SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________________ to _____________________
Commission File No. 2017-6
------------------
ECB Bancorp, Inc.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
North Carolina 56-0215930
- ------------------------------- -----------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
Post Office Box 337, Engelhard, North Carolina 27824
---------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(252) 925-9411
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
As of November 10, 1998, 1,780,254 shares of the registrant's common stock,
$3.50 par value, were outstanding.
This Form 10-QSB has 20 pages.
<PAGE>
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
ECB BANCORP, INC. AND SUBSIDIARY
Consolidated Balance Sheets
September 30, 1998 and December 31, 1997
(unaudited)
(dollar amounts in thousands)
September 30, December 31,
Assets 1998 1997
- ------------------------------------------------------- -------
Non-interest bearing deposits and cash $ 11,601 $ 8,281
Federal funds sold 2,625 4,425
- ------------------------------------------------------- -------
Total cash and cash equivalents 14,226 12,706
- ------------------------------------------------------- -------
Investment securities
Available-for-sale, at market value
(cost of $47,941 and 48,418 47,120
$46,655 at September 30, 1998
and December 31, 1997, respectively)
Loans 130,659 121,209
Allowance for possible loan losses (2,728) (2,660)
- ------------------------------------------------------ -------
Loans, net 127,931 118,549
- ------------------------------------------------------ -------
Real estate acquired in settlement of loans, net 50 340
Real estate held for sale, net - 150
Federal Home Loan Bank common stock, at cost 565 503
Bank premises and equipment, net 6,883 6,266
Accrued interest receivable 2,323 1,923
Other assets 748 671
- ------------------------------------------------------ -------
Total $ 201,144 $ 188,228
- ------------------------------------------------------ -------
Liabilities and Shareholders' Equity
- ------------------------------------------------------ -------
Deposits
Demand, noninterest bearing $ 39,600 $ 31,897
Demand interest bearing 44,935 41,256
Savings 15,363 14,713
Time 81,591 83,043
- ------------------------------------------------------ -------
Total deposits 181,489 170,909
- ------------------------------------------------------ -------
Accrued interest payable 774 699
Postretirement benefit liabilities 534 516
Other liabilities 708 391
- ------------------------------------------------------ -------
Total liabilities 183,505 172,515
- ------------------------------------------------------ -------
Shareholders' equity
Common stock, par value $3.50 per share;
authorized 10,000,000 shares; issued
and outstanding 1,780,254 6,231 6,231
Capital surplus 3,200 3,200
Retained earnings 7,520 5,975
Unrealized gain on available-for-sale
securities, net 688 307
- ------------------------------------------------------ -------
Total shareholders' equity 17,639 15,713
- ------------------------------------------------------ -------
Commitments and contingencies
- ------------------------------------------------------ -------
Total $ 201,144 $ 188,228
- ------------------------------------------------------ -------
See accompanying notes to consolidated financial statements.
2
<PAGE>
<TABLE>
<CAPTION>
ECB BANCORP, INC. AND SUBSIDIARY
Consolidated Income Statements
For the three and nine months ended September 30, 1998 and 1997
(unaudited - dollar amounts in thousands, except net income per share)
Three months ended Nine months ended
September 30 September 30
--------------------- --------------------
1998 1997 1998 1997
- -------------------------------- ------- ------- ------- -------
<S> <C> <C> <C> <C>
Interest Income:
Interest and fees on loans $ 3,249 $ 2,796 $ 9,068 $ 8,133
Interest on investment securities:
Interest exempt from federal
income taxes 190 130 552 358
Taxable interest income 445 417 1,346 1,263
Interest on federal funds sold 105 177 188 365
- -------------------------------- ------- ------- ------- -------
Total interest income 3,989 3,520 11,154 10,119
- -------------------------------- ------- ------- ------- -------
Interest expense:
Deposits:
Demand accounts 174 181 488 529
Savings 70 79 214 230
Time 1,097 1,115 3,304 3,246
Other - - 8 1
- -------------------------------- ------- ------- ------- -------
Total interest expense 1,341 1,375 4,014 4,006
- -------------------------------- ------- ------- ------- -------
Net interest income 2,648 2,145 7,140 6,113
Provision for possible loan losses 60 105 180 315
- -------------------------------------- ------- ------- ------- -------
Net interest income after
provision for possible
loan losses 2,588 2,040 6,960 5,798
- -------------------------------------- ------- ------- ------- -------
Other income:
Service charges on deposit accounts 324 352 984 1,028
Other service charges and fees 217 201 479 427
Net gain (loss) on sale of securities - (3) - (3)
Net gain (loss) on sale of real
estate acquired in settlement
of loans - - 6 -
Other operating income 12 16 26 33
- -------------------------------- ------- ------- ------- -------
Total other income 553 566 1,495 1,485
- -------------------------------- ------- ------- ------- -------
Other expenses:
Salaries 810 720 2,376 2,163
Retirement and other employee
benefits 235 237 717 679
Occupancy 197 164 545 458
Equipment 228 196 645 534
Deposit Insurance premiums 5 - 15 14
Professional fees 48 37 227 103
Supplies 60 48 182 155
Telephone 64 60 201 157
Postage 39 39 124 114
Other operating expenses 457 422 1,253 999
- -------------------------------- ------- ------- ------- -------
Total other expenses 2,143 1,923 6,285 5,376
- -------------------------------- ------- ------- ------- -------
Income before income taxes 998 683 2,170 1,907
Income taxes 355 195 625 550
- -------------------------------- ------- ------- ------- -------
Net income $ 643 $ 488 $ 1,545 $ 1,357
- -------------------------------- ======= ======= ======= =======
Net income per share (basic and
diluted) $ 0.36 $ 0.27 $ 0.87 $ 0.76
- -------------------------------- ======= ======= ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
ECB BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Shareholders' Equity
For the nine months ended September 30, 1998 and 1997
(unaudited - dollar amounts in thousands)
Net Unrealized
Gains/(Losses) on
Common Capital Retained Available-for-Sale
Stock Surplus Earnings Securities Total
-------------------------------------------------------
Balance January 1, 1998 $6,231 $3,200 $5,975 $307 $15,713
Net Income - - 1,545 - 1,545
Change in unrealized
gains (losses),
net of income taxes - - - 381 381
-------------------------------------------------------
Balance September 30,
1998 $6,231 $3,200 $7,520 $688 $17,639
=======================================================
Net Unrealized
Gains/(Losses) on
Common Capital Retained Available-for-Sale
Stock Surplus Earnings Securities Total
-------------------------------------------------------
Balance January 1, 1997 $6,231 $3,200 $4,718 $101 $14,250
Net Income - - 1,357 - 1,357
Change in unrealized
gains (losses),
net of income taxes - - - 84 84
-------------------------------------------------------
Balance September 30,
1997 $6,231 $3,200 $6,075 $185 $15,691
=======================================================
See accompanying notes to consolidated financial statements.
