<SUBMISSION>
      <TYPE>  10-Q
      <FILER>  
            <CIK>  0001091491
            <CCC>  xxxxxxx
      </FILER>
      <NOTIFY-INTERNET>  atacust@merrillcorp.com
      <PERIOD>  09/30/2011
      <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 September 30, 2011

 

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

 

Smaller reporting company x

(do not check if smaller reporting company)

 

 

 

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 November 8, 2011.

 

 

 



Table of Contents

 

HCSB FINANCIAL CORPORATION

 

Index

 

 

Page No.

 

 

PART I. FINANCIAL INFORMATION

 

 

 

Item 1. Financial Statements (Unaudited)

 

 

 

Condensed Consolidated Balance Sheets - September 30, 2011 and December 31, 2010

3

 

 

Condensed Consolidated Statements of Operations – Nine months ended September 30, 2011 and 2010 And Three months ended September 30, 2011 and 2010

4

 

 

Condensed Consolidated Statements of Shareholders’ Equity and Comprehensive Loss - Nine months ended September 30, 2011 and 2010

5

 

 

Condensed Consolidated Statements of Cash Flows - Nine months ended September 30, 2011 and 2010

6

 

 

Notes to Condensed Consolidated Financial Statements

7-38

 

 

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

41-65

 

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

65

 

 

Item 4. Controls and Procedures

65

 

 

PART II. OTHER INFORMATION

 

 

 

Item 1. Legal Proceedings

66

 

 

Item 1A. Risk Factors

66

 

 

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

66

 

 

Item 3. Defaults Upon Senior Securities

66

 

 

Item 4. (Removed and Reserved)

66

 

 

Item 5. Other Information

66

 

 

Item 6. Exhibits

66

 

2



Table of Contents

 

HCSB FINANCIAL CORPORATION

 

Condensed Consolidated Balance Sheets

 

(Dollars in thousands)

 

September 30,
2011

 

December 31,
2010

 

 

 

(Unaudited)

 

(Audited)

 

Assets:

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

Cash and due from banks

 

35,508

 

12,191

 

Federal funds sold

 

 

7,371

 

Total cash and cash equivalents

 

35,508

 

19,562

 

Securities available-for-sale

 

80,855

 

265,190

 

Nonmarketable equity securities

 

4,936

 

6,076

 

Total investment securities

 

85,791

 

271,266

 

Loans held for sale

 

18,091

 

15,137

 

 

 

 

 

 

 

Loans receivable

 

373,356

 

430,537

 

Less allowance for loan losses

 

(19,675

)

(14,489

)

Loans, net

 

353,681

 

416,048

 

 

 

 

 

 

 

Premises and equipment, net

 

22,757

 

23,389

 

Accrued interest receivable

 

2,571

 

4,476

 

Cash value of life insurance

 

10,186

 

9,896

 

Other real estate owned

 

13,811

 

16,891

 

Other assets

 

2,034

 

10,776

 

Total assets

 

544,430

 

787,441

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Liabilities:

 

 

 

 

 

Deposits:

 

 

 

 

 

Noninterest-bearing transaction accounts

 

42,685

 

38,255

 

Interest-bearing transaction accounts

 

49,329

 

42,348

 

Money market savings accounts

 

135,367

 

197,067

 

Other savings accounts

 

7,394

 

6,707

 

Time deposits $100 and over

 

107,579

 

151,667

 

Other time deposits

 

151,241

 

192,917

 

Total deposits

 

493,595

 

628,961

 

Repurchase Agreements

 

7,030

 

6,646

 

Advances from the Federal Home Loan Bank

 

22,000

 

104,200

 

Subordinated debentures

 

12,062

 

12,062

 

Junior subordinated debentures

 

6,186

 

6,186

 

Accrued interest payable

 

1,295

 

1,252

 

Other liabilities

 

1,790

 

1,635

 

Total liabilities

 

543,958

 

760,942

 

Shareholders’ Equity

 

 

 

 

 

Preferred stock, $1,000 par value. Authorized 5,000,000 shares; issued and and outstanding 12,895 at September 30, 2011 and December 31, 2010

 

12,304

 

12,152

 

Common stock, $.01 par value; 10,000,000 shares authorized, 3,738,337 and 3,780,845 shares issued and outstanding at September 30, 2011 and December 31, 2010, respectively

 

37

 

38

 

Capital surplus

 

30,224

 

30,787

 

Common stock warrants

 

1,012

 

1,012

 

Nonvested restricted stock

 

 

(564

)

Retained deficit

 

(41,883

)

(16,813

)

Accumulated other comprehensive loss

 

(1,222

)

(113

)

Total shareholders’ equity

 

472

 

26,499

 

Total liabilities and shareholders’ equity

 

544,430

 

787,441

 

 

3



Table of Contents

 

HCSB FINANCIAL CORPORATION

 

Condensed Consolidated Statements of Operations

(Unaudited)

 

 

 

Nine Months Ended Sept 30,

 

Three Months Ended Sept 30,

 

(Dollars in thousands)

 

2011

 

