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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.
FORM 10-Q
X QUARTERLY REPORT PURSANT TO SECTION 13 OR 15(d)
--- OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2005
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 No.
0-25933
SOUTHCOAST FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
South Carolina 28-2384011
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
530 Johnnie Dodds Boulevard
Mt. Pleasant, South Carolina 29464
(Address of principal executive offices)
843-884-0504
(Registrant's telephone number, including area code)
------------------------------------------------
Indicate by checkmark 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 preceeding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES [ ] NO [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
3,319,258 shares of common stock, no par value, as of April 30, 2005
See notes to condensed consolidated financial statements.
1
SOUTHCOAST FINANCIAL CORPORATION
INDEX
PART I - FINANCIAL INFORMATION Page No.
- ------------------------------ --------
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - March 31, 2005 and December 31, 2004...................................2
Condensed Consolidated Statements of Income - Three months ended March 31, 2005 and 2004.......................3
Condensed Consolidated Statements of Shareholders' Equity and Comprehensive Income -
Three months ended March 31, 2005 and 2004...................................................................4
Condensed Consolidated Statements of Cash Flows - Three months ended March 31, 2005 and 2004...................5
Notes to Condensed Consolidated Financial Statements..................................................................6-8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................9-12
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................................... 13
Item 4. Controls and Procedures.......................................................................................13
PART II - OTHER INFORMATION
Item 6. Exhibits......................................................................................................14
Signatures ............................................................................................................15
See notes to condensed consolidated financial statements.
2
SOUTHCOAST FINANCIAL CORPORATION
Condensed Consolidated Balance Sheets
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
March 31, December 31,
2005 2004
---- ----
(Unaudited)
Assets
Cash and cash equivalents:
Cash and due from banks .............................................................. $ 5,250,923 $ 11,853,273
Federal funds sold ................................................................... 24,749,000 4,236,000
------------- -------------
Total cash and cash equivalents .................................................. 29,999,923 16,089,273
Investment securities
Available for sale ................................................................... 24,470,725 21,738,335
Federal Home Loan Bank Stock, at Cost ................................................ 3,000,100 3,093,100
------------- -------------
Total investment securities ...................................................... 27,470,825 24,831,435
Loans held for sale .................................................................... 8,399,534 12,009,550
Loans, net of allowance of $3,575,845 and $3,403,970 ................................... 304,334,496 293,206,968
Property and equipment, net ............................................................ 16,839,776 14,843,884
Other assets ........................................................................... 6,140,206 5,122,013
------------- -------------
Total assets ....................................................................... $ 393,184,760 $ 366,103,123
============= =============
Liabilities
Deposits
Noninterest-bearing .................................................................. $ 36,385,461 $ 27,954,739
Interest bearing ..................................................................... 255,318,607 230,198,544
------------- -------------
Total deposits ..................................................................... 291,704,068 258,153,283
Advances from Federal Home Loan Bank ................................................... 51,000,000 58,000,000
Junior subordinated debentures ......................................................... 11,345,000 11,345,000
Other liabilities ...................................................................... 1,744,360 2,034,091
------------- -------------
Total liabilities .................................................................. 355,793,428 329,532,374
------------- -------------
Shareholders' Equity
Common stock (no par value; 20,000,000 shares authorized; 3,317,617 shares
outstanding at March 31, 2005 and 2,970,663 at December 31, 2004) .................... 37,552,570 34,080,782
Retained earnings ...................................................................... - 2,364,340
Accumulated other comprehensive income (loss) .......................................... (161,238) 125,627
------------- -------------
Total shareholders' equity ......................................................... 37,391,332 36,570,749
------------- -------------
Total liabilities and shareholders' equity ......................................... $ 393,184,760 $ 366,103,123
============= =============
See notes to condensed consolidated financial statements.
