10QSB 1 d10qsb.txt FORM 10-QSB SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-QSB [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 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. 2017-6 -------------------------- ECB Bancorp, Inc. ----------------- (Exact name of registrant as specified in its charter) North Carolina 56-0215930 -------------- ---------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) Post Office Box 337, Engelhard, North Carolina 27824 ----------------------------------------------------------- (Address of principal executive offices) (Zip Code) (252) 925-9411 -------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No___ --- 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. As of August 13, 2002, 2,065,891 shares of the registrant's common stock, $3.50 par value, were outstanding. This Form 10-QSB has 18 pages. Part I. FINANCIAL INFORMATION Item 1. Financial Statements ECB BANCORP, INC. AND SUBSIDIARY Consolidated Balance Sheets June 30, 2002 and December 31, 2001
June 30, December 31, Assets 2002 2001* ------------------------------------------------------------------------------------------------- ------------ (unaudited) Non-interest bearing deposits and cash $ 16,707,193 $ 17,473,420 Federal funds sold 10,525,000 7,950,000 ------------------------------------------------------------------------------------------------- ------------ Total cash and cash equivalents 27,232,193 25,423,420 ------------------------------------------------------------------------------------------------- ------------ Investment securities Available-for-sale, at market value (cost of $78,501,177 and $81,366,622 at June 30, 2002 and December 31, 2001, respectively) 79,875,460 81,531,173 Loans 206,017,683 188,861,167 Allowance for probable loan losses (2,966,132) (2,850,000) ------------------------------------------------------------------------------------------------- ------------ Loans, net 203,051,551 186,011,167 ------------------------------------------------------------------------------------------------- ------------ Real estate acquired in settlement of loans, net 100,820 170,626 Federal Home Loan Bank common stock, at cost 632,800 632,800 Bank premises and equipment, net 7,983,509 8,208,109 Accrued interest receivable 2,376,118 2,386,936 Other assets 8,319,851 7,132,258 ------------------------------------------------------------------------------------------------- ------------ Total $329,572,302 $311,496,489 ------------------------------------------------------------------------------------------------- ------------ Liabilities and Shareholders' Equity ------------------------------------------------------------------------------------------------- ------------ Deposits Demand, noninterest bearing $ 64,730,794 $ 57,207,001 Demand interest bearing 72,323,071 63,254,778 Savings 15,279,424 13,931,905 Time 124,304,533 134,072,937 ------------------------------------------------------------------------------------------------- ------------ Total deposits 276,637,822 268,466,621 ------------------------------------------------------------------------------------------------- ------------ Accrued interest payable 774,682 976,002 Short-term borrowings 3,446,304 5,119,212 Long-term obligations 20,000,000 10,000,000 Other liabilities 1,427,669 1,408,729 ------------------------------------------------------------------------------------------------- ------------ Total liabilities 302,286,477 285,970,564 ------------------------------------------------------------------------------------------------- ------------ Shareholders' equity Common stock, par value $3.50 per share; authorized 10,000,000 shares; issued and outstanding 2,065,891 in 2002 and 2001, respectively. 7,230,619 7,230,619 Capital surplus 5,762,477 5,762,477 Retained earnings 13,511,778 12,507,403 Deferred compensation - restricted stock (64,232) (75,896) Accumulated other comprehensive income 845,183 101,322 ------------------------------------------------------------------------------------------------- ------------ Total shareholders' equity 27,285,825 25,525,925 ------------------------------------------------------------------------------------------------- ------------ Commitments ------------------------------------------------------------------------------------------------- ------------ Total $329,572,302 $311,496,489 ------------------------------------------------------------------------------------------------- ------------
See accompanying notes to consolidated financial statements. * Derived from audited consolidated financial statements. 2 ECB BANCORP, INC. AND SUBSIDIARY Consolidated Income Statements For the three and six months ended June 30, 2002 and 2001 (unaudited)
Three months ended Six months ended June, 30 June, 30 2002 2001 2002 2001 ---------------------------------------------- ------------ ----------- ------------ ----------- Interest income: Interest and fees on loans $ 3,555,909 $ 3,942,289 $ 6,973,363 $ 7,886,105 Interest on investment securities: Interest exempt from federal income taxes 169,532 145,021 339,960 293,516 Taxable interest income 849,676 694,408 1,727,400 1,506,957 Dividend income 48,822 63,588 112,650 79,560 FHLB stock dividends 8,972 11,313 18,941 23,640 Interest on federal funds sold 23,584 60,294 48,516 171,857 ---------------------------------------------- ------------- ------------ ------------- ------------ Total interest income 4,656,495 4,916,913 9,220,830 9,961,635 ---------------------------------------------- ------------- ------------ ------------- ------------ Interest expense: Deposits: Demand accounts 134,046 207,315 249,700 505,901 Savings 20,602 39,025 44,256 89,270 Time 936,930 1,693,321 1,995,265 3,523,027 Short-term borrowings 7,360 22,357 15,893 56,564 Long-term obligations 129,722 - 259,444 11,802 ---------------------------------------------- ------------- ------------ ------------- ------------ Total interest expense 1,228,660 1,962,018 2,564,558 4,186,564 ---------------------------------------------- ------------- ------------ ------------- ------------ Net interest income 3,427,835 2,954,895 6,656,272 5,775,071 Provision for probable loan losses 120,000 120,000 320,000 200,000 ---------------------------------------------- ------------- ------------ ------------- ------------ Net interest income after provision for probable loan loss 3,307,835 2,834,895 6,336,272 5,575,071 ---------------------------------------------- ------------- ------------ ------------- ------------ Noninterest income: Service charges on deposit accounts 692,538 417,962 1,320,036 