2010

 

2011

 

2010

 

Interest income

 

 

 

 

 

 

 

 

 

Loans, including fees

 

$

16,194

 

$

19,989

 

$

5,129

 

$

6,501

 

Investment securities:

 

 

 

 

 

 

 

 

 

Taxable

 

3,315

 

4,223

 

584

 

1,337

 

Tax-exempt

 

564

 

158

 

153

 

62

 

Nonmarketable equity securities

 

39

 

16

 

15

 

8

 

Other interest income

 

45

 

61

 

16

 

33

 

Total

 

20,157

 

24,447

 

5,897

 

7,941

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

 

 

Certificates of deposit $100,000 & over

 

1,687

 

2,116

 

494

 

686

 

Other deposits

 

3,189

 

5,503

 

892

 

1,920

 

Advances from the Federal Home Loan Bank

 

1,242

 

2,616

 

192

 

830

 

Other interest expense

 

1,110

 

765

 

375

 

377

 

Total

 

7,228

 

11,000

 

1,953

 

3,813

 

Net interest income

 

12,929

 

13,447

 

3,944

 

4,128

 

Provision for loan losses

 

20,175

 

15,511

 

2,560

 

4,099

 

Net interest income (loss) after provision for loan losses

 

(7,246

)

(2,064

)

1,384

 

29

 

 

 

 

 

 

 

 

 

 

 

Noninterest income

 

 

 

 

 

 

 

 

 

Service charges on deposit accounts

 

1,014

 

1,096

 

334

 

372

 

Credit life insurance commission

 

13

 

56

 

2

 

7

 

Gain on sale of mortgage loans

 

455

 

679

 

131

 

251

 

Other fees and commissions

 

312

 

276

 

99

 

85

 

Brokerage commission

 

307

 

194

 

105

 

73

 

Gain on sale of securities

 

2,621

 

192

 

60

 

70

 

Income from cash value life insurance

 

355

 

364

 

117

 

122

 

Other operating income

 

87

 

189

 

35

 

29

 

Total

 

5,164

 

3,046

 

883

 

1,009

 

 

 

 

 

 

 

 

 

 

 

Noninterest expense

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

5,697

 

7,069

 

1,811

 

2,301

 

Occupancy expense

 

946

 

948

 

325

 

322

 

Advertising and marketing expense

 

126

 

285

 

32

 

88

 

Furniture and equipment expense

 

1,006

 

1,017

 

329

 

350

 

Prepayment penalties on FHLB borrowings

 

2,554

 

0

 

0

 

0

 

Gain/(loss) on sale of assets

 

(3

)

21

 

0

 

7

 

Loss on sale/writedowns on OREO

 

2,517

 

1,382

 

1,484

 

1,253

 

FDIC insurance premiums

 

1,732

 

793

 

484

 

267

 

Other operating expenses

 

3,263

 

2,820

 

1,077

 

1,091

 

Total

 

17,838

 

14,335

 

5,542

 

5,679

 

 

 

 

 

 

 

 

 

 

 

Loss before income taxes

 

(19,920

)

(13,353

)

(3,275

)

(4,641

)

Income tax expense (benefit)

 

4,998

 

(4,654

)

0

 

(1,624

)

Net loss

 

$

(24,918

)

$

(8,699

)

$

(3,275

)

$

(3,017

)

 

 

 

 

 

 

 

 

 

 

Accretion of preferred stock to redemption value

 

152

 

142

 

51

 

48

 

Preferred dividends accrued

 

487

 

163

 

163

 

83

 

Net loss available to common shareholders

 

(25,557

)

(9,004

)

(3,489

)

(3,148

)

 

 

 

 

 

 

 

 

 

 

Basic net loss per share

 

$

(6.83

)

$

(2.38

)

$

(0.93

)

$

(0.83

)

Diluted net loss per share

 

$

(6.83

)

$

(2.38

)

$

(0.93

)

$

(0.83

)

 

4



Table of Contents

 

HCSB FINANCIAL CORPORATION

 

Condensed Consolidated Statements of Shareholders’ Equity and Comprehensive Loss

For the Nine Months ended September 30, 2011 and 2010

(Unaudited)

 

(Dollars in thousands except 

 

Common Stock

 

Common
Stock

 

Preferred Stock

 

Nonvested
Restricted

 

Capital

 

Retained
Earnings

 

Accumulated
other
comprehensive

 

 

 

share data)

 

Shares

 

Amount

 

Warrants

 

Shares

 

Amount

 

Stock

 

Surplus

 

(deficit)

 

income

 

Total

 

Balance, December 31, 2009

 

3,787,170

 

$

38

 

$

1,012

 

12,895

 

$

11,962

 

$

(645

)

$

30,856

 

$

1,291

 

$

558

 

$

45,072

 

Net loss for the period

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(8,699

)

 

 

(8,699

)

Other comprehensive income, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,201

 

1,201

 

Comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(7,498

)

Accretion of preferred stock to redemption value

 

 

 

 

 

 

 

 

 

142

 

 

 

 

 

(142

)

 