3
SOUTHCOAST FINANCIAL CORPORATION
Condensed Consolidated Statements of Income
(Unaudited)
For the Three Months Ended
March 31,
---------
2005 2004
---- ----
Interest income
Loans, including fees ......................................................... $4,853,483 $3,317,212
Investment securities ......................................................... 280,786 183,632
Federal funds sold ............................................................ 115,619 30,736
---------- ----------
Total interest income ..................................................... 5,249,888 3,531,580
Interest expense
Deposits and borrowings ....................................................... 2,103,098 1,196,120
---------- ----------
Net interest income .............................................................. 3,146,790 2,335,460
Provision for loan losses ....................................................... 171,255 150,000
---------- ----------
Net interest income after provision for loan losses .............................. 2,975,535 2,185,460
Noninterest income
Service fees on deposit accounts .............................................. 221,985 220,962
Fees on loans sold ............................................................ 147,988 51,137
Other ......................................................................... 95,910 42,492
---------- ----------
Total noninterest income .................................................. 465,883 314,591
---------- ----------
Noninterest expenses
Salaries and employment benefits .............................................. 1,256,065 976,136
Occupancy ..................................................................... 165,924 106,696
Furniture and equipment ....................................................... 177,644 175,410
Advertising and public relations .............................................. 48,971 29,363
Professional fees ............................................................. 62,186 56,100
Travel and entertainment ...................................................... 68,097 44,115
Telephone, postage and supplies ............................................... 93,373 87,603
Other operating expenses ...................................................... 225,081 128,528
---------- ----------
Total noninterest expenses ................................................ 2,097,341 1,603,951
---------- ----------
Income before income taxes ....................................................... 1,344,077 896,100
Income tax expense ............................................................... 455,437 278,719
---------- ----------
Net income ....................................................................... $ 888,640 $ 617,381
========== ==========
Basic net income per common share ................................................ $ .27 $ .19
Diluted net income per common share .............................................. $ .27 $ .19
Weighted average shares outstanding
Basic ......................................................................... 3,286,002 3,252,482
Diluted ....................................................................... 3,308,921 3,289,965
See notes to condensed consolidated financial statements.
4
SOUTHCOAST FINANCIAL CORPORATION
Condensed Consolidated Statement of Changes in Shareholders' Equity
and Comprehensive Income
For the three months ended March 31, 2005 and 2004
(Unaudited)
Accumulated
other
Common Stock comprehensive
------------ Retained income
Shares Amount earnings (loss) Total
------ ------ -------- ------ -----
Balance, December 31, 2003 ..................... 2,680,501 $33,298,027 $ - $ 112,384 $ 33,140,411
Net income for the period ................... 617,381 617,381
Other comprehensive income,
net of tax
Unrealized holding gains
on securities available for sale ........ 130,980 130,980
------------
Comprehensive income ........................ 748,361
Stock dividend .............................. 269,564 617,381 (617,381)
Exercise of stock options ................... 12,336 57,639 57,639
Employee stock purchase plan ................ 1,137 18,840 18,840
--------- ------------ ------------ ------------ ------------
Balance, March 31, 2004 ........................ 2,963,538 $ 33,991,887 $ - $ 243,364 $ 34,235,251
========= ============ ============ ============ ============
Balance, December 31, 2004 ..................... 2,970,663 $ 34,080,782 $ 2,364,340 $ 125,627 $ 35,570,749
Net income for the period ................... 888,640 888,640
Other comprehensive income,
net of tax
Unrealized holding losses
on securities available for sale ........ (286,865) (286,865)
----------
Comprehensive income ........................ 601,775
Stock dividend .............................. 301,601 3,252,980 (3,252,980)
Exercise of stock options ................... 43,843 186,268 186,268
Employee stock purchase plan ................ 1,510 32,540 32,540
--------- ------------ ------------ ------------ ------------
Balance, March 31, 2005 ........................ 3,317,617 $ 37,552,570 $ - $ (161,238) $ 37,391,332
========= ============ ============ ============ ============
See notes to condensed consolidated financial statements.
