Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-looking Statements
This Quarterly Report on Form 10-QSB may contain certain forward-looking statements consisting of
estimates with respect to the financial condition, results of operations and business of the Company that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, but are not
limited to, general economic conditions, changes in interest rates, deposit flows, loan demand, real estate values, and competition; changes in accounting principles, policies, or guidelines; changes in legislation or regulation; and other economic,
competitive, governmental, regulatory, and technological factors affecting the Company’s operations, pricing, products and services. These factors should be considered in evaluating forward-looking statements and undue reliance should not be
placed on such statements. We do not undertake any obligation to update any forward-looking statement to reflect circumstances and events that occur after the date on which the forward-looking statement was made.
Critical Accounting Policies and Estimates
The Company’s discussion and analysis of its financial condition and results of operations are based upon its consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in
the United States of America. The preparation of these consolidated financial statements requires the Company to make estimates and judgments regarding uncertainties that affect the reported amounts of assets, liabilities, revenues and expenses. On
an ongoing basis, the Company evaluates its estimates which are based upon historical experience and on other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different
assumptions or conditions.
The Company considers the following accounting policies to be most critical in their potential effect on its financial position
or results of operations:
Allowance for Loan Losses
Due to the estimation process and the potential materiality of the amounts involved, the Company has identified the accounting for the allowance for loan losses and the related provision for loan losses as an accounting policy critical to
the Company’s consolidated financial statements. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when
management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for
loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that
may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more
information becomes available.
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are
classified as either doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is
lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could
affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the
portfolio.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the
scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting
scheduled principal and interest payments when due. All non-accrual loans are considered impaired.
Loans that experience insignificant payment delays and
payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking
- 10 -
into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the
borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the
loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous
loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and certain residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.
Interest Income Recognition
The accrual of
interest on loans is discontinued at the time the loan is 90 days past due or impaired. Past due status is based on contractual terms of the loan. In all cases, loans are placed on non-accrual status at an earlier date if collection of principal or
interest is considered doubtful according to internal evaluation policies.
All interest accrued but not collected for loans that are placed on non-accrual
or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and
interest amounts contractually due are brought current and future payments are reasonably assured.
Loans are also placed on non-accrual status in cases
where it is uncertain as to whether the borrower can satisfy the contractual terms of the loan agreement. Amounts received on non-accrual loans generally are applied first to interest and then to principal only after all past due interest has been
collected. Restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal have been granted due to the borrower’s weakened
financial condition. Interest is accrued on restructured loans at the restructured rates when it is anticipated that no loss of original principal will occur.
Recent Accounting Pronouncements
See Note E to the financial statements for a full description of recent
accounting pronouncements including the respective expected dates of adoption and effects on results of operations and financial condition.
Comparison of Financial Condition at
December 31, 2007 and June 30, 2007
Total assets decreased by $15.3 million, from $236.7 million at June 30, 2007, to $221.4 million at December 31, 2007. The Company’s decrease in assets
was largely attributable to decreases in federal funds sold and cash that were used to fund the maturities of borrowings and brokered certificates of deposit.
The Company’s interest-earning liquid assets, including interest-earning balances in other banks, federal funds sold and investment securities decreased by $14.8 million, to $17.8 million at December 31, 2007, representing 8% of
total assets at that date as compared with $32.6 million or 13.8% of total assets at June 30, 2007.
Loans receivable decreased by $4.8 million from
$178.7 million at June 30, 2007, to $173.9 million at December 31, 2007, primarily due to a decrease in real estate loans due to a decline in loan request volume.
Total deposits decreased by $15.8 million from $171.2 million at June 30, 2007, to $155.4 million at December 31, 2007, primarily due to decreases in large customer certificates of deposit and maturing
brokered certificates of deposit.
Total stockholders’ equity increased by $485,000 from $27.3 million at June 30, 2007, to $27.8 million at
December 31, 2007. The increase in stockholders’ equity from net income, the exercise of stock options and increases in the fair market value of available for sale securities were offset by cash dividends paid and treasury stock
repurchases.
- 11 -
Comparison of Results of Operations for the
Three Months Ended December 31, 2007 and 2006
Net Income
. Net income for the quarter ended December 31, 2007 was $315,000, a decrease of $66,000 from net income of $381,000 for the quarter ended December 31, 2006. On a per share basis, net income for the current
quarter was $0.18 per diluted share as compared with $0.22 per diluted share for the first quarter of the last fiscal year. The decrease in net income was primarily a result of incurred nondeductible merger costs of $57,000.
Net Interest Income.