4
<PAGE>
ECB BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
For the nine months ended September 30, 1998 and 1997
(unaudited - dollar amounts in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
---------------------
Cash flows from operating activities: 1998 1997
------- -------
<S> <C> <C>
Net income $ 1,545 $1,357
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation 498 442
Provision for possible loan losses 180 315
Loss on sale of premises & equipment 6 7
Gain on sale of real estate acquired in
settlement of loans (6) 0
Amortization of premium on investment securities, net 41 33
Increase in accrued interest receivable (400) (511)
Increase in other assets (272) (73)
Increase (decrease) in other liabilities 410 (179)
- -------------------------------- ------- -------
Net cash provided by operating activities 2,002 1,391
- -------------------------------- ------- -------
Cash flows from investing activities:
Proceeds from sales and maturities of
investment securities 8,884 15,315
Purchase of Federal Home Loan Bank common stock (62) (503)
Proceeds from disposal of premises and equipment 255 22
Purchases of premises and equipment (1,376) (1,058)
Proceeds from disposal of real estate
acquired in settlement of loans 496 0
Purchase of investment securities (9,646) (23,348)
Net loan repayments (originations) (9,613) (6,375)
- -------------------------------- ------- -------
Net cash used by investing activities (11,062) (15,947)
- -------------------------------- ------- -------
Cash flows from financing activities:
Net increase in deposits 10,580 21,758
- -------------------------------- ------- -------
Net cash provided by financing activities 10,580 21,758
- -------------------------------- ------- -------
Increase in cash and cash equivalents 1,520 7,202
Cash and cash equivalents at beginning of period 12,706 14,412
------- -------
Cash and cash equivalents at end of period $ 14,226 $21,614
======= =======
Cash paid for:
Interest 4,089 4,080
======= =======
Income Taxes 229 532
======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
ECB BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(1) Basis of Presentation
---------------------
The consolidated financial statements include the accounts of ECB Bancorp,
Inc. ("Bancorp") (see note 6) and its wholly-owned subsidiary, The East
Carolina Bank (the "Bank") (collectively referred to hereafter as the
"Company"). The Bank has two wholly-owned subsidiaries, Carolina Financial
Courier, Inc. and Carolina Financial Realty, Inc. (collectively referred
to as the "Bank".) All intercompany transactions and balances are
eliminated in consolidation.
The preparation of the consolidated financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect reported amounts of assets and
liabilities at the date of the financial statements, as well as the
amounts of income and expenses during the reporting period. Actual results
could differ from those estimates.
All adjustments considered necessary for a fair presentation of the
results for the interim periods presented have been included (such
adjustments are normal and recurring in nature). The footnotes in the
Bank's annual report on Form 10-KSB should be referenced when reading
these unaudited interim financial statements. Operating results for the
nine month period ended September 30, 1998, are not necessarily indicative
of the results that may be expected for the year ending December 31, 1998.
(2) Cash and Cash Equivalents
-------------------------
For purposes of reporting cash flows, cash and cash equivalents include
cash and due from banks (with original maturities of ninety days or less)
and federal funds sold. Generally, federal funds are purchased and sold
for one-day periods.
(3) Allowance for Loan Losses
-------------------------
The following summarizes the activity in the allowance for loan losses for
the nine months ended September 30, 1998 and 1997, respectively.
Nine months ended September 30,
--------------------------------
1998 1997
---- ----
Balance at the beginning of the
period $ 2,660,000 2,400,000
Provision for loan losses 180,000 315,000
Charge-offs (184,000) (147,000)
Recoveries 72,000 84,000
----------- -----------
Net charge-offs (112,000) (63,000)
------------ -----------
Balance at the end of the period $ 2,728,000 2,652,000
============ ===========
(4) Net income per share
--------------------
6
<PAGE>
ECB BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
The Company adopted SFAS No. 128, "Earnings Per Share", in 1997, which
requires net income per share to be calculated on both a basic and diluted
basis. The stock options granted in 1998 (discussed in note 7) had no
dilutive effect on net income per share for the three or nine months ended
September 30, 1998.
(5) Reclassifications
-----------------
Certain items in the September 30, 1997 and December 31, 1997 consolidated
financial statements have been reclassified to conform with the September
30, 1998 presentation. Such reclassifications had no impact on net income
or shareholders' equity.