5
SOUTHCOAST FINANCIAL CORPORATION
Condensed Consolidated Statements of Cash Flows
(Unaudited)
For the Three Months Ended
March 31,
---------
2005 2004
---- ----
Operating activities
Net income ...................................................................... $ 888,640 $ 617,381
Adjustments to reconcile net income to net
cash provided (used) by operating activities
Income tax .................................................................. 455,437 278,719
Provision for loan losses ................................................... 171,255 150,000
Depreciation and amortization ............................................... 179,079 169,715
Increase in other assets .................................................... (1,018,193) (839,934)
Increase in other liabilities ............................................... (602,313) (11,934)
------------ ------------
Net cash provided by operating activities ................................. 73,905 363,947
------------ ------------
Investing activities
Sale (purchase) Federal Home Loan Bank stock .................................... 93,000 315,000
Sale (purchase) of investment securities available for sale ..................... (3,165,074) 448,120
Net increase in loans ........................................................... (7,688,767) (6,651,720)
Purchase of property and equipment .............................................. (2,172,007) (2,575,238)
------------ ------------
Net cash used for investing activities .................................... (12,932,848) (8,463,838)
------------ ------------
Financing activities
Increase (decrease) in borrowings ............................................... (7,000,000) (10,100,000)
Proceeds from issuance of stock ................................................. 218,808 76,479
Net increase in deposits ........................................................ 33,550,785 48,566,461
------------ ------------
Net cash provided by financing activities ................................. 26,769,593 38,542,940
------------ ------------
Increase in cash and due and cash equivalents ............................. 13,910,650 30,443,049
Cash and cash equivalents, beginning of period ..................................... 16,089,273 17,581,376
------------ ------------
Cash and cash equivalents, end of period ........................................... $ 29,999,923 $ 48,024,425
============ ============
See notes to condensed consolidated financial statements.
6
SOUTHCOAST FINANCIAL CORPORATION
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 1 - Basis of Presentation
The accompanying unaudited condensed financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and with the instructions to Form 10-Q
and rule 10-01(a)-(c) of Regulation S-X of the Securities and Exchange
Commission. Accordingly they do not include all information and notes required
by generally accepted accounting principles for complete financial statements.
However, in the opinion of management, all adjustments (consisting of normal
recurring adjustments) considered necessary for a fair presentation have been
included.
Note 2 - Organization
Southcoast Financial Corporation (the "Company") is a South Carolina corporation
organized in 1999 for the purpose of being a holding company for Southcoast
Community Bank (the "Bank"). On April 29, 1999, pursuant to a Plan of Exchange
approved by the shareholders, all of the outstanding shares of capital stock of
the Bank were exchanged for shares of common stock of the Company. The Company
presently engages in no business other than that of owning the Bank and another
subsidiary and has no employees.
Note 3 - Stock-Based Compensation
We have a stock-based employee compensation plan which is accounted for under
the recognition and measurement principles of Accounting Principles Board
("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related
Interpretations. No stock-based employee compensation cost is reflected in net
income, as all stock options granted under these plans had an exercise price
equal to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per share
as if we had applied the fair value recognition provisions of Financial
Accounting Standards Board ("FASB") SFAS No. 123, Accounting for Stock-Based
Compensation, to stock-based employee compensation.
Three months ended March 31,
----------------------------
2005 2004
---- ----
(Unaudited)
Net income, as reported .......................... $888,640 $617,381
Deduct: Total stock-based employee
compensation expense determined
under fair value based method
for all awards, net of related tax effects ..... - 91,113
-------- --------
Pro forma net income ............................. $888,640 $526,268
======== ========
Earnings per share:
Basic - as reported ............................ $ .27 $ 0.19
======== ========
Basic - pro forma .............................. $ .27 $ 0.16
======== ========
Diluted - as reported .......................... $ .27 $ 0.19
======== ========
Diluted - pro forma ............................ $ .27 $ 0.16
======== ========
7
SOUTHCOAST FINANCIAL CORPORATION
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 4 - Net Income Per Share
Net income per share is computed on the basis of the weighted average number of
common shares outstanding in accordance with Statement of Financial Accounting
Standards No. 128, "Earnings per Share". The treasury stock method is used to
compute the effect of stock options on the weighted average number of shares
outstanding for diluted earnings per share.
On April 27, 2005, the Company declared a ten percent stock dividend to
shareholders' of record as of May 27, 2005 and payable June 24, 2005. The March
31, 2005 financials reflect this dividend. The Company also declared a ten
percent stock dividend in April 2004. The weighted average number of shares and
all other share data have been restated for all periods presented to reflect
these stock dividends.
