<SUBMISSION>
      <TYPE>  10-Q
      <FILER>  
            <CIK>  0001091491
            <CCC>  xxxxxxx
      </FILER>
      <NOTIFY-INTERNET>  atacust@merrillcorp.com
      <PERIOD>  03/31/2012
      <SMALL-REPORTING-CO>  Yes
      <SROS>  NONE
      <SUBMISSION-CONTACT>  
            <NAME>  EDGAR  Advantage  Service  Team
            <PHONE>  (800)  688  -  1933
      </SUBMISSION-CONTACT>

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the Quarterly Period Ended March 31, 2012

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Transition Period from                   to                  

 

Commission File Number 000-26995

 

HCSB FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

South Carolina

 

57-1079444

(State or other jurisdiction
of incorporation)

 

(I.R.S. Employer
Identification No.)

 

5201 Broad Street

Loris, South Carolina 29569

(Address of principal executive
offices, including zip code)

 

(843) 756-6333

(Issuer’s telephone number, including area code)

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No 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 preceding12 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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See 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 o
(do not check if 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 Exchange Act).  Yes o  No  x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 3,738,337 shares of common stock, par value $.01 per share, were issued and outstanding as of May 14, 2012.

 

 

 



Table of Contents

 

HCSB FINANCIAL CORPORATION

 

Index

 

 

Page No.

PART I. FINANCIAL INFORMATION

 

 

 

Item 1. Financial Statements (Unaudited)

 

 

 

Condensed Consolidated Balance Sheets - March 31, 2012 and December 31, 2011

3

 

 

Condensed Consolidated Statements of Operations - Three months ended March 31, 2012 and 2011

4

 

 

Condensed Consolidated Statements of Comprehensive Income (Loss) — Three months ended March 31, 2012 and 2011

5

 

 

Condensed Consolidated Statements of Shareholders’ Equity - Three months ended March 31, 2012 and 2011

6

 

 

Condensed Consolidated Statements of Cash Flows - Three months ended March 31, 2012 and 2011

7

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

8-40

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

41-57

 

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

57

 

 

Item 4. Controls and Procedures

58

 

 

PART II. OTHER INFORMATION

 

 

 

Item 1. Legal Proceedings

58

 

 

Item 1A. Risk Factors

58

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

58

 

 

Item 3. Defaults Upon Senior Securities

58

 

 

Item 4. Mine Safety Disclosures

58

 

 

Item 5. Other Information

58

 

 

Item 6. Exhibits

59

 

2



Table of Contents

 

HCSB FINANCIAL CORPORATION

Condensed Consolidated Balance Sheets

 

 

 

March 31,

 

December 31,

 

(Dollars in thousands, except shares)

 

2012

 

2011

 

 

 

(Unaudited)

 

(Audited)

 

Assets:

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

Cash and due from banks

 

$

31,915

 

$

33,672

 

Securities available-for-sale

 

118,037

 

100,207

 

Nonmarketable equity securities

 

3,975

 

3,975

 

Total investment securities

 

122,012

 

104,182

 

Loans receivable

 

350,847

 

366,995

 

Less allowance for loan losses

 

(20,690

)

(21,178

)

Loans, net

 

330,157

 

345,817

 

Premises and equipment, net

 

22,281

 

22,514

 

Accrued interest receivable

 

2,836

 

2,776

 

Cash value of life insurance

 

10,377

 

10,285

 

Other real estate owned

 

15,998

 

15,665

 

Other assets

 

1,168

 

787

 

Total assets

 

$

536,744

 

$

535,698

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Liabilities:

 

 

 

 

 

Deposits:

 

 

 

 

 

Noninterest-bearing transaction accounts

 

$

37,459

 

$

37,029

 

Interest-bearing transaction accounts

 

45,737

 

44,989

 

Money market savings accounts

 

123,764

 

124,987

 

Other savings accounts

 

8,207

 

7,615

 

Time deposits $100 M and over

 

145,196

 

131,561

 

Other time deposits

 

129,428

 

144,672

 

Total deposits

 

489,791

 

490,853

 

Repurchase Agreements

 

8,465

 

7,492

 

Advances from the Federal Home Loan Bank

 

22,000

 

22,000

 

Subordinated debentures

 

12,062

 

12,062

 

Junior subordinated debentures

 

6,186

 

6,186

 

Accrued interest payable

 

1,273

 

1,015

 

Other liabilities

 

1,303

 

1,306

 

Total liabilities

 

541,080

 

540,914

 

Shareholders’ Equity

 

 

 

 

 

Preferred stock, $1,000 par value. Authorized 5,000,000 shares; issued and outstanding 12,895 at March 31, 2012 and December 31, 2011

 

12,409

 

12,355

 

Common stock, $.01 par value; 10,000,000 shares authorized, 3,738,337 shares issued and outstanding at March 31, 2012 and December 31, 2011

 

37

 

37

 

Capital surplus

 

30,224

 

30,224

 

Common stock warrants

 

1,012

 

1,012

 

Accumulated deficit

 

(46,343

)

(46,033

)

Accumulated other comprehensive loss

 

(1,675

)

(2,811

)

Total shareholders’ equity

 

(4,336

)

(5,216

)

Total liabilites and shareholders’ equity

 

$

536,744

 

$

535,698

 

 

See notes to condensed financial statements.

 

3



Table of Contents

 

HCSB FINANCIAL CORPORATION

Condensed Consolidated Statements of Operations

(Unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

(Dollars in thousands, except per share amounts)

 

2012

 

2011

 

Interest income:

 

 

 

 

 

Loans, including fees

 

$

4,682

 

$

5,670

 

Investment securities:

 

 

 

 

 

Taxable

 

727

 

1,682

 

Tax-exempt

 

103

 

216

 

Nonmarketable equity securities

 

11

 

8

 

Other interest income

 

20

 

14

 

Total

 

5,543

 

7,590

 

 

 

 

 

 

 

Interest expense:

 

 

 

 

 

Certificates of deposit $100M and over

 

350

 

666

 

Other deposits

 

710

 

1,270

 

Other interest expense

 

561

 

1,045

 

Total

 

1,621

 

2,981

 

Net interest income

 

3,922

 

4,609

 

Provision for loan losses

 

1,318

 

8,550

 

 

 

 

 

 

 

Net interest income (loss) after provision for loan losses

 

2,604

 

(3,941

)

 

 

 

 

 

 

Noninterest income:

 

 

 

 

 

Service charges on deposit accounts

 

281

 

337

 

Credit life insurance commissions

 

6

 

7

 

Gain on sale of securities available-for-sale

 

72

 

1,815

 

Gain on sale of mortgage loans

 

50

 

155

 

Other fees and commissions

 

102

 

93

 

Brokerage commissions

 

37

 

67

 

Income from cash value of life insurance

 

115

 

116

 

Gain on sale of assets

 

170

 

 

Other operating income

 

38

 

25

 

Total

 

871

 

2,615

 

 

 

 

 

 

 

Noninterest expenses:

 

 

 

 

 

Salaries and employee benefits

 

1,660

 

1,974

 

Net occupancy expense

 

308

 

308

 

Furniture and equipment expense

 

301

 

328

 

Marketing expense

 

9

 

60

 

Prepayment penalties on FHLB advances

 

 

1,312

 

FDIC insurance premiums

 

391

 

523

 

Net cost of operations of other real estate owned

 

337

 

1,019

 

Other operating expenses

 

725

 

826

 

Total

 

3,731

 

6,350

 

Loss before income taxes

 

(256

)

(7,676

)

Income tax benefit

 

 

 

Net loss

 

$

(256

)

$

(7,676

)

Accretion of preferred stock to redemption value

 

54

 

50

 

Preferred dividends accrued

 

161

 

161

 

Net loss available to common shareholders

 

(471

)

(7,887

)

 

 

 

 

 

 

Basic loss per share

 

$

(0.13

)

$

(2.10

)

Diluted loss per share

 

$

(0.13

)

$

(2.10

)

 

See notes to condensed financial statements.