(6) Formation of Bank Holding Company / Merger of Bank
--------------------------------------------------
On July 22, 1998, and pursuant to a charter amendment, the Bank effected a
three-for-one stock split of the Bank's common stock increasing the number
of shares of common stock from 593,418 to 1,780,254. Additionally, by way
of the same charter amendment, the Bank increased the post-split par value
of the common stock from $3.33 per share to $3.50 per share. In connection
with the stock split and increase in par value, the Bank increased the
capital surplus account in accordance with North Carolina General Statutes
Section 53-88. All references to the number of common shares and per share
amounts in the financial statements have been restated as appropriate to
reflect the effect of the split, for all periods presented. Additionally,
common stock, capital surplus, and retained earnings have been restated
for all periods presented as appropriate to reflect the stock split, the
increase in par value, and the increase in the capital surplus account.
On July 22, 1998, the Bank was acquired by ECB Bancorp, Inc. ("Bancorp"),
which was formed by the Bank on March 4, 1998 for the purpose of becoming
the Bank's parent holding company. Each outstanding share of the Bank's
common stock was exchanged for one share of Bancorp's common stock with
the Bank becoming the wholly-owned subsidiary of Bancorp. Bancorp's
primary purpose is to serve as the parent of the Bank. The combination was
accounted for in a manner similar to a pooling-of-interests and all prior
period financial statements have been restated.
(7) Adoption of Financial Accounting Standards ("SFAS")
---------------------------------------------------
On January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income" ("SFAS No. 130") which establishes standards for
reporting and display of comprehensive income and its components in a full
set of financial statements. Comprehensive income is defined as the change
in equity during a period for non-owner transactions and is divided into
net income and other comprehensive income. Other comprehensive income
includes revenues, expenses, gains, and losses that are excluded from
earnings under current accounting standards. This statement does not
change or modify the reporting or display in the income statement. SFAS
No. 130 is effective for interim and annual periods beginning after
December 15, 1997. Comparative financial
7
<PAGE>
ECB BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
statements provided for earlier periods are required to be reclassified
to reflect the application of this statement. For the nine months ended
September 30, 1998 and 1997, total comprehensive income, consisting of net
income and unrealized securities gains and losses, net of taxes, was
$1,926,000 and $1,441,000, respectively.
(8) Stock Option Plan
-----------------
During January 1998, the Bank's Board of Directors adopted an Omnibus
Stock Ownership and Long-Term Incentive Plan ("the Omnibus Plan") which
was approved by the Bank's shareholders at the May 13, 1998 annual meeting
and which provides for the issuance of up to an aggregate of 159,000
shares of common stock of the Bank pursuant to stock options and other
awards granted or issued under its terms. At that time, the Board of
Directors also awarded to certain officers of the Bank options to purchase
an aggregate of 9,516 shares of the Bank's common stock pusuant to the
terms of the Omnibus Plan at a price equal to the then current market
value of $12.50 per share (as such number of shares and purchsae price
have been adjusted in accordance with the terms of the Omnibus Plan to
reflect the three-for-one stock split which was effective July 22, 1998).
Upon consummation of the reorganization discussed in note 6, the Bank
assumed all of the Bank's obligations under the Omnibus Plan, and each of
the then outstanding options under the Omnibus Plan were converted, in
accordance with its terms, into options to purchase shares of Bancshares'
common stock.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
ECB Bancorp, Inc. ("Bancshares") is a bank holding company headquartered in
Engelhard, North Carolina. Bancshares' wholly-owned subsidiary, The East
Carolina Bank (the "Bank") (collectively referred to hereafter as the
"Company"), is a state-chartered community bank which was founded in 1919. The
Bank offers a full range of banking services through 15 branches serving eastern
North Carolina, including the communities of Engelhard, Swan Quarter, Columbia,
Creswell, Fairfield, Nags Head, Manteo, Southern Shores, Barco, Avon, Hatteras,
Ocracoke and Greenville (three branches). The Bank also operates a loan
production facility in Washington, North Carolina and is expected to open its
sixteenth branch in this community in the near future.
The operations of the Company and depository institutions in general are
significantly influenced by general economic conditions and by related monetary,
fiscal and other policies of depository institution regulatory agencies,
including the Federal Reserve Board, the Federal Deposit Insurance Corporation
(the "FDIC") and the North Carolina State Banking Commission. Deposit flows and
costs of funds are influenced by interest rates on competing investments and
general market rates of interest. Lending activities are affected by the demand
for financing of real estate and other types of loans, which in turn are
affected by the interest rates at which such financing may be offered and other
factors affecting local demand and availability of funds.
Comparison of the Results of Operations for the Nine Month Periods Ended
September 30, 1998 and 1997
Summary
- -------
For the nine months ended September 30, 1998, the Company had net income of
$1,545,000, or $0.87 basic and diluted earnings per share, compared to
$1,357,000, or $0.76 basic and diluted earnings per share (as restated for
three-for-one stock split effected July 22, 1998), for the nine months ended
September 30, 1997. For the nine months ended September 30, 1998, net interest
income increased 16.80% and non-interest income increased 0.67% when compared to
the same period last year. Non-interest expense increased $909,000 or 16.91% for
the nine months period ended September 30, 1998 as compared to the same period
in 1997 partly attributable to several expense items related to the opening of a
loan production office in Washington, North Carolina and two full-service
branches (one in Barco/Currituck County and one in Avon/Dare County). The
Company incurred some nonrecurring legal expenses related to the formation of a
holding company and increased marketing expenses as the Company launched a broad
range of mortgage products and a new credit card product.