Note 5 - Recently Issued Accounting Standards
The following is a summary of recent authoritative pronouncements that affect
accounting, reporting, and disclosure of financial information by the Company:
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment" ("SFAS No. 123(R)"). Statement No.123(R) covers a wide range of
share-based compensation arrangements including share options, restricted share
plans, performance-based awards, share appreciation rights, and employee share
purchase plans. SFAS No. 123(R) will require companies to measure all employee
stock-based compensation awards using a fair value method and record such
expense in its financial statements. In addition, the adoption of SFAS No.
123(R) requires additional accounting and disclosure related to the income tax
and cash flow effects resulting from share-based payment arrangements. SFAS No.
123(R) is effective beginning within the first interim or annual reporting
period of a company's first fiscal year beginning on or after June 15, 2005.
In April 2005, the Securities and Exchange Commission's Office of the Chief
Accountant and its Division of Corporation Finance has released Staff Accounting
Bulletin (SAB) No.107. SAB 107 provides interpretive guidance related to the
interaction between Statement No.123(R) and certain SEC rules and regulations,
as well as the staff's views regarding the valuation of share-based payment
arrangements for public companies. SAB 107 also reminds public companies of the
importance of including disclosures within filings made with the SEC relating to
the accounting for share-based payment transactions, particularly during the
transition to Statement No.123(R). The Company is currently evaluating the
impact that the adoption of SFAS No. 123(R) will have on the financial position,
results of operations and cash flows.
In December 2003, the FASB issued FIN No. 46 (revised), "Consolidation of
Variable Interest Entities" ("FIN No. 46(R)"), which addresses consolidation by
business enterprises of variable interest entities. FIN No. 46(R) requires a
variable interest entity to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entity's
activities or entitled to receive a majority of the entity's residual returns,
or both. FIN No. 46(R) also requires disclosures about variable interest
entities that a company is not required to consolidate, but in which it has a
significant variable interest. FIN No. 46(R) provides guidance for determining
whether an entity qualifies as a variable interest entity by considering, among
other considerations, whether the entity lacks sufficient equity or its equity
holders lack adequate decision-making ability. The consolidation requirements of
FIN No. 46(R) applied immediately to variable interest entities created after
January 31, 2003. The consolidation requirements applied to the Company's
existing variable interest entities in the first reporting period ending after
March 15, 2004. Certain of the disclosure requirements applied to all financial
statements issued after December 31, 2003, regardless of when the variable
interest entity was established. The adoption of FIN No. 46(R) did not have a
material impact on the Company's financial position or results of operations.
8
SOUTHCOAST FINANCIAL CORPORATION
Notes to Condensed Consolidated Financial Statements
(Unaudited)
In November 2003, the Emerging Issues Task Force ("EITF") reached a consensus
that certain quantitative and qualitative disclosures should be required for
debt and marketable equity securities classified as available for sale or held
to maturity under SFAS No. 115 and SFAS No. 124 that are impaired at the balance
sheet date but for which other-than-temporary impairment has not been
recognized. Accordingly the EITF issued EITF No. 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments."
This issue addresses the meaning of other-than-temporary impairment and its
application to investments classified as either available for sale or held to
maturity under SFAS No. 115 and provides guidance on quantitative and
qualitative disclosures. The disclosure requirements of EITF No. 03-1 are
effective for annual financial statements for fiscal years ending after June 15,
2004. The effective date for the measurement and recognition guidance of EITF
No. 03-1 has been delayed. The FASB staff has issued a proposed Board-directed
FASB Staff Position ("FSP"), FSP EITF 03-1-a, "Implementation Guidance for the
Application of Paragraph 16 of Issue No. 03-1." The proposed FSP would provide
implementation guidance with respect to debt securities that are impaired solely
due to interest rates and/or sector spreads and analyzed for
other-than-temporary impairment under the measurement and recognition
requirements of EITF No. 03-1. The delay of the effective date for the
measurement and recognition requirements of EITF No. 03-1 will be superseded
concurrent with the final issuance of FSP EITF 03-1-a. Adopting the disclosure
provisions of EITF No. 03-1 did not have any impact on the Company's financial
position or results of operations.
Other accounting standards that have been issued or proposed by the FASB or
other standards-setting bodies that do not require adoption until a future date
are not expected to have a material impact on the consolidated financial
statements upon adoption.