 

 

Payment of dividend on preferred stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(483

)

 

 

(483

)

Stock compensation expense

 

 

 

 

 

 

 

 

 

 

 

 

 

12

 

 

 

 

 

12

 

Balance, Sept 30, 2010

 

3,787,170

 

$

38

 

$

1,012

 

12,895

 

$

12,104

 

$

(645

)

$

30,868

 

$

(8,033

)

$

1,759

 

$

37,103

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(24,918

)

 

 

(24,918

)

Other comprehensive loss, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,109

)

(1,109

)

Comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(26,027

)

Accretion of preferred stock to redemption value

 

 

 

 

 

 

 

 

 

152

 

 

 

 

 

(152

)

 

 

 

Termination of employee

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock option plans

 

(42,508

)

(1

)

 

 

 

564

 

(563

)

 

 

 

Balance, Sept 30, 2011

 

3,738,337

 

$

37

 

$

1,012

 

12,895

 

$

12,304

 

$

 

$

30,224

 

$

(41,883

)

$

(1,222

)

$

472

 

 

See notes to condensed financial statements.

 

5



Table of Contents

 

HCSB FINANCIAL CORPORATION

 

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

Nine Months Ended

 

(Dollars in thousands)

 

Sept 30, 2011

 

Sept 30,2010

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(24,918

)

$

(8,699

)

Adjustments to reconcile net loss to net cash provided (used) by operating activities:

 

 

 

 

 

Depreciation

 

771

 

795

 

Deferred income tax expense (benefit)

 

4,862

 

(232

)

Provision for loan losses

 

20,175

 

15,511

 

Amortization less accretion on investments

 

(120

)

763

 

Amortization of deferred loan costs

 

19

 

21

 

Originations from sales of loans held for sale

 

(21,801

)

(34,628

)

Sale or paydowns of loans

 

18,847

 

21,420

 

Stock compensation expense

 

 

12

 

Net gain on sale of securities available-for-sale

 

(2,621

)

(192

)

Net writedowns or sale of other real estate owned

 

2,517

 

1,382

 

Gain on sale of fixed assets

 

 

(4

)

Increase in interest payable

 

43

 

174

 

Decrease in interest receivable

 

1,905

 

337

 

(Increase) decrease in other assets

 

4,531

 

(4,355

)

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

 

(290

)

(303

)

Increase in other liabilities

 

155

 

663

 

Net cash provided (used) by operating activities

 

4,075

 

(7,335

)

Cash flows from investing activities:

 

 

 

 

 

Decrease in loans to customers

 

34,031

 

9,989

 

Purchases of securities available-for-sale

 

(16,581

)

(164,368

)

Maturities of securities available-for-sale

 

28,995

 

70,639

 

Proceeds from sale of other real estate owned

 

8,705

 

2,764

 

Proceeds from sales of securities available-for-sale

 

172,902

 

18,677

 

Proceeds from sales of premises and equipment

 

 

16

 

Redemptions (purchases) of nonmarketable equity securities

 

1,140

 

432

 

Purchases of premises and equipment

 

(139

)

(227

)

Net cash provided (used) by investing activities

 

229,053

 

(62,078

)

Cash flows from financing activities:

 

 

 

 

 

Net increase (decrease) in demand deposits and savings

 

(49,602

)

63,269

 

Net decrease in time deposits

 

(85,764

)

(13,270

)

Decrease in FHLB borrowings

 

(82,200

)

(9,600

)

Increase (decrease) in repurchase agreements

 

384

 

(1,220

)

Dividend paid on preferred stock

 

 

(483

)

Net increase in subordinated debentures

 

 

12,062

 

Net cash provided (used) by financing activities

 

(217,182

)

50,758

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

15,946

 

(18,655

)

Cash and cash equivalents, beginning of period

 

19,562

 

46,309

 

Cash and cash equivalents, end of period

 

35,508

 

$

27,654

 

 

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Income taxes

 

$

 

$

 

Interest

 

$

7,186

 

$

8,662

 

 

See notes to condensed financial statements.

 

6



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 13 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.  During the third quarter of 2011, the Bank closed its Covenant Towers branch located at Myrtle Beach.  All deposits were transferred to the Bank’s Myrtle Beach branch and the Bank does not expect any disruption of service in that market for its customers.

 

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 September 30, 2011 and for the interim periods ended September 30, 2011 and 2010 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 September 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.  The financial information as of December 31, 2010 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 2010 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, in February, May and August 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 September 30, 2011, the Company had $487,000 accrued on our dividend payments due on our Series T Preferred Stock issued to the U.S. Treasury.  Because we have deferred these three payments, we are prohibited from paying any dividends on our common stock until all deferred payments have been made in full.  Prior to March 6, 2012, so long as the Treasury owns the 12,895 shares of Series T Preferred Stock, we are not permitted to increase cash dividends on our common stock without the Treasury’s consent.  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 January 2010 and January 2011.

