10QSB 1 d51529_10-qsb.txt QUARTERLY REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB (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, 2002. |_| 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 0-23971 Citizens South Banking Corporation (Exact name of registrant as specified in its charter) United States 56-2063438 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 245 West Main Avenue, Gastonia, North Carolina 28052-4140 (Address of principal executive offices) Registrant's telephone number, including area code: (704)-868-5200 Gaston Federal Bancorp, Inc. Former name, former address and former fiscal year, if changed since last report Indicate by check |X| whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| 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: There were 4,209,434 shares of the Registrant's common stock outstanding as of August 13, 2002. Citizens South Banking Corporation INDEX Page PART I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements ............................. 2 Consolidated Statements of Financial Condition as of June 30, 2002 and December 31, 2001 ........................ 2 Consolidated Statements of Operations for the three and six months ended June 30, 2002 and 2001 .......................... 3 Consolidated Statements of Comprehensive Income for the six months ended June 30, 2002 and 2001 ...................... 4 Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and 2001 ................................. 5 Notes to Consolidated Financial Statements ....................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ..................................... 8 PART II. OTHER INFORMATION ................................................. 13 Exhibit 99.1 Certification of Chief Executive Officer and Chief Financial Officer ....................................... 15 2 PART I. FINANCIAL INFORMATION ITEM 1. Consolidated Financial Statements Citizens South Banking Corporation Consolidated Statements of Financial Condition (in thousands)
June 30, December 31, 2002 2001 ---- ---- (unaudited) Assets: Cash and due from banks ................................................ $ 6,356 $ 6,047 Interest-earning bank balances ......................................... 16,423 14,892 --------- --------- Cash and cash equivalents ........................................... 22,779 20,939 Investment securities available-for-sale, at fair value ................ 32,788 25,946 Mortgage-backed and related securities available-for-sale, at fair value 25,919 25,405 Loans, net ............................................................. 321,020 334,321 Real estate owned ...................................................... 1,538 1,470 Accrued interest receivable ............................................ 1,937 1,727 Premises and equipment, net ............................................ 8,484 8,640 Federal Home Loan Bank stock ........................................... 3,390 3,893 Cash value of life insurance policies .................................. 6,657 6,479 Core deposit intangible ................................................ 1,839 2,447 Goodwill ............................................................... 6,624 6,581 Other assets ........................................................... 6,293 9,733 --------- --------- Total assets ........................................................ $ 439,268 $ 447,581 ========= ========= Liabilities and Stockholders' Equity: Demand deposit accounts ................................................ $ 34,142 $ 33,283 Money market deposit accounts .......................................... 31,062 29,489 Savings accounts ....................................................... 46,197 44,011 Time deposits .......................................................... 235,428 246,909 --------- --------- Total deposits ...................................................... 346,829 353,692 Borrowed money ......................................................... 40,526 42,057 Advances from borrowers for taxes and insurance ........................ 1,250 515 Accrued interest payable ............................................... 510 414 Other liabilities ...................................................... 6,492 9,273 --------- --------- Total liabilities ................................................... 395,607 405,951 Common stock, $1.00 par value, 20,000,000 shares authorized, 4,581,034 shares issued in 2002 and 2001 ............................ 4,581 4,581 Additional paid-in-capital ............................................. 16,843 16,843 Unallocated common stock held by Employee Stock Ownership Plan ......... (1,183) (1,239) Retained earnings, substantially restricted ............................ 26,947 25,105 Accumulated unrealized gain on securities available-for-sale, net of tax 1,249 1,116 Treasury stock of 371,600 shares at cost at 2002 and 2001 .............. (4,776) (4,776) --------- --------- Total stockholders' equity .......................................... 43,661 41,630 --------- --------- Total liabilities and stockholders' equity ............................. $ 439,268 $ 447,581 ========= =========