 

4



Table of Contents

 

HCSB FINANCIAL CORPORATION

 

Condensed Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

(Dollars in thousands)

 

2012

 

2011

 

Net loss

 

$

(256

)

$

(7,676

)

Other comprehensive income (loss):

 

 

 

 

 

Unrealized gains on securities available for sale:

 

 

 

 

 

Unrealized holding gains arising during the period, pretax

 

788

 

(335

)

Tax expense

 

 

124

 

Reclassification to realized gains

 

(72

)

(1,815

)

Tax expense

 

 

672

 

Write-down of deferred tax asset on AFS securities

 

420

 

 

Other comprehensive income

 

1,136

 

(1,354

)

Comprehensive income (loss)

 

$

880

 

$

(9,030

)

 

See notes to condensed financial statements.

 

5



Table of Contents

 

HCSB FINANCIAL CORPORATION

 

Condensed Consolidated Statements of Shareholders’ Equity

For the Three Months ended March 31, 2012 and 2011

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

Common

 

 

 

 

 

Nonvested

 

 

 

Retained

 

other

 

 

 

(Dollars in thousands except

 

Common Stock

 

Stock

 

Preferred Stock

 

Restricted

 

Capital

 

Earnings

 

comprehensive

 

 

 

share data)

 

Shares

 

Amount

 

Warrants

 

Shares

 

Amount

 

Stock

 

Surplus

 

(deficit)

 

income

 

Total

 

Balance, December 31, 2010

 

3,780,845

 

$

38

 

$

1,012

 

12,895

 

$

12,152

 

$

(564

)

$

30,787

 

$

(16,813

)

$

(113

)

$

26,499

 

Net loss for the period

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(7,676

)

 

 

(7,676

)

Other comprehensive income, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,354

)

(1,354

)

Accretion of preferred stock to redemption value

 

 

 

 

 

 

 

 

 

50

 

 

 

 

 

(50

)

 

 

 

Termination of employee stock option plans

 

(42,508

)

(1

)

 

 

 

 

 

 

564

 

(563

)

 

 

 

 

 

Balance, March 31, 2011

 

3,738,337

 

$

37

 

$

1,012

 

12,895

 

$

12,202

 

$

 

$

30,224

 

$

(24,539

)

$

(1,467

)

$

17,469

 

Balance, December 31, 2011

 

3,738,337

 

$

37

 

$

1,012

 

12,895

 

$

12,355

 

$

 

$

30,224

 

$

(46,033

)

$

(2,811

)

$

(5,216

)

Net loss for the period

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(256

)

 

 

(256

)

Other comprehensive income, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

716

 

716

 

Valuation allowance on deferred tax asset on AFS securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

420

 

420

 

Accretion of preferred stock to redemption value

 

 

 

 

 

 

 

 

 

54

 

 

 

 

 

(54

)

 

 

 

Balance, March 31, 2012

 

3,738,337

 

$

37

 

$

1,012

 

12,895

 

$

12,409

 

$

 

$

30,224

 

$

(46,343

)

$

(1,675

)

$

(4,336

)

 

See notes to condensed financial statements.

 

6



Table of Contents

 

HCSB FINANCIAL CORPORATION

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

Three Months Ended

 

(Dollars in thousands)

 

March 31, 2012

 

March 31, 2011

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(256

)

$

(7,676

)

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

239

 

259

 

Provision for loan losses

 

1,318

 

8,550

 

Amortization less accretion on investments

 

(138

)

195

 

Amortization of deferred loan costs

 

22

 

6

 

Net gain on sale of securities available-for-sale

 

(72

)

(1,815

)

(Gain) loss on sale of other real estate owned

 

63

 

(33

)

Gain on sale of other assets

 

(170

)

 

Writedowns of other real estate owned

 

 

789

 

Increase (decrease) in interest payable

 

258

 

69

 

(Increase) decrease in interest receivable

 

(60

)

704

 

(Increase) decrease in other assets

 

(431

)

1,072

 

Income (net of mortality cost) on cash value of life insurance

 

(92

)

(96

)

Decrease in other liabilities

 

(3

)

(260

)

Net cash provided by operating activities

 

678

 

1,764

 

Cash flows from investing activities:

 

 

 

 

 

Decrease in loans to customers

 

12,583

 

10,060

 

Purchases of securities available-for-sale

 

(27,812

)

(514

)

Maturities and calls of securities available-for-sale

 

9,039

 

11,663

 

Proceeds from sale of other real estate owned

 

1,341

 

4,228

 

Proceeds from sales of securities available-for-sale

 

2,289

 

94,232

 

Proceeds from sale of other assets

 

220

 

 

Repurchases of nonmarketable equity securities

 

 

(910

)

Purchases of premises and equipment

 

(6

)

(118

)

Net cash provided (used) by investing activiities

 

(2,346

)

118,641

 

Cash flows from financing activities:

 

 

 

 

 

Net increase (decrease) in demand deposits and savings

 

547

 

(19,314

)

Net decrease in time deposits

 

(1,609

)

(49,190

)

Net decrease in FHLB borrowings

 

 

(56,000

)

Net increase in repurchase agreements

 

973

 

2,397

 

Net increase in fed funds purchased

 

 

330

 

Net cash provided (used) by financing activities

 

(89

)

(121,777

)

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

(1,757

)

(1,372

)

Cash and cash equivalents, beginning of period

 

33,672

 

19,562

 

Cash and cash equivalents, end of period

 

$

31,915

 

$

18,190

 

 

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Income taxes

 

$

 

$

 

Interest

 

$

1,363

 

$

2,912

 

 

See notes to condensed financial statements.

 

7



Table of Contents

 

HCSB FINANCIAL CORPORATION

 

NOTE 1 — BASIS OF PRESENTATION

 

HCSB Financial Corporation (the “Company,” which may be referred to as “we,” “us,” or “our”) 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.  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.

 

HCSB Financial Trust I (the “Trust”) is a special purpose subsidiary organized for the sole purpose of issuing trust preferred securities.  The operations of the Trust have not been consolidated in these financial statements.

 

The accompanying consolidated financial statements have been prepared in accordance with the requirements for interim financial statements and, accordingly, they are condensed and omit disclosures, which would substantially duplicate those contained in the most recent annual report to shareholders.  The financial statements as of March 31, 2012 and for the interim periods ended March 31, 2012 and 2011 are unaudited and, in our opinion, include all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation.  Operating results for the three month period ended March 31, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.  The financial information as of December 31, 2011 has been derived from the audited financial statements as of that date.  For further information, refer to the financial statements and the notes included in HCSB Financial Corporation’s 2011 Annual Report.

 

On March 6, 2009, as part of the Troubled Asset Relief Program (the “TARP”) Capital Purchase Program (the “CPP”) established by the U.S. Treasury under the Emergency Economic Stabilization Act of 2009 (“EESA”), the Company issued and sold to the U.S. Treasury (i) 12,895 shares of its 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 its common stock at an initial exercise price of $21.09 per share (the “CPP Warrant”), for an aggregate purchase price of $12,895,000 in cash.  Refer to the accompanying Management’s Discussion and Analysis of Financial Condition and results of Operations for additional information.