Net interest income for each of the quarters ended December 31, 2007 and 2006 was $1.6 million. Both interest income and interest
expense increased primarily due to the increase in average loans, deposits and borrowings over the same period last year. Decreases in Wall Street Journal Prime and Federal Funds rates and other market interest rates had no significant impact on the
Company’s net interest income quarter over quarter.
Provision for Loan Losses.
The provision for loan losses totaled $100,000 in the current
quarter, compared to $60,000 in the quarter ended December 31, 2006.
We experienced changes in the loan portfolio mix as well as increases in
non-performing loans from December 31, 2006 to 2007, both of which increased the necessary amount of the allowance for loan losses when the changes were analyzed in our allowance for loan loss model. We also increased our qualitative factor
related to regional economic conditions which impacted the allowance for loan losses and this resulted in the provision for loan losses of $100,000 for the three months ended December 31, 2007. Our loan loss methodology allowance model takes
into consideration the different levels of risk for all outstanding loans. (see – “Analysis of Allowance for Loan Losses”). The following table provides the changes in the allowance for loan losses for the quarters ended
December 31, 2007 and 2006, respectively.
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended
December 31,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
Balance at the beginning of the period
|
|
$
|
1,987
|
|
|
$
|
1,940
|
|
|
|
|
|
|
Charge-offs:
|
|
|
|
|
|
|
|
|
|
Real estate mortgage
|
|
|
84
|
|
|
|
—
|
|
|
Installment loans to individuals
|
|
|
5
|
|
|
|
12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
89
|
|
|
|
12
|
|
|
|
|
|
|
|
|
|
|
|
|
Recoveries:
|
|
|
|
|
|
|
|
|
|
Real estate mortgage
|
|
|
2
|
|
|
|
—
|
|
|
Installment loans to individuals
|
|
|
1
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
Net charge-offs
|
|
|
86
|
|
|
|
11
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for loan losses
|
|
|
100
|
|
|
|
60
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
$
|
2,001
|
|
|
$
|
1,989
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratio of net charge-offs during the period to average loans outstanding during the period
|
|
|
0.0450
|
%
|
|
|
0.0001
|
%
|
Non-Interest Income
. Non-interest income increased by $12,000, from $257,000 for the three months ended
December 31, 2006 to $269,000 for the three months ended December 31, 2007. This increase is due primarily to a gain on sale of investment securities of $12,000 and increases in deposit service charges $12,000 and decreases in investment
service income of $10,000.
Non-Interest Expenses
. Non-interest expenses increased $71,000 for the three months ending December 31, 2007 when
compared to the same period in 2006. This increase was largely attributable to expenses related to the merger of $57,000 and a loss on sale of REO of $28,000, offset by decreases in occupancy cost of $16,000, when compared to the December 2006
quarter.
- 12 -
Provision for Income Taxes
. The provision for income taxes, as a percentage of income before income taxes, was
42.1% and 38.3% for the quarters ended December 31, 2007 and 2006, respectively. The increase in the provision for income tax was due to merger costs treated as nondeductible permanent differences for income tax purposes.
Comparison of Results of Operations for the
Six Months Ended December 31, 2007 and 2006
Net Income
. Net income for the six months ended
December 31, 2007 was $410,000, a decrease of $424,000 from net income of $834,000 for the six months ended December 31, 2006. On a per share basis, net income for the current quarter was $0.24 per diluted share as compared with $0.49 per
diluted share for the first six months of the last fiscal year. The decrease in net income was primarily a result of incurred nondeductible merger costs of $361,000.
Net Interest Income.
Net interest income for each of six months ended December 31, 2007 and 2006 was $3.4 million. Both interest income and interest expense increased primarily due to the increase in
average loans, deposits and borrowings over the same period last year. Decreases in Wall Street Journal Prime and Federal Funds rates and other market interest rates had no significant impact on the Company’s net interest income during the six
months ended December 31, 2007.
Provision for Loan Losses.
The provision for loan losses totaled $167,000 in the current six month period,
compared to $107,000 for the six months ended December 31, 2006.
We experienced changes in the loan portfolio mix as well as increases in
non-performing loans from December 31, 2006 to 2007, both of which increased the necessary amount of the allowance for loan losses when the changes were analyzed in our allowance for loan loss model. We also increased our qualitative factor
related to regional economic conditions which impacted the allowance for loan losses. The changes when analyzed in our model resulted in the provision for loan losses of $167,000 for the six months ended December 31, 2007. Our loan loss
methodology allowance model takes into consideration the different levels of risk for all outstanding loans. (see – “Analysis of Allowance for Loan Losses”). The following table provides the changes in the allowance for loan losses
for the six months ended December 31, 2007 and 2006, respectively.