See accompanying notes to consolidated financial statements. 2 Citizens South Banking Corporation Consolidated Statements of Operations (unaudited) (in thousands, except per share data)
Three Months Six Months Ended June 30, Ended June 30, -------------- -------------- 2002 2001 2002 2001 ----- ----- ---- ---- Interest income: Loans ................................................. $5,425 $3,149 $11,013 $6,302 Investment securities ................................. 357 475 679 951 Interest-bearing deposits ............................. 113 232 215 570 Mortgage-backed and related securities ................ 297 396 585 764 ------ ------ ------- ------ Total interest income ............................... 6,192 4,252 12,492 8,587 Interest Expense: Deposits .............................................. 1,992 2,043 4,118 4,090 Borrowed funds ........................................ 547 598 1,098 1,221 ------ ------ ------- ------ Total interest expense .............................. 2,539 2,641 5,216 5,311 ------ ------ ------- ------ Net interest income ................................... 3,653 1,611 7,276 3,276 Provision for loan losses ............................. 70 30 135 60 ------ ------ ------- ------ Net interest income after provision for loan losses . 3,583 1,581 7,141 3,216 Noninterest Income: Service charges and fee income on deposit accounts .... 570 475 1,093 843 Income on mortgage banking and other lending activities 171 103 314 191 Dividends on Federal Home Loan Bank stock ............. 44 36 99 76 Gain on sale of assets ................................ 21 0 109 0 Other income .......................................... 98 184 307 306 ------ ------ ------- ------ Total noninterest income ............................ 904 798 1,922 1,416 Noninterest Expense: Compensation and benefits ............................. 1,241 938 2,647 1,770 Occupancy ............................................. 349 171 710 331 Professional services ................................. 99 54 178 101 Amortization of intangible assets ..................... 252 0 608 0 Loss on sale of assets ................................ 17 0 17 9 Other expenses ........................................ 752 477 1,584 940 ------ ------ ------- ------ Total noninterest expense ........................... 2,710 1,640 5,744 3,151 Income before income taxes ............................ 1,777 739 3,319 1,481 Provision for income taxes ............................ 647 229 1,197 459 ------ ------ ------- ------ Net income ............................................ $1,130 $ 510 $ 2,122 $1,022 ====== ====== ======= ====== Per Share Data: Net income - basic .................................... $ 0.28 $ 0.13 $ 0.52 $ 0.25 Net income - diluted .................................. 0.27 0.13 0.52 0.25 Cash dividends paid ................................... 0.08 0.075 0.16 0.15 Book value ............................................ 10.37 9.74 10.37 9.74
See accompanying notes to consolidated financial statements. 3 Citizens South Banking Corporation Consolidated Statements of Comprehensive Income (unaudited) (in thousands)
Six Months Ended June 30, 2002 2001 ---- ---- Net income .................................................................. $ 2,122 $1,022 Other comprehensive income, net of tax: Unrealized gains on securities: Unrealized holding gains (losses) arising during period ............. 178 520 Reclassification adjustment for (gains) losses included in net income (45) 6 ------- ------ Other comprehensive income .............................................. 133 526 ------- ------ Comprehensive income ........................................................ $ 2,255 $1,548 ------- ------
See accompanying notes to consolidated financial statements. 4 Citizens South Banking Corporation Consolidated Statements of Cash Flows (unaudited) (in thousands)
Six Months Ended June 30, 2002 2001 ---- ---- Cash flows from operating activities: Net income ...................................................................... $ 2,122 $ 1,022 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses ................................................... 135 60 Depreciation ................................................................ 413 199 (Gain) loss on sale of investments, available for sale ...................... (70) 9 (Gain) on sale of other assets .............................................. (22) 0 Purchase of bank-owned life insurance ....................................... 0 (2,578) Amortization of intangible assets ........................................... 608 0 Decrease in other assets .................................................... 3,253 130 (Decrease) in other liabilities ............................................. (2,684) (118) -------- -------- Net cash provided by (used for) operating activities ...................... 3,755 (1,276) -------- -------- Cash flows from investing activities: Net (increase) decrease in loans receivable ..................................... 