 

As of February, 2011, the Federal Reserve Bank of Richmond, the Company’s primary federal regulatory, has required the Company to defer dividend payments on the 12,895 shares of the Series T Preferred Stock issued to the U.S. Treasury in March 2009 pursuant to the CPP and interest payments on the $6,000,000 of trust preferred securities issued in December 2004.  Therefore, for each quarterly period beginning in February 2011, the Company notified the U.S. Treasury of our deferral of quarterly dividend payments on the 12,895 shares of Series T Preferred Stock and also informed the Trustee of the $6,000,000 of trust preferred securities of our deferral of a quarterly interest payments.  The amount of each of our quarterly interest payments was $161,000, and as of March 31, 2012, the Company had $806,000 accrued on our dividend payments due on our Series T Preferred Stock issued to the U.S. Treasury.  Because we have deferred these five payments, we are prohibited from paying any dividends on our common stock until all deferred payments have been made in full.  As a result of our financial condition and these restrictions on the Company, including the restrictions on our Bank’s ability to pay dividends to the Company, there was no stock dividend declared in 2010, 2011, or the first three months of 2012.

 

NOTE 2 — REGULATORY MATTERS AND GOING CONCERN CONSIDERATIONS

 

Consent Order with the Federal Deposit Insurance Corporation and South Carolina Board of Financial Institutions

 

On February 10, 2011, the Bank entered into a Consent Order (the “Consent Order”) with the FDIC and the South Carolina Board of Financial Institutions (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.  A summary of the requirements of the Consent Order and the Bank’s status on complying with the Consent Order is as follows:

 

Requirements of the Consent Order

 

Bank’s Compliance Status

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.

 

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

 

8



Table of Contents

 

 

 

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, management believes that in the short-term the more realistic opportunity will be to raise additional capital.

 

 

 

Submit, by April 11, 2011, a written capital plan to the supervisory authorities.

 

We believe we have complied with this provision of the Consent Order.

 

 

 

Establish, by March 12, 2011, a plan to monitor compliance with the Consent Order, which shall be monitored by the Bank’s Directors’ Committee.

 

We believe we have complied with this provision of the Consent Order. The Directors’ Committee meets monthly and each meeting includes reviews and discussions of all areas required in the Consent Order.

 

 

 

Develop, by May 11, 2011, a written analysis and assessment of the Bank’s management and staffing needs.

 

We believe we have complied with this provision of the Consent Order. In 2011, the Bank engaged an independent third party to perform an assessment of the Bank’s staffing needs to ensure the Bank has an appropriate organizational structure with qualified management in place. The Board of Directors has reviewed all recommendations regarding the Bank’s organizational structure.

 

 

 

Notify the supervisory authorities in writing of the resignation or termination of any of the Bank’s directors or senior executive officers.

 

We believe we have complied with this provision of the Consent Order.

 

 

 

Eliminate, by March 12, 2011, by charge-off or collection, all assets or portions of assets classified “Loss” and 50% of those assets classified “Doubtful.”

 

The Bank is in full compliance with requirement to eliminate all loans classified “Loss” and reduce by 50% all assets classified “Doubtful” by March 13, 2011, and reduce all classified assets by specific percentages over a period of two years. Assets classified in the Report of Examination conducted as of June 30, 2010 have been reduced by 44.2%, which is slightly less than the target reduction of 45% by February 9, 2012 as stated in the Consent Order. Management has allocated additional resources to the handling of non-accrual loans, loans in liquidation, and the disposition of OREO.

 

 

 

Review and update, by April 11, 2011, its policy to ensure the adequacy of the Bank’s allowance for loan and lease losses, which must provide for a review of the Bank’s allowance for loan and lease losses at least once each calendar quarter.

 

We believe we have complied with this provision of the Consent Order.

 

 

 

Submit, by April 11, 2011, a written plan to the

 

We believe we have complied with this provision of the

 

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supervisory authorities to reduce classified assets, which shall include, among other things, a reduction of the Bank’s risk exposure in relationships with assets in excess of $750,000 which are criticized as “Substandard” or “Doubtful”.

 

Consent Order. Assets classified in the Report of Examination conducted as of June 30, 2010 have been reduced by 44.2%, which is slightly less than the target reduction of 45% by February 9, 2012 as stated in the Consent Order.

 

 

 

Revise, by April 11, 2011, its policies and procedures for managing the Bank’s Adversely Classified Other Real Estate Owned.

 

We believe we have complied with this provision of the Consent Order.

 

 

 

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, in whole or in part, “Loss” or “Doubtful” and is uncollected. In addition, the Bank may not extend any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been criticized, in whole or in part, “Substandard” and is uncollected, unless the Bank’s board of directors determines that failure to extend further credit to a particular borrower would be detrimental to the best interests of the Bank.

 

We believe we have complied with this provision of the Consent Order. In the second quarter of 2010, the Bank engaged the services of an independent firm to perform an extensive review of the Bank’s credit portfolio and help management implement a more comprehensive lending and collection policy and more enhanced loan review.

 

 

 

Perform, by April 11, 2011, a risk segmentation analysis with respect to the Bank’s Concentrations of Credit and develop a written plan to systematically reduce any segment of the portfolio that is an undue concentration of credit.

 

We believe we have complied with this provision of the Consent Order.

 

 

 

Review, by April 11, 2011 and annually thereafter, the Bank’s loan policies and procedures for adequacy and, based upon this review, make all appropriate revisions to the policies and procedures necessary to enhance the Bank’s lending functions and ensure their implementation.

 

We believe we have complied with this provision of the Consent Order. As noted above, the Bank engaged the services of an independent firm to perform an extensive review of the Bank’s credit portfolio and help management implement a more comprehensive lending and collection policy and more enhanced loan review.

 

 

 

Adopt, by May 11, 2011, an effective internal loan review and grading system to provide for the periodic review of the Bank’s loan portfolio in order to identify and categorize the Bank’s loans, and other extensions of credit which are carried on the Bank’s books as loans, on the basis of credit quality.

 

We believe we have complied with this provision of the Consent Order. As noted above, the Bank engaged the services of an independent firm to perform an extensive review of the Bank’s credit portfolio and help management implement a more comprehensive lending and collection policy and more enhanced loan review.

 

 

 

Review and update, by May 11, 2011, its written profit plan to ensure the Bank has a realistic, comprehensive budget for all categories of income and expense, which must address, at minimum, goals and strategies for improving and sustaining the earnings of the Bank, the major areas in and means by which the Bank will seek to improve the Bank’s operating performance, realistic and comprehensive budgets, a budget review process to monitor income and expenses of the Bank to compare actual figure with budgetary projections, the operating assumptions that form the basis for and adequately support major projected income and expense components of the plan, and coordination of the Bank’s loan, investment, and operating policies and budget and profit planning with the funds management policy.

 

We believe we have complied with this provision of the Consent Order. The Bank has engaged an independent third party to assist management with a strategic plan to help restructure its balance sheet, increase capital ratios, return to profitability and maintain adequate liquidity.

 

 

 

Review and update, by May 11, 2011, its written plan

 

We believe we have complied with this provision of the

 

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addressing liquidity, contingent funding, and asset liability management.

