-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RXdEj3PqIFWbswZwRChLXfMdF1F251HiwGrC/THD38958aNCxSZM9ScYp3LQDe/S /0nQrkT5YH6nZmcKO7NmTg== 0000914317-05-001491.txt : 20050428 0000914317-05-001491.hdr.sgml : 20050428 20050428142953 ACCESSION NUMBER: 0000914317-05-001491 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20041231 FILED AS OF DATE: 20050428 DATE AS OF CHANGE: 20050428 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CAPITAL BANK CORP CENTRAL INDEX KEY: 0001071992 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 562101930 STATE OF INCORPORATION: NC FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-30062 FILM NUMBER: 05779913 BUSINESS ADDRESS: STREET 1: 4901 GLENWOOD AVENUE CITY: RALEIGH STATE: NC ZIP: 27612 BUSINESS PHONE: 9196456312 MAIL ADDRESS: STREET 1: PO BOX 18949 CITY: RALEIGH STATE: NC ZIP: 27619-8949 10-K/A 1 form10ka-68446_capital.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A ----------- Amendment No. 2 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2004 Commission File Number 0-30062 CAPITAL BANK CORPORATION (Exact name of registrant as specified in its charter) North Carolina 56-2101930 (State of incorporation) (I.R.S. Employer Identification Number) 4901 Glenwood Avenue Raleigh, North Carolina 27612 (Address of principal executive office) Registrant's telephone number, including area code: (919) 645-6400 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par value per share Nasdaq National Market (Title of Class) (Name of Exchange on Which Registered) 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 |_| Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. |_| Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes |X| No |_|. The aggregate market value of the registrant's Common Stock, no par value per share, as of June 30, 2004, held by those persons deemed by the registrant to be non-affiliates was approximately $87,363,642 (5,343,342 shares held by non-affiliates at $16.35 per share). For purposes of the forgoing calculation only, all directors, executive officers, and 5% shareholders of the registrant have been deemed affiliates. As of March 7, 2005, there were 6,593,787 shares of the registrant's Common Stock, no par value per share, outstanding. DOCUMENTS INCORPORATED BY REFERENCE Document Incorporated Where - --------------------- ----- 1. Portions of the registrant's Proxy Statement for the Annual Meeting Part III of Shareholders to be held on May 26, 2005 Explanatory Note On March 15, 2005, Capital Bank Corporation (the "Company") filed with the Securities and Exchange Commission (the "SEC") its annual report on Form 10-K for the fiscal year ended December 31, 2004 (the "Annual Report"). On April 19, 2005, the Company filed Amendment No. 1 to the Annual Report ("Amendment No. 1") to correct a typographical error in the Report of Independent Registered Public Accounting Firm contained in Item 8 of Part II of the Annual Report. In reliance upon the Order of the SEC issued under Section 36 of the Securities Exchange Act of 1934 (Release No. 50754, November 30, 2004), the Company omitted from Item 9A of the Annual Report, as amended by Amendment No. 1, both the annual report of its management on internal control on financial reporting, as required by Item 308(a) of Regulation S-K, as well as the related attestation report of a registered public accounting firm, as required by Item 308(b) of Regulation S-K. The Company is filing this Amendment No. 2 to the Annual Report on Form 10-K (this "Amendment No. 2") to provide the information that was omitted from Item 9A of the Annual Report, as amended by Amendment No. 1. All other items of the Annual Report, as amended by Amendment No. 1, are refiled herein for the convenience of reference. No other items of the Annual Report, as amended by Amendment No. 1, are being amended and this Amendment No. 2 does not reflect any events occurring after the filing on March 15, 2005 of the original Annual Report, except for inclusion of the typographically corrected Report of Independent Registered Public Accounting Firm that was filed with Amendment No. 1. CAPITAL BANK CORPORATION Annual Report on Form 10-K INDEX PART I.................................................................................. ..............2 Item 1. Business..................................................................................2 Item 2. Properties...............................................................................10 Item 3. Legal Proceedings........................................................................10 Item 4. Submission of Matters to a Vote of Security Holders......................................10 PART II............................................................................... ...............11 Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases .11 Item 6. Selected Financial Data..................................................................11 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....12 Item 7A. Quantitative and Qualitative Disclosures About Market Risk...............................30 Item 8. Financial Statements and Supplementary Data..............................................34 Item 9. Changes In and Disagreements With Accountants On Accounting and Financial Disclosure.....64 Item 9A. Controls and Procedures..................................................................64 PART III............................................................................. ................65 Item 10. Directors and Executive Officers of the Registrant.......................................65 Item 11. Executive Compensation...................................................................65 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters..................................................................................65 Item 13. Certain Relationships and Related Transactions...........................................65 Item 14. Principal Accountant Fees and Services...................................................65 PART IV............................................................................ ..................65 Item 15. Exhibits and Financial Statement Schedules.............................................65 Signatures........................................................................................67
PART I Item 1. Business. General Capital Bank Corporation (the "Company") is a financial holding company incorporated under the laws of North Carolina on August 10, 1998. The Company's primary function is to serve as the holding company for its wholly-owned subsidiaries, Capital Bank and Capital Bank Investment Services, Inc. In addition, the Company has interest in two trusts, Capital Bank Statutory Trust I and II (hereinafter collectively referred to as the "Trusts"). These Trusts are not consolidated with the financial statements of the Company per the provisions of FIN 46R. Capital Bank (the "Bank") was incorporated under the laws of the State of North Carolina on May 30, 1997, and commenced operations as a state-chartered banking corporation on June 20, 1997. The Bank is not a member of the Federal Reserve System and has no subsidiaries. Capital Bank Investment Services, Inc. ("CBIS") was incorporated under the laws of the State of North Carolina on January 3, 2001 and commenced operations as a full service investment company on March 1, 2001. In the third quarter of 2003 CBIS ceased operations, but remains a subsidiary of the Company. As of December 31, 2004, the Company had assets of approximately $882.3 million, gross loans outstanding of approximately $654.9 million and deposits of approximately $655.0 million. The Company's corporate office is located at 4901 Glenwood Avenue, Raleigh, North Carolina 27612, and its telephone number is (919) 645-6400. In addition to the corporate office, the Company has four branch offices in Raleigh, two in Cary, one in Siler City, one in Oxford, one in Wake Forest, three in Sanford, two in Burlington, one in Graham, one in Greensboro, three in Asheville and one in Hickory, North Carolina. -2- Capital Bank is a community bank engaged in the general commercial banking business in Wake, Chatham, Granville, Alamance, Lee, Buncombe, Guilford and Catawba Counties of North Carolina. Wake County has a diversified economic base, comprised primarily of services, retail trade, government and manufacturing and includes the City of Raleigh, the state capital. Lee, Granville and Chatham counties are significant centers for various industries, including agriculture, manufacturing, lumber and tobacco. Alamance and Guilford counties have a diversified economic base, comprised primarily of manufacturing, agriculture, retail and wholesale trade, government, services and utilities. Catawba County, which includes the town of Hickory, is a regional center for manufacturing and wholesale trade. The economic base of the city of Asheville, in Buncombe County, is comprised primarily of services, medical, tourism and manufacturing industries. The Bank offers a full range of banking services, including the following: checking accounts; savings accounts; NOW accounts; money market accounts; certificates of deposit; loans for real estate, construction, businesses, agriculture, personal uses, home improvement and automobiles; equity lines of credit; credit loans; consumer loans; credit cards; individual retirement accounts; safe deposit boxes; bank money orders; internet banking; electronic funds transfer services including wire transfers; traveler's checks; various investments; and free notary services to all Bank customers. In addition, the Bank provides automated teller machine access to its customers for cash withdrawals through nationwide ATM networks. At present, the Bank does not provide the services of a trust department. In the third quarter of 2004, the Bank began to offer non-insured investment products and services through Capital Bank Financial Services, creating a partnership with Capital Investment Group, a leading Raleigh, North Carolina based broker-dealer. The Bank has hired four commission-based financial advisors during 2004 to offer full-service brokerage to individual and corporate customers. With the addition of the Financial Services division, Capital Bank now has the ability to compete with much larger institutions in North Carolina. The Trusts were formed for the sole purpose of issuing trust preferred securities. The proceeds from such issuances were loaned to the Company in exchange for the Debentures (as defined below), which are the sole assets of the Trust. A portion of the proceeds from the issuance of the Debentures were used by the Company to repurchase shares of Company common stock. The Company's obligation under the Debentures constitutes a full and unconditional guarantee by the Company of the Trust's obligations under the trust preferred securities. The Trusts have no operations other than those that are incidental to the issuance of the trust preferred securities. Lending Activities and Deposits Loan Types and Lending Policies. The Company makes a variety of loans, including loans secured by real estate, loans for construction, loans for commercial purposes and loans to individuals for personal and household purposes. During 2004, there were no large concentrations of credit to any particular industry. The economic trends of the area served by the Company are influenced by the significant industries within the region. Consistent with the Company's emphasis on being a community-oriented financial institution, virtually all the Company's business activity is with customers located in and around counties in which the Company has banking offices. The ultimate collectibility of the Company's loan portfolio is susceptible to changes in the market conditions of these geographic regions. The Company uses a centralized risk management process to ensure uniform credit underwriting that adheres to the Bank's loan policy as approved annually by the Board. Lending policies are reviewed on a regular basis to confirm that the Company is prudent in setting its underwriting criteria. Credit risk is managed through a number of methods including loan grading of commercial loans, committee approval of larger loans and class and purpose coding of loans. Management believes that early detection of credit problems through regular contact with the Company's clients coupled with consistent reviews of the borrowers' financial condition are important factors in overall credit risk management. -3- The following table sets forth, as of December 31, 2004, the approximate composition of the Company's loan portfolio: Loan Type Amount Percentage --------------------------- (In thousands) Commercial $ 532,091 82% Consumer 34,865 5% Home Equity Lines 61,924 9% Residential mortgages 25,987 4% ----------- ----------- $ 654,867 100% =========== =========== Deposits. The majority of the Company's deposit customers are individuals and small to medium-size businesses located in Wake, Chatham, Granville, Alamance, and Lee Counties, North Carolina and contiguous areas and the Asheville, Greensboro and Hickory, North Carolina communities. The Company's deposit base is well diversified, with no material concentration in a single industry or group of related industries. Management of the Company does not believe that the deposits or the business of the Company in general are seasonal in nature. Deposits vary with local and national economic conditions, but not enough, management believes, to have a material effect on planning and policy making. The Company attempts to control deposit flow through the pricing of deposits and promotional activities. Management believes that the Company's rates are competitive with those offered by other institutions in the same geographic area. The following table sets forth the mix of depository accounts at the Company as a percentage of total deposits as of December 31, 2004: Non-interest bearing demand 10% Interest checking 12% Market rate investment 15% Savings 2% Time deposits: Under $100,000 40% Equal to or over $100,000 21% ------ 100% ====== Competition Commercial banking in North Carolina is extremely competitive in large part due to statewide branching. The Company competes in its market area with some of the largest banking organizations in the state and the country and other community financial institutions, such as federally and state-chartered savings and loan institutions and credit unions, as well as consumer finance companies, mortgage companies and other lenders engaged in the business of extending credit. Many of the Company's competitors have broader geographic markets, easier access to capital and lower cost funding and higher lending limits than the Company and are also able to provide more services and make greater use of media advertising. The enactment of legislation authorizing interstate banking has caused increases in the size and financial resources of some of the Company's competitors. In addition, as a result of interstate banking, out-of-state commercial banks may acquire North Carolina banks and heighten the competition among banks in North Carolina. Despite the competition in its market area, the Company believes that it has certain competitive advantages that distinguish it from its competition. The Company believes that its primary competitive advantages are its strong local identity and affiliation with the communities it serves and its emphasis on providing specialized services to small and medium-sized business enterprises, as well as professional and upper-income individuals. The Company offers customers modern, high-tech banking without forsaking community values such as prompt, personal service and friendliness. The Company offers many personalized services and attracts customers by being responsive and sensitive to their individualized needs. The Company also relies on goodwill and referrals from shareholders and satisfied customers, as well as traditional media to attract new customers. To enhance a positive image in the community, the Company supports and participates in local events and its officers and directors serve on boards of local civic and charitable organizations. -4- Employees At March 1, 2005, the Company employed 241 persons, of which 224 were full-time and 17 were part-time. None of its employees are represented by a collective bargaining unit. The Company considers relations with its employees to be good. Supervision and Regulation Holding companies, banks and many of their non-bank affiliates are extensively regulated under both federal and state law. The following is a brief summary of certain statutes, rules and regulations affecting the Company and the Bank. This summary is qualified in its entirety by reference to the particular statutory and regulatory provisions referred to below and is not intended to be an exhaustive description of the statutes or regulations applicable to the Company's or the Bank's business. Supervision, regulation and examination of the Company and the Bank by bank regulatory agencies is intended primarily for the protection of the Bank's depositors rather than holders of the Company's common stock. The Company is also regulated by the Securities and Exchange Commission ("SEC") as a result of its common stock being publicly traded. Due to recent legislation, the regulatory compliance burden of being a publicly traded company has increased significantly over the last few years. Holding Company Regulation General. The Company is a holding company registered with the Federal Reserve under the Bank Holding Company Act of 1956 (the "BHCA"). As such, the Company and the Bank are subject to the supervision, examination and reporting requirements contained in the BHCA and the regulation of the Federal Reserve. The BHCA requires that a bank holding company obtain the prior approval of the Federal Reserve before: (i) acquiring direct or indirect ownership or control of more than five percent of the voting shares of any bank; (ii) taking any action that causes a bank to become a subsidiary of the bank holding company; (iii) acquiring all or substantially all of the assets of any bank; or (iv) merging or consolidating with any other bank holding company. The BHCA generally prohibits a bank holding company, with certain exceptions, from engaging in activities other than banking, or managing or controlling banks or other permissible subsidiaries, and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those activities determined by the Federal Reserve to be closely related to banking, or managing or controlling banks, as to be a proper incident thereto. In determining whether a particular activity is permissible, the Federal Reserve must consider whether the performance of such an activity can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. For example, banking, operating a thrift institution, extending credit or servicing loans, leasing real or personal property, providing securities brokerage services, providing certain data processing services, acting as agent or broker in selling credit life insurance and certain other types of insurance underwriting activities have all been determined by regulations of the Federal Reserve to be permissible activities. Pursuant to delegated authority, the Federal Reserve Bank of Richmond has authority to approve certain activities of holding companies within its district, including the Company, provided the nature of the activity has been approved by the Federal Reserve. Despite prior approval, the Federal Reserve has the power to order a holding company or its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when it believes that continuation of such activity or such ownership or control constitutes a serious risk to the financial safety, soundness or stability of any bank subsidiary of that bank holding company. Financial Holding Companies. The Gramm-Leach-Bliley Financial Modernization Act of 1999 (the "GLB"): o allows bank holding companies meeting management, capital and the Community Reinvestment Act of 1977 (the "CRA") standards to engage in a substantially broader range of non-banking activities than was permissible prior to enactment, including insurance underwriting and making merchant banking investments in commercial and financial companies; -5- o allows insurers and other financial services companies to acquire banks; o removes various restrictions that applied to bank holding company ownership of securities firms and mutual fund advisory companies; and o establishes the overall regulatory structure applicable to bank holding companies that also engage in insurance and securities operations. The Company is authorized to operate as a financial holding company and therefore is eligible to engage in the broader range of activities that are permitted by the GLB. The GLB also is designed to modify other current financial laws, including laws related to financial privacy and community reinvestment. The new financial privacy provisions generally prohibit financial institutions, including the Company, from disclosing nonpublic personal financial information to nonaffiliated third parties unless customers have the opportunity to "opt out" of the disclosure. Mergers and Acquisitions. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "IBBEA") permits interstate acquisitions of banks and bank holding companies without geographic limitation, subject to any state requirement that the bank has been organized for a minimum period of time, not to exceed five years, and the requirement that the bank holding company, prior to, or following the proposed acquisition, controls no more than 10% of the total amount of deposits of insured depository institutions in the U.S. and no more than 30% of such deposits in any state (or such lesser or greater amount set by state law). In addition, the IBBEA permits a bank to merge with a bank in another state as long as neither of the states has opted out of the IBBEA prior to May 31, 1997. The state of North Carolina has "opted in" to such legislation. In addition, a bank may establish and operate a de novo branch in a state in which the bank does not maintain a branch if that state expressly permits de novo interstate branching. As a result of North Carolina's opt-in law, North Carolina law permits unrestricted interstate de novo branching. Additional Restrictions and Oversight. Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve on any extensions of credit to the bank holding company or any of its subsidiaries, investments in the stock or securities thereof and the acceptance of such stock or securities as collateral for loans to any borrower. A bank holding company and its subsidiaries are also prevented from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. An example of a prohibited tie-in would be any arrangement that would condition the provision or cost of services on a customer obtaining additional services from the bank holding company or any of its other subsidiaries. The Federal Reserve may issue cease and desist orders against bank holding companies and non-bank subsidiaries to stop actions believed to present a serious threat to a subsidiary bank. The Federal Reserve also regulates certain debt obligations, changes in control of bank holding companies and capital requirements. Under the provisions of the North Carolina law, the Company is registered with and subject to supervision by the North Carolina Commissioner of Banks (the "Commissioner"). Capital Requirements. The Federal Reserve has established risk-based capital guidelines for bank holding companies. The minimum standard for the ratio of capital to risk-weighted assets (including certain off balance sheet obligations, such as standby letters of credit) is eight percent. At least half of this capital must consist of common equity, retained earnings and a limited amount of perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less certain goodwill items and other adjustments ("Tier 1 capital"). The remainder ("Tier 2 capital") may consist of mandatorily redeemable convertible debt securities and a limited amount of other preferred stock, subordinated debt and loan loss reserves. In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum leverage ratio of Tier 1 capital to adjusted average quarterly assets less certain amounts ("Leverage Ratio") equal to three percent for bank holding companies that meet certain specified criteria, including having the highest regulatory rating. All other bank holding companies will generally be required to maintain a Leverage Ratio of between four percent and five percent. -6- The guidelines also provide that bank holding companies experiencing significant growth, whether through internal expansion or acquisitions, will be expected to maintain strong capital ratios well above the minimum supervisory levels without significant reliance on intangible assets. The same heightened requirements apply to bank holding companies with supervisory, financial, operational or managerial weaknesses, as well as to other banking institutions if warranted by particular circumstances or the institution's risk profile. Furthermore, the guidelines indicate that the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") will continue to consider a "tangible Tier 1 Leverage Ratio" (deducting all intangibles) in evaluating proposals for expansion or new activity. The Federal Reserve has not advised the Company of any specific minimum Leverage Ratio or tangible Tier 1 Leverage Ratio applicable to it. As of December 31, 2004, the Company had Tier 1 risk-adjusted, total regulatory capital and leverage capital of approximately 11.08%, 12.33% and 9.61%, respectively, all in excess of the minimum requirements. Those same ratios as of December 31, 2003 were 10.68%, 12.13% and 8.71%, respectively. International Money Laundering Abatement and Financial Anti-Terrorism Act Of 2001. Title III of the USA Patriot Act of 2001 contains the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (the "IMLAFA"). The anti-money laundering provisions of IMLAFA impose affirmative obligations on a broad range of financial institutions, including banks, brokers, and dealers. Among other requirements, IMLAFA requires all financial institutions to establish anti-money laundering programs that include, at minimum, internal policies, procedures, and controls; specific designation of an anti-money laundering compliance officer; ongoing employee training programs; and an independent audit function to test the anti-money laundering program. IMLAFA requires financial institutions that establish, maintain, administer, or manage private banking accounts for non-United States persons or their representatives to establish