11,868 (6,948) Proceeds from the sale of investment securities ................................. 2,000 0 Proceeds from the sale of mortgage-backed securities ............................ 3,066 1,243 Proceeds from the sale of loans ................................................. 1,361 0 Proceeds from the sale of other assets .......................................... 156 196 Maturities and prepayments of investment securities ............................. 926 3,930 Maturities and prepayments of mortgage-backed securities ........................ 7,424 3,597 Purchases of investments ........................................................ (10,000) (4,400) Purchases of mortgage-backed securities ......................................... (10,995) (9,066) Sale of FHLB stock .............................................................. 503 0 Net cash flows from other investing activities .................................. (284) (1,082) -------- -------- Net cash provided by (used for) investment activities ..................... 6,025 (12,530) -------- -------- Cash flows from financing activities: Net increase (decrease) in deposits ............................................. (6,864) 12,177 Dividends paid to stockholders .................................................. (280) (267) Repurchase of common stock ...................................................... 0 (115) Net (decrease) in borrowed money ................................................ (1,531) (631) Increase in advances from borrowers for insurance and taxes ..................... 735 454 -------- -------- Net cash provided by (used for) financing activities ...................... (7,940) 11,618 -------- -------- Net increase (decrease) in cash and cash equivalents .............................. 1,840 (2,188) Cash and cash equivalents at beginning of period .................................. 20,939 26,709 -------- -------- Cash and cash equivalents at end of period ........................................ $ 22,779 $ 24,521 ======== ========
See accompanying notes to consolidated financial statements. 5 CITIZENS SOUTH BANKING CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note A - Basis of Presentation In management's opinion, the financial information, which is unaudited, reflects all adjustments, consisting of solely of normal recurring accruals, necessary for a fair presentation of the financial information as of and for the three and six month periods ended June 30, 2002 and 2001, in conformity with generally accepted accounting principles. The financial statements include the accounts of Citizens South Banking Corporation (the "Company"), formerly Gaston Federal Bancorp, Inc., and its wholly-owned subsidiary, Citizens South Bank (the "Bank"). Operating results for the three and six month periods ended June 30, 2002, are not necessarily indicative of the results that may be expected for future periods. The organization and business of the Company, accounting policies followed, and other information are contained in the notes to the consolidated financial statements of the Company as of and for the years ended December 31, 2001 and 2000, filed as part of the Company's annual report on Form 10-KSB. These consolidated financial statements should be read in conjunction with the annual consolidated financial statements. The Company's critical accounting policy relates to the allowance for loan losses on loans. It is based on management's opinion of an amount that is adequate to absorb losses in an existing portfolio. The allowance for loan losses is established through a provision for loan losses based on management's evaluation of the risk inherent in the loan portfolio, the composition of the portfolio, specific impaired loans, and current economic conditions. This evaluation considers the estimated fair value of the underlying collateral, historical loss experience, management's estimate of probable credit losses, and other factors that warrant recognition in providing for an adequate loan loss allowance. Note B - Earnings per Share Earnings per share has been determined under the provisions of the Statement of Financial Accounting Standards No. 128, Earnings Per Share. For the quarters ended June 30, 2002 and 2001, basic earnings per share has been computed based upon the weighted average common shares outstanding of 4,099,741 and 4,074,992, respectively. For the six months ended June 30, 2002 and 2001, basic earnings per share has been computed based upon the weighted average common shares outstanding of 4,098,472 and 4,078,814, respectively. The only potential stock of the Company as defined in the Statement of Financial Accounting Standards No. 128, Earnings Per Share, is stock options granted to various directors and officers of the Bank. The following is a summary of the diluted earnings per share calculation for the three and six months ended June 30, 2002 and 2001: (in thousands, except share data)