9
<PAGE>
Net interest income
- -------------------
Net interest income for the nine months ended September 30, 1998 was $7,140,000,
an increase of $1,027,000 or 16.80% when compared to net interest income of
$6,113,000 for the nine months ended September 30, 1997. The net yield on
interest-earning assets, on a tax-effected basis, for the nine months ended
September 30, 1998 was 5.68% compared to 5.10% in 1997. This improvement in the
Company's net interest margin is attributable to loans representing a larger
portion of the Company's total earning assets and in part to interest recoveries
on certain non-accrual loans and a lower cost of funds. During the first nine
months of 1998, the Bank had interest recoveries on non-accrual loans in the
amount of $242,331. These interest recoveries increased the yield on earnings
assets by approximately 18 basis points and the Bank's net interest margin
without these recoveries would have been approximately 5.49%.
Total interest income increased $1,035,000 for the nine months ended September
30, 1998 compared to the nine months ended September 30, 1997, principally due
to an increase in the average volume of loans of $8.2 million. Total interest
expense increased $8,000 for the nine months ended September 30, 1998 compared
to the nine months ended September 30, 1997, principally due to an increase in
average certificate of deposit balances of $3.1 million.
Provision for possible loan losses
- ----------------------------------
The provision for possible loan losses charged to operations during the first
nine months of 1998 was $180,000, compared to $315,000 during the first nine
months of 1997. Net charge-offs for the nine months ended September 30, 1998
totaled $112,000, compared to net charge-offs of $63,000 during the same period
of 1997. The reduction in provision for possible loan losses is the result of
management's review and evaluation of the portfolio under current and projected
economic conditions, past due loans, past loan loss experience and significant
reduction of nonperforming loans. Nonperforming loans decreased from $1,985,000
at December 31, 1997 to $542,000 at September 30, 1998 due to the pay-off of two
large nonperforming lending relationships during the first nine months of the
year.
Noninterest income
- ------------------
Noninterest income increased $10,000 to $1,495,000 for the nine months ended
September 30, 1998 from $1,485,000 for the same period in 1997. This increase is
principally due to increased ATM surcharge fees of $50,000 that were effected by
the Company after first quarter of 1997 and mortgage loan origination fees of
$26,000 generated by the Company's new mortgage loan product. These increases
were partially offset by a decrease in NSF service charges of $64,000 when
compared to the same period in 1997.
Noninterest expense
- -------------------
Noninterest expense increased $909,000 to $6,285,000 for the nine months ended
September 30, 1998 from $5,376,000 for the same period in 1997. This increase is
principally due to the opening of a new full service branch in Avon and Barco,
and a loan production office in Washington, North Carolina. Salaries and related
personnel expense increased $251,000 over the first nine months of 1997 due
principally to the opening of these new offices. When compared to
10
<PAGE>
September 30, 1997, net occupancy expense increased $87,000 as a result of
opening the aforementioned offices and equipment expense increased $111,000 due
to the Company upgrading its host computer system and the introduction of branch
platform automation. The Company's telephone expense increased $44,000 over last
year as a result of increased usage of the Company's Xpress phone banking
service introduced during the second quarter of 1997. Professional fees
increased approximately $124,000 in connection with non-recurring legal and
accounting fees incurred related to the formation of a holding company. Other
operating expenses increased $254,000 from $999,000 for the nine months ended
September 30, 1997 to $1,253,000 for the nine months ended September 30, 1998.
This increase is primarily attributable to increases in marketing expenses,
employee related travel expenses, and regulatory agency expenses. Marketing
expense increased approximately $241,000 during the first nine months of the
year as the Company launched a broad range of mortgage products and its new Club
7 Visa Card, a program done in conjunction with a local television station. In
addition, employee related travel expense increased approximately $20,000 while
fees paid to regulatory agencies increased $23,000.
Income taxes
- ------------
Income tax expense for the nine months ended September 30, 1998 and 1997 was
$625,000 and $550,000, respectively, resulting in effective tax rates of 28.80%
and 28.84%, respectively. The effective tax rates in both years differ from the
federal statutory rate of 34.00% primarily due to tax-exempt interest income.
Comparison of the Results of Operations for the Three Month Periods Ended
September 30, 1998 and 1997
Summary
- -------
For the three months ended September 30, 1998, ECB had net income of $643,000,
or $0.36 basic and diluted earnings per share, compared to $488,000, or $0.27
basic and diluted earnings per share (as restated for three-for-one stock split
effected July 22,1998), for the three months ended September 30, 1997. For the
quarter ended September 30, 1998, net interest income increased 23.45% and
non-interest income decreased 2.30% as compared to the prior year quarter.
Non-interest expense increased $220,000 or 11.44% for the quarter ended
September 30, 1998 compared to the prior year quarter due to several expense
items related to the opening of a loan production office in Washington, North
Carolina and two full-service branches (one in Barco/Currituck County and one in
Avon/Dare County). Increased marketing expenses were also incurred during the
quarter as the Company launched a broad range of mortgage products and a new
credit card product.
Net interest income
- -------------------
Net interest income for the three months ended September 30, 1998 was
$2,648,000, an increase of $503,000 or 23.45% when compared to net interest
income of $2,145,000 for the three months ended September 30, 1997. The net
yield on interest-earning assets, on a tax-effected basis, for the three months
ended September 30, 1998 was 5.95% compared to 5.12% in the same period of
11
<PAGE>
1997. This improvement in the Company's net interest margin is attributable an
increase in average loans outstanding and in part to interest recoveries on
certain non-accrual loans and a lower cost of funds. Interest recoveries on
non-accrual loans during the third quarter of 1998 amounted to $150,336 and had
the effect of increasing the Bank's yield on earning assets by approximately 32
basis points. The Bank's net interest margin without these recoveries have been
approximately 5.62%.