 

Consent Order. In 2011, the Bank engaged an independent third party to assist management in its development of a strategic plan that achieves all requirements of the Consent Order. The strategic plan reflects the Bank’s plans to restructure its balance sheet, increase capital ratios, return to profitability, and maintain adequate liquidity. The Board of Directors has reviewed and adopted the Bank’s strategic plan.

 

 

 

Eliminate, by March 12, 2011, all violations of law and regulation or contraventions of policy set forth in the FDIC’s safety and soundness examination of the Bank in November 2009.

 

We believe we have complied with this provision of the Consent Order.

 

 

 

Not accept, renew, or rollover any brokered deposits unless it is in compliance with the requirements of 12 C.F.R. § 337.6(b).

 

Since entering into the Consent Order, the Bank has not accepted, renewed, or rolled-over any brokered deposits.

 

 

 

Limit asset growth to 5% per annum.

 

We believe we have complied with this provision of the Consent Order.

 

 

 

Not declare or pay any dividends or bonuses or make any distributions of interest, principal, or other sums on subordinated debentures without the prior approval of the supervisory authorities.

 

We believe we have complied with this provision of the Consent Order.

 

 

 

The Bank shall comply with the restrictions on the effective yields on deposits as described in 12 C.F.R. § 337.6.

 

We believe we have complied with this provision of the Consent Order.

 

 

 

Furnish, by March 12, 2011 and within 30 days of the end of each quarter thereafter, written progress reports to the supervisory authorities detailing the form and manner of any actions taken to secure compliance with the Consent Order.

 

We believe we have complied with this provision of the Consent Order, and we have submitted the required progress reports to the supervisory authorities.

 

 

 

Submit, by March 12, 2011, a written plan to the supervisory authorities for eliminating its reliance on brokered deposits.

 

We believe we have complied with the provision of the Consent Order.

 

 

 

Adopt, by April 11, 2011, an employee compensation plan after undertaking an independent review of compensation paid to all of the Bank’s senior executive officers.

 

We believe we have complied with the provision of the Consent Order.

 

 

 

Prepare and submit, by May 11, 2011, its written strategic plan to the supervisory authorities.

 

We believe we have complied with this provision of the Consent Order. In 2011, the Bank engaged an independent third party to assist management in its development of a strategic plan that achieves all requirements of the Consent Order. The Board of Directors has reviewed and adopted the Bank’s strategic plan.

 

There can be no assurance that the Bank will be able to comply fully with the provisions of the Consent Order, and the determination of the Bank’s compliance will be made by the FDIC and the State Board.  However, we believe we are currently in substantial compliance with the Consent Order except for the requirements to (i) 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, and (ii) eliminate, by March 12, 2011, by charge-off or collection, all assets or portions of assets classified “Loss” and 50% of those assets classified “Doubtful.”  Should we fail to comply with the capital requirements in the Consent Order, or suffer a continued deterioration in our financial condition, the

 

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Bank may be subject to being placed into a federal conservatorship or receivership by the FDIC, with the FDIC appointed as conservator or receiver.  In addition, the supervisory authorities may amend the Consent Order based on the results of their ongoing examinations.

 

At March 31, 2012, the Bank was categorized as “significantly undercapitalized.”  Our losses during 2010 and 2011 have adversely impacted our capital.  As a result, we have been pursuing a plan through which we intend to achieve the capital requirements set forth under the Consent Order and have ceased to grow the Bank.  Our plan to increase our capital ratios includes, among other things, the sale of assets, reduction in total assets, reduction of overhead expenses, and reduction of dividends as the primary means of improving the Bank’s capital position, as well as raising additional capital at either the Bank or the holding company level and attempting to find a merger partner for the Company or the Bank.  Pursuant to the requirements under the Consent Order, we submitted our capital plan to the FDIC for review.  The FDIC directed us to revise the capital plan and, in addition, to develop a capital restoration plan, which we resubmitted in September 2011.  We received the FDIC’s non-objection to the revised capital restoration plan on December 6, 2011.

 

We anticipate that we will need to raise a material amount of capital to return the Bank to an adequate level of capitalization.  As a result, with the assistance of our financial advisors, we are currently exploring a number of strategic alternatives to strengthen the capital level of the Bank.  We note that there are no assurances that we will be able to raise this capital on a timely basis or at all.

 

We are also working diligently to improve asset quality and to reduce the Bank’s investment in commercial real estate loans as a percentage of Tier 1 capital.  The Company is reducing its reliance on brokered deposits and is committed to improving the Bank’s capital position.

 

Written Agreement

 

On May 9, 2011, the Company entered into the Written Agreement with the Federal Reserve Bank of Richmond.  The Written Agreement is designed to enhance the Company’s ability to act as a source of strength to the Bank.

 

The Written Agreement contains provisions similar to those in the Bank’s Consent Order.  Specifically, pursuant to the Written Agreement, the Company agreed, among other things, to seek the prior written approval of the Federal Reserve Bank of Richmond before undertaking any of the following activities:

 

·                  declaring or paying any dividends,

·                  directly or indirectly taking dividends or any other form of payment representing a reduction in capital from the Bank,

·                  making any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities,

·                  directly or indirectly, incurring, increasing or guarantying any debt, and

·                  directly or indirectly, purchasing or redeeming any shares of its stock.

 

The Company also agreed to comply with certain notice provisions set forth in the Federal Deposit Insurance Act and Board of Governors’ Regulations in appointing any new director or senior executive officer, or changing the responsibilities of any senior executive officer so that the officer would assume a different senior executive officer position.  The Company is also required to comply with certain restrictions on indemnification and severance payments pursuant to the Federal Deposit Insurance Act and FDIC regulations.

 

We believe we are currently in substantial compliance with the Written Agreement.

 

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Going Concern Considerations

 

The going concern assumption is a fundamental principle in the preparation of financial statements. It is the responsibility of management to assess the Company’s ability to continue as a going concern. In assessing this assumption, the Company has taken into account all available information about the future, which is at least, but is not limited to, twelve months from the balance sheet date of March 31, 2012. The Company has a history of profitable operations and sufficient sources of liquidity to meet its short-term and long-term funding needs. However, the Bank’s financial condition has suffered during 2010, 2011 and the first three months of 2012 from the extraordinary effects of what may ultimately be the worst economic downturn since the Great Depression.

 

The effects of the current economic environment are being felt across many industries, with financial services and residential real estate being particularly hard hit. The Bank, with a loan portfolio consisting of a concentration in commercial real estate loans, has seen a decline in the value of the collateral securing its portfolio as well as rapid deterioration in its borrowers’ cash flow and ability to repay their outstanding loans to the Bank. As a result, the Bank’s level of nonperforming assets increased substantially during 2010 and 2011.  However, the Bank’s nonperforming assets began to stabilize during the first three months of 2012, as the Bank’s nonperforming assets equaled $86,449,000, or 16.11% of assets, as of March 31, 2012 as compared to $86,894,000, or 16.22% of assets, as of December 31, 2011. However, our level of impaired loans increased to $81,141,000 at March 31, 2012 compared to $80,410,000 at December 31, 2011. For the three months ended March 31, 2012, the Bank recorded a $1,318,000 provision to increase the allowance for loan losses to a level which, in management’s best judgment, adequately reflected the increased risk inherent in the loan portfolio as of March 31, 2012. Nevertheless, given the current economic climate, management recognizes the possibility of further deterioration in the loan portfolio for the remainder of 2012.  For the three months ended March 31, 2012, we recorded net loan charge-offs of $1,806,000, or 0.50% of average loans, as compared to net loan charge-offs of $6,969,000, or 1.58% of average loans, for the three months ended March 31, 2011.

