10-K 1 peoples10k06.txt United States SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005 [ ] 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. 000-20616 Peoples Bancorporation, Inc. (Exact name of Registrant as specified in its charter) South Carolina 57-0951843 -------------- ---------- (State or other jurisdiction (IRS Employer of incorporation or organization) Identification No.) 1818 East Main Street, Easley, South Carolina 29640 (Address of Principal Executive Offices, Including Zip Code) Registrant's Telephone Number, Including Area Code: (864) 859-2265 Securities Registered Pursuant to Section 12 (b) of the Securities Exchange Act of 1934: None Securities Registered Pursuant to Section 12 (g) of the Securities Exchange Act of 1934: Common Stock, $1.11 Par Value (Title of Class) Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X] 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 to this Form 10-K. [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] The aggregate market value of the voting and non-voting common equity held by nonaffiliates of the Registrant (4,127,093 shares) on June 30, 2005 was approximately $70,160,600. The aggregate market value of the voting and non-voting common equity held by nonaffiliates of the Registrant (4,362,586 shares) on March 13, 2006 was approximately $57,804,300. As of such dates, no organized trading market existed for the common stock of the Registrant. For the purpose of this response, officers, directors and holders of 5% or more of the Registrant's common stock are considered affiliates of the Registrant. The number of shares outstanding of the Registrant's common stock, as of March 13, 2006: 6,250,006 shares of $1.11 par value common stock. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Proxy Statement for the 2006 Annual Meeting of Shareholders - Part III FORWARD LOOKING STATEMENTS This Annual Report contains forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products and similar matters. All statements that are not historical facts are "forward-looking statements." Words such as "estimate," "project," "intend," "expect," "believe," "anticipate," "plan," and similar expressions identify forward-looking statements. These forward-looking statements are based on current expectations, estimates and projections about our industry, management's beliefs, and assumptions made by management. Such information includes, without limitation, discussions as to estimates, expectations, beliefs, plans, strategies, and objectives concerning the Company's future financial and operating performance. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from those expressed or forecasted in such forward-looking statements. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with terms of the safe harbor, the Company notes that a variety of factors could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. The risks and uncertainties that may affect the operations, performances, development and results of the Company's business include, but are not limited to, the following: risks from changes in economic and industry conditions; changes in interest rates; risks inherent in making loans including repayment risks and value of collateral; adequacy of the allowance for loan losses; dependence on senior management; and recently-enacted or proposed legislation. Statements contained in this filing regarding the demand for the Company's products and services, changing economic conditions, interest rates, consumer spending and numerous other factors may be forward-looking statements and are subject to uncertainties and risks. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties, and assumptions, the forward-looking events discussed in this report might not occur. PART I ITEM 1. BUSINESS The Company Peoples Bancorporation, Inc. (the "Company") was incorporated under South Carolina law on March 6, 1992, for the purpose of becoming a bank holding company by acquiring all of the common stock of The Peoples National Bank, Easley, South Carolina. The Company commenced operations on July 1, 1992 upon effectiveness of the acquisition of The Peoples National Bank. In 2000, the 2 Company elected to become a financial holding company, but it has not yet engaged in any activities permitted to financial holding companies that are impermissible for bank holding companies. The Company has three wholly-owned subsidiaries: The Peoples National Bank, Easley, South Carolina, a national bank which commenced business operations in August 1986; Bank of Anderson, National Association, Anderson, South Carolina, a national bank which commenced business operations in September 1998; and, Seneca National Bank, Seneca, South Carolina, a national bank which commenced business operations in February 1999 (sometimes referred to herein as "the Banks"). The Company engages in no significant operations other than the ownership of its three subsidiaries and the support thereof. The Company conducts its business from seven banking offices located in the Upstate Area of South Carolina. The principal offices of the Company are located at 1818 East Main Street, Easley, South Carolina 29640. The Company's telephone number is (864) 859-2265. The principal office of The Peoples National Bank is located at 1800 East Main Street, Easley, South Carolina 29640. The principal office of Bank of Anderson, National Association is located at 201 East Greenville Street, Anderson, South Carolina 29621, and the principal office of Seneca National Bank is located at 201 Bypass 123, Seneca, South Carolina 29678. General Business Some of the major services which the Company provides through its banking subsidiaries include checking accounts; NOW accounts; savings and other time deposits of various types; daily repurchase agreements; alternative investment products such as annuities, mutual funds, stocks and bonds; loans for business, agriculture, real estate, personal uses, home improvement and automobiles; residential mortgage loan origination; credit cards; letters of credit; home equity lines of credit; an accounts receivable financing program; safe deposit boxes; bank money orders; wire transfer services; Internet banking and use of ATM facilities. The Banks do not have trust powers. The Company has no material concentration of deposits from any single customer or group of customers. No significant portion of its loans is concentrated within a single industry or group of related industries and the Company does not have any foreign loans. There are no material seasonal factors that would have an adverse effect on the Company. As a financial holding company, the Company is a legal entity separate and distinct from its subsidiaries. The Company coordinates the financial resources of the consolidated enterprises and maintains financial, operational and administrative systems that allow centralized evaluation of subsidiary operations and coordination of selected policies and activities. The Company's operating revenues and net income are derived primarily from its subsidiaries through dividends and fees for services performed. 3 Territory Served and Competition The Peoples National Bank serves its customers from four locations; two offices in the city of Easley and one office in the city of Pickens, South Carolina, which are located in Pickens County, and one office in the unincorporated community of Powdersville, South Carolina, which is located in the northeast section of Anderson County, South Carolina. Easley, South Carolina is located approximately 10 miles west of Greenville, South Carolina. Pickens, South Carolina is located approximately 8 miles north of Easley, and Powdersville, South Carolina is located approximately 12 miles southeast of Easley. Bank of Anderson, National Association, serves its customers from one location in the City of Anderson and another location in Anderson County, South Carolina. Anderson is located approximately 25 miles southwest of Greenville, South Carolina and approximately 25 miles south of Easley in Anderson County, South Carolina. Seneca National Bank serves its customers from one location in the City of Seneca, South Carolina. Seneca is located approximately 30 miles northwest of Easley, South Carolina in Oconee County, South Carolina. Each subsidiary of the Company is a separately chartered bank, and therefore each bank is responsible for developing and maintaining its own customers and accounts. Located in Easley, South Carolina, The Peoples National Bank's customer base has been primarily derived from Pickens County, South Carolina and the northeast section of Anderson County, South Carolina. Bank of Anderson's primary service area is Anderson County, South Carolina, more particularly, the City of Anderson. Seneca National Bank derives most of its customer base from the City of Seneca and surrounding Oconee County, South Carolina. The Banks compete with several major banks, which dominate the commercial banking industry in their service areas and in South Carolina generally. In addition, the Banks compete with other community banks, savings institutions and credit unions. In Pickens County, there are thirty (30) competitor bank offices, one (1) savings institution, and two (2) credit union offices. In Anderson County there are fifty-six (56) competitor bank offices and five (5) credit union offices. In Oconee County, there are fifteen (15) competitor bank offices, four (4) savings institution offices, and one (1) credit union office. The Peoples National Bank had approximately 13.22% of the deposits of FDIC-insured institutions in Pickens County. The Peoples National Bank and Bank of Anderson, combined, had approximately 8.87% of the deposits of FDIC-insured institutions in Anderson County. Seneca National Bank had approximately 4.55% of the deposits of FDIC-insured institutions in Oconee County. The foregoing information is as of June 30, 2005, the most recent date for which such information is available from the FDIC. Many competitor institutions have substantially greater resources and higher lending limits than the Banks, and they perform certain functions for 4 their customers, including trust services and investment banking services, which none of the Banks is equipped to offer directly. However, the Banks do offer some of these services through correspondent banks. In addition to commercial banks, savings institutions and credit unions, the Banks compete for deposits and loans with other financial intermediaries and investment alternatives, including, but not limited to, mortgage companies, captive finance companies, money market mutual funds, brokerage firms, insurance companies, governmental and corporation bonds and other securities. Several of these non-bank competitors are not subject to the same regulatory restrictions as the Company and its subsidiaries and many have substantially greater resources than the Company. The extent to which other types of financial institutions compete with commercial banks has increased significantly within the past few years as a result of federal and state legislation that has, in several respects, deregulated financial institutions. The full impact of existing legislation and subsequent laws that deregulate the financial services industry cannot be fully assessed or predicted. 5 DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDER'S EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL The following is a presentation of the average consolidated balance sheets of the Company for the years ended December 31, 2005, 2004 and 2003. This presentation includes all major categories of interest-earning assets and interest-bearing liabilities:
AVERAGE CONSOLIDATED BALANCE SHEETS (dollars in thousands) For the years ended December 31, -------------------------------- 2005 2004 2003 ---- ---- ---- Assets Cash and Due from Banks ....................................... $ 12,325 $ 12,159 $ 11,539 Taxable Securities ............................................ 66,889 68,952 75,300 Tax-Exempt Securities ......................................... 8,529 6,953 4,837 Federal Funds Sold ............................................ 6,411 6,443 15,784 Mortgage Loans Held for Sale .................................. - 6,377 32,511 Gross Loans ................................................... 352,193 311,524 275,424 Less: Loan Loss Reserve ...................................... 3,846 3,558 3,299 -------- -------- -------- Net Loans ..................................................... 348,347 307,966 272,125 -------- -------- -------- Other Assets .................................................. 24,470 22,332 15,447 -------- -------- -------- Total Assets .................................................. $466,971 $431,182 $427,543 ======== ======== ======== Liabilities and Shareholders' Equity Noninterest-bearing Deposits .................................. $ 50,864 $ 47,795 $ 50,352 Interest-bearing Deposits: Interest Checking ......................................... 51,802 42,917 37,650 Savings Deposits .......................................... 11,870 10,945 9,513 Money Market .............................................. 47,881 53,735 61,048 Certificates of Deposit ................................... 191,677 172,283 171,155 Individual Retirement Accounts ............................ 27,655 25,079 23,500 -------- -------- -------- Total Interest-bearing Deposits ............................... 330,885 304,959 302,866 -------- -------- -------- Short-term Borrowings ......................................... 36,761 33,393 31,747 Long-term Borrowings .......................................... 5,000 5,000 5,000 Other Liabilities ............................................. 3,019 2,704 2,830 -------- -------- -------- Total Liabilities ......................................... 426,529 393,851 392,795 -------- -------- -------- Common Stock .................................................. 6,594 6,174 5,903 Additional Paid-in Capital .................................... 32,602 29,738 26,334 Retained Earnings ............................................. 1,246 1,419 2,511 -------- -------- -------- Total Shareholders' Equity ................................ 40,442 37,331 34,748 -------- -------- -------- Total Liabilities and Shareholders' Equity ........................................................ $466,971 $431,182 $427,543 ======== ======== ========
6 The following is a presentation of an analysis of the net interest income of the Company for the years ended December 31, 2005, 2004 and 2003 with respect to each major category of interest-earning assets and each major category of interest-bearing liabilities:
Year Ended December 31, 2005 ---------------------------- (dollars in thousands) Average Interest Average Assets Amount Earned/Paid Yield/Rate ------ ------ ----------- ---------- Securities - Taxable ............................................... $ 66,889 $ 1,891 2.83% Tax-Exempt ............................................ 8,529 260 4.62%* Interest-bearing deposits at other banks ........................... 942 30 3.18% Federal Funds Sold ................................................. 6,411 194 3.03% Mortgage loans held for sale ....................................... - - 0.00% Gross Loans ........................................................ 352,193 23,915 6.79% -------- -------- Total Earning Assets ........................................... $434,964 $ 26,290 6.07%* ======== ======== Liabilities Interest Checking .................................................. $ 51,802 $ 137 0.26% Savings Deposits ................................................... 11,870 26 0.22% Money Market ....................................................... 47,881 690 1.44% Certificates of Deposit ............................................ 191,677 6,094 3.18% Individual Retirement Accounts ..................................... 27,655 977 3.53% -------- -------- 330,885 7,924 Short-term Borrowings .............................................. 36,761 765 2.08% Long-term Borrowings ............................................... 5,000 244 4.88% -------- -------- Total Interest-bearing Liabilities ............................. $372,646 $ 8,933 2.40% ======== ======== Excess of interest-earning assets over interest-bearing liabilities ................................ $ 62,318 ======== Net interest income ................................................ $ 17,357 ======== Interest rate spread ............................................... 3.67%* Net yield on earning assets ........................................ 4.02%*
* Yield adjusted to a fully taxable equivalent basis using a federal tax rate of 34%. For purposes of these analyses, non-accruing loans are included in the average balances. Loan fees included in interest earned are not material to the presentation. Net yield on interest-earning assets is calculated by dividing net interest earnings by total interest-earning assets. 7
Year Ended December 31, 2004 ---------------------------- (dollars in thousands) Average Interest Average Assets Amount Earned/Paid Yield/Rate ------ ------ ----------- ---------- Securities - Taxable ....................................................... $ 68,952 $ 1,866 2.71% Tax-Exempt .................................................... 6,953 233 5.08%* Interest-bearing deposits at other banks ................................... 729 9 1.23% Federal Funds Sold ......................................................... 6,443 88 1.37% Mortgage loans held for sale ............................................... 6,377 318 4.99% Gross Loans ................................................................ 311,524 18,549 5.95% ------------- ------------- Total Earning Assets ................................................... $ 400,978 $ 21,063 5.28%* ============= ============= Liabilities Interest Checking .......................................................... $ 42,917 $ 88 0.21% Savings Deposits ........................................................... 10,945 18 0.16% Money Market ............................................................... 53,735 401 0.75% Certificates of Deposit .................................................... 172,283 4,506 2.62% Individual Retirement Accounts ............................................. 25,079 815 3.25% ------------- ------------- 304,959 5,828 Short-term Borrowings ...................................................... 33,393 368 1.10% Long-term Borrowings ....................................................... 5,000 245 4.90% ------------- ------------- Total Interest-bearing Liabilities ..................................... $ 343,352 $ 6,441 1.88% ============= ============= Excess of interest-earning assets over interest-bearing liabilities ........................................ $ 57,626 ============= Net interest income ........................................................ $ 14,622 ============= Interest rate spread ....................................................... 3.40%* Net yield on earning assets ................................................ 3.67%*
* Yield adjusted to a fully taxable equivalent basis using a federal tax rate of 34%. For purposes of these analyses, non-accruing loans are included in the average balances. Loan fees included in interest earned are not material to the presentation. Net yield on interest-earning assets is calculated by dividing net interest earnings by total interest-earning assets. 8
Year Ended December 31, 2003 ---------------------------- (dollars in thousands) Average Interest Average Assets Amount Earned/Paid Yield/Rate ------ ------ ----------- ---------- Securities - Taxable ........................................................ $ 75,300 $ 2,392 3.18% Tax-Exempt ..................................................... 4,837 180 5.64%* Interest-bearing deposits at other banks .................................... 379 4 1.06% Federal Funds Sold .......................................................... 15,784 176 1.12% Mortgage loans held for sale ................................................ 32,511 1,002 3.08% Gross Loans ................................................................. 275,424 17,153 6.23% ------------- ------------- Total Earning Assets .................................................... $ 404,235 $ 20,907 5.19%* ============= ============= Liabilities Interest Checking ........................................................... $ 37,650 $ 150 0.40% Savings Deposits ............................................................ 9,513 43 0.45% Money Market ................................................................ 61,048 752 1.23% Certificates of Deposit ..................................................... 171,155 5,069 2.96% Individual Retirement Accounts .............................................. 23,500 844 3.59% ------------- ------------- 302,866 6,858 Short-term Borrowings ....................................................... 31,747 427 1.35% Long-term Borrowings ........................................................ 5,000 241 4.82% ------------- ------------- Total Interest-bearing Liabilities ...................................... $ 339,613 $ 7,526 2.22% ============= ============= Excess of interest-earning assets over interest-bearing liabilities ......................................... $ 64,622 ============= Net interest income ......................................................... $ 13,381 ============= Interest rate spread ........................................................ 2.97%* Net yield on earning assets ................................................. 3.33%*
* Yield adjusted to a fully taxable equivalent basis using a federal tax rate of 34%. For purposes of these analyses, non-accruing loans are included in the average balances. Loan fees included in interest earned are not material to the presentation. Net yield on interest-earning assets is calculated by dividing net interest earnings by total interest-earning assets. 9 RATE/VOLUME ANALYSIS OF NET INTEREST INCOME The effect of changes in average balances (volume) and rates on interest income, interest expense and net interest income, for the periods indicated, is shown below. The effect of a change in average balance has been determined by applying the average rate in the earlier period to the change in average balance in the later period, as compared with the earlier period. The effect of a change in the average rate has been determined by applying the average balance in the earlier period to the change in the average rate in the later period, as compared with the earlier period.
Year Ended December 31, 2005 compared to 2004 (dollars in thousands) Change in Change in Total Volume Rate Change ------ ---- ------ Interest earned on: Securities Taxable ...................................... $ (51) $ 76 $ 25 Tax-Exempt ................................... 45 (18) 27 Interest-bearing deposits at other banks .......... 3 18 21 Federal Funds Sold ................................ - 106 106 Mortgage Loans Held for Sale ...................... (318) - (318) Gross Loans ....................................... 2,585 2,781 5,366 ------------- ------------- ------------- Total Interest Income ............................. 2,264 2,963 5,227 ------------- ------------- ------------- Interest paid on: Interest Checking ............................ 20 29 49 Savings Deposits ............................. 2 6 8 Money Market ................................. (38) 327 289 Certificates of Deposit ...................... 545 1,043 1,588 Individual Retirement Accounts ............... 88 74 162 ------------- ------------- ------------- 616 1,480 2,096 Short-term Borrowings ............................. 40 357 397 Long-term Borrowings .............................. - (1) (1) ------------- -------------- -------------- Total Interest Expense ............................ 657 1,835 2,492 ------------- ------------- ------------- Change in Net Interest Income ..................... $ 1,608 $ 1,127 $ 2,735 ============= ============= =============
Note: Changes that are not solely attributable to volume or rate have been allocated to volume and rate on a pro-rata basis. For purposes of these analyses, non-accruing loans are included in the average balances. Tax-exempt income is shown on an actual, rather than, tax-exempt basis. Loan fees included in interest earned are not material to the presentation. Net yield on interest-earning assets is calculated by dividing net interest earnings by total interest-earning assets. As reflected in the table above, most of the increase in net interest income of $2,735,000 during 2005 was due to the change in volume. The $5,227,000 increase in interest income was related to the change in volume and change in 10 rates in the loan portfolios. In reviewing the Company's deposits, substantially all the $2,492,000 increase in interest expense was due to the increases in the rates paid on all deposit accounts, principally Certificates of Deposit.
