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            <CCC>  xxxxxxx
            <ACCELERATED-STATUS>  Not  Applicable
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      <NOTIFY-INTERNET>  atacust@merrillcorp.com
      <PERIOD>  12/31/2011
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

 

x  ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

- For the fiscal year ended December 31, 2011

 

Commission File Number:  000-26995

 

HCSB FINANCIAL CORPORATION

(Name of small business Issuer in its charter)

 

South Carolina

(State or other jurisdiction

of incorporation or organization)

 

57-1079444

(I.R.S. Employer

Identification No.)

 

 

 

3640 Ralph Ellis Boulevard

Loris, South Carolina

(Address of principal executive offices)

 

29569

(Zip Code)

 

Issuer’s telephone number: (843) 756-6333

 

Securities registered under Section 12(b) of the Exchange Act: None

 

Securities registered under Section 12(g) of the Exchange Act: Common Stock

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o  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 o  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 Exchange Act of 1934 during the past 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 o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statement incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer o
(Do not check if a smaller reporting company)

 

Smaller reporting company x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes  o  No x

 

The estimated aggregate market value of the Common Stock held by non-affiliates (shareholders holding less than 5% of an outstanding class of stock, excluding directors and executive officers) of the Company on June 30, 2011 was $3,469,803.  See Part II, Item 5 of this Form 10-K for information on the market for the Company’s common stock.

 

The number of shares outstanding of the issuer’s common stock, as of March 15, 2012 was 3,738,337.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Annual Report to Shareholders for the Year Ended December 31, 2011

 

Part II (Items 5, 7-8)

 

 

 

Proxy Statement for the Annual Meeting of Shareholders to be held on April 26, 2012

 

Part III (Portions of Items 10-14)

 

 

 



 

PART I

 

Item 1.  Description of Business.

 

This Report, including information included or incorporated by reference in this document, contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  Forward-looking statements may relate to our financial condition, results of operation, plans, objectives, or future performance.  These statements are based on many assumptions and estimates and are not guarantees of future performance.  Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control.  The words “may,”  “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “believe,” “continue,” “assume,” “intend,” “plan,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements.  Potential risks and uncertainties that could cause our actual results to differ from those anticipated in any forward-looking statements include, but are not limited to, those described below under Item 1A- Risk Factors and the following:

 

·                  reduced earnings due to higher credit losses generally and specifically because losses in the sectors of our loan portfolio secured by real estate are greater than expected due to economic factors, including, but not limited to, declining real estate values, increasing interest rates, increasing unemployment, or changes in payment behavior or other factors;

·                  reduced earnings due to higher credit losses because our loans are concentrated by loan type, industry segment, borrower type, or location of the borrower or collateral;

·                  our ability to comply with the Consent Order and the Written Agreement potential regulatory actions if we fail to comply;

·                  our ability to maintain appropriate levels of capital and to comply with our higher individual minimum capital ratios;

·                  the adequacy of the level of our allowance for loan losses and the amount of loan loss provisions required in future periods;

·                  results of examinations by the Federal Deposit Insurance Corporation (the “FDIC”) and the South Carolina Board of Financial Institutions (the “State Board”) and other regulatory authorities, including the possibility that any such regulatory authorities may, among other things, require us to increase our allowance for loan losses or write-down assets;

·                  the high concentration of our real estate-based loans collateralized by real estate in a weak commercial real estate market;

·                  increased funding costs due to market illiquidity, increased competition for funding, and/or increased regulatory requirements with regard to funding;

·                  significant increases in competitive pressure in the banking and financial services industries;

·                  changes in the interest rate environment which could reduce anticipated margins;

·                  changes in political conditions or the legislative or regulatory environment, including but not limited to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and regulations adopted thereunder, changes in federal and/or state tax laws or interpretations thereof by taxing authorities, changes in laws, rules or regulations applicable to companies that have participated in the U.S. Treasury’s TARP Capital Purchase Program and other governmental initiatives affecting the financial services industry;

·                  general economic conditions, either nationally or regionally and especially in our primary service area, being less favorable than expected, resulting in, among other things, a deterioration in credit quality;

·                  changes occurring in business conditions and inflation;

·                  changes in deposit flows;

·                  changes in technology;

·                  changes in monetary and tax policies;

·                  the rate of delinquencies and amount of loans charged-off;

·                  the rate of loan growth and the lack of seasoning of our loan portfolio;

·                  adverse changes in asset quality and resulting credit risk-related losses and expenses;

 

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·                  loss of consumer confidence and economic disruptions resulting from terrorist activities;

·                  changes in monetary and tax policies, including confirmation of the income tax refund claims received by the Internal Revenue Service (“IRS”);

·                  changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board and the Financial Accounting Standards Board;

·                  our ability to retain our existing customers, including our deposit relationships;

·                  changes in the securities markets; and

·                  other risks and uncertainties detailed from time to time in our filings with the Securities and Exchange Commission (the “SEC”).

 

These risks are exacerbated by the developments over the last three years in national and international financial markets, and we are unable to predict what effect these uncertain market conditions will continue to have on our Company.  Beginning in 2008 and continuing throughout 2011, the capital and credit markets experienced unprecedented levels of extended volatility and disruption.  There can be no assurance that these unprecedented developments will not continue to materially and adversely affect our business, financial condition and results of operations.

 

All forward-looking statements in this report are based on information available to us as of the date of this report.  Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee you that these expectations will be achieved.  We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

 

General Overview

 

HCSB Financial Corporation was incorporated on June 10, 1999 to become a holding company for Horry County State Bank (the “Bank”).  The Bank is a state chartered bank which commenced operations on January 4, 1988.  Our primary market includes Horry County in South Carolina and Columbus and Brunswick Counties in North Carolina.  From our 11 branch locations, we offer a full range of deposit services, including checking accounts, savings accounts, certificates of deposit, money market accounts, and IRAs, as well as a broad range of non-deposit investment services.  As of December 31, 2011, we had total assets of $535.7 million, net loans of $345.8 million, deposits of $490.9 million and shareholders’ deficit of ($5.2) million.

 

On March 6, 2009, as part of the Capital Purchase Program established by the U.S. Treasury under the Emergency Economic Stabilization Act of 2008 (the “EESA”), we entered into a Letter of Agreement with Treasury pursuant to which we issued and sold to Treasury (i) 12,895 shares of our Fixed Rate Cumulative Perpetual Preferred Stock, Series T, having a liquidation preference of $1,000 per share (the “Series T Preferred Stock”), and (ii) a ten-year warrant to purchase up to 91,714 shares of our common stock at an initial exercise price of $21.09 per share, for an aggregate purchase price of $12,895,000 in cash. The Series T Preferred Stock qualifies as Tier 1 capital and is entitled to cumulative dividends at a rate of 5% per annum for the first five years, and 9% per annum thereafter.  We must consult with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) before we are able to redeem the Series T Preferred Stock but we may not necessarily be required to raise additional equity capital in order to redeem this stock.

 

Recent Regulatory Developments

 

Consent Order

 

As a result of the issues stemming from the current economic recession, on February 10, 2011, the Bank entered into a Consent Order (the “Consent Order”) with the FDIC and the State Board.  The Consent Order requires the Bank to, among other things, take the following actions: achieve and maintain, by July 10, 2011, Total Risk-Based capital at least equal to 10% of risk-weighted assets and Tier 1 capital at least equal to 8% of total assets; reduce the level of the Bank’s classified assets; eliminate all assets or portions of assets classified “Loss” and 50% of those assets classified “Doubtful” in the Bank’s most recent

 

3



 

examination report; analyze and assess the Bank’s management and staffing needs to ensure the Bank has qualified management in place as well as the appropriate organizational structure; increase board oversight of the Bank; limit asset growth; eliminate the Bank’s reliance on brokered deposits; ensure the adequacy of the Bank’s allowance for loan and lease losses; formulate and implement a comprehensive financial plan to address profitability, improve income, monitor expenses, and restructure the Bank’s balance sheet; ensure the full implementation of the Bank’s revised written lending and collection policy to provide effective guidance and control over the Bank’s lending function; implement a plan addressing liquidity, contingency funding, and overall balance sheet management; establish an enhanced internal loan review program; correct all violations of law, regulation, and contraventions of policy which are listed in the Bank’s most recent examination report; not extend any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been charged off or classified “Loss” or “Doubtful” and is uncollected; not declare or pay dividends or bonuses without the prior written approval of the FDIC and the State Board; reduce any segment of the Bank’s loan portfolio that is an undue concentration of credit; and supply written progress reports to the FDIC and the State Board.

 

Prior to receipt of the Consent Order, the Bank’s board of directors and management adopted and began executing a proactive and aggressive strategic plan to address the matters described in the Consent Order.  The Bank’s board of directors and management have been, and continue to be, keenly focused on executing this plan and have already complied with a number of the requirements of the Consent Order.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report to Shareholders for the year ended December 31, 2011, which is incorporated herein by reference, for more discussion of the Consent Order.

 

Written Agreement

 

On May 9, 2011, the Company entered into a Written Agreement (the “Written Agreement”) with the Federal Reserve Bank of Richmond.  The Agreement is designed to enhance the Company’s ability to act as a source of strength to the Bank.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report to Shareholders for the year ended December 31, 2011, which is incorporated herein by reference, for more discussion of the Written Agreement.

 

Going Concern Considerations

 

We have prepared the consolidated financial statements contained in this Report assuming that the Company will be able to continue as a going concern, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future.  However, as a result of recurring losses, as well as uncertainties associated with the Bank’s ability to increase its capital levels to meet regulatory requirements, management has concluded that there is substantial doubt about the Company’s ability to continue as a going concern. In its report dated March 19, 2012, our independent registered public accounting firm stated that these uncertainties raise substantial doubt about our ability to continue as a going concern.  Our financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern.  If we are unable to continue as a going concern, our shareholders will likely lose all of their investment in the Company.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 2-”Regulatory Matters and Going Concern Considerations” to our Consolidated Financial Statements, each contained in our Annual Report to Shareholders for the year ended December 31, 2011, which is incorporated herein by reference.

 

Our Strategic Plan

 

As a response to the general economic downturn, and more recently, to the terms of the Consent Order and the Written Agreement, we adopted a new strategic plan, which includes not only a search for additional capital but also a search for a potential merger partner.  We are continuing to pursue both of these approaches simultaneously, though given the lack of a market for bank mergers, particularly in the Southeast, as a result of the current economic and regulatory climate, we believe that in the short-term our more realistic opportunity will be to raise additional capital.  Approximately $7.5 million in capital would return the Bank to “adequately capitalized” and approximately $17.5 million in capital would return the Bank to “well capitalized” under regulatory guidelines on a pro forma basis as of December 31, 2011.  If

 

4



 

we continue to decrease the size of the Bank or return the Bank to profitability, then we could achieve these capital ratios with less additional capital.  However, if we suffer additional loan losses or losses in our OREO portfolio, then we would need additional capital to achieve these ratios.  There are no assurances that we will be able to raise this capital on a timely basis or at all.  If we cannot meet the minimum capital requirements set forth under the Consent Order and return the Bank to a “well capitalized” designation, or if we suffer a continued deterioration in our financial condition, we may be placed into a federal conservatorship or receivership by the FDIC.

 

We have also been taking a number of steps to stabilize the Bank’s financial condition, including steps to reduce expenses, decrease the size of the Bank, and improve asset quality.  We believe that with these steps the Bank’s financial condition is stabilizing, which will help the Bank as it continues its efforts to secure a merger partner or raise capital.

 

Decreasing the Bank’s Assets.  We reduced the Bank’s total assets from $787.4 million at December 31, 2010 to $535.7 million at December 31, 2011, as we believe this approach, in addition to raising new capital and reducing expenses, represents the quickest path to restoring the Bank’s capital levels, returning the Bank to profitability, and facilitating compliance with the terms of the Consent Order and the Written Agreement.  We will continue to evaluate strategies for reducing the Bank’s overall asset size, but do not have current plans for any material additional decrease.

 

Enhancing the Credit Quality of the Loan Portfolio.  During 2010 and 2011, we aggressively increased our reserves for losses and focused substantial time and effort on managing the liquidation of nonperforming assets.  We are working to hold our borrowers accountable for the principal and interest owed.  We have initiated workout plans for problem loans that are designed to promptly collect on or rehabilitate those problem loans in an effort to convert them to earning assets, and we are pursuing foreclosure in certain instances.  Additionally, we are marketing our inventory of foreclosed real estate, but given that we would likely be required to accept discounted sales prices below appraised value if we tried to dispose of these assets quickly, we have been taking a more measured and deliberate approach with these sales efforts.

 

As a result of these efforts, we believe credit quality indicators generally showed signs of stabilization during the second half of 2011.  Primarily as a result of the stabilization and improvement in our loan portfolio, we incurred a net loss of $7.4 million during the last six months of 2011 compared to a net loss of $21.6 million during the first six months of 2011.

 

Although we have generally curtailed new lending while we focus on restoring the Bank’s financial condition, we remain focused on disciplined underwriting practices and prudent credit risk management.  We performed an expanded internal loan review during June and July 2010, hired an independent firm to perform an independent review of our loan portfolio in June 2010 and February and July 2011, and substantially revised our lending policy and credit procedures in early 2011.  We expanded the scope and depth of the initial loan review performed by our loan officers on all loans, and we incorporated more objective measurements in our internal loan analysis which more accurately addresses each borrower’s probability of default.

 

Reducing ADC and CRE Loan Concentrations.  As a result of the current economic environment and its impact on acquisition, development and construction and commercial real estate loans, we have effectively ceased making any new loans of these types while proactively decreasing the level of these types of loans in our existing portfolio.  We have worked to decrease our concentration by various means, including (i) through the normal sale of real estate by borrowers and their resulting repayments of the borrowed funds, (ii) transfers of problem loans to other real estate owned or charge-off if loss is considered confirmed, and (iii) encouraging customers with these types of loans to seek other financing when their loans mature.  During the period from December 31, 2009 to December 31, 2011, we were able to decrease the Bank’s total CRE loan portfolio from $198.8 million to $142.5 million, or 28.3%.  If the above initiatives do not reduce our concentrations to acceptable levels, we may seek avenues to sell a portion of these types of loans to outside investors.

 

Increasing Operating Earnings.  Management is focused on increasing our operating earnings by implementing strategies to improve the core profitability of our franchise.  These strategies change the mix

 

5



 

of our earning assets while reducing the size of our balance sheet.  Specifically, we are reducing the level of nonperforming assets, controlling our operating expenses, improving our net interest margin and increasing fee income.  We plan to reduce the amount of our nonperforming assets, which may require us to record additional provisions for loan losses to accomplish within this timeframe.  Additionally, we are carefully evaluating all renewing loans in our portfolio to ensure that we are focusing our capital and resources on our best relationship customers.

 

The benefits of reducing the size of our balance sheet include more disciplined loan and deposit pricing going forward, which we believe will result in an improvement in our net interest margin.  Additionally, we will seek to expand our net interest margin as our current loans and deposits reprice and renew.  We typically seek to put floors, or minimum interest rates, in our variable rate loans at origination or renewal.

 

Focusing on Reducing Noninterest Expenses and Collecting Noninterest Income.  We continue to review our noninterest income and noninterest expense categories for potential revenue enhancements and expense reductions.  We have implemented several initiatives to help reduce expenses and manage our overhead at an efficient level.  To achieve this goal, management and the Board have already reduced compensation expenses by, among other things, eliminating over 50 employment positions, eliminating salary increases and bonuses of any type since December 31, 2009, eliminating employer matching contributions to officer and employee 401(k) accounts and reducing the percentage of health and dental insurance benefits paid by the Bank for all of its employees.  In addition, certain of the Bank’s senior officers have accepted salary reductions and forfeited certain retirement benefits and incentive compensation.  Management and the Board also determined in 2011, after careful review of hourly customer traffic counts, to reduce the hours of service on Friday afternoons.  All of these steps served to enable the Bank to reduce its compensation expenses by over $2.9 million from 2009 to 2011.  In addition, the Board has eliminated monthly director fees, and several directors who had elected to defer their director fees until retirement have forfeited their deferred fees entirely.

 

We have also reduced marketing expenses incurred by the Bank at a savings of $307,000 in 2011 as compared to 2009.  We closed two branches in January 2012, and we continue to analyze other noninterest expenses for further opportunities for reductions.  We believe that reduction of our level of nonperforming assets will also significantly reduce our operating costs, which is evidenced by the fact that expenses related to nonperforming assets in 2011 were more than $1.5 million above similar expenses incurred in 2008 prior to the downturn in the local real estate market and the resulting rise in the level of nonperforming assets.

 

At the same time, we are focused on enhancing revenues from noninterest income sources, such as service charges, residential mortgage loan originations and fees earned from fiduciary activities, as well as from minimizing waivers of fees for late charges on loans and fees charged for insufficient funds checks presented for payment.  We will continue to look for additional strategies to increase fee-based income as we expect that these efforts will help to bolster our noninterest income levels.

 

Location and Service Area

 

Our primary markets include Horry County, South Carolina and Columbus and Brunswick Counties, North Carolina.  Many of the banks in these areas are branches of large regional banks.  Although size gives the larger banks certain advantages in competing for business from large corporations, including higher lending limits and the ability to offer services in other areas of South Carolina and North Carolina, we believe that there is a void in the community banking market in our market that we successfully fill.  We generally do not attempt to compete for the banking relationships of large corporations, but concentrate our efforts on small- to medium-sized businesses, individuals, and farmers.

 

6



 

Banking Services

 

We offer a full range of deposit services that are typically available in most banks and savings and loan associations, including checking accounts, NOW accounts, savings accounts, and time deposits of various types, ranging from daily money market accounts to longer-term certificates of deposit.  The transaction accounts and time certificates are tailored to our principal market area at rates competitive to those offered in our market area.  In addition, we offer certain retirement account services, such as Individual Retirement Accounts.  All deposit accounts are insured by the FDIC up to the maximum amount allowed by law (generally, $250,000 per depositor, subject to aggregation rules).  We solicit these accounts from individuals, businesses, associations and organizations, and governmental authorities.

 

Lending Activities

 

Presented below are our general lending activities.  However, due to the Bank’s efforts to restructure the balance sheet, during 2011 the Bank strictly limited any new lending, particularly with respect to real estate loans.

 

General.  We emphasize a range of lending services, including real estate, commercial, agricultural and consumer loans, to individuals and small to medium-sized businesses and professional concerns that are located in or conduct a substantial portion of their business in our market area. The characteristics of our loan portfolio and our underwriting procedures, collateral types, risks, approval process and lending limits are discussed below.

 

Real Estate Loans. The primary component of our loan portfolio is loans collateralized by real estate, which made up approximately 83.4% of our loan portfolio at December 31, 2011.  These loans are secured generally by first or second mortgages on residential, agricultural or commercial property.  These loans consist of commercial real estate loans, construction and development loans, and residential real estate loans (but exclude home equity loans, which are classified as consumer loans).  As discussed above under “Our Strategic Plan - Reducing ADC and CRE Loan Concentrations”, due to concerns regarding the current economic environment and our concentration of commercial real estate loans, which as of December 31, 2011 totaled $142,485,000, or 46.57% of our real estate loans, we have effectively ceased making any new loans of these types while proactively decreasing the level of these types of loans in our existing portfolio.  We anticipate decreasing our amount of commercial real estate loans in 2012.

 

Commercial Loans.  At December 31, 2011, approximately 11.5% of our loan portfolio consisted of commercial loans.  Commercial loans consist of secured and unsecured loans, lines of credit, and working capital loans.  We make these loans to various types of businesses.  Included in this category are loans to purchase equipment, finance accounts receivable or inventory, and loans made for working capital purposes.

 

Consumer Loans.  Consumer loans made up approximately 2.4% of our loan portfolio at December 31, 2011.  These are loans made to individuals for personal and household purposes, such as secured and unsecured installment and term loans, home equity loans and lines of credit, and revolving lines of credit such as overdraft protection.  Automobiles and small recreational vehicles are pledged as security for their purchase.

 

Agricultural Loans.  Approximately 2.5% of our loan portfolio consisted of agricultural loans at December 31, 2011.  These are loans made to individuals and businesses for agricultural purposes, including loans to finance crop production and livestock operating expenses, to purchase farm equipment, and to store crops.  These loans are secured generally by liens on growing crops and farm equipment.  Also included in this category are loans to agri-businesses, which are substantially similar to commercial loans, as discussed above.

 

Construction and Development Loans.  The remaining 18.2% of our loan portfolio at December 31, 2011 was composed of consumer and commercial real estate construction and commercial development loans.  These loans are secured by the real estate for which construction is planned and, in many cases, by supplementary collateral.

 

7



 

Underwriting Procedures, Collateral, and Risk.  Although we have generally curtailed new lending while we focus on restoring the Bank’s financial condition, we remain focused on disciplined underwriting practices and prudent credit risk management.  We use our established credit policies and procedures when underwriting each type of loan.  Although there are minor variances in the characteristics and criteria for each loan type, which may require additional underwriting procedures, we generally evaluate borrowers using the following defined criteria:

 

·                  Character — we evaluate whether the borrower has sound character and integrity by examining the borrower’s history.

·                  Capital — we evaluate the borrower’s overall financial strength, as well as the equity investment in the asset being financed.

·                  Collateral — we evaluate whether the collateral is adequate from the standpoint of quality, marketability, value and income potential.

·                  Capacity — we evaluate the borrower’s ability to service the debt.

·                  Conditions — we underwrite the credit in light of the effects of external factors, such as economic conditions and industry trends.

 

It is our practice to obtain collateral for most loans to help mitigate the risk associated with lending.  We generally limit our loan-to-value ratio to 80%.  For example, we obtain a security interest in real estate for loans secured by real estate, including construction and development loans, and other commercial loans.  For commercial loans, we typically obtain security interests in equipment and other company assets.  For agricultural loans, we typically obtain a security interest in growing crops, farm equipment, or real estate.  For consumer loans used to purchase vehicles, we obtain appropriate title documentation.  For secured loans that are not associated with real estate, or for which the mortgaged real estate does not provide an acceptable loan-to-value ratio, we typically obtain other available collateral such as stocks or savings accounts.

 

Every loan carries a credit risk, simply defined as the potential that the borrower will not be willing or able to repay the debt.  While this risk is common to all loan types, each type of loan may carry risks that distinguish it from other loan types.  The following paragraphs discuss certain risks that are associated with each of our loan types.

 

Each real estate loan is sensitive to fluctuations in the value of the real estate that secures that loan.  Certain types of real estate loans have specific risk characteristics that vary according to the type of collateral that secures the loan, the terms of the loan, and the repayment sources for the loan.  Construction and development real estate loans generally carry a higher degree of risk than long term financing of existing properties.  These projects are usually dependent on the completion of the project on schedule and within cost estimates and on the timely sale of the property.  Inferior or improper construction techniques, changes in economic conditions during the construction and marketing period, and rising interest rates which may slow the sale of the property are all risks unique to this type of loan.  Residential mortgage loans, in contrast to commercial real estate loans, generally have longer terms and may have fixed or adjustable interest rates.

 

Commercial loans primarily have risk that the primary source of repayment will be insufficient to service the debt.  Often this occurs as the result of changes in economic conditions in the location or industry in which the borrower operates which impact cash flow or collateral value.  Consumer loans, other than home equity loan products, are generally considered to have more risk than loans to individuals secured by first or second mortgages on real estate due to dependence on the borrower’s employment status as the sole source of repayment.  Agricultural loans carry the risk of crop failure, which adversely impacts both the borrower’s ability to repay the loan and the value of the collateral.

 

By following defined underwriting criteria as noted above, we can help to reduce these risks.  Additionally we help to reduce the risk that the underlying collateral may not be sufficient to pay the outstanding balance by using appraisals or taking other steps to determine that the value of the collateral is adequate, and lending amounts based upon lower loan-to-value ratios.  We also control risks by reducing the concentration of our loan portfolio in any one type of loan.

 

8



 

Loan Approval and Review.  Our loan approval policies provide for various levels of officer lending authority.  When the amount of aggregate loans to a single borrower exceeds that individual officer’s lending authority, the loan request is considered by an officer with a higher lending limit.  Any loan in excess of this lending limit is approved by the directors’ loan committee.  We do not make any loans to any of our directors or executive officers unless the loan is approved by a three-fourth’s vote of the board of directors of the Bank and is made on terms not more favorable to such person than would be available to a person not affiliated with us.  Aggregate credit in excess of 10% of the Bank’s aggregate capital, surplus, retained earnings, and reserve for loan losses must be approved by a three-fourth’s vote of our Bank’s board of directors.

 

Residential Mortgage Loans.  We offer a variety of residential mortgage lending products, including loans with fixed rates for fifteen and thirty years as well as adjustable rate mortgages (ARMs).  Typically, we close these loans with funds provided by a secondary market investor, although we may close them in the Bank’s name under a pre-approved commitment to sell the loans to an investor within a few weeks from the date the loan is closed.

 

Lending Limits.  Our lending activities are subject to a variety of lending limits imposed by federal law.  While differing limits apply to certain loan types or borrowers, in general we are subject to a loan-to-one-borrower limit.  These limits increase or decrease as our capital increases or decreases.  Unless we sell participations in loans to other financial institutions, we are not able to meet all of the lending needs of loan customers requiring aggregate extensions of credit above these limits.