804,498 Other service charges and fees 356,461 313,202 575,846 515,578 Net gain on sale of securities 15,155 27,739 61,184 75,586 Income from bank owned life insurance 67,354 - 134,448 - Other operating income 12,831 11,682 25,110 22,072 ---------------------------------------------- ------------- ------------ ------------- ------------ Total noninterest income 1,144,339 770,585 2,116,624 1,417,734 ---------------------------------------------- ------------- ------------ ------------- ------------ Noninterest expenses: Salaries 1,189,075 1,091,916 2,343,412 2,179,423 Retirement and other employee benefits 540,488 356,447 1,025,646 695,248 Occupancy 260,432 241,184 485,898 489,258 Equipment 351,428 327,487 685,311 641,607 Professional fees 65,483 66,771 181,866 134,794 Supplies 85,258 82,285 144,610 143,033 Telephone 79,389 76,950 158,230 166,640 Postage 50,939 44,078 98,310 96,922 Other operating expenses 796,469 654,999 1,389,059 1,163,005 ---------------------------------------------- ------------- ------------ ------------- ------------ Total noninterest expenses 3,418,961 2,942,117 6,512,342 5,709,930 ---------------------------------------------- ------------- ------------ ------------- ------------ Income before income taxes 1,033,213 663,363 1,940,554 1,282,875 Income taxes 275,627 160,000 523,000 320,000 ---------------------------------------------- ------------- ------------ ------------- ------------ Net income $ 757,586 $ 503,363 $ 1,417,554 $ 962,875 ---------------------------------------------- ============= ============ ============= ============ Net income per share - basic $ 0.37 $ 0.24 $ 0.69 $ 0.47 Net income per share - diluted $ 0.37 $ 0.24 $ 0.69 $ 0.47 Weighted average shares outstanding - basic 2,056,649 2,059,599 2,056,649 2,062,599 Weighted average shares outstanding - diluted 2,069,230 2,063,282 2,065,857 2,067,498
See accompanying notes to consolidated financial statements. 3 ECB BANCORP, INC. AND SUBSIDIARY Consolidated Statements of Shareholders' Equity Six months ended June 30, 2002 and 2001 (unaudited)
Deferred Accumulated compensation- other Common Capital Retained restricted comprehensive Comprehensive stock surplus earnings stock income income Total ----------- ----------- ------------ --------- --------- ----------- ------------ Balance January 1, 2001 $ 7,255,784 $ 5,821,523 $ 10,682,300 $ (23,698) $ 207,093 $ 23,943,002 Unrealized gains, net of income taxes of $201,652 386,398 $ 386,398 386,398 Net income 962,875 962,875 962,875 ----------- Total comprehensive income $ 1,349,273 =========== Deferred compensation - restricted stock issuance 21,147 54,378 (75,525) Recognition of deferred compensation - restricted stock 11,664 11,664 Repurchase of common stock (40,012) (96,060) (136,072) Cash dividends ($.18 per share) (372,179) (372,179) ----------- ----------- ------------ --------- --------- ------------ Balance June 30, 2001 $ 7,236,919 $ 5,779,841 $ 11,272,996 $ (87,559) $ 593,491 $ 24,795,688 =========== =========== ============ ========= ========= ============
Deferred Accumulated compensation- other Common Capital Retained restricted comprehensive Comprehensive stock surplus earnings stock income income Total ----------- ----------- ------------ --------- --------- ----------- ------------ Balance January 1, 2002 $ 7,230,619 $ 5,762,477 $ 12,507,403 $ (75,896) $ 101,322 $ 25,525,925 Unrealized losses, net of income taxes of $465,871 743,861 $ 743,861 743,861 Net income 1,417,554 1,417,554 1,417,554 ----------- Total comprehensive income $ 2,161,415 =========== Recognition of deferred compensation - restricted stock 11,664 11,664 Cash dividends ($.20 per share) (413,179) (413,179) ----------- ----------- ------------ --------- --------- ------------ Balance June 30, 2002 $ 7,230,619 $ 5,762,477 $ 13,511,778 $ (64,232) $ 845,183 $ 27,285,825 =========== =========== ============ ========= ========= ============
See accompanying notes to consolidated financial statements. 4 ECB BANCORP, INC. AND SUBSIDIARY Consolidated Statements of Cash Flows Six months ended June 30, 2002 and 2001 (Unaudited)
Six Months Ended June 30, 2002 2001 ------------ ------------ Cash flows from operating activities: Net income $ 1,417,554 $ 962,875 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 400,352 407,269 Amortization (accretion) of investment securities, net 20,027 (4,683) Provision for probable loan losses 320,000 200,000 Gain on sale of securities (61,184) (75,586) Deferred compensation - restricted stock 11,664 11,664 Decrease (increase) in accrued interest receivable 10,818 (149,594) Loss on disposal of premises and equipment 2,985 - Loss (gain) on sale of real estate acquired in settlement of loans 8,369 (2,200) Increase in other assets (1,653,464) (1,137,049) (Decrease) increase in accrued interest payable (201,320) 191,436 Increase in postretirement benefit liability 17,783 23,032 Decrease in other liabilities, net (19,501) (98,525) ------------------------------------------------------------ ------------ ------------ Net cash provided by operating activities 274,083 328,639 ------------------------------------------------------------ ------------ ------------ Cash flows from investing activities: Proceeds from sales of investment securities classified as available-for-sale 8,122,573 12,583,417 Proceeds from maturities of investment securities classified as available-for-sale 8,746,250 9,765,000 Purchases of investment securities classified as available-for-sale (13,962,221) (19,681,069) Proceeds from disposal of premises and equipment 36,085 - Purchases of premises and equipment (214,822) (1,049,038) Proceeds from disposal of real estate acquired in settlement of loans and real estate held for sale 61,437 23,475 Net loan originations (17,360,384) (14,781,458) ------------------------------------------------------------ ------------ ------------ Net cash used by investing activities (14,571,082) (13,139,673) ------------------------------------------------------------ ------------ ------------ Cash flows from financing activities: Net increase in deposits 8,171,201 15,234,332 Net (decrease) increase in short-term borrowings (1,672,908) 37,705 Increase (decrease) in long-term obligations 10,000,000 (3,000,000) Dividends paid (392,521) (357,324) Repurchase of common stock - (136,072) ------------------------------------------------------------ ------------ ------------ Net cash provided by financing activities 16,105,772 11,778,641 ------------------------------------------------------------ ------------ ------------ Increase (decrease) in cash and cash equivalents 1,808,773 (1,032,393) Cash and cash equivalents at beginning of period 25,423,420 20,317,044 ------------ ------------ Cash and cash equivalents at end of period $ 27,232,193 $ 19,284,651 ============ ============ Cash paid during the period: Interest $ 2,765,878 $ 3,994,967 Taxes 880,060 307,700 Supplemental disclosures of noncash financing and investing activities: Cash dividends declared but not paid $ 206,591 $ 186,092 Unrealized gains on available-for-sale securities, net of deferred taxes 743,861 386,398