Year Ended December 31, 2004 compared to 2003 (dollars in thousands) Change in Change in Total Volume Rate Change ------ ---- ------ Interest earned on: Securities Taxable ...................................... $ (191) $ (335) $ (526) Tax-Exempt ................................... 69 (16) 53 Interest-bearing deposits at other banks .......... 4 1 5 Federal Funds Sold ................................ (142) 54 (88) Mortgage Loans Held for Sale ...................... (2,958) 2,274 (684) Gross Loans ....................................... 2,100 (704) 1,396 ------------- -------------- ------------- Total Interest Income ............................. (1,118) (1,274) 156 -------------- -------------- ------------- Interest paid on: Interest Checking ............................ 25 (87) (62) Savings Deposits ............................. 8 (33) (25) Money Market ................................. (82) (269) (351) Certificates of Deposit ...................... 34 (597) (563) Individual Retirement Accounts ............... 70 (99) (29) ------------- -------------- -------------- 54 (1,084) (1,030) Short-term Borrowings ............................. 24 (83) (59) Long-term Borrowings .............................. - 4 4 ------------- ------------- ------------- Total Interest Expense ............................ 78 (1,163) (1,085) ------------- -------------- -------------- Change in Net Interest Income ..................... $ (1,196) $ 2,437 $ 1,241 ============== ============= =============
Note: Changes that are not solely attributable to volume or rate have been allocated to volume and rate on a pro-rata basis. For purposes of these analyses, non-accruing loans are included in the average balances. Tax-exempt income is shown on an actual, rather than, tax-exempt basis. Loan fees included in interest earned are not material to the presentation. Net yield on interest-earning assets is calculated by dividing net interest earnings by total interest-earning assets. As reflected in the table above, the increase in net interest income of $1,241,000 during 2004 was due to the change in volume. The majority of the $156,000 increase in interest income was related to the volume growth in the loan portfolios, lessened by the change in rates, and the exit of the wholesale mortgage loan division of The Peoples National Bank. In reviewing the Company's deposits, substantially all the $1,085,000 decrease in interest expense was due to the decreases in the rates paid on all deposit accounts, principally Money Market accounts and Certificates of Deposit. 11 LOAN PORTFOLIO The Company engages, through the Banks, in a full complement of lending activities, including commercial, consumer, installment, and real estate loans. Commercial lending is directed principally towards businesses whose demands for funds fall within each Bank's legal lending limits and which are potential deposit customers of the Banks. This category of loans includes loans made to individuals, partnerships or corporate borrowers, and which are obtained for a variety of business purposes. Particular emphasis is placed on loans to small and medium-sized businesses. The Company's commercial loans are spread throughout a variety of industries, with no industry or group of related industries accounting for a significant portion of the commercial loan portfolio. Commercial loans are made on either a secured or unsecured basis. When taken, security usually consists of liens on inventories, receivables, equipment, and furniture and fixtures. Unsecured commercial loans are generally short-term with emphasis on repayment strengths and low debt to worth ratios. At December 31, 2005, approximately $9,936,000, or 7.7%, of commercial loans were unsecured compared to approximately $8,675,000 or 6.4% at December 31, 2004. The Company's real estate loans are primarily construction loans and loans secured by real estate, both commercial and residential, located within the Company's market areas. The Company does not actively pursue long-term, fixed-rate mortgage loans for retention in its loan portfolio. The Banks do employ mortgage loan originators who originate loans that are pre-sold at origination to third parties. The Company formerly also purchased mortgage loans through a wholesale mortgage loan division of The Peoples National Bank, which loans were pre-sold at origination to third parties. These loans were classified as loans held for sale for reporting purposes. In 2004, the Company originated $149,881,000 and sold $156,689,000 in mortgage loans held for sale. Management made the decision to completely exit the wholesale mortgage business by the end of 2004. Accordingly, there were no mortgage loans held for sale at December 31, 2005 and 2004. The Banks' direct consumer loans consist primarily of secured installment loans to individuals for personal, family and household purposes, including automobile loans to individuals, and pre-approved lines of credit. Management believes the loan portfolio is adequately diversified. Real estate lending (both mortgage and construction loans) continues to be the largest component of the loan portfolio, representing $318,632,000 or 84.4% of total loans at December 31, 2005, compared to $264,925,000 or 81.3% at year-end 2004. There are no foreign loans and few agricultural loans. The following table presents various categories of loans contained in the Company's loan portfolio and the total amount of all loans at December 31, 2005, 2004, 2003, 2002 and 2001. 12 Loan Portfolio Composition (dollars in thousands)
December 31, ------------ 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- Commercial and industrial - not secured by real estate .......... $ 39,669 $ 39,723 $ 44,306 $ 35,548 $ 26,997 Commercial and industrial - secured by real estate ............... 90,186 95,965 84,805 72,600 53,445 Real Estate - mortgage .............................................. 107,398 105,580 90,299 69,579 60,881 Real estate - construction .......................................... 121,048 63,380 55,139 48,452 48,099 Consumer loans ...................................................... 19,194 21,255 21,703 24,308 23,114 -------- -------- -------- -------- -------- Loans held for investment ........................................... 377,495 325,903 296,252 250,487 212,536 Loans held for sale ................................................. 0 0 5,101 55,026 40,925 Less: Allowance for loan losses ................................... 3,854 3,691 3,438 2,850 2,288 -------- -------- -------- -------- -------- Net Loans ........................................................... $373,641 $322,212 $297,915 $302,663 $251,173 ======== ======== ======== ======== ========
Percentage of Loans Held for Investment 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- Commercial and Industrial - not secured by real estate ..... 10.51% 12.18% 14.95% 14.19% 12.70% Commercial and industrial - secured by real estate .......... 23.89% 29.45% 28.63% 28.98% 25.15% Real Estate - mortgage ......................................... 28.45% 32.40% 30.48% 27.78% 28.64% Real estate - construction ..................................... 32.07% 19.45% 18.61% 19.34% 22.63% Consumer loans ................................................. 5.08% 6.52% 7.33% 9.71% 10.88% ------ ------ ------ ------ ------ Total ..................................................... 100.00% 100.00% 100.00% 100.00% 100.00%
The following is a presentation of an analysis of maturities of loans as of December 31, 2005:
Loan Maturity and Interest Sensitivity (dollars in thousands) Due After 1 Due in 1 Year up to Due after Type of Loans Year or less 5 years 5 years Total ------------- ------------ ------- ------- ----- Commercial and Industrial ........ $ 18,553 $ 18,134 $ 2,984 $ 39,669 Real Estate ...................... 155,482 137,675 25,475 318,632 Consumer Loans ................... 4,438 11,855 2,901 19,194 -------------- -------------- -------------- -------------- Total ........................ $ 178,472 $ 167,664 $ 31,359 $ 377,495
All loans are recorded according to contractual terms, and demand loans, overdrafts, and loans having no stated repayment terms or maturity are reported as due in one year or less. At December 31, 2005, the amount of loans due after one year with predetermined interest rates totaled approximately $4,538,000 while the amount of loans due after one year with floating interest rates totaled approximately $194,485,000. 13 The following table presents information on non-performing loans and real estate acquired in settlement of loans:
December 31, ------------ (dollars in thousands) Non-performing Assets 2005 2004 2003 2002 2001 --------------------- ---- ---- ---- ---- ---- Non-performing loans: Non-accrual loans ................................... $ 1,206 $ 670 $ 829 $ 926 $ 993 Past due 90 days or more ............................ 10 838 122 5 - Other restructured loans ............................ 922 - - - 8 ---------- ---------- ---------- ---------- ---------- Total non-performing loans ............................ 2,138 1,508 951 931 1,001 Real estate acquired in settlement of loans ................................. 2,007 756 517 193 950 ---------- ---------- ---------- ---------- ---------- Total non-performing assets ........................... $ 4,145 $ 2,264 $ 1,468 $ 1,124 $ 1,951 ========== ========== ========== ========== ========== Non-performing assets as a Percentage of loans and other real estate ................................... 1.09% 0.69% 0.49% 0.37% 0.77% Allowance for loan losses as a percentage of non- performing loans .................................... 180% 245% 362% 306% 229%
In an effort to more accurately reflect the status of the Company's loan portfolio, accrual of interest is discontinued on a loan that displays certain problem indications which might jeopardize full and timely collection of principal and/or interest. The Company's Loan Policy drives the administration of problem loans. Loans are monitored through continuing review by credit managers, monthly reviews of exception reports, and ongoing analysis of asset quality trends, economic and business factors. Credit management activities, including specific reviews of new large credits, are reviewed by the Directors' Loan Committees of each banking subsidiary, which meet monthly. With respect to the loans accounted for on a non-accrual basis and restructured loans, the gross interest income that would have been recorded if the loans had been current in accordance with their original terms and outstanding throughout the period or since origination amounts to $89,000 for the year ended December 31, 2005. The interest on those loans that was included in net income for 2005 amounts to $22,000. As of December 31, 2005, there were no potential problem loans classified for regulatory purposes as doubtful, substandard or special mention that have not been disclosed above, which (i) represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources of the Company, or (ii) represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms. The Company accounts for impaired loans in accordance with Statement of Financial Accounting Standards ("SFAS") No. 114 "Accounting by Creditors for Impairment of a Loan." A loan is impaired when, based on current information and events, it is probable a creditor will be unable to collect all amounts due (interest as well as principal) according to the contractual terms of the loan 14 agreement. Under Statement No. 114, a loan is also impaired when its original terms are modified in a troubled debt restructuring. SFAS No. 114, as amended by SFAS No. 118, requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, the market price of the loan, if available, or the underlying collateral values as defined in the pronouncement. The Company complies with the provisions of SFAS No. 114, as necessary, when determining the adequacy of the allowance for loan losses. When the ultimate collectibility of an impaired loan's principal is in doubt, wholly or partially, all cash receipts are applied to principal. When this doubt does not exist, cash receipts are applied under the contractual terms of the loan agreement. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to interest income, to the extent that any interest has been foregone. Further cash receipts are recorded as recoveries on any amounts previously charged off. There were no impaired loans at each of December 31, 2005 and December 31, 2004. 15 PROVISION AND ALLOWANCE FOR LOAN LOSSES, LOAN LOSS EXPERIENCE The purpose of the Company's allowance for loan losses is to absorb loan losses that occur in the loan portfolios of its bank subsidiaries. Management determines the adequacy of the allowance quarterly and considers a variety of factors in establishing a level of the allowance for losses and the related provision, which is charged to expense. Factors considered in determining the adequacy of the allowance for loan losses include: historical loan losses experienced by the Company, current economic conditions affecting a borrower's ability to repay, the volume of outstanding loans, the trends in delinquent, non-accruing and potential problem loans, and the quality of collateral securing non-performing and problem loans. By considering the above factors, management attempts to determine the amount of reserves necessary to provide for inherent losses in the loan portfolios of its subsidiaries. However, the amount of reserves may change in response to changes in the financial condition of larger borrowers, changes in the Company's local economies and expected industry trends. The allowance for loan losses for each portfolio segment is set at an amount that reflects management's best judgment of the extent to which historical loss levels are more or less accurate indicators of current losses in the loan portfolios of its bank subsidiaries. While it is the Company's policy to charge off in the current period loans in which a loss is considered probable, there are inherent losses that cannot be quantified precisely or attributed to particular loans or classes of loans. Because the state of the economy, industry trends, and conditions affecting individual borrowers may affect the amount of such losses, management's estimate of the appropriate amount of the allowance is necessarily approximate and imprecise. The Company and its bank subsidiaries are also subject to regulatory examinations and determinations as to adequacy of the allowance for loan losses, which may take into account such factors as the methodology used to calculate the allowance for loan losses and the size of the allowance for loan losses in comparison to a group of peer companies identified by the regulatory agencies. In assessing the adequacy of the allowance, management relies predominantly on its ongoing review of the loan portfolio, including historical charge-offs, which is undertaken both to ascertain whether there are probable losses that must be charged off and to assess the risk characteristics of the portfolio in the aggregate. The Company utilizes its credit administration department, as well as the services of an outside consultant from time to time, to perform quality reviews of its loan portfolio. The review considers the judgments and estimates of management and also those of bank regulatory agencies that review the loan portfolio as part of their regular examination process. The Comptroller of the Currency, as part of its routine examination process of national banks, including the Company's Banks, may require additions to the allowance for loan losses based upon the regulators' credit evaluations differing from those of management. The Company's management believes they have in place the controls and personnel to adequately monitor its loan portfolios and the adequacy of the allowance for loan losses. 16 Management does not segregate the allowance by loan category and the entire allowance is available to absorb losses from all loan categories. At December 31, 2005 the allowance for loan losses was $3,854,000, or 1.02% of gross outstanding loans, compared to $3,691,000, or 1.13% of gross outstanding loans at December 31, 2004. During 2005, the Company experienced net charge-offs of $685,000, or 0.19% of average loans, compared to net charge-offs of $336,000, or 0.11% of average loans during 2004. Consumer loan net charge-offs were $168,000 in 2005 compared to net charge-offs of $61,000 in 2004. Commercial loan net charge-offs were $31,000 in 2005 compared to net charge-offs of $166,000 in 2004. Mortgage loan net charge-offs were $486,000 in 2005 compared to net charge-offs of $109,000 in 2004. The Company made provisions for loan losses of $848,000 in fiscal 2005 compared to $589,000 for fiscal 2004. The increased provision was attributable to the increase in net loans charged off. Management continues to closely monitor the levels of non-performing and potential problem loans and will address the weaknesses in these credits to enhance the amount of ultimate collection or recovery on these assets. Should increases in the overall level of non-performing and potential problem loans accelerate from the current trend, management intends to adjust the methodology for determining the allowance for loan losses and will increase the provision and allowance for loan losses. This would likely decrease net income. The following table summarizes the allowance for loan loss balances of the Company at the beginning and end of each period, changes in the allowance arising from charge-offs and recoveries by category and additions to the allowance, which have been charged to expense. Analysis of the Allowance for Loan Losses (dollars in thousands)
Year Ended December 31, ----------------------- 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- Balance at beginning of year .................................... $ 3,691 $ 3,438 $ 2,850 $ 2,288 $ 2,023 Charge-offs: Commercial and industrial - not secured by real estate ...... 32 212 28 277 406 Commercial and industrial - secured by real estate ............. 26 0 33 0 53 Real estate - mortgage ............................................ 327 169 358 47 67 Real estate - construction ........................................ 141 0 0 0 0 Consumer loans .................................................... 178 67 146 86 129 ---------- ---------- ---------- ---------- ----------- 704 448 565 410 655 ---------- ---------- ---------- ---------- ----------- Recoveries: Commercial and industrial - not secured by real estate ........ 1 46 8 5 3 Commercial and industrial - secured by real estate ............. 0 0 0 2 0 Real estate - mortgage ............................................ 8 60 3 4 1 Real estate - construction ........................................ 0 0 0 0 0 Consumer loans .................................................... 10 6 36 17 24 ---------- ---------- ---------- ---------- ----------- 19 112 47 28 28 ---------- ---------- ---------- ---------- ----------- Net Charge-offs ................................................... 685 336 518 382 627 Provision for loan losses ......................................... 848 589 1,106 944 892 ---------- ---------- ---------- ---------- ----------- Balance at end of year ............................................ $ 3,854 $ 3,691 $ 3,438 $ 2,850 $ 2,288 ========== ========== ========== ========== ===========
17 The following table sets forth ratios of net charge-offs or the allowance for loan losses to the items stated: Asset Quality Ratios:
Year Ended December 31, ----------------------- 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- Net charge-offs to average loans outstanding during the year ........................ 0.19% 0.11% 0.19% 0.17% 0.32% Net charge-offs to total loans outstanding at end of year ........................ 0.18% 0.10% 0.17% 0.15% 0.34% Allowance for loan losses to average loans ............ 1.09% 1.18% 1.25% 1.24% 1.16% Allowance for loan losses to total loans at end of year ........................ 1.02% 1.13% 1.16% 1.14% 1.08% Net charge-offs to allowance for loan losses at end of year ........................ 17.77% 9.10% 15.07% 13.40% 27.40% Net charge-offs to provision for loan losses ....................................... 80.78% 57.05% 46.84% 40.47% 70.29%
The allowance for loan losses is increased by direct charges to operating expense through the provision for loan losses. Losses on loans are charged against the allowance in the period in which management determines it is more likely than not that the full amounts of such loans have become uncollectable. Recoveries of previously charged-off loans are credited to the allowance. Management considers the allowance for loan losses adequate to cover inherent losses on the loans outstanding at December 31, 2005. In the opinion of management, there are no material risks or significant loan concentrations in the present portfolio. It must be emphasized, however, that the determination of the allowance for loan losses using the Company's procedures and methods rests upon various judgments, estimates and assumptions about present and future economic conditions and other factors affecting loans. No assurance can be given that the Company will not sustain loan losses in any particular period which are sizable in relation to the amount reserved or that subsequent evaluation of the loan portfolio, in light of conditions and factors then prevailing, will not require significant changes in the allowance for loan losses or future charges to earnings. The allowance for loan losses is also subject to review and approval by various regulatory agencies through their periodic examinations of the Company's subsidiaries. Such examinations could result in required changes to the allowance for loan losses. INVESTMENTS The Company invests primarily in obligations of the United States or obligations guaranteed as to principal and interest by the United States, other taxable securities and in certain obligations of states and municipalities. The Banks enter into federal funds transactions with their principal correspondent banks and usually act as net sellers of such funds. The sale of federal funds amounts to a short-term loan from the selling bank to the other bank. 18 The following table summarizes the book and market values of investment securities held by the Company at December 31, 2005, 2004 and 2003.
Securities Portfolio Composition (dollars in thousands) 2005 2004 2003 ---- ---- ---- Amortized Market Amortized Market Amortized Market Cost Value Cost Value Cost Value ---- ----- ---- ----- ---- ----- AVAILABLE FOR SALE Obligations of U.S. Government Agencies and Corporations ................... $66,303 $65,009 $62,749 $62,052 $78,620 $78,714 State and Political Subdivisions ............... - - - - - - ------- ------- ------- ------- ------- ------- Total Available for Sale ....................... 66,303 65,009 62,749 62,052 78,620 78,714 ------- ------- ------- ------- ------- ------- HELD TO MATURITY State and Political Subdivisions ............... 10,855 10,674 7,386 7,451 5,632 5,752 ------- ------- ------- ------- ------- ------- Other Investments .............................. 2,197 2,197 1,809 1,809 2,147 2,147 ------- ------- ------- ------- ------- ------- Total ................................. $79,355 $77,880 $71,944 $71,312 $86,399 $86,613 ======= ======= ======= ======= ======= =======
The Company accounts for investments in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Investments classified as available for sale are carried at market value. Unrealized holding gains or losses are reported as a component of shareholders' equity net of deferred income taxes in comprehensive income. Securities classified as held for investment are carried at cost, adjusted for the amortization of premiums and the accretion of discounts. In order to qualify as held for investment, the Company must have the ability and intent to hold the securities to maturity. The Company has no trading securities. At December 31, 2005 the Company's total investment portfolio classified as available for sale had a book value of $66,303,000 and a market value of $65,009,000 for an unrealized net loss of $1,294,000. The changes in the market valuation of the investment portfolio were directly related to the changes in market interest rates during the year and not the credit quality of the issuer and therefore, these losses are not considered other-than-temporary. Management believes that maintaining most of its securities in the available-for- sale category provides greater flexibility in the management of the overall investment portfolio. The Company has the ability and intent to hold these securities until the value recovers or the securities mature. 19 The following table indicates the respective maturities and weighted-average yields of securities as of December 31, 2005:
Securities Maturity Schedule (dollars in thousands) Amortized Weighted Cost Average Yield** ---- --------------- AVAILABLE FOR SALE Obligations of U.S. Treasury and other Government agencies: 0-1 Year .................................................. $ 37,949 2.24% 1-5 Years ................................................. 11,133 3.11% 5-10 Years ................................................ 12,124 4.05% Greater than 10 Years ..................................... 5,097 4.64% ------------- $ 66,303 2.90% ============= HELD TO MATURITY State and political subdivisions: 0-1 Year .................................................. $ 160 6.74%* 1-5 Years ................................................. 3,800 4.11%* 5-10 Years ................................................ 4,546 3.93%* Greater than 10 Years ..................................... 2,349 4.60%* ------------- Total ............................................ $ 10,855 4.18%* =============
* Yield adjusted to a fully taxable equivalent basis using a federal tax rate of 34%. ** Weighted average yields on available for sale securities are based on amortized cost. DEPOSITS The Company offers a full range of interest-bearing and noninterest-bearing accounts, including commercial and retail checking accounts, negotiable orders of withdrawal ("NOW") accounts, public funds accounts, money market accounts, individual retirement accounts, including Keogh plans with stated maturities, regular interest-bearing statement savings accounts and certificates of deposit with fixed rates and a range of maturity date options. The sources of deposits are residents, businesses and employees of businesses within the Company's market areas obtained through the personal solicitation of the Company's officers and directors, direct mail solicitations and advertisements published in the local media. From time to time the Company garners deposits from sources outside of its normal trade areas through the Internet or through brokers. These deposits are short-term in nature and are used to manage the Company's short-term liquidity position. These brokered deposits are generally more volatile than deposits acquired in the local market areas. There were no Internet deposits at December 31, 2005 and December 31, 20 2004. There were no brokered deposits at December 31, 2005 and December 31, 2004. During 2005 and 2004 the Company reduced its dependence on these nontraditional deposits, replacing them with core deposits obtained through several market area deposit gathering campaigns. The Company pays competitive interest rates on interest checking, savings, money market, time and individual retirement accounts. In addition, the Banks have implemented a service charge fee schedule competitive with other financial institutions in the Banks' market areas, covering such matters as maintenance fees on checking accounts, per item processing fees on checking accounts, returned check charges and the like. The Company's average deposits in 2005 were $381,749,000 compared to $352,754,000 the prior year, an increase of $28,995,000 or 8.2%. In 2005 the average noninterest-bearing deposits increased approximately $3,069,000 or 6.4%, average interest-bearing checking accounts increased $8,885,000 or 20.7%, average savings accounts increased $925,000 or 8.5%, average money market accounts decreased $5,854,000 or 10.9%, average certificates of deposit increased $19,394,000 or 11.3%, and individual retirement accounts increased $2,576,000 or 10.3%. Competition for deposit accounts is primarily based on the interest rates paid, service charge structure, location convenience and other services offered. The following table presents, for the years ended December 31, 2005, 2004 and 2003, the average amount of, and average rate paid on, each of the following deposit categories:
Deposit Category Average Amount Average Rate Paid ---------------- -------------- ----------------- (dollars in thousands) 2005 2004 2003 2005 2004 2003 ---- ---- ---- ---- ---- ---- Noninterest-bearing Deposits ............. $ 50,864 $ 47,795 $ 50,352 - - - Interest-bearing Deposits Interest Checking .................... 51,802 42,917 37,650 0.26% 0.21% 0.40% Savings Deposits ..................... 11,870 10,945 9,513 0.22% 0.16% 0.45% Money Market ......................... 47,881 53,735 61,048 1.44% 0.75% 1.23% Certificates of Deposit .............. 191,677 172,283 171,155 3.18% 2.62% 2.96% Individual Retirement Accounts ....... 27,655 25,079 23,500 3.53% 3.25% 3.59%
The Company's core deposit base consists of consumer time deposits less than $100,000, savings accounts, NOW accounts, money market accounts and checking accounts. Although such core deposits are becoming increasingly interest-sensitive for both the Company and the industry as a whole, such core deposits continue to provide the Company with a large and stable source of funds. Core deposits as a percentage of average total deposits averaged approximately 77% in 2005 compared to approximately 75% in 2004. The Company closely monitors its reliance on certificates of deposits greater than $100,000, which are generally considered less stable and less reliable than core deposits. However, local customers hold virtually all of these certificates of deposit over $100,000. The following table indicates amounts outstanding of time certificates of deposit of $100,000 or more and respective maturities as of December 31, 2005: Time Certificates of Deposit ---------------------------- (dollars in thousands) 3 months or less .................. $ 19,574 4-6 months ........................ 10,104 7-12 months ....................... 22,335 Over 12 months .................... 47,242 ---------- Total .................... $ 99,255 ========== 21 RETURN ON EQUITY AND ASSETS Returns on average consolidated assets and average consolidated equity for the years ended December 31, 2005, 2004 and 2003 are as follows:
2005 2004 2003 ----- ----- ----- Return on average assets ..................... 0.88% 0.82% 1.18% Return on average equity ..................... 10.20% 9.45% 14.52% Average equity to average assets ratio ....... 8.66% 8.66% 8.13% Dividend payout ratio (1) .................... 28.97% 30.36%(2) 19.96%
(1) Includes cash-in-lieu of fractional shares paid on 5% stock dividend. (2) Includes cash-in-lieu of fractional shares paid on 3-for-2 stock split. SHORT-TERM BORROWINGS The following table summarizes the Company's short-term borrowings for the years ended December 31, 2005, 2004 and 2003. These borrowings consist of federal funds purchased and securities sold under agreements to repurchase, which generally mature on a one-business-day basis.