 

Other Banking and Related Services

 

Other bank services which are in place or planned include cash management services, sweep accounts, repurchase agreements, cellular phone banking, remote deposit capture, safe deposit boxes, travelers checks, direct deposit of payroll and social security checks, on-line banking and automatic drafts for various accounts.  We are associated with a shared network of automated teller machines that may be used by our customers throughout South Carolina and other regions.  Three of our non-executive officers are registered representatives of Investment Professionals Inc. (IPI), and they effect transactions in securities and other non-deposit investment products.  We also offer MasterCard and VISA credit card services through a third party vendor.  We continue to seek and evaluate opportunities to offer additional financial services to our customers.

 

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Competition

 

The banking business is highly competitive.  We compete with other commercial banks, savings and loan associations, credit unions, and money market mutual funds operating in our service area and elsewhere.  According to the FDIC data as of June 30, 2011, there were 25 financial institutions operating in Horry County, 12 financial institutions operating in Brunswick County and 7 financial institutions operating in Columbus County.

 

We believe that our community bank focus, with our emphasis on service to small businesses, individuals, farmers and professional concerns, gives us an advantage in our markets.  Nevertheless, a number of these competitors are well established in our service area.  Some of the larger financial companies in our markets may have greater resources than we have, which afford them a marketplace advantage by enabling them to maintain numerous locations and mount extensive promotional and advertising campaigns.  Additionally, due to their size, many competitors may offer a broader range of products and services as well as better pricing for those products and services than we offer.  In addition, banks and other financial institutions with larger capitalization and financial intermediaries that are not subject to bank regulatory restrictions may have larger lending limits that allow them to serve the lending needs of larger customers.  Because larger competitors have advantages in attracting business from larger corporations, we do not generally compete for that business.  Instead, we concentrate our efforts on attracting the business of individuals and small and medium-size businesses. With regard to such accounts, we generally compete on the basis of customer service and responsiveness to customer needs, the convenience of our branches and hours, and the availability and pricing of our products and services.

 

Employees

 

As of March 15, 2012, we had 120 full-time employees and two part-time employees.  We are not a party to a collective bargaining agreement, and we consider our relations with our employees to be good.

 

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SUPERVISION AND REGULATION

 

Both HCSB Financial Corporation and Horry County State Bank are subject to extensive state and federal banking laws and regulations that impose specific requirements and restrictions on and provide for general regulatory oversight of their operations.  These laws and regulations generally are intended to protect depositors and not shareholders.  The following summary is qualified by reference to the statutory and regulatory provisions discussed.  Changes in applicable laws or regulations may have a material effect on our business and prospects.  Our operations may be affected by legislative changes and the policies of various regulatory authorities.  We cannot predict the effect that fiscal or monetary policies, economic control, or new federal or state legislation may have on our business and earnings in the future.

 

The following discussion is not intended to be a complete list of all the activities regulated by the banking laws or of the impact of such laws and regulations on our operations.  It is intended only to briefly summarize some material provisions.

 

Recent Legislative and Regulatory Developments

 

The Congress, Treasury and the federal banking regulators, including the FDIC, have taken broad actions since early September 2008 to address the volatility and disruption in the U.S. banking system.  Several regulatory and governmental actions have been announced including:

 

·                                          In October 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted.  The EESA authorized Treasury to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies in a troubled asset relief program (“TARP”).  The Treasury also allocated $250 billion towards the TARP Capital Purchase Program (“CPP”), pursuant to which the U.S. Treasury purchased debt or equity securities from participating institutions.  Participants in the CPP are subject to executive compensation limits and are encouraged to expand their lending and mortgage loan modifications.  The EESA also temporarily increased FDIC deposit insurance on most accounts from $100,000 to $250,000.

 

·                                          On March 6, 2009, as part of the CPP established by Treasury under the EESA, we entered into a Letter of Agreement and Securities Purchase Agreement with Treasury pursuant to which we issued and sold to Treasury (i) 12,895 shares of our Fixed Rate Cumulative Perpetual Preferred Stock, Series T, having a liquidation preference of $1,000 per share (the “Series T Preferred Stock”), and (ii) a ten-year warrant to purchase up to 91,714 shares of our common stock at an initial exercise price of $21.09 per share, for an aggregate purchase price of $12,895,000 in cash. The Series T Preferred Stock qualifies as Tier 1 capital and is entitled to cumulative dividends at a rate of 5% per annum for the first five years, and 9% per annum thereafter, but will be paid only if, as, and when declared by our board of directors.  The Series T Preferred Stock has no maturity date and ranks senior to the common stock with respect to the payment of dividends and distributions and amounts payable upon liquidation, dissolution and winding up of the Company. The Series T Preferred Stock generally is non-voting.

 

Pursuant to the terms of the certificate of designations creating the Series T Preferred Stock, we may only redeem the Series T Preferred Stock at par after May 15, 2012. Prior to this date, we may redeem the Series T Preferred Stock at par if (i) we have raised aggregate gross proceeds in one or more Qualified Equity Offerings (as defined in the Purchase Agreement) in excess of approximately $3.2 million, and (ii) the aggregate redemption price does not exceed the aggregate net proceeds from such Qualified Equity Offerings. Any redemption is subject to the consent of the Federal Reserve.  However, pursuant to the terms of American Recovery and Reinvestment Act (the “Recovery Act”) which modified EESA, we may, upon consultation with our primary federal regulator, repay the amount received for the Series T Preferred Stock at any time, without regard to whether we have replaced such funds from any source or to any waiting period. Upon

 

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repayment of the amount received for the Series T Preferred Stock, the Treasury Department will also liquidate the associated Warrant in accordance with the Recovery Act and any rules and regulations thereunder.

 

·                                          On February 17, 2009, the Recovery Act was signed into law in an effort to, among other things, create jobs and stimulate growth in the United States economy.  The Recovery Act specifies appropriations of approximately $787 billion for a wide range of Federal programs and will increase or extend certain benefits payable under the Medicaid, unemployment compensation, and nutrition assistance programs.  The Recovery Act also reduces individual and corporate income tax collections and makes a variety of other changes to tax laws.  The Recovery Act also imposes certain limitations on compensation paid by participants in TARP.

 

·                                          On May 22, 2009, the FDIC levied a one-time special assessment on all banks due on September 30, 2009.

 

·                                          On November 12, 2009, the FDIC issued a final rule to require banks to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012 and to increase assessment rates effective on January 1, 2011.

 

·                                          In June 2010, the Federal Reserve, the FDIC and the Office of the Comptroller of the Currency (the “OCC”) issued a comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.

 

·                                          The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

 

·                                          On July 21, 2010, the U.S. President signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”).  The Dodd-Frank Act is intended to effect a fundamental restructuring of federal banking regulation.  Among other things, the Dodd-Frank Act creates a new Financial Stability Oversight Council to identify systemic risks in the financial system and gives federal regulators new authority to take control of and liquidate financial firms.  The Dodd-Frank Act also creates a new independent federal regulator to administer federal consumer protection laws.  Many of the provisions of the Dodd-Frank Act have delayed effective dates and the legislation requires various federal agencies to promulgate numerous and extensive implementing regulations over the next several years.  Although the substance and scope of these regulations cannot be completely determined at this time, it is expected that the legislation and implementing regulations will increase our operating and compliance

 

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costs.  The following discussion summarizes certain significant aspects of the Dodd-Frank Act:

 

·                                          The Dodd-Frank Act requires the Federal Reserve to apply consolidated capital requirements to depository institution holding companies that are no less stringent than those currently applied to depository institutions.  Under these standards, trust preferred securities will be excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by a bank holding company with less than $15 billion in assets.  The Dodd-Frank Act additionally requires capital requirements to be countercyclical so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, consistent with safety and soundness.

 

·                                          The Dodd-Frank Act permanently increases the maximum deposit insurance amount for financial institutions to $250,000 per depositor, and extends unlimited deposit insurance to noninterest bearing transaction accounts through December 31, 2012.  The Dodd-Frank Act also broadens the base for FDIC insurance assessments.  Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution.  The Dodd-Frank Act requires the FDIC to increase the reserve ratio of the Deposit Insurance Fund from 1.15% to 1.35% of insured deposits by 2020 and eliminates the requirement that the FDIC pay dividends to insured depository institutions when the reserve ratio exceeds certain thresholds.  Effective as of July 21, 2011, the Dodd-Frank Act eliminated the federal statutory prohibition against the payment of interest on business checking accounts.

 

·                                          The Dodd-Frank Act requires publicly traded companies to give stockholders a non-binding vote on executive compensation at their first annual meeting taking place six months after the date of enactment and at least every three years thereafter and on so-called “golden parachute” payments in connection with approvals of mergers and acquisitions unless previously voted on by shareholders.  The new legislation also authorizes the SEC to promulgate rules that would allow shareholders to nominate their own candidates using a company’s proxy materials.  Additionally, the Dodd-Frank Act directs the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of $1.0 billion, regardless of whether the institution is publicly traded or not.  The Dodd-Frank Act gives the SEC authority to prohibit broker discretionary voting on elections of directors and executive compensation matters.

 

·                                          Effective as of July 21, 2011, the Dodd-Frank Act prohibits a depository institution from converting from a state to federal charter or vice versa while it is the subject of a cease and desist order or other formal enforcement action or a memorandum of understanding with respect to a significant supervisory matter unless the appropriate federal banking agency gives notice of the conversion to the federal or state authority that issued the enforcement action and that agency does not object within 30 days.  The notice must include a plan to address the significant supervisory matter.  The converting institution must also file a copy of the conversion application with its current federal regulator which must notify the resulting federal regulator of any ongoing supervisory or investigative proceedings that are likely to result in an enforcement action and provide access to all supervisory and investigative information relating hereto.

 

·                                          The Dodd-Frank Act authorizes national and state banks to establish branches in other states to the same extent as a bank chartered by that state would be

 

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permitted to branch. Previously, banks could only establish branches in other states if the host state expressly permitted out-of-state banks to establish branches in that state.  Accordingly, banks will be able to enter new markets more freely.

 

·                                          Effective as of July 21, 2011, the Dodd-Frank Act expands the definition of affiliate for purposes of quantitative and qualitative limitations of Section 23A of the Federal Reserve Act to include mutual funds advised by a depository institution or its affiliates.  The Dodd-Frank Act will apply Section 23A and Section 22(h) of the Federal Reserve Act (governing transactions with insiders) to derivative transactions, repurchase agreements and securities lending and borrowing transaction that create credit exposure to an affiliate or an insider.  Any such transactions with affiliates must be fully secured.  The current exemption from Section 23A for transactions with financial subsidiaries will be eliminated.  The Dodd-Frank Act will additionally prohibit an insured depository institution from purchasing an asset from or selling an asset to an insider unless the transaction is on market terms and, if representing more than 10% of capital, is approved in advance by the disinterested directors.

 

·                                          The Dodd-Frank Act requires that the amount of any interchange fee charged by a debit card issuer with respect to a debit card transaction must be reasonable and proportional to the cost incurred by the issuer.  Effective on October 1, 2011, the Federal Reserve set new caps on interchange fees at $0.21 per transaction, plus an additional five basis-point charge per transaction to help cover fraud losses. An additional $0.01 per transaction is allowed if certain fraud-monitoring controls are in place.  While the restrictions on interchange fees do not apply to banks that, together with their affiliates, have assets of less than $10 billion, such as the Company, the new restrictions could negatively impact bank card services income for smaller banks if the reductions that are required of larger banks cause industry-wide reduction of swipe fees.

 

·                                          The Dodd-Frank Act creates a new, independent federal agency called the Consumer Financial Protection Bureau (“CFPB”), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act and certain other statutes.  The CFPB will have examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets.  Depository institutions with less than $10 billion in assets, such as our Bank, will be subject to rules promulgated by the CFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes.  The CFPB will have authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products.  The Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower’s ability to repay.  In addition, the Dodd-Frank Act will allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB.  The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.

 

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·                                          The Basel Committee on Banking Supervision (the “Basel Committee”) released in December 2010 revised final frameworks for the regulation of capital and liquidity of internationally active banking organizations.  These new frameworks are generally referred to as “Basel III”.  Although the U.S. banking agencies have not yet published a notice of proposed rulemaking to implement Basel III in the United States, they are likely to do so (at least with respect to the Basel III capital framework) during the first half of 2012.

 

Although it is likely that further regulatory actions may arise as the federal government continues to attempt to address the economic situation, we cannot predict the effect that fiscal or monetary policies, economic control, or new federal or state legislation may have on our business and earnings in the future.

 

Proposed Legislation and Regulatory Action

 

From time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies.  Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system.  Such legislation could change banking statutes and the operating environment of the Company in substantial and unpredictable ways.  If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions.  We cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would have on the financial condition or results of operations of the Company.  A change in statutes, regulations or regulatory policies applicable to the Company or the Bank could have a material effect on the business of the Company.

 

HCSB Financial Corporation

 

We own 100% of the outstanding capital stock of the Bank, and therefore we are considered to be a bank holding company under the federal Bank Holding Company Act of 1956 (the “Bank Holding Company Act”).  As a result, we are primarily subject to the supervision, examination and reporting requirements of the Federal Reserve under the Bank Holding Company Act and its regulations promulgated thereunder.  As a bank holding company located in South Carolina, the State Board also regulates and monitors all significant aspects of our operations.

 

Permitted Activities. Under the Bank Holding Company Act, a bank holding company is generally permitted to engage in, or acquire direct or indirect control of more than 5% of the voting shares of any company engaged in, the following activities:

 

·                  banking or managing or controlling banks;

 

·                  furnishing services to or performing services for our subsidiaries; and

 

·                  any activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.

 

Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:

 

·                  factoring accounts receivable;

 

·                  making, acquiring, brokering or servicing loans and usual related activities;

 

·                  leasing personal or real property;

 

·                  operating a non-bank depository institution, such as a savings association;

 

·                  trust company functions;

 

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·                  financial and investment advisory activities;

 

·                  conducting discount securities brokerage activities;

 

·                  underwriting and dealing in government obligations and money market instruments;

 

·                  providing specified management consulting and counseling activities;

 

·                  performing selected data processing services and support services;

 

·                  acting as agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and

 

·                  performing selected insurance underwriting activities.

 

As a bank holding company we also can elect to be treated as a “financial holding company,” which would allow us to engage in a broader array of activities.  In sum, a financial holding company can engage in activities that are financial in nature or incidental or complementary to financial activities, including insurance underwriting, sales and brokerage activities, providing financial and investment advisory services, underwriting services and limited merchant banking activities.  We have not sought financial holding company status, but may elect such status in the future as our business matures.  If we were to elect in writing for financial holding company status, each insured depository institution we control would have to be well capitalized, well managed and have at least a satisfactory rating under the Community Reinvestment Act (CRA) (discussed below).

 

The Federal Reserve has the authority to order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company’s continued ownership, activity or control constitutes a serious risk to the financial safety, soundness or stability of it or any of its bank subsidiaries.

 

Change in Control.  In addition, and subject to certain exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with regulations promulgated thereunder, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company.  Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of a bank holding company.  Control will be rebuttably presumed to exist unless a person acquires no more than 33% of the total equity of a bank or bank holding company, of which it may own, control or have the power to vote not more than 15% of any class of voting securities.

 

Source of Strength.  There are a number of obligations and restrictions imposed by law and regulatory policy on bank holding companies with regard to their depository institution subsidiaries that are designed to minimize potential loss to depositors and to the FDIC insurance funds in the event that the depository institution becomes in danger of defaulting under its obligations to repay deposits.  Under a 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. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), to avoid receivership of its insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become “undercapitalized” within the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency up to the lesser of (i) an amount equal to 5% of the institution’s total assets at the time the institution became undercapitalized, or (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan.

 

The Federal Reserve also has the authority under the BHCA to require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the

 

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financial soundness or stability of any subsidiary depository institution of the bank holding company.  Further, federal law grants federal bank regulatory authorities additional discretion to require a bank holding company to divest itself of any bank or nonbank subsidiary if the agency determines that divestiture may aid the depository institution’s financial condition.

 

In addition, the “cross guarantee” provisions of the Federal Deposit Insurance Act (the “FDIA”) require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by 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’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 would give depositors a preference over general and subordinated creditors and shareholders in the event a receiver is appointed to distribute the assets of our Bank.

 

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.

 

Capital Requirements.  The Federal Reserve imposes certain capital requirements on the bank holding company under the Bank Holding Company Act, including a minimum leverage ratio and a minimum ratio of “qualifying” capital to risk-weighted assets.  These requirements are essentially the same as those that apply to the Bank described below under “Horry County State Bank - Capital Regulations.”  Nevertheless, our Company remains subject to these capital requirements.  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 Bank’s financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.  The Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.  At December 31, 2011, our Bank is “significantly undercapitalized” under the capital requirements as set per bank regulatory agencies.

 

Subject to our capital requirements and certain other restrictions, we are able to borrow money to make a capital contribution to the Bank, and these loans may be repaid from dividends paid from the Bank to the Company.  Our ability to pay dividends depends on the Bank’s ability to pay dividends to us, which is subject to regulatory restrictions as described below in “Horry County State Bank — Dividends.”  We are also able to raise capital for contribution to the Bank by issuing securities without having to receive regulatory approval, subject to compliance with federal and state securities laws.

 

South Carolina State Regulation.  As a South Carolina bank holding company under the South Carolina Banking and Branching Efficiency Act, we are subject to limitations on sale or merger and to regulation by the State Board.  We are not required to obtain the approval of the South Carolina Board prior to acquiring the capital stock of a national bank, but we must notify them at least 15 days prior to doing so.  We must receive the State Board’s approval prior to engaging in the acquisition of a South Carolina state chartered bank or another South Carolina bank holding company.

 

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Horry County State Bank

 

The Bank operates as a state bank incorporated under the laws of the State of South Carolina and is subject to examination by the State Board.  Deposits at the Bank are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. The Deposit Insurance Fund is the successor to the Bank Insurance Fund and the Savings Association Insurance Fund, which were merged effective March 31, 2006.

 

The State Board and the FDIC regulate or monitor virtually all areas of the Bank’s operations, including:

 

·                  security devices and procedures;

 

·                  adequacy of capitalization and loss reserves;

 

·                  loans;

 

·                  investments;

 

·                  borrowings;

 

·                  deposits;

 

·                  mergers;

 

·                  issuances of securities;

 

·                  payment of dividends;

 

·                  interest rates payable on deposits;

 

·                  interest rates or fees chargeable on loans;

 

·                  establishment of branches;

 

·                  corporate reorganizations;

 

·                  maintenance of books and records; and

 

·                  adequacy of staff training to carry on safe lending and deposit gathering practices.

 

The State Board requires the Bank to maintain specified capital ratios and imposes limitations on the Bank’s aggregate investment in real estate, bank premises, and furniture and fixtures.  The State Board also requires the Bank to prepare quarterly reports on the Bank’s financial condition in compliance with its minimum standards and procedures.

 

All insured institutions must undergo regular on site examinations by their appropriate banking agency.  The cost of examinations of insured depository institutions and any affiliates may be assessed by the appropriate agency against each institution or affiliate as it deems necessary or appropriate.  Insured institutions are required to submit annual reports to the FDIC, their federal regulatory agency, and their state supervisor when applicable.  The FDIC has developed a method for insured depository institutions to provide supplemental disclosure of the estimated fair market value of assets and liabilities, to the extent feasible and practicable, in any balance sheet, financial statement, report of condition or any other report of any insured depository institution.  The FDICIA also requires the federal banking regulatory agencies to prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating, among other things, to the following:

 

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·                  internal controls;

 

·                  information systems and audit systems;

 

·                  loan documentation;

 

·                  credit underwriting;

 

·                  interest rate risk exposure; and

 

·                  asset quality.

 

Prompt Corrective Action.  As an insured depository institution, the Bank is required to comply with the capital requirements promulgated under the FDIA and the regulations thereunder, which set forth five capital categories, each with specific regulatory consequences.  Under these regulations, the categories are:

 

·                  Well Capitalized — The institution exceeds the required minimum level for each relevant capital measure.  A well capitalized institution is one (i) having a total capital ratio of 10% or greater, (ii) having a tier 1 capital ratio of 6% or greater, (iii) having a leverage capital ratio of 5% or greater and (iv) that is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure.

 

·                  Adequately Capitalized — The institution meets the required minimum level for each relevant capital measure.  No capital distribution may be made that would result in the institution becoming undercapitalized.  An adequately capitalized institution is one (i) having a total capital ratio of 8% or greater, (ii) having a tier 1 capital ratio of 4% or greater and (iii) having a leverage capital ratio of 4% or greater or a leverage capital ratio of 3% or greater if the institution is rated composite 1 under the CAMELS (Capital, Assets, Management, Earnings, Liquidity and Sensitivity to market risk) rating system.

 

·                  Undercapitalized — The institution fails to meet the required minimum level for any relevant capital measure.  An undercapitalized institution is one (i) having a total capital ratio of less than 8% or (ii) having a tier 1 capital ratio of less than 4% or (iii) having a leverage capital ratio of less than 4%, or if the institution is rated a composite 1 under the CAMELS rating system, a leverage capital ratio of less than 3%.

 

·                  Significantly Undercapitalized — The institution is significantly below the required minimum level for any relevant capital measure.  A significantly undercapitalized institution is one (i) having a total capital ratio of less than 6% or (ii) having a tier 1 capital ratio of less than 3% or (iii) having a leverage capital ratio of less than 3%.

 

·                  Critically Undercapitalized — The institution fails to meet a critical capital level set by the appropriate federal banking agency.  A critically undercapitalized institution is one having a ratio of tangible equity to total assets that is equal to or less than 2%.

 

If the FDIC determines, after notice and an opportunity for hearing, that the Bank is in an unsafe or unsound condition, the regulator is authorized to reclassify the Bank to the next lower capital category (other than critically undercapitalized) and require the submission of a plan to correct the unsafe or unsound condition.

 

If a bank is not well capitalized, it cannot accept brokered deposits without prior FDIC approval.  In addition, a bank that is not well capitalized cannot offer an effective yield in excess of 75 basis points over interest paid on deposits of comparable size and maturity in such institution’s normal market area for deposits accepted from within its normal market area, or national rate paid on deposits of comparable size and maturity for deposits accepted outside the bank’s normal market area.  Moreover, the FDIC generally prohibits a depository institution from making any capital distributions (including payment of a dividend)

 

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or paying any management fee to its parent holding company if the depository institution would thereafter be categorized as undercapitalized.  Undercapitalized institutions are subject to growth limitations (an undercapitalized institution may not acquire another institution, establish additional branch offices or engage in any new line of business unless determined by the appropriate federal banking agency to be consistent with an accepted capital restoration plan, or unless the FDIC determines that the proposed action will further the purpose of prompt corrective action) and are required to submit a capital restoration plan. The agencies may not accept a capital restoration plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital.  In addition, for a capital restoration plan to be acceptable, the depository institution’s parent holding company must guarantee that the institution will comply with the capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of an amount equal to 5.0% of the depository institution’s total assets at the time it became categorized as undercapitalized or the amount that is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is categorized as significantly undercapitalized.

 

Significantly undercapitalized categorized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become categorized as adequately capitalized, requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks.  The appropriate federal banking agency may take any action authorized for a significantly undercapitalized institution if an undercapitalized institution fails to submit an acceptable capital restoration plan or fails in any material respect to implement a plan accepted by the agency.  A critically undercapitalized institution is subject to having a receiver or conservator appointed to manage its affairs and for loss of its charter to conduct banking activities.

 

An insured depository institution may not pay a management fee to a bank holding company controlling that institution or any other person having control of the institution if, after making the payment, the institution would be undercapitalized. In addition, an institution cannot make a capital distribution, such as a dividend or other distribution, that is in substance a distribution of capital to the owners of the institution if following such a distribution the institution would be undercapitalized.  Thus, if payment of such a management fee or the making of such would cause a bank to become undercapitalized, it could not pay a management fee or dividend to the bank holding company.

 

As of December 31, 2011, the Bank was deemed to be “significantly undercapitalized.”  As further described above and under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report to Shareholders for the year ended December 31, 2011, which is incorporated herein by reference, on February 10, 2011, the Bank entered into the Consent Order with the FDIC and the State Board which, among other things, required the Bank to achieve Tier 1 capital at least equal to 8% of total assets and Total Risk-Based capital at least equal to 10% of total risk-weighted assets by July 10, 2011.  The Bank did not meet the capital ratios as specified in the Consent Order and, as a result, submitted a revised capital restoration plan to the FDIC on July 15, 2011.  The revised capital restoration plan was determined by the FDIC to be insufficient and, as a result, we submitted a further revised capital restoration plan to the FDIC on September 30, 2011.  We received the FDIC’s non-objection to the further revised capital restoration plan on December 6, 2011.  The Bank is working diligently to increase its capital ratios in order to strengthen its balance sheet and satisfy the commitments required under the Consent Order.  The Bank has engaged independent third parties to assist the Bank in its efforts to increase its capital ratios.  In addition to continuing to search for additional capital, the Bank is also searching for a potential merger partner.  While the Bank is pursuing both of these approaches simultaneously, though given the lack of a market for bank mergers, particularly in the Southeast, as a result of the current economic and regulatory climate, we believe that in the short-term the more realistic opportunity will be to raise additional capital.

 

The Basel Committee released in December 2010 revised final frameworks for the regulation of capital and liquidity of internationally active banking organizations.  These new frameworks are generally referred to as “Basel III”.  Basel III, when implemented by the U.S. banking agencies and fully phased-in, will require certain bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity.

 

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The Basel III final capital framework, among other things, (i) introduces as a new capital measure called “Common Equity Tier 1” (“CET1”), (ii) specifies that Tier 1 capital consist of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements, (iii) defines CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) expands the scope of the adjustments as compared to existing regulations.