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Six Months Ended
December 31,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
Balance at the beginning of the period
|
|
$
|
1,938
|
|
|
$
|
1,901
|
|
|
|
|
|
|
Charge-offs:
|
|
|
|
|
|
|
|
|
|
Real estate mortgage
|
|
|
84
|
|
|
|
1
|
|
|
Installment loans to individuals
|
|
|
24
|
|
|
|
20
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
108
|
|
|
|
21
|
|
|
|
|
|
|
|
|
|
|
|
|
Recoveries:
|
|
|
|
|
|
|
|
|
|
Real estate mortgage
|
|
|
3
|
|
|
|
—
|
|
|
Installment loans to individuals
|
|
|
1
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
|
Net charge-offs
|
|
|
104
|
|
|
|
19
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for loan losses
|
|
|
167
|
|
|
|
107
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
$
|
2,001
|
|
|
$
|
1,989
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratio of net charge-offs during the period to average loans outstanding during the period
|
|
|
0.0425
|
%
|
|
|
0.0001
|
%
|
Non-Interest Income
. Non-interest income decreased by $3,000, from $547,000 for the six months ended
December 31, 2006 to $544,000 for the six months ended December 31, 2007. This decrease is due primarily to decreases in other income of $60,000 offset by increases in investment service income and deposit service charges of $29,000 and
$22,000, respectively.
- 13 -
Non-Interest Expenses
. Non-interest expenses increased $417,000 for the six months ended December 31, 2007
when compared to the same period in 2006. This increase was largely attributable to expenses related to the merger of $361,000 and a loss on sale of REO of $28,000.
Provision for Income Taxes
. The provision for income taxes, as a percentage of income before income taxes, was 53.8% and 38.3% for the six months ended December 31, 2007 and 2006, respectively. The
increase in the provision for income tax was due to merger costs treated as nondeductible permanent differences for income tax purposes.
Asset Quality
The Company considers asset quality to be of primary importance, and employs a formal internal loan review process to
ensure adherence to the Lending Policy as approved by the Board of Directors. An ongoing systematic evaluation process serves as the basis for determining, on a monthly basis, the allowance for loan losses and any resulting provision to be charged
against earnings. Consideration is given to historical loan loss experience, nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the value and adequacy of collateral, and prevailing
economic conditions in the Company’s market area. For loans determined to be impaired, the allowance is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral if the loan is
collateral dependent. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant revision. The
provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance considered adequate to absorb probable losses inherent in the portfolio.
The Company’s policy regarding past due loans normally requires a prompt charge-off to the allowance for loan losses when uncollectibility of the loan balance is
confirmed. Further collection efforts are then pursued through various means available. Subsequent recoveries, if any, are credited to the allowance. Loans carried in a non-accrual status are generally collateralized, and probable future losses are
considered in the determination of the allowance for loan losses.
Nonperforming Assets
The following table sets forth, at the dates indicated, information with respect to the Company’s nonaccrual loans, restructured loans, total nonperforming loans
(nonaccrual loans plus restructured loans), and total nonperforming assets.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
2007
|
|
|
June 30,
2007
|
|
|
December 31,
2006
|
|
|
|
|
(Dollars in thousands)
|
|
|
Nonaccrual loans
|
|
$
|
1,006
|
|
|
$
|
1,248
|
|
|
$
|
872
|
|
|
Restructured loans
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total nonperforming loans
|
|
|
1,006
|
|
|
|
1,248
|
|
|
|
872
|
|
|
Real estate and other assets owned
|
|
|
155
|
|
|
|
94
|
|
|
|
27
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total nonperforming assets
|
|
$
|
1,161
|
|
|
$
|
1,342
|
|
|
$
|
899
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accruing loans past due 90 days or more
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
Allowance for loan losses
|
|
|
2,001
|
|
|
|
1,938
|
|
|
|
1,989
|
|
|
Nonperforming loans to period-end loans
|
|
|
0.58
|
%
|
|
|
0.70
|
%
|
|
|
0.47
|
%
|
|
Allowance for loan losses to period-end loans
|
|
|
1.15
|
%
|
|
|
1.08
|
%
|
|
|
1.07
|
%
|
|
Allowance for loan losses to nonperforming loans
|
|
|
198.91
|
%
|
|
|
155.29
|
%
|
|
|
228.10
|
%
|
|
Nonperforming assets to total assets
|
|
|
0.52
|
%
|
|
|
0.56
|
%
|
|
|
0.41
|
%
|
The nonperforming loans as of December 31, 2007 consist primarily of one commercial real-estate loan and
several one - four family mortgage loans. Our portfolio typically includes a small amount of non-performing loans; these loans are not the result of any trend.