 

The Company and the Bank operate in a highly regulated industry and must plan for the liquidity needs of each entity separately. A variety of sources of liquidity are available to the Bank to meet its short-term and long-term funding needs. Although a number of these sources have been limited following execution of the Consent Order, management has prepared forecasts of these sources of funds and the Bank’s projected uses of funds during 2012 in an effort to ensure that the sources available are sufficient to meet the Bank’s projected liquidity needs for this period.

 

The Company relies on dividends from the Bank as its primary source of liquidity. The Company is a legal entity separate and distinct from the Bank. Various legal limitations restrict the Bank from lending or otherwise supplying funds to the Company to meet its obligations, including paying dividends. In addition, the terms of the Consent Order described below further limits the Bank’s ability to pay dividends to the Company to satisfy its funding needs.

 

Management believes the Bank’s liquidity sources are adequate to meet its needs for at least the next 12 months, but if the Bank is unable to meet its liquidity needs, then the Bank may be placed into a federal conservatorship or receivership by the FDIC, with the FDIC appointed conservator or receiver.

 

The Company will also need to raise substantial additional capital to increase capital levels to meet the standards set forth by the FDIC. As a result of the recent downturn in the financial markets, the availability of many sources of capital (principally to financial services companies) has become significantly restricted or has become increasingly costly as compared to the prevailing market rates prior to the volatility. Management cannot predict when or if the capital markets will return to more favorable conditions. Management is actively evaluating a number of capital sources, asset reductions and other balance sheet management strategies to ensure that the Bank’s projected level of regulatory capital can support its balance sheet.

 

There can be no assurances that the Company will be successful in its efforts to raise additional capital during 2012, or at all. An equity financing transaction would result in substantial dilution to the Company’s current shareholders and could adversely affect the market price of the Company’s common stock. It is difficult to predict if these efforts will be successful, either on a short-term or long-term basis. Should these efforts be unsuccessful, due to the regulatory restrictions which exist that restrict cash payments between the Bank and the Company, the Company may be unable to realize its assets and discharge its liabilities in the normal course of business.

 

As a result of management’s assessment of the Company’s ability to continue as a going concern, the accompanying consolidated financial statements for the Company have been prepared on a going concern basis, which

 

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contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future, and does not include any adjustments to reflect the possible future effects on the recoverability or classification of assets.

 

NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Management’s Estimates - In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the balance sheet date and income and expenses for the period.  Actual results could differ significantly from those estimates.

 

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, including valuation allowances for impaired loans, and the carrying amount of real estate acquired in connection with foreclosures or in satisfaction of loans.  Management must also make estimates in determining the estimated useful lives and methods for depreciating premises and equipment.

 

While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowance may be necessary based on changes in local economic conditions.  In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowances for losses on loans and foreclosed real estate.  Such agencies may require the Company to recognize additions to the allowances based on their judgments about information available to them at the time of their examination.  Because of these factors, it is reasonably possible that the allowances for losses on loans and foreclosed real estate may change materially in the near term.

 

Investment Securities - Investment securities available-for-sale by the Company are carried at amortized cost and adjusted to their estimated fair value for reporting purposes.  The unrealized gain or loss is recorded in shareholders’ equity net of the deferred tax effects.  Management does not actively trade securities classified as available-for-sale, but intends to hold these securities for an indefinite period of time and may sell them prior to maturity to achieve certain objectives.  Reductions in fair value considered by management to be other than temporary are reported as a realized loss and a reduction in the cost basis in the security.  The adjusted cost basis of securities available-for-sale is determined by specific identification and is used in computing the realized gain or loss from a sales transaction.

 

Nonmarketable Equity Securities - Nonmarketable equity securities include the Company’s investments in the stock of the Federal Home Loan Bank (the “FHLB”).  The FHLB stock is carried at cost because the stock has no quoted market value and no ready market exists.  Investment in FHLB stock is a condition of borrowing from the FHLB, and the stock is pledged to collateralize the borrowings.  Dividends received on FHLB stock are included as a separate component in interest income.

 

Loans Receivable - Loans receivable are stated at their unpaid principal balance.  Interest income on loans is computed based upon the unpaid principal balance.  Interest income is recorded in the period earned.

 

The accrual of interest income is generally discontinued when a loan becomes contractually 90 days past due as to principal or interest.  Management may elect to continue the accrual of interest when the estimated net realizable value of collateral exceeds the principal balance and accrued interest.

 

Loan origination, commitment fees, and certain direct loan origination costs (principally salaries and employee benefits) are deferred and amortized to income over the contractual life of the related loans or commitments, adjusted for prepayments, using the straight-line method.

 

Loans are defined as impaired when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement.  All loans are subject to this criteria except for smaller balance homogeneous loans that are collectively evaluated for impairment and loans measured at fair value or at the lower of cost or fair value.  The Company considers its consumer installment portfolio, credit card loans, and home equity lines as such exceptions.  Therefore, loans within the real estate and commercial loan portfolios are reviewed individually.

 

Impairment of a loan is measured based on the present value of expected future cash flows discounted at the loan’s

 

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NOTE 3 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued

 

effective interest rate or the fair value of the collateral if the loan is collateral dependent.  When management determines that a loan is impaired, the difference between the Company’s investment in the related loan and the present value of the expected future cash flows, or the fair value of the collateral, is charged off with a corresponding entry to the allowance for loan losses.  The accrual of interest is discontinued on an impaired loan when management determines the borrower may be unable to meet payments as they become due.

 

Concentrations of Credit Risk - Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of loans receivable, investment securities, federal funds sold and amounts due from banks.

 

The Company makes loans to individuals and small businesses for various personal and commercial purposes primarily throughout Horry County in South Carolina and Columbus and Brunswick counties in North Carolina.  The Company’s loan portfolio is not concentrated in loans to any single borrower or a relatively small number of borrowers.  However, the loan portfolio does include a concentration in loans secured by residential and commercial real estate and commercial and industrial non-real estate loans.  These loans are especially susceptible to being adversely effected by the current economic downturn.  The current downturn in the real estate market has resulted in an increase in loan delinquencies, defaults and foreclosures, and we believe these trends are likely to continue, especially in the Myrtle Beach area.  In some cases, this downturn has resulted in a significant impairment to the value of our collateral and our ability to sell the collateral upon foreclosure, and there is a risk that this trend will continue.  The commercial 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.  If real estate values in our market areas continue to decline, it is also more likely that we would be required to increase our allowance for loan losses.

 

In addition to monitoring potential concentrations of loans to particular borrowers or groups of borrowers, industries and geographic regions, management monitors exposure to credit risk from concentrations of lending products and practices such as loans that subject borrowers to substantial payment increases (e.g. principal deferral periods, loans with initial interest-only periods, etc.), and loans with high loan-to-value ratios. Additionally, there are industry practices that could subject the Company to increased credit risk should economic conditions change over the course of a loan’s life.  For example, the Company makes variable rate loans and fixed rate principal-amortizing loans with maturities prior to the loan being fully paid (i.e. balloon payment loans).  These loans are underwritten and monitored to manage the associated risks.  Therefore, management believes that these particular practices do not subject the Company to unusual credit risk.

 

The Company’s investment portfolio consists principally of obligations of the United States, its agencies or its corporations and general obligation municipal securities.  In the opinion of management, there is no concentration of credit risk in its investment portfolio.  The Company places its deposits and correspondent accounts with and sells its federal funds to high quality institutions.  Management believes credit risk associated with correspondent accounts is not significant.