 

If fully phased in on January 1, 2019, Basel III would require certain banks to maintain (i) as a newly adopted international standard, a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% CET1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7.0%), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of Total (that is, Tier 1 plus Tier 2) capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation) and (iv) as a newly adopted international standard, a minimum leverage ratio of 3.0%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (computed as the average for each quarter of the month-end ratios for the quarter).

 

The implementation of the Basel III final framework is anticipated to commence January 1, 2013. On that date, affected banking institutions would be required to meet the following minimum capital ratios:

 

·              3.5% CET1 to risk-weighted assets;

·              4.5% Tier 1 capital to risk-weighted assets; and

·              8.0% Total capital to risk-weighted assets.

 

Although the U.S. banking agencies have not yet published a notice of proposed rulemaking to implement Basel III in the United States, they are likely to do so (at least with respect to the Basel III capital framework) during the first half of 2012.

 

Standards for Safety and Soundness.   The FDIA also requires the federal banking regulatory agencies to prescribe, by regulation or guideline, operational and managerial standards for all insured depository institutions relating to: (i) internal controls, information systems, and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; and (v) asset growth.  The agencies also must prescribe standards for asset quality, earnings, and stock valuation, as well as standards for compensation, fees, and benefits.  The federal banking agencies have adopted regulations and Interagency Guidelines Prescribing Standards for Safety and Soundness to implement these required standards.  These guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired.  Under the regulations, if the FDIC determines that the Bank fails to meet any standards prescribed by the guidelines, the agency may require the Bank to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the FDIC.  The final regulations establish deadlines for the submission and review of such safety and soundness compliance plans.

 

Transactions with Affiliates and Insiders.  The Company is a legal entity separate and distinct from the Bank and its other subsidiaries.  Various legal limitations restrict the Bank from lending or otherwise supplying funds to the Company or its non-bank subsidiaries.  The Company and the Bank are subject to Section 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W.  Section 23A of the Federal Reserve Act places limits on the amount of loans or extensions of credit to, or investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates.  The aggregate of all covered transactions is limited in amount, as to any one affiliate, to 10% of the Bank’s capital and surplus and, as to all affiliates combined, to 20% of the Bank’s capital and surplus.  Furthermore, within the foregoing limitations as to amount, each covered transaction must meet specified collateral requirements.  The Bank is forbidden to purchase low quality assets from an affiliate.

 

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Section 23B of the Federal Reserve Act, among other things, prohibits an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

 

Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve Board decides to treat these subsidiaries as affiliates.  The regulation also limits the amount of loans that can be purchased by a bank from an affiliate to not more than 100% of the bank’s capital and surplus.

 

The Bank is also subject to certain restrictions on extensions of credit to executive officers, directors, certain principal shareholders, and their related interests.  Such extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties and (ii) must not involve more than the normal risk of repayment or present other unfavorable features.

 

As noted above, effective as of July 21, 2011, the Dodd-Frank Act expands the definition of affiliate for purposes of quantitative and qualitative limitations of Section 23A of the Federal Reserve Act to include mutual funds advised by a depository institution or its affiliates.  The Dodd-Frank Act will apply Section 23A and Section 22(h) of the Federal Reserve Act (governing transactions with insiders) to derivative transactions, repurchase agreements and securities lending and borrowing transaction that create credit exposure to an affiliate or an insider.  Any such transactions with affiliates must be fully secured.  The current exemption from Section 23A for transactions with financial subsidiaries will be eliminated.  The Dodd-Frank Act will additionally prohibit an insured depository institution from purchasing an asset from or selling an asset to an insider unless the transaction is on market terms and, if representing more than 10% of capital, is approved in advance by the disinterested directors.

 

Branching.  Under current South Carolina law, we may open branch offices throughout South Carolina with the prior approval of the State Board.  In addition, with prior regulatory approval, the Bank will be able to acquire existing banking operations in South Carolina.  Furthermore, federal legislation permits interstate branching, including out-of-state acquisitions by bank holding companies, interstate branching by banks, and interstate merging by banks.  The Dodd-Frank Act removes previous state law restrictions on de novo interstate branching in states such as South Carolina.  This change permits out-of-state banks to open de novo branches in states where the laws of the state where the de novo branch to be opened would permit a bank chartered by that state to open a de novo branch.

 

Anti-Tying Restrictions.   Under amendments to the Bank Holding Company Act and Federal Reserve regulations, a bank is prohibited from engaging in certain tying or reciprocity arrangements with its customers.  In general, a bank may not extend credit, lease, sell property, or furnish any services or fix or vary the consideration for these on the condition that (i) the customer obtain or provide some additional credit, property, or services from or to the bank, the bank holding company or subsidiaries thereof or (ii) the customer may not obtain some other credit, property, or services from a competitor, except to the extent reasonable conditions are imposed to assure the soundness of the credit extended.  Certain arrangements are permissible: a bank may offer combined-balance products and may otherwise offer more favorable terms if a customer obtains two or more traditional bank products; and certain foreign transactions are exempt from the general rule.  A bank holding company or any bank affiliate also is subject to anti-tying requirements in connection with electronic benefit transfer services.

 

Community Reinvestment Act.  The Community Reinvestment Act (“CRA”) requires that, in connection with examinations of financial institutions within their respective jurisdictions, a financial institution’s primary regulator, which is the FDIC for the Bank, shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate income neighborhoods.  These factors are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility.  Failure to adequately meet these criteria could impose additional requirements and limitations on our Bank.  Additionally, we must publicly disclose the terms of various Community Reinvestment Act-related agreements.

 

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Finance Subsidiaries.  Under the Gramm-Leach-Bliley Act (the “GLBA”), subject to certain conditions imposed by their respective banking regulators, national and state-chartered banks are permitted to form “financial subsidiaries” that may conduct financial or incidental activities, thereby permitting bank subsidiaries to engage in certain activities that previously were impermissible.  The GLBA imposes several safeguards and restrictions on financial subsidiaries, including that the parent bank’s equity investment in the financial subsidiary be deducted from the bank’s assets and tangible equity for purposes of calculating the bank’s capital adequacy.  In addition, the GLBA imposes new restrictions on transactions between a bank and its financial subsidiaries similar to restrictions applicable to transactions between banks and non-bank affiliates.

 

Consumer Protection Regulations.  Activities of the Bank are subject to a variety of statutes and regulations designed to protect consumers.  Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates.  The Bank’s loan operations are also subject to federal laws applicable to credit transactions, such as the:

 

·                  The federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

 

·                  The Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

 

·                  The Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

 

·                  The Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act, governing the use and provision of information to credit reporting agencies, certain identity theft protections and certain credit and other disclosures;

 

·                  The Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;

 

·                  The Credit Card Accountability, Responsibility, and Disclosure Act of 2009, governing interest rate increases and fee limits; and

 

·                  The Rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.

 

The deposit operations of the Bank also are subject to:

 

·                  the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and

 

·                  the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve Board to implement that Act, which governs 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.

 

Enforcement Powers.  The Bank and its “institution-affiliated parties,” including its management, employees, agents, independent contractors, and consultants such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs, are subject to potential civil and criminal penalties for violations of law, regulations or written orders of a government agency. These practices can include the failure of an institution to timely file required reports or the filing of false or misleading information or the submission of inaccurate reports.  Civil penalties may be as high as $1,000,000 a day for such violations.  Criminal penalties for some financial institution crimes have been increased to 20 years.  In addition, regulators are provided with greater flexibility to commence enforcement actions against

 

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institutions and institution-affiliated parties.  Possible enforcement actions include the termination of deposit insurance.  Furthermore, banking agencies’ power to issue cease-and-desist orders were expanded.  Such orders may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnifications or guarantees against loss.  A financial institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts, or take other actions as determined by the ordering agency to be appropriate.

 

Anti-Money Laundering.   Financial institutions must maintain anti-money laundering programs that include established internal policies, procedures, and controls; a designated compliance officer; an ongoing employee training program; and testing of the program by an independent audit function. The Company and the Bank are also prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence and “knowing your customer” in their dealings with foreign financial institutions and foreign customers.  Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions, and recent laws provide law enforcement authorities with increased access to financial information maintained by banks.  Anti-money laundering obligations have been substantially strengthened as a result of the USA Patriot Act, enacted in 2001 and renewed in 2006.  Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.  The regulatory authorities have been active in imposing “cease and desist” orders and money penalty sanctions against institutions found to be violating these obligations.

 

USA PATRIOT Act.  The USA PATRIOT Act became effective on October 26, 2001, amended, in part, the Bank Secrecy Act, and provides, in part, for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering by enhancing anti-money laundering and financial transparency laws, as well as enhanced information collection tools and enforcement mechanics for the U.S. government, including: (i) requiring standards for verifying customer identification at account opening; (ii) rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (iii) reports by nonfinancial trades and businesses filed with the Treasury Department’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and (iv) filing suspicious activities reports by brokers and dealers if they believe a customer may be violating U.S. laws and regulations and requires enhanced due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons.  Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.

 

Under the USA PATRIOT Act, the Federal Bureau of Investigation (“FBI”) can send our banking regulatory agencies lists of the names of persons suspected of involvement in terrorist activities.  The Bank can be requested to search its records for any relationships or transactions with persons on those lists.  If the Bank finds any relationships or transactions, it must file a suspicious activity report and contact the FBI.

 

The Office of Foreign Assets Control (“OFAC”), which is a division of the Treasury, is responsible for helping to insure that United States entities do not engage in transactions with “enemies” of the United States, as defined by various Executive Orders and Acts of Congress.  OFAC has sent, and will send, our banking regulatory agencies lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts.  If the Bank finds a name on any transaction, account or wire transfer that is on an OFAC list, it must freeze such account, file a suspicious activity report and notify the FBI.  The Bank has appointed an OFAC compliance officer to oversee the inspection of its accounts and the filing of any notifications.  The Bank actively checks high-risk OFAC areas such as new accounts, wire transfers and customer files.  The Bank performs these checks utilizing software, which is updated each time a modification is made to the lists provided by OFAC and other agencies of Specially Designated Nationals and Blocked Persons.

 

Privacy and Credit ReportingFinancial institutions are required to disclose their policies for collecting and protecting confidential information.  Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer or when the financial

 

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institution is jointly sponsoring a product or service with a nonaffiliated third party.  Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers.  It is the Bank’s policy not to disclose any personal information unless required by law.

 

Like other lending institutions, the Bank utilizes credit bureau data in its underwriting activities.  Use of such data is regulated under the Federal Credit Reporting Act on a uniform, nationwide basis, including credit reporting, prescreening, sharing of information between affiliates, and the use of credit data.  The Fair and Accurate Credit Transactions Act of 2003 (the “FACT Act”) authorizes states to enact identity theft laws that are not inconsistent with the conduct required by the provisions of the FACT Act.

 

Payment of Dividends. A South Carolina state bank may not pay dividends from its capital.  All dividends must be paid out of undivided profits then on hand, after deducting expenses, including reserves for losses and bad debts.  In addition, under the FDICIA, the Bank may not pay a dividend if, after paying the dividend, the Bank would be undercapitalized.  As described above and in our Annual Report to Shareholders for the year ended December 31, 2011, which is incorporated herein by reference, on February 10, 2011, the Bank entered into the Consent Order with the FDIC and the State Board which, among other things, prohibits the Bank from declaring or paying any dividends on its shares of common stock without the prior approval of the supervisory authorities.

 

Check 21.  The Check Clearing for the 21st Century Act gives “substitute checks,” such as a digital image of a check and copies made from that image, the same legal standing as the original paper check.  Some of the major provisions include:

 

·                                          allowing check truncation without making it mandatory;

 

·                                          demanding that every financial institution communicate to accountholders in writing a description of its substitute check processing program and their rights under the law;

 

·                                          legalizing substitutions for and replacements of paper checks without agreement from consumers;

 

·                                          retaining in place the previously mandated electronic collection and return of checks between financial institutions only when individual agreements are in place;

 

·                                          requiring that when accountholders request verification, financial institutions produce the original check (or a copy that accurately represents the original) and demonstrate that the account debit was accurate and valid; and

 

·                                          requiring the re-crediting of funds to an individual’s account on the next business day after a consumer proves that the financial institution has erred.

 

Effect of Governmental Monetary Policies.  Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies.  The Federal Reserve Bank’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession.  The monetary policies of the Federal Reserve Board have major effects upon the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulation of the discount rate on borrowings of member banks and the reserve requirements against member bank deposits.  It is not possible to predict the nature or impact of future changes in monetary and fiscal policies.

 

Insurance of Accounts and Regulation by the FDIC.   The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC.  The Deposit Insurance Fund is the successor to the Bank Insurance Fund and the Savings Association Insurance Fund, which were merged effective March 31, 2006.  As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC insured institutions.  It also may prohibit any FDIC insured institution from engaging in any activity the FDIC determines by regulation or order to pose a

 

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serious risk to the insurance fund.  The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the OCC an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.

 

Under regulations effective January 1, 2007, the FDIC adopted a new risk-based premium system that provides for quarterly assessments based on an insured institution’s ranking in one of four risk categories based upon supervisory and capital evaluations.  For deposits held as of March 31, 2009, institutions were assessed at annual rates ranging from 12 to 50 basis points, depending on each institution’s risk of default as measured by regulatory capital ratios and other supervisory measures. Effective April 1, 2009, assessments also took into account each institution’s reliance on secured liabilities and brokered deposits.  This resulted in assessments ranging from 7 to 77.5 basis points.  In May 2009, the FDIC issued a final rule which levied a special assessment applicable to all insured depository institutions totaling 5 basis points of each institution’s total assets less Tier 1 capital as of June 30, 2009, not to exceed 10 basis points of domestic deposits.  This special assessment was part of the FDIC’s efforts to rebuild the Deposit Insurance Fund.

 

In November 2009, the FDIC published a final rule to require FDIC insured banks to prepay the fourth quarter assessment and the next three years assessment by December 31, 2009.  The calculation of the prepaid assessment provides for a 5% growth rate assumption in the deposit base and a 3 basis point increase in FDIC assessments in 2011 and 2012.  Therefore, if deposits grow quicker than 5%, our quarterly expense in the future will increase compared to previous periods.  During 2011, we expensed $2.4 million of deposit insurance resulting in a balance at December 31, 2011 of $0 of prepaid assessment as compared to $2.1 million at December 31, 2010 due to the increase in our composite rating with the FDIC.

 

In February 2011, the FDIC approved two rules that amended the deposit insurance assessment regulations.  The first rule changed the assessment base from one based on domestic deposits to one based on assets.  The assessment base changed from adjusted domestic deposits to average consolidated total assets minus average tangible equity.  The second rule changed the deposit insurance assessment system for large institutions in conjunction with the guidance given in the Dodd-Frank Act.  Since the new base would be much larger than the current base, the FDIC lowered assessment rates which achieved the FDIC’s goal of not significantly altering the total amount of revenue collected from the industry.  Risk categories and debt ratings were eliminated from the assessment calculation for large banks which now use scorecards.  The scorecards will include financial measures that are predictive of long-term performance.  A large financial institution is defined as an insured depository institution with at least $10 billion in assets.  Both changes in the assessment system became effective as of April 1, 2011.

 

FDIC insured institutions are required to pay a Financing Corporation assessment to fund the interest on bonds issued to resolve thrift failures in the 1980s.  The Financing Corporation quarterly assessment for the fourth quarter of 2011 equaled 5.765 basis points for each $100 in domestic deposits at our institution. These assessments, which may be revised based upon the level of deposits, will continue until the bonds mature in the years 2017 through 2019.

 

The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OCC.  It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC.  Management is not aware of any practice, condition or violation that might lead to termination of the Bank’s deposit insurance.

 

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Item 1A.  Risk Factors.

 

Our business, financial condition, and results of operations could be harmed by any of the following risks, or other risks that have not been identified or which we believe are immaterial or unlikely.  Shareholders should carefully consider the risks described below in conjunction with the other information in this Form 10-K and the information incorporated by reference in this Form 10-K, including our consolidated financial statements and related notes.

 

Risks Related to Our Business

 

There is substantial doubt about our ability to continue as a going concern.

 

We have prepared the consolidated financial statements contained in this Summary assuming that the Company will be able to continue as a going concern, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future.  However, as a result of recurring losses, as well as uncertainties associated with the Bank’s ability to increase its capital levels to meet regulatory requirements, management has concluded that there is substantial doubt about the Company’s ability to continue as a going concern.  In its report dated March 19, 2012, our independent registered public accounting firm stated that these uncertainties raise substantial doubt about our ability to continue as a going concern.  Our financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern.  If we are unable to continue as a going concern, our shareholders will likely lose all of their investment in the Company.

 

We have an immediate need to raise capital, and we will need additional capital in the future, but capital may not be available to us as needed or on favorable terms.

 

We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations.  Pursuant to the Consent Order, the Bank was required to achieve Tier 1 capital at least equal to 8% of total assets and Total Risk-Based capital at least equal to 10% of total risk-weighted assets by July 10, 2011. As of December 31, 2011, the Bank is not in compliance with the minimum capital requirements established in the Consent Order and is designated as “significantly undercapitalized.”  As a result, we have an immediate need to raise capital.  The Bank is working diligently to increase its capital ratios in order to strengthen its balance sheet and satisfy the commitments required under the Consent Order.  The Bank has engaged independent third parties to assist the Bank in its efforts to increase its capital ratios, including by raising capital during 2012.  Our ability to raise additional capital will depend in part on conditions in the capital markets at that time, which are outside our control, and on our financial performance.  In addition, we may find it particularly difficult given the amount of our outstanding senior equity and debt securities, including the Series T Preferred Stock, the trust preferred securities, and our 2010 subordinated promissory notes.  Accordingly, additional capital may not be raised, if and when needed, on terms acceptable to us, or at all.  If we issue additional equity capital, it may be at a lower price and in all cases our existing shareholders’ interest would be diluted.  If we cannot raise additional capital to meet the minimum capital requirements set forth under the Consent Order, or if we suffer a continued deterioration in our financial condition, we may be placed into a federal conservatorship or receivership by the FDIC.  If this were to occur, then you would lose your investment in the Company.

 

We are subject to a Consent Order that requires us to take certain actions, and if we do not comply with the Consent Order, or if our condition continues to deteriorate, our Bank may be placed in a federal conservatorship or receivership by the FDIC.

 

On February 10, 2011, the Bank entered into the Consent Order with the FDIC and the State Board, which contains, among other things, a requirement that our Bank achieve and maintain minimum capital requirements that exceed the minimum regulatory capital ratios for “well-capitalized” banks.  Under this enforcement action, the Bank may no longer accept, renew, or roll over brokered deposits.  In addition, under the Consent Order, we are required to obtain FDIC approval before making certain payments to

 

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departing executives and before adding new directors or senior executives.  Our regulators have considerable discretion in whether to grant required approvals, and no assurance can be given that such approvals would be forthcoming.  In addition, we are required to take certain other actions in the areas of capital, liquidity, asset quality, and interest rate risk management, as well as to file periodic reports with the FDIC and the State Board regarding our progress in complying with the Consent Order.

 

The Bank failed to meet the minimum capital requirements by the July 9, 2011 deadline set forth in the Consent Order and, as a result, the Bank submitted a revised Capital Restoration Plan to the FDIC on September 30, 2011 detailing the steps the Bank plans to take to achieve these minimum capital requirements. The Bank is not currently in compliance with the minimum capital requirements and, as of December 31, 2011, the Bank is categorized as “significantly undercapitalized.”  As a result, a number of requirements or restrictions can or will be imposed on the Company and the Bank in addition to those set forth under the Consent Order and the Written Agreement.  These additional requirements and restrictions: (i) prohibit the Bank from paying any bonus to a senior executive officer or providing compensation to a senior executive officer at a rate exceeding the officer’s average rate of compensation (excluding bonuses, stock options and profit-sharing) during the 12 months preceding the month in which the Bank became undercapitalized, without prior written approval from the FDIC; (ii) require the FDIC to impose one or more of the following on the Bank: (A) require a sale of Bank shares or obligations of the Bank sufficient to return the Bank to adequately capitalized status; (B) if grounds exist for the appointment of a receiver or conservator for the Bank, require the Bank to be acquired or merged with another institution; (C) impose additional restrictions on transactions with affiliates beyond the normal restrictions applicable to all banks; (D) impose more stringent growth restrictions on the Bank, or require the Bank to further reduce its total assets; (E) require the Bank to alter, reduce or terminate any activities the FDIC determines pose excessive risk to the Bank; (F) order a new election of Bank directors; (G) require the Bank to dismiss any senior executive officer or director who held office for more than 180 days before the Bank became undercapitalized; (H) require the Bank to employ “qualified” senior executive officers; (I) require the Company to divest the Bank if the regulators determine that the divestiture would improve the Bank’s financial condition and future prospects; and (J) require the Bank to take any other action that the FDIC determines will better carry out the purposes of the statute requiring the imposition of one or more of the restrictions described in (A)-(I) above; and (iii) requiring prior regulatory approval for material transactions outside the usual course of business, extending credit for a highly leveraged transactions, amending the Bank’s Articles of Incorporation or bylaws, making a material change to accounting methods, paying excessive compensation or bonuses, and paying interest on new or renewed liabilities at a rate that would increase the Bank’s weighted average cost of funds to a level significantly exceeding the prevailing rates on interest on deposits in the Bank’s normal market areas.

 

If the Bank were to fall to “critically undercapitalized,” then the FDIC would be required to place the Bank into conservatorship or receivership within 90 days of the Bank becoming critically undercapitalized, unless the FDIC determined that “other action” would better achieve the purposes of the FDIC’s prompt corrective action capital requirements.  If the Bank were to be taken into receivership, then you would lose your investment in the Company.  See the prior section entitled “Our Strategic Plan” for information on the actions the Bank is currently taking and plans to take to meet the minimum capital requirements set forth by the Consent Order.

 

If we do not generate positive cash flow and earnings, there will be an adverse effect on our future results of operations.

 

For the years ended December 31, 2011 and 2010, we incurred a net loss of $29.0 million and $17.3 million, respectively.  In light of the current economic environment, significant additional provisions for loan losses may be necessary to supplement the allowance for loan losses in the future.  As a result, we may incur significant additional credit costs in 2012, which could adversely impact our financial condition, results of operations, and the value of our common stock.

 

If our nonperforming assets increase, our earnings will be adversely affected.

 

At December 31, 2011, our nonperforming assets (which consist of nonaccruing loans, loans 90 days or more past due, restructured trouble loans and other real estate owned) totaled $86.9 million, or

 

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16.22% of total assets.  At December 31, 2010, our nonperforming assets were $74.2 million, or 9.43% of total assets.  Our nonperforming assets adversely affect our net income in various ways:

 

·                  We do not record interest income on nonaccrual loans or real estate owned.

 

·                  We must provide for probable loan losses through a current period charge to the provision for loan losses.

 

·                  Noninterest expense increases when we must write down the value of properties in our other real estate owned portfolio to reflect changing market values.

 

·                  There are legal fees associated with the resolution of problem assets, as well as carrying costs, such as taxes, insurance, and maintenance fees related to other real estate owned.

 

·                  The resolution of nonperforming assets requires the active involvement of management, which can distract them from more profitable activity.

 

If additional borrowers become delinquent and do not pay their loans and we are unable to successfully manage our nonperforming assets, our losses and troubled assets could increase significantly, which could have a material adverse effect on our results of operations.

 

We have sustained losses from a decline in credit quality and may see further losses.

 

Our ability to generate earnings is significantly affected by our ability to properly originate, underwrite and service loans.  We have sustained losses primarily because borrowers, guarantors or related parties have failed to perform in accordance with the terms of their loans and we failed to detect or respond to deterioration in asset quality in a timely manner.  We could sustain additional losses for these reasons.  Further problems with credit quality or asset quality could cause our interest income and net interest margin to further decrease, which could adversely affect our business, financial condition and results of operations.  We have recently identified credit deficiencies with respect to certain loans in our loan portfolio which are primarily related to the downturn in the residential housing industry.  As a result of the decline of the residential housing market, property values for this type of collateral have declined substantially.  In response to this determination, we increased our loan loss reserve throughout 2010 and the first six months of 2011 to a total loan loss reserve of $21.2 million at December 31, 2011 to address the risks inherent within our loan portfolio.  Although credit quality indicators generally showed signs of stabilization in the second half of 2011, further deterioration in the coastal South Carolina real estate market as a whole may cause management to adjust its opinion of the level of credit quality in our loan portfolio.  Such a determination may lead to an additional increase in our provisions for loan losses, which could also adversely affect our business, financial condition, and results of operations.

 

Difficult market conditions in our coastal markets and economic trends have adversely affected our industry and our business and may continue to do so.

 

Our business has been directly affected by market conditions, trends in industry and finance, legislative and regulatory changes, and changes in governmental monetary and fiscal policies and inflation, all of which are beyond our control.  The current economic downturn, increase in unemployment and other events that have negatively affected both household and corporate incomes, both nationally and locally, have decreased the demand for loans and our other products and services and have increased the number of customers who fail to pay interest and/or principal on their loans.  As a result, we have experienced significant declines in our coastal real estate markets with decreasing prices and increasing delinquencies and foreclosures, which have negatively affected the credit performance of our loans and resulted in increases in the level of our nonperforming assets and charge-offs of problem loans.  At the same time, competition among depository institutions for quality loans has increased significantly.  Bank and bank holding company stock prices have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets compared to recent years.  These market conditions and the tightening of credit have led to increased deficiencies in our loan portfolio, increased market volatility and widespread reduction in general business activity.