Three Months Ended Six Months Ended June 30, June 30, -------- -------- 2002 2001 2002 2001 ----- ----- ---- ---- Net income ........................ $ 1,130 $ 510 $ 2,122 $ 1,022 Weighted average outstanding shares 4,099,741 4,074,992 4,098,472 4,078,814 Dilutive effect of stock options .. 68,641 3,067 47,869 1,534 ---------- ---------- ---------- ---------- Weighted average diluted shares ... 4,168,382 4,078,059 4,146,341 4,080,348 Diluted earnings per share ....... $ 0.27 $ 0.13 $ 0.51 $ 0.25
6 Note C - Stock Compensation Plans On April 12, 1999, the Company's shareholders approved the Gaston Federal Bank (now Citizens South Bank) 1999 Stock Option Plan that provided for the issuance of 211,335 options for directors and officers to purchase the Company's common stock. As of June 30, 2002, 201,748 options had been awarded under the plan at a weighted average exercise price of $12.18, determined based on the fair market value of the Company's stock on the award date, and a weighted average contractual life of 84 months. There were 161,598 options fully vested as of June 30, 2002, of which 65% were incentive and 35% were non-statutory stock options. The Company applies the provisions of Accounting Principles Board Opinion No. 25 in accounting for the Stock Option Plan described above and, accordingly, no compensation expense has been recognized in connection with the granting of the stock options. Note D - Dividend Declaration On July 15, 2002, the Board of Directors of the Company approved and declared a regular cash dividend of $0.08 per share of common stock to shareholders of record as of August 1, 2002, and payable on August 15, 2002. The Mutual Holding Company, the majority stockholder of the Company, waived receipt of this dividend on the shares it owns of the Company's common stock. The Office of Supervision expressed no objection to this waiver of dividend. Note E - Impact of Recently Adopted Accounting Standards Effective January 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets". SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with its provisions. SFAS 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values. In connection with adoption of SFAS 142, the Company is required to perform an initial assessment of whether there is an indication that goodwill is impaired. During the second quarter of 2002, the Company completed its initial analysis of potential impairment under the provisions of SFAS No. 142, and determined based on that analysis that goodwill was not impaired. Goodwill will be tested for impairment annually, or between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company had no goodwill related to acquisitions initiated prior to July 1, 2001, or other intangible assets recorded prior to the adoption of the provisions of SFAS No. 142 whose carrying amounts or amortization were changed by the adoptions of the provisions of SFAS No. 142. SFAS 144, "Accounting for the Impairment or Disposal of Long-lived Assets", was issued in August 2001 and supersedes SFAS No. 121. SFAS No. 144 establishes standards for the financial accounting and reporting requirements for the impairment or disposal of long-lived assets. The provisions of SFAS No. 144 were adopted effective January 1, 2002. The adoption of the provisions of SFAS No. 144 did not have a material impact on the consolidated financial statements of the Company. 7 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements From time to time, the Company may publish forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products, and similar matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements provided that the Company notes that a variety of factors could cause the Company's actual results to differ materially from the anticipated results expressed in the Company's forward-looking statements. The risks and uncertainties that may affect the operations, performance, and results of the Company's business include, but are not limited to, changes in economic conditions, changes in interest rates, and changes in laws and regulations. Accordingly, past results and trends should not be used by investors to anticipate future results or trends. Statements included in this report should be read in conjunction with the Company's Annual Report on Form 10-KSB which is incorporated into this discussion by this reference. Recent Events On May 23, 2002, the Company announced that the Board of Directors of Citizens South Holdings, MHC, the Company's mutual holding company (the "Mutual Holding Company"), and the Board of Directors of the Company and the Bank had adopted a plan to fully convert the Mutual Holding Company to a capital stock corporation. The Mutual Holding Company is a federally chartered mutual holding company that owns 2,457,007 shares, or approximately 58.4% of the outstanding shares of capital stock in the Company. Upon conversion, shares of the Company's common stock currently held by the public will be exchanged for shares of a newly formed Delaware holding company, which after the conversion, will be the Bank's parent