The accrual of interest on loans is discontinued at the time the loan is 90 days past due or impaired unless the credit is well-secured and in process of collection. Past due status is based on contractual terms of the loan. In all cases,
loans are placed on non-accrual status at an earlier date if collection of principal or interest is considered doubtful according to internal evaluation policies.
- 14 -
All interest accrued but not collected for loans that are placed on non-accrual or charged off is reversed against
interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are
brought current and future payments are reasonably assured.
Loans are also placed on non-accrual status in cases where it is uncertain as to whether the
borrower can satisfy the contractual terms of the loan agreement. Amounts received on non-accrual loans generally are applied first to interest and then to principal only after all past due interest has been collected. Restructured loans are those
for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal have been granted due to the borrower’s weakened financial condition. Interest is
accrued on restructured loans at the restructured rates when it is anticipated that no loss of original principal will occur.
Analysis of Allowance for Loan Losses
The provision for loan losses charged to operations is an amount sufficient to bring the
allowance for loan losses to an estimated balance considered adequate to absorb probable losses inherent in the portfolio. The following table outlines the allocation of the allowance for loan losses for each reported period and reflects the result
of the allowance for loan loss model as discussed above.
Allocation of the Allowance for Loan Losses (dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2007
|
|
|
As of June 30, 2007
|
|
|
|
|
Amount
|
|
Percent of loans
in each category
to total loans
|
|
|
Amount
|
|
Percent of loans
in each category
to total loans
|
|
|
Commercial, Financial & Agricultural
|
|
$
|
160
|
|
5.54
|
%
|
|
$
|
157
|
|
4.37
|
%
|
|
Real Estate - construction
|
|
|
254
|
|
18.82
|
%
|
|
|
241
|
|
17.61
|
%
|
|
Real Estate - mortgage
|
|
|
1,151
|
|
72.99
|
%
|
|
|
1,154
|
|
75.39
|
%
|
|
Installment loans to individuals
|
|
|
80
|
|
2.10
|
%
|
|
|
90
|
|
2.04
|
%
|
|
Other
|
|
|
85
|
|
0.55
|
%
|
|
|
71
|
|
0.59
|
%
|
|
Unallocated
|
|
|
271
|
|
N/A
|
|
|
|
225
|
|
N/A
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,001
|
|
100.00
|
%
|
|
$
|
1,938
|
|
100.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liquidity and Capital Resources
During the six months ended December 31, 2007 the Company paid cash dividends of $0.32 per share. Although the Company anticipates that it will continue to declare
cash dividends on a regular basis, the Board of Directors will review its policy on the payment of dividends on an ongoing basis, and such payment will be subject to future earnings, cash flows, capital needs, and regulatory and merger restrictions.
Maintaining adequate liquidity while managing interest rate risk is the primary goal of Great Pee Dee Bancorp’s asset and liability management
strategy. Liquidity is the ability to fund the needs of the Bank’s borrowers and depositors, pay operating expenses, and meet regulatory liquidity requirements. Maturing investments, loan and mortgage-backed security principal repayments,
deposits and income from operations are the main sources of liquidity. The Bank’s primary uses of liquidity are to fund loans and to make investments.
As of December 31, 2007, liquid assets (cash, interest-earning deposits, and investment securities) were approximately $20.0 million, which represents 12.0% of deposits. At that date, outstanding loan commitments were $1.2 million. The
undisbursed portion of construction loans was $7.0 million and undrawn lines of credit totaled $18.8 million. Brokered certificates of deposit scheduled to mature within the next year total $13.3 million. Funding for these commitments is expected to
be provided from deposits, loan principal repayments, maturing investments, income generated from operations and, to the extent necessary, from borrowings.
- 15 -
Under federal capital regulations, Sentry must satisfy certain minimum leverage ratio requirements and risk-based capital
requirements. Failure to meet such requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial
statements. At December 31, 2007, Sentry exceeded all such requirements and is considered “well capitalized” under current regulatory capital guidelines.
The Bank is restricted in its ability to pay dividends and to make distributions. A significant source of Great Pee Dee’s funds is dividends received from the Bank. No dividends were paid by the Bank to Great Pee
Dee in the six months ended December 31, 2007. Under Office of Thrift Supervision regulations, prior notice is required to be given to the Office of Thrift Supervision for any payment of dividends from Sentry Bank & Trust to Great Pee
Dee.