See accompanying notes to consolidated financial statements. 5 ECB BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements (1) Basis of Presentation The consolidated financial statements include the accounts of ECB Bancorp, Inc. ("Bancorp") and its wholly-owned subsidiary, The East Carolina Bank (the "Bank") (collectively referred to hereafter as the "Company"). The Bank has two wholly-owned subsidiaries, Carolina Financial Services, Inc. and Carolina Financial Realty, Inc. All intercompany transactions and balances are eliminated in consolidation. The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts of assets and liabilities at the date of the financial statements, as well as the amounts of income and expenses during the reporting period. Actual results could differ from those estimates. All adjustments considered necessary for a fair presentation of the results for the interim periods presented have been included (such adjustments are normal and recurring in nature). The footnotes in Bancorp's annual report on Form 10-KSB should be referenced when reading these unaudited interim financial statements. Operating results for the periods ended June 30, 2002, are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. Certain prior period amounts have been reclassified in the financial statements to conform with the current period presentation. The reclassifications had no effect on previously reported net income or shareholders' equity. (2) Allowance for Probable Loan Losses The following summarizes the activity in the allowance for probable loan losses for the six-month periods ended June 30, 2002 and 2001, respectively.
Six-months ended June 30, ------------------------- 2002 2001 ---- ---- Balance at the beginning of the period $ 2,850,000 2,800,000 Provision for probable loan losses 320,000 200,000 Charge-offs (237,762) (269,806) Recoveries 33,894 26,554 ----------- ----------- Net charge-offs (203,868) (243,252) ----------- ----------- Balance at the end of the period $ 2,966,132 2,756,748 =========== ===========
(3) Net Income Per Share The following is a reconciliation of the numerators and denominators used in computing Basic and Diluted Net Income Per Share. 6
For the six month periods ended June 30, ---------------------------------------------------------------------------------------------------------------------- 2002 2001 ---------------------------------------------------------------------------------------------------------------------- Income Shares Per Share Income Shares Per Share (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount Basic Net Income Per Share 1,417,554 2,056,649 $ 0.69 962,875 2,062,599 $ 0.47 =========== =========== Effect of dilutive securities - 9,208 - 4,899 ------------- ---------------- ------------- ---------------- Diluted Net Income Per Share 1,417,554 2,065,857 $ 0.69 962,875 2,067,498 $ 0.47 ============= ================ =========== ============= ================ ===========
For the three month periods ended June 30, ---------------------------------------------------------------------------------------------------------------------- 2002 2001 ---------------------------------------------------------------------------------------------------------------------- Income Shares Per Share Income Shares Per Share (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount Basic Net Income Per Share 757,586 2,056,649 $ 0.37 503,363 2,059,599 $ 0.24 =========== =========== Effect of dilutive securities - 12,581 - 3,683 ------------- ---------------- ------------- ---------------- Diluted Net Income Per Share 757,586 2,069,230 $ 0.37 503,363 2,063,282 $ 0.24 ============= ================ =========== ============= ================ ===========
(4) Long-term Obligations On June 26, 2002 the Company completed a private issuance of $10 million in trust preferred securities as part of a pooled re-securitization transaction with several other financial institutions. The trust preferred securities bear a floating rate of interest of 3.45% over the three-month LIBOR rate, and the initial coupon, set at 5.34%, is payable quarterly. ECB Bancorp intends to use the net proceeds for the opportunistic acquisition of fee income producing entities, market expansion, the repurchase of Bancorp stock and for other corporate and strategic purposes. The trust preferred securities were issued by a wholly-owned finance subsidiary of ECB Bancorp, Inc., and ECB Bancorp has fully and unconditionally guaranteed the repayment of those securities. The proceeds from the issuance of trust preferred securities were invested in debentures issued by ECB Bancorp, Inc. and that investment became the sole asset of the trust. ECB Bancorp may redeem the trust preferred securities in whole or in part on or after June 26, 2007. The trust preferred securities mature on June 26, 2032. (5) New Accounting Pronouncements The Financial Accounting Standards Board ("FASB") has issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations". This statement improves the transparency of the accounting and reporting for business combinations by requiring that all business combinations be accounted for under a single method--the purchase method. On July 1, 2001, the Company adopted SFAS No. 141, "Business Combinations". The FASB has also issued SFAS No. 142 "Goodwill and Other Intangible Assets". This Statement requires that goodwill no longer be amortized to earnings, but instead be reviewed for impairment. This change provides investors with greater transparency regarding the economic value of goodwill and its impact on earnings. The amortization of goodwill ceases upon adoption of the statement. The Company adopted this statement on January 1, 2002 with no material effect due to the fact that the Company does not have goodwill or other intangible assets. 