9
SOUTHCOAST FINANCIAL CORPORATION
Item 2. - Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion and analysis should be read in conjunction with the
financial statements and related notes appearing in the 2004 Form 10-K of
Southcoast Financial Corporation. Results of operations for the period ending
March 31, 2005 are not necessarily indicative of the results to be attained for
any other period. Statements included in Management's Discussion and Analysis
which are not historical in nature are intended to be, and are hereby identified
as "forward looking statements" for purposes of the safe harbor provided by
section 21E of the Securities Exchange Act of 1934, as amended. Words such as
"estimate," "project," "intend," "expect," "plan," "anticipate," "believe," and
similar expressions identify forward-looking statements. The Company cautions
readers that forward looking statements including without limitation, those
relating to the Company's new offices, future business prospects, revenues,
allowance for loan losses, working capital, liquidity, capital needs, interest
costs, and income, are subject to certain risks and uncertainties that could
cause actual results to differ from those indicated in the forward looking
statements, due to several important factors herein identified, among others,
and other risks and factors identified from time to time in the Company's
reports filed with the Securities and Exchange Commission.
Results of Operations
The Company's net income for the three months ended March 31, 2005 was $888,640
or $.27 per basic share, compared to $617,381 or $.19 per basic share, for the
three months ended March 31, 2004. The average number of shares for the quarter
ending March 31, 2005 was 3,286,002 compared to 3,252,482 for the period ending
March 31, 2004.
Net Interest Income
Net interest income is the difference between the interest earned on interest
earning assets and the interest paid for funds acquired to support those assets.
Net interest income, the principal source of the Company's earnings, was
$3,146,790 for the three months ended March 31, 2005, compared to $2,335,460 for
the three months ended March 31, 2004.
Changes that affect net interest income include changes in the average rate
earned on interest earning assets, changes in the average rate paid on interest
bearing liabilities, and changes in the volumes of interest earning assets and
interest bearing liabilities.
Average earning assets for the three months ending March 31, 2005 increased 49.4
percent to $356.7 million from the $238.7 million reported for the three months
ending March 31, 2004. The increase was mainly attributable to the increase in
loans, supported by a $112.6 million increase in average interest bearing
liabilities, which resulted from the continued growth of the Charleston market
area, growth in the Company's branches, and the Company's marketing efforts.
The following table compares the average balances, yields and rates for the
interest sensitive segments of the Company's balance sheets for the three months
ended March 31, 2005 and 2004. The increase in net interest income is due to
increased volume of earning assets.
10
SOUTHCOAST FINANCIAL CORPORATION
Net Interest Income - continued
For the three months ended For the three months ended
March 31, 2005 March 31, 2004
-------------- --------------
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate(1) Balance Expense Rate(1)
------- ------- ------- ------- ------- -------
Assets
Federal funds sold .................... $ 18,791,967 $ 115,619 2.46% $ 9,407,516 $ 20,736 0.88%
Investments ........................... 26,069,206 280,786 4.31 19,469,138 183,632 3.77
------------ ------------ ------------ ----------
Total investments and
federal funds sold ................ 44,861,173 396,405 3.53 28,876,654 204,368 2.83
Loans ................................. 311,871,957 4,853,483 6.22 209,784,627 3,317,212 6.32
------------ ------------ ------------ ----------
Total earning assets ................ 356,733,130 5,249,888 5.89 238,661,281 3,521,580 5.90
------------ ----------
Other assets ........................ 24,959,460 16,893,013
------------ ------------
Total assets ........................ $381,692,590 $255,554,294
============ ============
Liabilities
Interest bearing deposits ............. $247,297,402 1,482,734 2.40% $151,920,416 725,832 1.91
Other borrowings ...................... 63,789,444 620,364 3.89 46,552,761 460,288 3.95
------------ ------------ ------------ ----------
Total interest bearing liabilities .. 311,086,846 2,103,098 2.70 198,473,177 1,186,120 2.39
------------ ----------
Non-interest bearing liabilities ..... 33,887,264 23,119,835
------------ ------------
Total liabilities ................... 344,974,110 2,103,098 2.44 221,593,012 1,186,120 2.14
------------ ----------
Equity ................................ 36,718,480 33,961,282
------------ ------------
Total liabilities and equity ........ $381,692,590 $255,554,294
============ ============
Net interest income/margin .......... $ 3,146,790 3.53 $2,335,460 3.91
============ ==========
Net interest spread ................. 3.19% 3.51%
(1) Annualized
As reflected above, for the three months ended March 31, 2005 the average yield
on earning assets was 5.89 percent, while the average cost of interest bearing
liabilities was 2.70 percent. For the three months ended March 31, 2004 the
average yield on earning assets was 5.90 percent and the average cost of
interest-bearing liabilities was 2.39 percent. The slight decrease in the yield
on earning assets is attributable to a change in the mix of the Company's
lending portfolio and short term investments offset by the increase in overall
market rates. The increase in the rate paid on interest bearing liabilities is
attributable to the market interest rate increases over the last year and the
maturing of lower yield certificates of deposits. The net interest margin is
computed by subtracting interest expense from interest income and dividing the
resulting figure by average interest earning assets. The net interest margin for
the three months ended March 31, 2005 was 3.53 percent compared to 3.91 percent
for the three months ended March 31, 2004. The decrease in the net-interest
margin is primarily attributable to the change in the mix of the loan portfolio
and the temporary increase in short term investments caused by an increase in
short term escrow deposits. The cost of total liabilities was 2.44 percent for
the three months ended March 31, 2005 compared to 2.14 percent for the three
months ended March 31, 2004.