 

NOTE 2 — GOING CONCERN

 

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 September 30, 2011. 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 and the first nine months of 2011 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 effects of the economic downturn have been particularly severe during the last 24 months. 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

 

7



Table of Contents

 

NOTE 2 – GOING CONCERN - continued

 

borrowers’ cash flow and ability to repay their outstanding loans to the Bank. As a result, the Bank’s level of nonperforming assets has increased substantially during 2010 and the nine months of 2011. As of September 30, 2011, our nonperforming assets equaled $90,632,000, or 16.65% of assets, as compared to $86,386,000, or 10.93% of assets, as of December 31, 2010. In addition, our level of impaired loans increased to $76,821,000 at September 30, 2011 compared to $69,495,000 at December 31, 2010. For the nine months ended September 30, 2011, the Bank recorded a $20,175,000 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 September 30, 2011. Nevertheless, given the current economic climate, management recognizes the possibility of further deterioration in the loan portfolio for the remainder of 2011.  For the nine months ended September 30, 2011, we recorded net loan charge-offs of $14,989.000, or 3.57% of average loans, as compared to net loan charge-offs of $9,570,000, or 2.28% of average loans, for the nine months ended September 30, 2010.

 

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 with the Federal Deposit Insurance Corporation (the “FDIC”) and the South Carolina Board of Financial Institutions (the “State Board”) on February 11, 2011 (the “Consent Order”), management has prepared forecasts of these sources of funds and the Bank’s projected uses of funds during 2011 in an effort to ensure that the sources available are sufficient to meet the Bank’s projected liquidity needs for this period. See Note 13 — “Regulatory Matters,” for a more detailed description of the Consent Order.

 

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 the remainder of 2011, in 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 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

 

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NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued

 

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 is included as a separate component in interest income.

 

Loans held for Sale - Loans held for sale consist of residential mortgage loans the Company originates for sale to secondary market investors.  They are carried at the lower of aggregate cost or market value.  Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.  Fees collected in conjunction with origination activities are deferred as part of the cost basis of the loan and recognized when the loan is sold.  Gains or losses on sales are recognized when the loans are sold and are determined as the difference between the sales price and the carrying value of the loans.

 

The Company issues rate lock commitments to borrowers based on prices quoted by secondary market investors.  When rates are locked with borrowers, a sales commitment is immediately entered (on a best efforts basis) at a specified price with a secondary market investor.  Accordingly, any potential liabilities associated with rate lock commitments are offset by sales commitments to investors.

 

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

 

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NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued

 

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 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 September 30, 2011, our gross deferred tax asset was $12,342,000.  However, as of September 30, 2011, 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 $12,342,000.  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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Table of Contents

 

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.

 

In July 2010, the Receivables topic of the Accounting Standards Codification (“ASC”) was amended by Accounting Standards Update (“ASU”) 2010-20 to require expanded disclosures related to a company’s allowance for credit losses and the credit quality of its financing receivables. The amendments require the allowance disclosures to be provided on a disaggregated basis.  The Company is required to include these disclosures in its interim and annual financial statements.  See Note 7 — “Loan Portfolio”.

 

Disclosures about Troubled Debt Restructurings (“TDRs”) required by ASU 2010-20 were deferred by the Financial Accounting Standards Board (“FASB”) in ASU 2011-01 issued in January 2011. In April 2011, the FASB issued ASU 2011-02 to assist creditors with their determination of when a restructuring is a TDR.   The determination is based on whether the restructuring constitutes a concession and whether the debtor is experiencing financial difficulties as both events must be present. Disclosures related to TDRs under ASU 2010-20 are required beginning with this quarter ended September 30, 2011.  See Note 7 — “Loan Portfolio” for applicable disclosures.

 

In April 2011, the criteria used to determine effective control of transferred assets in the Transfers and Servicing topic of the ASC was amended by ASU 2011-03.  The requirement for the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms and the collateral maintenance implementation guidance related to that criterion were removed from the assessment of effective control.  The other criteria to assess effective control were not changed.  The amendments are effective for the Company beginning January 1, 2012 but are not expected to have a material effect on the financial statements.

 

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 will be applicable to the Company on January 1, 2012 and will be applied retrospectively.

 

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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.  See Note 13 — “Regulatory Matters” for additional discussions of Regulatory Matters.

 

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:

 

 

 

Nine Months Ended September 30, 2011

 

 

 

Income

 

Average Shares

 

Per Share

 

(Dollars in thousands, except share amounts)

 

(Numerator)

 

(Denominator)

 

Amount

 

Basic loss per share

 

 

 

 

 

 

 

Loss available to common shareholders

 

$

(25,557

)

3,743,787

 

$

(6.83

)

Effect of dilutive securities

 

 

 

 

 

 

 

Stock options

 

 

 

 

 

Diluted loss per share

 

 

 

 

 

 

 

Loss available to common shareholders plus assumed conversions

 

$

(25,557

)

$

3,743,787

 

$

(6.83

)

 

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NOTE 4 – EARNINGS (LOSSES) PER SHARE (continued)

 

 

 

Nine Months Ended September 30, 2010

 

 

 

Income

 

Average Shares

 

Per Share

 