appropriate, specific, and where necessary, enhanced due diligence policies, procedures, and controls designed to detect and report money laundering. Additionally, IMLAFA provides for the Department of Treasury to issue minimum standards with respect to customer identification at the time new accounts are opened. The Company has determined the impact that IMLAFA will have on the Bank's operations is not material. The Bank has established policies and procedures to ensure compliance with the IMLAFA that were approved by the Board of Directors. Bank Regulation The Bank is subject to numerous state and federal statutes and regulations that affect its business, activities, and operations, and is supervised and examined by the Commissioner and the Federal Reserve. The Federal Reserve and the Commissioner regularly examine the operations of banks over which they exercise jurisdiction. They have the authority to approve or disapprove the establishment of branches, mergers, consolidations and other similar corporate actions. They also have authority to prevent the continuance or development of unsafe or unsound banking practices and other violations of law. The Federal Reserve and the Commissioner regulate and monitor all areas of the operations of banks and their subsidiaries, including loans, mortgages, issuances of securities, capital adequacy, loss reserves and compliance with the CRA as well as other laws and regulations. Interest and certain other charges collected and contracted for by banks are also subject to state usury laws and certain federal laws concerning interest rates. The deposit accounts of the Bank are insured by the Bank Insurance Fund (the "BIF") of the Federal Deposit Insurance Corporation (the "FDIC") up to a maximum of $100,000 per insured depositor. The FDIC issues regulations and conducts periodic examinations, requires the filing of reports and generally supervises the operations of its insured banks. This supervision and regulation is intended primarily for the protection of depositors. Any insured bank that is not operated in accordance with or does not conform to FDIC regulations, policies and directives may be sanctioned for noncompliance. Civil and criminal proceedings may be instituted against any insured bank or any director, officer or employee of such bank for the violation of applicable laws and regulations, breaches of fiduciary duties or engaging in any unsafe or unsound practice. The FDIC has the authority to terminate insurance of accounts pursuant to procedures established for that purpose. Under the North Carolina corporation laws, the Company may not pay a dividend or distribution, if after giving its effect, the Company would not be able to pay its debts as they become due in the usual course of business or the Company's total assets would be less than its liabilities. In general, the Company's ability to pay cash dividends is dependent upon the amount of dividends paid by the Bank. The ability of the Bank to pay dividends to the Company is -7- subject to statutory and regulatory restrictions on the payment of cash dividends, including the requirement under the North Carolina banking laws that cash dividends be paid only out of undivided profits and only if the bank has surplus of a specified level. The Federal Reserve also imposes limits on the Bank's payment of dividends. Like the Company, the Bank is required by federal regulations to maintain certain minimum capital levels. The levels required of the Bank are the same as required for the Company. At December 31, 2004, the Bank had Tier 1 risk-adjusted, total regulatory capital and leverage capital of approximately 10.23%, 11.48% and 8.87%, respectively, all in excess of the minimum requirements. The Bank is subject to insurance assessments imposed by the FDIC. The FDIC has adopted a risk-based assessment schedule providing for annual assessment rates ranging from 0% to .27% of an institution's average assessment base, applicable to institutions insured by both the BIF and the Savings Association Insurance Fund ("SAIF"). The actual assessment to be paid by each insured institution is based on the institution's assessment risk classification, which focuses on whether the institution is considered "well capitalized," "adequately capitalized" or "under capitalized," as such terms are defined in the applicable federal regulations. Within each of these three risk classifications, each institution will be assigned to one of three subgroups based on supervisory risk factors. In particular, regulators will assess supervisory risk based on whether the institution is financially sound with only a few minor weaknesses (Subgroup A), whether it has weaknesses which, if not corrected, could result in an increased risk of loss to the BIF (Subgroup B) or whether such weaknesses pose a substantial probability of loss to the BIF unless effective corrective action is taken (Subgroup C). The FDIC also is authorized to impose one or more special assessments in an amount deemed necessary to enable repayment of amounts borrowed by the FDIC from the United States Treasury Department and all banks are now required to pay additional annual assessments at rates set by the Financing Corporation, which was established by the Competitive Equality Banking Act of 1987. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") provides for, among other things, (i) publicly available annual financial condition and management reports for certain financial institutions, including audits by independent accountants, (ii) the establishment of uniform accounting standards by federal banking agencies, (iii) the establishment of a "prompt corrective action" system of regulatory supervision and intervention, based on capitalization levels, with greater scrutiny and restrictions placed on depository institutions with lower levels of capital, (iv) additional grounds for the appointment of a conservator or receiver and (v) restrictions or prohibitions on accepting brokered deposits, except for institutions which significantly exceed minimum capital requirements. FDICIA also provides for increased funding of the FDIC insurance funds and the implementation of risk-based premiums. A central feature of FDICIA is the requirement that the federal banking agencies take "prompt corrective action" with respect to depository institutions that do not meet minimum capital requirements. Pursuant to FDICIA, the federal bank regulatory authorities have adopted regulations setting forth a five-tiered system for measuring the capital adequacy of the depository institutions that they supervise. Under these regulations, a depository institution is classified in one of the following capital categories: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." An institution may be deemed by the regulators to be in a capitalization category that is lower than is indicated by its actual capital position if, among other things, it receives an unsatisfactory examination rating with respect to asset quality, management, earnings or liquidity. FDICIA provides the federal banking agencies with significantly expanded powers to take enforcement action against institutions which fail to comply with capital or other standards. Such action may include the termination of deposit insurance by the FDIC or the appointment of a receiver or conservator for the institution. Banks are also subject to the CRA, which requires the appropriate federal bank regulatory agency, in connection with its examination of a bank, to assess such bank's record in meeting the credit needs of the community served by that bank, including low and moderate-income neighborhoods. Each institution is assigned one of the following four ratings of its record in meeting community credit needs: "outstanding," "satisfactory," "needs to improve" or "substantial noncompliance." The regulatory agency's assessment of the bank's record is made available to the public. Further, such assessment is required of any bank which has applied to (i) charter a national bank, (ii) obtain deposit insurance coverage for a newly chartered institution, (iii) establish a new branch office that will accept deposits, (iv) relocate an office or (v) merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution. In the case of a bank holding company applying for approval to acquire a bank or other bank holding company, the Federal Reserve will assess the record of each subsidiary bank of the applicant bank holding company, and such records may be the basis for denying the application. -8- The GLB's "CRA Sunshine Requirements" call for financial institutions to disclose publicly certain written agreements made in fulfillment of the CRA. Banks that are parties to such agreements also must report to federal regulators the amount and use of any funds expended under such agreements on an annual basis, along with such other information as regulators may require. Monetary Policy and Economic Controls The Company and the Bank are directly affected by governmental policies and regulatory measures affecting the banking industry in general. Of primary importance is the Federal Reserve Board, whose actions directly affect the money supply which, in turn, affects banks' lending abilities by increasing or decreasing the cost and availability of funds to banks. The Federal Reserve Board regulates the availability of bank credit in order to combat recession and curb inflationary pressures in the economy by open market operations in United States government securities, changes in the discount rate on member bank borrowings, changes in reserve requirements against bank deposits and limitations on interest rates that banks may pay on time and savings deposits. Deregulation of interest rates paid by banks on deposits and the types of deposits that may be offered by banks have eliminated minimum balance requirements and rate ceilings on various types of time deposit accounts. The effect of these specific actions and, in general, the deregulation of deposit interest rates has generally increased banks' cost of funds and made them more sensitive to fluctuations in money market rates. In view of the changing conditions in the national economy and money markets, as well as the effect of actions by monetary and fiscal authorities, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand, or the business and earnings of the Bank or the Company. As a result, banks, including the Bank, face a significant challenge to maintain acceptable net interest margins. Executive Officers The executive officers of the Company as of December 31, 2004 were as follows: Name Age Position With Company - ---- --- --------------------- B. Grant Yarber 40 President and Chief Executive Officer Richard W. Edwards 45 Executive Vice President and Chief Financial Officer Karen H. Priester 47 Senior Vice President and Chief Credit Officer Grant Yarber serves as President and Chief Executive Officer for Capital Bank Corporation and Capital Bank, overseeing the day-to-day operations of the Bank. Mr. Yarber joined Capital Bank during the summer of 2003 as the Chief Credit Officer and was then promoted to Chief Operating Officer and President before his appointment to CEO. He had served previously as Chief Lending Officer and Chief Credit Officer of MountainBank in Hendersonville, N.C. With more than 15 years of banking experience, Mr. Yarber has particular strength in lending and credit management. His background includes leadership positions with Bank of America, including Southeast Credit Manager and Regional Executive for Business Banking and Professional/Executive Banking for Missouri and Illinois. Rick Edwards serves as Executive Vice President and Chief Financial Officer for Capital Bank Corporation and Capital Bank. In this position, Mr. Edwards is responsible for the financial activities of the company, including investment portfolio management, analyst relations and strategic planning. Mr. Edwards previously held senior accounting and financial positions with some of the country's top banking institutions in the Southeast. Mr. Edwards spent eight years with Ernst & Young and held several management positions with Bank of America. He also has served as the Chief Financial Officer at New South Bancshares, Inc., a $1.4 billion savings bank, and later became the Chief Accounting Officer at National Commerce Financial Corporation before joining Capital Bank. Mr. Edwards is also a director and audit committee chair for Hemagen Diagnostics, Inc. in Baltimore, MD. Karen Priester serves as Senior Vice President and Chief Credit Officer for Capital Bank Corporation and the Bank. Prior to this position, she was Regional Credit Administrator and Wake County Senior Lender in her six years of -9- employment at Capital Bank. Ms. Priester has over twenty years of banking experience, concentrating in the commercial lending and credit areas. In her function as Chief Credit Officer, Ms. Priester is responsible for credit quality, loan review, special assets, government lending, compliance, and the credit department. Website Access to Capital Bank Corporation's Filings with the Securities and Exchange Commission Since becoming an "accelerated filer," all of the Company's electronic filings with the SEC, including the Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act have been made available at no cost on the Corporation's web site, www.capitalbank-nc.com, as soon as reasonably practicable after the Company filed such material with, or furnished it to, the SEC. The Company's SEC filings are also available through the SEC's web site at www.sec.gov. In addition, any reports the Company files with the SEC are available at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, DC 20549. Information may be obtained about the Public Reference Room by calling the SEC at 1-800-SEC-0330. Item 2. Properties. The Company currently leases property located at 4901 Glenwood Avenue, Raleigh, North Carolina for its principal offices and a branch office. The lease is for approximately 21,600 square feet, of which approximately 18,600 square feet is for the Company's principal offices and the remainder for the branch office. In addition to this facility, the Company owns 12 properties throughout North Carolina that are used as branch locations and which are located in Sanford (2), Cary (2), Siler City, Oxford, Burlington (2), Graham, Greensboro, Hickory and Raleigh. The Company also leases 10 other properties throughout North Carolina that are used as branch locations, operations facilities or mortgage production offices and which are located in Raleigh (3), Sanford, Asheville (3), Cary, Pittsboro and Wake Forest. Management believes the terms of the various leases, which are reviewed on an annual basis, are consistent with market standards and were arrived at through arm's length bargaining. Item 3. Legal Proceedings. There are no pending material legal proceedings to which the Company is a party or of which any of its property is subject. In addition, the Company is not aware of any threatened litigation, unasserted claims or assessments that could have a material adverse effect on the Company's business, operating results or financial condition. Item 4. Submission of Matters to a Vote of Security Holders During the fourth quarter of the year ended December 31, 2004, there were no matters submitted to a vote of the Company's shareholders. -10- PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities. Shares of Capital Bank Corporation common stock are traded on the Nasdaq National Market under the symbol "CBKN." As of March 1, 2005, the Company had approximately 1,588 holders of record of its common stock. The following table sets forth, for the indicated periods, the high and low sales prices for the common stock (based on published sources) and the cash dividend declared per share of the Company's common stock: Cash Dividends Per Share 2004 High Low Declared --------------------------------------------------------------------- First Quarter $18.12 $15.45 $ 0.05 Second Quarter 17.06 15.20 0.05 Third Quarter 16.74 15.88 0.05 Fourth Quarter 18.98 15.97 0.06 Cash Dividends Per Share 2003 High Low Declared --------------------------------------------------------------------- First Quarter $14.70 $12.95 $ 0.05 Second Quarter 15.98 13.20 0.05 Third Quarter 16.40 14.10 0.05 Fourth Quarter 16.93 15.09 0.05 Dividend Policy. The Company's shareholders are entitled to receive such dividends or distributions as the Board of Directors authorizes in its discretion. The Company's ability to pay dividends is subject to the restrictions of the North Carolina Business Corporation Act. There are also various statutory limitations on the ability of the Bank to pay dividends to the Company. Subject to the legal availability of funds to pay dividends, during fiscal year 2004, the Company declared and paid dividends totaling $0.21 per share (see chart above for actual quarterly payouts). The Company intends to pay approximately 20% to 30% of its annual net earnings to shareholders in the form of annual cash dividends if such cash dividends are in the best interest of the Company in the business judgment of its Board of Directors and are consistent with maintaining the Company's status as a "well-capitalized" institution under applicable banking laws and regulations. Recent Sales of Unregistered Securities. The Company did not sell any securities in the fiscal year ended December 31, 2004 which were not registered under the Securities Act of 1933, as amended (the "Securities Act"). Repurchases of Equity Securities. Neither the Company nor any affiliated purchasers made any purchases of Company equity securities registered pursuant to Section 12 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), during the fourth quarter ended December 31, 2004. Item 6. Selected Financial Data. The following table sets forth selected financial information for the Company that has been derived from the financial statements and notes thereto included elsewhere in this report. This information should be read in conjunction with Management's Discussion and analysis of Financial Condition and Results of Operations and the consolidated financial statements and notes thereto included elsewhere in this report. -11-
(In thousands, except share and per share data) As of and for the Years Ended December 31 2004 2003 2002 2001 2000 --------------------------------------------------------------- Selected Balance Sheet Data Cash and Due From Banks $ 23,007 $ 22,408 $ 32,837 $ 15,173 $ 27,676 Federal Funds Sold and Sort Term Investments 4 3,202 18,696 944 750 Securities 160,580 165,913 155,304 73,702 61,947 Gross Loans 654,867 625,945 600,609 306,891 242,275 Allowance for Loan Losses 10,721 11,613 9,390 4,286 3,463 Total Assets 882,294 857,734 840,976 406,741 343,620 Deposits 654,976 629,619 644,887 304,443 279,094 Borrowings 102,320 114,591 97,858 50,000 15,000 Repurchase Agreements 16,755 11,014 13,081 11,167 9,804 Shareholders' Equity 77,738 72,923 75,471 36,983 35,015 Summary of Operations Interest Income $ 42,391 $ 40,440 $ 36,244 $ 26,173 $ 23,751 Interest Expense 16,257 16,318 15,895 14,701 13,101 --------------------------------------------------------------- Net Interest Income 26,134 24,122 20,349 11,472 10,650 Provision for Loan Losses 1,038 8,247 4,190 1,215 1,110 --------------------------------------------------------------- Net Interest Income After Provision For Loan Losses 25,096 15,875 16,159 10,257 9,540 Other Operating Income 6,905 10,322 7,987 4,490 2,193 Other Operating Expense (1) 23,824 25,165 17,465 11,847 9,596 --------------------------------------------------------------- Pre-tax Net Income 8,177 1,032 6,681 2,900 2,137 Income Tax Expense (Benefit) 2,866 38 2,374 480 (36) --------------------------------------------------------------- Net Income $ 5,311 $ 994 $ 4,307 $ 2,420 $ 2,173 =============================================================== Per Share Data Net Income - Basic $ .79 $ .15 $ .79 $ .65 $ .61 Net Income - Diluted .77 .15 .76 .65 .59 Dividends .21 .20 .20 -- -- Book Value 11.76 11.15 11.44 10.28 9.57 Number of Common Shares Outstanding 6,612,787 6,541,495 6,595,784 3,597,339 3,658,689 As of and for the Years Ended December 31 2004 2003 2002 2001 2000 --------------------------------------------------------------- Selected Ratios Return On Average Assets .60% .11% .66% .65% .73% Return on Average Shareholders' Equity 7.04% 1.34% 7.43% 6.69% 6.21% Dividend Payout Ratio 26% 133% 26% 0% 0% Average Shareholders' Equity to Average Total Assets 8.58% 8.55% 8.89% 9.69% 11.83% Net Interest Margin (2) 3.28% 3.06% 3.38% 3.28% 3.78%
(1) Includes non-recurring merger related costs of $90,000 for year ended December 31, 2000. (2) On a tax equivalent basis Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis is intended to aid the reader in understanding and evaluating the results of operations and financial condition of the Company, the Bank and CBIS. In addition, the Company has interest in the Trusts, but the Trusts are not consolidated with the Company per the provisions of FIN 46R. This discussion is designed to provide more comprehensive information about the major components of the Company's results of operations and financial condition, liquidity, and capital resources than can be obtained from reading the financial -12- statements alone. This discussion should be read in conjunction with the Company's consolidated financial statements, the related notes and the selected financial data presented elsewhere in this report. Safe Harbor Discussion Information set forth in this Annual Report on Form 10-K contains various "forward looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, which statements represent the Company's judgment concerning the future and are subject to risks and uncertainties that could cause the Company's actual operating results and financial position to differ materially from the forward looking statements. Such forward looking statements can be identified by the use of forward looking terminology such as "may," "will," "expect," "anticipate," "estimate," "believe," or "continue," or the negative thereof or other variations thereof or comparable terminology. The Company cautions that any such forward looking statements are further qualified by important factors that could cause the Company's actual operating results to differ materially from those in the forward looking statements, including without limitation, the management of the Company's growth, the risks associated with possible or completed acquisitions, the risks associated with the Bank's loan portfolio, competition within the industry, dependence on key personnel, government regulation and the other risk factors described herein under "Risk Factors." Overview. Capital Bank is a full-service state chartered community bank conducting business throughout North Carolina. The Bank operates through four North Carolina regions; Triangle, Sandhills, Triad and Western. The Bank was incorporated on May 30, 1997 and opened its first branch in June of that same year in Raleigh. In 1999, the shareholders of the Bank approved the reorganization of the Bank into a bank holding company. In 2001, the Company received approval to become a financial holding company. In the third quarter of 2004, the Bank reintroduced non-insured investment products and services through Capital Bank Financial Services (a division of the Bank), creating a partnership with Capital Investment Group, a leading Raleigh, North Carolina based broker-dealer. The Bank employs commission-based Financial Advisors to offer full-service brokerage to individual and corporate customers. As of December 31, 2004, the Company conducted no business other than holding stock in the Bank and each of the Trusts. As a community bank, the Bank's profitability depends primarily upon its levels of net interest income, which is the difference between interest income from interest-earning assets and interest expense on interest-bearing liabilities. The Bank's operations are also affected by its provision for loan losses, other operating income, and other operating expenses. During 2004, the Company's focus was on the following priorities: o Strong, sustainable earnings o A sound credit culture o Disciplined growth in existing or adjacent markets o Unparalleled customer service by experienced community bankers For the year ended December 31, 2004, the Company achieved record earnings as net income exceeded $5 million for the first time in the Company's history and net interest margin expanded 22 basis points for the year. Nonperforming assets declined during the year and net charge-offs declined significantly. The Company sold three branches in northern North Carolina and opened locations in the higher growth markets of Greensboro, Wake Forest and Asheville. The Company believes our "Service Worth Talking About" continues to enhance our customer experience in all communities we serve. The Company also strengthened its management team during the year appointing Grant Yarber as Chief Executive Officer and hiring Rick Edwards as Chief Financial Officer in April. In addition, new executives were hired for the -13- Sandhills region and the mortgage division during the year. The Company believes it has an experienced management team that is dedicated to providing exceptional value to its customers and shareholders. Critical Accounting Policies and Estimates. The Company's discussion and analysis of its financial condition and results of operations are based on the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments regarding uncertainties that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to the reserve for loan losses, investment and intangible asset values, income taxes, and contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements: o Loan Loss Reserves - The Company records estimated loan loss reserves based on known problem loans and estimated risk in the existing loan portfolio. The reserve calculation takes into account historic write-off trends and current market and economic conditions. If economic conditions were to decline significantly or the financial condition of the Bank's customers were to deteriorate, resulting in an impairment of their ability to make payments, additional reserves may be required. o Investments - The Company records an investment impairment charge when it believes an investment has experienced a decline in value that is other than temporary. Future adverse changes in market conditions and associated market values of investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment's current carrying value, thereby possibly requiring an impairment charge in the future. In addition, accounting standard setters