Weighted Maximum Weighted Average Outstanding Annual Average Interest at any Average Interest Year End Rate at Year Ended December 31, Month End Balance Rate Balance Year End ----------------------- --------- ------- ---- ------- -------- (dollars in thousands) 2005: Federal funds purchased ........................... $ 4,039 $ 640 4.77% $ 4,039 4.57% Securities sold under repurchase agreements ....... $ 34,757 $ 31,594 1.94% $ 31,736 2.03% 2004: Federal funds purchased ........................... $ 1,854 $ 345 2.30% $ 572 2.64% Securities sold under repurchase agreements ....... $ 36,243 $ 31,479 1.07% $ 33,953 1.57% 2003: Federal funds purchased ........................... $ 1,579 $ 152 2.99% $ - 1.37% Securities sold under repurchase agreements ....... $ 33,035 $ 28,783 1.34% $ 24,390 0.94%
22 MARKET RISK - INTEREST RATE SENSITIVITY Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to a change in interest rates, exchange rates and equity prices. The Company's primary type of market risk is interest-rate risk. The primary objective of Asset/Liability Management at the Company is to manage interest-rate risk and achieve reasonable stability in net interest income throughout interest-rate cycles in order to maintain adequate liquidity. The Company seeks to achieve this objective by maintaining the proper balance of rate-sensitive earning assets and rate-sensitive liabilities. The relationship of rate-sensitive earning assets to rate-sensitive liabilities is the principal factor in projecting the effect that fluctuating interest rates will have on future net interest income. Rate-sensitive assets and rate-sensitive liabilities are those that can be repriced to current market rates within a relatively short time period. Management monitors the rate sensitivity of earning assets and interest-bearing liabilities over the entire life of these instruments, but places particular emphasis on the first year. Each of the Company's banking subsidiaries has established an Asset/Liability Management Committee. These committees use a variety of tools to analyze interest-rate sensitivity, including a static gap presentation and a simulation model. A static gap presentation reflects the difference between total interest-sensitive assets and liabilities within certain time periods. While the static gap is a widely used measure of interest rate sensitivity, it is not, in management's opinion, the best indicator of a company's true sensitivity position. Accordingly, the Company's banking subsidiaries also use an earnings simulation model that estimates the variations in interest income under different interest-rate environments to measure and manage the bank's short-term interest-rate risk. According to the model, as of December 31, 2005 the Company was positioned so that net interest income would increase $738,000 in the next twelve months if market interest rates were to gradually rise by 100 basis points over the same period. Conversely, net interest income would decline $772,000 in the next twelve months if interest rates were to gradually decline by 100 basis points. Computation of prospective effects of hypothetical interest-rate changes are based on numerous assumptions, including relative levels of market interest rates and loan prepayment, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions the Company and its customers could undertake in response to changes in interest rates. Additionally, each of the Company's banking subsidiaries measures anticipated changes in its economic value of equity in order to ascertain its long-term interest rate risk. This is done by calculating the difference between the theoretical market value of the bank's assets and liabilities and subjecting the balance sheet to different interest-rate environments to measure and manage long-term interest rate risk. It is the responsibility of the Asset/Liability Committees to establish parameters for various interest risk measures, to set strategies to control 23 interest rate risk within those parameters, to maintain adequate and stable net interest income, and to direct the implementation of tactics to facilitate achieving their objectives. Management is not aware of any known events or uncertainties that are expected to have or are reasonably likely to have a material effect on the Company's liquidity, capital resources or results of operations. Management is not aware of any current recommendations by the regulatory authorities, which if they were to be implemented, would have a material effect on the Company's liquidity, capital resources or results of operations. LIQUIDITY Liquidity management involves meeting the cash flow requirements of the Company. The Company's liquidity position is primarily dependent upon its need to respond to short-term demand for funds caused by withdrawals from deposit accounts and upon the liquidity of its assets. The Company's primary liquidity sources include cash and due from banks, federal funds sold and "securities available for sale." In addition, the Company (through the Banks) has the ability, on a short-term basis, to borrow funds from the Federal Reserve System and to purchase federal funds from other financial institutions. At December 31, 2005 the Banks, in aggregate, had unused federal funds lines of credit totaling $26,711,000 with various correspondent banks. The Banks are also members of the Federal Home Loan Bank System and have the ability to borrow both short- and long-term funds on a secured basis. At December 31, 2005 The Peoples National Bank had $5,000,000 in long-term borrowings and $3,500,000 in short-term borrowings from the Federal Home Loan Bank of Atlanta. At December 31, 2005, The Peoples National Bank had unused borrowing capacity from the Federal Home Loan Bank of Atlanta of $45,550,000. At December 31, 2005, Bank of Anderson, N. A. had no long-term borrowings and $6,500,000 in short-term borrowings from the Federal Home Loan Bank of Atlanta. At December 31, 2005, Bank of Anderson, N. A. had unused borrowing capacity from the Federal Home Loan Bank of Atlanta of $9,400,000. Seneca National Bank had no long-term borrowings and $2,500,000 in short-term borrowings from the Federal Home Loan Bank of Atlanta at December 31, 2005. Seneca National Bank had unused borrowing capacity from the Federal Home Loan Bank of Atlanta of $2,800,000 at December 31, 2005. The Federal Home Loan Bank requires that investment securities, qualifying mortgage loans and stock of the Federal Home Loan Bank owned by the Banks be pledged to secure any advances from the Federal Home Loan Bank. The unused borrowing capacity currently available assumes that the Banks' $1,649,000 investment in Federal Home Loan Bank stock as well as certain securities and qualifying mortgages would be pledged to secure future borrowings. Management believes that it could obtain additional borrowing capacity from the Federal Home Loan Bank by identifying additional qualifying collateral that could be pledged. Peoples Bancorporation, Inc., the parent holding company, has limited liquidity needs outside of those of its subsidiaries. Peoples Bancorporation requires liquidity to pay limited operating expenses and cash dividends. The 24 parent company's liquidity needs are fulfilled through management fees assessed each subsidiary bank and from dividends passed up to the parent company from The Peoples National Bank. The Company plans to meet its future cash needs through the liquidation of temporary investments, maturities or sales of loans and investment securities, generation of deposits, and Federal Home Loan Bank advances. Company management believes its liquidity sources are adequate to meet its operating needs and does not know of any trends that may result in the Company's liquidity materially increasing or decreasing. OFF-BALANCE SHEET ARRANGEMENTS AND DERIVATIVE FINANCIAL INSTRUMENTS The Company, through the operations of the Banks, makes contractual commitments to extend credit in the ordinary course of its business activities. These commitments are legally binding agreements to lend money to customers of the Banks at predetermined interest rates for a specified period of time. At December 31, 2005 the Banks had issued commitments to extend credit of $111,082,000 through various types of arrangements, described further in the table below. The commitments generally expire in one year. Past experience indicates that many of these commitments to extend credit will expire not fully used. However, as described under LIQUIDITY, the Company believes that it has adequate sources of liquidity to fund commitments that are drawn upon by the borrowers.
December 31, 2005 ----------------- (dollars in thousands) Unused Commitments Lines of credit secured by residential properties ......... $ 40,469 Lines of credit secured by commercial properties .......... 44,986 Other unused commitments .................................. 25,627 ------------------- Total .................................................. $ 111,082 ===================
In addition to commitments to extend credit, the Banks also issue letters of credit, which are assurances to a third party that it will not suffer a loss if the bank's customer fails to meet its contractual obligation to the third party. At December 31, 2005, there was $6,742,000 committed under letters of credit. Past experience indicates that many of these letters of credit will expire unused. However, through its various sources of liquidity, the Company believes that it will have the necessary resources to meet these obligations should the need arise. Various types of collateral secure most of the letters of credit. The Company believes that the risk of loss associated with letters of credit is comparable to the risk of loss associated with its loan portfolio. Moreover, the fair value associated with any letters of credit issued by the Company is immaterial to the Company. 25 Until October 15, 2004 and in years prior the Company engaged in the origination, funding and sale of residential mortgage loans and entered into commitments on an individual loan basis to both originate and sell residential mortgage loans, whereby the interest rate on the loan to the borrower and to the end purchaser of the loan was determined prior to funding (rate lock commitments). Beginning October 16, 2004 the Company no longer engaged in the funding or selling of residential mortgage loans. The Company continues to originate residential mortgage loans, which are committed to and funded by unaffiliated third parties. Therefore, at December 31, 2005 and 2004 the Company had no commitments outstanding to originate residential mortgage loans under rate lock commitments and no commitments to sell mortgage loans to third parties under rate lock commitments. Neither the Company nor its subsidiaries are involved in any other off-balance sheet arrangements or transactions that could result in liquidity needs or other commitments or significantly impact earnings. The Company did not maintain any obligations under non-cancelable operating lease agreements at December 31, 2005. Refer to Note 11 and Note 12 of the Company's consolidated financial statements for discussion on commitments and contingencies and financial instruments with off-balance sheet risk. CAPITAL ADEQUACY AND RESOURCES The capital needs of the Company have been met through the retention of earnings and from the proceeds of prior public stock offerings. For bank holding companies with total assets of more than $150 million, such as the Company, capital adequacy is evaluated on a consolidated basis. The Company's banking subsidiaries must separately meet additional regulatory capital requirements. Generally, the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") expects bank holding companies to operate above minimum capital levels. The Office of the Comptroller of the Currency ("Comptroller") regulations establish the minimum leverage capital ratio requirement for national banks at 3% in the case of a national bank that has the highest regulatory examination rating and is not contemplating significant growth or expansion. All other national banks are expected to maintain a ratio of at least 1% to 2% above the stated minimum. Furthermore, the Comptroller reserves the right to require higher capital ratios in individual banks on a case-by-case basis when, in its judgment, additional capital is warranted by a deterioration of financial condition or when high levels of risk otherwise exist. The Banks have not been notified that they must maintain capital levels above regulatory minimums. 26 The Company and Banks capital ratios are presented as follows: December 31, ------------ 2005 2004 ----- ----- Peoples Bancorporation, Inc. Risk-based capital ratio .................... 11.93% 12.35% Tier 1 capital (to risk weighted assets) .... 10.93% 11.27% Tier 1 capital (to average assets) .......... 8.97% 8.92% Peoples National Bank Risk-based capital ratio .................... 11.58% 12.61% Tier 1 capital (to risk weighted assets) .... 10.69% 11.57% Tier 1 capital (to average assets) .......... 8.93% 9.10% Bank of Anderson Risk-based capital ratio .................... 10.68% 10.26% Tier 1 capital (to risk weighted assets) .... 9.53% 9.19% Tier 1 capital (to average assets) .......... 7.08% 7.21% Seneca National Bank Risk-based capital ratio .................... 12.53% 12.59% Tier 1 capital (to risk weighted assets) .... 11.30% 11.34% Tier 1 capital (to average assets) .......... 8.52% 9.11% The decreases in the Company's and Banks' leverage capital ratios resulted primarily from the growth in assets experienced during 2005. The Federal Reserve Board has adopted a risk-based capital rule that requires bank holding companies to have qualifying capital to risk-weighted assets of at least 8%, with at least 4% being "Tier 1" capital. Tier 1 capital consists principally of common shareholders' equity, non-cumulative preferred stock, qualifying perpetual preferred stock, and minority interests in equity accounts of consolidated subsidiaries, less goodwill and certain intangible assets. "Tier 2" (or supplementary) capital consists of general loan loss reserves (subject to certain limitations), certain types of preferred stock and subordinated debt, and certain hybrid capital instruments and other debt securities such as equity commitment notes. A bank holding company's qualifying capital base for purposes of its risk-based capital ratio consists of the sum of its Tier 1 and Tier 2 capital components, provided that the maximum amount of Tier 2 capital that may be treated as qualifying capital is limited to 100% of Tier 1 capital. The Comptroller imposes a similar standard on national banks. The regulatory agencies expect national banks and bank holding companies to operate above minimum risk-based capital levels. (See "Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operation"). PAYMENT OF DIVIDENDS Payment of dividends by the Company is within the discretion of its Board of Directors subject to certain regulatory requirements. The Company's primary sources of funds with which to pay dividends to shareholders are the dividends it receives from its subsidiary banks. In 2005 The Peoples National 27 Bank paid dividends of $1,187,000 to the Company, which in turn paid those dividends to its shareholders, compared to $1,051,000 in 2004. Bank of Anderson and Seneca National Bank paid no dividends to the Company in 2005 or 2004. Payment of dividends by the Banks is subject to regulatory restrictions. If a national bank's surplus fund equals the amount of its capital stock, the directors may declare quarterly, semi-annual or annual dividends out of the bank's net profits, after deduction of losses and bad debts. If the surplus fund does not equal the amount of capital stock, a dividend may not be paid until one-tenth of the bank's net profits of the preceding half year, in the case of quarterly or semi-annual dividends, or the preceding two years, in the case of an annual dividend, are transferred to the surplus fund. The approval of the Comptroller is required if the total of all dividends declared by a national bank in any calendar year will exceed the total of its retained net profits of that year combined with its retained net profits for the preceding two years, less any required transfers to surplus or a fund for the retirement of any preferred stock. The Comptroller's regulations provide that provisions for possible credit losses cannot be added back to net income and charge-offs cannot be deducted from net income in calculating the level of net profits available for the payment of dividends. The payment of dividends by the Banks may also be affected or limited by other factors, such as the requirements to maintain adequate capital above regulatory guidelines. If, in the opinion of the Comptroller, a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), the Comptroller may require, after notice and hearing, that such bank cease and desist from such practice. The Comptroller has indicated that paying dividends that deplete a national bank's capital base to an inadequate level would be an unsafe and unsound banking practice. The Federal Reserve, the Comptroller and the FDIC have issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings. MONETARY POLICIES AND EFFECT OF INFLATION The earnings of bank holding companies are affected by the policies of regulatory authorities, including the Federal Reserve Board, in connection with its regulation of the money supply. Various methods employed by the Federal Reserve Board include open market operations in U. S. Government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These methods are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may also affect interest rates charged on loans or paid on deposits. The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. 28 The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and results of operations in terms of historical dollars, without consideration of changes in the relative purchasing power over time due to inflation. Unlike companies in most other industries, virtually all of the assets and liabilities of financial institutions are monetary in nature. As a result, interest rates generally have a more significant effect on a financial institution's performance than does the effect of inflation. Interest rates do not necessarily change in the same magnitude as do the prices of goods and services. While the effect of inflation on banks is normally not as significant as is its influence on those businesses that have large investments in plant and inventories, it does have some effect. During periods of high inflation, there are normally corresponding increases in the money supply, and banks will normally experience above-average growth in assets, loans and deposits. Also, general increases in the prices of goods and services will result in increased operating expenses. Inflation that affects the Banks' customers may also have an indirect affect on the Banks. CORRESPONDENT BANKING Correspondent banking involves the provision of services by one bank to another bank, which cannot provide that service for itself, or chooses not to, from an economic, regulatory or practical standpoint. The Banks purchase correspondent services offered by larger banks, including check collections, the sale and purchase of federal funds, security safekeeping, investment services, over-line and liquidity loan participations and sales of loans to or participations with correspondent banks. The Banks have the option to sell loan participations to correspondent banks with respect to loans that exceed the Banks' lending limits. Management of the Banks has established correspondent banking relationships with Wachovia Bank, N. A., Charlotte, North Carolina; The Bankers Bank, Atlanta, Georgia; and Community Bankers Bank, Midlothian, Virginia. As compensation for services provided by correspondents, the Banks may maintain certain balances with such correspondents in non-interest bearing accounts. DATA PROCESSING The Company has a data-processing department, which performs a full range of data-processing services for the Banks. Such services include an automated general ledger, deposit accounting, loan accounting and data processing. 29 SUPERVISION AND REGULATION The Company and the Banks operate in a highly regulated environment, and their business activities are governed by statute, regulation and administrative policies. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to such statutes and regulations. Any change in applicable law or regulation may have a material effect on the business of the Company and the Banks. General The business activities of the Company and Banks are closely supervised by a number of federal regulatory agencies, including the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"), the Comptroller of the Currency (the "Comptroller") and the Federal Deposit Insurance Corporation (the "FDIC"). As a bank holding company, the Company is required to file with the Federal Reserve Board an annual report of its operations at the end of each fiscal year and such additional information as the Federal Reserve Board may require pursuant to the Bank Holding Company Act. The Federal Reserve Board may also make examinations of the Company and any subsidiaries. The Company is regulated by the Federal Reserve Board under the Federal Bank Holding Company Act of 1956, as amended (the "BHCA"). Under the BHCA, a bank holding company is generally prohibited from acquiring control of any company that is not a bank and from engaging in any business other than the business of banking or managing and controlling banks. However, there are certain activities which have been identified by the Federal Reserve Board to be so closely related to banking as to be a proper incident thereto, and are thus permissible for bank holding companies, including the following activities: acting as an investment or financial advisor to subsidiaries and certain outside companies; leasing personal and real property or acting as a broker with respect thereto; providing management consulting advice to nonaffiliated banks and non-bank depository institutions; operating collection agencies and credit bureaus; acting as a futures commission merchant; providing data processing and data transmission services; acting as an insurance agent or underwriter with respect to limited types of insurance; performing real estate appraisals; arranging commercial real estate equity financing; providing securities brokerage services; and underwriting and dealing in obligations of the United States, the states and their political subdivisions. The BHCA also requires every bank holding company to obtain the prior approval of the Federal Reserve Board before acquiring more than 5% of the voting shares of any bank or all or substantially all of the assets of a bank, and before merging or consolidating with another bank holding company. As discussed below under the caption "Gramm-Leach-Bliley Act," Congress has adopted extensive changes in the laws governing the financial services industry. Among the changes adopted are creation of the financial holding company, a new type of bank holding company with powers that greatly exceed 30 those of standard holding companies, and creation of the financial subsidiary, a subsidiary that can be used by national banks to engage in many, though not all, of the same activities in which a financial holding company may engage. Although the Company elected to become a financial holding company as of June 23, 2000, neither the Company nor the Banks has yet made a decision as to how to adapt this legislation to their use. Accordingly, the following discussion relates to the supervisory and regulatory provisions that apply to the Company and the Banks as they currently operate. The Company also is subject to limited regulation by the South Carolina State Board of Financial Institutions (the "State Board"). Consequently, the Company must give notice to, or receive the approval of, the State Board pursuant to applicable law and regulations prior to engaging in the acquisition of South Carolina banking institutions or holding companies. The Company also may be required to file with the State Board periodic reports with respect to its financial condition and operation, management and inter-company relations between the Company and its subsidiaries. Obligations of the Company to its Subsidiary Banks A number of obligations and restrictions are imposed on bank holding companies and their depository institution subsidiaries by Federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance funds in the event the depository institution is in danger of becoming insolvent or is insolvent. For example, under the policy of the Federal Reserve, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such policy. In addition, the "cross-guarantee" provisions of the Federal Deposit Insurance Act, as amended ("FDIA"), require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by either the Savings Association Insurance Fund ("SAIF") or the Bank Insurance Fund ("BIF") of the FDIC as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default. The FDIC may decline to enforce the cross-guarantee provisions if it determines that a waiver is in the best interest of the SAIF or the BIF or both. The FDIC's claim for damages is superior to claims of shareholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institutions. The FDIA also provides that amounts received from the liquidation or other resolution of any insured depository institution by any receiver must be distributed (after payment of secured claims) to pay the deposit liabilities of the institution prior to payment of any other general or unsecured senior liability, subordinated liability, general creditor or shareholder. This provision gives depositors a preference over general and subordinated creditors and shareholders in the event a receiver is appointed to distribute the assets of any of the Banks. 31 Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment. Certain Transactions by the Company with its Affiliates Federal law regulates transactions among the Company and its affiliates, including the amount of the Banks' loans to or investments in nonbank affiliates and the amount of advances to third parties collateralized by securities of an affiliate. Further, a bank holding company and its affiliates are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. Capital Adequacy Guidelines for Bank Holding Companies and National Banks Both the Company and the Banks are subject to regulatory capital requirements imposed by the Federal Reserve Board and the Comptroller (see "CAPITAL ADEQUACY AND RESOURCES"). Failure to meet capital guidelines could subject the Banks to a variety of enforcement remedies, including the termination of deposit insurance by the FDIC and placing the Banks in receivership. A joint rule promulgated by the Federal Reserve Board, the FDIC and the Comptroller provides that the banking agencies must include in their evaluations of a bank's capital adequacy an assessment of the exposure to declines in the economic value of the bank's capital due to changes in interest rates. The agencies have issued statements that describe the process the banking agencies will use to measure and assess the exposure of a bank's net economic value to changes in interest rates. Another joint rule promulgated by the financial institution regulators further provides that the risk-based capital guidelines must take account of concentration of credit risk and the risk of non-traditional activities. The rule explicitly identifies concentration of credit risk and the risk arising from other sources, as well as an institution's overall capital adequacy. Bank regulators continue to indicate their desire to raise capital requirements applicable to banking organizations beyond their current levels. However, management of the Company is unable to predict whether and when higher capital requirements would be imposed and, if so, at what levels and on what schedule. The Company and each of the Banks exceeded all applicable capital requirements at December 31, 2005. 32 Payment of Dividends The Company is a legal entity separate and distinct from the Banks. Most of the revenues of the Company are expected to continue to result from dividends paid to the Company by the Banks. There are statutory and regulatory requirements applicable to the payment of dividends by subsidiary banks as well as by the Company to its shareholders. See "PAYMENT OF DIVIDENDS." Regulation of the Banks As national banks, the Banks are subject to supervision by the Comptroller and, to a limited extent, the FDIC and the Federal Reserve Board. With respect to expansion, the Banks may establish branch offices anywhere within the State of South Carolina. In addition, the Banks are subject to various other state and federal laws and regulations, including state usury laws, laws relating to fiduciaries, consumer credit and laws relating to branch banking. The Banks' loan operations are subject to certain federal consumer credit laws and regulations promulgated thereunder, including, but not limited to; the federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers; the Home Mortgage Disclosure Act, requiring financial institutions to provide certain information concerning their mortgage lending; the Equal Credit Opportunity Act and the Fair Housing Act, prohibiting discrimination on the basis of certain prohibited factors in extending credit; and the Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies. The deposit operations of the Banks are subject to the Truth in Savings Act, requiring certain disclosures about rates paid on savings accounts; the Expedited Funds Availability Act, which deals with disclosure of the availability of funds deposited in accounts and the collection and return of checks by banks; the Right to Financial Privacy Act, which imposes a duty to maintain certain confidentiality of consumer financial records and the Electronic Funds Transfer Act and regulations promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers' rights and liabilities arising from the use of automated teller machines and other electronic banking services. The Banks are also subject to the Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies; the Bank Secrecy Act, dealing with, among other things, the reporting of certain currency transactions; and the USA Patriot Act, dealing with, among other things, requiring the establishment of anti-money laundering programs including standards for verifying customer information at account opening. The Banks are also subject to the requirements of the Community Reinvestment Act (the "CRA"). The CRA imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of their local communities, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions. Each financial institution's actual performance in meeting community credit needs is evaluated as part of the examination process, and also is considered in evaluating mergers, acquisitions and applications to open a branch or facility. 