 

Allowance for Loan Losses - The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings.  Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.  The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experiences, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.  Management’s judgments about the adequacy of the allowance are based on numerous assumptions about current events, which

 

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NOTE 3 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued

 

management believes to be reasonable, but which may or may not prove to be accurate.  Thus, there can be no assurance that loan losses in future periods will not exceed the current allowance amount or that future increases in the allowance will not be required.  No assurance can be given that management’s ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the allowance, thus adversely affecting the operating results of the Company.

 

The allowance is subject to examination by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the allowance relative to that of peer institutions, and other adequacy tests.  In addition, such regulatory agencies could require the Company to adjust its allowance based on information available to them at their examination.

 

The methodology used to determine the reserve for unfunded lending commitments, which is included in other liabilities, is inherently similar to that used to determine the allowance for loan losses adjusted for factors specific to binding commitments, including the probability of funding and historical loss ratio.

 

Premises, Furniture and Equipment - Premises, furniture and equipment are stated at cost less accumulated depreciation.  The provision for depreciation is computed by the straight-line method.  Rates of depreciation are generally based on the following estimated useful lives:  buildings - 40 years; furniture and equipment - three to 25 years.  The cost of assets sold or otherwise disposed of and the related accumulated depreciation is eliminated from the accounts, and the resulting gains or losses are reflected in the income statement.

 

Maintenance and repairs are charged to current expense as incurred, and the costs of major renewals and improvements are capitalized.

 

Other Real Estate Owned - Other real estate owned includes real estate acquired through foreclosure.  Other real estate owned is initially recorded at the lower of cost (principal balance of the former loan plus costs of improvements) or fair value, less estimated costs to sell.

 

Any write-downs at the dates of acquisition are charged to the allowance for loan losses.  Expenses to maintain such assets, subsequent write-downs, and gains and losses on disposal are included in other expenses.

 

Income and Expense Recognition - The accrual method of accounting is used for all significant categories of income and expense.  Immaterial amounts of insurance commissions and other miscellaneous fees are reported when received.

 

Income Taxes - Amounts provided for income taxes are based on income reported for financial statement purposes. Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities.  Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.  As of March 31, 2012, our gross deferred tax asset was $18,099,023.  However, as of March 31, 2012, due to the Company’s recent financial results, the uncertainty involved in projecting near-term profitability, and evaluation of appropriate tax planning strategies, management has provided a 100% valuation allowance for our deferred tax asset in the amount of $18,099,023.  This valuation allowance reflects management’s estimate that the deferred tax asset is not more-likely-than-not to be realized.

 

The Company believes that its income tax filing positions taken or expected to be taken in its tax returns will more likely than not be sustained upon audit by the taxing authorities and does not anticipate any adjustments that will result in a material adverse impact on the Company’s financial condition, results of operations, or cash flow.  Therefore, no reserves for uncertain income tax positions have been recorded.

 

Net Income (Loss) Per Common Share - Basic income (loss) per common share is calculated by dividing net income (loss) by the weighted-average number of shares outstanding during the year.  Diluted net income per share is computed based on net income divided by the weighted average number of common and potential common shares.  Retroactive recognition has been given for the effects of all stock dividends and splits in computing the weighted-average number of shares.  The only potential common share equivalents are those related to stock options

 

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NOTE 3 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES —( continued)

 

and restricted stock awards.  Stock options that are anti-dilutive are excluded from the calculation of diluted net income per share.

 

Comprehensive Income - Accounting principles generally require recognized income, expenses, gains, and losses to be included in net income.  Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.

 

Statements of Cash Flows - For purposes of reporting cash flows, the Company considers certain highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.  Cash equivalents include amounts due from banks, federal funds sold, and time deposits with other banks with maturities of three months or less.

 

Off-Balance-Sheet Financial Instruments - In the ordinary course of business, the Company enters into off-balance-sheet financial instruments consisting of commitments to extend credit and letters of credit.  These financial instruments are recorded in the financial statements when they become payable by the customer.

 

Recently Issued Accounting Pronouncements — The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and / or disclosure of financial information by the Company.

 

ASU 2011-04 was issued in May 2011 to amend the Fair Value Measurement topic of the ASC by clarifying the application of existing fair value measurement and disclosure requirements and by changing particular principles or requirements for measuring fair value or for disclosing information about fair value measurements.  The amendments will be effective for the Company beginning January 1, 2012 but are not expected to have a material effect on the financial statements.

 

The Comprehensive Income topic of the ASC was amended in June 2011.  The amendment eliminates the option to present other comprehensive income as a part of the statement of changes in stockholders’ equity.  The amendment requires consecutive presentation of the statement of net income and other comprehensive income and requires an entity to present reclassification adjustments from other comprehensive income to net income on the face of the financial statements.  The amendments were applicable to the Company on January 1, 2012 and have been applied retrospectively.  In December 2011, the topic was further amended to defer the effective date of presenting reclassification adjustments from other comprehensive income to net income on the face of the financial statements.  Companies should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect prior to the amendments while FASB redeliberates future requirements.

 

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NOTE 3 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued

 

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

 

Risks and Uncertainties - In the normal course of its business, the Company encounters two significant types of risks: economic and regulatory.  There are three main components of economic risk:  interest rate risk, credit risk and market risk.  The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different speeds, or on different basis, than its interest-earning assets.  Credit risk is the risk of default on the Company’s loan portfolio that results from borrower’s inability or unwillingness to make contractually required payments.  Market risk reflects changes in the value of collateral underlying loans receivable and the valuation of real estate held by the Company.

 

The Company is subject to the regulations of various governmental agencies.  These regulations can and do change significantly from period to period.  The Company also undergoes periodic examinations by the regulatory agencies, which may subject it to further changes with respect to asset valuations, amounts of required loss allowances and operating restrictions from the regulators’ judgments based on information available to them at the time of their examination.

 

Additionally, the Company is subject to certain regulations due to our participation in the U.S. Treasury’s CPP.  Pursuant to the terms of the CPP Purchase Agreement between us and the Treasury, we adopted certain standards for executive compensation and corporate governance for the period during which the Treasury holds the equity issued pursuant to the CPP Purchase Agreement, including the common stock which may be issued pursuant to the CPP Warrant.  These standards generally apply to our named executive officers. The standards include (1) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) 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; (3) prohibition on making golden parachute payments to senior executives; (4) prohibition on providing tax gross-up provisions; and (5) 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 will 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.

 

Legislation that has been adopted after we closed on our sale of Series T Preferred Stock and the Warrant to the U.S. Treasury for $12.9 million pursuant to the CPP on March 6, 2009, or any legislation or regulations that may be implemented in the future, may have a material impact on the terms of our CPP transaction with the Treasury.   If we determine that any such legislation or any regulations, in whole or in part, alter the terms of our CPP transaction with the Treasury in ways that we believe are adverse to our ability to effectively manage our business, then it is possible that we may seek to unwind, in whole or in part, the CPP transaction by repurchasing some or all of the preferred stock and warrants that we sold to the Treasury pursuant to the CPP.  If we were to repurchase all or a portion of such preferred stock or warrants, then our capital levels could be materially reduced.