 

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Our future success significantly depends upon the growth in population, income levels, deposits and housing starts in our market areas.  Unlike many larger institutions, we are not able to spread the risks of unfavorable economic conditions across a large number of diversified economies and geographic locations.  If the markets in which we operate do not recover and grow as anticipated or if prevailing economic conditions locally or nationally do not improve, our business may continue to be negatively impacted.

 

A significant portion of our loan portfolio is secured by real estate, and events that negatively impact the real estate market could hurt our business.

 

A significant portion of our loan portfolio is secured by real estate.  As of December 31, 2011, approximately 83.4% of our loans had real estate as a primary or secondary component of collateral.  The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended.  The recent weakening of the real estate market in our market areas, and particularly in our Myrtle Beach market area, could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality.  If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected.  Acts of nature, including hurricanes, tornados, earthquakes, fires and floods, each of which may be exacerbated by global climate change and may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact our financial condition.

 

We have a concentration of credit exposure in commercial real estate and challenges faced by the commercial real estate market could adversely affect our business, financial condition, and results of operations.

 

As of December 31, 2011, we had approximately $190.2 million in loans outstanding to borrowers whereby the collateral securing the loan was commercial real estate, representing approximately 51.8% of our total loans outstanding as of that date.  Approximately 27.8% of this real estate are owner-occupied properties.  Commercial real estate loans are generally viewed as having more risk of default than residential real estate loans.  They are also typically larger than residential real estate loans and consumer loans and depend on cash flows from the owner’s business or the property to service the debt.  Cash flows may be affected significantly by general economic conditions, and a downturn in the local economy or in occupancy rates in the local economy where the property is located could increase the likelihood of default.  Because our loan portfolio contains a number of commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in our level of non-performing loans.  An increase in non-performing loans could result in a loss of earnings from these loans, an increase in the related provision for loan losses and an increase in charge-offs, all of which could have a material adverse effect on our financial condition and results of operations.

 

The banking regulators are giving commercial real estate lending greater scrutiny, and may require banks with higher levels of commercial real estate loans to implement more stringent underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for losses and capital levels as a result of commercial real estate lending growth and exposures.  Our commercial real estate loans declined $56.3 million, or 28.3%, from December 31, 2009 to December 31, 2011 as we continue to seek to reduce our commercial real estate loan portfolio to improve our credit quality and reduce our concentration in commercial real estate.  We anticipate decreasing our amount of commercial real estate loans throughout 2012 in accordance with our strategic plan.

 

If our allowance for loan losses is not sufficient to cover actual loan losses, or if credit delinquencies increase, our losses could increase.

 

Our success depends, to a significant extent, on the quality of our assets, particularly loans.  Like other financial institutions, we face the risk that our customers will not repay their loans, that the collateral securing the payment of those loans may be insufficient to assure repayment, and that we may be unsuccessful in recovering the remaining loan balances.  The risk of loss varies with, among other things, general economic conditions, the type of loan, the creditworthiness of the borrower over the term of the

 

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loan and, for many of our loans, the value of the real estate and other assets serving as collateral.  Management makes various assumptions and judgments about the collectibility of our loan portfolio after considering these and other factors.  Based in part on those assumptions and judgments, we maintain an allowance for loan losses in an attempt to cover any loan losses that may occur.  In determining the size of the allowance, we also rely on an analysis of our loan portfolio based on historical loss experience, volume and types of loans, trends in classification, delinquencies and nonaccruals, national and local economic conditions and other pertinent information, including the results of external loan reviews.  Despite our efforts, our loan assessment techniques may fail to properly account for potential loan losses, and, as a result, our established loan loss reserves may prove insufficient.  If we are unable to generate income to compensate for these losses, they could have a material adverse effect on our operating results.

 

In addition, federal and state regulators periodically review our allowance for loan losses and may require us to increase our allowance for loan losses or recognize further loan charge-offs, based on judgments different than those of our management.  Higher charge-off rates and an increase in our allowance for loan losses may hurt our overall financial performance and may increase our cost of funds.  As of December 31, 2011, we had 92 loans on nonaccrual status totaling approximately $ 44.7 million, and our allowance for loan loss was $21.2 million.  For the year ended December 31, 2011, we recorded a provision for loan losses of $25.3 million as compared to a $23.1 million provision for loan losses for the year ended December 31, 2010.  Our current and future allowances for loan losses may not be adequate to cover future loan losses given current and future market conditions.

 

A percentage of the loans in our portfolio currently include exceptions to our loan policies and supervisory guidelines.

 

All of the loans that we make are subject to written loan policies adopted by our board of directors and to supervisory guidelines imposed by our regulators.  Our loan policies are designed to reduce the risks associated with the loans that we make by requiring our loan officers to take certain steps that vary depending on the type and amount of the loan, prior to closing a loan.  These steps include, among other things, making sure the proper liens are documented and perfected on property securing a loan, and requiring proof of adequate insurance coverage on property securing loans.  Loans that do not fully comply with our loan policies are known as “exceptions.”  We categorize exceptions as policy exceptions, financial statement exceptions and collateral exceptions.  As a result of these exceptions, such loans may have a higher risk of loan loss than the other loans in our portfolio that fully comply with our loan policies.  In addition, we may be subject to regulatory action by federal or state banking authorities if they believe the number of exceptions in our loan portfolio represents an unsafe banking practice.  Although we have taken steps to enhance the quality of our loan portfolio, we may not be successful in reducing the number of exceptions.

 

Liquidity risks could affect operations and jeopardize our financial condition.

 

The goal of liquidity management is to ensure that we can meet customer loan requests, customer deposit maturities and withdrawals, and other cash commitments under both normal operating conditions and under unpredictable circumstances of industry or market stress.  To achieve this goal, our asset/liability committee establishes liquidity guidelines that require sufficient asset-based liquidity to cover potential funding requirements and to avoid over-dependence on volatile, less reliable funding sources.

 

Liquidity is essential to our business.  An inability to raise funds through traditional deposits, borrowings, the sale of securities or loans, issuance of additional equity securities, and other sources could have a substantial negative impact on our liquidity.  Our access to funding sources in amounts adequate to finance our activities and with terms acceptable to us could be impaired by factors that impact us specifically or the financial services industry in general.  Factors that could detrimentally impact access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated, the change in our status from well-capitalized to significantly undercapitalized, or regulatory action against us.  Our ability to borrow could also be impaired by factors that are not specific to us, such as the current disruption in the financial markets and negative views and expectations about the prospects for the financial services industry as a result of the continuing turmoil and deterioration in the credit markets.

 

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Traditionally, the primary sources of funds of our Bank have been customer deposits and loan repayments.  As of December 31, 2011, we had brokered deposits of $75.6 million, representing 15.4% of our total deposits, of which $24.7 million is scheduled to mature in 2012, $24.4 million is scheduled to mature in 2013, $4.6 million is scheduled to mature in 2014 and the remainder is scheduled to mature in 2015.  Because of the Consent Order, we may not accept brokered deposits unless a waiver is granted by the FDIC.  We must find other sources of liquidity to replace these deposits as they mature.  Secondary sources of liquidity may include proceeds from the Federal Home Loan Bank (the “FHLB”) advances, federal funds lines of credit from correspondent banks and QwickRate CDs obtained via the Internet. The Bank’s credit risk rating at the FHLB has been negatively impacted, resulting in more restrictive borrowing requirements. Because we are significantly undercapitalized, we are required to pledge additional collateral for FHLB advances.

 

We actively monitor the depository institutions that hold our federal funds sold and due from banks cash balances.   We cannot provide assurances that access to our cash and cash equivalents and federal funds sold will not be impacted by adverse conditions in the financial markets.  Our emphasis is primarily on safety of principal, and we diversify cash, due from banks, and federal funds sold among counterparties to minimize exposure relating to any one of these entities.  We routinely review the financials of our counterparties as part of our risk management process.  Balances in our accounts with financial institutions in the U.S. may exceed the FDIC insurance limits.  While we monitor and adjust the balances in our accounts as appropriate, these balances could be impacted if the correspondent financial institutions fail.

 

There can be no assurance that our sources of funds will be adequate for our liquidity needs, and we may be compelled to seek additional sources of financing in the future.  Specifically, we may seek additional debt in the future to achieve our business objectives.  There can be no assurance that additional borrowings, if sought, would be available to us or, if available, would be on favorable terms. Bank and holding company stock prices have been negatively impacted by the recent adverse economic conditions, as has the ability of banks and holding companies to raise capital or borrow in the debt markets.  If additional financing sources are unavailable or not available on reasonable terms, our business, financial condition, results of operations, cash flows, and future prospects could be materially adversely impacted.

 

Higher FDIC deposit insurance premiums and assessments could adversely impact our financial condition.

 

Our deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC and are subject to deposit insurance assessments to maintain deposit insurance.  As an FDIC-insured institution, we are required to pay quarterly deposit insurance premium assessments to the FDIC.  Although we cannot predict what the insurance assessment rates will be in the future, either a deterioration in our risk-based capital ratios or adjustments to the base assessment rates could have a material adverse impact on our business, financial condition, results of operations, and cash flows.

 

We are dependent on key individuals and the loss of one or more of these key individuals could curtail our growth and adversely affect our prospects.

 

James R. Clarkson, our president and chief executive officer, has extensive and long-standing ties within our primary market area and he has contributed significantly to our growth.  If we lose the services of Mr. Clarkson, he would be difficult to replace, and our business and development could be materially and adversely affected.

 

Our success also depends, in part, on our continued ability to attract and retain experienced loan originators, as well as other management personnel.  The loss of the services of several of such key personnel could adversely affect our growth strategy and prospects to the extent we are unable to replace such personnel.

 

We are subject to extensive regulation that could restrict our activities and impose financial requirements or limitations on the conduct of our business and limit our ability to receive dividends from our Bank.

 

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We are subject to Federal Reserve regulation. Our Bank is subject to extensive regulation, supervision, and examination by our primary federal regulator, the FDIC, the regulating authority that insures customer deposits. Also, as a member of the FHLB, our Bank must comply with applicable regulations of the Federal Housing Finance Board and the FHLB. Regulation by these agencies is intended primarily for the protection of our depositors and the deposit insurance fund and not for the benefit of our shareholders. Our Bank’s activities are also regulated under consumer protection laws applicable to our lending, deposit, and other activities. A sufficient claim against our bank under these laws could have a material adverse effect on our results of operations.

 

We are exposed to further changes in the regulation of financial services companies.

 

Proposals for further regulation of the financial services industry are continually being introduced in the Congress of the United States of America and the General Assembly of the State of South Carolina. The agencies regulating the financial services industry also periodically adopt changes to their regulations. On September 7, 2008, the U.S. Treasury announced that Freddie Mac (along with Fannie Mae) had been placed into conservatorship under the control of the newly created Federal Housing Finance Agency. On October 3, 2008, EESA was signed into law, and on October 14, 2008 the U.S. Treasury announced its CPP under EESA. On February 17, 2009, the Recovery Act was signed into law. In November 2009, the FDIC announced a final rule to require FDIC insured banks to prepay the fourth quarter assessment and the next three years assessment by December 31, 2009. On July 21, 2010, the Dodd-Frank Act was signed into law. Pursuant to authority granted under the Dodd-Frank Act, effective on October 1, 2011, the Federal Reserve established new rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion. While we are not subject to the interchange fee restrictions, the new restrictions could negatively impact bank card services income for smaller banks if the reductions that are required of larger banks cause industry-wide reduction of swipe fees. In December 2010, the Basel Committee revised final frameworks for the regulation of capital and liquidity of internationally active banking organizations. Although the U.S. banking agencies have not yet published a notice of proposed rulemaking to implement Basel III in the United States, they are likely to do so (at least with respect to the Basel III capital framework) during the first half of 2012. In addition to Basel III, Dodd-Frank requires or permits the Federal banking agencies to adopt regulations affecting banking institutions’ capital requirements in a number of respects, including potentially more stringent capital requirements for systemically important financial institutions. It is possible that additional legislative proposals may be adopted or regulatory changes may be made that would have an adverse effect on our business. We can provide no assurance regarding the manner in which any new laws and regulations will affect us. See “Risk Factors—We are subject to extensive regulation that could restrict our activities and impose financial requirements or limitations on the conduct of our business and limit our ability to receive dividends from our Bank” above.

 

Because of our participation in the U.S. Treasury’s CPP, we are subject to several restrictions including restrictions on compensation paid to our executives.

 

Pursuant to the terms of the CPP Purchase Agreement between us and Treasury, we adopted certain standards for executive compensation and corporate governance for the period during which Treasury holds the equity issued pursuant to the CPP Purchase Agreement, including the common stock which may be issued pursuant to the Warrant.  These standards generally apply to our named executive officers. The standards include (i) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (ii) required clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (iii) prohibition on making golden parachute payments to senior executives; (iv) prohibition on providing tax gross-up provisions; and (v) agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive.  In particular, the change to the deductibility limit on executive compensation may likely increase the overall cost of our compensation programs in future periods and may make it more difficult to attract suitable candidates to serve as executive officers.

 

The Series T Preferred Stock impacts net income available to our common shareholders and earnings per common share, and the warrant we issued to Treasury may be dilutive to holders of our common stock.

 

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The dividends declared on the Series T Preferred Stock issued to Treasury through the CPP will reduce the net income available to common shareholders and our earnings per common share.  Notably, the dividend rate payable on the Series T Preferred Stock will increase from 5% to 9% on March 6, 2014.  Also, we have been forced to defer and accrue five quarterly dividend payments to Treasury and, thus, are prohibited from paying dividends on our common stock until all accrued dividends on our the Series T Preferred Stock are paid in full.  The Series T Preferred Stock will also receive preferential treatment in the event of liquidation, dissolution or winding up of the Company.

 

Additionally, the ownership interest of the existing holders of our common stock will be diluted to the extent the warrant we issued to Treasury in conjunction with the sale to Treasury of the Series T Preferred Stock is exercised.  The 91,714 shares of common stock underlying the warrant represent approximately 2.5% of the shares of our common stock outstanding as of December 31, 2011 (including the shares issuable upon exercise of the warrant in total shares outstanding).  Although Treasury has agreed not to vote any of the shares of common stock it receives upon exercise of the warrant, a transferee of any portion of the warrant or of any shares of common stock acquired upon exercise of the warrant is not bound by this restriction.  We note, however, that the exercise price on Treasury’s warrant is $21.09 and the Company’s current trading price was approximately $0.51 at December 31, 2011.

 

We may be adversely affected by the soundness of other financial institutions.

 

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships.  We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client.  In addition, our credit risk may be exacerbated when the collateral held by the Bank cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to the Bank.  Any such losses could have a material adverse effect on our financial condition and results of operations.

 

We could experience a loss due to competition with other financial institutions.

 

The banking and financial services industry is very competitive.  Legal and regulatory developments have made it easier for new and sometimes unregulated competitors to compete with us.  The financial services industry has and is experiencing an ongoing trend towards consolidation in which fewer large national and regional banks and other financial institutions are replacing many smaller and more local banks.  These larger banks and other financial institutions hold a large accumulation of assets and have significantly greater resources and a wider geographic presence or greater accessibility. In some instances, these larger entities operate without the traditional brick and mortar facilities that restrict geographic presence.  Some competitors are able to offer more services, more favorable pricing or greater customer convenience than the Company.  In addition, competition has increased from new banks and other financial services providers that target our existing or potential customers.  As consolidation continues among large banks, we expect other smaller institutions to try to compete in the markets we serve.

 

Technological developments have allowed competitors, including some non-depository institutions, to compete more effectively in local markets and have expanded the range of financial products, services and capital available to our target customers.  If we are unable to implement, maintain and use such technologies effectively, we may not be able to offer products or achieve cost-efficiencies necessary to compete in the industry. In addition, some of these competitors have fewer regulatory constraints and lower cost structures.

 

We depend on the accuracy and completeness of information about clients and counterparties.

 

In deciding whether to extend credit or enter into other transactions with clients and counterparties, we may rely on information furnished to us by or on behalf of clients and counterparties, including financial statements and other financial information. We also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors.  For example, in deciding whether to extend credit

 

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to clients, we may assume that a customer’s audited financial statements conform to accounting principles generally accepted in the United States of America (“GAAP”) and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer.  Our earnings are significantly affected by our ability to properly originate, underwrite and service loans.  Our financial condition and results of operations could be negatively impacted to the extent we incorrectly assess the creditworthiness of our borrowers, fail to detect or respond to deterioration in asset quality in a timely manner, or rely on financial statements that do not comply with GAAP or are materially misleading.

 

The accuracy of our financial statements and related disclosures could be affected because we are exposed to conditions or assumptions different from the judgments, assumptions or estimates used in our critical accounting policies.

 

The preparation of financial statements and related disclosure in conformity with GAAP requires us to make judgments, assumptions, and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes.  Our critical accounting policies, included in this document, describe those significant accounting policies and methods used in the preparation of our consolidated financial statements that are considered “critical” by us because they require judgments, assumptions and estimates that materially impact our consolidated financial statements and related disclosures.  As a result, if future events differ significantly from the judgments, assumptions and estimates in our critical accounting policies, such events or assumptions could have a material impact on our audited consolidated financial statements and related disclosures.

 

We are exposed to the possibility of technology failure and a disruption in our operations may adversely affect our business.

 

We rely on our computer systems and the technology of outside service providers. Our daily operations depend on the operational effectiveness of their technology.  We rely on our systems to accurately track and record our assets and liabilities.  If our computer systems or outside technology sources become unreliable, fail, or experience a breach of security, our ability to maintain accurate financial records may be impaired, which could materially affect our business operations and financial condition. In addition, a disruption in our operations resulting from failure of transportation and telecommunication systems, loss of power, interruption of other utilities, natural disaster, fire, global climate changes, computer hacking or viruses, failure of technology, terrorist activity or the domestic and foreign response to such activity or other events outside of our control could have an adverse impact on the financial services industry as a whole and/or on our business.  Our business recovery plan may not be adequate and may not prevent significant interruptions of our operations or substantial losses.

 

Negative public opinion surrounding our Company and the financial institutions industry generally could damage our reputation and adversely impact our earnings.

 

Reputation risk, or the risk to our business, earnings and capital from negative public opinion surrounding our Company and the financial institutions industry generally, is inherent in our business. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect our ability to keep and attract clients and employees and can expose us to litigation and regulatory action. Although we take steps to minimize reputation risk in dealing with our clients and communities, this risk will always be present given the nature of our business.

 

Given the geographic concentration of our operations, we could be significantly affected by any hurricane that affects coastal South Carolina.

 

Our loan portfolio consists of loans to persons and businesses located in coastal South Carolina.  The collateral for many of our loans consists of real and personal property located in this area, which is susceptible to hurricanes that can cause extensive damage to the general region.  Disaster conditions resulting from any hurricane that hits in this area would adversely affect the local economies and real estate markets, which could negatively impact our business.  Adverse economic conditions resulting from such a

 

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disaster could also negatively affect the ability of our customers to repay their loans and could reduce the value of the collateral securing these loans.  Furthermore, damage resulting from any hurricane could also result in continued economic uncertainty that could negatively impact businesses in those areas.  Consequently, our ability to continue to originate loans may be impaired by adverse changes in local and regional economic conditions in this area following any hurricane.

 

Risks Related to Our Common Stock

 

There is no active public trading market for our common stock, and one is not expected to develop.

 

Our common stock is not listed for trading on any securities exchange, and we presently do not intend to apply to list our common stock on any national securities exchange at any time in the foreseeable future.  Consequently, the liquidity of our common stock, and our investors ability to sell shares of our common stock, will depend upon the interest of the Company, existing shareholders and other potential purchasers.  As a result of this limited market, it may be difficult to identify buyers to whom our investors can sell their shares of our common stock, and our investors may be unable to sell their shares at an established market price, at a price that is favorable to the investors, or at all.  This limited market will restrict our investors ability to sell shares of our common stock at a desirable or stable price or at all, at any one time.  Our investors should be prepared to own our common stock indefinitely.

 

We are currently prohibited from paying cash dividends, and we may be unable to pay future dividends even if we desire to do so.

 

Our ability to pay cash dividends is limited by our Bank’s ability to pay cash dividends to our Company and by our need to maintain sufficient capital to support our operations.  The ability of our Bank to pay cash dividends to our Company is currently prohibited by the restrictions of the Consent Order.  Further, the Bank currently has negative retained earnings due to losses during 2009, 2010 and 2011 and therefore would be unable to pay cash dividends, regardless of the restrictions imposed by the Consent Order.  In addition, our Company also has negative retained earnings and is prohibited from paying dividends without the prior approval of the Federal Reserve Bank of Richmond.  Consequently, we do not anticipate paying cash dividends on shares of our common stock in the foreseeable future.

 

Shares of our preferred stock may be issued in the future which could materially adversely affect the rights of the holders of our common stock.

 

Pursuant to our Articles of Incorporation, we have the authority to issue additional series of preferred stock and to determine the designations, preferences, rights and qualifications or restrictions of those shares without any further vote or action of the shareholders. The rights of the holders of our common stock will be subject to, and may be materially adversely affected by, the rights of the holders of any preferred stock that may be issued by us in the future.

 

Shares of our common stock are not insured bank deposits and are subject to market risk.

 

Our shares of common stock are not deposits, savings accounts or other obligations of us, our Bank or any other depository institution, are not guaranteed by us or any other entity, and are not insured by the FDIC or any other governmental agency.

 

Item 1B.            Unresolved Staff Comments.

 

None.

 

Item 2.  Description of Property.

 

The main office of the Bank is located at 5009 Broad Street, Loris, South Carolina, 29569.  Our operational support services and executive offices are located in our Operations Center at 3640 Ralph Ellis Boulevard, Loris, South Carolina, 29569.  Our operational support services include central deposit and central credit operations, computer operations, audit and compliance operations, human resources, training,

 

36



 

marketing and credit administration operations.  Currently we have for sale or lease our former Operations Center at 5201 Broad Street, Loris, South Carolina, 29569.

 

The Bank presently owns 12 lots on which we have branch banking facilities in addition to the previously mentioned lot which houses our former operations facility and the lot which houses our current Operations Center.  In addition, the Bank has entered into one long-term lease agreement for a lot on which we have built a branch banking facility at 3210 Highway 701 Bypass, Loris, South Carolina, 29569.

 

During September, 2011, we closed our Covenant Towers branch in an effort to decrease our expenses.  Also in January 2012, the Company closed its branches in the Homewood community and on Meeting Street in Loris to decrease its number of branches from 13 to 11.  The Company closed these offices in order to reduce expenses without materially reducing the Company’s deposits and loans.

 

Item 3.  Legal Proceedings.

 

In the ordinary course of operations, we may be a party to various legal proceedings from time to time.  We do not believe that there is any pending or threatened proceeding against us, which, if determined adversely, would have a material effect on our business, results of operations, or financial condition.

 

Item 4.   Mine Safety Disclosures.

 

Not applicable.

 

PART II

 

Item 5.  Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

The information required by Item 5 is hereby incorporated by reference from our annual report to shareholders for the year ended December 31, 2011.

 

Item 6.  Selected Financial Data.

 

N/A.

 

Item 7.  Management’s Discussion and Analysis or Plan of Operation.

 

The information required by Item 7 is hereby incorporated by reference from our annual report to shareholders for the year ended December 31, 2011.

 

Item 8.  Financial Statements and Supplementary Data.

 

The information required by Item 8 is hereby incorporated by reference from our annual report to shareholders for the year ended December 31, 2011.

 

Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

 

None.

 

Item 9A.  Controls and Procedures.

 

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e).  Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our current disclosure controls and procedures are effective as of December 31, 2011.  There have been no significant changes in our internal controls over financial reporting during the fourth

 

37



 

fiscal quarter ended December 31, 2011 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events.  There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

 

Management’s Annual Report on Internal Controls Over Financial Reporting

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Exchange Act Rules 13a-15(f).  A system of internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

 

Under the supervision and with the participation of management, including the principal executive officer and the principal financial officer, the Company’s management has evaluated the effectiveness of its internal control over financial reporting as of December 31, 2011 based on the criteria established in a report entitled “Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission” and the interpretive guidance issued by the Commission in Release No. 34-55929.  Based on this evaluation, the Company’s management has evaluated and concluded that the Company’s internal control over financial reporting was effective as of December 31, 2011.

 

The Company is continuously seeking to improve the efficiency and effectiveness of its operations and of its internal controls. This results in modifications to its processes throughout the Company. However, there has been no change in its internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

 

ITEM 9B.  Other Information.

 

On December 30, 2010, the Board of Directors amended and restated the Company’s bylaws to amend Article 3:  Directors, Section 6:  Retirement of Directors, to increase the mandatory retirement age of directors from age 70 to 75.  The Company recently discovered that the amended and restated bylaws had not previously been filed with the SEC and, accordingly, are attached to this Annual Report on Form 10-K as Exhibit 3.2.

 

38



 

PART III

 

Item 10.  Directors, Executive Officers and Corporate Governance

 

Code of Ethics

 

We have adopted a Code of Ethics that applies to our board of directors, principal executive officer, principal financial officer, senior financial officers, and other executive officers in accordance with the Sarbanes-Oxley Corporate Responsibility Act of 2002.  The Code of Ethics is available to our shareholders via the internet at www.hcsbaccess.com.

 

Additional information required by Item 10 is hereby incorporated by reference from our proxy statement for our 2012 annual meeting of shareholders to be held on April 26, 2012.

 

Item 11.  Executive Compensation.

 

Information required by Item 11 is hereby incorporated by reference from our proxy statement for our 2012 annual meeting of shareholders to be held on April 26, 2012.

