 406,950 $ 7,260 3.57%
------- -------
Non-interest bearing liabilities 24,915 17,979
-------- --------
Total liabilities 463,626 424,929
Stockholders' equity 39,766 34,717
-------- --------
Total liabilities and stockholders' equity $503,392 $459,646
======== ========
Net interest income $ 8,576 $ 7,496
======= =======
Interest rate spread 3.39% 2.50%
==== ====
Net yield on interest-earning assets 3.60% 3.46%
Percentage of average interest-earning
assets to average interest-bearing
liabilities 108.6% 106.4%
===== =====
17
PROVISION AND ALLOWANCE FOR LOAN LOSSES
During the six-month period ended June 30, 2003 the Bank had net charge-offs
against the allowance for loan losses of $206,097 compared to $330,945 for the
same period in 2002. This decrease was primarily due to one larger credit being
charged off during the first quarter of 2002. The Bank added $380,000 to the
allowance for loan losses for the current six-month period increasing the
balance to $3.1 million at June 30, 2003. Management considers the current level
of the allowance to be appropriate based on loan composition, the current level
of delinquencies and other non-performing assets, overall economic conditions
and other factors. Future increases to the allowance may be necessary, however,
due to changes in loan composition or loan volume, changes in economic or market
area conditions and other factors. Additionally, 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 recognition of
adjustments to the allowance for loan losses based on their judgments of
information available to them at the time of their examination.
NONINTEREST INCOME
Noninterest income increased by 85.3% for the six-month period ended June 30,
2003, as compared to the same period a year ago. The change in noninterest
income can be attributed to gain on sale of loans increasing over $2.2 million
primarily as a result of the purchase of Lumina. The Bank has also started to
sell a larger percentage of its fixed rate mortgage loan originations in the
secondary market instead of through brokered arrangements. This change causes an
increase in gain on sale of loans and a reduction to service charges and fees on
loans. Deposit related fees increased 24.0% primarily due to a new service the
Bank offered beginning in April 2003, for checking accounts with non-sufficient
funds. During the first six months of 2002 the Bank sold a parking lot for
$500,000, resulting in the gain on sale of real estate, and the gain of $135,182
on sale of securities was due to selling bonds and purchasing mortgage backed
securities to give the Bank greater cash flow. No similar transactions occurred
during the six months ended June 30, 2003.
In the three-month period ended June 30, 2003, noninterest income increased
190.1% as compared to the same period last year. The net gains on sale of loans
and deposit-related fees increased $1.2 million and $113,951 respectively, for
the three-month period ended June 30, 2003 as compared to the same period a year
ago. The reasons for these increases are the same as stated above for the six
month period.
NONINTEREST EXPENSE
For the six-month period ended June 30, 2003, noninterest expense increased
44.3% as compared to the same period last year. Compensation and related costs
increased 58.3%. Higher personnel costs associated with the purchase of Lumina
accounted for the majority of the increase. Also, in January 2003, the Company
granted 117 shares of preferred stock in the REIT to officers, directors, and
Bank employees with at least one month of service and certain other parties.
Each individual that was granted the preferred stock received one share that had
a $500 value, for an aggregate increase to compensation expense of $58,500. In
addition, the increase was due to increases in costs of benefits, staffing
levels including the staffing for two additional branches, and normal increases
in salaries. Occupancy and equipment expense increased $240,174 primarily
because of the Lumina purchase and an increase in depreciation expense due to
the new branches and upgrades in hardware and software systems. The increase in
advertising and other noninterest expenses of $129,277 and $170,663
respectively, was mainly due to the purchase of Lumina.
In the three-month period ended June 30, 2003, noninterest expense increased
46.6% as compared to the same period last year. This increase can be principally
attributed to compensation and fringe benefits, occupancy and equipment expense,
advertising and other expense increasing $915,115, $110,954, $79,224 and
$102,158 respectively. The reasons for these changes are identical to the six
month period ended June 30, 2003.
INCOME TAXES
The effective tax rate for the six-month periods ended June 30, 2003 and 2002,
was 31.8% and 35.4% respectively. The effective tax rate for the three-month
periods ended June 30, 2003 and 2002 was 32.8% and 35.9% respectively. The
decreases resulted from the formation of Holdings and the REIT in December 2002.
18
NOTE REGARDING FORWARD-LOOKING STATEMENTS
In addition to historical information contained herein, the discussion contains
forward-looking statements that involve risks and uncertainties. Economic
circumstances, the Company's operations, and the Company's actual results could
differ significantly from those discussed in the forward-looking statements.
Some of the factors that could cause or contribute to such differences are
discussed herein, but also include changes in the economy and interest rates in
the nation, changes in the Company's regulatory environment and the Company's
market area.
ITEM 3 - MARKET RISK
The Company's primary market risk is interest rate risk. Interest rate risk is
the result of differing maturities or repricing intervals of interest earning
assets and interest bearing liabilities and the fact that rates on these
financial instruments do not change uniformly. These conditions may impact the
earnings generated by the Company's interest earning assets or the cost of its
interest bearing liabilities, thus directly impacting the Company's overall
earnings. The Company's management actively monitors and manages interest rate
risk. One way this is accomplished is through the development of and adherence
to the Company's asset/liability policy. This policy sets forth management's
strategy for matching the risk characteristics of the Company's interest earning
assets and liabilities so as to mitigate the effect of changes in the rate
environment. The Company's market risk profile has not changed significantly
since December 31, 2002.
ITEM 4 - CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and Chief Financial Officer have evaluated
the Company's disclosure controls and procedures (as such term is defined in
Rule 13a-14(c) under the Exchange Act) as of the end of the period covered by
this Form 10-Q. Based upon such evaluation, the Company's Chief Executive
Officer and Chief Financial Officer have concluded that the Company's disclosure
controls and procedures were effective. There have been no significant changes
in the Company's internal controls or in other factors that could significantly
affect internal controls during the quarter ended June 30, 2003
19
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) Not applicable
(b) Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
(a) Not applicable
(b) Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
(1) Annual Meeting of Stockholders, April 25, 2003
(a) Election of Directors
FOR WITHHELD
NUMBER PERCENTAGE NUMBER PERCENTAGE
OF VOTES OF VOTES OF VOTES OF VOTES
Frederick Willetts, III 2,319,444.6 94.26 141,022.5 5.74
F. Peter Fensel, Jr. 2,451,109.6 99.62 9,357.5 0.38
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 31.1 Section 302 Certification of the Chief Executive Officer
Exhibit 31.2 Section 302 Certification of the Chief Financial Officer
Exhibit 32 Certificate Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K.
The Company filed a current Report on Form 8-K dated April 24, 2003 to
report first quarter earnings and a current report on Form 8-K dated
July 24, 2003 to report second quarter earnings.
20
SIGNATURES
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.
Dated August 12, 2003 Cooperative Bankshares, Inc.
/s/ Frederick Willetts, III
----------------------------------
Frederick Willetts, III
President/Chief Executive Officer
Dated: August 12, 2003 /s/ Todd L. Sammons
----------------------------------
Todd L. Sammons
Senior Vice President/Chief
Financial Officer
21