holding company. The exchange ratio has not yet been determined. Additional shares of stock in the newly formed company will be offered for sale to depositors of the Bank and to the public. The conversion is subject to approval of the Office of Thrift Supervision as well as the approval of the Mutual Holding Company's members and the Company's stockholders. On June 28, 2002, the Company filed Form S-1 with the Securities and Exchange Commission, which included the prospectus and other related documents concerning the Plan of Conversion. Also, on June 28, 2002, the Company filed an application with the Office of Thrift Supervision for approval of the Plan of Conversion. No actions have been taken by either regulatory agency at this time. Also on May 23, 2002, the Company announced that its name had changed from Gaston Federal Bancorp, Inc. to Citizens South Banking Corporation and that its Nasdaq trading symbol had changed from "GBNK" to "CSBC" to correspond with the name change. This name change is reflective of the Company's efforts to expand outside of Gaston County, North Carolina, as evidenced by the Company's recent acquisition of Innes Street Financial Corporation in Salisbury, North Carolina. Comparison of Financial Condition Assets. Total assets of the Company decreased by $8.3 million, or 1.9%, from $447.6 million as of December 31, 2001, to $439.3 million as of June 30, 2002. During the period, cash and cash equivalents increased by $1.8 million to $22.8 million, investment securities increased by $6.8 million to $32.8 million and mortgage-backed securities increased by $513,000 to $25.9 million. These increases were primarily funded by higher than normal loan prepayments. In fact, net loans decreased by $13.3 million, or 4.0%, to $321.0 million due accelerated prepayments as borrowers refinanced their loans in the historically low interest rate environment. Most of this decrease was concentrated in the one-to-four family dwelling portfolio which decreased by $21.8 million, or 11.1% during the period. The portfolio of residential loans decreased due to the 8 fact that management typically originates all new fixed-rate residential loans in the name of various third party investors. This program allows the bank to offer a broader range of mortgage loan products to our customers. In addition, we are able to close and fund the loans in the name of a third party in order to reduce the Company's overall vulnerability to rising interest rates and immediately recognize fee income from the origination of these loans. During the same period, the combined gross portfolios for all other loans including multifamily residential, commercial mortgage, land, commercial business, and consumer loans increased by $8.0 million, or 5.5%. Management will continue to focus on growing these loan portfolios in a safe and sound manner with an emphasis on adjustable-rate loans or shorter-term fixed rate loans (generally five years or less). As of June 30, 2002, nonperforming loans amounted to $1.3 million, or 0.40% of gross loans, and nonperforming assets amounted to $2.8 million, or 0.65% of total assets. The Bank's allowance for loan loss reserves amounted to $3.1 million, or 0.94% of gross loans as of June 30, 2002, compared to $3.1 million, or 0.91% of gross loans as of December 31, 2001. Liabilities. Total liabilities decreased by $10.3 million, or 2.5%, from $405.9 million as of December 31, 2001, to $395.6 million as of June 30, 2002. This decrease was due, in part, to the prepayment of a $1.5 million Federal Home Loan Bank advance and a decrease in total deposits of $6.9 million, or 1.9%, to $346.8 million as of June 30, 2002. Most of the decrease in deposits was concentrated in higher-costing time deposits. During the six month period ended June 30, 2002, time deposits decreased by $11.5 million, or 4.7%, and core deposits including checking accounts, savings accounts, and money market deposit accounts increased by $4.6 million, or 4.3% to $111.4 million. Management plans to continue in its efforts to gain deposit market share through new product development and branch expansion with an emphasis on core deposits. Borrowed money decreased by $1.5 million, or 3.6%, to $40.5 million. Borrowed money is primarily comprised $39.0 million in various callable and fixed-term Federal Home Loan Bank advances with a weighted average interest rate of 5.63%. Equity. Total equity increased by $2.1 million, or 4.9%, from $41.6 million as of December 31, 2001, to $43.7 million as of June 30, 2002. This increase was primarily due to $2.1 million in earnings during the period and a $133,000 increase in accumulated unrealized gains on available-for-sale securities. The positive effects of earnings and increased gains on available-for-sale securities were offset, in part, by the payment of $280,000 in cash dividends. The Company was authorized to repurchase a total of 581,797 shares of common stock, or 136,335 additional shares, as of June 30, 2002. Management will consider repurchasing the common stock of the Company