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General ECB Bancorp, Inc. ("Bancorp") is a bank holding company headquartered in Engelhard, North Carolina. Bancorp's wholly-owned subsidiary, The East Carolina Bank (the "Bank" or "ECB") (collectively referred to hereafter as the "Company"), is a state-chartered community bank which was founded in 1919. The Bank offers a full range of banking services through 17 branches serving eastern North Carolina, including the communities of Engelhard, Swan Quarter, Columbia, Creswell, Fairfield, Nags Head, Manteo, Southern Shores, Barco, Avon, Hatteras, Ocracoke, Washington, Hertford, New Bern, Greenville (two branches) and a newly opened loan production office located in Williamston. The operations of the Company and depository institutions in general are significantly influenced by general economic conditions and by related monetary, fiscal and other policies of depository institution regulatory agencies, including the Federal Reserve Board, the Federal Deposit Insurance Corporation (the "FDIC") and the North Carolina State Banking Commission. Deposit flows and costs of funds are influenced by interest rates on competing investments and general market rates of interest. Lending activities are affected by the demand for financing of real estate and other types of loans, which in turn are affected by the interest rates at which such financing may be offered and other factors affecting local demand and availability of funds. Comparison of the Results of Operations for the Six Month Periods Ended June 30, 2002 and 2001 Summary For the six months ended June 30, 2002, the Company had net income of $1,417,544, or $0.69 basic and diluted earnings per share, compared to $962,875, or $0.47 basic and diluted earnings per share for the six months ended June 30, 2001. For the six months ended June 30, 2002, net interest income increased 15.26% and noninterest income increased 49.30% when compared to the same period last year. Noninterest expense increased $802,412 or 14.05% for the six months ended June 30, 2002 as compared to the same period in 2001, partly attributable to general increases in salary and employee benefits expense of $494,387. Net interest income Net interest income for the six months ended June 30, 2002 was $6,656,272, an increase of $881,201 or 15.26% when compared to net interest income of $5,775,071 for the six months ended June 30, 2001. The Company's net interest margin, on a tax-equivalent basis, for the six months ended June 30, 2002 was 4.88% compared to 4.78% in 2001. The increase of the Company's net interest margin is attributable to re-pricing a significant portion of the Bank's interest-sensitive liabilities at lower rates. Total interest income decreased $740,805 for the six months ended June 30, 2002 compared to the six months ended June 30, 2001, principally due to lower interest rates on earning assets. Yield on average earning assets, on a tax-equivalent basis, for the six months ended June 30, 2002 was 6.70% compared to 8.15% in 2001. This decrease in the Company's yield on earning assets is a result of a lower interest rate environment compared to first half of 2001 as the Federal Reserve Board lowered the federal funds target rate by 225 basis points during the last six months of 2001. The Bank is asset sensitive in the initial 90 to 120 day time horizon as interest rates on approximately 35% of the loan portfolio float with the prime rate. Consequently, the net interest margin is negatively affected by decreases in interest rates during this period. Beyond this initial asset sensitive period the Bank becomes liability sensitive on a cumulative basis due to re-pricing opportunities within the certificate of deposit portfolio. Total interest expense decreased $1,622,006 for the six months ended June 30, 2002 compared to the six months ended June 30, 2001, the result of a much lower interest rate environment. The cost of funds for the 8 Company during the six months ended June 30, 2002 was 2.27%, a decrease of 195 basis points when compared to 4.22% for the six months ended June 30, 2001. The Company's decrease in cost of funds was partially the result of decreased interest expense of $745,285 on jumbo certificates of deposit, despite the Company experiencing an increase in the average balance of jumbo certificates of deposit that exceeded $10.7 million over the prior year period. Management anticipates a decrease in the Company's net interest margin of approximately 20 basis points in the upcoming quarter as a result of additional interest expense associated with the $10 million of trust preferred securities issued June 26, 2002. Until the additional capital funds can be employed as assets internally generated by the Bank, management is evaluating a cost recovery strategy that would leverage the additional capital through borrowings from the Federal Home Loan Bank and the concomitant purchase of wholesale assets at a spread. Provision for probable loan losses The provision for probable loan losses charged to operations during the first six months of 2002 was $320,000, compared to $200,000 during the first six months of 2001. Net charge-offs for the six months ended June 30, 2002 totaled $203,868, compared to net charge-offs of $243,252 during the same period of 2001. The increase in provision for probable loan loss is the result of an increase in loans outstanding of $17.2 million since year-end 2001. Current year net charge-offs are principally the result of a charge-off of $150,000 on a single commercial credit during the first quarter of 2002. The provision for probable loan losses is the result of management's review and evaluation of the loan portfolio, which considers current conditions, past due loans, and prior loan loss experience. Noninterest income Noninterest income increased $698,890 to $2,116,624 for the six months ended June 30, 2002 from $1,417,734 for the same period in 2001. This is principally due to a net increase of $509,746 in Overdraft Banking Privilege (ODP) fees generated from a new banking product introduced by the Bank in December of 2001. Uncollected and charged-off ODP advances of approximately $183,883 and third party vendor fee expense of $221,681 have been netted from gross ODP fees generated. ODP advances are charged-off once the account has maintained a negative balance for 45 consecutive days. The product is designed to assist customers in the event of checking account overdrafts by automatically advancing funds to their account. An additional $134,448 of noninterest income was generated from Bank Owned Life Insurance (BOLI) policies purchased in November of 2001 as a funding mechanism for certain employee benefit plans. Income generated by the BOLI policies is not taxable. The Company generated an additional $67,966 of fee income through its new Financial Services Department which offers