11
SOUTHCOAST FINANCIAL CORPORATION
The following table presents changes in the Company's net interest income which
are primarily a result of changes in the volumes and rates of its
interest-earning assets and interest-bearing liabilities.
Analysis of Changes in Net Interest Income
For the three months ended March 31, 2005
(Dollars in thousands) Versus three months ended March 31, 2004
----------------------------------------
Volume Rate Net Change
Federal funds sold .............................................. $ 20,685 $ 64,198 $ 84,883
Investments ..................................................... 62,252 34,902 97,154
---------- ---------- ----------
Total investments and federal funds sold ........................ 82,937 99,100 182,037
Total loans ..................................................... 1,614,252 (77,981) 1,536,271
---------- ---------- ----------
Total earning assets ............................................ 1,697,189 21,119 1,718,308
Total interest-bearing liabilities .............................. 626,111 280,867 906,978
---------- ---------- ----------
Net interest income ............................................. $1,071,078 $ (259,748) $ 811,330
========== ========== ==========
Noninterest Income and Expenses
Noninterest income for the three months ended March 31, 2005 was $465,883
compared to $314,591 for the three months ended March 31, 2004. The increase is
attributable to a $96,851 increase in fees on loans sold, a $53,418 increase in
other income and a slight increase in service fees on deposit accounts.
Noninterest expenses for the three months ended March 31, 2005 were $2,097,341,
compared to $1,603,951 for the three months ended March 31, 2004. The increase
of $493,390 is mainly attributable to increases in salaries and benefits,
occupancy expense and administrative expenses. These increases primarily relate
to expenditures associated with the opening of the Goose Creek branch in
December 2004 as well as the increase in administrative staff to support the
growth of the Company's operations.
Liquidity
Liquidity is the ability to meet current and future obligations through
liquidation or maturity of existing assets or the acquisition of liabilities.
The Company manages both assets and liabilities to achieve appropriate levels of
liquidity. Cash and short-term investments are the Company's primary sources of
asset liquidity. These funds provide a cushion against short-term fluctuations
in cash flow from both deposits and loans. The investment portfolio is the
Company's principal source of secondary asset liquidity. However, the
availability of this source of funds is influenced by market conditions.
Individual and commercial deposits and borrowings from the Federal Home Loan
Bank are the Company's primary source of funds for credit activities. The
Company also has a $5.3 million line of credit with the Bankers Bank of Atlanta
and a $6.0 million line of credit with First Tennessee Bank. The Company is in
the process of opening one new branch office and an operations center. The total
unexpended cost of these facilities is $2,271,000. The funding for these offices
will come from normal operations. Management believes that the Company's
liquidity sources are adequate to meet its normal operating needs.
Federal Funds Sold
Federal funds sold increased $20.5 million during the first three months of 2005
to $24.7 million at March 31, 2005. The increase was a direct result of the
increase in escrow deposits held for a start up bank that plans to open in June
2005. These funds are being maintained in federal funds until the institution is
approved and opened.