are evaluating changes in accounting for unrealized losses on the Company's investment portfolio which could require us to record and realize certain unrealized losses through earnings. o Valuation Allowances - The Company assesses the need to record a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. The Company considers anticipated future taxable income and ongoing prudent and feasible tax planning strategies in determining the need for the valuation allowance which, at this time, it deems not to be necessary. In the event the Company were to determine that it would not be able to realize all or part of its net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made. o Goodwill - Goodwill is not amortized, but is reviewed for potential impairment on an annual basis at the reporting unit level. Identified intangible assets are amortized on a straight-line basis. An impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied value. o Impairment of Long-Lived Assets - Long-lived assets, including identified intangible assets, are evaluated for impairment if events or circumstances indicate a possible impairment. Such evaluations are based on undiscounted cash flow projections. The disposal of long-lived assets is measured based on the lower of the book or fair value less the costs to sell. Results of Operations. The Company reported net income of $5.3 million, $994,000, and $4.3 million for the years ended December 31, 2004, 2003 and 2002, respectively. On a fully diluted per share basis, net income for 2004, 2003, and 2002 was $.77, $.15, and $.76, respectively. Year Ended December 31, 2004 Compared with Year Ended December 31, 2003 Net Interest Income. Net interest income is the difference between total interest income and total interest expense and is the Company's principal source of earnings. The amount of net interest income is determined by the volume of interest-earning assets, the level of rates earned on those assets, and the volume and cost of supporting funds. Net -14- interest income increased from $24.1 million in 2003 to $26.1 million in 2004, an increase of $2.0 million or 8%. The increase during the period is primarily due to increases in market rates on the Bank's interest-earning assets as its loans shifted upwards with increases in the prime rate and premium amortization slowed on its investment portfolio from lower prepayments. Over the last six months of 2004, the Federal Reserve made five 25 basis point ("bp") upward adjustments in the Open Market Committee's benchmark federal funds rate. Another 25 bp increase occurred on February 4, 2005. Since the Bank's loan portfolio adjusts with prime at a faster rate than the time deposit portfolio, the increasing rate environment has had a positive effect on net interest spread and net interest margin. As the time deposits mature and reprice, the margin could be negatively impacted based on pricing competition to retain these deposits. In addition, the Bank's net interest income was positively affected by a shift in the mix of its earning assets as the Bank replaced lower yielding federal funds with higher yielding loans. Average federal funds and short term investments, yielding only 1.14% in 2003, dropped by $6.0 million from December 31, 2003 to December 31, 2004 while average loans, yielding 5.49% in 2004, increased by almost $18.0 million. The increase in average loans takes into account the effect of the following two nonrecurring transactions that occurred during the period: o The Company completed the sale of its Northern Region branches in Warrenton, Seaboard and Woodland to other financial institutions in September 2004. In those branch sales, the Company sold approximately $39.6 million of deposits and $12.8 million of loans, as well as other assets. The $39.6 million of deposits sold were comprised of $2.0 million non-interest bearing demand, $11.8 million of money market, savings and interest checking and $25.8 million of time deposits. A pre-tax gain of $1.2 million was recognized on the sale, which is included in non-interest income. o In December 2004, the Company sold approximately $19.4 million of its mortgage loans. In conjunction with this sale, a loss of $320,000 was recorded in non-interest income. A charge-off of $199,000 associated with these loans was taken in the third quarter of 2004 for reserves previously established. Despite these significant transactions, both of which would have had negative effects on earning assets or interest-bearing liabilities, average earning assets increased $9.3 million from December 31, 2003 to December 31, 2004 and average interest-bearing liabilities increased by $2.0 million. Net interest spread is the difference between rates earned on interest-earning assets and the interest paid on deposits and other borrowed funds. Net interest margin is the total of net interest income divided by average earning assets. Average earning assets in 2004 were $817.1 million, up 1.15% when compared to $807.8 million for 2003. The net interest margin was 3.28% on a fully tax equivalent ("TE") basis in 2004, a 22 bp increase from the 2003 net interest margin of 3.06%. On a TE basis, net interest spread was 3.06% and 2.85% for 2004 and 2003, respectively. Interest income increased 5% in 2004 to $42.4 million from $40.4 million in 2003. This increase is primarily due to the growth in the Bank's loan portfolio and increases in overall yield as discussed above. The average yield on interest-earning assets for 2004 was 5.27%, a 19 bp increase from the 2003 yield of 5.08%. The average loan portfolio as a percentage of earning assets was 80% in 2004, up 2% from 2003. The average balances of loans, which had yields of 5.49% and 5.43% for 2004 and 2003, respectively, increased from $632.1 million in 2003 to $650.1 million in 2004. The average balances of federal funds and other short-term investments decreased from $16.7 million in 2003 to $10.7 million in 2004 as these funds were used to fund loan growth, and the average yield in this category increased 32 bps from 1.14% to 1.46% over the same time period. Investment yield increased on an TE basis from 4.10% in 2003 to 4.60% in 2004. This increase reflects increases in market interest rates over the last year as mortgage backed security ("MBS") pay-downs have decreased from the prior year when the borrowers making up the underlying securities moved to refinance their mortgages. Increases in MBS payment speeds in the prior year accelerated the amortization of premiums associated with the assets and decreased the investment yield. Interest expense remained relatively flat from 2004 when measured against 2003. Interest expense in both years was $16.3 million. Average total interest-bearing deposits, including savings, interest-bearing demand deposits and time deposits declined slightly, from $600.9 million in 2003 to $597.7 million in 2004, largely as a result of selling three branches which had deposits of $39.6 million. In addition, the average rate paid on interest-bearing deposits declined 4 bps between 2003 and 2004 as those customers with time deposits shortened up the terms on those deposits in anticipation of higher future rates. The average rate on borrowings also declined from 3.55% in 2003 to 3.31% in 2004. This decline in a rising interest rate environment reflects the full year effect of interest rate swap agreements put into effect in July of 2003 which converted portions of the Bank's fixed rate long term debt to a floating rate. We -15- would expect the cost of borrowings to increase in 2005 as rates continue to increase. Decreases in interest expense in the areas discussed above were offset by an increase in interest paid on subordinated debt associated with two trust preferred offerings done in 2003. The average outstanding balance of subordinated debt increased year over year from $7.1 million in 2003 to $20.6 million in 2004, adding an additional $470,000 of interest expense as a result of the volume increase. Both subordinated debt issues are variable rate in nature and should increase in expense for 2005. The following two tables set forth certain information regarding the Company's yield on interest-earning assets and cost of interest-bearing liabilities and the component changes in net interest income. The first table reflects the Company's effective yield on earning assets and cost of funds. Yields and costs are computed by dividing income or expense for the year by the respective daily average asset or liability balance. Changes in net interest income from year to year can be explained in terms of fluctuations in volume and rate. The second table presents further information on those changes. -16- Average Balances, Interest Earned or Paid, and Interest Yields/Rates (Tax Equivalent Basis - Dollars in thousands) (1)
Year Ended December 31, 2004 Year Ended December 31, 2003 -------------------------------------------------------------------------- Average Amount Average Average Amount Average Balance Earned Rate Balance Earned Rate -------------------------------------------------------------------------- Assets Loans receivable: (2) Commercial $ 506,744 $ 27,487 5.42% $ 470,147 $ 24,563 5.22% Consumer 37,841 2,536 6.70% 49,367 3,261 6.61% Home equity 59,865 3,015 5.04% 49,686 2,631 5.30% Residential mortgages (3) 45,671 2,666 5.84% 62,925 3,897 6.19% -------------------------------------------------------------------------- Total loans 650,121 35,704 5.49% 632,125 34,352 5.43% Investment securities (4) 156,300 7,195 4.60% 159,030 6,514 4.10% Federal funds sold and other interest on short term investments 10,683 156 1.46% 16,676 190 1.14% -------------------------------------------------------------------------- Total interest earning assets 817,104 $ 43,055 5.27% 807,831 $ 41,056 5.08% ===================== ===================== Cash and due from banks 22,135 20,715 Other assets 51,449 47,505 Allowance for loan losses (11,465) (10,521) --------- --------- Total assets $ 879,223 $ 865,530 ========= ========= Liabilities and Equity Savings deposits $ 17,040 $ 45 0.26% $ 18,833 $ 71 0.38% Interest-bearing demand deposits 188,855 2,250 1.19% 188,624 2,087 1.11% Time deposits 391,783 9,487 2.42% 393,401 9,912 2.52% -------------------------------------------------------------------------- Total interest bearing deposits 597,678 11,782 1.97% 600,858 12,070 2.01% Borrowed funds 103,427 3,427 3.31% 110,107 3,911 3.55% Subordinated debt 20,620 929 4.51% 7,123 248 3.48% Repurchase agreements and fed funds purchased 12,865 119 0.92% 14,457 89 0.62% -------------------------------------------------------------------------- Total interest-bearing liabilities 734,590 $ 16,257 2.21% 732,545 $ 16,318 2.23% ===================== ===================== Non-interest bearing deposits 60,201 50,489 Other liabilities 9,009 8,523 --------- --------- Total liabilities 803,800 791,557 Shareholders' equity 75,423 73,973 --------- --------- Total liabilities and equity $ 879,223 $ 865,530 ========= ========= Net interest spread (5) 3.06% 2.85% Tax equivalent adjustment $ 664 $ 616 Net interest income and net interest margin (6) $ 26,798 3.28% $ 24,738 3.06% ==================== ====================
Year Ended December 31, 2002 ----------------------------------- Average Amount Average Balance Earned Rate ----------------------------------- Assets Loans receivable: (2) Commercial $ 324,900 $ 19,573 6.02% Consumer 36,408 2,852 7.83% Home equity 39,483 2,368 6.00% Residential mortgages (3) 69,267 4,808 6.94% ----------------------------------- Total loans 470,058 29,601 6.30% Investment securities (4) 119,925 6,604 5.51% Federal funds sold and other interest on short term investments 22,259 370 1.66% ----------------------------------- Total interest earning assets 612,242 $ 36,575 5.97% ===================== Cash and due from banks 15,965 Other assets 30,871 Allowance for loan losses (7,157) ---------- Total assets $ 651,921 ========== Liabilities and Equity Savings deposits $ 19,103 $ 170 0.89% Interest-bearing demand deposits 147,427 2,746 1.86% Time deposits 296,790 9,651 3.25% ----------------------------------- Total interest bearing deposits 463,320 12,567 2.71% Borrowed funds 72,067 3,116 4.32% Subordinated debt -- -- 0.00% Repurchase agreements and fed funds purchased 14,901 212 1.42% ----------------------------------- Total interest-bearing liabilities 550,288 $ 15,895 2.89% =================================== Non-interest bearing deposits 35,064 Other liabilities 8,610 ---------- Total liabilities 593,962 Shareholders' equity 57,959 ---------- Total liabilities and equity $ 651,921 ========== Net interest spread (5) 3.09% Tax equivalent adjustment $ 331 Net interest income and net interest margin (6) $ 20,680 3.38% ===================== (1) The taxable equivalent basis is computed using a blended federal and state rate of approximately 38%. (2) Loans receivable include nonaccrual loans for which accrual of interest has not been recorded. (3) Includes loans held for sale. (4) The average balance for investment securities exclude the effect of their market-to-market adjustment, if any. (5) Net interest spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. (6) Net interest margin represents the net interest income divided by average interest-earning assets. -17- Rate & Volume Variance Analysis (Tax Equivalent Basis - Dollars in thousands) (1)
Years Ended Years Ended December 31, 2004 December 31, 2003 vs. 2003 vs. 2002 Rate/ Rate/ Volume Rate Volume Total Volume Rate Volume Total Variance Variance Variance Variance Variance Variance Variance Variance --------------------------------------------- ------------------------------------------ Interest Income: Loans receivable $ 978 $ 364 $ 10 $ 1,352 $ 10,206 $ (4,056) $ (1,399) $ 4,751 Investment securities (112) 807 (14) 681 2,153 (1,691) (552) (90) Federal funds sold (69) 54 (19) (34) (93) (116) 29 (180) --------------------------------------------- ------------------------------------------ Total interest income 797 1,225 (23) 1,999 12,266 (5,863) (1,922) 4,481 --------------------------------------------- ------------------------------------------ Interest Expense: Savings and interest-bearing demand deposits and other (16) 154 (1) 137 717 (1,184) (291) (758) Time deposits (41) (386) 2 (425) 3,142 (2,174) (707) 261 Borrowed funds (237) (263) 16 (484) 1,645 (556) (294) 795 Subordinated debt 470 73 138 681 -- -- 248 248 Repurchase agreements and fed funds purchased (10) 45 (5) 30 (6) (121) 4 (123) --------------------------------------------- ------------------------------------------ Total interest expense 166 (377) 150 (61) 5,498 (4,035) (1,040) 423 --------------------------------------------- ------------------------------------------ Increase (decrease) in net interest income $ 631 $ 1,602 $ (173) $ 2,060 $ 6,768 $ (1,828) $ (882) $ 4,058 ============================================= ==========================================
(1) The taxable equivalent basis is computed using a blended federal and state rate of approximately 38%. Provision for Loan Losses. The provision for loan losses is the amount charged against earnings for the purpose of establishing an adequate allowance for loan losses. Loan losses are, in turn, charged to this allowance rather than being reported as a direct expense. In 2004 and 2003, amounts expensed as loan loss provisions were $1.0 million and $8.2 million, respectively. The amount of the allowance for loan losses is established based on management's estimate of the inherent risks associated with lending activities, estimated fair value of collateral, past experience and present indicators such as delinquency rates and current market conditions. The allowance is regularly reviewed and adjusted, as necessary. Loans of $750,000 or more are subject to specific review for impairment in accordance with Statement of Financial Accounting Standards No. 114. The allowance for loan losses was $10.7 million and $11.6 million on December 31, 2004 and 2003, respectively, and represented approximately 1.64% and 1.86% of total loans outstanding on those dates. During the year, the company reclassified $311,000 of the allowance which related to loss exposure on unfunded loan commitments and letters of credit into a separate other liability account. The Company experienced higher loan charge offs during 2003 when compared to 2004. Management believes that this was due in part to a weakened economy and in part to some large credit issues identified in the second quarter of 2003. As a result of those credit issues, management engaged two independent credit review firms in the latter part of 2003 to perform a detailed analysis of the Bank's loan portfolio. As a result of the review, management identified loans during that period aggregating approximately $2.7 million that were classified as a loss. In addition, management significantly increased its internal loan watch list. During 2003, the Company charged off an aggregate of $6.0 million in loans, net of $862,000 in recoveries. Of that amount, $4.3 million related to five business customer relationships. During 2004, the Company charged off an aggregate of $1.6 million in loans, net of $616,000 in recoveries. Included in the charge offs for 2004 was $497,000 related to one loan that had been classified as impaired at December 31, 2003 and for which a specific reserve of $825,000 had been established at that time. Also as a result of the 2003 loan review, the Company effected certain changes to try to mitigate such credit losses going forward, including procedural changes in the loan approval and credit review processes, changes in individual lending limits and centralization of the Company's lending operations functions into one facility. The Company also added a lender support area where all consumer loans are centrally underwritten and approved. Management has allocated the allowance for loan losses by category, as shown in the following table. This allocation is based on management's assessment of the risks associated with the different types of lending activities. -18- Allowance for Loan Losses by Category
At December 31, -------------------------------------------------------------------------- (Dollars in thousands) 2004 2003 -------------------------------------------------------------------------- Allowance % of Loans to Allowance % of Loans to Amount Total Loans Amount Total Loans -------------------------------------------------------------------------- Commercial $ 9,323 82% $ 9,885 76% Consumer 519 5% 1,012 7% Residential mortgages 299 9% 210 8% Equity lines 580 4% 506 9% ---------------------------------- ------------------------------------ $ 10,721 100% $ 11,613 100% ================================== ====================================
The following table shows changes in the allowance for loan losses arising from loans charged off and recoveries on loans previously charged off by loan category and additions to the allowance that have been charged to expenses. Analysis of Allowance for Loan Losses
As of and For the Years Ended December, 31 ------------------------------------ (Dollars in thousands) 2004 2003 2002 ------------------------------------ Average amount of loans outstanding, net of unearned income $ 650,121 $632,125 $470,058 ------------------------------------ Amount of loans outstanding at year end, net of unearned income 654,867 625,945 600,609 Reserve for loan losses: Balance at beginning of period $ 11,613 $ 9,390 $ 4,286 Adjustment for loans acquired -- -- 4,593 Loans charged off: Commercial 1,390 5,631 3,545 Consumer 504 637 470 Equity 1 5 -- Mortgage 340 613 -- ------------------------------------ Total chargeoffs 2,235 6,886 4,015 ------------------------------------ Recoveries of loans previously charged off: Commercial 411 797 263 Consumer 94 58 73 Equity 4 -- -- Mortgage 107 7 -- ------------------------------------ Total recoveries 616 862 336 ------------------------------------ Net loans charged off 1,619 6,024 3,679 ------------------------------------ Provision for loan losses 1,038 8,247 4,190 Reclassification to other liabilities (311) -- -- ------------------------------------ Balance at December 31 $ 10,721 $ 11,613 $ 9,390 ==================================== Ratio of net chargeoffs to average loans outstanding during the year 0.25% 0.95% 0.78% ==================================== Allowance for loan losses as a percent of total loans 1.64% 1.86% 1.56% ====================================
The following table shows the total of the nonperforming assets in the Company's portfolio as of December 31, 2004 and 2003. Loans deemed to be impaired at December 31, 2003 amounted to $3.0 million. There were no loans classified as impaired at December 31, 2004. Average impaired loans during 2004 and 2003 were $2.1 million and $3.2 million, respectively. -19- (Dollars in thousands) 2004 2003 ------ ------ Nonperforming assets: Nonaccrual loans - Commercial $3,964 $3,766 Nonaccrual loans - Mortgage 1,898 2,271 Nonaccrual loans - Construction 1,622 1,444 Nonaccrual loans - Consumer 312 258 Nonaccrual loans - Equity lines 415 271 ------ ------ Total nonaccrual loans 8,211 8,010 Foreclosed properties 418 978 ------ ------ Total nonperforming assets $8,629 $8,988 ====== ====== Nonperforming assets to: Loans outstanding at end of year 1.32% 1.44% Total assets at end of year 0.98% 1.05% Allowance for loan losses as a percent of nonperforming loans 131% 145% The allowance for loan losses decreased 2004 and many of the related allowance ratios also declined. The decreases were largely attributable to the resolution of the one impaired loan for which a specific reserve of $825,000 had been established. The majority of our nonperforming loans are secured by real estate collateral which should mitigate our exposure to losses compared those loans that are unsecured or collateralized with other types of assets. Other Operating Income. Other operating income was $6.9 million and $10.3 million for years ended December 31, 2004 and 2003, respectively, a decrease of $3.4 million or 33%. The decrease in other operating income for 2004 is primarily attributable to a substantial drop in fee income recorded by the Bank's mortgage department as a result of industry-wide decreased mortgage refinance business caused by increases in mortgage loan interest rates. Mortgage origination fees fell 74% to $1.3 million for 2004 from the $4.9 million earned in the twelve month period ended December 31, 2003. Securities gains also fell 96% during the period from $442,000 during the year ended December 31, 2003 to $18,000 during the same period of 2004. The mortgage revenue and securities gains decline between the two periods was partially offset by two significant non-recurring transactions occurring in the third quarter of 2004 which were discussed previously. Fees associated with deposit accounts remained fairly flat year over year with recorded balances of $2.9 million in both 2004 and 2003. The sale of the three mature branches impacted service charges in the latter part of 2004 as the sold branches had higher fee income than the newly opened branches. Total service charges and fees as a percent of the average total deposit base increased from ..44% in 2003 to .45% in 2004. Other Operating Expense. Other operating expense represents the costs of operating the Company. Management regularly monitors all categories of other operating expense in an attempt to improve productivity and operating performance. Other operating expense decreased 5% to $23.8 million in 2004 from $25.2 million in 2003. At December 31, 2003 there were 21 branches and the average number of full time equivalent employees during the year was 220. At December 31, 2004 there were 20 branches and the average number of full time equivalent employees during the year was 216. Salary and employee benefits expense for the years ended December 31, 2004 and 2003 were $12.1 million and $13.9 million, respectively. Commission expense decreased from $2.2 million in 2003 to $728,000 in 2004. These commissions are driven largely by mortgage fee income which decreased 74%. In addition, during 2003 the Company incurred $1.2 million in severance expenses related to certain executive and senior officers who separated from the Company compared to severance expenses during 2004 of only $61,000. Occupancy expense increased from $2.2 million in 2003 to $2.4 million in 2004. The increase was primarily a result of lease expenses associated with new locations and additional space needed for expansion of existing departments. Furniture and equipment expense increased from $1.5 million in 2003 to $1.7 million in 2004 due to the increase in assets associated with the new locations and general expansion. Telecommunications expense increased from -20- $337,000 to $542,000 as we added bandwidth for more rapid data communication. The increased bandwidth was required to implement upgrades in the data processing software from its main data processing supplier. Public relations and advertising costs increased 21% or $148,000 from $721,000 to $869,000 due to the branch openings and deposit campaign in 2004. Other expenses decreased from $4.0 million in 2003 to $3.9 million in 2004. The primary cause for the decrease was a $310,000 write down in real estate owned made in September of 2003. There were no such significant real estate write downs in 2004. However, this decrease was partially offset by increases in other areas including increased travel and entertainment expenses from $291,000 to $416,000 and an increase in franchise taxes from $159,000 to $219,000. All such increases were a direct result of changes in the business plan of the Company, the changing of the footprint of the organization, or expansion of existing departments. Provision for Income Taxes. The Company recorded an income tax expense of $2.9 million in 2004 compared to $38,000 for 2003. The increase in income tax expense is primarily the result of a significant increase in pretax net income year over year. Pretax net income for 2004 was $8.2 million compared to $1.0 million for 2003. Pretax net income for 2003 includes the effect of several large loan charge-offs, increases to the loan loss provision and severance expenses as discussed above. The overall effective rate adjusted upwards from 3.7% in 2003 to 35.0% in 2004. The rate for 2003 reflects the impact of permanent differences such as nontaxable municipal bond interest and insurance income on a smaller net income base. See Notes to Consolidated Financial Statements - Note 12 - Income Taxes. Year Ended December 31, 2003 Compared with Year Ended December 31, 2002 Net Interest Income. Net interest income increased from $20.3 million in 2002 to $24.1 million in 2003, an increase of $3.8 million or 