33 Loans and extensions of credit by national banks are subject to legal lending limitations. Under federal law, a national bank may grant unsecured loans and extensions of credit in an amount up to 15% of its unimpaired capital, surplus and allowance for loan losses to any person or entity. In addition, a national bank may grant loans and extensions of credit to a single person up to 10% of its unimpaired capital, surplus and allowance for loan losses, provided that the transactions are fully secured by readily marketable collateral having a market value determined by reliable and continuously available price quotations. This 10% limitation is separate from, and in addition to, the 15% limitation for unsecured loans. Loans and extensions of credit may exceed the general lending limits if they qualify under one of several exceptions. Such exceptions include, among others, certain loans or extensions of credit arising from the discount of commercial or business paper, the purchase of banker's acceptances, loans secured by documents of title, loans secured by U. S. obligations and loans to or guaranteed by the federal government. As national banks, the Banks are subject to examinations and reviews by the Comptroller. These examinations are typically completed on site, and the Banks are subject to off-site review as well. The Banks also submit to the FDIC quarterly reports of condition, as well as such additional reports as the national banking laws may require. FDIC Insurance Assessments The Banks are required to pay semiannual assessments to the FDIC. Since January 1997, the assessments imposed on all FDIC deposits for deposit insurance has an effective rate ranging from 0 to 27 basis points per $100 of insured deposits, depending on the institution's capital position and other supervisory factors. Legislation enacted in 1996 also requires that both SAIF-insured and BIF-insured deposits pay a pro rata portion of the interest due on the obligations issued by the Financing Corporation ("FICO"). The FICO assessment is adjusted quarterly to reflect changes in the assessment bases of the respective funds based on quarterly Call Report and Thrift Financial Report submissions. The Federal Deposit Insurance Reform Act of 2005 will change the manner and amount of insurance assessments beginning in 2006. The changes are not expected to have a material effect on the Banks in 2006. Other Safety and Soundness Regulations Prompt Corrective Action. The federal banking agencies have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institutions in question are "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." A bank that is "undercapitalized" becomes subject to provisions of the FDIA: restricting payment of capital distributions and management fees; requiring the FDIC to monitor the condition of the bank; prohibiting the acceptance of employee benefit plan deposits; requiring submission by the bank of a capital restoration plan; restricting the growth of the bank's assets and 34 requiring prior approval of certain expansion proposals. A bank that is "significantly undercapitalized" is also subject to restrictions on compensation paid to senior management of the bank, and a bank that is "critically undercapitalized" is further subject to restrictions on the activities of the bank and restrictions on payments of subordinated debt of the bank. The purpose of these provisions is to require banks with less than adequate capital to act quickly to restore their capital and to have the FDIC move promptly to take over banks that are unwilling or unable to take such steps. Brokered Deposits. Under current FDIC regulations, "well capitalized" banks may accept brokered deposits without restriction, "adequately capitalized" banks may accept brokered deposits with a waiver from the FDIC (subject to certain restrictions on payment of rates), while "undercapitalized" banks may not accept brokered deposits. The regulations provide that the definitions of "well capitalized", "adequately capitalized" and "undercapitalized" are the same as the definitions adopted by the agencies to implement the prompt corrective action provisions described in the previous paragraph. Interstate Banking Under the Riegel-Neal Interstate Banking and Branching Efficiency Act of 1994, the Company, and any other adequately capitalized bank holding company located in South Carolina can acquire a bank located in any other state, and a bank holding company located outside South Carolina can acquire any South Carolina-based bank, in either case subject to certain deposit percentages and other restrictions. The legislation also provides that in any state that has not previously elected to prohibit out-of-state banks from operating interstate branches within its territory, adequately capitalized and managed bank holding companies can consolidate their multi-state bank operations into a single bank subsidiary and branch interstate through acquisitions. De novo branching by an out-of-state bank is permitted only if the laws of the host state expressly permit it. The authority of a bank to establish, and operate branches within a state continue to be subject to applicable state branching laws. South Carolina law was amended effective July 1, 1996, to permit such interstate branching, but not de novo branching by an out-of-state bank. The Riegel-Neal Act, together with legislation adopted in South Carolina, resulted in a number of South Carolina banks being acquired by large out-of-state bank holding companies. Size gives the larger banks certain advantages in competing for business from larger customers. These advantages include higher lending limits and the ability to offer services in other areas of South Carolina and the region. As a result, the Company does not generally attempt to compete for the banking relationships of large corporations and businesses, but concentrates its efforts on small to medium-sized businesses and on individuals. The Company believes it has competed effectively in this market segment by offering quality, personal service. 35 Gramm-Leach-Bliley Act The Gramm-Leach-Bliley Act (the "Act"), which makes it easier for affiliations between banks, securities firms and insurance companies to take place, became effective in March 2000. The Act removes Depression-era barriers that had separated banks and securities firms, and seeks to protect the privacy of consumers' financial information. Under provisions of the legislation and regulations adopted by the appropriate regulators, banks, securities firms and insurance companies are able to structure new affiliations through a holding company structure or through a financial subsidiary. The legislation created a new type of bank holding company called a "financial holding company" which has powers much more extensive than those of standard holding companies. These expanded powers include authority to engage in "financial activities," which are activities that are (1) financial in nature; (2) incidental to activities that are financial in nature; or (3) complementary to a financial activity and that do not impose a safety and soundness risk. Significantly, the permitted financial activities for financial holding companies include authority to engage in merchant banking and insurance activities, including insurance portfolio investing. A bank holding company can qualify as a financial holding company and expand the services it offers only if all of its subsidiary depository institutions are well managed, well capitalized and have received a rating of "satisfactory" on their last Community Reinvestment Act examination. The legislation also created another new type of entity called a "financial subsidiary." A financial subsidiary may be used by a national bank or a group of national banks to engage in many of the same activities permitted for a financial holding company, though several of these activities, including real estate development or investment, insurance or annuity underwriting, insurance portfolio investing and merchant banking, are reserved for financial holding companies. A bank's investment in a financial subsidiary affects the way in which the bank calculates its regulatory capital, and the assets and liabilities of financial subsidiaries may not be consolidated with those of the bank. The bank must also be certain that its risk management procedures are adequate to protect it from financial and operational risks created both by itself and by any financial subsidiary. Further, the bank must establish policies to maintain the separate corporate identities of the bank and its financial subsidiary and to prevent each from becoming liable for the obligations of the other. The Act also established the concept of "functional supervision," meaning that similar activities should be regulated by the same regulator. Accordingly, the Act spells out the regulatory authority of the bank regulatory agencies, the Securities and Exchange Commission and state insurance regulators so that each type of activity is supervised by a regulator with corresponding expertise. The Federal Reserve Board is intended to be an umbrella supervisor with the authority to require a bank holding company or financial holding company or any subsidiary of either to file reports as to its financial condition, risk management systems, transactions with depository institution subsidiaries and affiliates, and compliance with any federal law that it has authority to enforce. 36 Although the Act reaffirmed that states are the regulators for insurance activities of all persons, including federally chartered banks, the Act prohibits states from preventing depository institutions and their affiliates from conducting insurance activities. The Act also established a minimum federal standard of privacy to protect the confidentiality of a consumer's personal financial information and gives the consumer the power to choose how financial institutions may use personal financial information. The privacy provisions of the Act have been implemented by regulations of various federal agencies. The Act and the regulations adopted pursuant to the Act create opportunities for the Company to offer expanded services to customers in the future. The Company elected to become a financial holding company effective June 23, 2000, but it has not yet used that status to engage in any activities that are not also permissible for bank holding companies. Furthermore, the Company has not yet determined what the nature of the expanded services it could offer might be or when the Company might find it feasible to offer them. The Act has increased competition from larger financial institutions that are currently more capable than the Company of taking advantage of the opportunity to provide a broader range of services. However, the Company continues to believe that its commitment to providing high quality, personalized service to customers will permit it to remain competitive in its market area. Sarbanes-Oxley Act of 2002 The Sarbanes-Oxley Act was signed into law on July 30, 2002, and mandated extensive reforms and requirements for public companies. The SEC has adopted extensive new regulations pursuant to the requirements of the Sarbanes-Oxley Act. The Sarbanes-Oxley Act and the SEC's new regulations have increased the Company's cost of doing business, particularly its fees for internal and external audit services and legal services, and the law and regulations are expected to continue to do so. However, the Company does not believe that it will be affected by Sarbanes-Oxley and the new SEC regulations in ways that are materially different or more onerous than those of other public companies of similar size and in similar businesses. Legislative Proposals Proposed legislation that could significantly affect the business of banking is introduced in Congress and the General Assembly of South Carolina from time to time. Management of the Company cannot predict the future course of such legislative proposals or their impact on the Company and the Banks should they be adopted. EMPLOYEES The Company and the Banks employed 129 full-time and 27 part-time persons as of December 31, 2005. Management believes that its employee relations are good. 37 EXECUTIVE OFFICERS The executive officers of the Company are R. Riggie Ridgeway, President and Chief Executive Officer; William B. West, Executive Vice President and Treasurer; Robert E. Dye, Jr., Senior Vice President, Chief Financial Officer and Secretary; and Patricia A. Jensen, Senior Vice President and Controller. In addition, L. Andrew Westbrook, III, is the President and Chief Executive Officer of the Company's two largest subsidiaries and, as such, is deemed to be an executive officer by the Board for 1934 Act reporting purposes. Information about all of the executive officers except Patricia A. Jensen, and L. Andrew Westbrook, III, is set forth in Item 10, Part III of this report on Form 10-K. Patricia A. Jensen, age 52, was promoted to Senior Vice President during 2003. Prior to that time, she served as Vice President of the Company since its formation in 1992. Mrs. Jensen has served as Vice President and Cashier of The Peoples National Bank since August 1986. She has also served as Cashier of Bank of Anderson, N.A. and Seneca National Bank since April 2005. Prior to joining The Peoples National Bank, Mrs. Jensen served as Vice President of First Union National Bank. L. Andrew Westbrook, III, age 43, has served as President and Chief Executive Officer of The Peoples National Bank since April 2005, and as President and Chief Executive Officer of Bank of Anderson, N. A., since January 2006. Prior to that, Mr. Westbrook served as Senior Vice President and City/Area Executive of Branch Banking & Trust Company (BB&T) in Greenville, South Carolina from 2002 to 2005 and Senior Vice President and City/Area Executive of BB&T in Spartanburg, South Carolina from 1993 to 2002. Mr. Westbrook serves as a Director of The Peoples National Bank and Bank of Anderson, N. A. AVAILABLE INFORMATION The Company electronically files with the Securities and Exchange Commission ("SEC") its annual reports on Form 10-K, its quarterly reports on Form 10-Q, its periodic reports on Form 8-K, amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 (the "1934 Act"), and proxy materials pursuant to Section 14 of the 1934 Act. The SEC maintains a site on the Internet at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The Company also makes its filings available, free of charge, upon written request to Ms. Patricia A. Jensen, Senior Vice President, Peoples Bancorporation, Inc., 1818 East Main Street, Easley, South Carolina 29640. 38 ITEM 1 A. RISK FACTORS Risks Related to Our Business We depend on the services of a number of key personnel, and a loss of any of those personnel could disrupt our operations and result in reduced revenues. The success of our business depends to a great extent on our customer relationships. Our growth and development to date have depended in large part on the efforts of our senior management team. A number of these senior officers have primary contact with our customers and are extremely important in maintaining personalized relationships with our customer base, a key aspect of our business strategy, and in increasing our market presence. The unexpected loss of services of one or more of these key employees could have a material adverse effect on our operations and possibly result in reduced revenues if we were unable to find suitable replacements promptly. We may be unable to successfully manage our sustained growth. Our future profitability will depend in part on our ability to manage growth successfully. Our ability to manage growth successfully will depend on our ability to maintain cost controls and asset quality while attracting additional loans and deposits, as well as on factors beyond our control, such as economic conditions and interest rate trends. If we grow too quickly and are not able to control costs and maintain asset quality, growth could materially adversely affect our financial performance. Our continued pace of growth or regulatory requirements may require us to raise additional capital in the future, but that capital may not be available when it is needed or be available on favorable terms. We anticipate that our current capital resources will satisfy our capital requirements for the foreseeable future. Nevertheless, we may need to raise additional capital to support additional growth or to meet regulatory requirements. Our ability to raise additional capital, if needed, will depend, among other things, on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance. If we cannot raise additional capital on acceptable terms when needed, our ability to further expand our operations through internal growth and acquisitions could be limited. If our loan customers do not pay us as they have contracted to, we may experience losses. Our principal revenue producing business is making loans. If the loans are not repaid, we will suffer losses. Even though we maintain an allowance for loan losses, the amount of the allowance may not be adequate to cover the losses we experience. We attempt to mitigate this risk by a thorough review of the creditworthiness of loan customers. Nevertheless, there is risk that our credit evaluations will prove to be inaccurate due to changed circumstances or otherwise. 39 Our business is concentrated in the Upstate area of South Carolina, and a downturn in the economy of the area, a decline in area real estate values or other events in our market area may adversely affect our business. Substantially all of our business is located in the Upstate area of South Carolina. As a result, our financial condition and results of operations may be affected by changes in the Upstate economy. A prolonged period of economic recession, a general decline in real estate values in our market area or other adverse economic conditions in the Upstate and South Carolina may result in decreases in demand for our services, increases in nonpayment of loans and decreases in the value of collateral securing loans, which could have a material adverse effect on our business, future prospects, financial condition or results of operations. We face strong competition from larger, more established competitors, which may adversely affect our ability to operate profitably. We encounter strong competition from financial institutions operating in the Upstate area of South Carolina. In the conduct of our business, we also compete with credit unions, insurance companies, money market mutual funds and other financial institutions, some of which are not subject to the same degree of regulation as we are. Many of these competitors have substantially greater resources and lending abilities than we have and offer services, such as investment banking, trust and international banking services that we do not provide. We believe that we have competed, and will continue to be able to compete, effectively with these institutions because of our experienced bankers and personalized service, as well as through loan participations and other strategies and techniques. However, we cannot promise that we are correct in our belief. If we are wrong, our ability to operate profitably may be negatively affected. Technological changes affect our business, and we may have fewer resources than many of our competitors to invest in technological improvements. The financial services industry continues to undergo rapid technological changes with frequent introductions of new technology-driven products and services. In addition to enabling financial institutions to serve clients better, the effective use of technology may increase efficiency and may enable financial institutions to reduce costs. Our future success may depend, in part, upon our ability to use technology to provide products and services that provide convenience to customers and to create additional efficiencies in our operations. We may need to make significant additional capital investments in technology in the future, and we may not be able to effectively implement new technology-driven products and services. Many of our competitors have substantially greater resources to invest in technological improvements. 40 Our profitability and liquidity may be affected by changes in interest rates and economic conditions. Our profitability depends upon our net interest income, which is the difference between interest earned on our interest-bearing assets, such as loans and investment securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Our net interest income will be adversely affected if market interest rates change such that the interest we pay on deposits and borrowings increases faster than the interest earned on loans and investments. Interest rates, and consequently our results of operations, are affected by general economic conditions (domestic and foreign) and fiscal and monetary policies. Monetary and fiscal policies may materially affect the level and direction of interest rates. Beginning in June 2004 through January 2006, the Federal Reserve has raised rates fourteen times for a total increase of 3.50%. Increases in interest rates generally decrease the market values of interest-bearing investments and loans held and therefore may adversely affect our liquidity and earnings. Increased interest rates also generally affect the volume of mortgage loan originations, the resale value of mortgage loans originated for resale, and the ability of borrowers to perform under existing loans of all types. Risks Related to Our Industry We are subject to governmental regulation, which could change and increase our cost of doing business or have an adverse effect on our business. We operate in a highly regulated industry and are subject to examination, supervision and comprehensive regulation by various federal and state agencies. Most of this regulation is designed to protect our depositors and other customers, not our shareholders. Our compliance with the requirements of these agencies is costly and may limit our growth and restrict certain of our activities, including, payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, and locations of offices. We are also subject to capitalization guidelines established by federal authorities and our failure to meet those guidelines could result in limitations being imposed on our activities or, in an extreme case, in our bank's being placed in receivership. We have also recently been subjected to the extensive and expensive requirements imposed on public companies by the Sarbanes-Oxley Act of 2002 and related regulations. The laws and regulations applicable to the banking industry could change at any time, and we cannot predict the impact of these changes on our business or profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, our cost of compliance could adversely affect our ability to operate profitably. We are susceptible to changes in monetary policy and other economic factors, which may adversely affect our ability to operate profitably. Changes in governmental, economic and monetary policies may affect the ability of our bank to attract deposits and make loans. The rates of interest payable on deposits and chargeable on loans are affected by governmental 41 regulation and fiscal policy as well as by national, state and local economic conditions. All of these matters are outside of our control and affect our ability to operate profitably. Risks Related to Our Common Stock Our common stock has a limited trading market, which may make the prompt execution of sale transactions difficult. Our common stock is not traded on any exchange or on the Nasdaq National Market System. Although our common stock is traded over-the-counter and quotations of bid and ask information are provided by the National Association of Securities Dealers, Inc.'s Over-The-Counter Bulletin Board, no active trading market has developed and none is expected to develop in the foreseeable future. Accordingly, if you wish to sell shares you may experience a delay or have to sell them at a lower price in order to sell them promptly, if at all. We may issue additional securities, which could affect the market price of our common stock and dilute your ownership. We may issue additional securities to raise additional capital, to support growth, or to make acquisitions. Sales of a substantial number of shares of our common stock, or the perception by the market that those sales could occur, could cause the market price of our common stock to decline or could make it more difficult for us to raise capital through the sale of common stock or to use our common stock in future acquisitions. There is no guarantee we will continue to pay cash dividends in the future at the same or any level. Declaration and payment of dividends are within the discretion of our board of directors. Our banks are currently our only source of funds with which to pay cash dividends. Our banks' declaration and payment of future dividends to us are within the discretion of the banks' boards of directors, and are dependent upon their earnings, financial condition, their need to retain earnings for use in the business and any other pertinent factors. The banks' payment of dividends is also subject to various regulatory requirements and the ability of the banks' regulators to forbid or limit their payment of dividends. Provisions in our articles of incorporation and South Carolina law may discourage or prevent takeover attempts, and these provisions may have the effect of reducing the market price for our stock. Our articles of incorporation include several provisions that may have the effect of discouraging or preventing hostile takeover attempts, and therefore of making the removal of incumbent management difficult. The provisions include staggered terms for our board of directors and requirements of supermajority votes to approve certain business transactions. In addition, South Carolina law contains several provisions that may make it more difficult for a third party to acquire control of us without the approval of our board of 42 directors, and may make it more difficult or expensive for a third party to acquire a majority of our outstanding common stock. To the extent that these provisions are effective in discouraging or preventing takeover attempts, they may tend to reduce the market price for our stock. Our common stock is not insured, so you could lose your total investment. Our common stock is not a deposit, savings account or obligation of our bank and is not insured by the Federal Deposit Insurance Corporation or any other government agency. Should our business fail you could lose your total investment. ITEM 1 B. UNRESOLVED STAFF COMMENTS The Company is not an accelerated filer or a large accelerated filer and has not received any comments from the Securities and Exchange Commission regarding its current or periodic reports in the 180 days prior to December 31, 2005. 43 ITEM 2. PROPERTIES The Company's corporate office is located at 1818 East Main Street in Easley, South Carolina. The property consists of a three-story brick building containing approximately 10,670 square feet on 0.665 acres of land owned by The Peoples National Bank. This building houses some of the Company's support functions, including administration, accounting, financial reporting, human resources, training, marketing, risk management, internal audit, compliance, facilities management, security, and purchasing. The Company also utilizes an adjacent office building located at 1814 East Main Street in Easley, South Carolina. The property consists of a two-story brick building containing approximately 6,624 square feet on 0.566 acres of land owned by The Peoples National Bank. This building houses some of the Company's support functions including operations, data processing, and information technology. The Peoples National Bank also owns several portions of an adjacent office building located at 1824 East Main Street in Easley, South Carolina. The property consists of approximately 6,600 square feet of office space located in a one-story brick building containing approximately 9,000 square feet on 0.704 acres of land. Peoples National Bank is using portions of this facility as office space and file storage, and a portion is currently being leased to a tenant. The main office of The Peoples National Bank is located at 1800 East Main Street in Easley, South Carolina, adjacent to the Company's corporate office. The property consists of a two-story brick building of approximately 10,412 square feet, which is constructed on 1.75 acres of land owned by The Peoples National Bank. Improvements include a three-lane drive-through teller installation, vault, night depository, safe-deposit facilities, and a drive-through automated teller machine. The Peoples National Bank owns and operates three branch facilities: one in Powdersville, South Carolina located approximately seven miles east of the Bank's main office containing approximately 3,158 square feet in a one-story brick building situated on 0.812 acres of land; a second branch office in Pickens, South Carolina located approximately ten miles west of the Bank's main office containing approximately 6,688 square feet in a two-story building on 0.925 acres of land; and a third branch office in Easley located approximately 2 miles west of the Bank's main office containing approximately 3,523 square feet in a one and one-half story building situated on l.077 acres of land. All branch facilities have improvements including drive-through teller installations, drive-through automated teller machines, vault, night depository, and safe deposit facilities. The Peoples National Bank currently operates a loan-production office in a leased facility located at 233 North Main Street in the downtown area of Greenville, South Carolina. The bank also has contracted to purchase a 2.418-acre parcel of land at 1 East Antrim Drive in Greenville, South Carolina, and subsequently plans to construct a facility to be used as a full-service retail banking office. The main office of Bank of Anderson, National Association is located at 201 East Greenville Street in Anderson, South Carolina. The property consists of 44 a two-story brick building with approximately 11,696 square feet, which is constructed on 1.935 acres of land owned by Bank of Anderson. Improvements include a three-lane drive-through teller installation, vault, night depository, safe-deposit facilities, and a drive-through automated teller machine. Bank of Anderson owns and operates one branch facility in Anderson County, South Carolina located approximately five miles northwest of the Bank's main office containing approximately 3,036 square feet in a one-story brick building situated on 0.86 acres of land. The branch facility has improvements including a drive-through teller installation, drive-through automated teller machine, vault, night depository, and safe deposit box facilities. Seneca National Bank, located at 201 By-Pass 123, Seneca, South Carolina, operates out of a two-story brick building containing approximately 6,688 square feet situated on 1.097 acres of land in Seneca, South Carolina, which is owned by Seneca National Bank. All locations of the Company and the Banks are considered suitable and adequate for their intended purposes. Management believes that insurance coverage on the foregoing properties is adequate. 