(Dollars in thousands, except share amounts)

 

(Numerator)

 

(Denominator)

 

Amount

 

Basic loss per share

 

 

 

 

 

 

 

Loss available to common shareholders

 

$

(9,004

)

3,787,170

 

$

(2.38

)

Effect of dilutive securities

 

 

 

 

 

 

 

Stock options

 

 

 

 

 

Diluted loss per share

 

 

 

 

 

 

 

Loss available to common shareholders plus assumed conversions

 

$

(9,004

)

3,787,170

 

$

(2.38

)

 

 

 

Three Months Ended September 30, 2011

 

 

 

Income

 

Average Shares

 

Per Share

 

(Dollars in thousands, except share amounts)

 

(Numerator)

 

(Denominator)

 

Amount

 

Basic loss per share

 

 

 

 

 

 

 

Loss available to common shareholders

 

$

(3,489

)

3,738,337

 

$

(0.93

)

Effect of dilutive securities

 

 

 

 

 

 

 

Stock options

 

 

 

 

 

Diluted loss per share

 

 

 

 

 

 

 

Loss available to common shareholders plus assumed conversions

 

$

(3,489

)

3,738,337

 

$

(0.93

)

 

 

 

Three Months Ended September 30, 2010

 

 

 

Income

 

Average Shares

 

Per Share

 

(Dollars in thousands, except share amounts)

 

(Numerator)

 

(Denominator)

 

Amount

 

Basic loss per share

 

 

 

 

 

 

 

Loss available to common shareholders

 

$

(3,148

)

3,787,170

 

$

(0.83

)

Effect of dilutive securities

 

 

 

 

 

 

 

Stock options

 

 

 

 

 

Diluted loss per share

 

 

 

 

 

 

 

Loss available to common shareholders plus assumed conversions

 

$

(3,148

)

3,787,170

 

$

(0.83

)

 

NOTE 5 — COMPREHENSIVE INCOME (LOSS)

 

The following table sets forth the amounts of other comprehensive income (loss) included in equity along with the related tax effect:

 

 

 

Nine Months Ended September 30, 2011

 

 

 

Pre-tax

 

(Expense)

 

Net-of-tax

 

(Dollars in thousands)

 

Amount

 

Benefit

 

Amount

 

Unrealized gains (losses) on securities:

 

 

 

 

 

 

 

Unrealized holding gains (losses) arising during the period

 

$

(4,381

)

$

1,621

 

$

(2,760

)

Plus: reclassification adjustment for gains (losses) realized in net income

 

2,621

 

(970

)

1,651

 

Net unrealized gains (losses) on securities

 

(1,760

)

651

 

(1,109

)

Other comprehensive (loss)/income

 

$

(1,760

)

$

651

 

$

(1,109

)

 

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NOTE 5 – COMPREHENSIVE INCOME (LOSS) (continued)

 

 

 

Nine Months Ended September 30, 2010

 

 

 

Pre-tax

 

(Expense)

 

Net-of-tax

 

(Dollars in thousands)

 

Amount

 

Benefit

 

Amount

 

Unrealized gains (losses) on securities:

 

 

 

 

 

 

 

Unrealized holding gains (losses) arising during the period

 

$

1,716

 

$

(636

)

$

1,080

 

Plus: reclassification adjustment for gains (losses) realized in net income

 

192

 

(71

)

121

 

Net unrealized gains (losses) on securities

 

1,908

 

(707

)

1,201

 

Other comprehensive gain

 

$

1,908

 

$

(707

)

$

1,201

 

 

 

 

Three Months Ended September 30, 2011

 

 

 

Pre-tax

 

(Expense)

 

Net-of-tax

 

(Dollars in thousands)

 

Amount

 

Benefit

 

Amount

 

Unrealized gains (losses) on securities:

 

 

 

 

 

 

 

Unrealized holding gains (losses) arising during the period

 

$

(609

)

$

225

 

$

(384

)

Plus: reclassification adjustment for gains (losses) realized in net income

 

60

 

(22

)

38

 

Net unrealized gains (losses) on securities

 

(549

)

203

 

(346

)

Other comprehensive (loss) income

 

$

(549

)

$

203

 

$

(346

)

 

 

 

Three Months Ended September 30, 2010

 

 

 

Pre-tax

 

(Expense)

 

Net-of-tax

 

(Dollars in thousands)

 

Amount

 

Benefit

 

Amount

 

Unrealized gains (losses) on securities:

 

 

 

 

 

 

 

Unrealized holding gains (losses) arising during the period

 

$

1,857

 

$

(687

)

$

1,170

 

Plus: reclassification adjustment for gains (losses) realized in net income

 

70

 

(26

)

44

 

Net unrealized gains (losses) on securities

 

1,927

 

(713

)

1,214

 

Other comprehensive gain

 

$

1,927

 

$

(713

)

$

1,214

 

 

Accumulated other comprehensive income (loss) consists solely of the unrealized gain (loss) on securities available-for-sale, net of the deferred tax effects.