19%. The increase during the period is primarily due to increases in the average volume of interest-bearing assets and liabilities as the Bank experienced internal growth. The increase was negatively affected by a decline in market rates during 2003. Rates dropped by 25 bps in July 2003. In 2002, the Federal Reserve held interest rates steady for a majority of the year, but made one move in November that resulted in an additional 50 bp drop in the prime rate to 4.25%. In addition, during 2001, the prime rate dropped from 9.00% in January to 4.75% in December with a decline in rates of at least 25 bps in every month of 2001 except July as the Federal Reserve made 11 separate moves to reduce interest rates in efforts to stimulate the economy. The Company felt the effects of these changes over an extended period of time due to the long term repricing or maturity dates of some of its assets and liabilities. Since the Bank's loan portfolio adjusts with prime at a faster rate than the deposit portfolio, the declining rate environments had a negative effect on net interest spread and net interest margin. Average earning assets in 2003 were $807.8 million, up 32% when compared to $612.2 million for 2002. The net interest margin was 3.06% in 2003, a 32 bp decline from the 2002 net interest margin of 3.38%. Net interest spread was 2.85% and 3.09% for 2003 and 2002, respectively. Interest income increased 12% in 2003 to $40.4 million from $36.2 million in 2002. This increase was primarily due to the growth in the Bank's loan portfolio. The average yield on interest-earning assets for 2003 was 5.01%, a decline of 91 bps from the 2002 yield of 5.92%. The decrease in average yield during 2003 was primarily attributable to the overall decline in market rates as explained above. The average loan portfolio as a percentage of earning assets was 78% in 2003, up 1% from 2002. The average balances of loans, which had yields of 5.43% and 6.30% for 2003 and 2002, respectively, increased from $470.1 million in 2002 to $632.1 million in 2003. The average balances of federal funds and other short-term investments decreased from $22.3 million in 2002 to $16.7 million in 2003, and the average yield in this category dropped 52 bps from 1.66% to 1.14% over the same time period. Investment yield decreased from 5.23% in 2002 to 3.71% in 2003. This decrease reflects the results of the decline in market interest rates over the last three years as MBS pay-downs increased significantly when the borrowers making up the underlying securities moved to refinance their mortgages. Increases in MBS payment speeds accelerated the amortization of premiums associated with the purchases and dropped the investment yield. Interest expense increased 3% in 2003 to $16.3 million from the $15.9 million recorded during 2002. This increase was primarily due to a significant increase in average interest-bearing deposits, which went from $463.3 million in 2002 to $600.9 million in 2003. In addition, average borrowed funds increased year over year from $72.7 million in 2002 to $110.3 million in 2003. Also, during 2003 the Company incurred junior subordinated debt associated with two trust preferred securities offerings. See Notes to Consolidated Financial Statements - Note 11 - Subordinated Debentures. The income effects of increases in volume were significantly offset by declines in rates during the period. -21- The average rates on interest-bearing deposits decreased from 2.71% in 2002 to 2.01% in 2003. The decrease in average rates during 2003 is reflective of the overall decrease in market rates offered during 2003 as compared to the previous year. As previously mentioned, the Bank's loan portfolio adjusts with prime at a faster rate than its deposit portfolio as a result of the Federal Reserve's actions to decrease interest rates. Much of the effect of the rapid rate declines of 2001 did not take place on the deposit portfolio until 2002 and 2003. In particular, the average rate on time deposits, which represented 54% of all interest bearing liabilities during 2003, dropped 73 bps in 2003 from 3.25% in 2002 to 2.52% in 2003. Provision for Loan Losses. In 2003 and 2002, amounts expensed as loan loss provisions were $8.2 million and $4.2 million, respectively. The allowance for loan losses was $11.6 million and $9.4 million on December 31, 2003 and 2002, respectively, and represented approximately 1.86% and 1.56% of total loans outstanding on those dates. The Company experienced higher loan charge offs during 2003 when compared to the previous year. Management believes that this is due in part to a weakened economy and in part to some large credit issues identified in the second quarter of 2003. As a result of these credit issues, management engaged two independent credit review firms in the latter part of 2003 to perform a detailed analysis of the Bank's loan portfolio. As a result of the review, management identified loans during that period aggregating approximately $2.7 million that were classified as a loss. In addition, management significantly increased its internal loan watch list. During 2003, the Company charged off an aggregate of $6.0 million in loans, net of $862,000 in recoveries. Of that amount, $4.3 million related to five business customer relationships. During 2002, the Company charged off $3.7 million in loans, net of $336,000 in recoveries. Also as a result of the loan review, the Company effected certain changes to try to protect against such credit losses going forward, including procedural changes in the loan approval and credit review processes, changes in individual lending limits and centralization of the Company's lending functions into one facility. The Company also added a lender support area where all consumer loans are centrally underwritten and approved. Other Operating Income. Other operating income was $10.3 million and $8.0 million for years ended December 31, 2003 and 2002, respectively, an increase of 29%. The increase in other operating income for 2003 was primarily attributable to increases in fees associated with deposit accounts and a large increase in fees associated with the Company's mortgage loan origination activities. The large increase in fees associated with the mortgage loan origination activities was a direct result of attractive mortgage rates during 2003 and 2002 due to the lower interest rate environment. Mortgage loan origination fees increased from $3.3 million during 2002 to $4.9 million for 2003. Fees associated with deposit accounts increased primarily as a result of the increased volume of average deposit accounts. However, the total average deposit base increased from $498.4 million in 2002 to $651.3 million in 2003. Service charges and fees increased from $2.4 million in 2002 to $2.9 million in 2003. Total service charges and fees as a percent of the average total deposit base dropped from .47% in 2002 to ..43% in 2003. Finally, the Company realized gains of $442,000 on the sale of investment securities during 2003 versus a realized gain of $981,000 in 2002. Other Operating Expense. Other operating expense increased 44% to $25.2 million in 2003 from $17.5 million in 2002. The increase in 2003 reflects a full year of expenses associated with the integration of the four additional branches in connection with the acquisition of First Community Corporation in January 2002 and three additional branches in connection with the acquisition of High Street Corporation in December 2002. At December 31, 2002 there were 21 branches and the average number of full time equivalent employees was 173. Salary and employee benefits expense for the years ended December 31, 2003 and 2002 were $13.9 million and $9.8 million, respectively. Increases were the result of additional personnel hired as new branches and departments were added or obtained through acquisition as discussed above. In addition, during 2003 the Company incurred $1.2 million in severance expenses related to certain executive and senior officers who separated from the Company. Commission expense increased from $1.6 million in 2002 to $2.2 million in 2003. Because these commissions are driven by the underlying mortgage fee income, the increase, $600,000, or 38%, closely related to the increase in mortgage origination fees. Occupancy expense increased from $1.6 million in 2002 to $2.2 million in 2003. The increase was primarily a result of lease expenses associated with new locations and additional space needed for expansion of existing departments. Furniture and equipment expense increased from $1.1 million in 2002 to $1.5 million in 2003 due to the increase in these assets needed for the new locations and general expansion. Other operating expenses increased from $3.0 million -22- in 2002 to $5.0 million in 2003. The increases in other operating expenses from 2002 to 2003 included a 76% increase in telephone expenses from $191,000 to $337,000, a 37% increase in postage from $256,000 to $351,000, and a 25% increase in public relations and advertising costs from $578,000 to $721,000. In addition, courier costs, or those costs associated with getting customer transactions to the Bank's outside processing center, increased due to the additional branches being serviced by such couriers. All such increases were a direct result of a full year of expense on the new branches or expansion of existing departments. In the third quarter of 2003, the Bank also incurred write downs of the carrying value of certain real estate held for sale of $310,000. Provision for Income Taxes. Throughout 2002, the Company recorded income tax expenses of $2.4 million. The Company recorded an income tax expense of $38,000 in 2003. The decrease in income tax expense was primarily the result of the loss recorded in the third quarter of 2003 and an overall drop in net taxable income. The third quarter loss reflects the significant charge-offs, the increase in the allowance for loan losses and the related loan loss provision recorded during that period. The overall effective rate dropped from 35.5% in 2002 to 3.7% in 2003. That rate reflects the impact of permanent differences such as nontaxable municipal bond interest on a smaller net income base. Total permanent differences in 2003 were $1.0 million in 2003 compared to $536,000 in 2002. The largest single component of this increase was an increase in municipal bond interest, which increased from $532,000 in 2002 to $997,000 in 2003. See Notes to Consolidated Financial Statements - Note 12 - Income Taxes for additional information on our tax expense. Financial Condition. The Company's financial condition is measured in terms of its asset and liability composition, asset quality, capital resources, and liquidity. The growth and composition of assets and liabilities during 2004 and 2003 reflect the repositioning of the Company's markets and product lines as several branches were sold or closed, three new branches were opened, a large mortgage portfolio was sold and the Company experienced internal growth as a result of its internal business development activities. Total assets were $882.3 million and $857.7 million at December 31, 2004 and 2003, respectively. The increase in total assets of $24.6 million in 2004, or 3%, reflects strong internal growth considering the fact that, while the Company completed no acquisitions during 2004, it did sell off approximately $40 million in deposits and $32 million in loans in two non-routine transactions discussed previously. The largest component of asset growth was the increase in loans. Total liabilities increased from $784.7 million in 2003 to $804.6 million in 2004. The main cause for the increase between the periods is an increase in time deposits of $25.1 million as the Company has used this source as its primary means to fund loan growth. Stockholders' equity increased from $72.9 million in 2003 to $77.7 million in 2004. The increase, $4.8 million or 7%, primarily reflects an increase of $3.9 million in retained earnings, comprised of $5.3 million of net income less dividends of $1.4 million. Common stock increased $960,000, largely the result of issuances of stock pursuant to stock options exercises. Assets Cash and Cash Equivalents. Cash and cash equivalents, including non-interest-bearing and interest-bearing cash and federal funds sold, decreased from $25.6 million in 2003 to $23.0 million in 2004. The decrease is primarily the result of growth in loans and the outlay of cash needed to fund those loans exceeding growth in deposits and borrowings. Loan Portfolio. Total loans were $654.9 million and $625.9 million as of December 31, 2004 and 2003, respectively. Loan growth, excluding the branch sale and mortgage portfolio sold previously discussed, was $65 million or 11.1% annualized. The increase was the result of internal growth as the Company completed no acquisitions in 2004 and reflects improvement in our operations during 2004. Accordingly, the Company's business development activities were key factors in the growth of the loan portfolio during 2004. At December 31, 2004, commercial loans, mortgage loans, consumer loans, and equity lines were $532.1 million, $26.0 million, $34.9 million, and $61.9 million, respectively. At December 31, 2003, commercial loans, mortgage loans, consumer loans, and equity lines were $474.3 million, $50.2 million, $42.9 million, and $58.4 million, respectively. See Notes to Consolidated Financial Statements - Note 6 - Loans and Allowances for Loan Losses. The commercial loan portfolio is comprised mainly of loans to small and mid-sized businesses with revenues up to $25 million. There were no significant concentrations of credit to -23- any one industry, class, or category. The following table reflects the maturities of the commercial loan portfolio and the mix of the commercial loans that mature greater than one year in the loan portfolio between fixed rate and adjustable rate notes. (Dollars in thousands) Commercial loans: Due within one year $165,401 Due one through five years 316,312 Due after five years 50,378 -------- $532,091 ======== Commercial loans due after 1 year: Fixed rate $159,241 Variable rate 207,449 -------- $366,690 ======== Although there were no large concentrations of credit to any particular industry, the economic trends of the area served by the Company are influenced by the significant industries within the region. The Company's primary business activity is with customers located in the Research Triangle area of North Carolina (Raleigh, Durham, and Chapel Hill) and its surrounding counties, the Alamance County area (Burlington and Graham, North Carolina), and the Interstate 40 corridor between Asheville and Hickory, North Carolina. The ultimate collectibility of the Company's loan portfolio is susceptible to changes in the market conditions of these geographic regions. The Company uses a centralized risk management process to ensure uniform credit underwriting that adheres to Company policy. Lending policies are reviewed on a regular basis to confirm that the Company is prudent in setting its underwriting criteria. Credit risk is managed through a number of methods including loan grading of commercial loans, committee approval of larger loans, and class and purpose coding of loans. Management believes that early detection of credit problems through regular contact with the Company's customers coupled with consistent reviews of the borrowers' financial condition are important factors in overall credit risk management. Management charged off loans totaling $1.6 million, $6.0 million, and $3.7 million net of recoveries, as uncollectible during 2004, 2003 and 2002, respectively. The large increase in the 2003 amount was the result of five large commercial loan relationships that totaled $4.3 million, or 72% of the total amount charged off, as well as continued softening in the economy and isolated instances of specific business problems. At December 31, 2004 and 2003, the allowance for loan losses as a percentage of total loans was 1.64% and 1.86%, respectively. Management believes the allowance for loan losses of $10.7 million at 2004 provides adequate coverage of the probable losses in the loan portfolio. Investment Securities. Investment securities represent the second largest component of earning assets. The Company's securities portfolio consists primarily of debt securities issued by U.S. government agencies and securities issued by Fannie Mae and Freddie Mac which have been segregated into one of two categories: available for sale or held to maturity. The "available for sale" classification allows flexibility in the management of interest rate risk, liquidity, and loan portfolio growth while the "held to maturity" classification protects the balance sheet against market value fluctuations in a rising rate environment. The Company has the intent and the ability to hold "held to maturity" securities until their maturity or prepayment. Securities available for sale are carried at their fair value and the mark-to-market adjustment was $497,000 in net unrealized gains at December 31, 2004. After considering applicable tax benefits, the mark-to-market adjustment increased total stockholders' equity by $305,000. Future fluctuations in stockholders' equity may occur due to changes in the fair values of available for sale securities. Growth of the investment securities portfolio in 2005 will depend on loan growth, the interest rates available for reinvesting maturing securities and changes in the interest rate yield curve. Due to an expected rising interest rate environment, the Company may curtail or refrain from the reinvestment of cash flows from its investment portfolio, instead using proceeds to pay off wholesale funding liabilities and deleveraging the balance sheet thereby improving capital ratios but lowering net interest income. The Company may also increase the investment portfolio depending on core deposit growth. -24- On December 31, 2004 and 2003, the recorded value of investments totaled $154.3 million and $160.2 million, respectively. At December 31, 2004, $140.9 million of these securities were classified as "available for sale" and recorded at market value and $13.3 million were classified as "held to maturity" and recorded at amortized cost. At December 31, 2003, all investments were classified as "available for sale". The Company has reviewed the investment portfolio and has not recorded any "other than temporary" impairment. The Company anticipates that substantially all of the book value of the investments will be recovered over the life of any securities whose market value is below amortized cost. The following table reflects the debt securities in the portfolio as of December 31, 2004 and 2003.
As of December 31, ----------------------------------------------------------------------------------------------------- Available for Sale Held to Maturity ------------------------------------------------- ------------------------------------------------ (Dollars in thousands) 2004 2003 2004 2003 ----------------------- ------------------------ ------------------------ ---------------------- Amortized Fair Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value Cost Value ----------------------- ------------------------ ------------------------ ---------------------- US Agency securities $ 35,511 $ 35,172 $ 35,747 $ 35,338 $ 5,000 $ 4,990 $ -- $ -- Municipal bonds 24,087 24,830 24,678 25,383 300 300 -- -- Mortgage-backed securities 80,851 80,944 99,177 99,495 8,036 7,983 -- -- ----------------------- ------------------------ ------------------------ ---------------------- $ 140,449 $ 140,946 $ 159,602 $ 160,216 $ 13,336 $ 13,273 $ -- $ -- ======================= ======================== ======================== ======================
The following table reflects the debt securities by contractual maturities as of December 31, 2004. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
(Dollars in thousands) Available for Sale Held to Maturity ------------------------------- ------------------------------ Weighed Weighed Carrying Average Carrying Average Value Yield Value Yield ----------------------------------------------------------------- US Agency securities: After 1 but within 5 years $ 24,465 3.89% $ 5,000 4.07% After 5 years 10,707 4.69% -- -- ------------------------------- ------------------------------ Total US Agency securities 35,172 4.14% 5,000 4.07% ------------------------------- ------------------------------ Municipal bonds (1) After 5 years 24,830 6.19% 300 4.50% ------------------------------- ------------------------------ Total Municipal bonds 24,830 6.19% 300 4.50% ------------------------------- ------------------------------ Mortgage-backed securities After 1 but within 5 years 3,777 4.08% -- -- After 5 years 77,167 4.55% 8,036 4.67% ------------------------------- ------------------------------ Total Mortgage-backed securities 80,944 4.53% 8,036 4.67% ------------------------------- ------------------------------ $ 140,946 4.72% $ 13,336 4.44% =============================== ==============================
(1) Municipal bonds shown at tax equivalent yield. Money Market Investments and Federal Funds. At December 31, 2004 and 2003, the Company had $975,000 and $3.8 million, respectively, in short-term money market investments and federal funds. These figures include interest-bearing cash accounts. The decrease between the periods was the result of a need to use interest earning cash and Fed Funds to fund a growth in loans during a period when deposits were declining. Deposits. Total deposits increased from $629.6 million at December 31, 2003 to $655.0 million at December 31, 2004. Of these amounts, $58.3 million and $65.7 million were in the form of non-interest-bearing demand deposits at December 31, 2003 and 2004, respectively, and $571.3 million and $589.3 million were in the form of interest-bearing deposits at December 31, 2003 and 2004, respectively. Balances in certificates of deposit of $100,000 and over were -25- $103.1 million and $135.3 million at December 31, 2003 and 2004, respectively. The largest area of growth was in brokered deposits, which grew from $3.7 million at December 31, 2003 to $20.3 million at December 31, 2004 as the Company used this form of wholesale funding to fund loan growth during the year and to replace funding provided by the three sold branches. The following table reflects the maturities of certificates of deposit of $100,000 and over as of December 31, 2004: Maturity Average (Dollars in thousands) Amount Rate ---------------------- Three months or less $ 26,483 2.05% Over three months to six months 65,622 2.28% Over six months to twelve months 39,193 3.22% Over twelve months 3,996 3.66% ---------------------- $ 135,294 2.55% ====================== Debt. At December 31, 2004 and 2003, the Company's outstanding advances with the Federal Home Loan Bank ("FHLB") were $102.3 million and $114.6 million, respectively. During the year ended December 31, 2004, the maximum outstanding advances were $118.4 million. The Company had average outstanding FHLB advances of $104.0 million and $110.3 million with effective costs of borrowing of 3.31% and 3.55% at December 31, 2004 and 2003, respectively. At December 31, 2004, approximately $67.3 million are fixed rate advances and $35.0 million are variable rate advances including $25.0 million of long-term advances for which the fixed interest rate has been converted to a variable rate through interest rate swaps discussed below. Capital Resources. Total shareholders' equity for 2004 and 2003, excluding unrealized gains net of taxes on available for sale securities of $305,000 in 2004 and $377,000 in 2003, was $77.4 million and $72.5 million, respectively. The increase is primarily the result of the change in retained earnings, comprised of $5.3 million of net income less dividends of $1.4 million. Common stock increased $960,000, largely the result of issuances of stock pursuant to stock options exercises. The Company paid cash dividends of $0.20 per share during 2003 and $0.21 per share during 2004. At December 31, 2004, the Company had a leverage ratio of 9.61%, a Tier 1 capital ratio of 11.08%, and a risk based capital ratio of 12.33%. These ratios exceed the federal regulatory minimum requirements for a "well capitalized" bank and increased from year-end 2003 levels. See Notes to Consolidated Financial Statements - Note 14 - Regulatory Matters and Restrictions for additional information on regulatory capital requirements. The Board of Directors has also authorized the repurchase of up to 150,000 shares of the Company's common stock through public or private transactions. The Company did not repurchase any shares in 2004. Management plans to utilize share repurchases to manage the capital levels of the Company. Subsequent to year end, we repurchased 20,000 shares at an average cost of $18.80 per share. Asset/Liability Management. Asset/liability management functions to maximize profitability within established guidelines for interest rate risk, liquidity, and capital adequacy. Measurement and monitoring of liquidity, interest rate risk, and capital adequacy are performed centrally through the Asset/Liability Management Committee, and reported under guidelines established by management, the Board of Directors and regulators. Oversight on asset/liability management matters is provided by the Board of Directors through its Asset/Liability Management Committee. See Item 7a. - Quantitative and Qualitative Disclosures About Market Risk - for information about interest rate risk. Liquidity management involves the ability to meet the cash flow requirements of depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. To ensure the Company is positioned to meet immediate and future cash demands, management relies on internal analysis of its liquidity, knowledge of current economic and market trends and forecasts of future conditions. Regulatory agencies set certain minimum liquidity standards including the setting of a reserve requirement by the Federal Reserve. The Company must submit weekly reports to the Federal Reserve to ensure that it meets those requirements. At December 31, 2004, the Company met all of its liquidity requirements. -26- The Company had $23.0 million in its most liquid assets, cash and cash equivalents at December 31, 2004. The Company's principal sources of funds are deposits, short-term borrowings and capital. Core deposits (total deposits less certificates of deposits in the amount of $100,000 or more), one of the most stable sources of liquidity, together with equity capital funded $597.4 million or 67.7% of total assets at December 31, 2004. At December 31, 2003, core deposits and equity capital totaled $599.4 million or 69.9% of total assets. The Company's liquidity can best be demonstrated by an analysis of its cash flows. In 2004, the Company used a net increase in deposits of $25.3 million to fund $28.9 million in net new internal loan growth. Excluding the effect of $39.6 million in deposits sold and $12.8 million in loans sold as a result of the sale of three branches in the third quarter and $18.7 million in loans sold related to a specific loan portfolio, net deposit growth was $64.9 million and net loans funded was $60.4 million. In addition, the Company had other financing activities including net repayment of borrowings from the FHLB of $12.3 million. Operating activities also provided $10.9 million of liquidity for the year ended December 31, 2004, compared to $16.8 million and $911,000 in 2003 and 2002, respectively. The principal elements of operating activities are net income, increased for significant non-cash expenses for the provision for loan losses and depreciation and amortization. A secondary source of liquidity for the Company comes from investing activities, principally the sales of, maturities of and cash flows from investment securities. During 2003 and 2002, due to the declining interest rate environment, the cash flow from mortgage-backed securities accelerated as borrowers holding the underlying mortgages refinanced and certain securities with call features were called. The cash received from these events, combined with maturities, amounted to $103.6 million and $76.6 million in 2003 and 2002, respectively. As rates began to rise, the refinance market slowed down and with it, the cash flow from the mortgage-backed securities declined. Repayments on these obligations in 2004 were $62.0 million. As of December 31, 2004, the Company had negligible investment securities that would mature in the next 12 months, although certain MBS securities will have principal reductions and agency securities may be called by the issuer. During 2004, the Company purchased $56.8 million of investment securities to replace the securities sold, called or matured during the same period and to meet liquidity needs. Additional sources of liquidity are available to the Bank through the Federal Reserve System and through membership in the FHLB system. As of December 31, 2004, the Bank had a maximum borrowing capacity of $176.5 million through the FHLB of Atlanta. These funds can be made available with various maturities and interest rate structures. Borrowings cannot exceed twenty percent of total assets or twenty times the amount of FHLB stock owned by the borrowing bank. At December 31, 2004, the Bank owned $6.3 million worth of FHLB stock or 6.2% percent of its outstanding advances of $102.3 million. Borrowings are collateralized by a blanket lien by the FHLB on the Bank's qualifying assets. The Company also has sources of liquidity from other sources such as federal funds lines, repurchased agreement lines and brokered CDs. These liquidity sources require collateral in the case of repurchase agreements but are generally unsecured or easily utilized by the Company. The following table reflects expected maturities of contractual obligations and expected expirations of ongoing commitments that affect the Company's liquidity. -27-
