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 March 31, 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 May 10, 2002, 2,065,891 shares of the registrant's common stock, $3.50 par value, were outstanding. This Form 10-QSB has 15 pages. Part I. FINANCIAL INFORMATION Item 1. Financial Statements ECB BANCORP, INC. AND SUBSIDIARY Consolidated Balance Sheets March 31, 2002 and December 31, 2001
March 31, December 31, Assets 2002 2001* ----------------------------------------------------------------------------------------------- ------------- (unaudited) Non-interest bearing deposits and cash $ 16,940,913 $ 17,473,420 Federal funds sold 6,500,000 7,950,000 ----------------------------------------------------------------------------------------------- ------------- Total cash and cash equivalents 23,440,913 25,423,420 ----------------------------------------------------------------------------------------------- ------------- Investment securities Available-for-sale, at market value (cost of $81,456,505 and $81,366,622 at March 31, 2002 and December 31, 2001, respectively) 80,745,661 81,531,173 Loans 195,444,092 188,861,167 Allowance for probable loan losses (2,890,664) (2,850,000) ----------------------------------------------------------------------------------------------- ------------- Loans, net 192,553,428 186,011,167 ----------------------------------------------------------------------------------------------- ------------- 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 8,041,889 8,208,109 Accrued interest receivable 2,239,443 2,386,936 Other assets 8,091,026 7,132,258 ----------------------------------------------------------------------------------------------- ------------- Total $ 315,845,980 $311,496,489 ----------------------------------------------------------------------------------------------- ------------- Liabilities and Shareholders' Equity ----------------------------------------------------------------------------------------------- ------------- Deposits Demand, noninterest bearing $ 60,224,582 $ 57,207,001 Demand interest bearing 64,800,376 63,254,778 Savings 14,225,870 13,931,905 Time 131,575,860 134,072,937 ----------------------------------------------------------------------------------------------- ------------- Total deposits 270,826,688 268,466,621 ----------------------------------------------------------------------------------------------- ------------- Accrued interest payable 930,216 976,002 Other liabilities 1,109,596 1,408,729 Short-term borrowings 7,532,837 5,119,212 Long-term obligations 10,000,000 10,000,000 ----------------------------------------------------------------------------------------------- ------------- Total liabilities 290,399,337 285,970,564 ----------------------------------------------------------------------------------------------- ------------- Shareholders' equity Common stock, par value $3.50 per share; authorized 10,000,000 shares; issued and outstanding 2,065,891 and 2,065,891 in 2002 and 2001, respectively. 7,230,619 7,230,619 Capital surplus 5,762,477 5,762,477 Retained earnings 12,960,780 12,507,403 Deferred compensation - restricted stock (70,064) (75,896) Accumulated other comprehensive (loss) income (437,169) 101,322 ----------------------------------------------------------------------------------------------- ------------- Total shareholders' equity 25,446,643 25,525,925 ----------------------------------------------------------------------------------------------- ------------- Commitments ----------------------------------------------------------------------------------------------- ------------- Total $ 315,845,980 $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 months ended March 31, 2002 and 2001 (unaudited)