 

NOTE 6 -  INVESTMENT PORTFOLIO

 

Investment securities available-for-sale decreased from $265,190,000 at December 31, 2010 to $80,855,000 at September 30, 2011 as a result of management’s concerted effort to decrease the assets of the Bank to help improve its capital position.  This represents a decrease of $184,335,000, or 69.51%, from December 31, 2010 to September 30, 2011.

 

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 September 30, 2011, all securities were classified as available-for-sale.

 

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NOTE 6 -  INVESTMENT PORTFOLIO  - (continued)

 

Securities available-for-sale consisted of the following:

 

 

 

Amortized

 

Gross Unrealized

 

Estimated

 

(Dollars in thousands)

 

Cost

 

Gains

 

Losses

 

Fair Value

 

September 30, 2011

 

 

 

 

 

 

 

 

 

Government-sponsored enterprises

 

$

22,511

 

$

211

 

$

 

$

22,722

 

Mortgage-backed securities

 

47,508

 

202

 

2,921

 

44,789

 

Obligations of state and local governments

 

12,776

 

603

 

35

 

13,344

 

Total

 

$

82,795

 

$

1,016

 

$

2,956

 

$

80,855

 

December 31, 2010

 

 

 

 

 

 

 

 

 

Government-sponsored enterprises

 

$

55,661

 

$

372

 

$

1,072

 

$

54,961

 

Mortgage-backed securities

 

187,649

 

3,313

 

1,878

 

189,084

 

Obligations of state and local governments

 

22,060

 

173

 

1,088

 

21,145

 

Total

 

$

265,370

 

$

3,858

 

$

4,038

 

$

265,190

 

 

The following is a summary of maturities of securities available-for-sale as of September 30, 2011.  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.

 

 

 

Estimated

 

(Dollars in thousands)

 

Fair Value

 

Due in less than one year

 

$

0

 

Due after one year but within five years

 

325

 

Due after five years but within ten years

 

16,143

 

Due after ten years

 

64,387

 

Total

 

$

80,855

 

 

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 September 30, 2011 and December 31, 2010:

 

Securities Available for Sale

 

 

 

 

 

 

 

September 30, 2011

 

 

 

 

 

 

 

Less than

 

Twelve months

 

 

 

 

 

 

 

twelve months

 

or more

 

Total

 

 

 

 

 

Unrealized

 

 

 

Unrealized

 

 

 

Unrealized

 

(Dollars in thousands)

 

Fair value

 

losses

 

Fair value

 

losses

 

Fair value

 

losses

 

Government-sponsored enterprises

 

$

 

$

 

$

 

$

 

$

 

$

 

Mortgage-backed securities

 

20,608

 

1,032

 

19,333

 

1,889

 

39,941

 

2,921

 

Obligations of state and local governments

 

1,760

 

35

 

 

 

1,760

 

35

 

Total

 

$

22,368

 

$

1,067

 

$

19,333

 

$

1,889

 

$

41,701

 

$

2,956

 

 

16



Table of Contents

 

NOTE 6 -  INVESTMENT PORTFOLIO (continued)

 

 

 

 

 

 

 

December 31, 2010

 

 

 

 

 

 

 

Less than

 

Twelve months

 

 

 

 

 

 

 

twelve months

 

or more

 

Total

 

 

 

 

 

Unrealized

 

 

 

Unrealized

 

 

 

Unrealized

 

(Dollars in thousands)

 

Fair value

 

losses

 

Fair value

 

losses

 

Fair value

 

losses

 

Government-sponsored enterprises

 

$

43,222

 

$

1,072

 

$

 

$

 

$

43,222

 

$

1,072

 

Mortgage-backed securities

 

58,691

 

1,537

 

8,459

 

341

 

67,150

 

1,878

 

Obligations of state and local governments

 

13,164

 

1,088

 

 

 

13,164

 

1,088

 

Total

 

$

115,077

 

$

3,697

 

$

8,459

 

$

341

 

$

123,536

 

$

4,038

 

 

At September 30, 2011, the Bank had 21 individual securities, or 23.91% 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 September 30, 2011 and 2010, investment securities with a book value of $34,748,000 and $149,706,000, respectively, and a market value of $34,535,000 and $152,213,000, respectively, were pledged to secure deposits.

 

Gross realized gains on sales of available-for-sale securities as of September 30, 2011 were $2,885,000 and gross realized losses were $264,000.

 

NOTE 7 - LOAN PORTFOLIO

 

The following table sets forth the composition of the loan portfolio by category at September 30, 2011 and December 31, 2010 and highlights the Company’s historic emphasis on mortgage lending.