Total interest income increased $469,000 for the three months ended September
30, 1998 compared to the three months ended September 30, 1997, principally due
to an increase in the average volume of loans of $11.0 million. Average
commercial and consumer loans increased $4.4 million and lines of credit
increased $4.0 million when compared to last year's third quarter averages.
Total interest expense decreased $34,000 for the three months ended September
30, 1998 compared to the three months ended September 30, 1997, principally due
to lower rates paid on deposits and in part to the maturity of approximately
$4.3 million in "Wise Choice" certificates of deposits that were added in a
deposit campaign during the first quarter of 1997.
Provision for possible loan losses
- ----------------------------------
The provision for possible loan losses charged to operations during the third
quarter of 1998 was $60,000, compared to $105,000 during the third quarter of
1997. Net charge-offs for the quarter ended September 30, 1998 totaled $22,000,
compared to net recoveries of $1,000 during the same period of 1997. This
reduction in provision for possible loan losses is the result of management's
review of the portfolio under current and projected economic conditions, past
due loans, past loan loss experience and significant reduction of nonperforming
loans. Nonperforming loans decreased from $1,985,000 at December 31, 1997 to
$542,000 at September 30, 1998.
Noninterest income
- ------------------
Noninterest income was $553,000 for the three months ended September 30, 1998
compared to $566,000 for the same period in 1997. The decrease is due to a
reduction in NSF check charges of $34,000. This decrease was partially offset by
an increase in other service charges and fees of $16,000. ATM surcharge fees
increased $15,000 and mortgage loan origination fees increased $14,000 over the
prior year quarter.
Noninterest expense
- -------------------
Noninterest expense increased $220,000 to $2,143,000 for the three months ended
September 30, 1998 from $1,923,000 for the same period in 1997. This increase
was mainly attributable to increased marketing related expenses of approximately
$97,000 incurred during the quarter as the Company continues to market its new
Club 7 Visa Card and home mortgage products. Personnel expense increased $90,000
during the third quarter of 1998 as compared to the same period in the prior
year, caused in part by the opening of a new full service branch in Avon and
Barco, and a loan production office in Washington, North Carolina. Occupancy
expense increased $33,000 during the third quarter of 1998 compared to the third
quarter of 1997 as a result of opening the aforementioned offices. Equipment
expense also increased $32,000 as a result of the Company upgrading its host
computer system and the introduction of branch platform automation.
12
<PAGE>
Income taxes
- ------------
Income tax expense for the three months ended September 30, 1998 and 1997 was
$355,000 and $195,000, respectively, resulting in effective tax rates of 35.57%
and 28.55%, respectively. The effective tax rates in both years differ from the
federal statutory rate of 34.00% primarily due to tax-exempt interest income.
Comparison of Financial Condition at September 30, 1998 and December 31, 1997
Total assets increased $12.9 million to $201,144,000, an increase of 6.86% when
compared to $188,228,000 at December 31, 1997. Asset growth was funded primarily
by increased non-interest-bearing demand deposits of $7.7 million as the Company
benefited from a successful summer tourist season on the famed "Outer Banks" of
North Carolina.
Loans receivable increased from $121.2 million at December 31, 1997 to $130.7
million at September 30, 1998. The Company has continued to expand its lending
base and the size of its loan portfolio despite increased competitive pressures
in its primary lending markets. The Company experiences seasonal loan growth
during the first and second quarters of each year as farm production loans and
commercial lines of credit are used by the Company's agricultural base and
tourist related businesses on the "Outer Banks." Seasonal lines of credit have
increased $7.5 million since year-end 1997.
Shareholders' equity increased from $15.7 million at December 31, 1997 to $17.6
million at September 30, 1998, as the Company generated net income of $1,545,000
and experienced an increase of net unrealized gains on available-for-sale
securities of $381,000. No dividends were paid during the first nine months of
1998.
Asset Quality
Management continuously analyzes the growth and risk characteristics of the
total loan portfolio under current and projected economic conditions in order to
evaluate the adequacy of the allowance for possible loan losses. The factors
that influence management's judgment in determining the amount charged to
operating expense include past loan loss experience, composition of the loan
portfolio, evaluation of possible future loan losses and current economic
conditions. The Company's watch committee, which includes three members of
senior management as well as regional managers and other credit administration
personnel, conducts a quarterly review of all credits classified as substandard.
This review follows a re-evaluation by the account officer who has primary
responsibility for the relationship. Various regulatory agencies, as an integral
part of their examination process, periodically review the Company's allowance
for possible loan losses. Such agencies may require the Company to recognize
additions to the allowance for possible loan losses based on their judgments
about information available to them at the time of their examination.
13
<PAGE>
Nonperforming assets, which consist of loans not accruing interest, restructured
debt and real estate acquired in settlement of loans, were $592,000 and
$2,325,000 at September 30, 1998 and December 31, 1997, respectively. The
decrease in nonperforming assets is primarily due to the pay-off of two large
nonperforming lending relationships during the first nine months of the year and
the sale of a significant portion of real estate acquired in settlement of
loans. Through sales, the Company has liquidated a significant portion of other
real estate owned reducing the balance to $50,000 at September 30, 1998 from
$490,000 at December 31, 1997.
Regulatory Matters
Management is not presently aware of any current recommendation to the Company
by regulatory authorities which, if they were to be implemented, would have a
material effect on the Company's liquidity, capital resources or operations.