Three months ended March 31 ------------------------------------- 2002 2001 ---------------------------------------------------------------------- ------------ ------------ Interest income: Interest and fees on loans $ 3,417,454 $ 3,943,816 Interest on investment securities: Interest exempt from federal income taxes 170,428 148,495 Taxable interest income 877,724 812,549 Dividend income 63,828 15,972 Interest on federal funds sold 24,932 111,563 FHLB stock dividends 9,969 12,327 ---------------------------------------------------------------------- ----------- ----------- Total interest income 4,564,335 5,044,722 ---------------------------------------------------------------------- ----------- ----------- Interest expense: Deposits: Demand accounts 115,654 298,586 Savings 23,654 50,245 Time 1,058,335 1,829,706 Short-term borrowings 8,533 34,207 Long-term obligations 129,722 11,802 ---------------------------------------------------------------------- ----------- ----------- Total interest expense 1,335,898 2,224,546 ---------------------------------------------------------------------- ----------- ----------- Net interest income 3,228,437 2,820,176 Provision for probable loan losses 200,000 80,000 ---------------------------------------------------------------------- ----------- ----------- Net interest income after provision for probable loan losses 3,028,437 2,740,176 ---------------------------------------------------------------------- ----------- ----------- Noninterest income: Service charges on deposit accounts 627,498 386,536 Other service charges and fees 219,385 202,376 Net gain on sale of securities 46,029 47,847 Income from bank owned life insurance 67,094 - Other operating income 12,279 10,390 ---------------------------------------------------------------------- ----------- ----------- Total noninterest income 972,285 647,149 ---------------------------------------------------------------------- ----------- ----------- Noninterest expense: Salaries 1,154,337 1,087,507 Retirement and other employee benefits 485,158 338,801 Occupancy 225,466 248,074 Equipment 333,883 314,120 Professional fees 116,383 68,023 Supplies 59,352 60,748 Telephone 78,841 89,690 Postage 47,371 52,844 Other 592,590 508,006 ---------------------------------------------------------------------- ----------- ----------- Total noninterest expenses 3,093,381 2,767,813 ---------------------------------------------------------------------- ----------- ----------- Income before income taxes 907,341 619,512 Income taxes 247,373 160,000 ---------------------------------------------------------------------- ----------- ----------- Net income $ 659,968 $ 459,512 ---------------------------------------------------------------------- ----------- ----------- Net income per share - basic $ 0.32 $ 0.22 Net income per share - diluted $ 0.32 $ 0.22 Weighted average shares outstanding - basic 2,056,649 2,065,532 Weighted average shares outstanding - diluted 2,063,488 2,069,197
See accompanying notes to consolidated financial statements. 3 ECB BANCORP, INC. AND SUBSIDIARY Consolidated Statements of Shareholders' Equity Three months ended March 31, 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 $201,652 391,480 $ 391,480 391,480 Net income 459,512 459,512 459,512 ------------- Total comprehensive income $ 850,992 ============= Deferred compensation - restricted stock issuance 21,147 54,378 (75,525) Recognition of deferred compensation - restricted stock 5,832 5,832 Repurchase of common stock (31,577) (74,905) (106,482) Cash dividends ($.09 per share) (186,086) (186,086) ------------ ----------- ------------- ------------- ----------- ------------ Balance March 31, 2001 $ 7,245,354 $5,800,996 $10,955,726 $(93,391) $ 598,573 $24,507,258 ============ =========== ============= ============= =========== ============ Deferred Accumulated compensation- other Common Capital Retained restricted comprehensive Comprehensive stock surplus earnings stock loss 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 $ 336,904 (538,491) $(538,491) (538,491) Net income 659,968 659,968 659,968 ------------- Total comprehensive income $ 121,477 ============= Recognition of deferred compensation - restricted stock 5,832 5,832 Cash dividends ($.10 per share) (206,591) (206,591) ------------ ------------ ------------- ------------ ------------ ------------ Balance March 31, 2002 $ 7,230,619 $5,762,477 $12,960,780 $ (70,064) $ (437,169) $25,446,643 ============ ============ ============= ============ ============ ============