 

NOTE 4 — EARNINGS (LOSSES) PER SHARE

 

A reconciliation of the numerators and denominators used to calculate basic and diluted earnings (losses) per share is as follows:

 

 

 

Three Months Ended March 31, 2012

 

 

 

Income

 

Average Shares

 

Per Share

 

(Dollars in thousands, except share amounts)

 

(Numerator)

 

(Denominator)

 

Amount

 

Basic loss per share

 

 

 

 

 

 

 

Loss available to common shareholders

 

$

(471

)

3,738,337

 

$

(0.13

)

Effect of dilutive securities

 

 

 

 

 

 

 

Stock options

 

 

 

 

 

Diluted loss per share

 

 

 

 

 

 

 

Loss available to common shareholders plus assumed conversions

 

$

(471

)

3,738,337

 

$

(0.13

)

 

18



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Three Months Ended March 31, 2011

 

 

 

Income

 

Average Shares

 

Per Share

 

(Dollars in thousands, except share amounts)

 

(Numerator)

 

(Denominator)

 

Amount

 

Basic loss per share

 

 

 

 

 

 

 

Loss available to common shareholders

 

$

(7,887

)

3,754,868

 

$

(2.10

)

Effect of dilutive securities

 

 

 

 

 

 

 

Stock options

 

 

 

 

 

Diluted loss per share

 

 

 

 

 

 

 

Loss available to common shareholders plus assumed conversions

 

$

(7,887

)

3,754,868

 

$

(2.10

)

 

NOTE 5 -  INVESTMENT PORTFOLIO

 

Investment securities available-for-sale increased from $100,207,000 at December 31, 2011 to $118,037,000 at March 31, 2012 as a result of management’s concerted effort to increase the yield on our earning assets while maintaining the Bank’s liquidity position.  This represents an increase of $17,830,000, or 17.79%, from December 31, 2011 to March 31, 2012.

 

Management classifies investment securities as either held-to-maturity or available-for-sale based on their intentions and the Company’s ability to hold them until maturity.  In determining such classifications, securities that management has the positive intent and the Company has the ability to hold until maturity are classified as held-to-maturity and carried at amortized cost.  All other securities are designated as available-for-sale and carried at estimated fair value with unrealized gains and losses included in shareholders’ equity on an after-tax basis.  As of March 31, 2012, all securities were classified as available-for-sale.

 

Securities available-for-sale consisted of the following:

 

 

 

Amortized

 

Gross Unrealized

 

Estimated

 

(Dollars in thousands)

 

Cost

 

Gains

 

Losses

 

Fair Value

 

March 31, 2012

 

 

 

 

 

 

 

 

 

Government-sponsored enterprises

 

$

51,548

 

$

126

 

$

229

 

$

51,445

 

Mortgage-backed securities

 

59,023

 

279

 

2,485

 

56,817

 

Obligations of state and local governments

 

9,141

 

634

 

 

9,775

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

119,712

 

$

1,039

 

$

2,714

 

$

118,037

 

 

 

 

Amortized

 

Gross Unrealized

 

Estimated

 

(Dollars in thousands)

 

Cost

 

Gains

 

Losses

 

Fair Value

 

December 31, 2011

 

 

 

 

 

 

 

 

 

Government-sponsored enterprises

 

$

42,010

 

$

165

 

$

33

 

$

42,142

 

Mortgage-backed securities

 

50,706

 

177

 

3,677

 

47,206

 

Obligations of state and local governments

 

10,302

 

558

 

1

 

10,859

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

103,018

 

$

900

 

$

3,711

 

$

100,207

 

 

The following is a summary of maturities of securities available-for-sale as of March 31, 2012.  The amortized cost and estimated fair values are based on the contractual maturity dates.  Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalty.

 

19



Table of Contents

 

 

 

 

Estimated

 

(Dollars in thousands)

 

Fair Value

 

 

 

 

 

Due in less than one year

 

$

 

Due after one year but within five years

 

 

Due after five years but within ten years

 

14,923

 

Due after ten years

 

103,114

 

 

 

 

 

Total

 

$

118,037

 

 

The following table shows gross unrealized losses and fair value, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2012 and December 31, 2011:

 

Securities Available for Sale

 

 

 

March 31, 2012

 

 

 

Less than twelve months

 

Twelve months or more

 

Total

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

(Dollars in thousands)

 

Value

 

losses

 

Value

 

losses

 

Value

 

losses

 

Government-sponsored enterprises

 

$

32,765

 

$

229

 

$

 

$

 

$

32,765

 

$

229

 

Mortgage-backed securities

 

14,785

 

978

 

20,928

 

1,507

 

35,713

 

2,485

 

Obligations of state and local governments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

47,550

 

$

1,207

 

$

20,928

 

$

1,507

 

$

68,478

 

$

2,714

 

 

 

 

December 31, 2011

 

 

 

Less than twelve months

 

Twelve months or more

 

Total

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

(Dollars in thousands)

 

Value

 

losses

 

Value

 

losses

 

Value

 

losses

 

Government-sponsored enterprises

 

$

11,967

 

$

33

 

$

 

$

 

$

11,967

 

$

33

 

Mortgage-backed securities

 

17,653

 

1,132

 

20,750

 

2,545

 

38,403

 

3,677

 

Obligations of state and local governments

 

1,576

 

1

 

 

 

1,576

 

1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

31,196

 

$

1,166

 

$

20,750

 

$

2,545

 

$

51,946

 

$

3,711

 

 

At March 31, 2012, the Bank had nine individual securities, or 17.73% of the security portfolio, that have been in an unrealized loss position for more than twelve months.  The Bank does not intend to sell these securities and it is more likely than not that the Bank will not be required to sell these securities before recovery of their amortized cost.  The Bank believes, based on industry analyst reports and credit ratings, that the deterioration in value is attributable to changes in market interest rates and is not in the credit quality of the issuer and, therefore, these losses are not considered other-than-temporary.

 

At March 31, 2012 and 2011, investment securities with a book value of $41,617,000 and $106,749,000, respectively, and a market value of $41,717,000 and $105,570,000, respectively, were pledged to secure deposits.

 

Proceeds from sales of available-for-sale securities were $2,289,000 and $94,232,000 for the periods ended March 31, 2012 and March 31, 2011, respectively.  Gross realized gains on sales of available-for-sale securities as of March 31, 2012 were $72,000 and gross realized losses were $0.  As of March 31, 2011, gross realized gains on sales of available-for-sale securities were $1,993,000 and gross realized losses were $178,000.

 

20



Table of Contents

 

NOTE 6 - LOAN PORTFOLIO

 

The Company has experienced a decline in its loan portfolio throughout 2012 of $16,148,000, as a result of a decline in loan demand in our marketplace, to $350,847,000 as of March 31, 2012.  Management has concentrated on improving the credit quality of the loan portfolio. The loan-to-deposit ratio is used to monitor a financial institution’s potential profitability and efficiency of asset distribution and utilization.  Generally, a higher loan-to-deposit ratio is indicative of higher interest income since loans typically yield a higher return than other interest-earning assets.  The loan-to-deposit ratios were 71.63% and 74.77% at March 31, 2012 and December 31, 2011, respectively.  The loans-to-total borrowed funds ratio was 65.15% and 68.14% at March 31, 2012 and December 31, 2011, respectively.

 

The following table sets forth the composition of the loan portfolio by category at March 31, 2012 and December 31, 2011 and highlights the Company’s general emphasis on mortgage lending.