at prices that are considered to be attractive. Comparison of Results of Operations for the Three Months Ended June 30, 2002 and 2001 General. Net income for the Company for the three months ended June 30, 2002, amounted to $1.1 million, or $0.28 per share, as compared to $510,000, or $0.13 per share, for the three months ended June 30, 2001. Net interest income. Net interest income increased by $2.0 million, or 126.7%, to $3.7 million for the three months ended June 30, 2002. This increase was primarily due to the acquisition of Innes Street Financial Corporation and its wholly-owned subsidiary, Citizens Bank, on December 31, 2001. Interest income increased by $1.9 million, or 45.6%. This increase was the result of a $152.9 million, or 62.6%, increase in average interest-earning assets, which was offset, in part, by a 66 basis point decrease in the average interest rate to 6.27%. Interest expense decreased by $102,000, or 3.9%, during the period. Average interest-bearing liabilities increased by $165.8 million, or 77.8%, the effects of which were partially offset by a 228 basis point 9 reduction in the cost of funds to 2.69%. The net interest margin for the Company was 3.32% for the quarter ended June 30, 2002, compared to 2.43% for the quarter ended June 30, 2001. Provision for loan losses. The provision for loan losses amounted to $70,000 for the three months ended June 30, 2002, compared to $30,000 for the three months ended June 30, 2001. The amount of the provision for loan losses was increased, in part, due to the increased loan volume resulting from the acquisition of Innes Street and a continued emphasis on commercial and consumer loans, rather than residential mortgage loans. Management establishes the provision for loan losses based on available information including the composition of the loan portfolio, historical loan losses, availability and quality of collateral, age of the various portfolios, changes in local economic conditions, and loan performance and quality of the portfolio. There have been no material changes in management's methods for determining the provision for loan losses during the past year. Future loan loss provisions will be made based on management's analysis and review of the information cited above. The allowance for loan losses was $3.1 million, or 0.94% of gross loans, as of June 30, 2002, compared to $1.5 million, or 0.91% of gross loans, as of June 30, 2001. The ratio of allowance for loan losses to total loans increased slightly due to a recent slowdown in local economic conditions, including layoffs and plant closings in our market area coupled with our continued emphasis on commercial business loans. The ratio of nonperforming loans to gross loans increased slightly form 0.32% as of June 30, 2001, to 0.40% as of June 30, 2002. Noninterest income. Noninterest income amounted to $904,000 for the three months ended June 30, 2002, as compared to $798,000 for the three months ended June 30, 2001. This increase of $106,000, or 13.3%, was primarily due to increased fees generated by the Bank's mortgage banking department and additional fee income derived from deposit products. Mortgage banking income increased $68,000, or 66.4%, due to higher residential loan originations resulting from a decrease in interest rates. These loans are generally sold to a third party and all fees collected are recognized as current period income. Income on deposit accounts increased $96,000, or 20.1%, due, in part, to the increased number of fee-generating demand deposit accounts resulting from the acquisition of three full-service branch offices. Management plans to continue in its efforts to increase its outstanding balance of fee-generating demand deposit accounts through targeted advertising and branch expansion. Total demand deposit accounts increased by $8.9 million, or 35.3%, during the past 12 months to $34.1 million as of June 30, 2002. During the quarter ended June 30, 2002, the Company recognized a gain of $21,000 from the sale of $1.7 million in mortgage-backed securities, $49,000 in loan participations, and other miscellaneous fixed assets. There were no gains on sales of assets during the quarter ended June 30, 2001. Noninterest expense. Noninterest expense amounted to $2.7 million for the quarter ended June 30, 2002, compared to $1.6 million for the quarter ended June 30, 2001, an increase of $1.0 million, or 65.3%. This increase was primarily due to $303,000 in higher compensation and $178,000 in increased occupancy expenses associated with the Company's acquisition of three full-service branch offices. In addition, during the June 30, 2002 quarter, the Bank incurred expenses associated with changing the name of both the Bank and the Company and increased expenses associated with servicing the Bank's growing demand deposit account portfolio. Also, the Bank incurred $252,000 in amortization of intangible assets during the quarter ended June 30, 2002, compared to no such expense for the comparable period of 2001. This expense was related to the amortization of the core deposit premium, created as a result of the Bank's acquisition of Innes Street Financial Corporation in December 2001. The core deposit intangible is being amortized over a seven year period using the accelerated method. 