See accompanying notes to consolidated financial statements. 4 ECB BANCORP, INC. AND SUBSIDIARY Consolidated Statements of Cash Flows Three months ended March 31, 2002 and 2001 (Unaudited)
Three Months Ended March 31, Cash flows from operating activities: 2002 2001 ------------ ------------ Net income $ 659,968 $ 459,512 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 204,241 198,162 Amortization (accretion) of investment securities, net 12,864 (7,824) Provision for probable loan losses 200,000 80,000 Gain on sale of securities (46,029) (47,847) Deferred compensation - restricted stock 5,832 5,832 Decrease (increase) in accrued interest receivable 147,493 (62,811) Loss on disposal of premises and equipment 1,071 Gain on sale of real estate acquired in settlement of loans 8,369 - (Increase) decrease in other assets (621,864) 1,285 (Decrease) increase in accrued interest payable (45,786) 218,030 Increase in postretirement benefit liability 8,891 11,359 Decrease in other liabilities, net (328,685) (104,519) ------------------------------------------------------------ ------------ ------------ Net cash provided by operating activities 206,365 751,179 ------------------------------------------------------------ ------------ ------------ Cash flows from investing activities: Proceeds from sales of investment securities classified as available-for-sale 1,693,123 10,863,449 Proceeds from maturities of investment securities classified as available-for-sale 4,137,474 5,265,000 Purchases of investment securities classified as available-for-sale (5,887,315) (14,971,288) Purchases of premises and equipment (39,092) (928,742) Proceeds from disposal of real estate acquired in settlement of loans and real estate held for sale 61,437 - Net loan originations (6,742,261) (7,459,317) ------------------------------------------------------------ ------------ ------------ Net cash used by investing activities (6,776,634) (7,230,898) ------------------------------------------------------------ ------------ ------------ Cash flows from financing activities: Net increase in deposits 2,360,067 4,869,157 Net increase in short-term borrowings 2,413,625 60,091 Decrease in long-term obligations - (3,000,000) Dividends paid (185,930) (171,394) Repurchase of common stock - (106,482) ------------------------------------------------------------ ------------ ------------ Net cash provided by financing activities 4,587,762 1,651,372 ------------------------------------------------------------ ------------ ------------ Decrease in cash and cash equivalents (1,982,507) (4,828,347) Cash and cash equivalents at beginning of period 25,423,420 20,317,044 ------------ ------------ Cash and cash equivalents at end of period $ 23,440,913 $ 15,488,697 ============ ============ Cash paid during the period: Interest $ 1,381,684 $ 2,007,000 Taxes - - Supplemental disclosures of noncash financing and investing activities: Cash dividends declared but not paid $ 206,591 $ 185,930 Unrealized gains (losses) on available-for-sale securities, net of deferred taxes (538,491) 391,480
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 three-month period ended March 31, 2002, are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. (2) Allowance for Probable Loan Losses The following summarizes the activity in the allowance for probable loan losses for the three-month periods ended March 31, 2002 and 2001, respectively. Three-months ended March 31, ---------------------------- 2002 2001 ---- ---- Balance at the beginning of the period $2,850,000 2,800,000 Provision for probable loan losses 200,000 80,000 Charge-offs (178,643) (63,492) Recoveries 19,307 10,065 ---------- ---------- Net charge-offs (159,336) (53,427) ---------- ---------- Balance at the end of the period $2,890,664 2,827,573 ========== ========== (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.