Payments Due By Period ---------------------------------------------------------------------------- Less Than 1 - 3 3 - 5 More Than (In thousands) 1 Year Years Years 5 Years Total ---------------------------------------------------------------------------- Contractual Obligations FHLB Advances $ 10,000 $ 5,000 $ 11,861 $ 75,459 $ 102,320 Subordinated Debentures - -- -- 20,620 20,620 Operating Leases 1,164 2,036 2,813 5,899 11,912 ---------------------------------------------------------------------------- $ 11,164 $ 7,036 $ 14,674 $ 101,978 $ 134,852 ============================================================================ Amount of Commitment Expiration by Period ---------------------------------------------------------------------------- Less Than 1 - 3 3 - 5 More Than Total 1 Year Years Years 5 Years Committed ---------------------------------------------------------------------------- Commercial Commitments Commercial Letters of Credit $ 1,359 $ -- $ -- $ -- $ 1,359 Other Commercial Loan Commitments 37,283 15,032 4,655 1,295 58,265 ---------------------------------------------------------------------------- $ 38,642 $ 15,032 $ 4,655 $ 1,295 $ 59,624 ============================================================================
Effects of Inflation. The Company's financial statements have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historic dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The rate of inflation has been relatively moderate over the past few years; however, the effect of inflation on interest rates can materially impact Bank operations, which rely on the spread between the yield on earning assets and rates paid on deposits and borrowings as the major source of earnings. Operating costs, such as salaries and wages, occupancy and equipment costs, can also be negatively impacted by inflation. Risk Factors In addition to the other information provided in this Annual Report of Form 10-K, you should consider the following material risk factors carefully before deciding to invest in the Company's securities. Additional risks and uncertainties not presently known to the Company, that the Company currently deems not material or that are similar to those faced by other companies in the Company's industry or business in general, such as competitive conditions, may also impact the Company's business operations. If any of the events described below occur, our business, financial condition, or results of operations could be materially adversely affected. In that event, the trading price of the Company's common stock may decline, in which case the value of your investment may decline as well. Our Results Are Impacted by the Economic Conditions of Our Principal Operating Regions Our operations are concentrated throughout Central and Western North Carolina. As a result of this geographic concentration, our results may correlate to the economic conditions in these areas. Deterioration in economic conditions in any of these market areas, particularly in the industries on which these geographic areas depend, may adversely affect the quality of our loan portfolio and the demand for our products and services, and accordingly, our results of operations. We Are Exposed to Risks in Connection with the Loans We Make A significant source of risk for us arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans. We have underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for loan losses, that we believe are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying our loan portfolio. Such policies and procedures, however, may not prevent unexpected losses that could adversely affect our results of operations. We Compete With Larger Companies for Business -28- The banking and financial services business in our market areas continues to be a competitive field and is becoming more competitive as a result of: o Changes in regulations; o Changes in technology and product delivery systems; and o The accelerating pace of consolidation among financial services providers. We may not be able to compete effectively in our markets, and our results of operations could be adversely affected by the nature or pace of change in competition. We compete for loans, deposits and customers with various bank and nonbank financial services providers, many of which have substantially greater resources including higher total assets and capitalization, greater access to capital markets and a broader offering of financial services. Our Trading Volume Has Been Low Compared With Larger Banks The trading volume in the Company's common stock on the NASDAQ National Market has been comparable to other similarly-sized banks. Nevertheless, this trading is relatively low when compared with more seasoned companies listed on the NASDAQ National Market or other consolidated reporting systems or stock exchanges. Thus, the market in the Company's common stock may be limited in scope relative to other companies. We Depend Heavily on Our Key Management Personnel The Company's success depends in part on its ability to retain key executives and to attract and retain additional qualified management personnel who have experience both in sophisticated banking matters and in operating a small to mid-size bank. Competition for such personnel is strong in the banking industry and we may not be successful in attracting or retaining the personnel we require. We expect to effectively compete in this area by offering financial packages that include incentive-based compensation and the opportunity to join in the rewarding work of building a growing bank. Technological Advances Impact Our Business The banking industry is undergoing technological changes with frequent introductions of new technology-driven products and services. In addition to improving customer services, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, on our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources than we do to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or successfully market such products and services to our customers. Government Regulations May Prevent or Impair Our Ability to Pay Dividends, Engage in Acquisitions or Operate in Other Ways Current and future legislation and the policies established by federal and state regulatory authorities will affect our operations. We are subject to supervision and periodic examination by the Federal Deposit Insurance Corporation and the North Carolina State Banking Commission. Banking regulations, designed primarily for the protection of depositors, may limit our growth and the return to you, our investors, by restricting certain of our activities, such as: o The payment of dividends to our shareholders; o Possible mergers with or acquisitions of or by other institutions; o Our desired investments; o Loans and interest rates on loans; o Interest rates paid on our deposits; o The possible expansion of our branch offices; and/or o Our ability to provide securities or trust services. -29- We also are subject to capitalization guidelines set forth in federal legislation, and could be subject to enforcement actions to the extent that we are found by regulatory examiners to be undercapitalized. We cannot predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that such changes may have on our future business and earnings prospects. The cost of compliance with regulatory requirements including those imposed by the Securities and Exchange Commission may adversely affect our ability to operate profitably. There Are Potential Risks Associated With Future Acquisitions and Expansions We intend to continue to explore expanding our branch system through selective acquisitions of existing banks or bank branches in the Research Triangle area and other North Carolina markets. We cannot say with any certainty that we will be able to consummate, or if consummated, successfully integrate, future acquisitions, or that we will not incur disruptions or unexpected expenses in integrating such acquisitions. In the ordinary course of business, we evaluate potential acquisitions that would bolster our ability to cater to the small business, individual and residential lending markets in North Carolina. In attempting to make such acquisitions, we anticipate competing with other financial institutions, many of which have greater financial and operational resources. In addition, since the consideration for an acquired bank or branch may involve cash, notes or the issuance of shares of common stock, existing shareholders could experience dilution in the value of their shares of our common stock in connection with such acquisitions. Any given acquisition, if and when consummated, may adversely affect our results of operations or overall financial condition. In addition, we may expand our branch network through de novo branches in existing or new markets. These de novo branches will have expenses in excess of revenues for varying periods after opening which could decrease our reported earnings. Compliance with Changing Regulation of Corporate Governance and Public Disclosure May Result in Additional Risks and Expenses Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002 and new SEC regulations, are creating uncertainty for companies such as ours. These laws, regulations and standards are subject to varying interpretations in many cases, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, our efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased expenses and a diversion of management time and attention. In particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding management's required assessment of our internal control over financial reporting and our external auditors' audit of that assessment has required the commitment of significant financial and managerial resources. We expect these efforts to require the continued commitment of significant resources. Further, the members of our Board of Directors, members of the Audit or Compensation committees, our chief executive officer, our chief financial officer and certain other of our executive officers could face an increased risk of personal liability in connection with the performance of their duties. As a result, our ability to attract and retain executive officers and qualified Board and committee members could be more difficult. In addition, it may become more difficult and more expensive to obtain director and officer liability insurance. Recent Accounting Developments. Please refer to Notes to Consolidated Financial Statements - Note 1 - Summary of Significant Accounting Policies for a discussion of recent accounting developments. Item 7A. Quantitative and Qualitative Disclosures About Market Risk The Company hopes to reach its strategic financial objectives through the effective management of market risk. Like many financial institutions, the Company's most significant market risk exposure is interest rate risk. The Company's primary goal in managing interest rate risk is to minimize the effect that changes in interest rates have on interest -30- income and expense. This is accomplished through the active management of asset and liability portfolios, which includes the strategic pricing of asset and liability accounts and ensuring a proper maturity combination of assets and liabilities. The goal of these activities is the development of maturity and repricing opportunities in the Company's portfolios of assets and liabilities that will produce consistent net interest income during periods of changing interest rates. The Company's Asset/Liability Committee ("ALCO"), made up of members of management and the Board, monitors loan, investment, and liability portfolios to ensure comprehensive management of interest rate risk. These portfolios are analyzed to ensure proper fixed and variable-rate mixes under several interest rate scenarios. The asset/liability management process is intended to accomplish relatively stable net interest margins and assure liquidity by coordinating the amounts, maturities, or repricing opportunities of earning assets, deposits, and borrowed funds. The ALCO has the responsibility to determine and achieve the most appropriate volume and combination of earning assets and interest-bearing liabilities, and ensure an adequate level of liquidity and capital, within the context of corporate performance objectives. The ALCO also sets policy guidelines and establishes long-term strategies with respect to interest rate risk exposure and liquidity. The ALCO meets regularly to review the Company's interest rate risk and liquidity positions in relation to present and prospective market and business conditions, and adopts balance sheet management strategies intended to ensure that the potential impact of earnings and liquidity as a result of fluctuations in interest rates is within acceptable guidelines. In 2003, the Bank began using financial instruments, commonly known as derivatives, to manage various financial risks. The derivatives used presently by the Bank consist of interest rate swaps and swaptions. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index, or referenced interest rate. The Bank uses derivatives to hedge its interest-bearing liabilities. These hedges resulted in a net increase in net interest income of $490,000 in 2004 and $238,000 in 2003. The Company anticipates the benefit to net interest income of the swaps and swaptions will decrease in 2005 as short-term interest rates continue to increase. Derivative contracts are written in amounts referred to as notional amounts. Notional amounts only provide the basis for calculating payments between counterparties and do not represent amounts to be exchanged between parties and are not a measure of financial risk. On December 31, 2004, the Bank had derivative financial instruments outstanding with notional amounts totaling $25.0 million. See Notes to Consolidated Financial Statements - Note 10 - Derivative Financial Instruments for additional information. As a financial institution, most of the Company's assets and liabilities are monetary in nature. This differs greatly from most commercial and industrial companies balance sheets, which are comprised primarily of fixed assets or inventories. Movements in interest rates and actions of the Board of Governors of the Federal Reserve System ("FRB") to regulate the availability and cost of credit have a greater effect on a financial institution's profitability than do the effects of higher costs for goods and services. Through its balance sheet management function, which is monitored by the ALCO, the Company is positioned to respond to changing needs for liquidity, changes in interest rates and inflationary trends. The Company utilizes an outside asset liability management advisory firm to help management evaluate interest rate risk and develop asset/liability management strategies. One tool used is a computer simulation model which projects the Company's performance under different interest rate scenarios. Analyses are prepared quarterly which evaluate the Company's performance in a base strategy that reflects the Company's 2004 and 2005 operating plan. Three interest rate scenarios (Flat, Rising and Declining) are applied to the base strategy to determine the effect of changing interest rates on net interest income. The December 31, 2004 analysis indicates that interest rate risk exposure over a twelve-month time horizon is within the guidelines established by the Board of Directors. The Company's interest rate sensitivity is illustrated in the following table. The Company continues to be "asset sensitive" at December 31, 2004 as its assets reprice faster than its liabilities. The table reflects rate-sensitive positions at December 31, 2004, and is not necessarily indicative of positions on other dates. The carrying amounts of interest rate sensitive assets and liabilities are presented in the periods in which they next reprice to market rates or mature and are aggregated to show the interest rate sensitivity gap. To reflect anticipated prepayments, certain asset and liability categories are shown in the table using estimated cash flows rather than contractual cash flows. -31-
Interest Rate Sensitivity Within One to Two to After One Year Two Years Five Years Five Years Total (Dollars in thousands) Assets Securities and other interest-earning assets (1) $ 50,409 $ 32,501 $ 58,211 $ 19,459 $ 160,580 Federal funds sold 975 -- -- -- 975 Loans and leases (2) 492,296 34,832 111,257 5,761 644,146 ---------------------------------------------------------------- Total interest-earning assets 543,680 67,333 169,468 25,220 805,701 Noninterest-earning assets -- -- -- 76,593 76,593 ---------------------------------------------------------------- $ 543,680 $ 67,333 $ 169,468 $ 101,813 $ 882,294 ================================================================ Liabilities Non Maturity Interest-Bearing Deposits (3) $ 65,921 $ 71,720 $ 55,794 $ -- $ 193,435 Other Time Deposits 259,763 60,284 75,807 14 395,868 Borrowings 42,122 15,387 26,107 35,459 119,075 Subordinated Debt -- -- -- 20,620 20,620 ---------------------------------------------------------------- Total interest-bearing liabilities 367,806 147,391 157,708 56,093 728,998 Non Maturity Non-Interest-Bearing Deposits (3) 8,208 8,209 24,627 24,629 65,673 Other Noninterest-bearing liabilities -- -- -- 9,885 9,885 Equity -- -- -- 77,738 77,738 ---------------------------------------------------------------- 376,014 155,600 182,335 168,345 882,294 ================================================================ Interest-rate sensitivity gap $ 167,666 $ (88,267) $ (12,867) $ (66,532) $ -- ================================================================ Cumulative interest-rate sensitivity gap $ 167,666 $ 79,399 $ 66,532 $ -- ==================================================
(1) Securities based on amortized cost (2) Loans and leases include loans held for sale and are net of unearned income (3) Projected runoff of deposits that do not have a contractual maturity date was computed based on decay rate assumptions developed by bank regulators to assist banks in addressing FDICIA rule 305 For the upcoming twelve month period in the Flat rate scenario, the Company is projected to earn $30.0 million in net interest income. In the Rising rate scenario, which contemplates a 200 bp increase in interest rates over a twelve month period, the Company is expected to see its annualized net interest income improve by $2.2 million, or 7.23%. Conversely, the Company will see a decline in net interest income of $980,000, or 3.27%, if rates decline 200 bps, as is contemplated in the Declining rate scenario. The table does not reflect the impact of the hedging strategies mentioned above. These interest rate hedges, accounted for as Fair Value Hedges, were designed to convert $25.0 million of long-term advances from fixed rates to a variable rate which is reset quarterly based on LIBOR. The swaps are collateralized by certain investment securities and mature as follows: Effective Year Amount Variable Rate ------------------------------------------------------ 2009 $ 10,000,000 LIBOR + 1.87 2011 15,000,000 LIBOR + 2.02 Item 8. Financial Statements and Supplementary Data. -32- Capital Bank Corporation Consolidated Balance Sheets December 31, 2004 and 2003 (In thousands, except share data)
2004 2003 ----------------------- Assets Cash and due from banks: Interest-earning $ 971 $ 569 Noninterest earning 22,036 21,839 Federal funds sold and short term investments 4 3,202 Investment securities - available for sale, at fair value (Note 4) 140,946 160,216 Investment securities - held to maturity, at amortized cost (Note 4) 13,336 -- Federal Home Loan Bank stock (Note 5) 6,298 5,697 Loans-net of unearned income and deferred fees (Note 6) 654,867 625,945 Less allowance for loan losses (10,721) (11,613) --------- --------- Net loans 644,146 614,332 --------- --------- Premises and equipment, net (Note 7) 15,608 14,190 Bank owned life insurance 13,500 9,429 Deposit premium and goodwill, net (Note 3) 13,065 14,530 Deferred tax assets (Note 12) 5,985 6,492 Accrued interest receivable and other assets 6,399 7,238 --------- --------- Total assets $ 882,294 $ 857,734 ========= ========= Liabilities and Shareholders' Equity Deposits (Note 8): Demand, non-interest bearing $ 65,673 $ 58,350 Savings and interest bearing checking 93,116 84,701 Money market deposit accounts 100,319 115,751 Time deposits less than $100,000 260,574 267,673 Time deposits $100,000 and greater 135,294 103,144 --------- --------- Total deposits 654,976 629,619 --------- --------- Repurchase agreements and fed funds purchased (Note 9) 16,755 11,014 Federal Home Loan Bank advances (Note 9) 102,320 114,591 Subordinated debentures (Note 11) 20,620 20,620 Accrued interest payable and other liabilities 9,885 8,967 --------- --------- Total liabilities 804,556 784,811 --------- --------- Commitments and contingencies (Notes 13, 14, 16 and 17) Shareholders' equity: Common stock, no par value; 20,000,000 shares authorized, 6,612,787 and 6,541,495 issued and outstanding as of 2004 and 2003, respectively 68,341 67,381 Accumulated other comprehensive income 305 377 Retained earnings 9,092 5,165 --------- --------- Total shareholders' equity 77,738 72,923 --------- --------- Total liabilities and shareholders' equity $ 882,294 $ 857,734 ========= =========
The accompanying notes are an integral part of these consolidated financial statements. -33- Capital Bank Corporation Consolidated Statements of Operations For the Years Ended December 31, 2004, 2003, and 2002 (In thousands except per share data)
2004 2003 2002 -------- -------- -------- Interest income: Loans and fees on loans $ 35,704 $ 34,352 $ 29,601 Investment securities 6,531 5,898 6,273 Federal funds and other interest income 156 190 370 -------- -------- -------- Total interest income 42,391 40,440 36,244 -------- -------- -------- Interest expense: Deposits 11,782 12,070 12,567 Borrowings and repurchase agreements 4,475 4,248 3,328 -------- -------- -------- Total interest expense 16,257 16,318 15,895 -------- -------- -------- Net interest income 26,134 24,122 20,349 Provision for loan losses 1,038 8,247 4,190 -------- -------- -------- Net interest income after provision for loan losses 25,096 15,875 16,159 -------- -------- -------- Other operating income: Service charges and fees 2,948 2,858 2,350 Net gain on sale of securities 18 442 981 Mortgage origination fees 1,288 4,864 3,294 Gain on sale of branches 1,164 -- -- Loss on sale of mortgage loan portfolio (320) -- -- Other fees and income 1,807 2,158 1,362 -------- -------- -------- Total other operating income 6,905 10,322 7,987 -------- -------- -------- Other operating expenses: Personnel 12,125 13,895 9,821 Occupancy 2,366 2,226 1,557 Data processing 1,130 1,164 917 Furniture and equipment 1,683 1,469 1,141 Amortization of intangibles 247 310 180 Advertising 869 721 578 Professional fees 989 1,017 304 Telecommunications 542 337 191 Other 3,873 4,026 2,776 -------- -------- -------- Total other operating expenses 23,824 25,165 17,465 -------- -------- -------- Net income before income tax expense 8,177 1,032 6,681 Income tax expense 2,866 38 2,374 -------- -------- -------- Net income $ 5,311 $ 994 $ 4,307 ======== ======== ======== Net income per share - basic $ .79 $ .15 $ .79 ======== ======== ======== Net income per share - diluted $ .77 $ .15 $ .76 ======== ======== ======== Dividends per share $ .21 $ .20 $ .20 ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. -34- Capital Bank Corporation Consolidated Statements of Changes in Shareholders' Equity For the Years Ended December 31, 2004, 2003, and 2002 (In thousands, except share and per share data)