45 ITEM 3. LEGAL PROCEEDINGS The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business. In the opinion of management based on consultation with external legal counsel, the outcome of any currently pending litigation is not expected to materially affect the Company's consolidated financial position or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted during the fourth quarter of 2005 to a vote of security holders of the Company. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The common stock of the Company is traded over-the-counter. Quotations of bid and ask information are provided electronically by the National Association of Securities Dealers, Inc.'s Over-The-Counter Bulletin Board under the symbol "PBCE.OB." The reported high and low bid prices for each quarter of 2005 and 2004 are shown in the following table. The quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. There is not an active trading market for our common stock. Sales Prices of the Company's Common Stock Quarter Ended Low High ------------- --- ---- March 31, 2004 ........................ $ 15.14 $ 16.42 June 30, 2004 ......................... $ 15.08 $ 17.42 September 30, 2004 .................... $ 16.08 $ 17.42 December 31, 2004 ..................... $ 17.00 $ 17.42 March 31, 2005 ........................ $ 18.15 $ 19.95 June 30, 2005 ......................... $ 15.69 $ 18.53 September 30, 2005 .................... $ 15.44 $ 17.58 December 31, 2005 ..................... $ 13.25 $ 16.86 As of March 13, 2006, the number of holders of record of the Company's common stock was 1,057 and the number of issued and outstanding shares was 6,250,006. During 2005 the Company paid four quarterly cash dividends totaling $0.20 per common share. In 2004, the Company paid four quarterly cash dividends totaling $0.26 per common share. 46 In addition, on each of July 13, 1992, July 12, 1993, December 12, 1994, November 30, 1995, November 8, 1996, October 31, 1997, December 7, 1998, January 14, 2000, January 5, 2001, January 4, 2002, November 18, 2002, November 17, 2003, January 4, 2005 and December 30, 2005 the Company paid 5% stock dividends to shareholders (2005 and 2004 prices in the table above have been adjusted for the 2005 stock dividends). It is the policy of the Board of Directors of the Company to reinvest earnings for such periods of time as is necessary to the successful operations of the Company and of the Banks. Future dividends will depend on the Company's earnings, capital requirements, financial condition and other factors considered relevant by the Board of Directors of the Company. Payment of dividends is also subject to regulatory restrictions (see Item 1, "PAYMENT OF DIVIDENDS"). The information required by Item 201(d) of Regulation S-K is set forth under Item 12 of this Form 10-K. Unregistered Sales of Equity Securities and Use of Proceeds. None. Purchases of Equity Securities by the Company and Affiliated Purchasers Neither the Company nor any "affiliated purchaser" as defined in 17 C.F.R. 240.10b-18(a)(3) purchased any shares or units of any class of the Company's equity securities that is registered pursuant to Section 12 of the Exchange Act during the fourth quarter of 2005. Accordingly, no disclosure is required pursuant to 17 C.F.R. ss.229.703. 47 ITEM 6. SELECTED FINANCIAL DATA
FIVE-YEAR FINANCIAL SUMMARY (All amounts, except per share data, in thousands) 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- INCOME STATEMENT DATA Net interest income .................................... $ 17,357 $ 14,622 $ 13,381 $ 12,609 $ 9,899 Provision for loan losses .............................. 848 589 1,106 944 892 Other operating income ................................. 3,609 4,996 10,302 6,564 5,267 Other operating expenses ............................... 14,338 13,847 14,665 11,380 9,567 Net income ............................................. 4,128 3,528 5,044 4,383 3,069 PER SHARE DATA (1) Net income per common share - Basic ............................................... $ 0.65 $ 0.58 $ 0.83 $ 0.71 $ 0.50 Diluted ............................................. $ 0.65 $ 0.56 $ 0.80 $ 0.69 $ 0.49 Cash dividends declared ................................ $ 0.20 $ 0.26 $ 0.28 $ 0.23 $ 0.18 BALANCE SHEET DATA Total Assets ........................................... $ 487,977 $ 429,796 $ 421,756 $ 416,122 $ 312,166 Total Deposits ......................................... 390,346 346,145 353,329 328,174 236,802 Total Loans (Net) ...................................... 373,641 322,212 297,915 302,663 251,173 Investment Securities .................................. 78,061 71,247 86,493 86,170 35,493 Total Earning Assets ................................... 456,456 400,809 399,925 394,351 296,181 Shareholders' Equity ................................... 41,171 38,240 36,161 32,747 28,551 OTHER DATA Return on average assets ............................... 0.88% 0.82% 1.18% 1.21% 1.07% Return on average equity ............................... 10.20% 9.45% 14.52% 14.49% 11.31%
(1) Per share data has been restated to reflect 5% stock dividends in 2001, 2002, 2003, 2004 and 2005, and the 3-for-2 stock split issued in October 2004. 48 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION The following discussion is intended to assist in understanding the financial condition and results of operations of the Company and should be read in conjunction with the consolidated financial statements of the Company included herein. CRITICAL ACCOUNTING POLICIES The Company has adopted various accounting policies, which govern the application of accounting principles generally accepted in the United States in the preparation of the Company's consolidated financial statements. The significant accounting policies of the Company are described in Item 8, Note 1 to the consolidated financial statements. Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and estimates and could have a material impact on the carrying values of assets and liabilities and the results of operations of the Company. Of these significant accounting policies, the Company considers its policies regarding the allowance for loan losses (the "Allowance") to be its most critical accounting policy due to the significant degree of management judgment involved in determining the amount of the Allowance. The Company has developed policies and procedures for assessing the adequacy of the Allowance, recognizing that this process requires a number of assumptions and estimates with respect to its loan portfolio. The Company's assessments may be impacted in future periods by changes in economic conditions, the impact of regulatory examinations, and the discovery of information with respect to borrowers, which is not known to management at the time of the issuance of the consolidated financial statements. Refer to the discussion under "PROVISION AND ALLOWANCE FOR LOAN LOSSES, LOAN LOSS" in Part I, Item 1 for a detailed description of the Company's estimation process and methodology related to the allowance for loan losses. DISCUSSION OF CHANGES IN FINANCIAL CONDITION Total assets increased $58,181,000 or 13.5% from $429,796,000 at December 31, 2004 to $487,977,000 at December 31, 2005. The Company experienced significant loan growth during 2005 as the total outstanding loans, the largest single category of assets, increased 49 $51,592,000 or 15.8% from $325,903,000 at December 31, 2004 to $377,495,000 at December 31, 2005, as a result of an increase in the amount of outstanding loans at the Company's three bank subsidiaries. The Company's securities portfolio collectively, at amortized cost, increased $7,411,000 or 10.3% from $71,944,000 at December 31, 2004 to $79,355,000 at December 31, 2005. The majority of this increase was attributable to the deployment of increased levels of deposit at the subsidiary banks. The sale of U.S. Government agencies and mortgage-backed securities in the available-for-sale portfolio in 2004 amounted to approximately $10,028,000, compared to $362,000 in 2005. The sale of these securities resulted in realized gains of $128,000 in 2004 and $7,000 in realized gains in 2005. Maturities, calls, and principal pay-downs on all securities amounted to $5,261,000 at December 31, 2005 compared to $31,714,000 in the year ended December 31, 2004. During 2005, the Company made purchases of $8,035,000 in available-for-sale securities and purchases of $4,737,000 in securities held-to-maturity compared to $25,375,000 and $2,302,000, respectively, in 2004. The Company does not engage in, and does not expect to engage in, hedging activities. Cash and due from banks balances increased $681,000 or 7.9% from $8,630,000 at December 31, 2004 to $9,311,000 at December 31, 2005. The Company had no federal funds sold as of December 31, 2005, compared to $2,631,000 at December 31, 2004. The swings in the levels of cash and federal funds sold are due to fluctuations in the Banks' needs and sources for immediate and short-term liquidity. Cash surrender value of life insurance increased $354,000 or 3.9% from $9,049,000 at December 31, 2004 to $9,403,000 at December 31, 2005 due to the normal appreciation in value associated with the ownership of these assets. Earnings from the ownership of these policies are informally used to partially offset the cost of certain employee-related benefits. Other assets, comprised largely of prepaid expenses, other real estate owned, and deferred income taxes, increased $1,491,000 or 71.0% to $3,585,000 at December 31, 2005 from $2,094,000 at December 31, 2004. This increase is largely attributable to an increase of $1,251,000 or 165.5% in other real estate owned to $2,007,000 at December 31, 2005 from $756,000 at December 31, 2004. The increase in other real estate owned is largely attributable to $1,048,000 in foreclosures on four properties representing a single customer relationship at Bank of Anderson. Deferred income taxes increased by $212,000 or 17.2% to $1,444,000 at December 31, 2005 from $1,232,000 at December 31, 2004. Total liabilities increased $55,250,000 or 14.1% from $391,556,000 at December 31, 2004 to $446,806,000 at December 31, 2005. Total deposits increased $44,204,000 or 12.8% to $390,349,000 at December 31, 2005 from $346,145,000 at 50 December 31, 2004. Of the $44,204,000 increase in total deposits, there was a $43,244,000 increase in interest-bearing deposits, largely certificates of deposit and interest-bearing transaction accounts. Securities sold under repurchase agreements decreased $2,217,000 or 6.5% from $33,953,000 at December 31, 2004 to $31,736,000 at December 31, 2005. Federal funds purchased increased $3,467,000 or 606.1% from $572,000 at December 31, 2004 to $4,039,000 at December 31, 2005. Federal Home Loan Bank advances increased $9,000,000 or 105.9% from $8,500,000 at December 31, 2004 to $17,500,000 at December 31, 2005. At both December 31, 2005 and December 31, 2004, $5,000,000 represents a long-term advance purchased in December 2000, which will mature in December 2010. The overall increase in these other interest-bearing liabilities is largely attributable to the need to fund the growth in loan volume at each of the Banks. Shareholders' equity increased $2,931,000 or 7.7% from $38,240,000 at December 31, 2004 to $41,171,000 at December 31, 2005. This increase comes primarily as a result of net earnings for the period of $4,128,000, which was partially offset by the declaration and payment of $1,187,000 in cash dividends and the payment of $9,000 of cash in lieu of fractional shares for the 5% stock dividend during 2005. 51 EARNINGS PERFORMANCE 2005 Compared to 2004 Overview The Company's consolidated operations for the twelve months ended December 31, 2005 resulted in net income of $4,128,000 or $0.66 per basic share ($0.65 per diluted share), compared to $3,528,000 or $0.58 per basic share ($0.56 per diluted share) for the twelve months ended December 31, 2004. The increase in the Company's net income of $600,000 or 17.0% for 2005 resulted largely from a significant increase in total interest income during 2005, and was partially offset by an increase in interest on deposits and other liabilities and a reduction in non-interest income. Interest Income, Interest Expense and Net Interest Income The Company's net interest income increased $2,753,000 or 18.7% to $17,357,000 for the year ended December 31, 2005 compared to $14,622,000 for the year ended December 31, 2004. The Company's total interest income increased $5,227,000 or 24.8% to $26,290,000 in 2005 compared to $21,063,000 for 2004. This increase is largely attributable to an increase in interest income and fees on loans of $5,048,000 resulting from an increase in outstanding loans at the Company's three bank subsidiaries and higher yields resulting from higher market interest rates. There was also an increase of $106,000 in interest on federal funds sold; a $46,000 increase in interest on taxable securities; and a $27,000 increase in interest on tax-exempt securities. These increases are primarily due to higher market yields on these types of earning assets. Total interest expense increased $2,492,000 or 38.7% to $8,933,000 in 2005 compared to $6,441,000 for 2004. The increases in the amount of interest paid on deposits increased $2,096,000; interest expense on federal funds purchased and securities sold under repurchase agreements increased $294,000; and the interest paid on notes payable to the Federal Home Loan Bank increased $102,000 in 2005. The increase in interest expense among the various types of interest-bearing liabilities is largely attributable to significantly higher market interest rates experienced at the Company's bank subsidiaries, as well as higher average balances during 2005 as compared to 2004. Provision and Allowance for Loan Losses The Company's provision for loan losses was $848,000 in 2005 compared to $589,000 for 2004, a $259,000 or 44.0% increase. This increase is largely attributable to a $349,000 increase in net charged-off loans. During 2005 the Company experienced net charge-offs of $685,000, or 0.19% of average outstanding loans (excluding loans held for sale), compared to net charge-offs of $336,000, 52 or 0.11% of average outstanding loans in 2004. At December 31, 2005 the allowance for loan losses was 1.02% as a percentage of outstanding loans compared to 1.13% at December 31, 2004. At December 31, 2005 the Company had $1,206,000 in non-accrual loans, $922,000 in restructured loans, $10,000 in loans past due 90 days or more but still accruing interest, and $2,007,000 in real estate acquired in settlement of loans, compared to $670,000, $0, $838,000, and $756,000 respectively at December 31, 2004. Non-performing assets as a percentage of all loans and other real estate owned were 1.09% and 0.69% at December 31, 2005 and 2004, respectively. In the cases of non-performing loans, management of the Company has reviewed the carrying value of any underlying collateral. In those cases where the collateral value may be less than the carrying value of the loan the Company has taken specific write-downs to the loan. Management of the Company does not believe it has any non-accrual loan that individually could materially impact the allowance for loan losses or long-term future operating results of the Company. The Company records real estate acquired through foreclosure at the lower of cost or estimated market value less estimated selling costs. Estimated market value is based upon the assumption of a sale in the normal course of business and not on a quick liquidation or distressed basis. Estimated market value is established by independent appraisal at the time of foreclosure. Management believes that other real estate owned at December 31, 2005 will not require significant write-downs in future accounting periods, and therefore will not have a significant effect on the Company's future operations. Other Income Total consolidated other income, including securities transactions, decreased $1,387,000 or 27.8% from $4,996,000 in 2004 to $3,609,000 in 2005. This decrease is largely attributable to a reduction of $1,213,000 or 71.1% in income associated with the origination of residential mortgage loans, which was reflected as $494,000 in mortgage banking income in 2005 versus $1,707,000 in the gain on sale of residential mortgage loans in 2004. During 2004, management made the decision to completely exit the wholesale mortgage business due to the significant decrease in demand for residential mortgage loans and refinancing, and therefore at December 31, 2004, the Company no longer owned any mortgage loans held for sale. Currently, the Company's mortgage banking income consists entirely of fees collected for the origination of residential mortgages funded by unrelated investors. Other non-interest income decreased $214,000 or 40.8% to $311,000 in 2005 when compared to $525,000 in 2004. The decrease is largely attributable to life insurance death benefits totaling $174,000 that were received in 2004 in conjunction with the death of the Company's former Chairman, President and CEO. The Company recorded a $7,000 gain on the sale of securities in 2005, a decrease of $121,000 or 94.5% from the gain of $128,000 recorded in 2004. 53 Other Expenses Total consolidated other expenses increased $491,000 or 3.6% to $14,338,000 in 2005 compared to $13,847,000 in 2004. Salaries and benefits, the largest component of non-interest expense, increased $38,000 or 0.5% to $8,205,000 in 2005 compared to $8,167,000 in 2004. Occupancy and furniture and equipment expenses increased $151,000 or 7.7% to $2,109,000 in 2005 compared to $1,958,000 in 2004. The increase is primarily attributable to the renovation of the Company's headquarters beginning in late 2004 and continuing through the third quarter of 2005, the completion of an expansion and renovation of the main office of Bank of Anderson, N. A. in the third quarter of 2004, and the purchase of an ATM facility at Seneca National Bank during the second quarter of 2005. Other post-employment benefits expense decreased $358,000 or 72.3% to $137,000 in 2005 compared to $495,000 in 2004. This decrease is primarily due to a one-time, non-recurring charge incurred in the first quarter of 2004 in the amount of $376,000 to fully fund the liability for death benefits payable to the beneficiary of the Company's former Chairman, President and CEO, who died in April 2004. This charge was required by SFAS No. 112 in accordance with generally accepted accounting principles. Marketing and advertising expense increased $118,000 or 39.7% to $415,000 in 2005 compared to $297,000 in 2004. This increase is attributable to the promotion of certain bank products and advertising associated with the upcoming 20th anniversary of Peoples National Bank. Legal and professional fees increased $111,000 or 42.7% from $260,000 in 2004 to $371,000 in 2005 due to expenses associated with compliance obligations under section 404 of the Sarbanes-Oxley Act of 2002, and consultation and revisions regarding articles of incorporation, bylaws, stock options, and executive employment contracts. Director fees increased $73,000 or 26.4% to $349,000 in 2005 compared to $276,000 in 2004, due to an increase in the amount of compensation per director for 2005. All other operating expenses were $2,752,000 in 2005 compared to $2,394,000 in 2004. Income Taxes Refer to Note 10 of the Company's consolidated financials statements for an analysis of income tax expense. 54 EARNINGS PERFORMANCE 2004 Compared to 2003 Overview The consolidated Company's operations for the twelve months ended December 31, 2004 resulted in net income of $3,528,000 or $0.58 per basic share ($0.56 per diluted share), compared to $5,044,000 or $0.83 per basic share ($0.80 per diluted share) for the twelve months ended December 31, 2003. The decrease in the Company's net income of $1,516,000 or 30.1% for 2004 resulted largely from a significant decrease in non-interest income during 2004, primarily from the slowing of the Company's residential mortgage-lending activities because of the major reduction in demand. Interest Income, Interest Expense and Net Interest Income The Company's net interest income increased $1,241,000 or 9.3% to $14,622,000 for the year ended December 31, 2004 compared to $13,381,000 for the year ended December 31, 2003. The Company's total interest income increased $156,000 or 0.8% to $21,063,000 in 2004 compared to $20,907,000 for 2003. This increase was largely attributable to an increase in interest income and fees on loans of $712,000 resulting from an increase in outstanding loans at the Company's three bank subsidiaries. This increase was partially offset by a decrease in interest income on taxable investments of $521,000 or 21.7% resulting from lower market rates and lower average balances experienced at the Company's three bank subsidiaries during 2004 when compared to 2003. The increase was also partially offset by a decrease in interest income on federal funds sold of $88,000 or 50.0% resulting from lower average balances of this account. Total interest expense decreased $1,085,000 or 14.4% to $6,441,000 in 2004 compared to $7,526,000 for 2003. The decreases in the amount of interest paid on the various categories of interest-bearing liability accounts in 2004 were largely attributable to lower market rates experienced at the Company's three bank subsidiaries during 2004 when compared to 2003. Provision and Allowance for Loan Losses The Company's provision for loan losses was $589,000 in 2004 compared to $1,106,000 for 2003, a $517,000 or 46.7% decrease. This decrease was largely attributable to slower loan growth at the Banks, coupled with an $182,000 decrease in net charged-off loans. During 2004 the Company experienced net charge-offs of $336,000, or 0.11% of average outstanding loans (excluding loans held for sale), compared to net charge-offs of $518,000, or 0.19% of average outstanding loans in 2003. At December 31, 2004 the allowance for loan losses was 1.13% as a percentage of outstanding loans (excluding loans held for sale) compared to 1.16% at December 31, 2003. 55 At December 31, 2004 the Company had $670,000 in non-accrual loans, no restructured loans, $838,000 in loans past due 90 days or more but still accruing interest, and $756,000 in real estate acquired in settlement of loans, compared to $829,000, $0, $122,000, and $517,000 respectively at December 31, 2003. Non-performing assets as a percentage of all loans and other real estate owned were 0.69% and 0.49% at December 31, 2004 and 2003, respectively. Other Income Total consolidated other income, including securities transactions, decreased $5,306,000 or 51.5% from $10,302,000 in 2003 to $4,996,000 in 2004. This decrease was largely attributable to a decrease of $5,936,000 or 77.7% from the gain on sale of residential mortgage loans from $7,643,000 in 2003 to $1,707,000 in 2004, and was partially offset by an increase of $200,000 or 200.0% in earnings on bank owned life insurance from $110,000 in 2003 to $330,000 in 2004, and an increase of $79,000 or 4.1% in service charges on deposit accounts from $1,923,000 in 2003 to $2,002,000 in 2004. The Company recorded a $128,000 gain on the sale of securities in 2004, an increase of $115,000 or 884.6% from the gain of $13,000 recorded in 2003. Other Expenses Total consolidated other expenses decreased $818,000 or 5.6% to $13,847,000 in 2004 compared to $14,665,000 in 2003. Salaries and benefits, the largest component of non-interest expense, decreased $777,000 or 8.7% to $8,167,000 in 2004 compared to $8,944,000 in 2003. The decrease in salaries and benefits for the comparative periods was primarily attributable to the reduced staffing associated with the residential mortgage lending personnel, reduction in commissions paid, and changes in personnel due to decreased volume of mortgage loans originated, and partially offset by normal salary increases and other changes in personnel throughout the company. Occupancy expense increased $59,000 or 9.7% to $668,000 in 2004 compared to $609,000 in 2003. Equipment expense increased $139,000 or 12.1% to $1,290,000 in 2004 compared to $1,151,000 in 2003. The increases in occupancy and equipment expenses were primarily attributable to the opening of a new branch office of Bank of Anderson, N.A. in August 2003, the purchase of additional office space by The Peoples National Bank in Easley, South Carolina in January 2004, and the completion of an expansion and renovation to the main office of Bank of Anderson, N.A. in the third quarter of 2004. Executive retirement benefit expense increased $321,000 or 184.5% to $495,000 in 2004 compared to $174,000 in 2003. This increase was primarily due to a one-time, non-recurring charge incurred in the first quarter of 2004 in the amount of $376,000 to increase the liability for death benefits payable to the beneficiary of the Company's former Chairman, President and CEO, who died in April 2004. This charge was required by SFAS No. 112 in accordance with generally accepted accounting principles. The increase was partially offset by a reduction in the number of executives covered from two to one, resulting in lower expenses for the remainder of the year. 56 Bank paid loan costs decreased $147,000 or 32.2% to $310,000 in 2004 compared to $457,000 in 2003. The decrease in bank paid loan costs for the two comparative periods was principally attributable to the significant decrease in the volume of mortgage loans originated during 2004 when compared to 2003. Miscellaneous other operating expenses decreased $413,000 or 12.4% to $2,917,000 in 2004 compared to $3,330,000 in 2003. Marketing and advertising expense decreased $95,000 or 24.2% to $297,000 in 2004 compared to $392,000 in 2003. This decrease was the result of a decision by management to curtail expenditures in this area. Communications expense decreased $66,000 or 24.3% to $206,000 in 2004 compared to $272,000 in 2003. This decrease was largely attributable to a redesign of telephone systems that incorporated newer technologies and allowed cost savings. Other operating expenses decreased $183,000 or 8.7% to $1,670,000 in 2004, compared to $1,904,000 in 2003. This decrease was attributable to decreases in postage expense; printing and supplies; and impact fees. Postage expense decreased $90,000 or 31.5% to $196,000 in 2004 compared to $286,000 in 2003, largely due to the decrease in postage associated with reduced activity in the mortgage loan department. Printing and supplies decreased $67,000 or 24.4% to $208,000 in 2004 compared to $275,000 in 2003, also largely associated with reduced activity in the mortgage loan department. Impact fees, which were paid to a consultant that assisted with the design and implementation of our overdraft privilege service, decreased by $109,000 or 80.7% to $26,000 in 2004 compared to $135,000 in 2003 due to the expiration of that contract. Other expenses included legal and professional fees; ATM and debit card expense; insurance expense; travel and administration expense; and other sundry expenses. Legal and professional fees increased $51,000 or 24.4% to $260,000 in 2004 compared to $209,000 in 2003 largely due to consultation and revisions regarding articles of incorporation, bylaws, stock option plans, and executive employment contracts. ATM and debit card expense increased $26,000 or 12.4% to $236,000 in 2004 compared to $210,000 in 2003. This increase was largely attributable to growth in the number of transactions and vendor fee increases that occurred in 2004. Insurance expense for directors and officers, bond, property, workers compensation, liability, etc. increased $22,000 or 20.2% to $131,000 in 2004 compared to $109,000 in 2003 as the result of increased insurance coverage. Travel and administration expense decreased $13,000 or 13.3% to $85,000 in 2004 compared to $98,000 in 2003. The retreat that was held for the Board of Directors in 2003 was not repeated in 2004, largely contributing to the decrease in travel and administration expense. 57 LIQUIDITY AND CAPITAL RESOURCES The sections "LIQUIDITY" and "CAPITAL ADEQUACY AND RESOURCES" included in "Business" under Item 1 of this Annual Report on Form 10-K are incorporated herein by reference. OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS The section "OFF-BALANCE SHEET ARRARNGEMENTS AND DERIVATIVE FINANCIAL INSTRUMENTS" included in "Business" under Item 1 of this Annual Report on Form 10-K is incorporated herein by reference. The following table summarizes the Company's contractual obligations as of December 31, 2005.