Liquidity
The Company relies on the investment portfolio as a source of liquidity, with
maturities designed to provide needed cash flows. Further, retail deposits
generated throughout the branch network has enabled management to fund asset
growth and maintain liquidity. These sources have allowed limited dependence on
short-term borrowed funds for liquidity or for asset expansion. External sources
of funds include the ability to access advances from the Federal Home Loan Bank
of Atlanta and Fed Fund lines with correspondent banks.
Impact of Inflation and Changing Prices
The consolidated financial statements and accompanying footnotes have been
prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars without consideration of changes in the relative purchasing
power of money over time due to inflation. The assets and liabilities of the
Company are primarily monetary in nature and changes in interest rates have a
greater impact on the Company's performance than do the effects of inflation.
Capital Resources
Bancshares and the Bank are subject to the capital requirements of the Federal
Reserve, the FDIC and the State Banking Commission. The FDIC requires the Bank
to maintain minimum ratios of Tier I capital to total risk-weighted assets and
total capital to risk-weighted assets of 4% and 8%, respectively. To be `well
capitalized,' the FDIC requires ratios of Tier I capital to total risk-weighted
assets and total capital to risk-weighted assets of 6% and 10%, respectively.
Tier I capital consists of total stockholders' equity calculated in accordance
with generally accepted accounting principles less intangible assets, and total
capital is comprised of Tier I capital plus certain adjustments, the only one of
which is applicable to the Bank is the allowance for loan losses. Risk-weighted
assets reflect the Banks' on- and off-balance sheet exposures after such
exposures have been adjusted for their relative risk levels using formulas set
forth in FDIC regulations. As of September 30, 1998, the Bank was in compliance
with all of the
14
<PAGE>
aforementioned capital requirements and satisfies the 'well-capitalized'
definition that is used by the FDIC in its evaluation of member banks.
Additionally, at September 30, 1998, Bancshares was also in compliance with the
applicable capital requirements set forth by the Federal Reserve.
Current Accounting Issues
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 128 ("SFAS No. 128"), "Earnings
per Share." SFAS No. 128 establishes standards of computing and presenting
earnings per share (EPS) and applies to entities with publicly held common stock
or potential common stock. This Statement simplifies the standards for computing
earnings per share previously found in APB Opinion No. 15, Earnings Per Share,
and makes them comparable to international EPS standards. It replaces the
presentation of primary EPS with a presentation of basic EPS. It also requires
dual presentation of basic and diluted EPS on the face of the income statement
for all entities with complex capital structures and requires a reconciliation
of the numerator and the denominator of the basic EPS computation to the
numerator and denominator of the diluted EPS computation. SFAS No. 128 is
effective for financial statements issued for periods ending after December 15,
1997 and requires restatement of all prior-period EPS data presented. The
Company adopted SFAS No. 128 in 1997 without any significant impact on its
consolidated financial statements.
On January 1, 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive
Income" ("SFAS No. 130"), which establishes standards for reporting and display
of comprehensive income and its components in a full set of financial
statements. Comprehensive income is defined as the change in equity during a
period for non-owner transactions and is divided into net income and other
comprehensive income. Other comprehensive income includes revenues, expenses,
gains, and losses that are excluded from earnings under current accounting
standards. This statement does not change or modify the reporting or display in
the income statement. For the nine months ended September 30, 1998 and 1997,
total comprehensive income, consisting of net income and changes in unrealized
securities gains and losses, net of tax effects, was $1,926,000 and $1,441,000,
respectively.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments on an
Enterprise and Related Information." SFAS No. 131 establishes standards for the
way that public business enterprises report information about operating segments
in annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related disclosures
about products and services, geographic areas, and major customers. This
Statement is effective for financial statements for periods beginning after
December 15, 1997 and in the initial year of application, comparative
information for earlier years is to be restated. The Company plans to adopt SFAS
No. 131 at December 31, 1998 and does not anticipate any significant impact on
its consolidated financial statements.
In February 1998, the FASB issued SFAS No. 132, "Employer's Disclosures about
Pensions and Other Postretirement Benefits." This statement standardizes the
disclosure requirements of
15
<PAGE>
pensions and other postretirement benefits. This statement does not change any
measurement of recognition provisions, and thus will not materially impact the
Company's consolidated financial statements. This statement is effective for
fiscal years beginning after December 15, 1997.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. It requires
that an entity recognize all derivatives as either assets or liabilities in the
balance sheet and measure those instruments at fair value. The accounting for
changes in the fair value of a derivative depends on the intended use of the
derivative and the resulting designation. This statement is effective for all
fiscal quarters of fiscal years beginning after June 15, 1999. Earlier
application of all of the provisions of this statement is encouraged. The
Company plans to adopt this statement at January 1, 2000 and does not anticipate
any material effect on its consolidated financial statements.
In October 1998, the FASB issued SFAS No. 134, "Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise". This statement allows mortgage banking firms to
account for certain securities and other interests retained after securitizing
mortgage loans that were held for sale based on the ability and intent to hold
or sell such investments, consistent with the guidance contained in SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities". This
statement is effective for the first fiscal quarter beginning after December 15,
1998. The Company plans to adopt this statement on January 1, 1999 and does not
anticipate any material effect on its consolidated financial statements.
The FASB also issues exposure drafts for proposed statements of financial
accounting standards. Such exposure drafts are subject to comment from the
public, to revisions by the FASB and to final issuance by the FASB as statements
of financial accounting standards. Management considers the effect of the
proposed statements on the consolidated financial statements of the Company and
monitors the status of changes to issued exposure drafts and to proposed
effective dates.
Year 2000 Issue
GENERAL. The year 2000 ("Y2K") issue confronting the Company and its
suppliers, customers, customers' suppliers and competitors centers on the
inability of computer systems to recognize the year 2000. Many existing
computer programs and systems originally were programmed with six digit dates
that provided only two digits to identify the calendar year in the date field.