Accumulated Other Number Common Comprehensive Retained of Shares Stock Income (Loss) Earnings Total ------------ ------------ -------------- ------------ -------- Balance at January 1, 2002 3,597,339 $ 34,109 $ 568 $ 2,306 $ 36,983 Repurchase of outstanding common stock (365,334) (4,945) -- -- (4,945) Issuance of common stock for compensation 5,622 57 -- -- 57 Issuance of common stock for options excercised 147,645 990 -- -- 990 Issuance of common stock for acquisition of subsidiaries 3,210,512 38,486 -- -- 38,486 Net income -- -- -- 4,307 4,307 Unrealized gain on securities, net of deferred tax expense of $456 -- -- 725 -- 725 -------- Comprehensive income 5,032 Cash dividends ($0.20 per share) -- -- -- (1,132) (1,132) ---------- ---------- -------- -------- -------- Balance at December 31, 2002 6,595,784 68,697 1,293 5,481 75,471 Repurchase of outstanding common stock (182,500) (2,701) -- -- (2,701) Issuance of common stock for compensation 2,357 24 -- -- 24 Issuance of common stock for options excercised 125,854 1,171 -- -- 1,171 Noncash compensation -- 190 -- -- 190 Net income -- -- -- 994 994 Unrealized loss on securities, net of deferred tax benefit of $577 -- -- (916) -- (916) -------- Comprehensive income 78 Cash dividends ($0.20 per share) -- -- -- (1,310) (1,310) ---------- ---------- -------- -------- -------- Balance at December 31, 2003 6,541,495 67,381 377 5,165 72,923 Issuance of common stock for compensation 2,028 22 -- -- 22 Issuance of common stock for options excercised 69,264 938 -- -- 938 Net income -- -- -- 5,311 5,311 Unrealized loss on securities, net of deferred tax benefit of $45 -- -- (72) -- (72) -------- Comprehensive income 5,239 Cash dividends ($0.21 per share) -- -- -- (1,384) (1,384) ---------- ---------- -------- -------- -------- Balance at December 31, 2004 6,612,787 $ 68,341 $ 305 $ 9,092 $ 77,738 ========== ========== ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. -35- Capital Bank Corporation Consolidated Statements of Cash Flows For the Years Ended December 31, 2004, 2003, and 2002 (In thousands)
2004 2003 2002 ---------------------------------------- Net income $ 5,311 $ 994 $ 4,307 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of intangibles 247 310 180 Writedown of intangible assets -- 10 -- Depreciation 1,480 1,459 1,228 Gain(loss) on disposal of equipment 70 (160) -- Amortization of premiums/discounts on securities, net 637 1,971 922 Gain on sale of investments (18) (442) (981) Funding of held for sale loans (69,893) (259,041) (191,608) Proceeds from sale of held for sale loans 71,334 264,447 181,366 Provision for loan losses 1,038 8,247 4,190 Deferred tax (benefit) expense 523 (564) 130 Issuance of stock for compensation 22 24 57 Other noncash compensation -- 190 -- Gain on sale of branches (1,164) -- -- Loss on sale of mortgage portfolio 320 -- -- Changes in assets and liabilities: Accrued interest receivable and other assets 1,130 222 710 Accrued interest payable and other liabilities (110) (885) 410 -------- --------- --------- Net cash provided by operating activities 10,927 16,782 911 -------- --------- --------- Cash flows from investing activities: Net increase in loans (64,755) (37,620) (23,946) Additions to premises and equipment (3,871) (2,712) (1,145) Proceeds from sale of equipment 645 622 1 Net (purchase) sale of Federal Home Loan Bank stock (600) (681) 91 Purchase of securities available for sale (17,014) (43,462) (33,851) Purchase of securities held to maturity (15,477) -- -- Purchase of mortgage-backed securities available for sale (24,317) (73,051) (71,883) Purchase of bank owned life insurance (3,500) (6,000) -- Proceeds from calls/maturities of securities available for sale 33,945 87,704 35,124 Proceeds from sales of securities available for sale 25,920 15,859 41,434 Proceeds from calls/maturities of securities held to maturity 2,140 -- -- Capitalized purchase costs of acquisitions -- (38) (47) Proceeds from sale of mortgage portfolio 18,667 -- -- Net cash paid in branch sale (23,054) -- -- Net cash acquired from acquisitions -- -- 20,695 -------- --------- --------- Net cash used by investing activities (71,271) (59,379) (33,527) -------- --------- ---------
The accompanying notes are an integral part of these consolidated financial statements. -36- Capital Bank Corporation Consolidated Statements of Cash Flows (Continued) For the Years Ended December 31, 2004, 2003, and 2002 (In thousands)
2004 2003 2002 -------------------------------------- Cash flows from financing activities: Net increase (decrease) in deposits $ 64,911 $(15,268) $ 51,718 Net increase (decrease) in repurchase agreements 5,741 (2,067) 1,914 Proceeds from Federal Home Loan Bank borrowings 42,500 71,000 86,123 Principal repayments of Federal Home Loan Bank borrowings (54,771) (54,267) (66,969) Proceeds from subordinated debentures, net of issuance costs -- 20,120 -- Repurchase of outstanding common stock -- (2,701) (4,945) Exercise of stock options 679 1,171 990 Cash dividends paid (1,315) (1,314) (799) -------- -------- -------- Net cash provided by financing activities 57,745 16,674 68,032 -------- -------- -------- Net change in cash and cash equivalents (2,599) (25,923) 35,416 Cash and cash equivalents at beginning of year 25,610 51,533 16,117 -------- -------- -------- Cash and cash equivalents at end of year $ 23,011 $ 25,610 $ 51,533 ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. -37- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- 1. Summary of Significant Accounting Policies Organization and Nature of Operations Capital Bank Corporation (the "Company") is a financial holding company incorporated under the laws of North Carolina on August 10, 1998. The Company's primary function is to serve as the holding company for its wholly-owned subsidiaries, Capital Bank and Capital Bank Investment Services, Inc. In addition, the Company has interest in two trusts, Capital Bank Statutory Trust I and II (hereinafter collectively referred to as the "Trusts"). The Trusts are not consolidated with the financial statements of the Company per the provisions of FIN 46R. Capital Bank (the "Bank") was incorporated under the laws of North Carolina on May 30, 1997 and commenced operations on June 20, 1997. The Bank is not a member of the Federal Reserve System and has no subsidiaries. The Bank is a community bank engaged in general commercial banking, providing a full range of banking services. The majority of the Bank's customers are individuals and small to medium-size businesses. The Bank's primary source of revenue is interest earned from loans to customers and from invested cash and securities and non-interest income derived from various fees. The Bank operates throughout North Carolina with branch facilities located in Raleigh (4), Sanford (3), Burlington (2), Asheville (3), Greensboro, Cary (2), Oxford, Hickory, Siler City, Graham, and Wake Forest. The Company's corporate headquarters are located on Glenwood Avenue in Raleigh, North Carolina. The Trusts were formed for the sole purpose of issuing trust preferred securities. The proceeds from such issuances were loaned to the Company in exchange for the Debentures (as defined below), which are the sole assets of the Trust. A portion of the proceeds from the issuance of the Debentures were used by the Company to repurchase shares of Company common stock. The Company's obligation under the Debentures constitutes a full and unconditional guarantee by the Company of the Trust's obligations under the trust preferred securities. The Trusts have no operations other than those that are incidental to the issuance of the trust preferred securities. See Note 11 - Subordinated Debentures. The Company has no operations other than those of its subsidiaries. Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The more significant estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, valuation of goodwill and intangible assets, valuation of investments, and tax assets, liabilities and expense. Actual results could differ from those estimates. Cash and Cash Equivalents Cash and cash equivalents include demand and time deposits (with original maturities of 90 days or less) at other institutions, federal funds sold and other short term investments. Generally, federal funds are purchased and sold for one-day periods. At times, the Bank places deposits with high credit quality financial institutions in amounts which may be in excess of federally insured limits. Banks are required to maintain reserve and clearing balances with the Federal Reserve Bank (the "FRB"). Accordingly, the Bank has amounts restricted for this purpose of $11,696 included in "cash and due from banks" on the Consolidated Balance Sheet at December 31, 2004. Securities -38- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- Investments in certain securities are classified into three categories and accounted for as follows: 1. Securities Held to Maturity - Debt securities that the institution has the positive intent and ability to hold to maturity are classified as held to maturity and reported at amortized cost; or 2. Trading Securities - Debt and equity securities that are bought and held principally for the purpose of selling in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings; or 3. Securities Available for Sale - Debt and equity securities not classified as either held to maturity securities or trading securities are classified as available for sale securities and reported at fair value, with unrealized gains and losses reported as other comprehensive income, a separate component of shareholders' equity. The initial classification of securities is determined at the date of purchase. Gains and losses on sales of securities, computed based on specific identification of the adjusted cost of each security, are included in other income at the time of the sales. Premiums and discounts on debt securities are recognized in interest income using the level interest yield method over the period to maturity, or when the debt securities are called. Loans Held for Sale Mortgage loans held for sale are valued at the lower of cost or market as determined by outstanding commitments from investors or current investor yield requirements, calculated on the aggregate loan basis. At December 31, 2004 and 2003, there were approximately $3.4 million and $4.8 million, respectively, in loans held for sale which are classified as loans on the balance sheet. Through the normal course of originating loans held for sale, the customer's interest rate is fixed upon lock-in by the customer. The Bank enters into a best efforts commitment to sell the loan to an investor after the rate lock-in by the customer. Rate lock commitments for loans held for sale are valued based on the value to be realized upon sale to an investor less any value attributable to the servicing rights which are also sold to the investor. Loans and Allowance for Loan Losses Loans are stated at the amount of unpaid principal, reduced by an allowance for loan losses and net deferred loan origination fees and costs. Interest on loans is calculated by using the simple interest method on daily balances of the principal amount outstanding. Deferred loan fees and costs are amortized to interest income over the contractual life of the loan using the level interest yield method. A loan is considered impaired, based on current information and events, if it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Uncollateralized loans are measured for impairment based on the present value of expected future cash flows discounted at the historical effective interest rate, while all collateral-dependent loans are measured for impairment based on the fair value of the collateral. There were no loans classified as impaired at December 31, 2004. Loans deemed to be impaired at December 31, 2003 amounted to $3.0 million and the related allowance for loan losses was $825,000. Average impaired loans during 2004 and 2003 were $2.1 million and $3.2 million, respectively. Interest income recognized on loans classified as impaired was $175,000 for the year ended December 31, 2004. The Bank uses several factors in determining if a loan is impaired. The internal asset classification procedures include a thorough review of significant loans and lending relationships and include the accumulation of related data. This data includes loan payment status, borrowers' financial data and borrowers' operating factors such as cash flows, operating income or loss, etc. It is possible that these factors and management's evaluation of the adequacy of the allowance for loan losses will change. The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb -39- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- probable losses on existing loans that may become uncollectible, based on evaluations of the collectibility of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions and trends that may affect the borrowers' ability to pay. Income Recognition on Impaired and Nonaccrual Loans Loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well-secured and in the process of collection. If a loan or a portion of a loan is classified as doubtful or as partially charged off, the loan is generally classified as nonaccrual. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual if repayment in full of principal and/or interest is in doubt. Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance (generally a minimum of six months) of interest and principal by the borrower in accordance with the contractual terms. While a loan is classified as nonaccrual and the future collectibility of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to the principal outstanding, except in the case of loans with scheduled amortizations where the payment is generally applied to the oldest payment due. When the future collectibility of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan had been partially charged-off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered. Foreclosed Assets Any assets acquired as a result of foreclosure are valued at the lower of the recorded investment in the loan or fair value less estimated costs to sell. The recorded investment is the sum of the outstanding principal loan balance and foreclosure costs associated with the loan. Any excess of the recorded investment over the fair value of the property received is charged to the allowance for loan losses. Valuations will be periodically performed by management and any subsequent write-downs due to the carrying value of a property exceeding its estimated fair value less estimated costs to sell are charged against other expenses. Premises and Equipment Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed by the straight-line method based on estimated service lives of assets. Useful lives range from 3 to 10 years for furniture and equipment. The cost of leasehold improvements is being amortized using the straight-line method over the terms of the related leases. Repairs and maintenance are charged to expense as incurred. Upon disposition, the asset and related accumulated depreciation or amortization are relieved and any gains or losses are reflected in operations. Income Taxes Deferred tax asset and liability balances are determined by application to temporary differences of the tax rate expected to be in effect when taxes will become payable or receivable. Temporary differences are differences between the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements that will result in taxable or deductible amounts in future years. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded for deferred tax assets if the Company determines that it is more likely than not that some portion or all of the deferred tax assets will not be realized. Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities The Company applies a financial-components approach that focuses on control when accounting and reporting for transfers and servicing of financial assets and extinguishments of liabilities. Under that -40- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. This approach provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. Derivatives The Company uses derivatives to manage interest rate risk. The instruments consist of interest rate swaps and swaptions. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index, or referenced interest rate. The Bank uses derivatives, accounted for as fair value hedges, to hedge its fixed rate interest-bearing liabilities. Under SFAS 133, derivatives are recorded in the balance sheet at fair value. For fair value hedges, the change in the fair value of the derivative and the corresponding change in fair value of the hedged risk in the underlying item being hedged are accounted for in earnings. Any difference in these two changes in fair value results in hedge ineffectiveness that results in a net impact to earnings. Derivative contracts are written in amounts referred to as notional amounts. Notional amounts only provide the basis for calculating payments between counterparties and do not represent amounts to be exchanged between parties and are not a measure of financial risk. Stock Option Plans The Company has a stock-based incentive compensation plan covering certain officers and directors. The Company grants stock options under the incentive plan for a fixed number of shares with an exercise price equal to the fair value of the shares on the date of grant. The Company has elected to account for these stock option grants in accordance with Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and accordingly, recognizes no compensation expense for these stock option grants. The Company discloses pro forma net income and earnings per share in these notes as if compensation was measured under the fair value based method promulgated under Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation. Under the fair value based method, compensation cost is measured at the grant date of the option based on the value of the award and is recognized over the service period, which is usually the vesting period. Had compensation expense for the stock option plans been determined consistent with SFAS No. 123, the Company's net income and net income per share for the years ended December 31, 2004, 2003 and 2002 would have been reduced to the pro forma amounts indicated below. These pro forma amounts may not be representative of the effect on reported net income in future years.
(In thousands, except per share data) 2004 2003 2002 --------------------------------------- Net income As reported $5,311 $ 994 $4,307 Pro forma 5,095 922 3,474 Net income per share - Basic As reported $ 0.79 $ 0.15 $ 0.79 Pro forma 0.76 0.14 0.64 Net income per share - Diluted As reported $ 0.77 $ 0.15 $ 0.76 Pro forma 0.74 0.14 0.62
The Company is required to disclose the pro forma effects on net income as if it had recorded compensation based on the fair value of options granted. The fair values of the options granted in 2004, 2003 and 2002 are estimated on the date of the grants using the Black-Scholes option-pricing model. Option pricing models require the use of highly subjective assumptions, including expected stock volatility, which when changed can materially affect fair value estimates. The fair values were estimated using the following weighted-average assumptions: -41- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- 2004 2003 2002 ------------------------------------- Dividend yield 1.04% 1.20% 1.46% Expected volatility 27.7% 28.0% 29.7% Riskfree interest rate 3.92% 3.72% 3.93% Expected life 7 years 7 years 7 years The weighted average fair value of options granted during 2004, 2003 and 2002 was $5.99, $5.15, and $4.47, respectively. Net Income Per Share The Company follows SFAS No. 128, Earnings Per Share. In accordance with SFAS No. 128, the Company has presented both basic and diluted EPS on the face of the Consolidated Statements of Operations. Basic EPS excludes dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. The weighted average number of shares outstanding for 2004, 2003, and 2002 were as follows:
2004 2003 2002 ------------------------------------------ (In thousands, except number of shares) Income available to stockholders - basic and diluted $ 5,311 $ 994 $ 4,307 ========== ========== ========== Shares used in the computation of earnings per share: Weighted average number of shares outstanding - basic 6,712,502 6,655,926 5,467,735 Incremental shares from assumed exercise of stock options 173,198 137,946 195,214 ---------- ---------- ---------- Weighted average number of shares outstanding - diluted 6,885,700 6,793,872 5,662,949 ========== ========== ==========
Comprehensive Income The Company follows SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes standards for reporting and displaying comprehensive income (loss) and its components (revenues, expenses, gains, and losses) in general-purpose financial statements. The Company's only components of other comprehensive income relate to unrealized gains and losses on available for sale securities. Information concerning the Company's other comprehensive income (loss) for the years ended December 31, 2004, 2003 and 2002 is as follows:
2004 2003 2002 ------------------------------------------ (In thousands) Unrealized (losses) gains on securities available for sale $ (99) $ (1,051) $ 2,162 Reclassification of gains recognized in net income (18) (442) (981) Income tax benefit (expense) 45 577 (456) ---------- ---------- ---------- Other comprehensive income (loss) $ (72) $ (916) $ 725 ========== ========== ==========
Segment Information The Company follows the provisions of SFAS No. 131 Disclosures about Segments of an Enterprise and Related Information. SFAS 131 requires that public business enterprises report certain information about operating segments in their annual financial statements and in condensed financial statements of interim periods issued to shareholders. It also requires that the public business enterprises report related disclosures -42- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- and descriptive information about products and services provided by significant segments, geographic areas, and major customers, differences between the measurements used in reporting segment information and those used in the enterprise's general-purpose financial statements, and changes in the measurement of segment amounts from period to period. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources, and in assessing performance. The Company has determined that it has one significant operating segment, the providing of general commercial financial services to customers located in the single geographic area of North Carolina. The various products are those generally offered by community banks, and the allocation of resources is based on the overall performance of the institution, versus the individual branches or products. Reclassifications Certain items included in the 2003 and 2002 financial statements have been reclassified to conform to the 2004 presentation. These reclassifications have no effect on net income or shareholders' equity previously reported. New Pronouncements In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment. This standard is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values and is effective for the first interim or annual reporting period beginning after June 15, 2005. The Company expects to adopt SFAS No. 123R on July 1, 2005, using the standard's modified prospective application method. Adoption of SFAS No. 123R will not affect the Company's cash flows or financial position, but it will reduce reported income and earnings per share because the Company will be required to recognize compensation expense for share purchase rights granted under its employee stock option and employee stock purchase plans, whereas the Company has not been required to record such expense under current accounting rules. Under SFAS No. 123R, the Company will recognize compensation expense for the fair value of its share purchase rights over the vesting period. The Company has not performed all of the final calculations for expensing stock options but the estimated impact is presented under the heading "Stock Option Plans" in Note 1 - Significant Accounting Policies. In addition, the Company has other plans and liabilities impacted by SFAS No. 123R. These are obligations which may be settled in the Company's shares. The most material obligations are deferred compensation plans for directors and advisory board members. The Company is evaluating alternatives for these plans to minimize the impact to the Company's net income, including payment of shares due under the plans prior to the effective date of SFAS No. 123R. If SFAS No. 123R were effective as of December 31, 2004, the impact on pretax income would have been approximately $1.0 million based on a share price of $18.75 per share. 2. Significant Activities On January 18, 2002, the Company acquired First Community Financial Corporation ("First Community"), the holding company for Community Savings Bank, Inc. ("Community Savings Bank"). As a result of the acquisition, the Company issued an additional 1.9 million shares of common stock. The transaction was accounted for under the purchase method and was intended to qualify as a tax-free reorganization under Section 368(a) of the Internal Revenue Code. On December 1, 2002, the Company acquired High Street Corporation ("High Street"), the holding company for High Street Banking Company ("High Street Bank"). As a result of the acquisition, the Company issued an additional 1.3 million shares of common stock. The transaction was accounted for under the purchase method and is intended to qualify as a tax-free reorganization under Section 368(a) of the Internal Revenue Code. The following table reflects the unaudited pro forma combined results of operations for the year ended December 31, 2002 assuming these acquisitions had occurred at the beginning of fiscal 2002: -43- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- 2002 ------- (In thousands, except per share amounts) Net interest income $24,436 Net income 3,530 Net earnings per diluted share 0.51 In management's opinion, these unaudited pro forma amounts are not necessarily indicative of what actual combined results of operations might have been if the acquisitions had been effective at the beginning of fiscal 2002. A summary of estimated fair values of assets acquired and liabilities assumed was as follows:
(In thousands) First High Community Street Total --------- --------- --------- Loans receivable $ 134,149 $ 126,175 $ 260,324 Premises and equipment 5,424 3,050 8,474 Deposit premium 782 976 1,758 Goodwill 3,835 5,319 9,154 Other assets 52,661 28,333 80,994 Deposits (156,241) (132,485) (288,726) Borrowings (16,414) (12,290) (28,704) Other liabilities (3,342) (1,446) (4,788) --------- --------- --------- Investment in subsidiary, net of dividends to shareholders and capitalized acquisition costs $ 20,854 $ 17,632 $ 38,486 ========= ========= =========
During 2003, the Company made several changes to its branch structure including the consolidation of two branches in Oxford into one main Oxford facility in a new location and the opening of an additional branch in Raleigh. In addition, during the third quarter of 2003, the Company made the decision to discontinue the operations of CBIS. CBIS will remain an inactive subsidiary of the Company. Also during 2003, the Company entered into two separate offerings of trust preferred securities, one in June by Trust I and the other in December by Trust II. See Notes to Consolidated Financial Statements - Note 11 - Subordinated Debentures for additional information on these Trusts. During 2004, the Company made additional changes to its branch structure including the sale of three branches in Warrenton, Seaboard and Woodland to other financial institutions in the third quarter. Included in the sale were approximately $39.6 million of deposits and $12.8 million of loans, as well as other assets. With the closing of the branch sale, the Company was required to make payments of $23.0 million dollars to cover the excess of liabilities over assets assumed by the acquiring companies. A one time gain was recorded for $1.2 million in connection with this sale. In addition, the Company opened three new branches during the year, one each in Wake Forest, Asheville and Greensboro, North Carolina. Also during 2004, the Company sold a mortgage portfolio which was being serviced by an independent organization and which had been acquired as a part of a previous bank acquisition. The sale included approximately $19.2 million in loans and $152,000 in foreclosed assets. The Company recorded a $320,000 one time loss on this sale. 3. Goodwill and Other Intangible Assets Net assets of companies acquired in purchase transactions are recorded at fair value at the date of acquisition, and as such, the historical cost basis of individual assets and liabilities are adjusted to reflect their fair value. Identified intangibles are amortized on a straight-line basis over the period benefited. In 2002, the Company adopted SFAS No. 142 Goodwill and Other Intangible Assets and accordingly, goodwill is no longer amortized, but is reviewed for potential impairment at least annually at the reporting unit level. An impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. -44- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- Other intangible assets are evaluated for impairment if events and circumstances indicate a possible impairment. Such evaluation of other intangible assets is based on undiscounted cash flow projections. No impairment charges were recorded in 2004 based on the evaluation and a $10,000 charge was recorded in 2003 related to the shutdown of CBIS. As of December 31, 2004 and 2003, intangible assets, primarily deposit premiums paid for acquisitions, and goodwill were as follows:
Accumulated (In thousands) Gross Amortization Net -------------------------------------- At December 31, 2004 From January 2002 acquisition of First Community: Deposit premium $ 782 $ (404) $ 378 Goodwill 3,834 -- 3,834 -------- -------- -------- 4,616 (404) 4,212 -------- -------- -------- From December 2002 acquisition of High Street: Deposit premium 976 (337) 639 Goodwill 5,381 -- 5,381 -------- -------- -------- 6,357 (337) 6,020 -------- -------- -------- From April 2000 branch acquisitions: Goodwill 1,996 (347) 1,649 From June 1997 branch acquisitions: Goodwill 2,164 (980) 1,184 -------- -------- -------- $ 15,133 $ (2,068) $ 13,065 ======== ======== ======== Accumulated Gross Amortization Net -------------------------------------- At December 31, 2003 From January 2002 acquisition of First Community: Deposit premium $ 782 $ (304) $ 478 Goodwill 3,834 -- 3,834 -------- -------- -------- 4,616 (304) 4,312 -------- -------- -------- From December 2002 acquisition of High Street: Deposit premium 976 (190) 786 Goodwill 5,381 -- 5,381 -------- -------- -------- 6,357 (190) 6,167 -------- -------- -------- From April 2000 branch acquisitions: Goodwill 3,471 (604) 2,867 From June 1997 branch acquisitions: Goodwill 2,164 (980) 1,184 -------- -------- -------- $ 16,608 $ (2,078) $ 14,530 ======== ======== ========
Deposit premiums are amortized over a period of up to 10 years using an accelerated method. During 2004 and 2003, deposit premiums were reduced by amortization expenses of $247,000 and $310,000, respectively. In addition, during 2004, goodwill was reduced by $1.2 million in connection with deposits sold in branch sales. Estimated amortization expenses for the next five fiscal years are as follows: -45- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- Year Ended (In thousands) December 31, ------------ 2005 $212,000 2006 185,000 2007 161,000 2008 137,000 2009 113,000 4. Securities Securities at December 31, 2004 and 2003 are summarized as follows:
Gross Gross Estimated Amortized Unrealized Unrealized Market (In thousands) Cost Gains Losses Value ---------- ----------- ----------- ----------- 2004 ---- Available for sale: U.S. Agency obligations $ 35,511 $ 86 $ 425 $ 35,172 Municipal bonds 24,087 828 85 24,830 Mortgage-backed securities 80,851 427 334 80,944 -------- -------- -------- -------- 140,449 1,341 844 140,946 -------- -------- -------- -------- Held to maturity: U.S. Agency obligations $ 5,000 $ 2 $ 12 4,990 Municipal bonds 300 -- -- 300 Mortgage-backed securities 8,036 15 68 7,983 -------- -------- -------- -------- 13,336 17 80 13,273 -------- -------- -------- -------- $153,785 $ 1,358 $ 924 $154,219 ======== ======== ======== ======== Gross Gross Estimated Amortized Unrealized Unrealized Market (In thousands) Cost Gains Losses Value ---------- ----------- ----------- ----------- 2003 ---- Available for sale: U.S. Agency obligations $ 35,747 $ 87 $ 507 $ 35,327 Municipal bonds 24,678 769 64 25,383 Mortgage-backed securities 99,189 859 542 99,506 -------- -------- -------- -------- $159,614 $ 1,715 $ 1,113 $160,216 ======== ======== ======== ========
The amortized cost and estimated market values of securities at December 31, 2004 by contractual maturities are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. -46- Capital Bank Corporation Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
(Dollars in thousands) Available for Sale Held to Maturity ----------------------- ----------------------- Estimated Estimated Amortized Market Amortized Market Cost Value Cost Value ----------------------- ----------------------- US Agency securities: Due after one year through five years $ 24,702 $ 24,465 $ 5,000 $ 4,990 Due after five years through ten years 3,918 3,943 -- -- Due after ten years 6,891 6,764 -- -- ----------------------- ----------------------- Total US Agency securities 35,511 35,172 5,000 4,990 ----------------------- ----------------------- Municipal bonds Due after five years through ten years 8,063 8,313 300 300 Due after ten years 16,024 16,517 -- -- ----------------------- ----------------------- Total Municipal bonds 24,087 24,830 300 300 ----------------------- ----------------------- Mortgage-backed securities Due after one year through five years 3,764 3,777 -- -- Due after five years through ten years 4,355 4,402 -- -- Due after ten years 72,732 72,765 8,036 7,983 ----------------------- ----------------------- Total Mortgage-backed securities 80,851 80,944 8,036 7,983 ----------------------- ----------------------- $140,449 $140,946 $ 13,336 $ 13,273 ======================= =======================
The following table shows the gross unrealized losses and fair value of the Company's investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2004:
(Dollars in thousands) Less Than 12 Months 12 Months or Greater Total ---------------------------------------------------------------------- Unrealized Unrealized Unrealized Description of Security Fair Value Losses Fair Value Losses Fair Value Losses ---------------------------------------------------------------------------------------------------------------------- Available for sale Direct obligations of U.S. government agencies $18,568 $ 181 $ 6,756 $ 244 $25,324 $ 425 Municipal bonds 1,569 43 1,268 42 2,837 85 Federal agency mortgage- backed securities 20,537 131 10,030 203 30,567 334 ---------------------------------------------------------------------- 40,674 355 18,054 489 58,728 844 ---------------------------------------------------------------------- Held to maturity Direct obligations of U.S. government agencies 3,982 12 -- -- 3,982 12 Mortgage-backed securities 2,842 68 -- -- 2,842 68 ---------------------------------------------------------------------- 6,824 80 -- -- 6,824 80 ---------------------------------------------------------------------- $47,498 $ 435 $18,054 $ 489 $65,552 $ 924 ======================================================================
Government Agency Obligations. The unrealized losses on the Company's investments in direct obligations of U.S. government agencies were the result of interest rate increases. The contractual terms of these investments do not permit the issuer to settle the securities at a price materially less than the amortized cost of the investment. Because the Company has the ability and intent to hold these investments until a recovery of fair value, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2004. Federal Agency Mortgage-Backed Securities. The unrealized losses on the Company's investment in agency mortgage-backed securities issued by FNMA, FHLMC, and GNMA were caused by interest rate increases. -47- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- The Company purchased most of these investments at either a discount or a premium relative to their face amount, and the contractual cash flows of each is guaranteed by the issuer organization. Accordingly, it is expected that the securities would not be settled at a price materially less than the amortized cost of the Company's investment. Because the decline in market value is attributable to changes in interest rates and not credit quality and because the Company has the ability to hold these investments until a recovery of fair value, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2004. During the years ended December 31, 2004, 2003 and 2002, the Company had gross realized gains of $18,000, $442,000 and $981,000, respectively, on sales of available for sale securities with book values of $25.9 million, $15.4 million and $40.5 million. Securities with an amortized cost of $66.8 million were pledged as of December 31, 2004 to secure public deposits, repurchase agreements, and FHLB advances. 5. Federal Home Loan Bank Stock During 2004, in order to raise additional capital, the Federal Home Loan Bank ("FHLB") restructured the stock ownership requirements in order to be a member of the FHLB System. As a member, the Bank is required to maintain an investment in capital stock of the FHLB in an amount equal to 0.20% of its total assets as of December 31st of the prior year (up to a maximum of $25.0 million) plus 4.5% of its outstanding FHLB advances. No ready market exists for the FHLB stock, and it has no quoted market value, therefore, cost approximates market at December 31, 2004 and 2003. 6. Loans and Allowance for Loan Losses The composition of the loan portfolio by loan classification at December 31, 2004 and 2003 is as follows: (In thousands) 2004 2003 ------------------------ Commercial $ 531,834 $ 474,104 Consumer 34,865 42,929 Home equity lines 61,925 58,430 Residential mortgages 26,020 50,437 --------- --------- 654,644 625,900 Less deferred loan fees (costs), net (223) (45) --------- --------- $ 654,867 $ 625,945 ========= ========= A summary of activity in the allowance for loan losses for the years ended December 31, 2004, 2003, and 2002 is as follows: -48- Capital Bank Corporation Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
(In thousands) 2004 2003 2002 ----------------------------------- Balance at beginning of year $ 11,613 $ 9,390 $ 4,286 Allowance for loan losses transferred from acquired companies -- -- 4,593 Provision for loan losses 1,038 8,247 4,190 Loans charged-off, net of recoveries (1,619) (6,024) (3,679) Reclassified (311) -------- -------- ------- Balance at end of year $ 10,721 $ 11,613 $ 9,390 ======== ======== =======
During the year, the Company reclassified $311,000 of the allowance which related to loss exposure on unfunded loan commitments and letters of credit into a separate other liability account. At December 31, 2004, nonperforming assets consisted of nonaccrual loans in the amount of $8.2 million and foreclosed real estate of $418,000. At December 31, 2003, nonperforming assets consisted of nonaccrual loans in the amount of $8.0 million and foreclosed real estate of $978,000. Unrecognized income on nonaccrual loans at December 31, 2004 and 2003 was $275,000 and $262,000, respectively. At December 31, 2004 and 2003, there were no loans past due greater than 90 days still accruing interest. In the normal course of business, certain directors and executive officers of the Company, including their immediate families and companies in which they have an interest, may be loan customers. Total loans to such groups at December 31, 2004 and activity during the year ended December 31, 2004, is summarized as follows: (In thousands) 2004 2003 2002 ------------------------------------ Beginning balance $ 23,392 $ 15,288 $ 8,286 New loans 16,737 14,562 13,015 Principal repayments (8,844) (4,048) (6,013) Reclassifications -- (2,410) -- -------- -------- -------- Ending balance $ 31,285 $ 23,392 $ 15,288 ======== ======== ======== In addition, such groups had available lines of credit in the amount of $7.7 million at December 31, 2004. The Company paid an aggregate of approximately $1.0 million, $922,000, and $705,000 to companies owned by members of the board of directors for leased space, equipment, construction and consulting services during 2004, 2003 and 2002, respectively. 7. Premises and Equipment Premises and equipment at December 31, 2004 and 2003 are as follows: -49- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- 2004 2003 ---------------------- (In thousands) Land $ 4,813 $ 4,679 Buildings and leasehold improvements 8,863 8,492 Furniture and equipment 9,488 8,344 Automobiles 324 256 Construction in progress 959 2 -------- -------- 24,447 21,773 Less accumulated depreciation and amortization (8,839) (7,583) -------- -------- $ 15,608 $ 14,190 ======== ======== 8. Deposits At December 31, 2004, the scheduled maturities of certificates of deposit are as follows: Weighted Average (In thousands) Balance Rate -------- -------- 2005 $259,763 2.16% 2006 60,284 3.15% 2007 64,757 3.17% 2008 2,749 2.98% 2009 and thereafter 8,315 3.93% -------- -------- $395,868 2.52% ======== ======== 9. Borrowings Short term borrowed funds. Following is an analysis of short-term borrowed funds at December 31, 2004 and 2003:
End of Period Daily Average Balance Maximum ---------------------- ---------------------- Outstanding Weighted Interest At Any (Dollars in thousands) Balance Avg Rate Balance Rate Month End ---------------------- ---------------------- ------------ 2004 Fed funds purchased $ 1,573 2.70% $ 564 1.77% $ 2,137 Repurchase agreements 15,182 1.68% 12,301 0.89% 17,875 -------- ----------------------- $ 16,755 $ 12,865 0.92% ======== ======================= 2003 Fed funds purchased $ -- n/a $ 177 1.41% $ -- Repurchase agreements 11,014 0.53% 14,280 0.61% 16,358 -------- ----------------------- $ 11,014 $ 14,457 0.62% ======== =======================
Interest on federal funds purchased totaled $10,000 in 2004 and $3,000 in 2003. Repurchase agreements are collateralized by U.S. government agency and mortgage-backed securities with carrying values of $17.8 million and fair values of $17.7 million at December 31, 2004. Interest expense on securities sold under agreements to repurchase totaled $109,000 in 2004 and $86,000 in 2003. Federal Home Loan Bank Advances. Advances from the FHLB had a weighted average rate of 4.08% and 4.21% at December 31, 2004 and 2003, respectively, and were collateralized by certain 1 - 4 family mortgages, multifamily first mortgage loans, home equity loans and qualifying commercial loans totaling -50- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- $103.5 million and $93.7 million at year-end 2004 and 2003, respectively. In addition, the Company pledged certain investment securities with an amortized cost of $25.2 million and $32.3 million at December 31, 2004 and 2003. See Note 4 - Securities. At December 31, 2004, the scheduled maturities of FHLB advances were as follows: Weighted Average (Dollars in thousands) Balance Rate ----------- ----------- 2005 $ 10,000 3.93% 2006 -- -- 2007 5,000 2.11% 2008 -- -- 2009 and thereafter 87,320 4.21% ----------- ----------- $ 102,320 4.08% =========== =========== At December 31, 2004, the Company had an additional $74.6 million of credit available with the FHLB. 10. Derivative Financial Instruments The Company maintains positions in derivative financial instruments to manage interest rate risk, to facilitate asset/liability management strategies, and to manage other risk exposures. In July 2003, the Company entered into interest rate swap agreements to convert portions of its fixed rate FHLB advances to floating interest rates. Because of the effectiveness of the swap agreements against the related debt instruments, the adjustments needed to record the swaps at fair value were offset by the adjustments needed to record the related debt instruments at fair value and the net difference between those amounts were not material. These interest rate hedges, accounted for as fair value hedges, have an aggregated notional amount of $25.0 million and reset quarterly at variable rates based on 90 day LIBOR. The counterparty for these hedges is a firm with an investment grade rating by a nationally recognized investment rating service. The swaps are collateralized by certain investment securities and are summarized as follows: Effective Maturity Amount Variable Rate ------------------------------------------------------ 2009 $ 10,000,000 LIBOR + 1.87 2011 15,000,000 LIBOR + 2.02 11. Subordinated Debentures In June 2003 and December 2003, the Company formed the Trusts. Each issued 10,000 of its floating rate capital securities (the "trust preferred securities"), with a liquidation amount of $1,000 per capital security, in pooled offerings of trust preferred securities. The Trusts sold their common securities to the Company for an aggregate of $620,000, resulting in total proceeds from each offering equal to $10,310,000 or $20,620,000 in aggregate. The Trusts then used these proceeds to purchase $20,620,000 in principal amount of the Company's Floating Rate Junior Subordinated Deferrable Interest Debentures (the "Debentures"). Following payment by the Company of a placement fee and other expenses of the offering, the Company's net proceeds from the offering aggregated $20.0 million. The trust preferred securities have a 30 year maturity and are redeemable after 5 years with certain exceptions. Prior to the redemption date, the trust preferred securities may be redeemed at the option of the Company after the occurrence of certain events, including without limitation events that would have a negative tax effect on the Company or the Trusts, would cause the trust preferred securities to no longer -51- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- qualify as Tier 1 capital, or would result in the Trusts being treated as an investment company. The Trusts' ability to pay amounts due on the trust preferred securities is solely dependent upon the Company making payment on the Debentures. The Company's obligation under the Debentures constitutes a full and unconditional guarantee by the Company of the Trusts' obligations under the trust preferred securities. The securities associated with both trusts are floating rate, based on 90 day LIBOR, and adjust quarterly. Those associated with Trust I, originally issued in June 2003, adjust at LIBOR + 3.10% while the securities associated with Trust II, issued in December 2003, adjust at LIBOR + 2.85%. The Debentures, which are subordinate and junior in right of payment to all present and future senior indebtedness and certain other financial obligations of the Company, are the sole assets of the Trusts and the Company's payment under the Debentures is the sole source of revenue for the Trusts. Per the provisions of FIN 46R, the assets and liabilities of the Trusts are not consolidated into the consolidated financial statements of the Company. Interest on the Debentures is included in the Company's Condensed Consolidated Statements of Income as interest expense. The Debentures are presented as a separate category of long-term debt on the Consolidated Statements of Financial Condition entitled "Subordinated Debentures." For regulatory purposes, the $20.0 million of trust preferred securities qualifies as Tier 1 capital, subject to certain limitations, or Tier 2 capital in accordance with regulatory reporting requirements. 12. Income Taxes Income taxes charged to operations for the years ended December 31, 2004, 2003, and 2002 consist of the following components: (In thousands) 2004 2003 2002 ----------------------------- Current income tax expense $2,343 $ 602 $2,244 Deferred income tax expense (benefit) 523 (564) 130 ------ ------ ------ Total income tax expense $2,866 $ 38 $2,374 ====== ====== ====== Income taxes for the years ended December 31, 2004, 2003 and 2002 were allocated as follows:
(In thousands) 2004 2003 2002 ------------------------------ Income from continuing operations $ 2,866 $ 38 $2,374 Stockholders' equity, for unrealized gains (losses) on securities available for sale (45) (577) 456 Stockholders' equity, for compensation expense for tax purposes in excess of financial reporting purposes (259) -- -- ------------------------------ $ 2,562 $ (539) $2,830 ==============================
A reconciliation of the difference between income tax expense and the amount computed by applying the statutory federal income tax rate of 34% is as follows: -52- Capital Bank Corporation Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
Amount % of Pretax Income ---------------------------------- ---------------------------------- (Dollars in thousands) 2004 2003 2002 2004 2003 2002 ------------------------------------------------------------------------------ ---------------------------------- Tax expense at statutory rate on income before taxes $ 2,780 $ 351 $ 2,272 34.00% 34.00% 34.00% State taxes, net of federal benefit 372 112 200 4.55% 10.85% 2.99% Increase (reduction) in taxes resulting from: Tax exempt interest on investment securities (366) (339) (181) -4.48% -32.85% -2.71% Non-taxable life insurance income (50) (62) (46) -0.61% -6.01% -0.69% Other, net 130 (24) 129 1.59% -2.31% 1.94% ---------------------------------- --------------------------------- $ 2,866 $ 38 $ 2,374 35.05% 3.68% 35.53% ================================== =================================
Significant components of deferred tax assets and liabilities at December 31, 2004 and 2003 are as follows: (In thousands) 2004 2003 -------------------- Deferred tax assets: Allowance for loan losses $ 4,224 $ 4,477 Deferred compensation 1,496 1,645 Net operating loss carryforwards 1,022 1,306 Directors fees 845 697 Contributions carryforwards 13 171 ------- ------- Total deferred tax assets 7,600 8,296 ------- ------- Deferred tax liabilities: Unrealized security gains (192) (250) Depreciation (608) (535) Purchase accounting adjustments (206) (338) FHLB stock (304) (304) Other (305) (377) ------- ------- Total deferred tax liabilites (1,615) (1,804) ------- ------- Net deferred tax assets $ 5,985 $ 6,492 ======= ======= At December 31, 2004 and 2003, the Company had net deferred tax assets of $6.0 million and $6.5 million, respectively. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. In management's opinion, it is more likely than not that the results of future operations will generate sufficient taxable income to recognize the deferred tax assets. Included in deferred tax assets are the tax benefits derived from net operating loss carryforwards totaling $3.0 million relating to a prior acquisition which expire in various amounts through 2022. Management expects to use be able to utilize all of these carryforward amounts before they expire. 13. Leases The Company has noncancelable operating leases for its corporate office and branch locations that expire at various times through 2027. Future minimum lease payments under the leases for years subsequent to December 31, 2004 are as follows: -53- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (In thousands) 2005 $ 1,164 2006 1,028 2007 1,008 2008 1,000 2009 1,000 Thereafter 6,712 ------- $11,912 ======= During 2004, 2003, and 2002, payments under operating leases were $1.2 million, $1.1 million, and $806,000, respectively. 14. Regulatory Matters and Restrictions The Company and the Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the consolidated financial statements. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios, as set forth in the table below. As of June 30, 2004, the most recent notification from regulators, the Bank was categorized as "well capitalized" by regulatory authorities. There are no conditions or events since that date that management believes could have an adverse effect on the Bank's category. Management believes that as of December 31, 2004, the Company meets all capital requirements to which it is subject. The Bank, as a North Carolina banking corporation, may pay dividends only out of undivided profits as determined pursuant to North Carolina General Statues Section 53-87. At December 31, 2004, the undivided profits of the Bank totaled $5.5 million. However, regulatory authorities may limit payment of dividends by any bank when it is determined that such a limitation is in the public interest and is necessary to ensure financial soundness of the bank. To be categorized as well capitalized, the Company and the Bank must maintain minimum amounts and ratios. The Company's actual capital amounts and ratios as of December 31, 2004 and 2003 and the minimum requirements are presented in the following table.