CONTRACTUAL OBLIGATIONS (dollars in thousands) Payments Due by Period ---------------------- Less than 1-3 4-5 After 5 --------- --- --- ------- Total 1 Year Years Years Years Long-term debt obligations .................. $ 5,000 $ - $ - $ - $ 5,000 ========= ========= ========= ========= ==========
The Peoples National Bank has a $5,000,000 advance from the Federal Home Loan Bank of Atlanta at a 4.82 percent interest rate that matures in December 2010. This obligation was entered into in December 2000 to provide liquidity to meet the needs of its customers. 58 ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The section "Market Risk - Interest Rate Sensitivity" included in "Business" under Item 1 of this Annual Report on Form 10-K is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following financial statements are filed with this report: - Report of Independent Registered Public Accounting Firm. - Consolidated Balance Sheets as of December 31, 2005 and 2004. - Consolidated Statements of Income for the years ended December 31, 2005, 2004 and 2003. - Consolidated Statements of Shareholders' Equity and Comprehensive Income for the years ended December 31, 2005, 2004 and 2003. - Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003. - Notes to Consolidated Financial Statements. 59 PEOPLES BANCORPORATION, INC. AND SUBSIDIARIES REPORT ON CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 60 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders and Board of Directors Peoples Bancorporation, Inc. Easley, South Carolina We have audited the accompanying consolidated balance sheets of Peoples Bancorporation, Inc. and Subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders' equity and comprehensive income, and cash flows for each of the years in the three year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Peoples Bancorporation, Inc. and Subsidiaries as of December 31, 2005 and 2004 and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America. /s/Elliott Davis LLC Greenville, South Carolina February 21, 2006 61 PEOPLES BANCORPORATION, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Amounts in thousands except share information)
DECEMBER 31, ------------ 2005 2004 ---- ---- ASSETS CASH AND DUE FROM BANKS ...................................................................... $ 9,311 $ 8,630 INTEREST - BEARING DEPOSITS IN OTHER BANKS ................................................... 900 1,028 FEDERAL FUNDS SOLD ........................................................................... - 2,631 --------- --------- Total cash and cash equivalents ..................................................... 10,211 12,289 SECURITIES Available for sale ..................................................................... 65,009 62,052 Held to maturity (fair value of $10,674 (2005) and $7,451 (2004)) ...................... 10,855 7,386 Other investments, at cost ............................................................. 2,197 1,809 LOANS, net of allowance for loan losses of $3,854 (2005) and $3,691 (2004) ................... 373,641 322,212 PREMISES AND EQUIPMENT, net of accumulated depreciation ...................................... 10,635 11,075 ACCRUED INTEREST RECEIVABLE .................................................................. 2,441 1,830 CASH SURRENDER VALUE OF LIFE INSURANCE ....................................................... 9,403 9,049 OTHER ASSETS ................................................................................. 3,585 2,094 --------- --------- $ 487,977 $ 429,796 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY DEPOSITS Noninterest-bearing ...................................................................... $ 52,467 $ 51,507 Interest-bearing ......................................................................... 337,882 294,638 --------- --------- Total deposits ..................................................................... 390,349 346,145 SECURITIES SOLD UNDER REPURCHASE AGREEMENTS .................................................. 31,736 33,953 FEDERAL FUNDS PURCHASED ...................................................................... 4,039 572 ADVANCES FROM FEDERAL HOME LOAN BANK ......................................................... 17,500 8,500 ACCRUED INTEREST PAYABLE ..................................................................... 2,281 1,154 OTHER LIABILITIES ............................................................................ 901 1,232 --------- --------- Total liabilities ................................................................... 446,806 391,556 --------- --------- COMMITMENTS AND CONTINGENCIES - Notes 11 and 12 SHAREHOLDERS' EQUITY Common stock - 15,000,000 shares authorized; $1.11 par value per share; 6,245,356 (2005) shares and 5,822,608 (2004) shares issued and outstanding ............................................................... 6,932 6,463 Additional paid-in capital ............................................................... 34,684 32,237 Retained earnings ........................................................................ 408 - Accumulated other comprehensive (loss) ................................................... (853) (460) --------- --------- Total shareholders' equity .......................................................... 41,171 38,240 --------- --------- $ 487,977 $ 429,796 ========= =========
The accompanying notes are an integral part of these consolidated financial statements. 62 PEOPLES BANCORPORATION, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Amounts in thousands except per share information)
For the years ended December 31, -------------------------------- 2005 2004 2003 ---- ---- ---- INTEREST INCOME Interest and fees on loans .................................................. $23,915 $18,867 $18,155 Interest on securities Taxable ................................................................... 1,921 1,875 2,396 Tax-exempt ................................................................ 260 233 180 Interest on federal funds sold .............................................. 194 88 176 ------- ------- ------- Total interest income .................................................. 26,290 21,063 20,907 ------- ------- ------- INTEREST EXPENSE Interest on deposits ........................................................ 7,924 5,828 6,858 Interest on federal funds purchased and securities sold under repurchase agreements ............................................... 642 348 391 Interest on advances from Federal Home Loan Bank ............................ 367 265 277 ------- ------- ------- Total interest expense ................................................. 8,933 6,441 7,526 ------- ------- ------- Net interest income .................................................... 17,357 14,622 13,381 PROVISION FOR LOAN LOSSES ....................................................... 848 589 1,106 ------- ------- ------- Net interest income after provision for loan losses .................... 16,509 14,033 12,275 ------- ------- ------- NONINTEREST INCOME Service charges on deposit accounts ......................................... 2,017 2,002 1,923 Customer service fees ....................................................... 168 161 133 Mortgage banking ............................................................ 494 - - Brokerage services .......................................................... 195 143 151 Bank owned life insurance ................................................... 417 330 110 Other noninterest income .................................................... 311 525 329 Gain on sale of mortgage loans held for sale ................................ - 1,707 7,643 Gain on sale of securities available for sale ............................... 7 128 13 ------- ------- ------- Total noninterest income ............................................... 3,609 4,996 10,302 ------- ------- ------- NONINTEREST EXPENSES Salaries and benefits ....................................................... 8,205 8,167 8,944 Occupancy ................................................................... 747 668 609 Equipment ................................................................... 1,362 1,290 1,151 Marketing and advertising ................................................... 415 297 392 Communications .............................................................. 222 206 272 Printing and supplies ....................................................... 139 208 275 Bank paid loan costs ........................................................ 318 310 457 Directors fees .............................................................. 349 276 278 Other post employment benefits .............................................. 137 495 174 Legal and professional fees ................................................. 371 260 209 Other operating ............................................................. 2,073 1,670 1,904 ------- ------- ------- Total noninterest expenses ............................................. 14,338 13,847 14,665 ------- ------- ------- Income before income taxes ............................................. 5,780 5,182 7,912 PROVISION FOR INCOME TAXES ...................................................... 1,652 1,654 2,868 ------- ------- ------- Net income ............................................................. $ 4,128 $ 3,528 $ 5,044 ======= ======= ======= BASIC NET INCOME PER COMMON SHARE ............................................... $ 0.66 $ 0.58 $ 0.83 ======= ======= ======= DILUTED NET INCOME PER COMMON SHARE ............................................. $ 0.65 $ 0.56 $ 0.80 ======= ======= =======
The accompanying notes are an integral part of these consolidated financial statements. 63 PEOPLES BANCORPORATION, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME For the years ended December 31, 2005, 2004 and 2003 (Amounts in thousands except share information)
Accumu- lated other compre- Total Common stock Additional hensive share- ------------ paid-in Retained income holders' Shares Amount capital earnings (loss) equity ------ ------ ------- -------- ------ ------ BALANCE, DECEMBER 31, 2002 .............................. 5,261,577 $ 5,839 $ 25,777 $ 446 $ 685 $ 32,747 --------- Net income .............................................. - - - 5,044 - 5,044 Other comprehensive income, net of tax: Unrealized holding losses on securities available for sale, net of income taxes of $316 ........... - - - - (614) (614) Less reclassification adjustment for gains included in net income, net of income taxes of $4 - - - - (9) (9) --------- --------- Comprehensive income .................................... 4,421 Stock dividend (5%) ..................................... 262,265 292 3,747 (4,039) - - Cash in lieu of fractional shares on stock dividend ..... - - - (13) - (13) Cash dividends ($.18 per share) ......................... - - - (994) - (994) --------- --------- --------- --------- --------- --------- BALANCE, DECEMBER 31, 2003 .............................. 5,523,842 6,131 29,524 444 62 36,161 --------- Net income .............................................. - - - 3,528 - 3,528 Other comprehensive income, net of tax: Unrealized holding losses on securities available for sale, net of income taxes of $224 ........... - - - - (438) (438) Less reclassification adjustment for gains included in net income, net of income taxes of $44 - - - - (84) (84) --------- --------- Comprehensive income .................................... 3,006 Stock dividend (5%) ..................................... 276,423 307 2,594 (2,901) - - Cash in lieu of fractional shares on 3-for-2 stock split - - - (7) - (7) Cash in lieu of fractional shares on stock dividend ..... - - - (13) - (13) Cash dividends ($.18 per share) ......................... - - - (1,051) - (1,051) Proceeds from stock options exercised ................... 22,343 25 119 - - 144 --------- --------- --------- --------- --------- --------- BALANCE, DECEMBER 31, 2004 .............................. 5,822,608 6,463 32,237 - (460) 38,240 --------- Net income .............................................. - - - 4,128 - 4,128 Other comprehensive income, net of tax: Unrealized holding losses on securities available .. - - - - (388) (388) for sale, net of income taxes of $202 Less reclassification adjustment for gains included in net income, net of income taxes of $2 - - - - (5) (5) --------- --------- Comprehensive income .................................... 3,735 Stock dividend (5%) ..................................... 296,844 330 2,194 (2,524) - - Cash in lieu of fractional shares on stock dividend ..... - - - (9) - (9) Cash dividends ($.20 per share) ......................... - - - (1,187) - (1,187) Proceeds from stock options exercised ................... 125,904 139 253 - - 392 --------- --------- --------- --------- --------- --------- BALANCE, DECEMBER 31, 2005 .............................. 6,245,356 $ 6,932 $ 34,684 $ 408 $ (853) $ 41,171 ========= ========= ========= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements. 64 PEOPLES BANCORPORATION, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in thousands)
For the years ended December 31, -------------------------------- 2005 2004 2003 ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES Net income ................................................................... $ 4,128 $ 3,528 $ 5,044 Adjustments to reconcile net income to net cash provided by operating activities (Gain) loss on sale of premises and equipment .............................. 25 (20) (12) Gain on sale of mortgage loans held for sale ............................... - (1,707) (7,643) Gain on sale of securities available for sale .............................. (7) (128) (13) Provision for loan losses .................................................. 848 589 1,106 Benefit from deferred income taxes ......................................... (10) (209) (97) Depreciation ............................................................... 1,127 1,075 967 Amortization and accretion (net) of premiums and discounts on securities ............................................. 132 168 369 Origination of mortgage loans held for sale ................................ - (149,881) (417,808) Sale of mortgage loans held for sale ....................................... - 156,689 475,416 (Increase) decrease in accrued interest receivable ......................... (611) (9) 155 Increase in other assets ................................................... (1,286) (558) (421) Increase (decrease) in accrued interest payable ............................ 1,127 (450) 29 Increase (decrease) in other liabilities ................................... (321) 57 354 --------- --------- --------- Net cash provided by operating activities ............................. 5,152 9,144 57,446 --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of securities held to maturity ................................... (4,737) (2,302) (1,308) Purchases of securities available for sale ................................. (8,035) (25,375) (83,094) Sales (purchases) of other investments ..................................... (388) 338 (263) Proceeds from principal pay downs on securities available for sale ......................................... 3,543 4,879 15,891 Proceeds from the maturities and calls of securities available for sale ......................................... 500 26,325 59,778 Proceeds from the sale of securities available for sale .................... 362 10,028 6,999 Proceeds from maturity of securities held to maturity ...................... 1,218 510 375 Investment in bank owned life insurance .................................... (354) (6,755) - Net increase in loans ...................................................... (52,277) (29,371) (46,283) Proceeds from the sale of premises and equipment ........................... 82 53 24 Purchase of premises and equipment ......................................... (794) (1,952) (1,671) --------- --------- --------- Net cash used for investing activities ................................ (60,880) (23,622) (49,552) --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase (decrease) in deposits ........................................ 44,204 (7,184) 25,155 Net increase in federal funds purchased .................................... 3,467 572 - Net increase (decrease) in securities sold under repurchase agreements ......................................... (2,217) 9,563 (10,941) Net increase (decrease) in advances from Federal Home Loan Bank .............................................. 9,000 3,500 (12,000) Proceeds from the exercise of stock options ................................ 392 144 - Cash dividends paid ........................................................ (1,187) (1,051) (994) Cash in lieu of fractional shares on stock dividends and splits ............................................... (9) (20) (13) --------- --------- --------- Net cash provided by financing activities ............................. 53,650 5,524 1,207 --------- --------- --------- Net increase (decrease) in cash and cash equivalents .................. (2,078) (8,954) 9,101 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR ..................................... 12,289 21,243 12,142 --------- --------- --------- CASH AND CASH EQUIVALENTS, END OF YEAR ........................................... $ 10,211 $ 12,289 $ 21,243 ========= ========= ========= CASH PAID FOR Interest ..................................................................... $ 7,806 $ 6,432 $ 7,497 ========= ========= ========= Income taxes ................................................................. $ 2,200 $ 1,540 $ 3,078 ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements 65 PEOPLES BANCORPORATION, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES Principles of consolidation and nature of operations The consolidated financial statements include the accounts of Peoples Bancorporation, Inc. (the "Company") and its wholly-owned subsidiaries, The Peoples National Bank, Bank of Anderson, N.A., and Seneca National Bank (collectively referred to as the "Banks"). All significant intercompany balances and transactions have been eliminated. The Banks operate under individual national bank charters and provide full banking services to customers. The Banks are subject to regulation by the Office of the Comptroller of the Currency. The Company is subject to regulation by the Federal Reserve Board. Estimates The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of interest and noninterest income and expenses during the reporting period. Actual results could differ from those estimates. Segments The Company, through its subsidiaries, provides a broad range of financial services to individuals and companies. These services include demand, time and savings deposits; lending and ATM processing and are substantially the same across subsidiaries. While the Company's decision-makers monitor the revenue streams of the various financial products and services by product line and by subsidiary, the operations and the allocation of resources are managed, and financial performance is evaluated, on an organization-wide basis. Accordingly, the Company's banking operation is considered by management to be one reportable operating segment. Securities The Company accounts for securities in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, Accounting for Certain Investments in Debt and Equity Securities. Debt securities are classified upon purchase as available for sale, held to maturity, or trading. Such assets classified as available for sale are carried at fair value. Unrealized holding gains or losses are reported as a component of shareholders' equity (accumulated other comprehensive income (loss)) net of deferred income taxes. Securities classified as held to maturity are carried at cost, adjusted for the amortization of premiums and the accretion of discounts into interest income using a methodology which approximates a level yield of interest over the estimated remaining period until maturity. To qualify as held to maturity, the Company must have the ability and intent to hold the securities to maturity. Trading securities are carried at market value. The Company has no trading securities. Gains or losses on dispositions of securities are based on the difference between the net proceeds and the adjusted carrying amount of the securities sold, using the specific identification method. Loans and interest on loans Loans are stated at the principal balance outstanding reduced by the allowance for loan losses. Interest income is recognized over the term of the loan based on the contractual interest rate and the principal balance outstanding. Loans generally are placed on non-accrual status when principal or interest becomes ninety days past due, or when payment in full is not anticipated. Interest payments received after a loan is placed on non-accrual status are applied as principal reductions until such time the loan is returned to accrual status. Generally, a loan is returned to accrual status when the loan is brought current and the collectibility of principal and interest no longer is in doubt. (Continued) 66 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued Allowance for loan losses The Company provides for loan losses using the allowance method. Provisions for loan losses are added to the allowance through charges to operating expenses. Loans which are determined to be uncollectible are charged against the allowance and recoveries on loans previously charged off are added to the allowance. The provision for loan losses is the amount deemed appropriate by management to establish an adequate allowance to meet the present and foreseeable risk characteristics of the current loan portfolio. Management's judgment is based on periodic and regular evaluation of individual loans, the overall risk characteristics of the various portfolio segments, past experience with losses, delinquency trends, and prevailing and anticipated economic conditions. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. The allowance for loan losses is subject to periodic evaluation by various regulatory authorities and may be subject to adjustment upon their examination. A loan is considered to be impaired when full payment according to the terms of the loan agreement is not probable or when the terms of a loan are modified. The fair value of impaired loans may be determined based upon the present value of expected cash flows discounted at the loan's effective interest rate, the market price of the loan, if available, or value of the underlying collateral if the loan is collateral-dependent. When the ultimate collectibility of an impaired loan's principal is in doubt, wholly or partially, all cash receipts are applied to principal. Once the reported principal balance has been reduced to zero, future cash receipts are applied to interest income, to the extent that any interest has been foregone. Further cash receipts are recorded as recoveries of any amounts previously charged-off. Mortgage loans held for sale Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are provided for in a valuation allowance by charges to operations. Gains and losses on sales of loans are recognized when the loans are sold to secondary market investors. During 2004, the Company ended its origination and sale of loans in the secondary market. Premises and equipment Premises and equipment are stated at cost less accumulated depreciation. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets. Additions to premises and equipment and major replacements or betterments are added at cost. Maintenance, repairs, and minor replacements are charged to expense when incurred. When assets are retired or otherwise disposed of, the cost and accumulated depreciation are removed from the accounts and any gain or loss is reflected in income. Other real estate owned Other real estate owned represents properties acquired through foreclosure and is carried at the lower of cost or fair value, adjusted for estimated selling costs. Fair values of real estate owned are reviewed regularly and writedowns are recorded when it is determined that the carrying value of real estate exceeds the fair value less estimated costs to sell. Costs relating to the development and improvement of such property are capitalized, whereas those costs relating to holding the property are charged to expense. At December 31, 2005 and 2004 real estate owned by the Company totaled $2,007,000 and $756,000, respectively, and is included in other assets. During 2005 and 2004, the Company transferred loans of $1,756,000 and $616,000, respectively to real estate acquired in foreclosure. (Continued) 67 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued Advertising and public relations expense Advertising, promotional and other business development costs are generally expensed as incurred. External costs incurred in producing media advertising are expensed the first time the advertising takes place. External costs relating to direct mailing costs are expensed in the period in which the direct mailings are sent. Income taxes The provision for income taxes includes deferred taxes on temporary differences between the recognition of certain income and expense items for tax and financial statement purposes. Income taxes are computed on the liability method as described in SFAS No. 109, Accounting for Income Taxes. Statements of cash flows For the purposes of reporting cash flows, the Company considers cash and cash equivalents to be those amounts included in the balance sheet captions "Cash and Due From Banks," "Interest-bearing Deposits in Other Banks" and "Federal Funds Sold." Cash and cash equivalents have an original maturity of three months or less. Reclassifications Certain prior year amounts have been reclassified to conform with the current presentation. These reclassifications have no effect on previously reported net income or shareholders' equity. Risk and uncertainties In the normal course of its business the Company encounters two significant types of risk: economic and regulatory. There are three main components of economic risk: interest rate risk, credit risk, and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different speeds, or on different bases, than its interest-earning assets. Credit risk is the risk of default on the Company's loan portfolio that results from borrowers' inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of collateral underlying loans receivable, the valuation of real estate held by the Company, and the valuation of loans held for sale and mortgage-backed securities available for sale. The Company is subject to the regulations of various government agencies. These regulations can and do change significantly from period to period. The Company also undergoes periodic examinations by the regulatory agencies, which may subject it to further changes with respect to asset valuations, amounts of required loss allowances, and operating restrictions, resulting from the regulators' judgments based on information available to them at the time of their examination. Stock option compensation plans The Company has a stock option compensation plan through which the Board of Directors may grant stock options to officers and employees to purchase common stock of the Company at prices not less than 100 percent of the fair value of the stock on the date of grant. The outstanding options become exercisable in various increments beginning on the date of grant and expiring ten years from the date of grant. The Company also has a directors' stock option plan through which non-employee directors of the Company are granted options to purchase 500 shares of common stock for each year served on the board to a maximum of 5,000 options per director. The option price shall not be less than 100 percent of the fair value of the stock on the grant date. The outstanding options become exercisable on the grant date and expire at the earlier of the end of the director's term or ten years from the grant date. The Company has historically accounted for the plans under the recognition and measurement principles of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all stock options granted under these plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Financial Accounting Standards Board ("FASB") SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation. (Continued) 68 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued
(tabular amounts in thousands, except per share information) For the years ended December 31, -------------------------------- 2005 2004 2003 ---- ---- ---- Net income, as reported ........................................................ $4,128 $3,528 $ 5,044 Deduct: total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects .................................................. (131) (120) (109) ------ ------ --------- Pro forma net income ........................................................... $3,997 $3,408 $ 4,935 ====== ====== ========= Net income per common share Basic-as reported ........................................................... $ 0.66 $ 0.58 $ 0.83 ====== ====== ========= Basic-pro forma ............................................................. $ 0.64 $ 0.56 $ 0.81 ====== ====== ========= Diluted-as reported ......................................................... $ 0.65 $ 0.56 $ 0.80 ====== ====== ========= Diluted-pro forma ........................................................... $ 0.63 $ 0.54 $ 0.78 ====== ====== =========