customers an array of financial products. These products became available early in the first quarter of 2002. During the first half of 2002, the Bank had a net gain on the sale of securities of $61,184 compared to $75,586 during the same period last year. Noninterest expense Noninterest expense increased $802,412 or 14.05% to $6,512,342 for the six months ended June 30, 2002 from $5,709,930 in the same period in 2001. Salary expense increased $163,989 over the prior year period as a result general salary increases of approximately $82,500 and additional salary expense of $81,489 associated with the Bank's new financial services department formed during December of 2001 and a new Loan Production Office located in Williamston, NC. Employee benefit expense increased $330,398 over the prior year period as the Company increased its incentive pay accrual by $146,506 over 2001. During November 2001, the Bank entered into separate agreements with its directors and certain key employees that provide specific individual retirement benefits from the Bank following their retirement from service resulting in expense of approximately $111,881 for the first half of 2002. This benefit is funded through the aforementioned BOLI policies. It is expected the Bank's annual return on the purchased life insurance policies will cover its cost associated with these benefits. Equipment expense increased $43,704 as equipment maintenance increased $50,660. Professional fees, which, increased $47,072 over the prior year period are primarily the result of additional consulting expense in connection with the Company's first quarter strategic planning session and outside independent loan review. Other operating expenses increased 9 $226,054 from $1,163,005 for the six months ended June 30, 2001 to $1,389,059 for the six months ended June 30, 2002. This increase is primarily due to write-down on repossessed loan collateral of $144,894 and increased contributions of $47,406. Income taxes Income tax expense for the six months ended June 30, 2002 and 2001 was $523,000 and $320,000, respectively, resulting in effective tax rates of 26.95% and 24.94%, respectively. The increase in the Bank's effective tax rate for 2002 is the result an increased state tax liability. Changes in the mix of investments within the Bank's investment portfolio during 2001 away from state tax exempt securities resulted in a higher state tax liability. The effective tax rates in both years differ from the federal statutory rate of 34.00% primarily due to tax-exempt interest income. Comparison of the Results of Operations for the Three Month Periods Ended June 30, 2002 and 2001 Summary For the three months ended June 30, 2002, the Company had net income of $757,586, or $0.37 basic and diluted earnings per share, compared to $503,363, or $0.24 basic and diluted earnings per share for the three months ended June 30, 2001. Net interest income increased $472,940 or 16.01% to $3,427,835 in the second quarter of 2002 from $2,954,895 in the second quarter of 2001, and noninterest income increased $373,754 or 48.50% when compared to the same period last year. Noninterest expense increased $476,844 or 16.21% for the three month period ended June 30, 2002 as compared to the same period in 2001, as salary and employee benefits expense increased $281,200 to $1,729,563 compared to $1,448,363 during the second quarter of 2001. Net interest income Net interest income for the three months ended June 30, 2002 was $3,427,835, an increase of $472,940 or 16.01% when compared to net interest income of $2,954,895 for the prior year period. The Company's net interest margin, on a tax-equivalent basis, for the three months ended June 30, 2002 was 4.91% compared to 4.84% in 2001. Total interest income decreased $260,418 for the three months ended June 30, 2002 compared to the three months ended June 30, 2001, due to lower yields on earning assets despite an increase of $35.5 million in average volume of earning assets. The yield on average earning assets, on a tax-equivalent basis, for the three months ended June 30, 2002 was 6.62% compared to 7.94% in 2001. Total interest expense decreased $733,358 for the three months ended June 30, 2002 compared to the three months ended June 30, 2001, as a result of lower cost of funds. The cost of funds for the Company during the three months ended June 30, 2002 was 2.03%, a decrease of 192 basis points when compared to 3.95% for the three months ended June 30, 2001. The Company's decrease in cost of funding was a combination of decreases in rates paid on deposits and an increase of $7.9 million in average volume of noninterest-bearing deposits in the second quarter of 2002 compared to the same period of 2001. Management anticipates a decrease in the Company's net interest margin of approximately 20 basis points in the upcoming quarter as a result of additional interest expense associated with $10 million of trust preferred securities issued June 26, 2002. Until the additional capital funds can be employed as assets internally generated by the Bank, management is evaluating a cost recovery strategy that would leverage the additional capital through borrowings from the Federal Home Loan Bank and the concomitant purchase of wholesale assets at a spread. Provision for probable loan losses The provision for probable loan losses charged to operations during the three months ended June 30, 2002 and 2001 was $120,000. Net charge-offs for the quarter ended June 30, 2002 totaled $44,533, compared to net charge-offs of $189,825 during the same period of 2001. The amount charged for provision for 10 probable loan losses is the result of management's review and evaluation of the loan portfolio, which considers current conditions, past due loans, and prior loan loss experience. Noninterest income Noninterest income increased $373,754 or 48.50% to $1,144,339 for the three months ended June 30, 2002 compared to $770,585 for the same period in 2001. This is principally due to an increase of $257,740 in Overdraft Banking Privilege (ODP) fees generated from a new banking product designed to automatically advance funds to assist in the event of checking account overdrafts. The Bank introduced the ODP product in December of 2001. Uncollected and charged-off ODP advances of approximately $55,043 and third party vendor fee expense of $117,630 has been netted from gross ODP fees generated. ODP advances are charged-off once the account has maintained a negative balance for 45 consecutive days. An additional $67,354 of noninterest income was generated from Bank Owned Life Insurance (BOLI) policies purchased in November of 2001 as a funding mechanism for certain employee benefit plans. Income generated by the BOLI policies is not taxable. During the second quarter of 2002, the Bank generated an additional $38,543 in brokerage fees from its newly formed financial services department. Noninterest expense Noninterest expense increased $476,844 or 16.21% to $3,418,961 for the three months ended June 30, 2002 from $2,942,117 for the same period in 2001. This increase is principally due to general increases in salary and employee benefits expense of $281,200 or 19.42%. Salary expense increased $97,159 over the prior year period as a result of additional salary expense of $81,459 associated with the Bank's new financial services department formed during December of 2001 and new loan production office opened early in the first quarter of 2002. Employee benefit expense increased $184,041 over the prior year period as the Company increased its incentive pay accrual by $75,000 and employee group insurance increased $61,624. During November 2001, the Bank entered into separate agreements with its directors and certain key employees that provide specific individual retirement benefits from the Bank following their retirement from service resulting in expense of $42,816 for the second quarter of 2002. This benefit is funded through the aforementioned BOLI policies. It is expected the Bank's annual return on the purchased life insurance policies will cover its cost associated with these benefits. Occupancy expense increased $19,248 over the prior year period as a result of increased building operating supplies of $13,271. Equipment expense increased $23,941 as equipment maintenance increased $30,824 over the prior year period. Other operating expenses increased $141,470 from $654,999 for the three months ended June 30, 2001 to $796,469 for the three months ended June 30, 2002. This increase is due to write-downs on repossessed loan collateral totaling $144,894 during the second quarter. Income taxes Income tax expense for the three months ended June 30, 2002 and 2001 was $275,627 and $160,000, respectively, resulting in effective tax rates of 26.67% and 24.12%, respectively. The increase in the Bank's effective tax rate for 2002 is the result an increased state tax liability. Changes in the mix of investments within the Bank's investment portfolio during 2001 away from state tax exempt securities resulted in a higher state tax liability. The effective tax rates in both years differ from the federal statutory rate of 34.00% primarily due to tax-exempt interest income. Comparison of Financial Condition at June 30, 2002 and December 31, 2001 Total assets increased $18.1 million to $329.6 million, an increase of 5.80% when compared to $311.5 million at December 31, 2001. Asset growth was funded by $10 million of trust preferred securities issued by the Company late in the second quarter and increased demand deposits of $16.6 million, partially offset by a decrease in time deposits of $9.8 million. On June 26, 2002 the Company completed a private issuance of $10 million in trust preferred securities as part of a pooled re-securitization transaction with several other financial institutions. The trust preferred 11 securities bear a floating rate of interest of 3.45% over the three-month LIBOR rate, and the initial coupon, set at 5.34%, is payable quarterly. Loans receivable have increased $17.2 million from $188.9 million at December 31, 2001 to $206.0 million at June 30, 2002. The Company has experienced favorable loan demand from all of its markets throughout the year. Real estate and real estate related loans have increased by $9.9 million since yearend while lines of credit have increased $6.7 million. Shareholders' equity increased by $1,759,900 from December 31, 2001 to June 30, 2002, as the Company generated net income of $1,417,554 and experienced an increase of net unrealized gains on available-for-sale securities of $743,861 and recognition of deferred compensation - restricted stock of $11,664. The Company declared cash dividends of $413,179 or 20 cents per share, during the first six months of 2002 compared to 18 cents per share in the prior year period. Asset Quality Allowance for probable loan losses The allowance for probable loan losses (AFLL) is established through a provision for loan and lease losses charged against earnings. The level of the allowance for probable loan losses reflects management's best estimate of probable losses inherent in the portfolio as of the balance sheet date and is based on management's evaluation of the risks in the loan portfolio and changes in the nature and volume of loan activity. Management's evaluation, which includes a review of loans for which full collectibility may not be reasonably assured, considers the loans' "risk grades," the estimated fair value of the underlying collateral, current economic conditions, historical loan loss experience and other current factors that warrant consideration in determining an adequate allowance. ECB's objective is to maintain a loan portfolio that is diverse in terms of loan type, industry concentration, and borrower concentration in order to manage overall credit risk by minimizing the adverse impact of any single event or combination of related events. Reserve Policy and Methodology The allowance for probable loan losses is composed of general reserves, specific reserves and an unallocated reserve. General reserves are established for the loan portfolio using loss percentages that are determined based on management's evaluation of the losses inherent in the various risk grades of loans. Loans are categorized as one of eight risk grades based on management's assessment of the overall credit quality of the loan, including the payment history, the financial position of the borrower, underlying collateral, internal credit reviews and the results of external regulatory examinations. The general reserve percentages are then applied to the loan balances within each risk grade to estimate the necessary allowance for probable losses in each risk category. The general reserve percentages used have been determined by management to be appropriate based primarily on historical loan losses and the level of risk assumed for the various risk grades. The reserve percentages for Special Mention, Substandard and Doubtful are based on rates used by banking regulators in conjunction with their examination of ECB. The process of classifying loans into the appropriate risk grades is performed initially as a component of the approval of the loan by the appropriate credit officer. Based on the size of the loan, senior credit officers and/or the loan committee may review the classification to ensure accuracy and consistency of classification. To determine the most appropriate risk grade classification for each loan, credit officers examine the borrower's liquidity level, the quality of any collateral, the amount of the borrower's other indebtedness, cash flow, earnings, sources of financing and existing lending relationships. Loan classifications are frequently reviewed by internal credit examiners to determine if any changes in the circumstances of the loan require a different risk grade. An independent vendor engaged by the Bank on an annual basis, conducts an external review of loan classifications as part of their credit review process. 