With the impending new millennium, these programs and computers will recognize
"00" as the year 1900 rather than the year 2000.
Financial institution regulators recently have increased their focus upon
Y2K compliance issues and have issued guidance concerning the responsibilities
of senior management and directors. The Federal Financial Institutions
Examination Council ("FFIEC") has issued several interagency statements on Y2K
Project Management Awareness. These statements require financial institutions
to, among other things, examine the Y2K implications of their reliance on
vendors and with respect to data exchange and the potential impact of the Y2K
issue on their customers, suppliers and borrowers. These statements also
require each federally regulated financial institution to survey its exposure,
measure its risk and prepare a plan to address the Y2K issue. In addition, the
federal banking regulators have issued safety and soundness guidelines to be
followed by insured depository institutions, such as the Bank, to assure
resolution of any Y2K problems. The federal banking agencies have asserted that
Y2K testing and certification is a key safety and soundness issue in
conjunction with regulatory exams and, thus, that an institution's failure to
address appropriately the Y2K issue could result in supervisory action,
including the reduction of the institution's supervisory ratings, the denial of
applications for approval of mergers or acquisitions or the imposition of civil
money penalties.
16
<PAGE>
RISKS. Like most financial service providers, the Company and its
operations may be significantly affected by the Y2K issue due to its dependence
on technology and date-sensitive data. Computer software and hardware and other
equipment, both within and outside the Company's direct control, and third
parties with whom the Company electronically or operationally interfaces
(including without limitation its customers and third party vendors) are likely
to be affected. If computer systems are not modified in order to be able to
identify the year 2000, many computer applications could fail or create
erroneous results. As a result, many calculations which rely on date field
information, such as interest, payment or due dates and other operating
functions, could generate results which are significantly misstated, and the
Company could experience an inability to process transactions, prepare
statements or engage in similar normal business activities. Likewise, under
certain circumstances, a failure to adequately address the Y2K issue could
adversely affect the viability of the Company's suppliers and creditors and the
creditworthiness of its borrowers. Thus, if not adequately addressed, the Y2K
issue could result in a significant adverse impact on the Company's operations
and, in turn, its financial condition and results of operations.
STATE OF READINESS. During November 1997, the Company formulated its plan
to address the Y2K issue. Since that time, the Company has taken the following
steps:
o Established senior management advisory and review responsibilities;
o Completed a company-wide inventory of applications and system software;
o Built an internal tracking database for application and vendor software;
o Developed compliance plans and schedules for all lines of business;
o Begun computer code testing;
o Initiated vendor compliance verification;
o Begun awareness and education activities for employees through existing
internal communication channels; and
o Developed a process to respond to customer inquiries as well as help
educate customers on the Y2K issue.
The following paragraphs summarize the phases of the Company's Y2K plan:
AWARENESS PHASE. The Company formally established a Y2K plan headed by a
senior manager, and a project team was assembled for management of the Y2K
project. The project team created a plan of action that includes
milestones, budget estimates, strategies, and methodologies to track and
report the status of the project. Members of the project team also attended
conferences and information sharing sessions to gain more insight into the
Y2K issue and potential strategies for addressing it. This phase is
substantially complete.
ASSESSMENT PHASE. The Company's strategies were further developed with
respect to how the objectives of the Y2K plan would be achieved, and a Y2K
business risk assessment was made to quantify the extent of the Company's
Y2K exposure. A corporate inventory (which is periodically updated as new
technology is acquired and as systems progress through subsequent phases)
was developed to identify and monitor Y2K readiness for information systems
(hardware, software, utilities, and vendors) as well as environmental
systems (security systems, facilities, etc.). Systems were prioritized
based on business impact and available alternatives. Mission critical
systems supplied by vendors were researched to determine Y2K readiness. If
Y2K-ready versions were not available, the Company began identifying
functional replacements which were either upgradable or currently
Y2K-ready, and a formal plan was developed to repair, upgrade or replace
all mission critical systems. This phase is substantially complete.
In August 1997, the Company began Y2K discussions with its larger borrowers
at the time of the annual review of their loans. Beginning in January 1998,
all credits greater than $250,000 were evaluated for Y2K exposure by the
relationship account officer using a questionnaire developed by the
Company's credit administration staff. As part of the current credit
approval process, all new and renewed loans are evaluated for Y2K risk.
During the course of these evaluations, Company personel have met
individually with each of its larger borrowers to discuss and obtain
information regarding each borrower's dependence on information technology
and third party vendors and the nature of steps being taken by the
borrowers to address their Y2K risk. While the Company will continue to
monitor the progress being made by its larger borrowers in addressing their
own Y2K issues, to date the Company is generally satisfied with these
customers' responses to the Company's inquiries and their progress in
addressing their Y2K risk.
RENOVATION PHASE. The Company's corporate inventory revealed that Y2K
upgrades were available for all vendor supplied mission critical systems,
and all these Y2K-ready versions have been delivered and placed into
production and have entered the validation process (with the exception of
hardware upgrades to certain of the Company's automated teller machines
which are expected to be completed by December 31, 1998).
17
<PAGE>
VALIDATION PHASE. The validation phase is designed to test the ability of
hardware and software to accurately process date sensitive data. The
Company currently is in the process of validation testing of each mission
critical system, with the degree of completion of such testing ranging from
25% to 100%. The Company has created a test environment comprised of an IBM
Model 170 dedicated to Y2K testing which is virtually insulated from
production and development environments. The Company anticipates that the
validation phase will follow the estimated industry norm in that it will
absorb approximately 50% of the total Y2K resources (computer and
personnel) over the life cycle of the project. The Company has increased
staff in anticipation of that work effort. The Company's validation phase
is expected to be completed by December 31, 1998 for all mission critical
systems (with the exception of the Company's automated teller machine
network as to which validation testing will be completed during the first
quarter of 1999). During the validation testing process to date, no
significant Y2K problems have been identified relating to any modified or
upgraded mission critical systems.