For the periods ended March 31, ------------------------------------------------------------------------------------------------------------ 2002 2001 ------------------------------------------------------------------------------------------------------------ Income Shares Per Share Income Shares Per Share (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount Basic Net Income Per Share 659,968 2,056,649 $ 0.32 459,512 2,065,532 $ 0.22 ========== ========== Effect of dilutive securities - 6,839 - 3,665 ---------- ----------- ----------- ----------- Diluted Net Income Per Share 659,968 2,063,488 $ 0.32 459,512 2,069,197 $ 0.22 ========== =========== ========== =========== =========== ==========
6 (4) 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 and Greenville (two branches). 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 Three Month Periods Ended March 31, 2002 and 2001 Summary ------- For the three months ended March 31, 2002, the Company had net income of $660,000, or $0.32 basic and diluted earnings per share, compared to $460,000, or $0.22 basic and diluted earnings per share for the three months ended March 31, 2001. Net interest income increased $408,000 or 14.48% to $3,228,000 in the first quarter of 2002 from $2,820,000 in the first quarter of 2001, and noninterest income increased $325,000 or 50.24% when compared to the same period last year. Noninterest expense increased $326,000 or 11.76% for the three month period ended March 31, 2002 as compared to the same period in 2001, as salary and employee benefits expense increased $213,000 to $1,639,000 compared to $1,426,000 during the first quarter of 2001. Net interest income ------------------- The Company's net interest margin, on a tax-equivalent basis, for the three months ended March 31, 2002 was 4.66% compared to 4.68% in 2001. Historically, the Company has consistently maintained net interest margins exceeding 5.00%. This decrease in the Company's net interest margin is a result of a lower interest rate environment compared to prior periods as the Federal Reserve Board lowered the federal funds target rate by 475 basis points since late fourth quarter of 2000. 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 prime rate. Consequently, its 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. The Bank anticipates that its net interest margin will return to historical levels once interest rates move upward. Net interest income for the three months ended March 31, 2002 was $3,228,000, an increase of $408,000 or 14.48% when compared to net interest income of $2,820,000 for the three months ended March 31, 2001. Total interest income decreased $480,000 for the three months ended March 31, 2002 compared to the three months ended March 31, 2001, due to lower yields on earning assets despite an increase of $30.9 million in average volume of earning assets. The yield on average earning assets, on a tax-equivalent basis, for the three months ended March 31, 2002 was 6.58% compared to 8.27% in 2001. 8 Total interest expense decreased $889,000 for the three months ended March 31, 2002 compared to the three months ended March 31, 2001, as a result of lower cost of funds. The cost of funds for the Company during the three months ended March 31, 2002 was 2.37%, a decrease of 208 basis points when compared to 4.45% for the three months ended March 31, 2001. The Company's decrease in cost of funding was a result of decreases in rates paid on deposits as the result of Federal Reserve action during all of last year. The average volume of interest-bearing deposits increased $25.5 million in the first quarter of 2002 compared to the same period of 2001. Provision for probable loan losses The provision for probable loan losses charged to operations during the three months ended March 31, 2002 was $200,000, compared to $80,000 during the three months ended March 31, 2001. Net charge-offs for the quarter ended March 31, 2002 totaled $159,000, compared to net charge-offs of $53,000 during the same period of 2001. The increase in provisions for probable loan loss is the result of higher current year charge-offs and an increase in loans outstanding of $6.6 million since year-end 2001. The increase in current year net charge-offs is principally the result of a charge-off of $150,000 on a single commercial credit during the first quarter of 2002. The amount charged for provision for probable loan losses is the result of management's review and evaluation of the portfolio, which considers current conditions, past due loans, and prior loan loss experience. Noninterest income Noninterest income increased $325,000 or 50.24% to $972,000 for the three months ended March 31, 2002 compared to $647,000 for the same period in 2001. This is principally due to an increase of $252,000 in Overdraft Banking Privilege fees generated from a new banking product designed to automatically advance funds to assist in the event of checking account overdrafts introduced by the Bank in December of 2001. An additional $67,000 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 first quarter of 2002, the Bank had a gain on the sale of securities of $46,000 compared to $48,000 during the same period last year. Noninterest expense Noninterest expense increased $326,000 or 11.76% to $3,093,000 for the three months ended March 31, 2002 from the same period in 2001. This increase is principally due to general increases in salary and employee benefits expense of $213,000 or 14.95%. Salary expense increased $67,000 over the prior year period as a result general salary increases of approximately $27,000 and additional salary expense of $29,000 associated with the Bank's new financial services department formed during December of 2001. Employee benefit expense increased $146,000 over the prior year period as the Company increased its incentive pay accrual by $72,000. 