 

Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

 

Additional information required by Item 12 is hereby incorporated by reference from our proxy statement for our 2012 annual meeting of shareholders to be held on April 26, 2012.

 

Item 13.  Certain Relationships and Related Transactions, and Director Independence.

 

In response to this Item 13, the information contained on page 8 of our Proxy Statement for the Annual Meeting of Shareholders to be held on April 26, 2012 is incorporated herein by reference.

 

Item 14.  Principal Accountant Fees and Services.

 

Information required by Item 14 is hereby incorporated by reference from our proxy statement for our 2012 annual meeting of shareholders to be held on April 26, 2012.

 

PART IV

 

Item 15.  Exhibits

 

3.1                               Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the Company’s Form 10-KSB for the fiscal year ended December 31, 1999).

 

3.2                               Amended and Restated Bylaws of HCSB Financial Corporation dated December 30, 2010.

 

3.3                               Articles of Amendment to Authorize Preferred Shares, filed March 2, 2009 (incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K filed March 6, 2009).

 

3.4                               Articles of Amendment to the Company’s Restated Articles of Incorporation establishing the terms of the Series T Preferred Stock (incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K filed March 10, 2009).

 

4.1                               Warrant to Purchase up to 91,714 shares of Common Stock (incorporated by reference to Exhibit 4.1 to the Company’s Form 8-K filed March 10, 2009).

 

4.2                               Form of Series T Preferred Stock Certificate (incorporated by reference to Exhibit 4.2 to the Company’s Form 8-K filed March 10, 2009).

 

39



 

10.1                        HCSB Financial Corporation Omnibus Stock Ownership and Long Term Incentive Plan (incorporated by reference to Exhibit 10.1 to the Company’s Form 10-KSB for the fiscal year ended December 31, 2003).*

 

10.2                        Form of Restricted Stock Option Agreement (incorporated by reference to Exhibit 10.2 to the Company’s Form 10-KSB for the fiscal year ended December 31, 2004).*

 

10.3                        Form of Incentive Stock Option Agreement (incorporated by reference to Exhibit 10.3 to the Company’s Form 10-KSB for the fiscal year ended December 31, 2004).*

 

10.4                        Form of Director Deferred Compensation Agreement adopted in 1997 by and between the Board of Directors and Horry County State Bank (incorporated by reference to Exhibit 10.4 to the Company’s Form 10-KSB for the fiscal year ended December 31, 2006).*

 

10.5                        Letter Agreement, dated March 6, 2009, including Securities Purchase Agreement — Standard Terms incorporated by reference therein, between the Company and the United States Department of the Treasury (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed March 10, 2009).*

 

10.6                        ARRA Side Letter Agreement, dated March 6, 2009, between the Company and the United States Department of the Treasury (incorporated by reference to Exhibit 10.2 to the Company’s Form 8-K filed March 10, 2009).*

 

10.7                        Form of Waiver, executed by each of Messrs. James R. Clarkson, Edward L. Loehr, Jr., and Glenn R. Bullard (incorporated by reference to Exhibit 10.3 to the Company’s Form 8-K filed March 10, 2009).*

 

10.8                        Form of Letter Amendment, executed by each of Messrs. James R. Clarkson, Edward L. Loehr, Jr., and Glenn R. Bullard with the Company (incorporated by reference to Exhibit 10.4 to the Company’s Form 8-K filed March 10, 2009).*

 

10.9                        Form of Salary Continuation Agreement adopted April 4, 2008 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed April 9, 2008).*

 

10.10                 Subordinated Note Purchase Agreement, dated March 29, 2010 (incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed April 23, 2010).

 

10.11                 Form of HCSB Financial Corporation Subordinated Note Due 2020 (incorporated by reference to Exhibit 10.2 of the Company’s Form 8-K filed April 23, 2010).

 

10.12                 Consent Order, effective February 10, 2011, between the FDIC, the South Carolina State Board of Financial Institutions, and Horry County State Bank (incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed February 16, 2011).

 

13                                  The Company’s 2011 Annual Report.

 

21                                  Subsidiaries of Registrant.

 

24                                  Power of Attorney (contained on signature pages herewith).

 

31.1                        Rule 13a-14(a) Certification of the Chief Executive Officer.

 

31.2                        Rule 13a-14(a) Certification of the Principal Financial Officer.

 

32                                  Section 1350 Certifications.

 

99.1                        Certification of the Chief Executive Officer Pursuant to Section 111(b)(4) of the Emergency Economic Stabilization Act of 2008.

 

99.2                        Certification of the Chief Financial Officer Pursuant to Section 111(b)(4) of the Emergency Economic Stabilization Act of 2008.

 

40



 

101                           The following materials from the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, formatted in XBRL; (i) Consolidated Balance Sheets at December 31, 2011 and 2010, (ii) Consolidated Statements of Operations for the years ended December 31, 2011 and 2010, (iii) Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income (Loss) for the years ended December 31, 2011 and 2010, (iv) Consolidated Statements of Cash Flows for the years ended December 31, 2011 and 2010, and (iv) Notes to Consolidated Financial Statements.**

 


*                                         Management contract of compensatory plan or arrangement required to be filed as an Exhibit to this Annual Report on Form 10-K.

**                                  Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

 

41



 

SIGNATURES

 

In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

HCSB FINANCIAL CORPORATION

 

 

 

Date: March 23, 2012

By:

/s/ James R. Clarkson

 

 

James R. Clarkson, President

 

 

& Chief Executive Officer

 

KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints James R. Clarkson, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that attorney-in-fact and agent, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

 

In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.

 

By:

/s/ Michael S. Addy

 

Date: March 23, 2012

 

Michael S. Addy, Director

 

 

 

 

 

 

By:

/s/ Johnny C. Allen

 

Date: March 23, 2012

 

Johnny C. Allen, Director

 

 

 

 

 

 

By:

/s/ Clay D. Brittain, III

 

Date: March 23, 2012

 

Clay D. Brittain, III, Director

 

 

 

 

 

 

By:

/s/ D. Singleton Bailey

 

Date: March 23, 2012

 

D. Singleton Bailey, Director

 

 

 

 

 

 

By:

/s/ Franklin C. Blanton

 

Date: March 23, 2012

 

Franklin C. Blanton, Director

 

 

 

 

 

 

By:

/s/ James R. Clarkson

 

Date: March 23, 2012

 

James R. Clarkson, Director, President &

 

 

 

Chief Executive Officer (Principal Executive

 

 

 

Officer)

 

 

 

 

 

 

By:

/s/ Tommie W. Grainger

 

Date: March 23, 2012

 

Tommie W. Grainger, Director

 

 

 

 

 

 

By:

/s/ Edward L. Loehr, Jr.

 

Date: March 23, 2012

 

Edward L. Loehr, Jr., Chief Financial

 

 

 

Officer (Principal Financial & Accounting

 

 

 

Officer)

 

 

 

 

 

 

By:

/s/ Gwyn G. McCutchen

 

Date: March 23, 2012

 

Gwyn G. McCutchen, Director

 

 

 

 

 

 

By:

/s/ T. Freddie Moore

 

Date: March 23, 2012

 

T. Freddie Moore, Director

 

 

 

42



 

By:

/s/ Carroll D. Padgett, Jr.

 

Date: March 23, 2012

 

Carroll D. Padgett, Jr., Director

 

 

 

43



 

EXHIBIT INDEX

 

3.2

 

Amended and Restated Bylaws of HCSB Financial Corporation dated December 30, 2010.

 

 

 

13

 

The Company’s 2011 Annual Report.

 

 

 

21

 

Subsidiaries of Registrant.

 

 

 

24

 

Power of Attorney (contained on signature pages herewith).

 

 

 

31.1

 

Rule 13a-14(a) Certification of the Chief Executive Officer.

 

 

 

31.2

 

Rule 13a-14(a) Certification of the Principal Financial Officer.

 

 

 

32

 

Section 1350 Certifications.

 

 

 

99.1

 

Certification of the Chief Executive Officer Pursuant to Section 111(b)(4) of the Emergency Economic Stabilization Act of 2008.

 

 

 

99.2

 

Certification of the Chief Financial Officer Pursuant to Section 111(b)(4) of the Emergency Economic Stabilization Act of 2008.

 

 

 

101

 

The following materials from the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, formatted in XBRL; (i) Consolidated Balance Sheets at December 31, 2011 and 2010, (ii) Consolidated Statements of Operations for the years ended December 31, 2011 and 2010, (iii) Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income (Loss) for the years ended December 31, 2011 and 2010, (iv) Consolidated Statements of Cash Flows for the years ended December 31, 2011 and 2010, and (iv) Notes to Consolidated Financial Statements.**

 


*

 

Management contract of compensatory plan or arrangement required to be filed as an Exhibit to this Annual Report on Form 10-K.

**

 

Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

 

44



Exhibit 3.2

 

Amended and Restated Bylaws of HCSB Financial Corporation

December 30, 2010

 



Exhibit 3.2

 

BYLAWS

 

OF

 

HCSB FINANCIAL CORPORATION

 

Amended and Restated December 30, 2010

 



 

HCSB FINANCIAL CORPORATION

 

TABLE OF CONTENTS

 

ARTICLE 1

 

OFFICES

1

Section 1: Registered Office and Agent

1

Section 2: Other Offices

1

 

 

ARTICLE 2

 

SHAREHOLDERS

1

Section 1: Place of Meetings

1

Section 2: Annual Meetings

1

Section 3: Special Meetings

1

Section 4: Notice

2

Section 5: Quorum

2

Section 6: Majority Vote; Withdrawal of Quorum

2

Section 7: Method of Voting

2

Section 8: Record Date

2

Section 9: Shareholder Proposals

2

 

 

ARTICLE 3

 

DIRECTORS

3

Section 1: Management

3

Section 2: Number, Classification and Terms of Office of Directors

3

Section 3: Qualifications of Directors

4

Section 4: Election of Directors

4

Section 5: Nomination of Directors

4

Section 6: Retirement of Directors

5

Section 7: Emeritus Directors

5

Section 8: Vacancies

5

Section 9: Removal of Directors

5

Section 10: Place of Meetings

5

Section 11: Regular Meetings

5

Section 12: Special Meetings

5

Section 13: Telephone and Similar Meetings

6

Section 14: Quorum; Majority Vote

6

Section 15: Compensation

6

Section 16: Procedure

6

Section 17: Action Without Meeting

6

 

 

ARTICLE 4

 

BOARD COMMITTEES

6

Section 1: Designation

6

Section 2: Meetings

6

Section 3: Quorum; Majority Vote

6

Section 4: Procedure

7

Section 5: Action Without Meeting

7

Section 6: Telephone and Similar Meetings

7

 

i



 

 

 

ARTICLE 5

 

OFFICERS

7

Section 1: Offices

7

Section 2: Term

7

Section 3: Vacancies

7

Section 4: Compensation

7

Section 5: Removal

7

Section 6: Chairman of the Board

7

Section 7: Chief Executive Officer

8

Section 8: President

8

Section 9: Vice Presidents

8

Section 10: Secretary

8

Section 11: Assistant Secretary

8

Section 12: Treasurer

8

 

 

ARTICLE 6

 

INDEMNIFICATION

9

Section 1: Indemnification of Directors

9

Section 2: Advancement of Expenses

9

Section 3: Indemnification of Officers, Employees and Agents

10

Section 4: Insurance

10

Section 5: Nonexclusivity of Rights; Agreements

10

Section 6: Continuing Benefits; Successors

10

Section 7: Interpretation; Construction

10

Section 8: Amendment

10

Section 9: Severability

10

 

 

ARTICLE 7

 

CERTIFICATES AND SHAREHOLDERS

10

Section 1: Certificates

10

Section 2: Issuance of Shares

11

Section 3: Rights of Corporation with Respect to Registered Owners

11

Section 4: Transfers of Shares

11

Section 5: Registration of Transfer

11

Section 6: Lost, Stolen or Destroyed Certificates

11

Section 7: Restrictions on Shares

11

Section 8: Voting of Stock Held

12

 

 

ARTICLE 8

 

GENERAL PROVISIONS

12

Section 1: Distributions

12

Section 2: Books and Records

12

Section 3: Execution of Documents

12

Section 4: Fiscal Year

12

Section 5: Seal

12

Section 6: Resignation

12

Section 7: Computation of Days

12

Section 8: Amendment of Bylaws

12

Section 9: Construction

13

Section 10: Headings

13

 

ii



 

BYLAWS

OF

HCSB FINANCIAL CORPORATION

 

ARTICLE 1: OFFICES

 

Section 1:  Registered Office and Agent.  The registered office of the Corporation shall be at 5009 Broad Street, Loris, South Carolina 29569.  The registered agent shall be James R. Clarkson.

 

Section 2:  Other Offices.  The Corporation may also have offices at such other places within and without the State of South Carolina as the Board of Directors may from time to time determine or the business of the Corporation may require.

 

ARTICLE 2: SHAREHOLDERS

 

Section 1:  Place of Meetings.  Meetings of shareholders shall be held at the time and place, within or without the State of South Carolina, stated in the notice of the meeting or in a waiver of notice.

 

Section 2:  Annual Meetings.  An annual meeting of the shareholders shall be held each year on the third Thursday of April, if not a legal holiday, but if a legal holiday, then on the next Thursday not a legal holiday, or on such other date and at a time to be set by the Board of Directors in accordance with all applicable notice requirements.  At the meeting, the shareholders shall elect directors and transact such other business as may properly be brought before the meeting.

 

Section 3:  Special Meetings.

 

(a)           Special meetings of the shareholders, for any purpose or purposes, unless otherwise required by the South Carolina Business Corporation Act of 1988, as amended from time to time (the “Act”), the Articles of Incorporation of the Corporation (the “Articles”), or these Bylaws, may be called by the chief executive officer, the president, the chairman of the Board of Directors or a majority of the Board of Directors.

 

(b)           In addition to a special meeting called in accordance with subsection 3(a) of this Article 2, the Corporation shall, if and to the extent that it is required by applicable law, hold a special meeting of shareholders if the holders of at least ten percent of all the votes entitled to be cast on any issue proposed to be considered at such special meeting sign, date and deliver to the secretary of the Corporation one or more written demands for the meeting.  Such written demands shall be delivered to the secretary by certified mail, return receipt requested.  Such written demands sent to the secretary of the Corporation shall set forth as to each matter the shareholder or shareholders propose to be presented at the special meeting (i) a description of the purpose or purposes for which the meeting is to be held (including the specific proposal(s) to be presented); (ii) the name and record address of the shareholder or shareholders proposing such business; (iii) the class and number of shares of the Corporation that are owned of record by the shareholder or shareholders as of a date within ten days of the delivery of the demand; (iv) the class and number of shares of the Corporation that are held beneficially, but not held of record, by the shareholder or shareholders as of a date within ten days of the delivery of the demand; and (v) any interest of the shareholder or shareholders in such business.  Any such special shareholders’ meeting shall be held at a location designated by the Board of Directors.  The Board of Directors may set such rules for any such meeting as it may deem appropriate, including when the meeting will be held (subject to any requirements of the Act), the agenda for the meeting (which may include any proposals made by the Board of Directors), who may attend the meeting in addition to shareholders of record and other such matters.

 

(c)           Business transacted at any special meeting shall be confined to the specific purpose or purposes stated in the notice of the meeting.

 

1



 

Section 4:  Notice.

 

(a)           Written or printed notice stating the place, day and hour of the meeting and, in the case of a special meeting, the specific purpose or purposes for which the meeting is called, shall be delivered by the Corporation not less than ten nor more than sixty days before the date of the meeting, either personally or by mail, to each shareholder of record entitled to vote at such meeting.  If mailed, such notice shall be deemed effective when deposited with postage prepaid in the United States mail, addressed to the shareholder at the address appearing on the stock transfer books of the Corporation.  Except as may be expressly provided by law, no failure or irregularity of notice of any regular meeting shall invalidate the same or any proceeding thereat.

 

(b)           The notice of each special shareholders meeting shall include a description of the specific purpose or purposes for which the meeting is called.  Except as provided by law, the Articles or these Bylaws, the notice of an annual shareholders meeting need not include a description of the purpose or purposes for which the meeting is called.

 

Section 5:  Quorum.  The holders of a majority of the shares issued and outstanding and entitled to vote thereat, present in person or represented by proxy, shall be requisite and shall constitute a quorum at meetings of the shareholders for the transaction of business except as otherwise provided by statute, by the Articles or by these Bylaws.  If a quorum is not present or represented at a meeting of the shareholders, the shareholders entitled to vote, present in person or represented by proxy, shall have the power to adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum is present or represented.  At an adjourned meeting at which a quorum is present or represented, any business may be transacted which might have been transacted at the meeting as originally notified.  Once a share is represented for any purpose at a meeting it is deemed present for quorum purposes.

 

Section 6:  Majority Vote; Withdrawal of Quorum.  Except in regards to the election of directors, when a quorum is present at a meeting, the vote of the holders of a majority of the shares having voting power, present in person or represented by proxy, shall decide any question brought before the meeting, unless the question is one on which, by express provision of the statutes, the Articles or these Bylaws, a higher vote is required in which case the express provision shall govern.  Directors shall be elected by a plurality vote of the shareholders.  The shareholders present at a duly constituted meeting may continue to transact business until adjournment, despite the withdrawal of enough shareholders to leave less than a quorum.

 

Section 7:  Method of Voting.  Each outstanding share of common stock shall be entitled to one vote on each matter submitted to a vote at a meeting of shareholders.  Each outstanding share of other classes of stock, if any, shall have such voting rights as may be prescribed by the Board of Directors.  Proxies delivered by facsimile to the Corporation, if otherwise in order, shall be valid.  Votes shall be taken by voice, by hand or in writing, as directed by the chairman of the meeting.  Voting for directors shall be in accordance with Article 3, Section 3 of these Bylaws.

 

Section 8:  Record Date.  For the purpose of determining shareholders entitled to notice of or to vote at any meeting of shareholders, including any special meeting, or shareholders entitled to receive payment of dividends, or in order to make a determination of shareholders for any other purpose, the Board of Directors may fix in advance a date as the record date for any such determination of shareholders, such date in any case to be not less than ten nor more than seventy days prior to the date on which the particular action, requiring such determination of shareholders, is to be taken.  Except as otherwise provided by law, if no record date is fixed for the determination of shareholders entitled to notice of or to vote at a meeting of shareholders, or of shareholders entitled to receive payment of dividends, the date on which notice of the meeting is mailed, or the date on which the resolution of the Board of Directors declaring such dividend is adopted, as the case may be, shall be the record date.

 

Section 9:  Shareholder Proposals.

 

(a)           To the extent required by applicable law, a shareholder may bring a proposal before an annual meeting of shareholders as set forth in this Section 9.  To be properly brought before an annual meeting of shareholders, business must be (i) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the Board of Directors; (ii) otherwise properly brought before the meeting by or at the direction of the Board of Directors; or (iii) otherwise properly brought before the meeting by a shareholder.  In addition to any other applicable requirements, for business to be properly brought before an annual meeting by a shareholder, the shareholder must have given timely notice thereof in writing to the secretary of the Corporation.  To be timely, a shareholder’s notice must be

 

2



 

given, either by personal delivery or by United States mail, postage prepaid, return receipt requested, to the secretary of the Corporation not less than 30 nor more than 60 days in advance of the annual meeting (provided, however, that if less than 31 days’ notice of the meeting is given to shareholders, such written notice shall be delivered or mailed, as prescribed, to the Secretary of Corporation not later than the close of the tenth day following the day on which notice of the meeting was mailed to shareholders). A shareholder’s notice to the secretary of the Corporation shall set forth for each matter the shareholder proposes to bring before the annual meeting (i) a description of the business desired to be brought before the annual meeting (including the specific proposal(s) to be presented) and the reasons for conducting such business at the annual meeting; (ii) the name and record address of the shareholder proposing such business; (iii) the class and number of shares of the Corporation that are owned of record, and the class and number of shares of the Corporation that are held beneficially, but not held of record, by the shareholder as of the record date for the meeting, if such date has been made publicly available, or as of a date within ten days of the effective date of the notice by the shareholder if the record date has not been made publicly available; and (iv) any interest of the shareholder in such business.  In the event that a shareholder attempts to bring business before an annual meeting without complying with the provisions of this Section 9, the chairman of the meeting shall declare to the meeting that the business was not properly brought before the meeting in accordance with the foregoing procedures, and such business shall not be transacted.  The chairman of any annual meeting, for good cause shown and with proper regard for the orderly conduct of business at the meeting, may waive in whole or in part the operation of this Section 9.

 

(b)           If any shareholder of the Corporation notifies the Corporation that such shareholder intends to present a proposal for action at a forthcoming meeting of the Corporation’s shareholders and requests that the Corporation include the proposal in its proxy statement and such shareholder complies with all the requirements of Rule 14a-8 promulgated under the Securities Exchange Act of 1934, the Corporation shall consider inclusion of such proposal in the proxy statement unless it determines that the proposal is inappropriate for consideration by the shareholders at the meeting.

 

ARTICLE 3:  DIRECTORS

 

Section 1:  Management.  The business and affairs of the Corporation shall be managed by the Board of Directors who may exercise all such powers of the Corporation and do all such lawful acts and things as are not by law, the Articles or these Bylaws directed or required to be done or exercised by the shareholders.

 

Section 2:  Number, Classification and Terms of Office of Directors.  Unless otherwise provided in the Articles of Incorporation, the number of directors of the Corporation shall be that number as may be fixed from time to time by resolution of the Board of Directors, but in no event shall the number be less than seven or greater than 25.  The initial number of directors shall be fourteen.  The number of members of the Board of Directors can be increased or decreased within the foregoing range at any time by the Board of Directors.  In addition, unless provided otherwise by resolution of the Board of Directors, if, in any case after proxy materials for an annual meeting of shareholders have been mailed to shareholders, any person named therein to be nominated at the direction of the Board of Directors becomes unable or unwilling to serve, the number of authorized directors shall be automatically reduced by a number equal to the number of such persons.  At any time that the Board has six or more members, unless provided otherwise by the Articles of Incorporation, the terms of office of directors will be staggered by dividing the total number of directors into three classes, with each class accounting for one-third, as near as may be, of the total.  The terms of directors in the first class expire at the first annual shareholders’ meeting after their election, the terms of the second class expire at the second annual shareholders’ meeting after their election, and the terms of the third class expire at the third annual shareholders’ meeting after their election.  At each annual shareholders’ meeting held thereafter, directors shall be chosen for a term of three years to succeed those whose terms expire.  If the number of directors is changed, any increase or decrease shall be so apportioned among the classes as to make all classes as nearly equal in number as possible, and when the number of directors is increased and any newly created directorships are filled by the board, the terms of the additional directors shall expire at the next election of directors by the shareholders.  Each director, except in the case of his earlier death, written resignation, retirement, disqualification or removal, shall serve for the duration of his term, as staggered, and thereafter until his successor shall have been elected and qualified.

 

Section 3:  Qualifications of Directors.  The members of the Board of Directors must be shareholders, but they need not be residents of any particular state.  No individual who is or becomes a Business Competitor (as defined below) or who is or becomes affiliated with, employed by or a representative of any individual, corporation, association, partnership, firm, business enterprise or other entity or organization which the

 

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Board of Directors, after having such matter formally brought to its attention, determines to be in competition with the Corporation or any of its subsidiaries (any such individual, corporation, association, partnership, firm, business enterprise or other entity or organization being hereinafter referred to as a “Business Competitor”) shall be eligible to serve as a director if the Board of Directors determines that it would not be in the Corporation’s best interests for such individual to serve as a director of the Corporation. Such affiliation, employment or representation may include, without limitation, service or status as an owner, partner, shareholder, trustee, director, officer, consultant, employee, agent, or counsel, or the existence of any relationship which results in the affected person having an express or implied obligation to act on behalf of a Business Competitor; provided, however, that passive ownership of a debt or equity interest not exceeding 1% of the outstanding debt or equity, as the case may be, in any Business Competitor shall not constitute such affiliation, employment or representation. Any financial institution having branches or affiliates in Horry County, South Carolina, or in Columbus County, North Carolina, shall be presumed to be a Business Competitor unless the Board of Directors determines otherwise. Provided, however that, any director appointed by the Series T preferred shareholders will not be subject to the requirements of this section 3.3.

 

Section 4:  Election of Directors.  Directors shall be elected by a plurality vote.  Directors elected by a majority of the Series T preferred shareholders (if any) shall serve for a term until all accrued and unpaid dividends on all outstanding shares of preferred stock have been declared and paid in full at which time such directors shall cease to be qualified as directors and the term of office of such directors shall terminate immediately.  Except as stated above, each director shall hold office until the expiration of the term for which he or she is elected, except as stated above, and thereafter until his or her successor has been elected and qualified.

 

Section 5:  Nomination of Directors.

 

(a)           Nomination of persons to serve as directors of the Corporation, other than those made by or on behalf of the Board of Directors of the Corporation, shall be made in writing and shall be delivered either by personal delivery or by United States mail, postage prepaid, return receipt requested, to the secretary of the Corporation no later than (i) with respect to an election to be held at an annual meeting of shareholders, ninety days in advance of such meeting; and (ii) with respect to an election to be held at a special meeting of shareholders for the election of directors, the close of business on the seventh day following the date on which notice of such meeting is first given to shareholders.  Each notice shall set forth:  (i) the name and address of the shareholder who intends to make the nomination and of the person or persons to be nominated; (ii) a representation that the shareholder is a holder of record of stock of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to nominate the person or persons specified in the notice; (iii) a description of all arrangements or understandings between the shareholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by the shareholder; (iv) such other information regarding each nominee proposed by such shareholder as would be required to be included in a proxy statement filed pursuant to the proxy rules of the Securities and Exchange Commission, had the nominee been nominated, or intended to be nominated, by the Board of Directors; and (v) the consent of each nominee to serve as a director of the Corporation if so elected.  The chairman of the meeting may refuse to acknowledge the nomination of any person not made in compliance with the foregoing procedure.  The chairman of any such meeting, for good cause shown and with proper regard for the orderly conduct of business at the meeting, may waive in whole or in part the operation of this Section 4.