12 Specific reserves are provided on impaired commercial loans and are determined on a loan-by-loan basis based on management's evaluation of ECB's loss exposure for each credit, given the current payment status of the loan and the value of any underlying collateral. Loans for which specific reserves are provided are excluded from the general allowance calculations described above to prevent duplicate reserves. The calculations of specific reserves on commercial loans incorporate the results of measuring impaired loans pursuant to the requirements of Statement of Financial Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan." SFAS No. 114, as amended, requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, at the loan's observable market price, or the fair value of the collateral if the loan is collateral-dependent. A loan is impaired when, based on current information and events, it is probable that ECB will be unable to collect all amounts due according to the contractual terms of the loan agreement. When the measurement of the impaired loan is less that the recorded investment in the loan, the amount of the impairment is recorded through a specific reserve. It is ECB's policy to classify and disclose all commercial loans that are on nonaccrual status as impaired loans. Substantially all other loans made by ECB are excluded from the scope of SFAS No. 114 as they are comprised of large groups of smaller balance homogeneous loans (e.g., residential mortgage and consumer installment) that are evaluated collectively for impairment in the general reserves estimation process discussed above. There are two primary components considered in determining an appropriate level for the unallocated reserve. A portion of the unallocated reserve is established to cover the elements of imprecision and estimation risk inherent in the calculations of the general and specific reserves described above. The remaining portion of the unallocated reserve is determined based on management's evaluation of various conditions that are not directly measured by any other component of the reserve, including current general economic and business conditions affecting key lending areas, credit quality trends, collateral values, loan volumes and concentrations, seasoning of the loan portfolio, the findings of internal credit examinations and results from external bank regulatory examinations. While management uses the best information available to establish the allowance for probable loan losses, future adjustments to the allowance or to the reserving methodology may be necessary if economic conditions differ substantially from the assumptions used in making the valuations or, if required by regulators, based upon information at the time of their examinations. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels may vary from previous estimates. Nonperforming assets consist of loans not accruing interest, restructured debt and real estate acquired in settlement of loans and other repossessed collateral. It is ECB's policy to place loans on nonaccrual status when any portion of principal or interest becomes 90 days past due, or earlier if full collection of principal and interest become doubtful. When loans are placed on nonaccrual status, interest receivable is reversed against interest income in the current period. Interest payments received thereafter are applied as a reduction of the remaining principal balance so long as doubt exists as to the ultimate collection of the principal. Loans are removed from nonaccrual status when they become current as to both principal and interest and when the collectibility of principal or interest is no longer doubtful. Nonperforming assets were $254,904 and $477,163 at June 30, 2002 and December 31, 2001, respectively. At June 30, 2002, the recorded investment in loans that are considered to be impaired under SFAS No. 114 was $6,892 compared to $67,914 at December 31, 2001, all of which were on a non-accrual basis. Trends and dollar amounts of nonperforming loans are used by management in evaluating the overall adequacy of the allowance for probable loan losses. The allowance for probable loan losses as a percentage of loans outstanding was 1.44% and 1.51% at June 30, 2002 and December 31, 2001, respectively. Management has allowed the AFLL to represent a slightly smaller percentage of total loans outstanding not only due to reductions in nonperforming assets and improved asset quality, but also the effect of seasonal lines of credit. Regulatory Matters Management is not presently aware of any current recommendations to the Company by regulatory authorities which, if they were to be implemented, would have a material effect on the Company's liquidity, capital resources or operations. 13 Liquidity The Company relies on the investment portfolio as a source of liquidity, with maturities designed to provide needed cash flows. Further, retail deposits generated throughout the branch network have enabled management to fund asset growth and maintain liquidity. These sources have allowed limited dependence on short-term borrowed funds for liquidity or for asset expansion. External sources of funds include the ability to access advances from the Federal Home Loan Bank of Atlanta and Fed Fund lines with correspondent banks. Long-term borrowings increased $10 million during the second quarter, the result of the issuance of trust preferred securities by the Company on June 26, 2002. Capital Resources Bancorp and the Bank are subject to the capital requirements of the Federal Reserve, the FDIC and the State Banking Commission. The FDIC requires the Bank to maintain minimum ratios of Tier I capital to total risk-weighted assets and total capital to risk-weighted assets of 4% and 8%, respectively. To be "well capitalized," the FDIC requires