Loans
Commercial loans (most of which are incidentally secured with real estate) made
up 47.7 percent of the total loan portfolio as of March 31, 2005, totaling
$146.9 million. Loans secured by real estate for construction and land
development totaled $32.6 million or 10.6% percent of the portfolio, while all
other loans secured by real estate totaled $125.1 million or 40.6 percent of the
total loan portfolio, as of March 31, 2005. Installment loans and other consumer
loans to individuals comprised $3.3 million or 1.1 percent of the total loan
portfolio. The allowance for loan losses was 1.16 percent of loans as of March
31, 2005 compared to 1.15 percent as of December 31, 2004. In management's
opinion, the allowance for loan losses is adequate. At March 31, 2005, the
Company did not have any loans 90 days delinquent and still accruing interest
and had $1.4 million of non-accruing loans and $ 0.3 million of other real
estate owned.
12
SOUTHCOAST FINANCIAL CORPORATION
Deposits
Deposits increased $33,550,785 during the first three months of 2005 to
$291,704,068 at March 31, 2005. The increase was attributable to several
factors. Noninterest bearing deposits increased $8,430,722 during the first
three months as a result of the normal growth of the Bank. Interest bearing
checking, money market and savings accounts increased by $15,489,036 mainly due
to escrow accounts. Brokered deposits increased $9,384,000 during the same
period.
Capital Resources
The capital base for the Company increased by $820,583 for the first three
months of 2005, due to operating income, capital raised through the Employee
Stock Purchase Plan and exercise of stock options, net of unrealized losses on
available for sale securities. The Company's tier one capital to asset ratio was
12.72% percent as of March 31, 2005 compared to 13.64% percent as of December
31, 2004.
The Federal Deposit Insurance Corporation has established risk-based capital
requirements for banks and the Federal Reserve has established similar
requirements for bank holding companies. As of March 31, 2005, each of the
Company and the subsidiary bank exceeded the capital requirement levels that are
to be maintained as shown in the following table.
Capital Ratios
Well Capitalized Adequately Capitalized
(Dollars in thousands) Actual Requirement Requirement
------ ----------- -----------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
The Bank
Total capital (to risk-weighted assets) ............ $ 34,327 12.52% $ 21,934 8.00% $ 27,418 10.00%
Tier 1 capital (to risk-weighted assets) ........... 31,202 11.38% 10,967 4.00% 16,451 6.00%
Tier 1 capital (to average assets) ................. 31,202 8.51% 14,671 4.00% 18,338 5.00%
The Company
Total capital (to risk-weighted assets) ............ $ 48,553 18.02% $ 28,921 10.00% N/A N/A
Tier 1 capital (to risk-weighted assets) ........... 52,128 16.79% 17,353 6.00% N/A N/A
Tier 1 capital (to average assets) ................. 52,128 12.72% 19,064 5.00% N/A N/A
Off-Balance Sheet Risk
The Company makes contractual commitments to extend credit and issues standby
letters of credit in the ordinary course of its business activities. These
commitments are legally binding agreements to lend money to customers at
predetermined interest rates for a specified period of time. At March 31, 2005,
the Company had issued commitments to extend credit of $38,530,000 and standby
letters of credit of $1,022,000 through various types of commercial lending
arrangements. Approximately $33,913,000 of these commitments to extend credit
had variable rates.
The following table sets forth the length of time until maturity for unused
commitments to extend credit and standby letters of credit at March 31, 2005.
After One After Three
Within Through Through Within Greater
One Three Twelve One Than
(Dollars in thousands) Month Months Months Year One Year Total
----- ------ ------ ---- -------- -----
Unused commitments to extend credit ............... $ 1,655 $ 3,486 $ 15,259 $ 20,400 $ 18,130 $ 38,530
Standby letters of credit ......................... 65 0 932 997 25 1,022
----------- ----------- ----------- ----------- ----------- -----------
Totals ........................................ $ 1,720 $ 3,486 $ 16,191 $ 21,397 $ 18,155 $ 39,552
=========== =========== =========== =========== =========== ===========
Based on historical experience, many of the commitments and letters of credit
will expire unfunded. Accordingly, the amounts shown in the table above do not
necessarily reflect the Company's need for funds in the periods shown.