 

(b)           Notwithstanding subsection (a) of this Section 4, if the Corporation or any banking subsidiary of the Corporation is subject to the requirements of Section 914 of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, then no person may be nominated by a shareholder for election as a director at any meeting of shareholders unless the shareholder furnishes the written notice required by subsection (a) of this Section 4 to the secretary of the Corporation at least ninety days prior to the date of the meeting and the nominee has received regulatory approval to serve as a director prior to the date of the meeting.

 

Section 6:  Retirement of Directors.  No person shall be elected or reelected a director of the Corporation after attaining the age of 75.  Provided however that, any director appointed by the Series T preferred shareholders will not be subject to the requirements of this section 3.6.

 

Section 7:  Emeritus Directors.  The Board of Directors may, from time to time, appoint individuals (including individuals who have retired from the Board of Directors) to serve as members of the Emeritus Board of Directors of the Corporation.  Each member of the Emeritus Board of Directors of the Corporation, except in the case of

 

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his earlier death, resignation, retirement, disqualification or removal, shall serve until the next succeeding annual meeting of the Board of Directors of the Corporation.  Members of the Emeritus Board of Directors may be removed without cause by a vote of the members of the Board of Directors.  Any individual appointed as a member of the Emeritus Board of Directors of the Corporation may, but shall not be required to, attend meetings of the Board of Directors of the Corporation and may participate in any discussions at such meetings, but such individual may not vote or be counted in determining a quorum at any meeting of the Board of Directors of the Corporation.  It shall be the duty of the members of the Emeritus Board of Directors of the Corporation to serve as goodwill ambassadors of the Corporation, but such individuals shall not have any responsibility or be subject to any liability imposed upon a member of the Board of Directors of the Corporation or in any manner otherwise be deemed to be a member of the Board of Directors of the Corporation.  Each member of the Emeritus Board of Directors of the Corporation shall be paid such compensation as may be set from time to time by the Chairman of the Board of Directors of the Corporation and shall remain eligible to participate in any stock option plan in which directors are eligible to participate which is maintained by, or participated in, from time to time by the Corporation, according to the terms and conditions thereof.

 

Section 8:  Vacancies.  Except as otherwise provided by law, in the Articles of Incorporation, or in these Bylaws (a) the office of a director shall become vacant if he dies, resigns, or is removed from office, and (b) the Board of Directors may declare vacant the office of a director if (i) he is interdicted or adjudicated an incompetent, (ii) an action is filed by or against him, or any entity of which he is employed as his principal business activity, under the bankruptcy laws of the United States, (iii) in the sole opinion of the Board of Directors he becomes incapacitated by illness or other infirmity so that he is unable to perform his duties for a period of six months or longer, or (iv) he ceases at any time to have the qualifications required by law, the Articles of Incorporation or these Bylaws.  The remaining directors may, by a majority vote, fill any vacancy on the Board of Directors (including any vacancy resulting from an increase in the authorized number of directors, or from the failure of the shareholders to elect the full number of authorized directors) for an unexpired term; provided that the shareholders shall have the right at any special meeting called for such purpose prior to action by the Board of Directors to fill the vacancy.  Any vacancy occurring in the Board of Directors with respect to directors serving at the election of the Series T preferred shareholders (if any) (i) by reason of removal with or without cause, shall be filled by the affirmative vote of the majority of such preferred shareholders, to the extent the voting rights of such preferred shareholders are then exercisable, and (ii) by any reason other than removal with or without cause, shall be filled by the appointment of the remaining director serving at the election of the Series T preferred shareholders.

 

Section 9:  Removal of Directors.  Unless provided otherwise by the Articles of Incorporation, directors may be removed with or without cause by the affirmative vote of the holders of at least a majority of the shares entitled to vote at an election of directors, such vote being taken at a meeting of the shareholders called for that purpose at which a quorum is present.

 

Section 10:  Place of Meetings.  Meetings of the Board of Directors, regular or special, may be held either within or without the State of South Carolina.

 

Section 11:  Regular Meetings.  Regular meetings of the Board of Directors may be held without notice at such time and place as shall from time to time be determined by the Board of Directors.

 

Section 12:  Special Meetings.  Special meetings of the Board of Directors may be called by the chairman, the chief executive officer, or the president of the Corporation, on not less than twenty-four hours’ notice.  Notice of a special meeting may be given by personal notice, telephone, facsimile, electronic communication, overnight courier or United States mail to each director.  Any such special meeting shall be held at such time and place as shall be stated in the notice of the meeting.  The notice need not describe the purpose or purposes of the special meeting.

 

Section 13:  Telephone and Similar Meetings.  Directors may participate in and hold a meeting by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other.  Participation in such a meeting shall constitute presence in person at the meeting, except where a person participates in the meeting for the express purpose of objecting to the holding of the meeting or the transacting of any business at the meeting on the ground that the meeting is not lawfully called or convened, and does not thereafter vote for or assent to action taken at the meeting.

 

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Section 14:  Quorum; Majority Vote.  At meetings of the Board of Directors a majority of the number of directors then in office shall constitute a quorum for the transaction of business.  The act of a majority of the directors present at a meeting at which a quorum is present shall be the act of the Board of Directors, except as otherwise specifically provided by law, the Articles or these Bylaws.  If a quorum is not present at a meeting of the Board of Directors, the directors present may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum is present.

 

Section 15:  Compensation.  Each director shall be entitled to receive such reasonable compensation as may be determined by resolution of the Board of Directors.  By resolution of the Board of Directors, the directors may be paid their expenses, if any, of attendance at each meeting of the Board of Directors and may be paid a fixed sum for attendance at each meeting of the Board of Directors.  No such payment shall preclude any director from serving the Corporation in any other capacity and receiving compensation therefor.  Members of committees may, by resolution of the Board of Directors, be allowed compensation for attending committee meetings.

 

Section 16:  Procedure.  The Board of Directors shall keep regular minutes of its proceedings.  The minutes shall be placed in the minute book of the Corporation.

 

Section 17:  Action Without Meeting.  Any action required or permitted to be taken at a meeting of the Board of Directors may be taken without a meeting if the action is assented to by all the members of the Board.  Such consent shall have the same force and effect as a meeting vote and may be described as such in any document.

 

ARTICLE 4:  BOARD COMMITTEES

 

Section 1:  Designation.  The Board of Directors may, by resolution adopted by a majority of the full Board, designate one or more committees.  Each committee must have two or more members who serve at the pleasure of the Board of Directors.  To the extent specified by the Board of Directors, in the Articles or in these Bylaws, each committee may exercise the authority of the Board of Directors.  So long as prohibited by law, however, a committee of the Board may not (a) authorize distributions; (b) approve or propose to shareholders action required by the Act to be approved by shareholders; (c) fill vacancies on the Board of Directors or on any of its committees; (d) amend the Articles; (e) adopt, amend or repeal these Bylaws; (f) approve a plan of merger not requiring shareholder approval; (g) authorize or approve reacquisition of shares, except according to a formula or method prescribed by the Board of Directors; or (h) authorize or approve the issuance or sale or contract for sale of shares, or determine the designation and relative rights, preferences and limitations of a class or series of shares, except that the Board of Directors may authorize a committee (or a senior executive officer of the Corporation) to do so within limits specifically prescribed by the Board of Directors.  Any director may serve one or more committee.  Any committee appointed under this Section 1 shall perform such duties and assume such responsibility as may from time to time be placed upon it by the Board of Directors.

 

Section 2:  Meetings.  Time, place and notice of all committee meetings shall be as called and specified by the chief executive officer, the committee chairman or any two members of each committee.

 

Section 3:  Quorum; Majority Vote.  At meetings of committees, a majority of the number of members designated by the Board of Directors shall constitute a quorum for the transaction of business.  The act of a majority of the members present at any meeting at which a quorum is present shall be the act of such committee, except as otherwise specifically provided by the Act, the Articles or these Bylaws.  If a quorum is not present at a meeting of the committee, the members present may adjourn the meeting from time to time, without notice other than an announcement at the meeting, until a quorum is present.

 

Section 4:  Procedure.  Committees shall keep regular minutes of their proceedings and report the same to the Board of Directors at its next regular meeting.  The minutes of the proceedings of the committee shall be placed in the minute book of the Corporation.

 

Section 5:  Action Without Meeting.  Any action required or permitted to be taken at a meeting of any committee may be taken without a meeting if the action is assented to by all the members of the committee.  Such consent shall have the same force and effect as a meeting vote and may be described as such in any document.

 

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Section 6:  Telephone and Similar Meetings.  Committee members may participate in and hold a meeting by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other.  Participation in such a meeting shall constitute presence in person at the meeting, except where a person participates in the meeting for the express purpose of objecting to the holding of the meeting or the transacting of any business at the meeting on the ground that the meeting is not lawfully called or convened, and does not thereafter vote for or assent to action taken at the meeting.

 

ARTICLE 5:  OFFICERS

Officers

 

Section 1:  Offices.  The officers of the Corporation shall consist of a chief executive officer, president and secretary, each of whom shall be elected by the Board of Directors.  The Board of Directors may also create and establish the duties of other offices as it deems appropriate.  The Board of Directors shall also elect a chairman of the Board and may elect a vice chairman of the Board from among its members.  The Board of Directors from time to time may appoint, or may authorize the president to appoint or authorize specific officers to appoint, the persons who shall hold such other offices as may be established by the Board of Directors, including one or more vice presidents (including executive vice presidents, senior vice presidents, assistant vice presidents), one or more assistant secretaries, and one or more assistant treasurers.  Any two or more offices may be held by the same person.

 

Section 2:  Term.  Each officer shall serve at the pleasure of the Board of Directors (or, if appointed pursuant to this Article, at the pleasure of the Board of Directors, the president, or the officer authorized to have appointed the officer) until his or her death, resignation, or removal, or until his or her replacement is elected or appointed in accordance with this Article.

 

Section 3:  Vacancies.  Any vacancy occurring in any office of the Corporation may be filled by the Board of Directors.  Any vacancy in an office which was filled by the president or another officer may also be filled by the president or by any officer authorized to have filled the office vacant.

 

Section 4:  Compensation.  The compensation of all officers of the Corporation shall be fixed by the Board of Directors or by a committee or officer appointed by the Board of Directors.  Officers may serve without compensation.

 

Section 5:  Removal.  All officers (regardless of how elected or appointed) may be removed, with or without cause, by the Board of Directors.  Any officer appointed by the president or another officer may also be removed, with or without cause, by the president or by any officer authorized to have appointed the officer to be removed.  Removal will be without prejudice to the contract rights, if any, of the person removed, but shall be effective notwithstanding any damage claim that may result from infringement of such contract rights.

 

Section 6:  Chairman of the Board.  The office of the chairman of the board may be filled by the Board at its pleasure by the election of one of its members to the office.  The chairman shall preside at all meetings of the Board and meetings of the shareholders and shall perform such other duties as may be assigned to him by the Board of Directors.  No director may serve as Chairman of Board for more than three consecutive years.

 

Section 7:  Chief Executive Officer. The chief executive officer shall be responsible for the general and active management of the business and affairs of the Corporation, and shall see that all orders and resolutions of the Board are carried into effect.  He shall perform such other duties and have such other authority and powers as the Board of Directors may from time to time prescribe.

 

Section 8:  President.  The president shall be responsible for the general and active management of the business and affairs of the Corporation, and shall see that all orders and resolutions of the Board are carried into effect.  He shall perform such other duties and have such other authority and powers as the Board of Directors may from time to time prescribe.  The president shall preside as chairman of the Board of Directors during the absence of the Board chairman.

 

Section 9:  Vice Presidents.  The vice presidents (executive, senior, or assistant), as such offices are appointed by the Board of Directors upon the recommendation of the President, in the order of their seniority, unless

 

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otherwise determined by the Board of Directors, shall, in the absence or disability of the president, perform the duties and have the authority and exercise the powers of the president.  They shall perform such other duties and have such other authority and powers as the Board of Directors may from time to time prescribe or as the president may from time to time delegate.

 

Section 10:  Secretary.

 

(a)           The secretary shall attend all meetings of the Board of Directors and all meetings of the shareholders and record all votes, actions and the minutes of all proceedings in a book to be kept for that purpose and shall perform like duties for the executive and other committees when required.

 

(b)           The secretary shall give, or cause to be given, notice of all meetings of the shareholders and special meetings of the Board of Directors.

 

(c)           The secretary shall keep in safe custody the seal of the Corporation and, when authorized by the Board of Directors or the executive committee, affix it to any instrument requiring it.  When so affixed, it shall be attested by the secretary’s signature or by the signature of the treasurer or an assistant secretary.

 

(d)           The secretary shall be under the supervision of the president and shall perform such other duties and have such other authority and powers as the Board of Directors may from time to time prescribe or as the president may from time to time delegate.

 

Section 11:  Assistant Secretary.  The assistant secretaries, as such offices are created by the Board of Directors, in the order of their seniority, unless otherwise determined by the Board of Directors, shall, in the absence or disability of the secretary, perform the duties and have the authority and exercise the powers of the secretary.  They shall perform such other duties and have such other powers as the Board of Directors may from time to time prescribe or as the president may from time to time delegate.

 

Section 12:  Treasurer.

 

(a)           The treasurer shall have the custody of the corporate funds and securities and shall keep full and accurate accounts of receipts and disbursements of the Corporation and shall deposit all moneys and other valuables in the name and to the credit of the Corporation in appropriate depositories.

 

(b)           The treasurer shall disburse the funds of the Corporation ordered by the Board of Directors and prepare financial statements as they direct.

 

(c)           The treasurer shall perform such other duties and have such other authority and powers as the Board of Directors may from time to time prescribe or as the president may from time to time delegate.

 

(d)           The treasurer’s books and accounts shall be opened at any time during business hours to the inspection of any directors of the Corporation.

 

ARTICLE 6: INDEMNIFICATION

 

Section 1:  Indemnification of Directors.

 

(a)           The Corporation shall indemnify and hold harmless, to the fullest extent permitted by applicable law, any person (an “Indemnified Person”) who was or is a party or is threatened to be made a party to or is otherwise involved in any threatened, pending or completed action, suit or other proceeding, whether civil, criminal, administrative or investigative and whether formal or informal, by reason of the fact that he, or a person for whom he is a legal representative (or other similar representative), is or was a director of the Corporation or is or was serving at the Corporation’s request as a director, officer, partner, trustee, employee or agent of another corporation, partnership, joint venture, trust, employee benefit plan or other enterprise, against expenses (including attorneys’ fees), judgments, fines, amounts paid in settlement or other similar costs actually and reasonably incurred in connection with such action, suit or

 

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proceeding.  For purposes of this Article 6, all terms used herein that are defined in Section 33-8-500 of the Act or any successor provision or provisions shall have the meanings so prescribed in such Section.

 

(b)           Without limiting the provisions of Section 1(a) of this Article 6, the Corporation shall indemnify a director who was wholly successful, on the merits or otherwise, in the defense of any proceeding to which he was a party because he is or was a director of the Corporation against reasonable expenses incurred by him in connection with the proceeding.  In addition, the Corporation shall indemnify an individual made a party to a proceeding because he is or was a director against liability incurred in the proceeding if:  (i) he conducted himself in good faith; (ii) he reasonably believed:  (A) in the case of conduct in his official capacity with the Corporation, that his conduct was in its best interest; and (B) in all other cases, that his conduct was at least not opposed to its best interest; and (iii) in the case of any criminal proceeding, he had no reasonable cause to believe his conduct was unlawful.  The termination of a proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent is not, of itself, determinative that the director did not meet the standard of conduct described in this subsection (b).  The determination of whether the director met the standard of conduct described in this subsection (b) shall be made in accordance with Section 33-8-550 of the Act or any successor provision or provisions.

 

Section 2:  Advancement of Expenses.

 

(a)           With respect to any proceeding to which an Indemnified Person is a party because he is or was a director of the Corporation, the Corporation shall, to the fullest extent permitted by applicable law, pay for or reimburse the Indemnified Person’s reasonable expenses (including, but not limited to, attorneys’ fees and disbursements, court costs, and expert witness fees) incurred by the Indemnified Person in advance of final disposition of the proceeding.

 

(b)           Without limiting the provisions of Section 2(a) of this Article 6, the Corporation shall, to the fullest extent permitted by applicable law, pay for or reimburse the reasonable expenses (including, but not limited to, attorneys’ fees and disbursements, court costs and expert witness fees) incurred by a director who is a party to a proceeding in advance of final disposition of the proceeding if:  (a) the director furnishes the Corporation a written affirmation of his good faith belief that he has met the standard of conduct described in Section 1(b) of this Article 6; (b) the director furnishes the Corporation a written undertaking, executed personally or on his behalf, to repay the advance if it is ultimately determined that he did not meet such standard of conduct; and (c) a determination is made that the facts then known to those making the determination would not preclude indemnification under this Article 6.  The Corporation shall expeditiously pay the amount of such expenses to the director following the director’s delivery to the Corporation of a written request for an advance pursuant to this Section 2 together with a reasonable accounting of such expenses.  The undertaking required by this Section 2 shall be an unlimited general obligation of the director but need not be secured and may be accepted without reference to financial ability to make repayment.  Determinations and authorizations of payments under this Section 2 shall be made in the manner specified in Section 33-8-550 of the Act or any successor provision or provisions.

 

Section 3:  Indemnification of Officers, Employees and Agents.  An officer of the Corporation who is not a director is entitled to the same indemnification rights which are provided to directors of the Corporation in Section 1 of this Article 6 and the Corporation shall advance expenses to officers of the Corporation who are not directors to the same extent and in the same manner as to directors as provided in Section 2 of this Article 6.  In addition, the Board of Directors shall have the power to cause the Corporation to indemnify, hold harmless and advance expenses to any officer, employee or agent of the Corporation who is not a director to the fullest extent permitted by public policy, by adopting a resolution to that effect identifying such officers, employees or agents (by position and name) and specifying the particular rights provided, which may be different for each of the persons identified.  Any officer entitled to indemnification pursuant to the first sentence of this Section 3 and any officer, employee or agent granted indemnification by the Board of Directors in accordance with the second sentence of this Section 3 shall, to the extent specified herein or by the Board of Directors, be an “Indemnified Party” for the purposes of the provisions of this Article 6.

 

Section 4:  Insurance.  The Corporation may purchase and maintain insurance on behalf of an individual who is or was a director, officer, employee or agent of the Corporation, or who, while a director, officer, employee or agent of the Corporation, is or was serving at the request of the Corporation as a director, officer, partner, trustee, employee or agent of another foreign or domestic corporation, partnership, joint venture, trust, employee benefit

 

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plan or other enterprise, against liability asserted against or incurred by him in that capacity or arising from his status as a director, officer, employee or agent, whether or not the Corporation would have the power to indemnify him against the same liability under this Article 6.

 

Section 5:  Nonexclusivity of Rights; Agreements.  The rights conferred on any person by this Article 6 shall neither limit nor be exclusive of any other rights which such person may have or hereafter acquire under any statute, agreement, provision of the Articles, these Bylaws, vote of shareholders or otherwise.  The provisions of this Article 6 shall be deemed to constitute an agreement between the Corporation and each person entitled to indemnification hereunder.  In addition to the rights provided in this Article 6, the Corporation shall have the power, upon authorization by the Board of Directors, to enter into an agreement or agreements providing to any person who is or was a director, officer, employee or agent of the Corporation certain indemnification rights.  Any such agreement between the Corporation and any director, officer, employee or agent of the Corporation concerning indemnification shall be given full force and effect, to the fullest extent permitted by applicable law, even if it provides rights to such director, officer, employee or agent more favorable than, or in addition to, those rights provided under this Article 6.

 

Section 6:  Continuing Benefits; Successors.  The indemnification and advancement of expenses provided by or granted pursuant to this Article 6 shall, unless otherwise provided when authorized or ratified, continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such person.  For purposes of this Article 6, the term “Corporation” shall include any corporation, joint venture, trust, partnership or unincorporated business association that is the successor to all or substantially all of the business or assets of this Corporation, as a result of merger, consolidation, sale, liquidation or otherwise, and any such successor shall be liable to the persons indemnified under this Article 6 on the same terms and conditions and to the same extent as this Corporation.

 

Section 7:  Interpretation; Construction.  This Article 6 is intended to provide indemnification to the directors and permit indemnification to the officers of the Corporation to the fullest extent permitted by applicable law as it may presently exist or may hereafter be amended and shall be construed in order to accomplish this result.  To the extent that a provision herein prevents a director or officer from receiving indemnification to the fullest extent intended, such provision shall be of no effect in such situation.  If at any time the Act is amended so as to permit broader indemnification rights to the directors and officers of this Corporation, then these Bylaws shall be deemed to automatically incorporate these broader provisions so that the directors and officers of the Corporation shall continue to receive the intended indemnification to the fullest extent permitted by applicable law.

 

Section 8:  Amendment.  Any amendment to this Article 6 that limits or otherwise adversely affects the right of indemnification, advancement of expenses or other rights of any Indemnified Person hereunder shall, as to such Indemnified Person, apply only to claims, actions, suits or proceedings based on actions, events or omissions (collectively, “Post Amendment Events”) occurring after such amendment and after delivery of notice of such amendment to the Indemnified Person so affected.  Any Indemnified Person shall, as to any claim, action, suit or proceeding based on actions, events or omissions occurring prior to the date of receipt of such notice, be entitled to the right of indemnification, advancement of expenses and other rights under this Article 6 to the same extent as if such provisions had continued as part of the Bylaws of the Corporation without such amendment.  This Section 8 cannot be altered, amended or repealed in a manner effective as to any Indemnified Person (except as to Post Amendment Events) without the prior written consent of such Indemnified Person.

 

Section 9:  Severability.  Each of the Sections of this Article 6, and each of the clauses set forth herein, shall be deemed separate and independent, and should any part of any such Section or clause be declared invalid or unenforceable by any court of competent jurisdiction, such invalidity or unenforceability shall in no way render invalid or unenforceable any other part thereof or any separate Section or clause of this Article 6 that is not declared invalid or unenforceable.

 

ARTICLE 7:  CERTIFICATES AND SHAREHOLDERS

 

Section 1:  Certificates.  Certificates in the form determined by the Board of Directors shall be delivered representing all shares of which shareholders are entitled.  Certificates shall be consecutively numbered and shall be entered in the books of the Corporation as they are issued.  At a minimum, each share certificate must state on its face:  (a) the name of the Corporation and that it is organized under the laws of South Carolina; (b) the name of the

 

10



 

person to whom the certificate is issued; and (c) the number and class of shares and the designation of the series, if any, the certificate represents.  Each share certificate (a) must be signed (either manually or in facsimile) by at least two officers, including the president, the secretary, or such other officer or officers as the Board of Directors shall designate; and (b) may bear the corporate seal or its facsimile.  If the person who signed (either manually or in facsimile) a share certificate no longer holds office when the certificate is issued, the certificate is nevertheless valid.

 

Section 2:  Issuance of Shares.  The Board of Directors may authorize shares to be issued for consideration consisting of any tangible or intangible property or benefit to the Corporation, including cash, promissory notes, services performed, written contracts for services to be performed or other securities of the Corporation.  Before the Corporation issues shares, the Board of Directors must determine that the consideration received or to be received for shares to be issued is adequate.  That determination by the Board of Directors is conclusive insofar as the adequacy of consideration for the issuance of shares relates to whether the shares are validly issued, fully paid and nonassessable.  When the Corporation receives the consideration for which the Board of Directors authorized the issuance of shares, the shares issued therefor are fully paid and nonassessable.

 

Section 3:  Rights of Corporation with Respect to Registered Owners.  Prior to due presentation for transfer of registration of its shares, the Corporation may treat the registered owner of the shares as the person exclusively entitled to vote the shares, to receive any dividend or other distribution with respect to the shares, and for all other purposes; and the Corporation shall not be bound to recognize any equitable or other claim to or interest in the shares on the part of any other person, whether or not it has express or other notice of such a claim or interest, except as otherwise provided by law.

 

Section 4:  Transfers of Shares.  Transfers of shares shall be made upon the books of the Corporation kept by the Corporation or by the transfer agent designated to transfer the shares, only upon direction of the person named in the certificate or by an attorney lawfully constituted in writing.  Before a new certificate is issued, the old certificate shall be surrendered for cancellation or, in the case of a certificate alleged to have been lost, stolen or destroyed, the provisions of these Bylaws shall have been complied with.

 

Section 5:  Registration of Transfer.  The Corporation shall register the transfer of a certificate for shares presented to it for transfer if:  (a) the certificate is properly endorsed by the registered owner or by his duly authorized attorney; (b) the signature of such person has been guaranteed by a commercial bank or brokerage firm that is a member of the National Association of Securities Dealers and reasonable assurance is given that such endorsements are effective; (c) the Corporation has no notice of an adverse claim or has discharged any duty to inquire into such a claim; (d) any applicable law relating to the collection of taxes has been complied with; and (e) the transfer is in compliance with applicable provisions of any transfer restrictions of which the Corporation shall have notice.