10 During the quarter ended June 30, 2002, the Company recognized a loss of $17,000 from the sale of miscellaneous fixed assets and real estate owned. There were no losses on sale of assets during the quarter ended June 30, 2001. Income taxes. Income taxes amounted to $647,000, or 36.4% of taxable income, for the quarter ended June 30, 2002, as compared to $229,000, or 31.0% of taxable income, for the quarter ended June 30, 2001. The increase in the overall tax rate was due to a lower percentage of income being derived from tax-advantaged assets such as municipal securities, bank-owned life insurance, and government agency securities. Comparison of Results of Operations for the Six Months Ended June 30, 2002 and 2001 General. Net income for the Company for the six months ended June 30, 2002, amounted to $2.1 million, or $0.52 per share, as compared to $1.0 million, or $0.25 per share, for the six months ended June 30, 2001. Net interest income. Net interest income increased by $4.0 million, or 122.1%, to $7.3 million for the six months ended June 30, 2002. This increase was primarily due to the acquisition of Innes Street Financial Corporation and its wholly-owned subsidiary, Citizens Bank, on December 31, 2001. Interest income increased by $3.9 million, or 45.5%. This increase was the result of a $155.8 million, or 64.0%, increase in average interest-earning assets, which was offset, in part, by a 76 basis point decrease in the average interest rate to 6.33%. Interest expense decreased by $95,000, or 1.8%, during the period. Average interest-bearing liabilities increased by $171.4 million, or 81.3%, the effects of which were partially offset by a 236 basis point reduction in the cost of funds to 2.75%. The net interest margin for the Company was 3.29% for the six month period ended June 30, 2002, compared to 2.50% for the six month period ended June 30, 2001. Provision for loan losses. The provision for loan losses amounted to $135,000 for the six months ended June 30, 2002, compared to $60,000 for the six months ended June 30, 2001. The amount of the provision for loan losses was increased, in part, due to the increased loan volume resulting from the acquisition of Innes Street and a continued emphasis on commercial and consumer loans, rather than residential mortgage loans. Management establishes the provision for loan losses based on available information including the composition of the loan portfolio, historical loan losses, availability and quality of collateral, age of the various portfolios, changes in local economic conditions, and loan performance and quality of the portfolio. There have been no material changes in management's methods for determining the provision for loan losses during the past year. Future loan loss provisions will be made based on management's analysis and review of the information cited above. The allowance for loan losses was $3.1 million, or 0.94% of gross loans, as of June 30, 2002, compared to $1.5 million, or 0.91% of gross loans, as of June 30, 2001. The ratio of allowance for loan losses to total loans increased slightly due to a recent slowdown in local economic conditions, including layoffs and plant closings in our market area coupled with our continued emphasis on commercial business loans. The ratio of nonperforming loans to gross loans increased slightly form 0.32% as of June 30, 2001, to 0.40% as of June 30, 2002. Noninterest income. Noninterest income amounted to $1.9 million for the six months ended June 30, 2002, as compared to $1.4 million for the six months ended June 30, 2001. This increase of $506,000, or 35.8%, was primarily due to increased fees generated by the Bank's mortgage banking department and additional fee income derived from deposit products. Mortgage banking income increased $123,000, or 64.2%, due to higher residential loan originations resulting from historically low interest rates. These loans are generally sold to a third party and all fees collected are recognized as current period income. Income on deposit 11 accounts increased $250,000, or 29.7%, due, in part, to the increased number of fee-generating demand deposit accounts resulting from the acquisition of three full-service branch offices. Management plans to continue in its efforts to increase its outstanding balance of fee-generating demand deposit accounts through targeted advertising and branch expansion. Total demand deposit accounts increased by $8.9 million, or 35.3%, during the past 12 months to $34.1 million as of June 30, 2002. During the six month period ended June 30, 2002, the Company recognized a gain of $109,000 from the sale of $3.1 million in mortgage-backed securities, $2.0 million in investment securities, $1.3 million in loans and other miscellaneous fixed assets. There were no gains on sales of assets during the