 

 

 

March 31,

 

December 31,

 

(Dollars in thousands)

 

2012

 

2011

 

Residential

 

$

159,552

 

$

163,502

 

Commercial Real Estate

 

132,309

 

142,485

 

Commercial

 

50,938

 

52,273

 

Consumer

 

8,048

 

8,735

 

Total gross loans

 

$

350,847

 

$

366,995

 

 

The primary component of our loan portfolio is loans collateralized by real estate, which made up approximately 83.18% of our loan portfolio at March 31, 2012.  These loans are secured generally by first or second mortgages on residential, agricultural or commercial property.  Commercial real estate loans declined $10.2 million, or 7.1%, 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 the remainder of 2012 in accordance with our strategic plan.  There are no foreign loans, and agricultural loans, as of March 31, 2012, were $9,719,000.  There are no significant concentrations of loans in any particular individuals or industry or group of related individuals or industries.

 

Provision and Allowance for Loan Losses

 

An allowance for loan losses is maintained at a level deemed appropriate by management to adequately provide for known and inherent losses in the loan portfolio.  The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings.  Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.

 

In evaluating the adequacy of the Company’s loan loss reserves, management identifies loans believed to be impaired. A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due, according to the contractual terms of the loan agreement.  Impaired loans are reviewed individually by management and the net present value of the collateral is estimated. Reserves are maintained for each loan in which the principal balance of the loan exceeds the net present value of the collateral. In addition to the specific allowance for individually reviewed loans, a general allowance for potential loan losses is established based on management’s review of the composition of the loan portfolio with the purpose of identifying any concentrations of risk, and an analysis of historical loan charge-offs and recoveries. The final component of the allowance for loan losses incorporates management’s evaluation of current economic conditions and other risk factors which may impact the inherent losses in the loan portfolio. These evaluations are highly subjective and require that a great degree of judgmental assumptions be made by management. This component of the allowance for loan losses includes additional estimated reserves for internal factors such as changes in lending staff, loan policy and underwriting guidelines, and loan seasoning and quality, and external factors such as national and local economic trends and conditions.

 

21



Table of Contents

 

NOTE 6 - LOAN PORTFOLIO (continued)

 

 

 

Three months ended

 

 

 

March 31,

 

(Dollars in thousands)

 

2012

 

2011

 

Balance, January 1

 

$

21,178

 

$

14,489

 

Provision for loan losses for the period

 

1,318

 

8,550

 

Net loans charged-off for the period

 

(1,806

)

(6,969

)

Balance, end of period

 

$

20,690

 

$

16,070

 

 

The following chart details the activity within our allowance for loan losses as of March 31, 2012 and December 31, 2011:

 

March 31, 2012

 

 

 

Commercial

 

 

 

 

 

 

 

(Dollars in thousands)

 

Commercial

 

Real Estate

 

Consumer

 

Residential

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

3,239

 

$

10,240

 

$

103

 

$

7,596

 

$

21,178

 

Charge-offs

 

(284

)

(408

)

(20

)

(1,284

)

(1,996

)

Recoveries

 

88

 

92

 

4

 

6

 

190

 

Provisions

 

278

 

(104

)

10

 

1,134

 

1,318

 

Ending balance

 

$

3,321

 

$

9,820

 

$

97

 

$

7,452

 

$

20,690

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balances:

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for impairment

 

$

1,981

 

$

7,011

 

$

11

 

$

3,640

 

$

12,643

 

 

 

 

 

 

 

 

 

 

 

 

 

Collectively evaluated for impairment

 

$

1,340

 

$

2,809

 

$

86

 

$

3,812

 

$

8,047

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

3,321

 

$

9,820

 

$

97

 

$

7,452

 

$

20,690

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans receivable:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance - total

 

$

50,938

 

$

132,309

 

$

8,048

 

$

159,552

 

$

350,847

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balances:

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for impairment

 

$

7,238

 

$

47,490

 

$

149

 

$

26,264

 

$

81,141

 

 

 

 

 

 

 

 

 

 

 

 

 

Collectively evaluated for impairment

 

$

43,700

 

$

84,819

 

$

7,899

 

$

133,288

 

$

269,706

 

 

22



Table of Contents

 

December 31, 2011

 

 

 

Commercial

 

 

 

 

 

 

 

(Dollars in thousands)

 

Commercial

 

Real Estate

 

Consumer

 

Residential

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

1,822

 

$

7,237

 

$

131

 

$

5,299

 

$

14,489

 

Charge-offs

 

(3,484

)

(10,769

)

(193

)

(5,389

)

(19,835

)

Recoveries

 

136

 

543

 

29

 

545

 

1,253

 

Provisions

 

4,765

 

13,229

 

136

 

7,141

 

25,271

 

Ending balance

 

$

3,239

 

$

10,240

 

$

103

 

$

7,596

 

$

21,178

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balances:

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for impairment

 

$

1,827

 

$

6,605

 

$

 

$

4,191

 

$

12,623

 

 

 

 

 

 

 

 

 

 

 

 

 

Collectively evaluated for impairment

 

$

1,412

 

$

3,635

 

$

103

 

$

3,405

 

$

8,555

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

3,239

 

$

10,240

 

$

103

 

$

7,596

 

$

21,178

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans receivable:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance - total

 

$

52,273

 

$

142,485

 

$

8,735

 

$

163,502

 

$

366,995

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balances:

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for impairment

 

$

7,036

 

$

52,957

 

$

44

 

$

20,373

 

$

80,410

 

 

 

 

 

 

 

 

 

 

 

 

 

Collectively evaluated for impairment

 

$

45,237

 

$

89,528

 

$

8,691

 

$

143,129

 

$

286,585

 

 

23



Table of Contents

 

The following chart summarizes delinquencies and nonaccruals, by portfolio class, as of March 31, 2012 and December 31, 2011.

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Recorded

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investments

 

 

 

30-59 Days

 

60-89 Days

 

Nonaccrual

 

Total Past

 

 

 

Total Loans

 

90 Days and

 

March 31, 2012

 

Past Due

 

Past Due

 

Loans

 

Due

 

Current

 

Receivable

 

Accruing

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

$

300

 

$

292

 

$

2,817

 

$

3,409

 

$

47,529

 

$

50,938

 

$

 

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Construction

 

1,714

 

201

 

20,693

 

22,608

 

38,618

 

61,226

 

 

Other

 

1,595

 

 

9,658

 

11,253

 

59,830

 

71,083

 

 

Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

940

 

1,905

 

10,218

 

13,063

 

146,489

 

159,552

 

 

Consumer:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

136

 

51

 

82

 

269

 

6,916

 

7,185

 

 

Revolving credit

 

8

 

1

 

 

9

 

854

 

863

 

 

Total

 

$

4,693

 

$

2,450

 

$

43,468

 

$

50,611

 

$

300,236

 

$

350,847

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Recorded

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investments

 

 

 

30-59 Days

 

60-89 Days

 

Nonaccrual

 

Total Past

 

 

 

Total Loans

 

90 Days and

 

December 31, 2011

 

Past Due

 

Past Due

 

Loans

 

Due

 

Current

 

Receivable

 

Accruing

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

$

743

 

$

117

 

$

2,076

 

$

2,936

 

$

49,261

 

$

52,273

 

$

76

 

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Construction

 

224

 

1,239

 

20,659

 

22,122

 

44,755

 

$

66,877

 

 

Other

 

 

341

 

9,342

 

9,683

 

65,925

 

$

75,608

 

 

Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential

 

2,331

 

1,321

 

12,585

 

16,237

 

147,265

 

$

163,502

 

 

Consumer:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

159

 

58

 

20

 

237

 

7,594

 

$

7,831

 

 

Revolving credit

 

17

 

6

 

 

$

23

 

881

 

$

904

 

 

Total

 

$

3,474

 

$

3,082

 

$