 

Section 6:  Lost, Stolen or Destroyed Certificates.  The Corporation shall issue a new certificate in place of any certificate for shares previously issued if the registered owner of the certificate:  (a) makes proof in affidavit form that the certificate has been lost, destroyed or wrongfully taken; (b) requests the issuance of a new certificate before the Corporation has notice that the certificate has been acquired by a purchaser for value in good faith and without notice of an adverse claim; (c) gives a bond in such form, and with such surety or sureties, with fixed or open penalty, as the Corporation may direct, to indemnify the Corporation (and its transfer agent and registrar, if any) against any claim that may be made on account of the alleged loss, destruction or theft of the certificate; and (d) satisfies any other reasonable requirements imposed by the Corporation.  When a certificate has been lost, apparently destroyed or wrongfully taken, and the holder of record fails to notify the Corporation within a reasonable time after he has notice of it, and the Corporation registers a transfer of the shares represented by the certificate before receiving such notification, the holder of record is precluded from making any claim against the Corporation for the transfer or for a new certificate.

 

Section 7:  Restrictions on Shares.  The Board of Directors, on behalf of the Corporation, or the shareholders may impose restrictions on the transfer of shares (including any security convertible into, or carrying a right to subscribe for or acquire shares) to the maximum extent permitted by law.  A restriction does not affect shares issued before the restriction was adopted unless the holders of the shares are parties to the restriction agreement or voted in favor of the restriction.  A restriction on the transfer of shares is valid and enforceable against the holder or a transferee of the holder if the restriction is authorized by this Section 7 and its existence is noted conspicuously on the front or back of the certificate.

 

11



 

Section 8:  Voting of Stock Held.  Unless otherwise provided by resolution of the Board of Directors, the president or any executive vice president shall from time to time appoint an attorney or attorneys or agent or agents of this Corporation, in the name and on behalf of this Corporation, to cast the vote which this Corporation may be entitled to cast as a shareholder or otherwise in any other corporation, any of whose stock or securities may be held by this Corporation, at meetings of the holders of the stock or other securities of such other corporation, or to consent in writing to any action by any of such other corporation, and shall instruct the person or persons so appointed as to the manner of casting such votes or giving such consent and may execute or cause to be executed on behalf of this Corporation and under its corporate seal or otherwise, such written proxies, consents, waivers or other instruments as may be necessary or proper; or, in lieu of such appointment, the president or any executive vice president may attend in person any meetings of the holders of stock or other securities of any such other corporation and their vote or exercise any or all power of this Corporation as the holder of such stock or other securities of such other corporation.

 

ARTICLE 8:  GENERAL PROVISIONS

 

Section 1:  Distributions.  The Board of Directors may authorize, and the Corporation may make, distributions (including dividends on its outstanding shares) in the manner and upon the terms and conditions provided by applicable law and the Articles.

 

Section 2:  Books and Records.  The Corporation shall keep correct and complete books and records of account and shall keep minutes of the proceedings of its shareholders and Board of Directors.

 

Section 3:  Execution of Documents.  The Board of Directors or these Bylaws shall designate the officers, employees and agents of the Corporation who shall have the power to execute and deliver deeds, contracts, mortgages, bonds, debentures, checks and other documents for and in the name of the Corporation, and may authorize such officers, employees and agents to delegate such power (including authority to redelegate) to other officers, employees or agents of the Corporation.  Unless so designated or expressly authorized by these Bylaws, no officer, employee or agent shall have any power or authority to bind the Corporation by any contract or engagement or to pledge its credit or to render it liable pecuniarily for any purpose or any amount.

 

Section 4:  Fiscal Year.  The fiscal year of the Corporation shall be the same as the calendar year.

 

Section 5:  Seal.  The Corporation may provide a seal which contains the name of the Corporation and the name of the state of incorporation.  The seal may be used by impressing it or reproducing a facsimile of it or otherwise.

 

Section 6:  Resignation.  A director may resign by delivering written notice to the  Board of Directors, the chairman or the Corporation.  Such resignation of a director is effective when the notice is delivered unless the notice specifies a later effective date.  An officer may resign at any time by delivering notice to the Corporation.  Such resignation of an officer is effective when the notice is delivered unless the notice specifies a later effective date.  If a resignation of an officer is made effective at a later date and the Corporation accepts the future effective date, the Board of Directors may fill the pending vacancy before the effective date if the Board of Directors provides that the successor does not take office until the effective date.

 

Section 7:  Computation of Days.  In computing any period of days prescribed hereunder the day of the act after which the designated period of days begins to run is not to be included.  The last day of the period so computed is to be included.

 

Section 8:  Amendment of Bylaws.

 

(a)           Except to the extent required otherwise by law, these Bylaws, or the Articles of Incorporation, these Bylaws may be altered, amended or repealed or new Bylaws may be adopted at any meeting of the Board of Directors at which a quorum is present, by the affirmative vote of a majority of the directors then in office, provided notice of the proposed alteration, amendment or repeal is contained in the notice of the meeting.

 

(b)           Except to the extent required otherwise by law, these Bylaws, or the Articles of Incorporation, these Bylaws may also be altered, amended or repealed or new Bylaws may be adopted at any meeting of

 

12



 

the shareholders at which a quorum is present or represented by proxy, by the affirmative vote of the holders of a majority of each class of shares entitled to vote thereon, provided notice of the proposed alteration, amendment or repeal is contained in the notice of the meeting.

 

(c)           Upon adoption of any new bylaw by the shareholders, the shareholders may provide expressly that the Board of Directors may not adopt, amend or repeal that bylaw or any bylaw on that subject.

 

Section 9:  Construction.  If any portion of these Bylaws shall be invalid or inoperative, then, so far as is reasonable and possible:  (a) the remainder of these Bylaws shall be considered valid and operative and (b) effect shall be given to the intent manifested by the portion held invalid or inoperative.

 

Section 10:  Headings.  The headings are for convenience of reference only and shall not affect in any way the meaning or interpretation of these Bylaws.

 

13



 

The undersigned, as President of the Corporation, hereby certifies that the amended and restated bylaws contained herein are the true and correct bylaws adopted by the Corporation’s board of directors in compliance with any procedural requirements of the Corporation’s Articles of Incorporation and the laws of the State of South Carolina, and the rules and regulations promulgated thereunder, and effective December 30, 2010.

 

 

/s/ James R. Clarkson

 

James R. Clarkson

 

President

 

 

 

Date:

December 30, 2010

 

14



 

Exhibit 13

 

2011 Annual Report of HCSB Financial Corporation.

 



Exhibit 13

 

HCSB FINANCIAL CORPORATION

 

 

Loris, South Carolina

 

Annual Report

 

2011

 

www.hcsbaccess.com

 



 

HCSB FINANCIAL CORPORATION AND SUBSIDIARY

 

Contents

 

 

Page

 

 

Message to Shareholders

2

 

 

Ten Year History

4

 

 

Selected Financial Data

5

 

 

Description of Company’s Business

6

 

 

Market for Common Shares and Dividends

7-8

 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

9-41

 

 

Report of Independent Registered Public Accounting Firm

42

 

 

Consolidated Balance Sheets

43

 

 

Consolidated Statements of Operations

44

 

 

Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income (Loss)

45

 

 

Consolidated Statements of Cash Flows

46

 

 

Notes to Consolidated Financial Statements

47-89

 

 

Board of Directors

90

 

 

Corporate Officers

91

 

 

Branch Locations

91

 

Headquarters

 

3640 Ralph Ellis Boulevard

 

Mailing Address:

Loris, South Carolina 29569

 

Post Office Box 218

(843) 716-4272

 

Loris, South Carolina 29569

 

Certain statements in this annual report contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, such as statements relating to the future plans and expectations, and are thus prospective. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from future results expressed or implied by such forward-looking statements.  Please see our annual report filed on Form 10-K for further discussion of these risks.

 

HCSB Financial Corporation will furnish, free of charge, copies of this Annual Report and the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (Form 10-K) upon written request to James R. Clarkson, President and CEO, HCSB Financial Corporation, Post Office Box 218, Loris, South Carolina 29569.

 



 

HCSB FINANCIAL CORPORATION AND SUBSIDIARY

 

MESSAGE TO SHAREHOLDERS

 

The fallout from the demise in our area’s economy in general and real estate market in particular that began in 2009 and continued through 2011 took a major toll on our bank’s performance in 2011.  As a result of the drastic decline in values of real estate (which has traditionally been the primary and strongest form of collateral for bank loans), the quality of our bank’s loan portfolio took a significant hit in 2011 and as a result the bank produced a net loss for the third consecutive year.

 

Specifically, the sharp decrease in real estate values required us to substantially increase our reserve for potential loan losses.  In addition, the degree of falling property values coupled with rising unemployment rates and declining levels of income and liquidity of our borrowers led to a much larger than normal rate of default in loan repayments.  This also required additions to our reserve for possible loan losses, as did the costs associated with litigation processes and carrying costs for an abnormal amount of foreclosed properties that the bank acquired during the year.  The result of these events was a significant net loss for the year as well as a substantial decline in the bank’s capital position.

 

In 2010, the Board of Directors and management of the bank realized that the impact of the demise of the local economy and real estate market was going to be considerably more extensive than had originally been projected.  It was at that time that we began to take proactive steps to counter the effect of these negative factors on the bank’s balance sheet and income statement.  We have implemented numerous actions designed to reduce losses and prevent further erosion of the bank’s capital ratios.

 

Several of these steps taken include:

 

·                  Several bank officers voluntarily gave up their retirement savings by terminating their salary continuation plans which effectively returned $431,000 in capital to the bank.

·                  Several directors who had elected to defer receipt of their director fees over the years also voluntarily gave up their retirement savings by electing to forfeit their deferred fees which effectively returned $563,000 in capital to the bank.

·                  We reduced the size of our workforce by 33% over the last two years which, combined with the elimination of various employee benefits, reductions of salaries of senior officers and other actions, resulted in a savings of total compensation expenses in excess of $2.1 million in 2011 compared to 2009.

·                  After careful consideration, we closed three underachieving branches at a projected annual savings in excess of $275,000.

·                  We increased the bank’s net interest margin by 61 basis points over the course of 2011.

 

In addition, management has by design taken steps to reduce the size of the bank’s assets from a peak of $809 million at May 31, 2010 to $536 million as of December 31, 2011.  This was accomplished largely through a reduction of the bank’s securities portfolio which enabled the bank to prepay borrowings from the Federal Home Loan Bank.  The additional loan loss provisions which were expensed in 2011 also served to increase the bank’s allowance for loan and lease losses to 5.77% of outstanding loans as of December 31, 2011.  In addition, we believe it is important to note that in the year 2011 the bank earned a profit of $2.5 million prior to the expenses of the loan loss provision and the write off of the deferred tax asset, despite the fact that in 2011 the bank incurred a substantially abnormal level of non-interest expenses for such items as legal fees, appraisal fees, expenses associated with foreclosed properties, consulting fees, accountant fees and FDIC insurance premiums which in the aggregate exceeded these same expenditures incurred in 2009 by over $2.9 million.

 

Regardless of what I may say, however, 2011 remains unquestionably a very dismal year for our bank and for our shareholders.  And despite the fact that I would love to assure you that everything negative is now behind us and smooth sailing lies ahead, I cannot in good conscience say that.  I can honestly tell you, however, that there appear to be many more positive indicators today than there were one year ago.  For example:

 

2



 

HCSB FINANCIAL CORPORATION AND SUBSIDIARY

 

MESSAGE TO SHAREHOLDERScontinued

 

·                  Real estate appraisals that we are receiving now typically have far less declines in values than they were showing early last year, and in a few instances we have even seen slight increases in values.

·                  Construction seems to be picking up some speed as well, although admittedly at a much slower pace than we saw in years prior to 2008.

·                  Agricultural commodity prices continue to be strong for our area farmers.

·                  Our ratio of loans past due from 30 to 89 days has declined substantially, which illustrates that the rate of loan defaults has subsided dramatically.

 

In short, we have experienced some tremendously difficult times which have weakened the bank considerably.  Even though there are indicators that better times may be just ahead, there are no guarantees that our bank will weather the current economic storm and ultimately return to profitability.  I do know that we have taken numerous blows, but we are still breathing and fighting.  Our determination to get through this and live for the better times has not wavered.  The compassion and pride for this bank that has been demonstrated on numerous occasions over the past couple of years by our employees has been remarkable, although not unexpected knowing the quality of the folks with whom I proudly work.  And certainly the Board of Directors has dedicated ourselves to doing whatever is necessary to get our company headed back up the ladder of success that we climbed quite well for the vast majority of our 24 years in existence.

 

In order that we might significantly improve the bank’s capital ratios, thereby returning the bank to a level of strength that will satisfy our banking regulatory agencies as well as ourselves as investors, we are exploring a number of strategic alternatives, including raising capital during 2012.  We believe that, if we are successful in raising additional capital, in addition to reducing expenses and improving asset quality, and the bank’s financial condition stabilizes, then we can ultimately meet the capital requirements set forth by our regulators and return the bank to its normal place as a leader in providing financial services to the residents, businesses and farmers within the bank’s primary trade area of Horry, Columbus and Brunswick counties.  However, as the first step in us achieving this goal, we will need your approval at the upcoming annual shareholders meeting of an amendment to our Articles of Incorporation to substantially increase the number of shares of common stock that the company is authorized to issue and thereby make available for sale.  Thus, on behalf of our Board of Directors, I strongly encourage that you support this endeavor and vote in favor of this amendment for the long-term benefit of our bank.

 

Please know that we, the Board of Directors and employees of HCSB Financial Corporation and Horry County State Bank, are deeply concerned over the direction our bank has taken over the last few years.  We are totally committed, however, to reinstating the levels of performance and respect that we enjoyed prior to the economic devastation that has so adversely affected our community and our bank.  Your loyalty and that of the vast majority of our customers has been steadfast, and we are truly humbled and appreciative.  There is an old saying that “a winner never quits, and a quitter never wins.”  I assure you that we are not quitters.

 

Most Respectfully,

 

 

 

James R. Clarkson

President & CEO

 

3



 

HCSB FINANCIAL CORPORATION AND SUBSIDIARY

Ten Year History

(Dollars in thousands)

 

Year

 

Assets

 

Deposits

 

Loans (net)

 

Capital

 

Earnings

 

 

 

 

 

 

 

 

 

 

 

 

 

2002

 

$

211,598

 

$

164,161

 

$

161,381

 

$

19,850

 

$

1,161

 

 

 

 

 

 

 

 

 

 

 

 

 

2003

 

269,714

 

209,931

 

190,055

 

21,509

 

1,568

 

 

 

 

 

 

 

 

 

 

 

 

 

2004

 

296,807

 

222,389

 

210,649

 

23,454

 

2,055

 

 

 

 

 

 

 

 

 

 

 

 

 

2005

 

331,662

 

254,137

 

232,509

 

25,303

 

2,408

 

 

 

 

 

 

 

 

 

 

 

 

 

2006

 

359,357

 

275,151

 

251,849

 

28,350

 

2,805

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

438,353

 

340,851

 

350,679

 

30,983

 

2,040

 

 

 

 

 

 

 

 

 

 

 

 

 

2008

 

644,347

 

484,751

 

424,692

 

34,450

 

2,244

 

 

 

 

 

 

 

 

 

 

 

 

 

2009

 

760,359

 

578,292

 

485,796

 

45,072

 

(1,348

)

 

 

 

 

 

 

 

 

 

 

 

 

2010

 

787,441

 

628,961

 

431,185

 

26,499

 

(17,269

)

 

 

 

 

 

 

 

 

 

 

 

 

2011

 

535,698

 

490,853

 

345,817

 

(5,216

)

(29,017

)

 

4



 

Selected Financial Data

 

The following table sets forth certain selected financial data concerning the Company.  The selected financial data has been derived from the financial statements.  This information should be read in conjunction with the financial statements of the Company, including the accompanying notes, included elsewhere herein.

 

Year Ended December 31,

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands, except per share) 

 

2011

 

2010

 

2009

 

2008

 

2007

 

Financial Condition:

 

 

 

 

 

 

 

 

 

 

 

Investment securities, available for sale

 

$

100,207

 

$

265,190

 

$

169,463

 

$

166,992

 

$

49,609

 

Allowance for loan losses

 

21,178

 

14,489

 

7,525

 

4,416

 

3,535

 

Net loans

 

345,817

 

431,185

 

485,796

 

424,692

 

350,679

 

Premises and equipment, net

 

22,514

 

23,389

 

24,152

 

19,056

 

16,051

 

Total assets

 

535,698

 

787,441

 

760,359

 

644,347

 

438,353

 

Noninterest-bearing deposits

 

37,029

 

38,255

 

31,661

 

31,285

 

32,407

 

Interest-bearing deposits

 

453,824

 

590,706

 

546,631

 

453,466

 

308,444

 

Total deposits

 

490,853

 

628,961

 

578,292

 

484,751

 

340,851

 

Advances from the Federal Home Loan Bank

 

22,000

 

104,200

 

118,800

 

92,000

 

52,300

 

Total liabilities

 

540,914

 

760,942

 

715,287

 

609,897

 

407,370

 

Total shareholders’ equity (deficit)

 

(5,216

)

26,499

 

45,072

 

34,450

 

30,983

 

 

 

 

 

 

 

 

 

 

 

 

 

Results of Operations:

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

25,654

 

$

32,550

 

$

34,101

 

$

31,139

 

$

28,536

 

Interest expense

 

8,924

 

14,567

 

15,593

 

14,537

 

14,252

 

Net interest income

 

16,730

 

17,983

 

18,508

 

16,602

 

14,284

 

Provision for loan losses

 

25,271

 

23,084

 

10,361

 

1,754

 

985

 

Net interest income (loss) after provision for loan losses

 

(8,541

)

(5,101

)

8,147

 

14,848

 

13,299

 

Other income

 

6,217

 

4,090

 

7,605

 

3,586

 

2,696

 

Other expense

 

21,695

 

20,641

 

17,940

 

15,086

 

12,903

 

Income (loss) before income taxes

 

(24,019

)

(21,652

)

(2,188

)

3,348

 

3,092

 

Income tax expense (benefit)

 

4,998

 

(4,383

)

(840

)

1,104

 

1,052

 

Net income (loss)

 

$

(29,017

)

$

(17,269

)

$

(1,348

)

$

2,244

 

$

2,040

 

 

 

 

 

 

 

 

 

 

 

 

 

Per Share Data (1):

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) — basic

 

$

(7.98

)

$

(4.78

)

$

(0.44

)

$

0.59

 

$

0.53

 

Period end book value

 

$

(4.70

)

$

3.79

 

$

8.74

 

$

9.09

 

$

8.17

 

 


(1)    Adjustments have also been made for the 3% stock dividends declared in February 2008 and January 2009, as well as the two-for-one stock split in the form of a 100% stock dividend declared in January 2007.  There was no stock dividend declared in 2010, 2011 or 2012.

 

5



 

Description of Company’s Business

 

HCSB Financial Corporation (the “Company”) was incorporated on June 10, 1999 to become a holding company for Horry County State Bank.  The Company’s only significant asset is its wholly owned subsidiary, Horry County State Bank (the “Bank”).  The Bank is a state-chartered bank incorporated on December 18, 1987 and located at 3640 Ralph Ellis Boulevard, Loris, South Carolina.  The Company’s primary market includes Horry County in South Carolina and Columbus and Brunswick Counties in North Carolina.  From its 11 branch locations, the Company offers a full range of deposit services, including checking accounts, savings accounts, certificates of deposit, money market accounts, and IRAs, as well as a broad range of non-deposit investment services.

 

The Company is primarily engaged in the business of attracting deposits from the general public and using these deposits together with other funds to make agricultural, commercial, consumer, and real estate loans.  The Company’s operating results depend to a substantial extent on the difference between interest and fees earned on loans and investments and the Company’s interest expense, consisting principally of interest paid on deposits and borrowings.  Unlike most industrial companies, virtually all of the assets and liabilities of financial institutions are monetary.  As a result, interest rates have a greater effect on a financial institution’s performance.  In addition to competing with other traditional financial institutions, the Company also competes for checking and savings dollars with nontraditional financial intermediaries, such as mutual funds, as well as with investment opportunities available via the internet.  This has resulted in a highly competitive market area.  The Company attempts to compete in this highly competitive market by focusing on providing the highest quality of personal service and attention to its customers.

 

In 1995, the Company opened its first branch office in the Mt. Olive community of Horry County and has since expanded its branch network to 11 banking offices located throughout Horry County, as well as an Operations Center in Loris, South Carolina which houses the Company’s executive offices and support services.  This expansion of its branch system has enabled the Company to more effectively compete for deposits and loans.  In January 2012, the Company closed its branches in the Homewood community and on Meeting Street in Loris to decrease its number of branches from 13 to 11.  The Company closed these branches in order to reduce expenses without materially reducing the Company’s deposits and loans.

 

By expanding into different communities, the Company has been able to substantially diversify its market place from one of a predominantly agricultural flavor to one which blends residential developments of retirees and others, tourism, major employment areas, central county government and the market’s most active overall growth areas.  In so doing, the Company has reduced considerably the seasonality in its loan portfolio.  At the same time the coastal markets have proven to offer primarily commercial real estate lending opportunities, and commercial real estate has been significantly adversely impacted by the current economic recession.

 

In order to support this growth in its branch network, the Company has undertaken several secondary common stock offerings.  Prior to its reorganization from a bank into the holding company, Horry County State Bank undertook three such secondary offerings of its common stock in efforts to strengthen the Bank’s regulatory capital position to support projected future growth in assets.  Since the reorganization was consummated in 1999, the Company committed to another secondary offering in 2002 whereby the Company issued an additional 365,712 shares of common stock at a price per share of $22.00, resulting in over $8,000,000 in added capital.

 

In December 2004, the Company participated in the issuance of $6,000,000 of trust preferred securities through its non-consolidated subsidiary HCSB Financial Trust I (the Trust) to enable the Company to pursue its growth goals and yet maintain a “well-capitalized” status as defined by banking regulatory agencies.

 

On March 6, 2009, the Company issued 12,985 shares of preferred stock, having $0.01 par value per share and a liquidation preference of $1,000 per share, in connection with the United States Treasury’s Capital Purchase Program.  The dividend rate of 5% per annum will be payable for the first five years, increasing to 9% per annum in

 

6



 

DESCRIPTION OF BUSINESS continued

 

2014.  The Company also issued 91,714 warrants to purchase common stock at a strike price of $21.09 per share.  The warrants expire 10 years from the issue date.

 

Due to the Company’s current financial condition, as of February 2011, the Federal Reserve Bank of Richmond required the Company to defer dividend payments on the preferred stock issued to the U.S. Treasury pursuant to the Capital Purchase Program and interest payments on the trust preferred securities.  The Company may defer dividend payments on the preferred stock, although the dividend is a cumulative dividend and failure to pay dividends for six dividend periods, whether or not consecutive, would trigger board appointment rights for the holder of the preferred stock.  The Company may defer interest payments on the trust preferred securities for up to 20 consecutive quarterly periods, although interest will continue to accrue on the trust preferred securities and interest on such deferred interest will accrue and compound quarterly from the date such deferred interest would have been payable were it not for the extension period.  The Company has deferred dividend payments on the preferred stock for five consecutive dividend periods and interest payments on the trust preferred securities for four consecutive interest payment periods.

 

On July 31, 2010, the Company completed a private placement of subordinated promissory notes that totaled $12,062,011.  The notes initially bear interest at a rate of 9% per annum payable semiannually on April 5th and October 5th and are callable by the Company four years after the date of issuance and mature 10 years from the date of issuance.  After October 5, 2014 and until maturity, the notes bear interest at a rate equal to the current Prime Rate in effect, as published by the Wall Street Journal, plus 3%; provided, that the rate of interest shall not be less than 8% per annum or more than 12% per annum.  Due to the financial condition of our Company, we will have to obtain approval from the Federal Reserve Bank of Richmond, the Company’s primary federal regulator, before we can make future interest payments on the notes.  Therefore, we can make no assurance that we can make future interest payments on the notes.

 

Market for Common Shares and Dividends

 

As of December 31, 2011, there were 3,738,337 shares of our common stock outstanding held by approximately 2,400 shareholders of record.  There is currently no established public trading market in our common stock and trading and quotations of our common stock have been limited and sporadic.  Most of the trades of which the Company is aware have been privately negotiated by local buyers and sellers.  In addition to these trades, the Company is aware of a number of trades reported on Yahoo! that occurred on the OTC Bulletin Board between January 1, 2011 and December 31, 2011.  These trades ranged from $0.20 to $8.98.  We have included these trades in the following table which sets forth the high and low closing prices for our common stock of which we are aware for the periods indicated.  Private trading of our common stock has been limited but has been conducted through the Private Trading System, which was implemented on our website (www.hcsbaccess.com) on April 1, 2010.  The Private Trading System is a passive mechanism created to assist buyers and sellers in facilitating trades in our common stock.  Because there has not been an established market for our common stock, we may not be aware of all prices at which our common stock has been traded.  We have not determined whether the trades of which we are aware were the result of arm’s-length negotiations between the parties.  Based on information available to us, we believe transactions in our common stock can be fairly summarized as follows for the periods indicated:

 

7



 

MARKET FOR COMMON SHARES AND DIVIDENDS continued

 

 

 

Low

 

High

 

 

 

 

 

 

 

2011

 

 

 

 

 

Fourth Quarter

 

$

0.20

 

$

0.75

 

Third Quarter

 

$

0.65

 

$

2.50

 

Second Quarter

 

$

1.01

 

$

1.30

 

First Quarter

 

$

1.10

 

$

8.98

 

 

 

 

 

 

 

2010

 

 

 

 

 

Fourth Quarter

 

$

2.25

 

$

10.00

 

Third Quarter

 

$

4.00

 

$

9.00

 

Second Quarter

 

$

5.25

 

$

10.50

 

First Quarter

 

$

4.50

 

$

11.50

 

 

All share and per share data in this report has been adjusted to reflect all stock dividends and splits declared by the Company.