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 $67,000 for the first 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 decreased $23,000 over the prior year period as a result of decreased utilities of $12,000 and decreases in property insurance and outside janitorial services of $3,000 and $5,000, respectively. Equipment expense increased $20,000 as equipment maintenance increased $20,000. Professional fees increased $48,000 over the prior year period primarily the result of additional consulting expense in connection with the Company's first quarter strategic planning session. Other operating expenses increased $85,000 from $508,000 for the three months ended March 31, 2001 to $593,000 for the three months ended March 31, 2002. This increase is primarily due to increased employee related training expense of $38,000 and increased contributions of $33,000. 9 Income taxes ------------ Income tax expense for the three months ended March 31, 2002 and 2001 was $247,000 and $160,000, respectively, resulting in effective tax rates of 27.26% and 25.83%, 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 March 31, 2002 and December 31, 2001 Total assets increased $4.3 million to $315.8 million, an increase of 1.40% when compared to $311.5 million at December 31, 2001. Asset growth was funded by increased demand deposits of $3.0 million and short-term borrowings (customer sweep accounts) of $2.4 million, partially offset by a decrease in time deposits of $2.5 million. Loans receivable have increased $6.5 million from $188.9 million at December 31, 2001 to $195.4 million at March 31, 2002. The Company has experienced steady loan demand from all of its markets throughout the quarter. During November 2001, the Bank purchased $5.06 million of BOLI policies as a funding mechanism for certain employee benefit plans. The cash surrender value of the policies at March 31, 2002 was $5.17 million and is included in other assets on the Company's balance sheet. Shareholders' equity decreased by $79,000 from December 31, 2001 to March 31, 2002, as the Company generated net income of $660,000 and experienced a decrease of net unrealized losses on available-for-sale securities of $538,000 and recognition of deferred compensation - restricted stock of $6,000. The Company declared cash dividends of $207,000 or 10 cents per share, during the first quarter of 2002 compared to 9 cents per share in the prior year period. Asset Quality ------------- Allowance for probable loan losses The allowance for probable loan losses 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. 10 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. 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. Credit Risk Management, 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. 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. 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 form 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 11 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 $576,000 and $478,000 at March 31, 2002 and December 31, 2001, respectively. At March 31, 2002, the recorded investment in loans that are considered to be impaired under SFAS No. 114 was $24,000 compared to $68,000 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. 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. 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. 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 March 31, 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 March 31, 2002, Bancorp was also in compliance with the applicable capital requirements set forth by the Federal Reserve. 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," 12 "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. 13 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 Not applicable. Item 5. Other Information Not applicable. Item 6. Exhibits and Reports on Form 8-KSB (a) Exhibits: Exhibit No. Description of Exhibit ----------- ---------------------- 10.1 Executive Supplemental Retirement Plan between the Bank and Arthur H. Kenney, III 10.2 Executive Supplemental Retirement Plan between the Bank and J Dorson White, Jr 10.3 Split-Dollar Life Insurance Agreement between the Bank and Arthur H. Keeney, III 10.4 Split-Dollar Life Insurance Agreement between the Bank and J. Dorson White, Jr 10.5 Form of Director Supplemental Retirement Agreements between the Bank and George T. Davis, Jr., John F. Hughes, Jr., Arthur H. Keeney III, Joseph T. Lamb, Jr., Robert L. Mitchell, R. S. Spencer, Jr. and Ray M. Spencer 10.6 Form of Director Supplemental Retirement Agreements between the Bank and Gregory C. Gibbs, J. Bryant Kittrell III, and B. Martelle Marshall 10.7 Form of Split-Dollar Life Insurance Agreements between the Bank and George T. Davis, Jr., Gregory C. Gibbs, John F. Hughes, Jr., Arthur H. Keeney III, J. Bryant Kittrell III, Joseph T. Lamb, Jr., B. Martelle Marshall, and R. S. Spencer, Jr. 14 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: 5/13/2002 By: /s/ Arthur H. Keeney, III --------------- ------------------------- Arthur H. Keeney, III (President & CEO) Date: 5/13/2002 By: /s/ Gary M. Adams --------------- ----------------- Gary M. Adams (Senior Vice President & CFO) 15