 

(Dollars in thousands)

 

September 30,
2011

 

December 31,
2010

 

Real estate - construction and land development

 

$

71,189

 

$

90,064

 

Real estate - other

 

235,982

 

262,131

 

Agricultural

 

13,996

 

10,679

 

Commercial and industrial

 

42,275

 

54,693

 

Consumer

 

9,611

 

12,446

 

Other, net

 

303

 

524

 

 

 

$

373,356

 

$

430,537

 

 

The primary component of our loan portfolio is loans collateralized by real estate, which made up approximately 82.27% of our loan portfolio at September 30, 2011.  These loans are secured generally by first or second mortgages on residential, agricultural or commercial property.  Commercial real estate loans declined $3,284,000, or 2.17%,  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 2011 in accordance with our strategic plan.  There are no foreign loans, and agricultural loans, as of September 30, 2011, were $13,996,000, or 3.75%, of our loan portfolio.  There are no significant concentrations of loans in any particular individuals or industry or group of related individuals or industries.

 

17



Table of Contents

 

NOTE 7 - LOAN PORTFOLIO - (continued)

 

For the three months ended September 30, 2011, we recorded a provision for loan losses of $2,560,000 and net loan charge-offs of $4,001,000, as compared to provisions for loan losses of $9,065,000 and $8,550,000 and net loan charge-offs of $4,019,000 and $6,969,00 for the three months ended June 30 and March 31, 2011, respectively.  We believe that we have now located the majority of our problem assets, but we will continue to monitor our loan portfolio very carefully and work aggressively to reduce our problem assets.

 

To the extent our loan portfolio continues to stabilize and improve, we may reduce our allowance for loan losses in future periods based on our assessment of the inherent risk in the loan portfolio at those future reporting dates.  A reduction in the allowance for loan losses would result in a lower provision for loans losses being recorded in future periods.  Conversely, there can be no assurance that loan losses in future periods will not exceed the current allowance for loan losses amount or that future increases in the allowance for loan losses will not be required.  Additionally, no assurance can be given that our ongoing evaluation of the loan portfolio, in light of changing economic conditions and other relevant factors, will not require significant future additions to the allowance for loan losses, thus adversely impacting our business, financial condition, results of operations, and cash flows.

 

Loan Performance and Asset Quality

 

Generally, a loan will be placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when management believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful.  When a loan is placed in nonaccrual status, interest accruals are discontinued and income earned but not collected is reversed.  Cash receipts on nonaccrual loans are not recorded as interest income, but are used to reduce principal.

 

18



Table of Contents

 

NOTE 7 - LOAN PORTFOLIO - (continued)

 

The following chart summarizes delinquencies and nonaccruals, by portfolio class, as of September 30, 2011 and December 31, 2010.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Recorded

 

September 30, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

Investments

 

(Dollars in

 

30-59 Days

 

60-89 Days

 

Nonaccrual

 

Total Past

 

 

 

Total Loans

 

90 Days and

 

Thousands)

 

Past Due

 

Past Due

 

Loans

 

Due

 

Current

 

Receivable

 

Accruing

 

Commercial

 

$

451

 

$

265

 

$

2,501

 

$

3,217

 

$

53,158

 

$

56,375

 

$

 

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Construction

 

309

 

457

 

16,655

 

17,421

 

53,768

 

71,189

 

 

Other

 

171

 

6,296

 

5,573

 

12,040

 

116,578

 

128,618

 

 

Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

2,017

 

1,252

 

11,424

 

14,693

 

92,671

 

107,364

 

 

Consumer:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

110

 

11

 

25

 

146

 

8,562

 

8,708

 

 

Revolving credit

 

1

 

 

1

 

2

 

901

 

903

 

 

Other

 

 

 

 

 

199

 

199

 

 

Total

 

$

3,059

 

$

8,281

 

$

36,179

 

$

47,519

 

$

325,837

 

$

373,356

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Recorded

 

December 31, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Investments

 

(Dollars in

 

30-59 Days

 

60-89 Days

 

Nonaccrual

 

Total Past

 

 

 

Total Loans

 

90 Days and

 

Thousands)

 

Past Due

 

Past Due

 

Loans

 

Due

 

Current

 

Receivable

 

Accruing

 

Commercial

 

$

710

 

$

51

 

$

966

 

$

1,727

 

$

52,966

 

$

54,693

 

$

 

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Construction

 

3,544

 

1,351

 

15,029

 

19,924

 

70,140

 

90,064

 

 

Other

 

1,951

 

56

 

1,107

 

3,114

 

73,636

 

76,750

 

 

Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

3,484

 

876

 

6,960

 

11,320

 

174,061

 

185,381

 

 

Consumer:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

251

 

24

 

6

 

281

 

11,206

 

11,487

 

 

Revolving credit

 

1

 

1

 

 

2

 

957

 

959

 

 

Other

 

 

9

 

1,129

 

1,138

 

10,065

 

11,203

 

 

Total

 

$

9,941

 

$

2,368

 

$

25,197

 

$

37,506

 

$

393,031

 

$

430,537

 

$

 

 

At September 30, 2011 and December 31, 2010, there were nonaccrual loans of $36,179,000 and $25,197,000, respectively.  Foregone interest income related to nonaccrual loans equaled $1,877,000 and $1,285,000 for the nine months ended September 30, 2011 and 2010, respectively.  No interest income was recognized on nonaccrual loans during for the nine months ended September 30, 2011 and 2010.  At both September 30, 2011 and December 31, 2010, there were no accruing loans which were contractually past due 90 days or more as to principal or interest payments.