 

Under the terms of the Written Agreement (the “Written Agreement”) the Company entered into with the Federal Reserve Bank of Richmond on May 9, 2011, the Company is currently prohibited from declaring or paying any dividends without the prior written approval of the Federal Reserve Bank of Richmond.  In addition, because the Company is a legal entity separate and distinct from the Bank and has little direct income itself, the Company relies on dividends paid to it by the Bank in order to pay dividends its common stock.  As a South Carolina state bank, the Bank may only pay dividends out of its net profits, after deducting expenses, including losses and bad debts.  Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (the “FDICIA”), the Bank may not pay a dividend if, after paying the dividend, the Bank would be undercapitalized.  As of December 31, 2011, the Bank was classified as “significantly undercapitalized,” and therefore it is prohibited under FDICIA from paying dividends until it increases its capital levels.  In addition, even if it increases its capital levels, under the terms of the Consent Order the Bank entered into with the Federal Deposit Insurance Corporation (the “FDIC”) and the South Carolina Board of Financial Institutions (the “State Board”) on February 10, 2011 (the “Consent Order”), the Bank is prohibited from declaring a dividend on its shares of common stock unless it receives approval from the FDIC and State Board.  Further, as a result of the Company’s deferral of dividend payments on the 12,895 shares of preferred stock issued to the U.S. Treasury in March 2009 pursuant to the Capital Purchase Program and interest payments on the $6,000,000 of trust preferred securities issued in December 2004, the Company is prohibited from paying any dividends on its common stock until all deferred payments have been made in full.

 

As a result of these restrictions on the Company, including the restrictions on the Bank’s ability to pay dividends to the Company, the Company does not anticipate paying dividends for the foreseeable future, and all future dividends will be dependent on the Company’s financial condition, results of operations, and cash flows, as well as capital regulations and dividend restrictions from the Federal Reserve Bank of Richmond, the FDIC, and the State Board.

 

8



 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

INTRODUCTION

 

The following discussion describes our results of operations for 2011 as compared to 2010 and also analyzes our financial condition as of December 31, 2011 as compared to December 31, 2010.  Like most community banks, we derive most of our income from interest we receive on our loans and investments.  Our primary source of funds for making these loans and investments is our deposits, both interest-bearing and noninterest-bearing.  Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits and borrowed funds.  In order to maximize our net interest income, we must not only manage the volume of these balance sheet items, but also the yields that we earn on our interest-earning assets and the rates that we pay on interest-bearing liabilities.

 

We have included a number of tables to assist in our description of these measures.  For example, the “Average Balances” table shows the average balance during 2011, 2010, and 2009 of each category of our assets and liabilities, as well as the yield we earned or the rate we paid with respect to each category.  A review of this table shows that our loans typically provide higher interest yields than do other types of interest earning assets, which is why we direct a substantial percentage of our earning assets into our loan portfolio.  Similarly, the “Rate/Volume Analysis” table helps demonstrate the impact of changing interest rates and changing volume of assets and liabilities during the years shown.  We also track the sensitivity of our various categories of assets and liabilities to changes in interest rates, and we have included an “Interest Rate Sensitivity Analysis” table to help explain this.  Finally, we have included a number of tables that provide details about our investment securities, our loans, and our deposits and other borrowings.

 

Of course, there are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible.  We establish and maintain this allowance by charging a provision for loan losses against our operating earnings.  In the “Loan Portfolio” section we have included a detailed discussion of this process, as well as several tables describing our allowance for loan losses and the allocation of this allowance among our various categories of loans.

 

In addition to earning interest on our loans and investments, we earn income through fees that we charge to our customers. Likewise, we incur other operating expenses as well.  We describe the various components of this noninterest income, as well as our noninterest expense, in the following discussion.

 

GENERAL

 

Effects of the Current Economic Environment on our Bank

 

Like many financial institutions across the United States and in South Carolina, our operations have been adversely affected by the current economic crisis.  Beginning in 2009 and continuing in 2010, we recognized that acquisition, development and construction real estate projects were slowing, guarantors were becoming financially stressed, and increasing credit losses were surfacing.  During 2009 through 2011, delinquencies over 90 days increased, resulting in an increase in nonaccrual loans, indicating significant credit quality deterioration and probable losses.  In particular, loans secured by real estate (approximately 83.4%, 82.4%, and 81.7% of our loans had real estate as a primary or secondary component of collateral as of December 31, 2009, 2010, and 2011, respectively), including acquisition, development and construction projects, demonstrated stress given reduced cash flows of individual borrowers, limited bank financing and credit availability, and slow property sales.  This deterioration manifested itself in our borrowers in the following ways: (i) the cash flows from underlying properties supporting the loans decreased (e.g., slower property sales for development type projects or lower occupancy rates or rental rates for operating properties); (ii) cash flows from the borrowers themselves and guarantors were under pressure given illiquid personal balance sheets and drainage by investing additional personal capital in the projects; and (iii) fair

 

9



 

values of real estate related assets declined, resulting in lower cash proceeds from sales or fair values declining to the point that borrowers were no longer willing to sell the assets at such deep discounts.

 

The cumulative result of the above was a significant increase in the level of our nonperforming assets during 2009, 2010 and 2011.  As of December 31, 2011, our nonperforming assets equaled $86.9 million, or 16.22% of assets, as compared to $74.2 million or 9.43% of assets, as of December 31, 2010, and $29.6 million, or 3.91% of assets, as of December 31, 2009.  The increase in our nonperforming assets led to the increase in our provision for loan losses and other noninterest expenses, as well as in the amount of other real estate we own, which includes real estate acquired through foreclosure.  For the year ended December 31, 2011, we recorded a provision for loan losses of $25.3 million and net loan charge-offs of $18.6 million, or 4.53% of average loans, as compared to a $23.1 million provision for loan losses and net loan charge-offs of $16.1 million, or 3.33% of average loans, for the year ended December 31, 2010, and a $10.4 million provision for loan losses and net loan charge-offs of $7.3 million, or 1.54% of average loans, for the year ended December 31, 2009.  Our amount of other real estate owned was $15.7 million at December 31, 2011, compared to $16.9 million at December 31, 2010 and $6.4 million at December 31, 2009.  In total, the above produced a net loss of $29.0 million in 2011, $17.3 million in 2010 and $1.3 million in 2009, compared to net income of $2.2 million in 2008.

 

Notwithstanding the increase in total nonperforming assets, provision for loan losses, and net loan charge-offs during 2010 and in the first six months of 2011, we believe credit quality indicators generally showed signs of stabilization during the second half of 2011.  For the three months ended September 30 and December 31, 2011, we recorded provisions for loan losses of $2.6 million and $5.1 million and net loan charge-offs of $4.0 million and $3.6 million, respectively, as compared to a provision for loan losses of $9.1 million and net loan charge-offs of $4.0 million for the three months ended June 30, 2011.  Primarily as a result of the stabilization and improvement in our loan portfolio, we incurred a net loss of $7.4 million during the last six months of 2011 compared to a net loss of $21.6 million during the first six months of 2011.

 

The following discussion and analysis also identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements.  We encourage you to read this discussion and analysis in conjunction with our financial statements and the other statistical information included in our filings with the SEC.

 

Recent Regulatory Developments

 

Consent Order

 

On February 10, 2011, the Bank entered into the Consent Order with the FDIC and the State Board.  The Consent Order conveys specific actions needed to address the Bank’s current financial condition, primarily related to capital planning, liquidity/funds management, policy and planning issues, management oversight, loan concentrations and classifications, and non-performing loans.  For additional information on the Consent Order, see Note 2-”Regulatory Matters and Going Concern Considerations — Consent Order with the Federal Deposit Insurance Corporation and South Carolina Board of Financial Institutions” to our Consolidated Financial Statements.

 

Written Agreement

 

On May 9, 2011, the Company entered into the Written Agreement with the Federal Reserve Bank of Richmond.  The Agreement is  designed to enhance the Company’s ability to act as a source of strength to the Bank.  For additional information on the Written Agreement, see Note 2-”Regulatory Matters and Going Concern Considerations — Written Agreement with the Federal Reserve Bank of Richmond” to our Consolidated Financial Statements.

 

Going Concern Considerations

 

We have prepared the consolidated financial statements contained in this Annual Report assuming that the Company will be able to continue as a going concern, which contemplates the realization of assets and the discharge of

 

10



 

liabilities in the normal course of business for the foreseeable future.  However, as a result of recurring losses, as well as uncertainties associated with the Bank’s ability to increase its capital levels to meet regulatory requirements, management has concluded that there is substantial doubt about the Company’s ability to continue as a going concern. In its report dated March 19, 2012, our independent registered public accounting firm stated that these uncertainties raise substantial doubt about our ability to continue as a going concern.  Our financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern.  If we are unable to continue as a going concern, our shareholders will likely lose all of their investment in the Company.  For additional information, see Note 2-”Regulatory Matters and Going Concern Considerations — Going Concern Considerations” to our Consolidated Financial Statements.

 

Our Strategic Plan

 

As a response to the general economic downturn, and more recently, to the terms of the Consent Order and the Written Agreement, we adopted a new strategic plan, which includes not only a search for additional capital but also a search for a potential merger partner.  We are continuing to pursue both of these approaches simultaneously, though given the lack of a market for bank mergers, particularly in the Southeast, as a result of the current economic and regulatory climate, we believe that in the short-term our more realistic opportunity will be to raise additional capital.  Approximately $7.5 million in capital would return the Bank to “adequately capitalized” and $17.5 million in capital would return the Bank to “well capitalized” under regulatory guidelines on a pro forma basis as of December 31, 2011.  If we continue to decrease the size of the Bank or return the Bank to profitability, then we could achieve these capital ratios with less additional capital.  However, if we suffer additional loan losses or losses in our other real estate owned portfolio, then we would need additional capital to achieve these ratios.  There are no assurances that we will be able to raise this capital on a timely basis or at all.  If we cannot meet the minimum capital requirements set forth under the Consent Order and return the Bank to a “well capitalized” designation, or if we suffer a continued deterioration in our financial condition, we may be placed into a federal conservatorship or receivership by the FDIC.

 

We have also been taking a number of steps to stabilize the Bank’s financial condition, including steps to reduce expenses, decrease the size of the Bank, and improve asset quality.  We believe that with these steps the Bank’s financial condition is stabilizing, which will help the Bank as it continues its efforts to secure a merger partner or raise capital.

 

Decreasing the Bank’s Assets.  We reduced the Bank’s total assets from $787.4 million at December 31, 2010 to $535.7 million at December 31, 2011, as we believe this approach, in addition to raising new capital and reducing expenses, represents the quickest path to restoring the Bank’s capital levels, returning the Bank to profitability, and facilitating compliance with the terms of the Consent Order and the Written Agreement.  We will continue to evaluate strategies for reducing the Bank’s overall asset size, but do not have current plans for any material additional decrease.

 

Enhancing the Credit Quality of the Loan Portfolio.  During 2010 and 2011, we aggressively increased our reserves for losses and focused substantial time and effort on managing the liquidation of nonperforming assets.  We are working to hold our borrowers accountable for the principal and interest owed.  We have initiated workout plans for problem loans that are designed to promptly collect on or rehabilitate those problem loans in an effort to convert them to earning assets, and we are pursuing foreclosure in certain instances.  Additionally, we are marketing our inventory of foreclosed real estate, but given that we would likely be required to accept discounted sales prices below appraised value if we tried to dispose of these assets quickly, we have been taking a more measured and deliberate approach with these sales efforts.

 

As a result of these efforts, we believe credit quality indicators generally showed signs of stabilization during the second half of 2011.  Primarily as a result of the stabilization and improvement in our loan portfolio, we incurred a net loss of $7.4 million during the last six months of 2011 compared to a net loss of $21.6 million during the first six months of 2011.

 

11



 

Although we have generally curtailed new lending while we focus on restoring the Bank’s financial condition, we remain focused on disciplined underwriting practices and prudent credit risk management.  We performed an expanded internal loan review during June and July 2010, hired an independent firm to perform an independent review of our loan portfolio in June 2010 and February and July 2011, and substantially revised our lending policy and credit procedures in early 2011.  We expanded the scope and depth of the initial loan review performed by our loan officers on all loans, and we incorporated more objective measurements in our internal loan analysis which more accurately addresses each borrower’s probability of default.

 

Reducing ADC and CRE Loan Concentrations.  As a result of the current economic environment and its impact on acquisition, development and construction and commercial real estate loans, we have effectively ceased making any new loans of these types while proactively decreasing the level of these types of loans in our existing portfolio.  We have worked to decrease our concentration by various means, including (i) through the normal sale of real estate by borrowers and their resulting repayments of the borrowed funds, (ii) transfers of problem loans to other real estate owned or charge-off if loss is considered confirmed, and (iii) encouraging customers with these types of loans to seek other financing when their loans mature.  During the period from December 31, 2009 to December 31, 2011, we were able to decrease the Bank’s total CRE loan portfolio from $199.8 million to $142.5 million, or 28.3%.  If the above initiatives do not reduce our concentrations to acceptable levels, we may seek avenues to sell a portion of these types of loans to outside investors.

 

Increasing Operating Earnings.  Management is focused on increasing our operating earnings by implementing strategies to improve the core profitability of our franchise.  These strategies change the mix of our earning assets while reducing the size of our balance sheet.  Specifically, we are reducing the level of nonperforming assets, controlling our operating expenses, improving our net interest margin and increasing fee income.  We plan to reduce the amount of our nonperforming assets, which may require us to record additional provisions for loan losses to accomplish within this timeframe.  Additionally, we are carefully evaluating all renewing loans in our portfolio to ensure that we are focusing our capital and resources on our best relationship customers.

 

The benefits of reducing the size of our balance sheet include more disciplined loan and deposit pricing going forward, which we believe will result in an improvement in our net interest margin.  Additionally, we will seek to expand our net interest margin as our current loans and deposits reprice and renew.  We typically seek to put floors, or minimum interest rates, in our variable rate loans at origination or renewal.

 

Focusing on Reducing Noninterest Expenses and Collecting Noninterest Income.  We continue to review our noninterest income and noninterest expense categories for potential revenue enhancements and expense reductions.  We have implemented several initiatives to help reduce expenses and manage our overhead at an efficient level.  To achieve this goal, management and the Board have already reduced compensation expenses by, among other things, eliminating over 50 employment positions, eliminating salary increases and bonuses of any type since December 31, 2009, eliminating employer matching contributions to officer and employee 401(k) accounts and reducing the percentage of health and dental insurance benefits paid by the Bank for all of its employees.  In addition, certain of the Bank’s senior officers have accepted salary reductions and forfeited certain retirement benefits and incentive compensation.  Management and the Board also determined in 2011, after careful review of hourly customer traffic counts, to reduce the hours of service on Friday afternoons.  All of these steps served to enable the Bank to reduce its compensation expenses by over $2.9 million from 2009 to 2011.  In addition, the Board has eliminated monthly director fees, and several directors who had elected to defer their director fees until retirement have forfeited their deferred fees entirely.

 

We have also reduced marketing expenses incurred by the Bank at a savings of $670,577 in 2011 as compared to 2009.  We closed two branches in January 2012, and we continue to analyze other noninterest expenses for further opportunities for reductions.  We believe that reduction of our level of nonperforming assets will also significantly reduce our operating costs, which is evidenced by the fact that expenses related to nonperforming assets in 2011 were more than $1.5 million above similar expenses incurred in 2008 prior to the downturn in the local real estate market and the resulting rise in the level of nonperforming assets.

 

12



 

At the same time, we are focused on enhancing revenues from noninterest income sources, such as service charges, residential mortgage loan originations and fees earned from fiduciary activities, as well as from minimizing waivers of fees for late charges on loans and fees charged for insufficient funds checks presented for payment.  We will continue to look for additional strategies to increase fee-based income as we expect that these efforts will help to bolster our noninterest income levels.

 

RESULTS OF OPERATIONS

 

The Company experienced a decrease of $6,896,000, or 21.19%, in total interest income for the year ended December 31, 2011.  The Company experienced a decrease in interest, including fees, on our loan portfolio of $5,208,000, or 19.92%, to $20,943,000 during 2011 from $26,151,000 during 2010, which was the result of an increase of loans in nonaccrual status during 2011.  The Company also experienced a decrease in the interest income on taxable securities, which decreased $2,068,000 or 34.59%, due to a decrease in our securities available-for-sale of $164,983,000 during 2011.  Because of the decline in total deposits of $138,108,000 and Federal Home Loan Bank (“FHLB”) borrowings of $82,200,000 during 2011 and declines in rates, total interest expense decreased $5,643,000, or 38.74%, to $8,924,000.  This resulted in a $1,253,000, or 6.97%, decrease in net interest income in 2011.  However, the Company did experience increases in non-interest income.  Non-interest income increased $2,127,000, or 52.00%, primarily due to the realization of gains on sale of available-for-sale securities of $2,952,000.  Non-interest expenses increased $1,054,000, or 5.11%, during 2011 primarily due to prepayment penalties on FHLB advances and increased FDIC insurance premiums, offset by decreases in salaries and benefits and net costs of operations of other real estate owned.  Overall, the Company incurred a net loss for the year ended December 31, 2011 of $29,017,000, compared to a net loss of $17,269,000 for the year ended December 31, 2010.  The net loss was primarily driven by the provision for loan losses of $25,271,000 for the year ended December 31, 2011, which increased $2,187,000, or 9.47%, from $23,084,000 for the year ended December 31, 2010.

 

ASSETS, LIABILITIES, AND SHAREHOLDERS’ EQUITY

 

During the twelve months ended December 31, 2011, total assets decreased $251,743,000, or 31.97%, when compared to December 31, 2010.  The primary reason for the decrease in total assets was a decrease in our securities portfolio of $167,084,000, or 61.59%, during 2011 from $271,266,000 at December 31, 2010.  Total deposits decreased $138,108,000, or 21.96%, from the December 31, 2010 amount of $628,961,000.  Interest-bearing deposits decreased $136,882,000, or 23.17%, and noninterest-bearing deposits decreased $1,226,000, or 3.20%, during 2011.  The decrease in total deposits was primarily due to the decrease in our money market savings accounts, which decreased $72,080,000, or 36.58%, from $197,067,000 at December 31, 2010 to $124,987,000 at December 31, 2011 and other time deposits which decreased $48,245,000, or 25.01%, from $192,917,000 at December 31, 2010 to $144,672,000 at December 31, 2011.  FHLB advances also decreased by $82,200,000, or 78.89%, from $104,200,000 at December 31, 2010 to $22,000,000 at December 31, 2011.

 

13



 

DISTRIBUTION OF ASSETS, LIABILITIES, AND SHAREHOLDERS’ EQUITY

 

The Company has sought to maintain a conservative approach in determining the distribution of its assets and liabilities. The following table presents the percentage relationships of significant components of the Company’s average balance sheets for the last three fiscal years.

 

Balance Sheet Categories as a Percent of Average Total Assets

 

 

 

2011

 

2010

 

2009

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

Interest earning assets:

 

 

 

 

 

 

 

Federal funds sold

 

3.44

%

3.49

%

2.55

%

Investment securities

 

23.98

 

28.42

 

26.69

 

Loans

 

65.42

 

60.85

 

64.57

 

Total interest earning assets

 

92.84

 

92.76

 

93.81

 

Cash and due from banks

 

0.74

 

0.97

 

1.21

 

Allowance for loan losses

 

(2.77

)

(1.30

)

(0.78

)

Premises and equipment

 

3.67

 

3.00

 

2.95

 

Other assets

 

5.52

 

4.57

 

2.81

 

Total assets

 

100.00

%

100.00

%

100.00

%

 

 

 

 

 

 

 

 

Liabilities and shareholders’ equity:

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

Interest-bearing deposits

 

78.95

%

72.77

%

71.51

%

Federal funds purchased

 

0.01

 

0.01

 

0.07

 

Advances from the Federal Home Loan Bank

 

7.91

 

13.92

 

14.70

 

Repurchase Agreements

 

1.37

 

0.94

 

1.44

 

Subordinate Debentures

 

1.92

 

0.98

 

0.00

 

Debt due to trust

 

0.99

 

0.78

 

0.85

 

Notes Payable

 

0.00

 

0.00

 

0.15

 

Total interest-bearing liabilities

 

91.15

 

89.40

 

88.72

 

Noninterest-bearing deposits

 

6.56

 

4.98

 

4.49

 

Accrued interest and other liabilities

 

0.46

 

0.44

 

0.67

 

Total liabilities

 

98.17

 

94.82

 

93.88

 

Shareholders’ equity

 

1.83

 

5.18

 

6.12

 

Total liabilities and shareholders’ equity

 

100.00

%

100.00

%

100.00

%

 

NET INTEREST INCOME

 

Earnings are dependent to a large degree on net interest income.  Net interest income represents the difference between gross interest earned on earning assets, primarily loans and investment securities, and interest paid on deposits and borrowed funds. Net interest income is affected by the interest rates earned or paid and by volume changes in loans, investment securities, deposits, and borrowed funds.  The interest rate spread and the net yield on earning assets are two significant elements in analyzing the Company’s net interest income.  The interest rate spread is the difference between the yield on average earning assets and the rate on average interest-bearing liabilities.  The net yield on earning assets is computed by dividing net interest income by the average earning assets.

 

For the year ended December 31, 2011, net interest income was $16,730,000, a decrease of $1,253,000, or 6.97%, from net interest income of $17,983,000 in 2010.  The decline in our net interest income was the result of the

 

14



 

NET INTEREST INCOME continued

 

decrease in our interest income on loans, including fees, of $5,208,000, or 19.92%, from $26,151,000 for the year ended December 31, 2010 to $20,943,000 for the year ended December 31, 2011.  This decrease was attributable to the decrease in the average volume of our loan portfolio of $483,570,000 as of December 31, 2010 to $410,043,000 as of December 31, 2011 with only a slight decrease in its yield, and also due to the loss of interest on nonaccrual loans.  Interest expense for the year ended December 31, 2011 was $8,924,000, compared to $14,567,000 for 2010.  This represents a decrease of $5,643,000, or 38.74%, compared to the prior year, and was primarily the result of the decrease in interest-bearing deposits of $136,882,000, decrease in advances from the FHLB in the amount of $82,200,000, and reduced interest rates.  The interest rate spread and net yield on earning assets improved during 2011 as compared to the previous two years due to the reduction of interest rates on our deposits.  The net yield realized on earning assets was 2.88% for 2011, compared to 2.44% in 2010.  The interest rate spread was 2.85% and 2.37% in 2011 and 2010, respectively.

 

The following table sets forth, for the periods indicated, the weighted-average yields earned, the weighted-average yields paid, the interest rate spread, and the net yield on earning assets.  The table also indicates the average daily balance and the interest income or expense by specific categories.

 

Average Balances, Income and Expenses, and Rates

 

 

 

2011

 

2010

 

2009

 

Year ended December 31,

 

Average

 

 

 

Yield/

 

Average

 

 

 

Yield/

 

Average

 

 

 

Yield/

 

(Dollars in thousands)

 

Balance

 

Interest

 

Rate

 

Balance

 

Interest

 

Rate

 

Balance

 

Interest

 

Rate

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans

 

$

410,043

 

$

20,943

 

5.11

%

$

483,570

 

$

26,151

 

5.41

%

$

469,675

 

$

25,997

 

5.54

%

Securities, taxable

 

127,087

 

3,910

 

3.08

%

210,778

 

5,978

 

2.84

%

181,759

 

7,811

 

4.30

%

Securities, nontaxable

 

17,546

 

685

 

3.90

%

8,502

 

315

 

3.71

%

6,261

 

236

 

3.77

%

Nonmarketable equity Securities

 

5,685

 

53

 

0.93

%

6,519

 

25

 

0.38

%

6,104

 

32

 

0.52

%

Fed funds sold and other (incl. FHLB)

 

21,532

 

63

 

0.29

%

27,747

 

81

 

0.29

%

18,546

 

26

 

0.14

%

Total earning assets

 

581,893

 

25,654

 

4.41

%

737,116

 

32,550

 

4.42

%

682,345

 

34,102

 

5.00

%

Cash and due from banks

 

4,643

 

 

 

 

 

7,728

 

 

 

 

 

8,810

 

 

 

 

 

Allowance for loan losses

 

(17,363

)

 

 

 

 

(10,309

)

 

 

 

 

(5,662

)

 

 

 

 

Premises & equipment

 

23,023

 

 

 

 

 

23,836

 

 

 

 

 

21,466

 

 

 

 

 

Other assets

 

34,609

 

 

 

 

 

36,316

 

 

 

 

 

20,467

 

 

 

 

 

Total assets

 

$

626,805

 

 

 

 

 

$

794,687

 

 

 

 

 

$

727,426

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Transaction accounts

 

$

494,898

 

$

6,011

 

1.21

%

$

578,260

 

$

10,044

 

1.73

%

$

520,167

 

$

11,632

 

2.17

%

Other borrowings

 

76,433

 

2,913

 

3.81

%

132,173

 

4,523

 

3.42

%

125,187

 

3,961

 

3.16

%

Total interest-bearing liabilities

 

571,331

 

8,924

 

1.56

%

710,433

 

14,567

 

2.05

%

645,354

 

15,593

 

2.42

%

Non-interest deposits

 

41,121

 

 

 

 

 

39,546