Minimum Requirements To Be: Actual Adequately Capitalized Well Capitalized --------------------- ---------------------- --------------------- (Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio -------- -------- --------- -------- -------- -------- 2004 ---- Total Capital (to Risk Weighted Assets) $ 92,971 12.33% $ 60,310 8.00% $ 75,387 10.00% Tier I Capital (to Risk Weighted Assets) 83,528 11.08% 30,155 4.00% 45,232 6.00% Tier I Capital (to Average Assets) 83,528 9.61% 34,783 4.00% 43,479 5.00% 2003 ---- Total Capital (to Risk Weighted Assets) $ 84,692 12.13% $ 55,853 8.00% $ 69,817 10.00% Tier I Capital (to Risk Weighted Assets) 74,572 10.68% 27,927 4.00% 41,890 6.00% Tier I Capital (to Average Assets) 74,572 8.71% 34,262 4.00% 42,827 5.00%
15. Employee Benefit Plans 401(k) Plan -54- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- The Company maintains a 401(k) plan (the "Plan") for the benefit of its employees, which includes provisions for employee contributions, subject to limitation under the Internal Revenue Code, with the Company to match contributions up to 6% of the employee's salary. The Plan provides that employees' contributions are 100% vested at all times and the Company's contributions vest 20% after the second year of service, an additional 20% after the third and fourth years of service and the remaining 40% after the fifth year of service. Further, the Company may make additional contributions on a discretionary basis. Aggregate contributions for 2004, 2003, and 2002 were $366,000, $387,000, and $342,000, respectively. 16. Stock Options The Company has stock option plans providing for the issuance of up to 650,000 options to purchase shares of the Company's stock to officers and directors. At December 31, 2004, options for 162,510 shares of common stock remained available for future issuance. In addition, there were approximately 567,000 options which were assumed under various plans from previously acquired financial institutions, of which approximately 288,000 remain outstanding. Grants of options are made by the Board or the Compensation Committee. All grants must be at no less than fair market value on the date of grant, must be exercised no later than 10 years from the date of grant, and may be subject to some vesting provisions. A summary of the activity during the years ending December 31, 2004, 2003 and 2002 of the Company's stock option plans, including the weighted average exercise price ("WAEP") is presented below:
2004 2003 2002 ---------------------------------------------------------------------------- Shares WAEP Shares WAEP Shares WAEP -------- -------- -------- -------- -------- -------- Outstanding at beginning of year 704,540 $ 10.40 786,366 $ 9.70 416,694 $ 10.43 Granted 84,250 17.85 81,000 15.82 16,000 12.54 Assumed in connection with acquisitions -- -- -- -- 502,977 8.13 Exercised (69,264) 9.80 (125,854) 9.31 (147,645) 6.71 Terminated (26,002) 13.58 (36,972) 11.16 (1,660) 10.25 -------- -------- -------- -------- -------- -------- Outstanding at end of year 693,524 $ 11.25 704,540 $ 10.40 786,366 $ 9.70 ======== ======== ======== ======== ======== ======== Options exercisable at year-end 580,010 $ 10.31 590,560 $ 9.66 720,394 $ 9.61 ======== ======== ======== ======== ======== ========
The following table summarizes information about the Company's stock options at December 31, 2004: Weighted Average Remaining Number Contractual Number Exercise Price Outstanding Life in Years Exercisable ----------------------- ------------ ------------------ ------------ $6.62 - $9.00 266,570 4.72 263,820 $9.01 - $12.00 166,201 5.73 165,237 $12.01 - $15.00 95,192 3.67 87,992 $15.01 - $18.00 98,811 8.29 27,711 $18.01 - $18.37 66,750 9.99 35,250 ------------ ------------------ ------------ 693,524 5.83 580,010 ============ ================== ============ -55- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- 17. Financial Instruments with Off-Balance Sheet Risk and Concentrations of Credit Risk To meet the financial needs of its customers, the Company is party to financial instruments with off-balance sheet risk in the normal course of business. At December 31, 2004, these financial instruments were comprised entirely of unused lines of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. The Company's exposure to credit loss in the event of nonperformance by the other party is represented by the contractual amount of those instruments. The Company uses the same credit policies in making these commitments as they do for on-balance sheet instruments. The amount of collateral obtained, if deemed necessary by the Company, upon extension of credit is based on management's credit evaluation of the borrower. Collateral held varies but may include trade accounts receivable, property, plant, and equipment and income-producing commercial properties. Since many unused lines of credit expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Unused lines of credit were $123.2 million and $115.3 million, respectively, at the end of 2004 and 2003. Outstanding letters of credit were $1.4 million and $1.6 million, respectively, at December 31, 2004 and 2003. The Bank's lending is concentrated primarily in Wake, Chatham, Alamance, Buncombe, Catawba, Granville, and Lee counties in North Carolina. 18. Fair Value of Financial Instruments SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires the disclosure of estimated fair values for financial instruments. Quoted market prices, if available, are utilized as an estimate of the fair value of financial instruments. Because no quoted market prices exist for a significant part of the Company's financial instruments, the fair value of such instruments has been derived based on management's assumptions with respect to future economic conditions, the amount and timing of future cash flows and estimated discount rates. Different assumptions could significantly affect these estimates. Accordingly, the net amounts ultimately collected could be materially different from the estimates presented below. In addition, these estimates are only indicative of the values of individual financial instruments and should not be considered an indication of the fair value of the Company taken as a whole. The fair values of cash and due from banks, Federal funds sold, interest bearing deposits in banks and accrued interest receivable/payable are equal to the carrying value due to the nature of the financial instruments. The estimated fair values of investment securities are provided in Note 4 - Securities. The fair value of the net loan portfolio has been estimated using the present value of expected cash flows, discounted at an interest rate giving consideration to estimated prepayment risk and credit loss factors. The fair value of the Bank's loan portfolio at December 31, 2004 and 2003 was as follows: (In thousands) 2004 2003 --------------------- Loans: Carrying amount $644,146 $614,332 Estimated fair value 643,663 617,705 The deposit liabilities and repurchase agreements with no stated maturities are predominately at variable rates and, accordingly, the fair values have been estimated to equal the carrying amounts (the amount payable on demand), totaling $275.9 million and $269.8 million at December 31, 2004 and 2003, respectively. The fair values of certificates of deposits and advances from the FHLB are estimated by discounting the future cash flows using the current rates offered for similar deposits and advances with the same remaining -56- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- maturities. The carrying value and estimated fair values of certificates of deposit, FHLB advances and subordinated debt at December 31, 2004 and 2003 were as follows: (In thousands) 2004 2003 ------------------------ Certificates of deposits: Carrying amount $395,868 $370,817 Estimated fair value 395,348 373,286 Advances from the FHLB: Carrying amount $102,320 $114,591 Estimated fair value 102,762 115,203 Subordinated Debt Carrying amount $ 20,620 $ 20,620 Estimated fair value 21,170 20,718 There is no material difference between the carrying amount and estimated fair value of off-balance sheet items totaling $124.6 million and $116.9 million at December 31, 2004 and 2003, respectively, which are primarily comprised of unfunded loan commitments. The Company's remaining assets and liabilities are not considered financial instruments. -57- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- 19. Parent Company Financial Information Condensed financial information of the financial holding company of the Bank at December 31, 2004 and 2003 and for the years ended December 31, 2004, 2003, and 2002 is presented below: (In thousands) Condensed Balance Sheets 2004 2003 ----------------- Assets: Cash $ 5,885 $ 3,514 Equity investment in subsidiary 92,020 90,245 Other assets 1,126 495 ------- ------- Total assets $99,031 $94,254 ======= ======= Liabilities: Subordinated debentures $20,620 $20,630 Deferred tax liabilities 192 237 Dividends payable 397 327 Other liabilities 84 137 ------- ------- Total liabilities 21,293 21,331 ------- ------- Shareholders' equity: Common stock 65,385 64,425 Accumulated other comprehensive income 305 377 Retained earnings 12,048 8,121 ------- ------- Total shareholders' equity 77,738 72,923 ------- ------- Total liabilities and shareholders' equity $99,031 $94,254 ======= =======
(In thousands) Condensed Statements of Operations 2004 2003 2002 ------------------------------------ Dividends from wholly-owned subsidiaries $ 4,000 $ 750 $ 2,750 Undistributed earnings of subsidiaries 1,892 401 1,570 Other income 66 15 -- Interest expense (929) (249) -- Other expenses (17) (4) (13) -------- -------- -------- Net income before tax benefits 5,012 913 4,307 Income tax benefit 299 81 -- -------- -------- -------- Net income $ 5,311 $ 994 $ 4,307 ======== ======== ========
-58- Capital Bank Corporation Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
(In thousands) Condensed Statements of Cash Flows 2004 2003 2002 ------------------------------------ Operating activities: Net income $ 5,311 $ 994 $ 4,307 Equity in undistributed earnings of subsidiary (1,892) (401) (1,570) Net change in other assets and liabilities (693) (200) -- -------- -------- -------- Cash flow provided by operating activities 2,726 393 2,737 -------- -------- -------- Investing activities: Additional investment in subsidiaries -- (14,594) -- -------- -------- -------- Cash flow used in investing activities -- (14,594) -- -------- -------- -------- Financing activities: Proceeds from issuance of common stock 960 1,171 990 Payments to repurchase common stock -- (2,677) (4,945) Proceeds from issuance of subordinated debentures, net of issuance costs -- 20,120 -- Dividends paid (1,315) (1,314) (799) Net cash from acquisitions -- -- 2,429 -------- -------- -------- Cash flow provided by (used in) financing activities (355) 17,300 (2,325) -------- -------- -------- Net increase in cash and cash equivalents 2,371 3,099 412 Cash and cash equivalents, beginning of year 3,514 415 3 -------- -------- -------- Cash and cash equivalents, end of year $ 5,885 $ 3,514 $ 415 ======== ======== ========
-59- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- 20. Supplemental Disclosure of Cash Flow Information
2004 2003 2002 -------------------------------------- (In thousands) Cash payments for interest $ 16,131 $ 16,552 $ 15,237 ========= ========= ========= Cash payments for income taxes $ 1,398 $ 1,008 $ 1,775 ========= ========= ========= Dividends payable $ 397 $ 328 $ 332 ========= ========= ========= Transfers from loans to real estate acquired through foreclosure $ 1,221 $ 854 $ 1,708 ========= ========= ========= Purchase of First Community: Loans, net of reserves $ -- $ -- $(134,149) Investments -- -- (39,001) Other assets acquired -- -- (10,435) Goodwill and deposit premium -- -- (4,617) Deposits -- -- 156,241 Borrowings -- -- 16,414 Other liabilities assumed -- -- 3,342 Issuance of stock -- -- 20,854 --------- --------- --------- Net cash and cash equivalents acquired $ -- $ -- $ 8,649 ========= ========= ========= Purchase of High Street: Loans, net of reserves $ -- $ -- $(126,175) Investments -- -- (12,275) Other assets acquired -- -- (7,062) Goodwill and deposit premium -- -- (6,295) Deposits -- -- 132,485 Borrowings -- -- 12,290 Other liabilities assumed -- -- 1,446 Issuance of stock -- -- 17,632 --------- --------- --------- Net cash and cash equivalents acquired $ -- $ -- $ 12,046 ========= ========= ========= Sale of Northern Region branches Loans, net of reserves $ 12,830 $ -- $ -- Property and equipment 258 -- -- Other assets and liabilities, net 1,030 -- -- Goodwill written off 1,218 -- -- Deposits (39,554) -- -- Net gain on sale 1,164 -- -- --------- --------- --------- Net cash and cash equivalents sold $ (23,054) $ -- $ -- ========= ========= ========= Sale of mortgage portfolio Loans, net of reserves $ 18,722 $ -- $ -- Real estate owned 152 -- -- Other assets and liabilities, net 113 -- -- Net loss on sale (320) -- -- --------- --------- --------- Net cash and cash equivalents acquired $ 18,667 $ -- $ -- ========= ========= =========
-60- Capital Bank Corporation Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- 21. Selected Quarterly Financial Data (Unaudited) Selected unaudited quarterly balances and results for the years ended December 31, 2004 and 2003 are as follows:
2004 --------------------------------------------------- Three Months Ended --------------------------------------------------- (In thousands, except per share data) Dec. 31 Sept. 30 June 30 March 31 --------------------------------------------------- Assets $ 882,294 $ 875,713 $ 885,754 $ 891,703 Loans 654,867 657,359 657,537 642,407 Investment securities 160,580 154,694 150,340 159,349 Deposits 654,976 647,037 671,796 678,817 Shareholders' equity 77,738 76,370 72,615 75,440 Net interest income $ 6,945 $ 6,689 $ 6,231 $ 6,269 Provision for loan losses 357 268 297 116 Other operating income 1,480 2,280 1,544 1,601 Other operating expenses 5,938 6,179 6,070 5,637 Income taxes 740 872 517 737 --------- --------- --------- --------- Net income $ 1,390 $ 1,650 $ 891 $ 1,380 ========= ========= ========= ========= Net income per share - Basic $ .21 $ .25 $ .13 $ .21 ========= ========= ========= ========= Net income per share - Diluted $ .20 $ .24 $ .13 $ .20 ========= ========= ========= ========= 2003 --------------------------------------------------- Three Months Ended --------------------------------------------------- (In thousands, except per share data) Dec. 31 Sept. 30 June 30 March 31 --------------------------------------------------- Assets $ 857,734 $ 871,780 $ 908,677 $ 856,076 Loans 625,945 637,745 645,525 622,015 Investment securities 165,913 166,940 161,938 155,835 Deposits 629,619 656,030 684,180 652,690 Shareholders' equity 72,923 70,776 75,144 76,512 Net interest income $ 6,274 $ 5,941 $ 5,972 $ 5,935 Provision for loan losses (12) 4,963 2,696 600 Other operating income 1,898 3,080 2,739 2,605 Other operating expenses 5,847 7,593 5,777 5,948 Income taxes 766 (1,392) (47) 711 --------- --------- --------- --------- Net income (loss) $ 1,571 $ (2,143) $ 285 $ 1,281 ========= ========= ========= ========= Net income (loss) per share - Basic $ .24 $ (.32) $ .04 $ .19 ========= ========= ========= ========= Net income (loss) per share - Diluted $ .24 $ (.32) $ .04 $ .19 ========= ========= ========= =========
-61- Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders Capital Bank Corporation We have completed an integrated audit of Capital Bank Corporation's 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below. Consolidated financial statements - --------------------------------- In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of changes in shareholders' equity and of cash flows present fairly, in all material respects, the financial position of Capital Bank Corporation and its subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. Internal control over financial reporting - ----------------------------------------- Also, in our opinion, management's assessment, included in Management's Report on Internal Control Over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of December 31, 2004 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the COSO. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management's assessment and on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions. -62- A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers LLP Raleigh, North Carolina March 10, 2005 with respect to our opinion relating to the consolidated financial statements and April 22, 2005 with respect to our opinions relating to internal control over financial reporting -63- Item 9. Changes In and Disagreements With Accountants On Accounting and Financial Disclosure. None. Item 9A. Controls and Procedures. Evaluation of Disclosure Controls and Procedures. The Company's management, under the supervision of and with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act as of the end of the period covered by this report. Based on such evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective in that they are reasonably designed to ensure that all material information relating to the Company required to be included in the Company's reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Changes in Internal Control Over Financial Reporting. There have not been any changes in the Company's internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, during the Company's fiscal quarter ended December 31, 2004 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. From time to time, the Company makes changes to its internal control over financial reporting that are intended to enhance the effectiveness of its internal control over financial reporting and which do not have a material effect on its overall internal control over financial reporting. Management's Report on Internal Control Over Financial Reporting. The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting, as that term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company's internal control over financial reporting was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate. Management has assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2004. Management based its assessment on the criteria for effective internal control over financial reporting set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control- Integrated Framework. Based on this assessment, management concluded that, as of December 31, 2004, the Company maintained effective internal control over financial reporting. Limitations on the Effectiveness of Controls. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Further, the design of disclosure controls and internal control over financial reporting must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. The Company plans to continue to evaluate the effectiveness of its disclosure controls and procedures and its -64- internal control over financial reporting on an ongoing basis and will take action as appropriate. Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting The Company's independent registered public accounting firm, PricewaterhouseCoopers LLP, has audited management's assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2004, as stated in its report, which is included herein in Report of Independent Registered Public Accounting Firm in Item 8 of Part II. PART III This Part incorporates certain information from the definitive proxy statement (the "2005 Proxy Statement") for the Company's 2005 Annual Meeting of Shareholders, to be filed with the SEC on or about April 25, 2005 which is not later than 120 days after the end of the Company's fiscal year. Item 10. Directors and Executive Officers of the Registrant. Information concerning the Company's executive officers is included under the caption "Executive Officers" on page 9 of this report. Information concerning the Company's directors and filing of certain reports of beneficial ownership is incorporated by reference to the sections entitled "Proposal 1 : Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the 2005 Proxy Statement. Information concerning the audit committee of the Company's Board of Directors is incorporated by reference to the section entitled "Information About Our Board of Directors - Board of Director Committees - Audit Committee" in the 2005 Proxy Statement. There have been no material changes to the procedures by which security holders may recommend nominees to the Company's Board of Directors since the date of the Company's Proxy Statement for the Company's 2004 Annual Meeting of Shareholders. We have adopted a Code of Business Conduct and Ethics (our "Code of Ethics") that applies to our employees, officers and directors. The complete Code of Ethics is available on our website at www.capitalbank-nc.com. If at any time it is not available on our website, we will provide a copy upon written request made to our Corporate Secretary, Capital Bank Corporation, 4901 Glenwood Avenue, Raleigh, North Carolina 27612 (telephone - 919-645-6400). Information on our website is not part of this report. If we amend or grant any waiver from a provision of our Code of Ethics that applies to our executive officers, we will publicly disclose such amendment or waiver as required by applicable law, including by posting such amendment or waiver on our website at www.capitalbank-nc.com or by filing a Current Report on Form 8-K. Item 11. Executive Compensation. This information is incorporated by reference from the section entitled "Compensation" in the 2005 Proxy Statement. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. This information is incorporated by reference from the sections entitled "Principal Shareholders" and "Compensation - Equity Compensation Plan Information" in the 2005 Proxy Statement. Item 13. Certain Relationships and Related Transactions. This information is incorporated by reference from the section entitled "Compensation - Certain Transactions" in the 2005 Proxy Statement. -65- Item 14. Principal Accountant Fees and Services This information is incorporated by reference from the section entitled "Proposal 3: Ratification of Appointment of Independent Accountants - Audit Fee Firm Summary" in the 2005 Proxy Statement. PART IV Item 15. Exhibits and Financial Statement Schedules. (a)(1) Financial Statements. The financial statements and information listed below are included in this report in Part I, Item 8: Financial Statements and Information ------------------------------------ Consolidated Balance Sheets as of December 31, 2004 and 2003 Consolidated Statements of Operations for the years ended December 31, 2004, 2003 and 2002 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2004, 2003 and 2002 Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002 Notes to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm (a)(2) Financial Statement Schedules. All applicable financial statement schedules required under Regulation S-X and pursuant to Industry Guide 3 under the Securities Act have been included in the Notes to the Consolidated Financial Statements. (a)(3) Exhibits. The exhibits required by Item 601 of Regulation S-K are listed in the Exhibit Index immediately following the signature pages to this report. -66- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Amendment No. 2 to Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in Raleigh, North Carolina, on the 28th day of April, 2005. CAPITAL BANK CORPORATION By: /s/ Richard W. Edwards ------------------------------------- Richard W. Edwards Chief Financial Officer -67- SIGNATURES AND POWER OF ATTORNEY Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities indicated and on April 28, 2005. Signature Title --------- ----- /s/ B. Grant Yarber - ------------------------ President and Chief Executive Officer and Director B. Grant Yarber (Principal Executive Officer) /s/ Richard W. Edwards - ------------------------ Chief Financial Officer Richard W. Edwards (Principal Financial Officer) /s/ Steven E. Crouse - ------------------------ Chief Accounting Officer Steven E. Crouse (Principal Accounting Officer) * - ------------------------ Director Charles F. Atkins * - ------------------------ Director William C. Burkhardt * - ------------------------ Director Leopold I. Cohen * - ------------------------ Vice Chairman of the Board of Directors William R. Gilliam * - ------------------------ Director John F. Grimes, III * - ------------------------ Director Robert L. Jones -68- * - ------------------------ Chairman of the Board of Directors Oscar A. Keller, III * - ------------------------ Director Oscar A. Keller, Jr. * - ------------------------ Director James D. Moser, Jr. * - ------------------------ Director George R. Perkins, III * - ------------------------ Director Don W. Perry * - ------------------------ Director Carl H. Ricker, Jr. * - ------------------------ Director J. Rex Thomas * - ------------------------- Director Samuel J. Wornom, III * /s/ Richard W. Edwards ------------------------ Richard W. Edwards Attorney-in-fact -69- EXHIBIT INDEX Exhibit No. Description - ----------- ----------- 3.01(1) Articles of Incorporation of the Company 3.02(2) Bylaws of the Company, as amended to date 4.01(1) Specimen Common Stock Certificate of the Company 4.02 In accordance with Item 601(b)(4)(iii)(A) of Regulation S-K, certain instruments respecting long-term debt of the registrant have been omitted but will be furnished to the Commission upon request. 10.01(1,3) Equity Incentive Plan 10.02(1,3) Deferred Compensation Plan for Outside Directors 10.03(3,4) Employment Agreement dated April 21, 2004 between B. Grant Yarber and Capital Bank Corporation 10.04(3,4) Employment Agreement dated April 16, 2004 between Richard W. Edwards and Capital Bank Corporation 10.05(3,5) Change of Control Agreement dated May 3, 2004 between Karen H. Priester and Capital Bank. 10.06(6) Lease Agreement, dated November 16, 1999, between Crabtree Park, LLC and the Company. 10.07(2) Agreement, dated November 2001 between Fiserv Solutions, Inc. and the Company. 21 Subsidiaries of the Registrant 23 Consent of Independent Registered Public Accounting Firm 31.01 Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.02 Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.01 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002. [This exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by that act, be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the case may be.] 32.02 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002. [This exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by that act, be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the case may be.] 1. Incorporated by reference to the Company's Registration Statement on Form S-4 filed with the SEC on October 19, 1998, as amended on November 10, 1998, December 21, 1998 and February 8, 1999. 2. Incorporated by reference to the Company's Annual Report on Form 10-K filed with the SEC on March 29, 2002. 3. Denotes a management contract or compensatory plan, contract or arrangement. 4. Incorporated by reference to the Company's Quarterly Report on Form 10-Q filed with the SEC on May 7, 2004. 5. Incorporated by reference to the Company's Quarterly Report on Form 10-Q filed with the SEC on August 3, 2004. 6. Incorporated by reference to the Company's Annual Report on Form 10-K filed with the SEC on March 27, 2000. -70- EX-21 2 ex21.txt Exhibit 21 Subsidiaries Capital Bank (North Carolina) Capital Bank Investment Services, Inc. (North Carolina) Capital Bank Statutory Trust I (Delaware) Capital Bank Statutory Trust II (Delaware) -71- EX-23 3 ex23.txt Exhibit 23.0 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (File No. 333-42628, No. 333-82602, No. 333-102774 and No. 333-76919) of Capital Bank Corporation of our report dated March 10, 2005 relating to the financial statements and April 22, 2005 relating to management's assessment of the effectiveness of internal control over financial reporting and the effectiveness of internal control over financial reporting, which appears in this Form 10-K/A /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Raleigh, North Carolina April 22, 2005 -72- EX-31.01 4 ex31-01.txt Exhibit 31.01 CERTIFICATION I, B. Grant Yarber, certify that: 1. I have reviewed this annual report on Form 10-K/A of Capital Bank Corporation; 2. Based on my knowledge, this annual report, as amended, does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report, as amended; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, as amended, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report, as amended; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15(d) - 15(f)) for the registrant and have: a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report, as amended, is being prepared; b. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this annual report, as amended, our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by the annual report, as amended, based on such evaluation; d. disclosed in this annual report, as amended, any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Date: April 28, 2005 /s/ B. Grant Yarber ------------------------------------- B. Grant Yarber President and Chief Executive Officer -73- EX-31.02 5 ex31-02.txt Exhibit 31.02 CERTIFICATION I, Richard W. Edwards certify that: 1. I have reviewed this annual report on Form 10-K/A of Capital Bank Corporation; 2. Based on my knowledge, this annual report, as amended, does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report, as amended; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, as amended, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report, as amended; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15(d) - 15(f)) for the registrant and have: a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report, as amended, is being prepared; b. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this annual report, as amended, our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by the annual report, as amended, based on such evaluation; d. disclosed in this annual report, as amended, any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Date: April 28, 2005 /s/ Richard W. Edwards ----------------------- Richard W. Edwards Chief Financial Officer -74- EX-32.01 6 ex32-01.txt Exhibit 32.01 Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Annual Report of Capital Bank Corporation (the "Company") on Form 10-K/A (Amendment No. 2) for the year ended December 31, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, B. Grant Yarber, President and Chief Executive Officer of the Company certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, to my knowledge, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ B. Grant Yarber ------------------------------------- B. Grant Yarber President and Chief Executive Officer April 28, 2005 ------------------------- Date This Certification is being furnished solely to accompany the Report pursuant to 18 U.S.C. ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed "filed" by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and shall not be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Report, irrespective of any general incorporation language contained in such filing. A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been provided to the Company and will retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. -75- EX-32.02 7 ex32-02.txt Exhibit 32.02 Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Annual Report of Capital Bank Corporation (the "Company") on Form 10-K/A (Amendment No. 2) for the year ended December 31, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Richard W. Edwards, Executive Vice President and Chief Financial Officer of the Company certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, to my knowledge that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Richard W. Edwards ---------------------- Richard W. Edwards Chief Financial Officer April 28, 2005 ----------------- Date This Certification is being furnished solely to accompany the Report pursuant to 18 U.S.C. ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed "filed" by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and shall not be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Report, irrespective of any general incorporation language contained in such filing. A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been provided to the Company and will retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. -76- -----END PRIVACY-ENHANCED MESSAGE-----