 

19



Table of Contents

 

NOTE 7 - LOAN PORTFOLIO - (continued)

 

Credit Risk Management

 

Another method used to monitor the loan portfolio is credit grading.  Credit risk entails both general risk, which is inherent in the process of lending, and risk that is specific to individual borrowers.  The management of credit risk involves the processes of loan underwriting and loan administration.  The Company seeks to manage credit risk through a strategy of making loans within the Company’s primary marketplace and within the Company’s limits of expertise.  Although management seeks to avoid concentrations of credit by loan type or industry through diversification, a substantial portion of the borrowers’ ability to honor the terms of their loans is dependent on the business and economic conditions in Horry County in South Carolina and Columbus and Brunswick Counties in North Carolina.  A continuation of the economic downturn could result in a further deterioration of the quality of our loan portfolio and reduce our level of deposits, which in turn would have a negative impact on our business.  Additionally, since real estate has historically been considered by the Company as the most desirable nonmonetary collateral, a significant portion of the Company’s loans are collateralized by real estate.  Generally, the value of real estate is not considered by the Company as the primary source of repayment for performing loans.  The cash flow of the borrower or the business enterprise is generally considered as the primary source of repayment.  The Company also seeks to limit total exposure to individual and affiliated borrowers.  The Company seeks to manage risk specific to individual borrowers through the loan underwriting process and through an ongoing analysis of the borrower’s ability to service the debt as well as the value of the pledged collateral.

 

The Company’s loan officers and loan administration staff are charged with monitoring the Company’s loan portfolio and identifying changes in the economy or in a borrower’s circumstances which may affect the ability to repay the debt or the value of the pledged collateral.  In order to assess and monitor the degree of risk in the Company’s loan portfolio, several credit risk identification and monitoring processes are utilized.  The Company assesses credit risk initially through the assignment of a risk grade to each loan based upon an assessment of the borrower’s financial capacity to service the debt and the presence and value of any collateral.  Commercial loans are individually graded at origination and credit grades are reviewed on a regular basis in accordance with our loan policy.  Consumer loans are assigned a “pass” credit rating unless something within the loan warrants a specific classification grade.

 

Credit grading is adjusted during the life of the loan to reflect economic and individual changes having an impact on the borrowers’ abilities to honor the terms of their commitments.  Management uses the risk grades as a tool for identifying known and inherent losses in the loan portfolio and for determining the adequacy of the allowance for loan losses.

 

20



Table of Contents

 

NOTE 7 - LOAN PORTFOLIO - (continued)

 

The following table summarizes management’s internal credit risk grades, by portfolio class, as of September 30, 2011 and December 31, 2010.

 

September 30, 2011
(Dollars in thousands)

 

Real Estate –
Other

 

Commercial
Real Estate

 

Commercial

 

Consumer

 

Total

 

Grade 1 – Minimal

 

$

 

$

45

 

$

2,316

 

$

1,162

 

$

3,523

 

Grade 2 – Modest

 

10,096

 

10,433

 

1,964

 

94

 

22,587

 

Grade 3 – Average

 

1,864

 

4,960

 

6,118

 

415

 

13,357

 

Grade 4 – Satisfactory

 

62,003

 

111,342

 

32,806

 

6,747

 

212,898

 

Grade 5 –Watch

 

4,001

 

1,725

 

1,516

 

602

 

7,844

 

Grade 6 – Special Mention

 

7,186

 

9,954

 

2,268

 

194

 

19,602

 

Grade 7 – Substandard

 

22,004

 

58,799

 

9,364

 

332

 

90,499

 

Grade 8 – Doubtful

 

210

 

2,548

 

288

 

 

3,046

 

Grade 9 – Loss

 

 

 

 

 

 

Total loans

 

$

107,364

 

$

199,806

 

$

56,640

 

$

9,546

 

$

373,356

 

 

December 31, 2010
(Dollars in thousands)

 

Real Estate –
Other

 

Commercial
Real Estate

 

Commercial

 

Consumer

 

Total

 

Grade 1 – Minimal

 

$

 

$

 

$

4,023

 

$

1,573

 

$

5,596

 

Grade 2 – Modest

 

9,899

 

17,447

 

3,939

 

125

 

31,410

 

Grade 3 – Average

 

2,003

 

4,035

 

5,416

 

516

 

11,970

 

Grade 4 – Satisfactory

 

68,520

 

123,615

 

37,908

 

8,988

 

239,031

 

Grade 5 –Watch

 

3,781

 

2,736

 

1,969

 

845

 

9,331

 

Grade 6 – Special Mention

 

13,293

 

18,822

 

4,152

 

17

 

36,284

 

Grade 7 – Substandard

 

23,606

 

63,107

 

7,688

 

369

 

94,770

 

Grade 8 – Doubtful

 

1,032

 

298

 

802

 

13

 

2,145

 

Grade 9 – Loss

 

 

 

 

 

 

Total loans

 

$

122,134

 

$

230,060

 

$

65,897

 

$

12,446