ratios of Tier I capital to total risk-weighted assets and total capital to risk-weighted assets of 6% and 10%, respectively. Tier I capital consists of total stockholders' equity calculated in accordance with generally accepted accounting principles excluding unrealized gains or losses, net of income taxes, on securities available-for-sale, and total capital is comprised of Tier I capital plus certain adjustments, the only one of which is applicable to the Bank is the allowance for probable loan losses. Risk-weighted assets reflect the Banks' on- and off-balance sheet exposures after such exposures have been adjusted for their relative risk levels using formulas set forth in FDIC regulations. As of June 30, 2002, the Bank was in compliance with all of the aforementioned capital requirements and meets the "well-capitalized" definition that is used by the FDIC in its evaluation of member banks. Additionally, at June 30, 2002, Bancorp was also in compliance with the applicable capital requirements set forth by the Federal Reserve. A portion, $6.6 million, of the trust preferred securities issued on June 26, 2002 qualify as Tier 1 capital for regulatory capital adequacy requirements for ECB Bancorp, Inc. and the entire $10 million was infused into the Bank, increasing the Bank's Tier 1 capital by $10 million. As of June 30, 2002, the Bank's Leverage Ratio was 11.49%, compared to 8.43% at December 31, 2001 and ECB Bancorp's Leverage Ratio was 10.40% on June 30, 2002, compared to 8.41% at December 31, 2001. As of June 30, 2002, the Bank's Tier 1 Risk-based Capital Ratio was 13.96%, compared to 11.33% at December 31, 2001. ECB Bancorp's Tier 1 Risk-based Capital Ratio was 10.40% on June 30, 2002, compared to 10.45% at December 31, 2001. These improved capital ratios during the second quarter of 2002 reflect the impact of the issuance of $10 million in trust preferred securities. Current Accounting Issues The Financial Accounting Standards Board ("FASB") issues exposure drafts for proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards. Management considers the effect of the proposed statements on the consolidated financial statements of the Company and monitors the status of changes to issued exposure drafts and to proposed effective dates. Forward-Looking Statements This discussion may contain statements that could be deemed forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act, which statements are inherently subject to risks and uncertainties. Forward-looking statements are statements that include projections, predictions, expectations, or beliefs about future events or results or otherwise are not statements of historical fact. Such statements are often characterized by the use of qualifying words (and their derivatives) such as "expect," "believe," "estimate," "plan," "project," 14 "anticipate," or other statements concerning opinions or judgment of Bancorp and its management about future events. Factors that could influence the accuracy of such forward-looking statements include, but are not limited to, the financial success or changing strategies of Bancorp's customers, actions of government regulators, the level of market interest rates, and general economic conditions. 15 PART II. OTHER INFORMATION Item 1. Legal Proceedings None. Item 2. Changes in Securities and Use of Proceeds Not applicable. Item 3. Defaults upon Senior Securities Not applicable. Item 4. Submission of Matters to a Vote of Security Holders (a) The Registrant's Annual Meeting of Shareholders was held on April 17, 2002. (b) At the Annual Meeting, the three Directors listed in the following table were elected for terms of three years or until their respective successors are duly elected and qualified. Registrant's incumbent Directors whose terms of office continued after the meeting are: George T. Davis, Jr.; Gregory C. Gibbs; John F. Hughes; Robert L. Mitchell; Arthur H. Keeney III; Joseph T. Lamb, Jr. and Ray M. Spencer. Voting for Directors was as follows: For Withheld Broker Non-vote ----------------------------------------- Bryant Kittrell III 1,680,315 2,168 none B. Martelle Marshall 1,680,315 2,168 none R. S. Spencer, Jr. 1,680,255 2,228 none In addition to the election of Directors, the following proposal was voted on and approved at the Annual Meeting: 1. Proposal to ratify the selection of KPMG LLP as independent auditors for the Registrant as described under the caption "Ratification of Selection of Independent Auditor" in the Registrant's Proxy Statement dated March 18, 2002 (approved by an affirmative vote of 1,661,280 shares or 98.74% of the shares that voted, 3,497 negative votes and 17,706 shares abstained). Item 5. Other Information Not applicable. 16 Item 6. Exhibits and Reports on Form 8-KSB (a) Exhibits: Exhibit Number Description ------ ----------- 3.1 Registrant's Articles of Incorporation (incorporated by reference from Exhibit 3.1 to Registrant's Registration Statement on Form SB-2, Reg. No. 333-61839) 3.2 Registrant's Bylaws (incorporated by reference from Exhibit 3.2 to Registrant's Registration Statement on Form SB-2, Reg. No. 333-61839) 4.1 Indenture dated as of June 26, between Registrant and State Street Bank and Trust Company of Connecticut, National Association. 4.2 Guarantee Agreement dated as of June 26, 2002, between Registrant and State Street Bank and Trust Company of Connecticut, National Association. 4.3 Amended and Restated Declaration of Trust dated as of June 26, 2002, by and among Registrant, State Street Bank and Trust Company of Connecticut, National Association and the Administrators. 17 SIGNATURES Under the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ECB BANCORP, INC. (Registrant) Date: 8/13/2002 By: /s/ Arthur H. Keeney, III --------------- ------------------------- Arthur H. Keeney, III (President & CEO) Date: 8/13/2002 By: /s/ Gary M. Adams --------------- ----------------- Gary M. Adams (Senior Vice President & CFO) CERTIFICATION (Pursuant to 18 U.S.C. Section 1350) The undersigned hereby certifies that, to his knowledge (i) the Form 10-Q filed by ECB Bancorp, Inc. (the "Issuer") for the quarter ended June 30, 2002, fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and (ii) the information contained in that report fairly presents, in all material respects, the financial condition and results of operations of the Issuer on the dates and for the periods presented therein. Date: 8/13/2002 /s/ Arthur H. Keeney, III ------------------------- Arthur H. Keeney, III (President & CEO) Date: 8/13/2002 /s/ Gary M. Adams ----------------- Gary M. Adams (Senior Vice President & CFO) 18