six month period ended June 30, 2001. Noninterest expense. Noninterest expense amounted to $5.7 million for the six months ended June 30, 2002, compared to $3.1 million for the six months ended June 30, 2001. This increase of $2.6 million was primarily due to an $877,000 increase in compensation and a $379,000 increase in occupancy expense associated the operation of three additional full-service branch offices. Also, the Bank incurred increased expenses associated with servicing the Bank's growing demand deposit account portfolio, additional costs associated with the changing of the Bank's name from Gaston Federal Bank to Citizens South Bank, and expenses associated with converting the acquired Bank's computer system and back-office operations. During the quarter ended March 31, 2002, the Bank successfully consolidated the back-office operations of the accounting department, payroll processing, loan administration, marketing, and human resources. In addition, the core data processing systems were converted to the Bank's existing core data processing system. These operations were consolidated with limited disruption of normal operations and have begun to improve our overall efficiency. During the six month period ended June 30, 2002, the Company recognized a loss of $17,000 from the sale of various investment securities, repossessed assets, and fixed assets. During the period ended June 30, 2001, the Company recognized a loss of $9,000 from the sale of $1.2 million in investment securities and miscellaneous fixed assets. Income taxes. Income taxes amounted to $1.2 million, or 36.1% of taxable income, for the six months ended June 30, 2002, as compared to $459,000, or 31.0% of taxable income, for the six months ended June 30, 2001. The increase in the overall tax rate was due to a lower percentage of income being derived from tax-advantaged assets such as municipal securities, bank-owned life insurance, and government agency securities. Liquidity and Capital Resources The objective of the Bank's liquidity management is to ensure the availability of sufficient cash flows to meet all financial commitments and to capitalize on opportunities for expansion. Liquidity management addresses the Bank's ability to meet deposit withdrawals on demand or at contractual maturity, to repay borrowings as they mature, and to fund new loans and investments as opportunities arise. The Bank's primary sources of internally generated funds are principal and interest payments on loans receivable and cash flows generated from operations. External sources of funds include increases in deposits and advances from the Federal Home Loan Bank of Atlanta. The Bank is subject to various regulatory capital requirements administered by the banking regulatory agencies. As of June 30, 2002, Citizens South Bank's level of capital exceeded all applicable regulatory requirements. Failure to meet minimum capital requirements can initiate certain mandatory and possibly discretionary actions by the regulators that, if undertaken, could have a direct material effect on the Bank's 12 financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classifications are subject to qualitative judgments by the regulators about components, risk-weightings, and other factors. PART II. OTHER INFORMATION Legal Proceedings There are various claims and lawsuits in which the Bank is periodically involved incidental to the Bank's business. In the opinion of management, no material loss is expected from any of such pending claims or lawsuits. Changes in Securities Not applicable. Defaults Upon Senior Securities Not applicable. Submission of Matters to a Vote of Security Holders The following proposals were considered and acted upon at the Annual Meeting of Stockholders of the Company held on May 13, 2002: Proposal 1: To consider the election of four Directors to the Board of Directors. Martha B. Beal For 3,836,494 Withheld 8,270 James J. Fuller For 3,836,494 Withheld 8,270 Charles D. Massey For 3,836,494 Withheld 8,270 Ronald E. Bostian For 3,836,494 Withheld 8,270 Proposal 2: To consider the approval of an amendment to the Company's Charter to change the name of the Company to Citizens South Banking Corporation; For 3,832,148 Against 11,030 Abstain 1,586 Proposal 3: To consider the ratification of the appointment of Cherry, Bekaert & Holland, LLP, as auditors for the Company for the fiscal year ending December 31, 2002. For 3,841,737 Against 2,656 Abstain 371 No other business came before the meeting. Exhibits and Report on Form 8-K. There were no reports filed on Form 8-K during the quarter ended June 30, 2002. 13 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed by the undersigned thereunto duly authorized. Citizens South Banking Corporation Date: August 13, 2002 By: /s/ Kim S. Price ------------------------------------------ Kim S. Price President and Chief Executive Officer Date: August 13, 2002 By: /s/ Gary F. Hoskins ----------------------------------------- Gary F. Hoskins Senior Vice President, Chief Financial Officer and Treasurer 14