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for grants in 2005, 2004 and 2003: dividend yields from $.17 to $.20 per share, expected volatility from 25 to 27 percent, risk-free interest rates from 4.06 to 5.00 percent and expected life of 10 years. The weighted average market value of options granted approximated $6.66 in 2005, $5.25 in 2004, and $8.45 in 2003. For purposes of the proforma calculations, compensation expense is recognized on a straight-line basis over the vesting period. Effective January 1, 2006, the Company has adopted the provisions of SFAS No. 123 (R), which changed the accounting methodology for its stock option plans. See "Recently issued accounting standards." Recently issued accounting standards The following is a summary of recent authoritative pronouncements that affect accounting, reporting, and disclosure of financial information by the Company: In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment ("SFAS No. 123(R)"). SFAS No. 123(R) will require companies to measure all employee stock-based compensation awards using a fair value method and record such expense in its financial statements. In addition, the adoption of SFAS No. 123(R) requires additional accounting and disclosure related to the income tax and cash flow effects resulting from share-based payment arrangements. SFAS No. 123(R) was effective for the Company beginning as of the first quarterly reporting period of 2006. SFAS No. 123(R) allows for adoption using either the modified prospective or modified retrospective methods. The Company elected to use the modified prospective method when this statement was adopted in the first quarter of 2006. The Company has evaluated the impact upon adoption of SFAS No. 123(R) and related guidance and has concluded that the adoption did not have a material impact on financial position or results of operations upon adoption. (Continued) 69 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets - an amendment of APB Opinion No. 29. The standard is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged and eliminates the exception under APB Opinion No. 29 for an exchange of similar productive assets and replaces it with an exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The standard is effective for nonmonetary exchanges occurring in fiscal periods beginning after June 15, 2005. The adoption of SFAS No. 153 is not expected to have any impact on the Company's financial position or results of operations. In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS No. 154 establishes retrospective application as the required method for reporting a change in accounting principle, unless it is impracticable, in which case the changes should be applied to the latest practicable date presented. SFAS No. 154 also requires that a correction of an error be reported as a prior period adjustment by restating prior period financial statements. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. In March 2005 the FASB issued FASB Interpretation ("FIN") No. 47, Accounting for Conditional Asset Retirement Obligations--an interpretation of FASB Statement No. 143. This Interpretation clarifies that the term conditional asset retirement obligation as used in SFAS No. 143, Accounting for Asset Retirement Obligations, refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and (or) method of settlement. Thus, the timing and (or) method of settlement may be conditional on a future event. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. The fair value of a liability for the conditional asset retirement obligation should be recognized when incurred--generally upon acquisition, construction, or development and (or) through the normal operation of the asset. Uncertainty about the timing and (or) method of settlement of a conditional asset retirement obligation should be factored into the measurement of the liability when sufficient information exists. FIN No. 47 is effective no later than the end of fiscal years ending after December 15, 2005. The Company adopted FIN No. 47 in 2005 and its adoption had no effect on financial position or results of operations. (Continued) 70 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued In March 2004, the FASB issued Emerging Issues Task Force ("EITF") Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. This Issue addresses the meaning of other-than-temporary impairment and its application to investments classified as either available for sale or held to maturity under SFAS No. 115 and it also provides guidance on quantitative and qualitative disclosures. The disclosure requirements in paragraph 21 of this Issue were adopted by the Company effective December 31, 2003. The recognition and measurement guidance in paragraphs 6-20 of this Issue was to be applied to other-than-temporary impairment evaluations in reporting periods beginning after June 15, 2004, but was delayed by FASB action in October 2004 through the issuance of a proposed FASB Staff Position ("FSP") on the issue. In July 2005, the FASB issued FSP FAS 115-1 and FSP FAS 124-1--The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. This FSP addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. This FSP also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. This FSP will be effective for other-than-temporary impairment analyses conducted in periods beginning after December 15, 2005. The Company has evaluated the impact of the adoption of FSP FAS 115-1 and FSP FAS 124-1 and has concluded that the adoption will not have a material impact on financial position and results of operations upon adoption. In December 2005, the FASB issued FSP SOP 94-6-1, Terms of Loan Products that May Give Rise to a Concentration of Credit Risk. The disclosure guidance in this FSP is effective for interim and annual periods ending after December 19, 2005. The FSP states that the terms of certain loan products may increase a reporting entity's exposure to credit risk and thereby may result in a concentration of credit risk as that term is used in SFAS No. 107, either as an individual product type or as a group of products with similar features. SFAS No. 107 requires disclosures about each significant concentration, including "information about the (shared) activity, region, or economic characteristic that identifies the concentration." The FSP suggests possible shared characteristics on which significant concentrations may be determined which include, but are not limited to (1) loans that subject borrowers to significant payment increases, (2) loans with terms that permit negative amortization, and (3) loans with high loan-to-value ratios. This FSP requires entities to provide the disclosures required by SFAS No. 107 for loan products that are determined to represent a concentration of credit risk in accordance with the guidance of this FSP for all periods presented. The Company adopted this disclosure standard effective December 31, 2005. Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption. NOTE 2 - RESTRICTIONS ON CASH AND DUE FROM BANKS The Banks are required to maintain average reserve balances with the Federal Reserve Bank ("FRB") based upon a percentage of deposits. The average amounts of reserve balances maintained by the Banks at December 31, 2005 and 2004 were approximately $3,070,000 and $2,934,000, respectively. (Continued) 71 NOTE 3 - SECURITIES Securities are summarized as follows as of December 31 (tabular amounts in thousands):
2005 ---- Unrealized holding Amortized ------------------ Fair cost Gains Losses value ---- ----- ------ ----- SECURITIES AVAILABLE FOR SALE: OBLIGATIONS OF U. S. GOVERNMENT AGENCIES AND CORPORATIONS Maturing within one year .................................. $37,949 $ - $ 556 $37,393 Maturing after one but within five years .................. 10,255 - 254 10,001 ------- ------- ------- ------- 48,204 - 810 47,394 ------- ------- ------- ------- MORTGAGE-BACKED SECURITIES Maturing after one but within five years .................. 878 - 21 857 Maturing after five but within ten years .................. 12,124 - 356 11,768 Maturing after ten years .................................. 5,097 - 107 4,990 ------- ------- ------- ------- 18,099 - 484 17,615 ------- ------- ------- ------- Total securities available for sale .................... $66,303 $ - $ 1,294 $65,009 ======= ======= ======= ======= SECURITIES HELD TO MATURITY: OBLIGATIONS OF STATES AND POLITICAL SUBDIVISIONS Maturing within one year .................................. $ 160 $ 2 $ - $ 162 Maturing after one but within five years .................. 3,800 6 40 3,766 Maturing after five but within ten years .................. 4,546 2 113 4,435 Maturing after ten years .................................. 2,349 - 38 2,311 ------- ------- ------- ------- Total securities held to maturity ...................... $10,855 $ 10 $ 191 $10,674 ======= ======= ======= =======
2004 ---- Unrealized holding Amortized ------------------ Fair cost Gains Losses value ---- ----- ------ ----- SECURITIES AVAILABLE FOR SALE: OBLIGATIONS OF U. S. GOVERNMENT AGENCIES AND CORPORATIONS Maturing within one year .................................. $ 500 $ - $ 7 $ 493 Maturing after one but within five years .................. 47,953 - 593 47,360 ------- ------- ------- ------- 48,453 - 600 47,853 ------- ------- ------- ------- MORTGAGE-BACKED SECURITIES Maturing after one but within five years .................. 1,546 3 6 1,543 Maturing after five but within ten years .................. 9,532 13 121 9,424 Maturing after ten years .................................. 3,218 17 3 3,232 ------- ------- ------- ------- 14,296 33 130 14,199 ------- ------- ------- ------- Total securities available for sale .................... $62,749 $ 33 $ 730 $62,052 ======= ======= ======= =======
(Continued) 72 NOTE 3 - SECURITIES, Continued
2004 ---- Unrealized holding Amortized ------------------ Fair cost Gains Losses value ---- ----- ------ ----- SECURITIES HELD TO MATURITY: OBLIGATIONS OF STATES AND POLITICAL SUBDIVISIONS Maturing within one year .................................. $1,056 $ 9 $ - $1,065 Maturing after one but within five years .................. 3,145 69 - 3,214 Maturing after five but within ten years .................. 2,980 27 39 2,968 Maturing after ten years .................................. 205 - 1 204 ------ ------ ------ ------ Total securities held to maturity ...................... $7,386 $ 105 $ 40 $7,451 ====== ====== ====== ======
The following table shows gross unrealized losses and fair value, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2005. Securities Available for Sale (tabular amounts in thousands):
Less than 12 Months 12 Months or More Total ------------------- ----------------- ----- Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses ----- ------ ----- ------ ----- ------ US Government agencies and corporations ...... $ 247 $ 2 $47,147 $ 807 $47,394 $ 810 Mortgage-backed securities ................... 10,075 194 7,540 291 17,615 484 ------- ------- ------- ------- ------- ------- Total ........................................ $10,322 $ 196 $54,687 $ 1,098 $65,009 $ 1,294 ======= ======= ======= ======= ======= =======
Sixty-two individual securities were in a continuous loss position for twelve months or more. Securities Held to Maturity (tabular amounts in thousands):
Less than 12 Months 12 Months or More Total ------------------- ----------------- ----- Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses ----- ------ ----- ------ ----- ------ States and political Subdivisions .............. $7,848 $ 108 $1,826 $ 83 $9,674 $ 191 ====== ====== ====== ====== ====== ======
Eight individual securities were in a continuous loss position for twelve months or more. The Company has the ability and intent to hold these securities until such time as the value recovers or the securities mature. The Company believes, based on industry analyst reports and credit ratings, that the deterioration in value is attributable to changes in market interest rates and not in the credit quality of the issuer and therefore, these losses are not considered other-than-temporary. (Continued) 73 NOTE 3 - SECURITIES, Continued Other Investments, at Cost (tabular amounts in thousands): The Banks, as member institutions, are required to own certain stock investments in the Federal Home Loan Bank of Atlanta ("FHLB") and the FRB. These investments are carried at cost and are generally pledged against any borrowings from these institutions (see Note 9). No ready market exists for the stock and they have no quoted market values. The Company's investments in stock are summarized below (tabular amounts in thousands): December 31, ------------ 2005 2004 ---- ---- FRB ...................................... $ 396 $ 396 FHLB ..................................... 1,649 1,269 Bankers Bank ............................. 152 144 ------ ------ $2,197 $1,809 ====== ====== Securities with carrying amounts of $54,936,000 and $57,887,000 at December 31, 2005 and 2004, respectively, were pledged to secure public deposits and for other purposes required or permitted by law. NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES Loans are summarized as follows (tabular amounts in thousands): December 31, ------------ 2005 2004 ---- ---- Commercial and industrial - not secured by real estate ... $ 39,669 $ 39,723 Commercial and industrial - secured by real estate ....... 90,186 95,965 Residential real estate - mortgage ....................... 107,398 105,580 Residential real estate - construction ................... 121,048 63,380 Loans to individuals for household, family and other personal expenditures ................. 19,194 21,255 -------- -------- 377,495 325,903 Less allowance for loan losses ........................... 3,854 3,691 -------- -------- $373,641 $322,212 ======== ======== The composition of gross loans by rate type is as follows: (tabular amounts in thousands): December 31, ------------ 2005 2004 ---- ---- Variable rate loans ...................... $194,904 $167,430 Fixed rate loans ......................... 182,591 158,473 -------- -------- $377,495 $325,903 ======== ======== (Continued) 74 NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES, Continued Changes in the allowance for loan losses were as follows: For the years ended December 31, -------------------------------- 2005 2004 2003 ---- ---- ---- BALANCE, BEGINNING OF YEAR ........... $ 3,691 $ 3,438 $ 2,850 Provision for loan losses ....... 848 589 1,106 Loans charged off ............... (704) (448) (565) Loans recovered ................. 19 112 47 -------- -------- -------- BALANCE, END OF YEAR ................. $ 3,854 $ 3,691 $ 3,438 ======== ======== ======== At December 31, 2005 and 2004 nonaccrual loans amounted to $1,206,000 and $670,000, respectively. Foregone interest income was approximately $89,000, $46,000 and $101,000 on nonaccrual loans for 2005, 2004 and 2003, respectively. There were no impaired loans at December 31, 2005 and 2004. NOTE 5 - PREMISES AND EQUIPMENT The principal categories and estimated useful lives of premises and equipment are summarized below (tabular amounts in thousands): December 31, Estimated ------------ useful lives 2005 2004 ------------ ---- ---- Land .................................... $ 2,195 $ 2,145 Building and improvements ............... 15 - 40 years 7,622 7,369 Furniture, fixtures and equipment ....... 3 - 10 years 7,267 7,082 ------- ------- 17,084 16,596 Less accumulated depreciation ........... 6,449 5,521 ------- ------- $10,635 $11,075 ======= ======= Depreciation expense of approximately $1,127,000, $1,075,000 and $967,000 for 2005, 2004 and 2003, respectively, is included in occupancy and equipment expenses in the accompanying consolidated statements of income. NOTE 6 - DEPOSITS The composition of deposits is as follows (tabular amounts in thousands): December 31, ------------ 2005 2004 ---- ---- Demand deposits, noninterest bearing ............. $ 52,467 $ 51,507 NOW and money market accounts .................... 102,225 95,604 Savings deposits ................................. 11,294 11,964 Time certificates, $100,000 or more .............. 99,255 81,015 Other time certificates .......................... 125,108 106,055 -------- -------- Total ................................... $390,349 $346,145 ======== ======== (Continued) 75 NOTE 6 - DEPOSITS, Continued December 31, ------------ 2005 2004 ---- ---- Time certificates maturing Within one year ............................. $127,271 $110,298 After one but within two years .............. 78,344 41,786 After two but within three years ............ 17,844 32,385 After three but within four years ........... 527 1,780 After four years ............................ 377 821 -------- -------- 224,363 187,070 Transaction and savings accounts ................. 165,986 159,075 -------- -------- $390,349 $346,145 ======== ======== Certificates of deposit in excess of $100,000 totaled approximately $89,607,000 and $81,015,000 at December 31, 2005 and 2004, respectively. Interest expense on certificates of deposit in excess of $100,000 was approximately, $2,893,000 in 2005, $2,422,000 in 2004 and $2,247,000 in 2003. The Banks had no brokered time certificates, at December 31, 2005 and 2004, respectively. NOTE 7 - SECURITIES SOLD UNDER REPURCHASE AGREEMENTS Securities sold under repurchase agreements are summarized as follows (tabular amounts in thousands):
December 31, ------------ 2005 2004 ---- ---- U. S. Government securities with an amortized cost of $44,851,000 ($44,000,000 fair value) and $48,768,000 ($48,322,000 fair value) at December 31, 2005 and 2004, respectively, collateralize the agreements .......... $31,736 $33,953 ======= =======
The Banks enter into sales of securities under agreements to repurchase. These obligations to repurchase securities sold are reflected as liabilities in the consolidated balance sheets. The dollar amount of securities underlying the agreements remains in the asset accounts. The securities underlying the agreements are book entry securities maintained by a safekeeping agent. The weighted average interest rate of these agreements was 1.94 percent and 1.07 percent for 2005 and 2004, respectively. The agreements mature daily. Securities sold under agreements to repurchase averaged $31,594,000 and $31,856,000 during 2005 and 2004, respectively. The maximum amounts outstanding at any month-end were $34,757,000 and $36,243,000 during 2005 and 2004, respectively. NOTE 8- FEDERAL FUNDS PURCHASED At December 31, 2005, the Banks had the ability to purchase federal funds from unrelated banks under short-term lines of credit totaling $30,750,000. These lines of credit are available on a one to seven day basis for general corporate purposes. At December 31, 2005 and 2004, there was $4,039,000 and $572,000, respectively, outstanding under such agreements. 76 NOTE 9 - ADVANCES FROM FEDERAL HOME LOAN BANK The Banks have the ability to borrow up to 20 percent of their total assets from the FHLB subject to available qualifying collateral. Borrowings may be obtained under various FHLB lending programs with various terms. Borrowings from the FHLB require qualifying collateral (which includes certain mortgage loans, investment securities and FHLB stock) and may require purchasing additional stock in the FHLB. The Banks had advances aggregating $17,500,000 and $8,500,000 at December 31, 2005 and 2004, respectively. At December 31, 2005 and 2004 respectively, the Banks had $12,500,000 and $3,500,000 of advances at interest rates of 4.44 and 1.63 percent and which matured daily. At December 31, 2005 and 2004, $5,000,000 of the advances bear interest at 4.82 percent and mature in December 2010. At December 31, 2005 and 2004, the advances were collateralized by qualifying mortgage loans aggregating approximately $68,112,000 and $61,445,000, respectively, and by FHLB stock owned by all three Banks. As of December 31, 2005, the Banks had the ability to borrow an additional $57,750,000 in the aggregate from the FHLB. NOTE 10 - INCOME TAXES Provision for income taxes consists of the following (tabular amounts in thousands): For the years ended December 31, -------------------------------- 2005 2004 2003 ---- ---- ---- Current tax provision Federal .......................... $ 1,474 $ 1,703 $ 2,736 State ............................ 188 160 229 ------- ------- ------- Total current taxes ............ 1,662 1,863 2,965 Deferred tax benefit ................. (10) (209) (97) ------- ------- ------- $ 1,652 $ 1,654 $ 2,868 ======= ======= ======= Income taxes differ from the tax expense computed by applying the statutory federal income tax rate of 34 percent to income before income taxes. The reasons for these differences are as follows (tabular amounts in thousands): For the years ended December 31, -------------------------------- 2005 2004 2003 ---- ---- ---- Tax expense at statutory rate ................. $ 1,965 $ 1,762 $ 2,690 Increase (decrease) in taxes resulting from: State income taxes, net of federal benefit 124 104 149 Tax-exempt interest income ................ (77) (79) (61) Investment in life insurance .............. (120) (159) (32) Other ..................................... (240) 26 122 ------- ------- ------- Provision for income taxes .............. $ 1,652 $ 1,654 $ 2,868 ======= ======= ======= (Continued) 77 NOTE 10 - INCOME TAXES, Continued Deferred tax assets (liabilities) result from temporary differences in the recognition of revenue and expenses for tax and financial statement purposes. Management believes realization of the deferred tax assets is more likely than not and accordingly has not recorded a valuation allowance. The sources and the cumulative tax effect of temporary differences are as follows (tabular amounts in thousands): December 31, ------------ 2005 2004 ---- ---- Deferred tax assets Allowance for loan losses .................... $ 1,318 $ 1,255 Deferred compensation ........................ 138 194 Unrealized holding losses on securities available for sale .............. 439 237 Other ........................................ - 48 ------- ------- 1,895 1,734 ------- ------- Deferred tax liabilities Depreciation ................................. (351) (502) Other ........................................ (100) - ------- ------- (451) (502) ------- ------- Net deferred tax assets included in other assets ................................ $ 1,444 $ 1,232 ======= ======= NOTE 11 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK The Banks are parties to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of their customers. These financial instruments include commitments to extend credit and standby letters of credit. They involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheets. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amounts of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any material condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. At December 31, 2005, unfunded commitments to extend credit were $111,082,000, of which $105,520,000 were at variable rates and $5,562,000 were at fixed rates. These commitments included $44,153,000 of unfunded amounts of construction loans, $39,744,000 of undisbursed amounts of home equity lines of credit, $20,338,000 of unfunded amounts under commercial lines of credit, and $6,847,000 of other commitments to extend credit. The Company evaluates each customer's creditworthiness on a case-by-case basis. 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 varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate. At December 31, 2005, there was $6,742,000 committed under letters of credit. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral varies but may include accounts receivable, inventory, equipment, marketable securities and property. Since most of the letters of credit are expected to expire without being drawn upon, they do not necessarily represent future cash requirements. The Company has not recorded a liability for the current carrying amount of the obligation to perform as a guarantor, and no contingent liability was considered necessary, as such amounts were not considered material. 78 NOTE 12 - COMMITMENTS AND CONTINGENCIES The Company has, from time to time, various lawsuits and claims arising from the conduct of its business. Management does not expect such items to have any material adverse effect on the financial position or results of operations of the Company. Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of loans receivable, investment securities, federal funds sold and amounts due from banks. The Company makes loans to individuals and small businesses for various personal and commercial purposes primarily in the upstate region of South Carolina. The Company's loan portfolio is not concentrated in loans to any single borrower or in a relatively small number of borrowers. Additionally, management is not aware of any concentrations of loans to classes of borrowers or industries that would be similarly affected by economic conditions. In addition to monitoring potential concentrations of loans to particular borrowers or groups of borrowers, industries and geographic regions, management monitors exposure to credit risk that could arise from potential concentrations of lending products and practices such as loans that subject borrowers to substantial payment increases (e.g. principal deferral periods, loans with initial interest-only periods, etc), and loans with high loan-to-value ratios. Additionally, there are industry practices that could subject the Company to increased credit risk should economic conditions change over the course of a loan's life. For example, the Company makes variable rate loans and fixed rate principal-amortizing loans with maturities prior to the loan being fully paid (i.e. balloon payment loans). These loans are underwritten and monitored to manage the associated risks. Management has determined that there is no concentration of credit risk associated with its lending policies or practices. The Company's investment portfolio consists principally of obligations of the United States, its agencies or its corporations and general obligation municipal securities. In the opinion of management, there is no concentration of credit risk in its investment portfolio. The Company places its deposits and correspondent accounts with and sells its federal funds to high quality institutions. Management believes credit risk associated with correspondent accounts is not significant. NOTE 13 - RELATED PARTY TRANSACTIONS At December 31, 2005 and 2004, certain officers, directors, employees, related parties and companies in which they have 10 percent or more beneficial ownership, were indebted to the Banks in the aggregate amount of $7,961,000 and $7,533,000, respectively. During 2005, $2,443,000 of new loans were made to this group and repayments of $2,015,000 were received. This same group had deposits in the Banks of $8,174,000 at December 31, 2005. NOTE 14 - COMMON STOCK AND EARNINGS PER SHARE SFAS No. 128, Earnings per Share requires that the Company present basic and diluted net income per common share. The assumed conversion of stock options creates the difference between basic and diluted net income per common share. Income per share is calculated by dividing net income by the weighted average number of common shares outstanding for each period presented. The weighted average number of common shares outstanding for basic net income per common share was 6,222,324 in 2005, 6,113,738 in 2004 and 6,090,355 in 2003. The weighted average number of common shares outstanding for diluted net income per common share was 6,368,083 in 2005, 6,336,152 in 2004 and 6,316,624 in 2003. (Continued) 79 NOTE 14 - COMMON STOCK AND EARNINGS PER SHARE, Continued The Company declared or issued five percent common stock dividends in 2005, 2004 and 2003. Additionally, the Company effected a 3-for-2 stock split in October 2004. Upon issuance of the 3-for-2 stock split, the Company filed articles of amendment to its Articles of Incorporation increasing its authorized shares from 10,000,000 to 15,000,000 and decreasing its par value from $1.67 per share to $1.11 per share. Net income and dividends per common share and the weighted average number of common shares outstanding for basic and diluted net income per common share in prior years have been restated to reflect these transactions. NOTE 15 - RESTRICTION OF DIVIDENDS The ability of the Company to pay cash dividends is dependent upon receiving cash in the form of dividends from the Banks. Federal banking regulations restrict the amount of dividends that can be paid and such dividends are payable only from the retained earnings of the Banks. At December 31, 2005 the Banks had aggregate retained earnings of $24,882,000. NOTE 16 - STOCK OPTION COMPENSATION PLANS A summary of the status of the plans as of December 31, 2005, 2004 and 2003, and changes during the years ending on those dates is presented below (all shares and exercise prices have been adjusted for stock dividends and the stock split):
2005 2004 2003 ---- ---- ---- Weighted Weighted Weighted Shares exercise price Shares exercise price Shares exercise price ------ -------------- ------ -------------- ------ -------------- Outstanding at beginning of year ..... 410,780 $ 6.18 394,590 $ 5.25 382,435 $ 4.84 Granted .............................. 20,475 17.16 40,513 14.33 12,155 11.52 Exercised ............................ (139,812) 4.04 (24,323) 5.90 - - Forfeited or expired ................. (3,183) - - - - - -------- ------- -------- Outstanding at end of year ........... 288,260 7.92 410,780 6.19 394,590 5.26 ======== ======= ======== Options exercisable at year-end ...... 257,450 7.15 377,433 5.53 378,289 5.06 Shares available for grant ........... 386,537 407,012 448,313