IMPLEMENTATION PHASE. The Company's plan calls for putting Y2K-ready code
into production before having actually completed Y2K validation testing.
Y2K-ready modified or upgraded versions have been installed and placed into
production with respect to all mission critical systems (with the exception
of the Company's automated teller machine network as to which hardware
upgrades are expected to be completed and in production by December 31,
1998).
COMPANY RESOURCES INVESTED. The Company's Y2K project team has been
assigned the task of ensuring that all systems across the Company are
identified, analyzed for Y2K compliance, corrected if necessary, tested, and
changes put into service by the end of 1998. The Y2K project team members
represent all functional areas of the Company, including branches, data
processing, loan administration, accounting, item processing and operations,
compliance, internal audit, human resources, and marketing. The team is headed
by a vice president who reports directly to a member of the Company's senior
management team. The Company's Board of Directors oversees the Y2K plan and
provides guidance and resources to, and receives quarterly updates from, the
Y2K project team.
The Company is expensing all costs associated with required system changes
as those costs are incurred, and such costs are being funded through operating
cash flows. The total cost of the Y2K conversion project for the Company is
estimated to be $200,000. Expenses of approximately $31,000 were incurred and
expensed by the Company through June 30, 1998. The Company does not expect
significant increases in future data processing costs relating to Y2K
compliance.
CONTINGENCY PLANS. During the assessment phase, the Company began to
develop back-up or contingency plans for each of its mission critical systems.
Virtually all of the Company's mission critical systems are dependent upon
third party vendors or service providers, therefore, contingency plans include
selecting a new vendor or service provider and converting to their system. In
the event a current vendor's system fails during the validation phase and it is
determined that the vendor is unable or unwilling to correct the failure, the
Company will convert to a new system from a pre-selected list of prospective
vendors. In each case, realistic trigger dates have been established to allow
for orderly and successful conversions. For some systems, contingency plans
consist of using spreadsheet software or reverting to manual systems until
system problems can be corrected.
The majority of the Company's mission critical systems fall into the
categories of its core-banking software, its proof of deposit system, and its
automatic teller machine network. The Company has received warranties from
vendors to the effect that the proof of deposit and automatic teller machine
network software is Y2K-ready. While no warranty has been received with respect
to the core-banking system, that system is used by a number of banking
institutions and has been reviewed by the Federal Reserve Bank of Atlanta and
found to be Y2K-ready.
With respect to each third party with whom the Company interfaces
electronically or from whom it obtains services or supplies (such as the
Company's credit and debit card processors, its correspondent bank, the Federal
Reserve Bank of Richmond, its electric and telephone company, and its suppliers
of business forms), the Company has requested information regarding that
party's preparations and state of preparedness with respect to Y2K issues.
While, in general, no such third parties will give warranties or guarantees
with respect to Y2K issues, the Company has received from each third party in
writing an acknowledgment of that party's awareness of the Y2K issue,
information regarding its plan for addressing Y2K concerns, and an assurance
that steps are being taken to prevent service interruptions. While these
assurances do not give the Company any specific legal rights or remedies, the
Company generally is satisfied with the responses it has received. In the case
of third parties with whom the Company interfaces electronically, testing of
those interfaces is being conducted or is scheduled and interruptions in the
services provided by such third parties have been taken into account in the
Company's contingency plans (which, for example, provide for increased
inventories of business forms and supplies, increased levels of cash on hand,
use of a generator to operate the Company's main computer system and operations
function, manual processing of branch transactions, direct clearing of checks
through the Federal Reserve rather than through a correspondent bank, and,
where possible, a change to a different third party supplier).
Management is not aware of any known trends, events, uncertainties, or current
recommendations by regulatory authorities that will or that are reasonably
likely to have a material effect on the Company's liquidity, capital resources
or other operations.
18
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities
Not applicable.
Item 3. Defaults upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-KSB
(a) Exhibits:
Exhibit 27 - Financial Data Schedule.
(b) Reports on Form 8-KSB
On August 6, 1998, Registrant filed a Current Report on Form 8-KSB which was
dated July 22, 1998 and reported (under Item 2) the consummation of the
one-bank holding company reorganization of The East Carolina Bank, Engelhard,
North Carolina (the "Bank"), pursuant to which Registrant became the Bank's
parent company. The Report contained the following statements:
1. financial statements of the Bank as of June 30, 1998 (unaudited) and as of
December 31, 1997 and 1996, and for the six months ended June 30, 1998 and
1997 (unaudited) and for each of the years in the three-year period ended
December 31, 1997; and,
2. financial statements of Registrant as of June 30, 1998 (unaudited) and as of
December 31, 1997 and 1996, and for six months ended June 30, 1998 and 1997
(unaudited) and for each of the years in the three-year period ended December
31, 1997.
19
<PAGE>
SIGNATURES
Under the requirements of the Securities Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
ECB BANCORP, INC.
-----------------
(Registrant)
Date: 11/16/98 By: /s/ Arthur H. Keeney, III
-------------------- ------------------------------
Arthur H. Keeney, III
(President & CEO)
Date: 11/16/98 By: /s/ Gary M. Adams
-------------------- ------------------------------
Gary M. Adams
(Senior Vice President & CFO)
20
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