The Company evaluates each customer's credit worthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary upon extension of credit,
is based on the company's credit evaluation of the borrower. Collateral varies
but may include accounts receivable, inventory, property, plant and equipment,
commercial and residential real estate.
13
SOUTHCOAST FINANCIAL CORPORATION
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the risk of loss from adverse changes in market prices and
interest rates. The Company's market risk arises principally from interest rate
risk inherent in our lending, deposit, and borrowing activities. Management
actively monitors and manages its interest rate risk exposure. Although the
Company manages other risks, such as credit quality and liquidity risk in the
normal course of business, management considers interest rate risk to be its
most significant market risk and this risk could potentially have the most
significant effect on the Company's financial condition and results of
operations. Other types of market risks, such as foreign currency exchange risk
and commodity price risk do not arise in the normal course of community banking
activities.
Achieving consistent growth in net interest income is the primary goal of the
company's asset/liability function. The Company attempts to control the mix and
maturities of assets and liabilities to achieve consistent growth in net
interest income despite changes in market interest rates. The Company seeks to
accomplish this goal while maintaining adequate liquidity and capital. The
Company's asset/liability mix is sufficiently balanced so that the effect of
interest rates moving in either direction is not expected to be material over
time.
The Bank's Asset/Liability Committee uses a simulation model to assist in
achieving consistent growth in net interest income while managing interest rate
risk. The model takes into account interest rate changes as well as changes in
the mix and volume of assets and liabilities. The model simulates the Bank's
balance sheet and income statement under several different rate scenarios. The
model's input (such as interest rates and levels of loans and deposits) are
updated on a quarterly basis in order to obtain the most accurate forecast
possible. The forecast presents information over a twelve month period. It
reports a base case in which interest rates remain flat and variations that
occur when rates increase or decrease 100, 200, and 300 basis points. According
to the model, as of March 31, 2005 the Bank is positioned so that net interest
income would increase $999,000 and net income would increase $613,000 if rates
were to rise 100 basis points in the next twelve months. Conversely, net
interest income would decline $899,000 and net income would decline $551,000 if
interest rates were to decline 100 basis points. Computation of prospective
effects of hypothetical interest rate changes are based on numerous assumptions,
including relative levels of market interest rates and loan prepayments, and
should not be relied upon as indicative of actual results. Further, the
computations do not contemplate any actions the Bank could undertake in response
to changes in interest rates or the effects of responses by others, including
borrowers and depositors.
As of March 31, 2005 there was no significant change from the interest rate
sensitivity analysis for the various changes in interest rates calculated as of
December 31, 2004. The foregoing disclosures related to the market risk of the
Company should be read in conjunction with Management's Discussion and Analysis
of Financial Position and Results of Operations included in the 2004 Annual
Report on Form 10-K.
Item 4. Controls and Procedures.
Based on the evaluation required by 17 C.F.R. Sections 240.13a-15(b) or
240.15d-15(b) of the Company's disclosure controls and procedures (as defined in
17 C.F.R. Section 240.13a-15(e) and 240.15d-15(e), the Company's chief executive
officer and chief financial officer concluded that such controls and procedures,
as of the end of the period covered by this quarterly report, were effective.
There has been no change in the Company's internal control over financial
reporting during the most recent fiscal quarter that has materially affected, or
is reasonably likely to materially affect, the Company's internal control over
financial reporting.
14
SOUTHCOAST FINANCIAL CORPORATION
PART II - OTHER INFORMATION
Item 6. Exhibits
31-1 Rule 13a-14(a) Certifications of CEO
31-2 Rule 13a-14(a) Certifications of CFO
32 Section 1350 Certification
15
SOUTHCOAST FINANCIAL CORPORATION
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.
Date: May 11, 2005 By: s/L. Wayne Pearson
---------------------------------
L. Wayne Pearson
Chief Executive Officer
Date: May 11, 2005 By: s/Robert M. Scott
---------------------------------
Robert M. Scott
Chief Financial Officer
16
SOUTHCOAST FINANCIAL CORPORATION
Exhibit Index
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This exhibit
is not "filed" for purposes of Section 18 of the Securities Exchange
Act of 1934 but is instead furnished as provided by applicable rules of
the Securities and Exchange Commission.
17