80 NOTE 16 - STOCK OPTION COMPENSATION PLANS, Continued Options Outstanding Options Exercisable ------------------- ------------------- Weighted average Weighted Weighted remaining average average Number contractual exercise Number exercise outstanding life price exercisable price ----------- ---- ----- ----------- ----- 104,670 1.3 years $ 3.87 104,670 $ 3.87 3,306 2.3 years 5.88 3,306 5.88 32,692 2.6 years 5.88 32,692 5.88 12,163 2.8 years 5.88 12,163 5.88 8,416 3.3 years 7.13 8,416 7.13 12,012 4.3 years 8.99 12,012 8.99 5,984 5.1 years 9.41 4,693 9.41 2,870 5.2 years 8.49 2,440 8.49 11,460 5.4 years 8.38 11,460 8.38 1,913 5.6 years 8.36 1,626 8.36 3,826 5.7 years 8.13 3,252 8.13 12,740 6.4 years 9.75 12,740 9.75 10,403 6.6 years 10.30 7,024 10.30 10,404 7.4 years 11.53 10,404 11.53 31,618 8.4 years 14.21 18,594 14.21 1,654 8.7 years 15.11 662 15.11 1,654 8.8 years 16.23 662 16.23 3,150 9.1 years 19.76 788 19.76 7,350 9.3 years 17.24 7,350 17.24 1,050 9.6 years 16.29 263 16.29 2,100 9.7 years 16.43 526 16.43 5,250 9.8 years 16.43 1,313 16.43 1,575 10.0 years 15.51 394 15.51 ------- ------- 288,260 257,450 ======= ======= The plans are administered by the Board of Directors or by a committee designated by the Board. The plans provide that if the shares of common stock shall be subdivided or combined into a greater or smaller number of shares or if the Company shall issue any shares of common stock as a stock dividend on its outstanding common stock, the number of shares of common stock deliverable upon the exercise of options shall be increased or decreased proportionately, and appropriate adjustments shall be made in the purchase price per share to reflect such subdivision, combination or stock dividend. 81 NOTE 17 - EMPLOYEE BENEFIT PLANS The Company maintains a 401(k) retirement plan for all eligible employees. Upon ongoing approval of the Board of Directors, the Company matches employee contributions equal to fifty percent of the first six percent of such contributions, subject to certain adjustments and limitations. Contributions to the plan of $142,255, $136,526 and $135,619, were charged to operations during 2005, 2004 and 2003, respectively. Supplemental benefits have been approved by the Board of Directors for certain executive officers of The Peoples National Bank. These benefits are not qualified under the Internal Revenue Code and they are not funded. However, certain funding is provided informally and indirectly by life insurance policies. The Company recorded expense related to these benefits of $74,383, $495,210 and $173,997, in 2005, 2004, and 2003, respectively. NOTE 18 - REGULATORY MATTERS The Banks are subject to various regulatory capital requirements administered by the federal 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 Banks' financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Banks must meet specific capital guidelines that involve quantitative measures of the Banks' assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Banks' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Banks to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets. Management believes, as of December 31, 2005, that the Banks meet all capital adequacy requirements to which they are subject. As of December 31, 2005, the most recent notification from the Office of the Comptroller of the Currency categorized the Banks as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Banks' categories. The Banks' actual capital amounts and ratios and minimum regulatory amounts and ratios are presented as follows: 82 NOTE 18 - REGULATORY MATTERS, Continued
To be well capitalized under For capital prompt corrective adequacy purposes action provisions ----------------- ----------------- Actual Minimum Minimum ------ ------- ------- Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- (dollar amounts in thousands) Peoples Bancorporation, Inc.: As of December 31, 2005 Total Capital (to risk-weighted assets) ........ $45,880 11.93% $30,766 8.00% N/A N/A Tier 1 Capital (to risk-weighted assets) ....... 42,025 10.93 15,380 4.00 N/A N/A Tier 1 Capital (to average assets) ............. 42,025 8.67 19,389 4.00 N/A N/A As of December 31, 2004 Total Capital (to risk-weighted assets) ........ $42,382 12.35% $27,454 8.00% $34,317 10.00% Tier 1 Capital (to risk-weighted assets) ....... 38,700 11.27 13,736 4.00 20,603 6.00 Tier 1 Capital (to average assets) ............. 38,700 8.92 17,354 4.00 21,693 5.00 The Peoples National Bank: As of December 31, 2005 Total Capital (to risk-weighted assets) ........ $26,129 11.58% $18,051 8.00% $22,564 10.00% Tier 1 Capital (to risk-weighted assets) ....... 24,136 10.69 9,031 4.00 13,547 6.00 Tier 1 Capital (to average assets) ............. 24,136 8.93 10,811 4.00 13,514 5.00 As of December 31, 2004 Total Capital (to risk-weighted assets) ........ $24,570 12.61% $15,588 8.00% $19,485 10.00% Tier 1 Capital (to risk-weighted assets) ....... 22,541 11.57 7,793 4.00 11,689 6.00 Tier 1 Capital (to average assets) ............. 22,541 9.10 9,908 4.00 12,385 5.00 Bank of Anderson, N.A.: As of December 31, 2005 Total Capital (to risk-weighted assets) ........ $ 12,539 10.68% $ 9,393 8.00% $11,741 10.00% Tier 1 Capital (to risk-weighted assets) ....... 11,185 9.53 4,695 4.00 7,042 6.00 Tier 1 Capital (to average assets) ............. 11,185 7.08 6,319 4.00 7,899 5.00 As of December 31, 2004 Total Capital (to risk-weighted assets) ........ $ 11,325 10.26% $ 8,830 8.00% $11,038 10.00% Tier 1 Capital (to risk-weighted assets) ....... 10,149 9.19 4,417 4.00 6,626 6.00 Tier 1 Capital (to average assets) ............. 10,149 7.21 5,631 4.00 7,038 5.00 Seneca National Bank: As of December 31, 2005 Total Capital (to risk-weighted assets) ........ $ 5,177 12.53% $ 3,305 8.00% $ 4,132 10.00% Tier 1 Capital (to risk-weighted assets) ....... 4,669 11.30 1,653 4.00 2,479 6.00 Tier 1 Capital (to average assets) ............. 4,669 8.52 2,192 4.00 2,740 5.00 As of December 31, 2004 Total Capital (to risk-weighted assets) ........ $ 4,794 12.59% $ 3,046 8.00% $ 3,808 10.00% Tier 1 Capital (to risk-weighted assets) ....... 4,318 11.34 1,523 4.00 2,285 6.00 Tier 1 Capital (to average assets) ............. 4,318 9.11 1,895 4.00 2,369 5.00
83 NOTE 19 - FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107, Disclosures about Fair Value of Financial Instruments requires disclosure of fair value information, whether or not recognized in the balance sheets, when it is practical to estimate the fair value. SFAS No. 107 defines a financial instrument as cash, evidence of an ownership interest in an entity or contractual obligations which require the exchange of cash or other financial instruments. Certain items are specifically excluded from the disclosure requirements, including the Company's common stock, premises and equipment and other assets and liabilities. Fair value approximates carrying value for the following financial instruments due to the short-term nature of the instrument: cash and due from banks, interest-bearing deposits in other banks and federal funds sold and purchased. Securities are valued using quoted fair market prices. Other investments are valued at par value. Fair value for variable rate loans that reprice frequently, loans held for sale, and for loans that mature in less than three months is based on the carrying value. Fair value for fixed rate mortgage loans, personal loans, and all other loans (primarily commercial) maturing after three months is based on the discounted present value of the estimated future cash flows. Discount rates used in these computations approximate the rates currently offered for similar loans of comparable terms and credit quality. Fair value for demand deposit accounts and interest-bearing accounts with no fixed maturity date is equal to the carrying value. Certificate of deposit accounts and securities sold under repurchase agreements maturing within one year are valued at their carrying value. The fair value of certificate of deposit accounts and securities sold under repurchase agreements maturing after one year are estimated by discounting cash flows from expected maturities using current interest rates on similar instruments. Fair value for long-term FHLB advances is based on discounted cash flows using the Company's current incremental borrowing rate. Discount rates used in these computations approximate rates currently offered for similar borrowings of comparable terms and credit quality. Fair value of off-balance sheet instruments are based on fees currently charged to enter into similar arrangements; taking into account the remaining terms of the agreement and the counterparties' credit standing. The Company has used management's best estimate of fair value based on the above assumptions. Thus, the fair values presented may not be the amounts which could be realized in an immediate sale or settlement of the instrument. In addition, any income taxes or other expenses which would be incurred in an actual sale or settlement are not taken into consideration in the fair value presented. The estimated fair values of the Company's financial instruments are as follows (amounts in thousands):
December 31, ------------ 2005 2004 ---- ---- Carrying Fair Carrying Fair amount value amount value ------ ----- ------ ----- Financial assets: Cash and due from banks ............................ $ 9,311 $ 9,311 $ 8,630 $ 8,630 Interest-bearing deposits in other banks ........... 900 900 1,028 1,028 Federal funds sold ................................. - - 2,631 2,631 Securities available for sale ...................... 65,009 65,009 62,052 62,052 Securities held to maturity ........................ 10,855 10,674 7,386 7,451 Other investments .................................. 2,197 2,197 1,809 1,809 Loans (gross) ...................................... 377,495 372,750 325,903 322,090
(Continued) 84 NOTE 19 - FAIR VALUE OF FINANCIAL INSTRUMENTS, Continued
December 31, ------------ 2005 2004 ---- ---- Carrying Fair Carrying Fair amount value amount value ------ ----- ------ ----- Financial liabilities: Deposits ................................................... $390,349 $392,023 $346,145 $349,592 Securities sold under repurchase agreements ................ 31,736 31,736 33,953 33,953 Federal funds purchased .................................... 4,039 4,039 572 572 Advances from Federal Home Loan Bank ....................... 17,500 17,406 8,500 8,500
NOTE 20 - CONDENSED FINANCIAL INFORMATION Following is condensed financial information of Peoples Bancorporation, Inc. (parent company only) (tabular amounts in thousands): CONDENSED BALANCE SHEETS December 31, ------------ 2005 2004 ---- ---- ASSETS Cash ......................................... $ 1,644 $ 1,701 Investment in bank subsidiaries .............. 39,307 36,680 Other assets ................................. 559 199 ------- ------- $41,510 $38,580 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Other liabilities ............................ $ 339 $ 340 Shareholders' equity ......................... 41,171 38,240 ------- ------- $41,510 $38,580 ======= ======= 85 NOTE 20 - CONDENSED FINANCIAL INFORMATION, Continued CONDENSED STATEMENTS OF INCOME For the years ended December 31, -------------------------------- 2005 2004 2003 ---- ---- ---- INCOME Fees and dividends from subsidiaries ...... $ 4,945 $ 4,271 $ 3,861 ------- ------- ------- EXPENSES Salaries and benefits ..................... 2,970 2,205 1,996 Occupancy ................................. 25 22 22 Equipment ................................. 330 298 233 Other operating ........................... 844 706 675 ------- ------- ------- 4,169 3,231 2,926 EQUITY IN UNDISTRIBUTED NET INCOME OF BANK SUBSIDIARIES .............................. 2,974 2,478 4,091 ------- ------- ------- Income before income taxes ........... 3,750 3,518 5,026 INCOME TAX BENEFIT ............................ (378) (10) (18) ------- ------- ------- Net income ........................... $ 4,128 $ 3,528 $ 5,044 ======= ======= ======= CONDENSED STATEMENTS OF CASH FLOWS
For the years ended December 31, -------------------------------- 2005 2004 2003 ---- ---- ---- OPERATING ACTIVITIES Net income .................................................................. $ 4,128 $ 3,528 $ 5,044 Adjustments to reconcile net income to net cash provided by operating activities Equity in undistributed net income of bank subsidiaries ................ (2,974) (2,478) (4,091) Depreciation ........................................................... - - - Amortization ........................................................... - - - (Increase)decrease in other assets ..................................... (369) 706 (120) Increase (decrease)in other liabilities ................................ (1) 124 (21) ------- ------- ------- Net cash provided by operating activities ............................ 784 1,880 812 ------- ------- ------- FINANCING ACTIVITIES Proceeds from the exercise of stock options ................................. 392 144 - Cash dividends .............................................................. (1,187) (1,051) (994) Cash in lieu of fractional share on stock dividends and splits .............. (9) (20) (13) Proceeds (repayment) of advances from subsidiaries .......................... (37) 192 131 ------- ------- ------- Net cash used for financing activities ............................... (841) (735) (876) ------- ------- ------- Net increase (decrease) in cash ...................................... (57) 1,145 (64) CASH, BEGINNING OF YEAR ......................................................... 1,701 556 620 ------- ------- ------- CASH, END OF YEAR ............................................................... $ 1,644 $ 1,701 $ 556 ======= ======= =======
86 NOTE 21 - QUARTERLY FINANCIAL DATA (UNAUDITED) Unaudited condensed financial data by quarter for 2005 and 2004 is as follows (amounts, except share data, in thousands):
Quarter ended ------------- 2005 March 31 June 30 September 30 December 31 ---- -------- ------- ------------ ----------- Interest income ........................................ $ 5,807 $ 6,398 $ 6,843 $ 7,242 Interest expense ....................................... 1,845 2,166 2,393 2,529 ---------- ---------- ---------- ---------- Net interest income ............................... 3,962 4,232 4,450 4,713 Provision for loan losses .............................. 173 183 165 327 ---------- ---------- ---------- ---------- Net interest income after provision for loan losses ...................... 3,789 4,049 4,285 4,386 Noninterest income ..................................... 889 890 899 931 Noninterest expenses ................................... 3,333 3,451 3,583 3,971 ---------- ---------- ---------- ---------- Income before income taxes ........................ 1,345 1,488 1,601 1,346 Provision for income taxes ............................. 434 487 528 203 ---------- ---------- ---------- ---------- Net income ........................................ $ 911 $ 1,001 $ 1,073 $ 1,143 ========== ========== ========== ========== Basic net income per common share (1) .................. $ 0.15 $ 0.16 $ 0.17 $ 0.18 ========== ========== ========== ========== Diluted net income per common share (1) ................ $ 0.14 $ 0.16 $ 0.17 $ 0.18 ========== ========== ========== ========== Basic weighted average shares outstanding(1) .................................... 6,177,488 6,226,668 6,240,508 6,244,633 ========== ========== ========== ========== Diluted weighted average shares outstanding(1) .................................... 6,378,034 6,383,167 6,358,622 6,406,581 ========== ========== ========== ========== Quarter ended ------------- 2004 March 31 June 30 September 30 December 31 ---- -------- ------- ------------ ----------- Interest income .......................................... $ 5,083 $ 5,113 $ 5,324 $ 5,543 Interest expense ......................................... 1,650 1,583 1,584 1,624 ---------- ---------- ---------- ---------- Net interest income ................................. 3,433 3,530 3,740 3,919 Provision for loan losses ................................ 130 153 153 153 ---------- ---------- ---------- ---------- Net interest income after provision for loan losses ........................ 3,303 3,377 3,587 3,766 Noninterest income ....................................... 1,303 1,530 1,193 970 Noninterest expenses ..................................... 3,792 3,456 3,298 3,301 ---------- ---------- ---------- ---------- Income before income taxes .......................... 814 1,451 1,482 1,435 Provision for income taxes ............................... 273 454 460 467 ---------- ---------- ---------- ---------- Net income .......................................... $ 541 $ 997 $ 1,022 $ 968 ========== ========== ========== ========== Basic net income per common share (1)(2) ................. $ 0.09 $ 0.16 $ 0.17 $ 0.16 ========== ========== ========== ========== Diluted net income per common share (1)(2) ............... $ 0.09 $ 0.16 $ 0.16 $ 0.15 ========== ========== ========== ========== Basic weighted average shares outstanding (1)(2) .................................. 6,090,355 6,090,355 6,101,110 6,105,481 ========== ========== ========== ========== Diluted weighted average shares outstanding (1)(2) .................................. 6,340,092 6,331,767 6,359,979 6,383,560 ========== ========== ========== ==========
(1) Per share data has been restated to reflect 5 percent stock dividends. (2) Per share data has been restated to reflect 3-for-2 stock split. 87 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There has been no occurrence requiring a response to this item. ITEM 9A. CONTROLS AND PROCEDURES Based on the evaluation required by 17 C.F.R. Section 240.13a-15(b) or 240.15d-15(b) of the Company's disclosure controls and procedures (as defined in 17 C.F.R. Sections 240.13a-15(e) and 240.15d-15(e))), the Company's chief executive officer and chief financial officer concluded that such controls and procedures, as of the end of the year covered by this annual report, were effective. No disclosure is required under 17 C.F.R. Section 229.308 (a) or (b). There has been no change in the Company's internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. ITEM 9 B. OTHER INFORMATION The Company was not required to disclose any information in a Form 8-K during the fourth quarter of 2005 that was not so disclosed. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information set forth under the caption "EXECUTIVE OFFICERS" under Part I, Item 1 of this report on Form 10-K, and the information set forth under the captions "ELECTION OF DIRECTORS AND DIRECTORS WHOSE TERMS WILL CONTINUE AFTER THE 2006 ANNUAL MEETING" and "SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE" in the Proxy Statement to be used in conjunction with the 2006 Annual Meeting of Shareholders (the "Proxy Statement"), which will be filed within 120 days of the Company's fiscal year end, is incorporated herein by reference. James A. Black, Jr., age 74, has served as a director of the Company since 2000 and as a director of Seneca National Bank since 1999. Mr. Black has reached mandatory retirement age for directors under the Company's Bylaws. Accordingly, Mr. Black has not been nominated for re-election at the 2006 annual shareholder meeting. Mr. Black retired in 1997 as Vice President of the Barnes Insurance Agency, Inc. in Easley, South Carolina. In addition, Mr. Black holds an Honorary Doctorate of Humanities from North Greenville College. 88 William A Carr, age 79, has served as a director of the Company and Peoples National Bank since 1992. Mr. Carr has reached mandatory retirement age for directors under the Company's Bylaws. Accordingly, Mr. Carr has not been nominated for re-election at the 2006 annual shareholder meeting. Mr. Carr served as mayor of the City of Easley, South Carolina from April 1983 through April 1999. Audit Committee Financial Expert The Company's board of directors has determined that the Company does not have an "audit committee financial expert," as that term is defined by Item 401(h) of Regulation S-K promulgated by the Securities and Exchange Commission, serving on its audit committee. The Company's audit committee is a committee of directors who are elected by the shareholders and who are independent of the Company and its management. After reviewing the experience and training of all of the Company's independent directors, the board of directors has concluded that no independent director meets the SEC's very demanding definition. Therefore, it would be necessary to find a qualified individual willing to serve as both a director and member of the audit committee and have that person elected by the shareholders in order to have an "audit committee financial expert" serving on the Company's audit committee. The Company's audit committee is, however, authorized to use consultants to provide financial accounting expertise in any instance where members of the committee believe such assistance would be useful. Accordingly, the Company does not believe that it needs to have an "audit committee financial expert" on its audit committee. Code of Ethics The Company has adopted a code of ethics that applies to the Company's principal executive officer, principal financial officer, principal accounting officer, controller, or persons serving in equivalent positions regardless of whether they are designated executive officers. The Company will provide a copy of the Code of Ethics to any person, without charge, upon written request to the Corporate Secretary, Peoples Bancorporation, Inc., 1818 East Main Street, Easley, South Carolina 29640. ITEM 11. EXECUTIVE COMPENSATION With the exception of information set forth under the captions "Board Compensation Committee Report on Executive Compensation" and "Performance Graph," which sub-sections are not incorporated herein by reference, the information set forth under the caption "EXECUTIVE COMPENSATION" in the Proxy Statement is incorporated herein by reference. 89 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENTAND RELATED STOCKHOLDER MATTERS The information set forth under the caption "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" in the Proxy Statement is incorporated herein by reference. The following table sets forth aggregated information as of December 31, 2005 about all of the Company's compensation plans (including individual compensation arrangements) under which equity securities of the Company are authorized for issuance:
Plan category Number of securities to Weighted-average Number of securities be issued upon exercise price of remaining available for exercise of outstanding options, future issuance outstanding options, warrants and rights under equity compensation warrants and rights plans (excluding securities reflected in column (a)) (a) (b) (c) ------------------ --------------- -------------- ----------------- Equity compensation Plans approved by Security holders ........... 288,260 $ 7.92 386,537 Equity compensation Plans not approved By security holders ........ 0 $ 0.00 0 ------- ------ ------- Total ...................... 288,260 $ 7.92 386,537
For further information about the Company's plans as set forth in the above table, see Note 16 of the consolidated financial statements set forth in Item 8 of this Form 10-K. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information set forth under the caption "CERTAIN TRANSACTIONS" in the Proxy Statement is incorporated herein by reference. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information set forth under the caption "INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM" in the Proxy Statement is incorporated herein by reference. 90 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES (a) (1) and (2) Financial Statements and Financial Schedules The following consolidated financial statements and report of independent auditors of Peoples Bancorporation, Inc. and subsidiaries are included in Item 8 of this Annual Report on Form 10-K: Report of Independent Registered Public Accounting Firm. Consolidated Balance Sheets - December 31, 2005 and 2004 Consolidated Statements of Income - Years ended December 31, 2005, 2004 and 2003 Consolidated Statements of Cash Flows - Years ended December 31, 2005, 2004 and 2003 Consolidated Statements of Shareholders' Equity and Comprehensive Income - Years ended December 31, 2005, 2004 and 2003 Notes to Consolidated Financial Statements - December 31, 2005 (a) (3) Listing of Exhibits: Exhibit No. Description of Exhibit 3 (i) Articles of Incorporation, as amended (incorporated by reference to Registrant's Form 10-Q for the quarter ended September 30, 2004). 3(ii) Bylaws (incorporated by reference to exhibits to Registrant's Current Report on Form 8-K filed June 20, 2005. 4.1 Specimen Common Stock Certificate (incorporated by reference to exhibits to Registrant's Registration Statement on Form S-4 (Number 33-46649)). 10.2 Peoples Bancorporation, Inc. 1993 Incentive Stock Option Plan (incorporated by reference to exhibits to Registrant's Registration Statement on Form S-8 (Number 333-121158)). 10.3 Peoples Bancorporation, Inc. 1997 Non-Employee Directors Stock Option Plan (incorporated by reference to exhibits to Registrant's Registration Statement on Form S-8 (Number 333-121157)). 91 10. 4 Peoples Bancorporation, Inc. 2004 Stock Option Plan (incorporated by reference to exhibits to Registrant's Registration Statement on Form S-8 (Number 333-121156)). 10.5 Non-competition, Severance and Employment Agreement, dated February 23, 2005 between the Company and R. Riggie Ridgeway (incorporated by reference to Registrant's Form 10-K for the year ended December 31, 2004 (the "2004 10-K")). 10.6 Non-competition, Severance and Employment Agreement, dated February 23, 2005 between the Company and William B. West (incorporated by reference to the 2004 Form 10-K). 10.7 Non-competition, Severance and Employment Agreement, dated February 23, 2005 between the Company and C. Kyle Thomas (incorporated by reference to the 2004 10-K). 10.8 Salary Continuation Agreement between The Peoples National Bank and Ralph R. Ridgeway, dated July 7, 1998, as amended (incorporated by reference to exhibits to Registrant's Form 10-K for the year ended December 31, 2002). 10.9 Spit Dollar Agreement between the Company and Ralph R. Ridgeway (incorporated by reference to exhibits to Registrant's Form 10-K for the year ended December 31, 2002). 10.10 Non-competition, Severance and Employment Agreement, dated April 8, 2005 between the Company and L. Andrew Westbrook, III. 21. Subsidiaries of the Registrant (incorporated by reference to exhibits to the 2004 10-K). 23. Consent of Elliott Davis, LLC 31.1 Rule 13a-14(a) / 15d-14(a) Certifications 31.2 Rule 13a-14(a) / 15d-14(a) Certifications 32 Section 1350 Certifications 92 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. Peoples Bancorporation, Inc. Dated: March 16, 2006 By: s/R. Riggie Ridgeway ------------------------------------- R. Riggie Ridgeway President and Chief Executive Officer Dated: March 16, 2006 By: s/Robert E. Dye, Jr. ------------------------------------- Robert E. Dye. Jr. Senior Vice President and Chief Financial Officer (Principal Financial and Principal Accounting Officer) 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 and in the capacities and on the dates indicated: Signature Title Date --------- ----- ---- Director March __, 2006 --------------------------- James A. Black, Jr. s/ William A. Carr Director March 16, 2006 --------------------------- William A. Carr Director March __, 2006 --------------------------- Charles E. Dalton s/ Robert E. Dye, Jr. Senior Vice March 16, 2006 --------------------------- President, Secretary Robert E. Dye, Jr. and Director s/ W. Rutledge Galloway Director March 16, 2006 --------------------------- W. Rutledge Galloway Director March __, 2006 --------------------------- Andrew M. McFall, III s/ E. Smyth McKissick, III Director March 16, 2006 --------------------------- E. Smyth McKissick, III s/ Eugene W. Merritt, Jr. Director March 16, 2006 --------------------------- Eugene W. Merritt, Jr. s/ George B. Nalley, Jr. Chairman and March 16, 2006 --------------------------- Director George B. Nalley, Jr. s/ G. Weston Nalley Director March 16, 2006 --------------------------- G. Weston Nalley Director March __, 2006 --------------------------- Larry D. Reeves s/ R. Riggie Ridgeway President, Chief March 16, 2006 --------------------------- Executive Officer, R. Riggie Ridgeway and Director s/ William R. Rowan, III Director March 16, 2006 --------------------------- William R. Rowan, III s/ Nell W. Smith Director March 16, 2006 --------------------------- Nell W. Smith s/ A. J. Thompson, Jr., M.D Director March 16, 2006 --------------------------- A. J. Thompson, Jr., M. D. s/ William B. West Executive Vice March 16, 2006 --------------------------- President, Treasurer William B. West and Director 93 EXHIBIT INDEX Exhibit No. Description of Exhibit 3 (i) Articles of Incorporation, as amended (incorporated by reference to Registrant's Form 10-Q for the quarter ended September 30, 2004). 3(ii) Bylaws (incorporated by reference to exhibits to Registrant's Current Report on Form 8-K filed June 20, 2005. 4.1 Specimen Common Stock Certificate (incorporated by reference to exhibits to Registrant's Registration Statement on Form S-4 (Number 33-46649)). 10.2 Peoples Bancorporation, Inc. 1993 Incentive Stock Option Plan (incorporated by reference to exhibits to Registrant's Registration Statement on Form S-8 (Number 333-121158)). 10.3 Peoples Bancorporation, Inc. 1997 Non-Employee Directors Stock Option Plan (incorporated by reference to exhibits to Registrant's Registration Statement on Form S-8 (Number 333-121157)). 10.4 Peoples Bancorporation, Inc. 2004 Stock Option Plan (incorporated by reference to exhibits to Registrant's Registration Statement on Form S-8 (Number 333-121156)). 10.5 Non-competition, Severance and Employment Agreement, dated February 23, 2005 between the Company and R. Riggie Ridgeway (incorporated by reference to Registrant's Form 10-K for the year ended December 31, 2004 (the "2004 10-K")). 10.6 Non-competition, Severance and Employment Agreement, dated February 23, 2005 between the Company and William B. West (incorporated by reference to the 2004 Form 10-K). 10.7 Non-competition, Severance and Employment Agreement, dated February 23, 2005 between the Company and C. Kyle Thomas (incorporated by reference to the 2004 10-K). 10.8 Salary Continuation Agreement between The Peoples National Bank and Ralph R. Ridgeway, dated July 7, 1998, as amended (incorporated by reference to exhibits to Registrant's Form 10-K for the year ended December 31, 2002). 10.9 Spit Dollar Agreement between the Company and Ralph R. Ridgeway (incorporated by reference to exhibits to Registrant's Form 10-K for the year ended December 31, 2002). 10.10 Non-competition, Severance and Employment Agreement, dated April 8, 2005 between the Company and L. Andrew Westbrook, III. 21. Subsidiaries of the Registrant (incorporated by reference to exhibits to the 2004 10-K). 23. Consent of Elliott Davis, LLC 31.1 Rule 13a-14(a) / 15d-14(a) Certifications 31.2 Rule 13a-14(a) / 15d-14(a) Certifications 32 Section 1350 Certifications 94