Attached files

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EX-23 - CONSENT OF DIXON HUGHES PLLC - MIDCAROLINA FINANCIAL CORPdex23.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - MIDCAROLINA FINANCIAL CORPdex311.htm
EX-32 - SECTION 906 CEO AND CFO CERTIFICATION - MIDCAROLINA FINANCIAL CORPdex32.htm
EX-21 - SCHEDULE OF SUBSIDIARIES - MIDCAROLINA FINANCIAL CORPdex21.htm
EX-31.2 - SECTION 302 CFO CERTIFICATION - MIDCAROLINA FINANCIAL CORPdex312.htm

 

 

U. S. Securities and Exchange Commission

Washington, D.C. 20549

 

 

Form 10-K

 

 

ANNUAL REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2009

Commission File Number 000-49848

 

 

MIDCAROLINA FINANCIAL CORPORATION

(Name of Issuer in Its Charter)

 

 

 

North Carolina   55-6144577

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

3101 South Church Street

Burlington, North Carolina

  27215
(Address of Principal Executive Offices)   (Zip Code)

(336) 538-1600

(Issuer’s Telephone Number, Including Area Code)

 

 

Securities Registered Under Section 12(b) of the Act: None

 

Securities Registered Under Section 12(g) of the Act: common stock, no par value
  

    Title of Class

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No   x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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

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

 

Large Accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨    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  ¨    No  x

The aggregate market value of the Registrant’s voting and non-voting common equity, held by non affiliates, computed by reference to the average bid and asked price of such common equity, as of the last business day of the Registrant’s most recently completed second fiscal quarter was $24.7 million.

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date. 4,927,828 shares of common stock, no par value, as of February 24, 2010.

 

 

 


DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2010 Annual Meeting of Shareholders of MidCarolina Financial Corporation, to be held on May 25, 2010 (the “Proxy Statement”), are incorporated by reference into Part III.

Statement Regarding Forward Looking Statements

Statements in this Report and its exhibits relating to plans, strategies, economic performance and trends, projections of results of specific activities or investments, expectations or beliefs about future events or results, and other statements that are not descriptions of historical facts, may be forward-looking statements as defined in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors which include, but are not limited to, factors discussed in our Annual Report on Form 10-K and in other documents we file with the Securities and Exchange Commission from time to time. Copies of those reports are available directly through the SEC’s Internet website at www.sec.gov or through our Internet website at www.midcarolinabank.com. Forward-looking statements may be identified by terms such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “forecasts,” “potential” or “continue,” or similar terms or the negative of these terms, or other statements concerning opinions or judgments of our management about future events. Factors that could influence the accuracy of forward-looking statements include, but are not limited to, (a) pressures on the earnings, capital and liquidity of financial institutions resulting from current and future adverse conditions in the credit and capital markets and the banking industry in general,(b) the financial success or changing strategies of our customers, (c) actions of government regulators,(d) the level of market interest rates, and (e) changes in general economic conditions and real estate values in our banking market (particularly changes that affect our loan portfolio, the abilities of our borrowers to repay their loans, and the values of loan collateral). Although we believe that the expectations reflected in the forward-looking statements are reasonable, they represent our management’s judgments only as of the date they are made, and we cannot guarantee future results, levels of activity, performance or achievements. As a result, readers are cautioned not to place undue reliance on these forward-looking statements. All forward-looking statements attributable to us are expressly qualified in their entirety by the cautionary statements in this paragraph. We have no obligation, and do not intend, to update these forward-looking statements.

 

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PART I

 

ITEM 1. DESCRIPTION OF BUSINESS

General

MidCarolina Financial Corporation (the “Company”) was formed in 2002 to serve as a holding company for MidCarolina Bank (the “Bank”). The Company is registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and the bank holding company laws of North Carolina. The Company’s office is located at 3101 South Church Street, Burlington, North Carolina 27216. The Company’s principal source of income is earnings on loans and investments, including any dividends that are declared and paid by the Bank on its capital stock.

The Bank is incorporated under the laws of North Carolina and began operations on August 14, 1997 as a North Carolina chartered commercial bank. The Bank is engaged in general commercial banking primarily in Alamance and Guilford Counties, North Carolina, and operates under the banking laws of North Carolina and the rules and regulations of the Federal Deposit Insurance Corporation (the “FDIC”).

As a North Carolina bank, the Bank is subject to examination and regulation by the FDIC and the North Carolina Commissioner of Banks (the “Commissioner”). The Bank is further subject to certain regulations of the Federal Reserve governing reserve requirements to be maintained against deposits and other matters. The business and regulation of the Bank are also subject to legislative changes from time to time. See “SUPERVISION AND REGULATION.”

The Bank’s primary market area is Alamance County and Guilford County, North Carolina. The Bank’s main office is located in Burlington, North Carolina. The Bank also has one full-service branch in Burlington, NC, one full-service branch in Graham, North Carolina, two full-service branches in Greensboro, North Carolina and one full-service branch in Mebane, North Carolina. The Bank has limited service offices in the Alamance Regional Medical Center and the Village of Brookwood Retirement Center, both of which are located in Burlington. The Bank’s loans and deposits are primarily generated from the areas where its offices are located.

The Bank’s primary sources of revenue are interest and fee income from its lending activities. These lending activities consist principally of originating commercial operating and working capital loans, residential mortgage loans, home equity lines of credit, other consumer loans and loans secured by commercial real estate. The Bank’s current lending strategy is to establish market share throughout Alamance and Guilford Counties, with an emphasis in Burlington, Graham, Greensboro and Mebane.

Interest and dividend income from investment activities generally provide the second largest source of income to the Bank after interest on loans. During 2009, the Bank chose to manage its overall liquidity position by re-deploying its funds into shorter duration securities.

Deposits are the primary source of the Bank’s funds for lending and other investment purposes. The Bank attracts both short-term and long-term deposits from the general public by offering a variety of accounts and rates. The Bank offers statement savings accounts, negotiable order of withdrawal accounts, money market demand accounts, non-interest-bearing accounts and fixed interest rate certificates with varying maturities. The Bank also utilizes alternative sources of funds such as brokered certificates of deposit and borrowings from the Federal Home Loan Bank (the “FHLB”) of Atlanta, Georgia.

The Bank’s deposits are obtained primarily from its primary market area. The Bank uses traditional marketing methods to attract new customers and deposits including print media advertising and direct mailings. Deposit flows are greatly influenced by economic conditions, the general level of interest rates, competition and other factors.

 

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The Bank is the sole banking subsidiary of the Company. Two trusts (MidCarolina I and MidCarolina Trust II) were formed as subsidiaries of the Company to facilitate the infusion of Trust Preferred Securities as a form of non-dilutive equity into the Company. The trusts are not consolidated in these financial statements. The majority of the Company’s operations are located at the Bank level. Throughout this Annual Report on Form 10-K, results of operations will be discussed on a consolidated basis by referring to the Bank’s operations, unless a specific reference is made to the Company and its operating results apart from the Bank.

The Company experienced steady growth during its formative years since its formation in 1997 through 2008. 2009 was a year of nominal growth reflecting the economic distresses experienced by the financial industry as a whole. The Bank’s assets totaled $541.0 million, $540.8 million and $467.2 million as of December 31, 2009, 2008 and 2007, respectively. The Company had net income available to common shareholders for the year ended December 31, 2009 of $2.0 million, or $0.40 per diluted share compared with $3.3 million, or $0.66 per diluted share for the year ended December 31, 2008.

At December 31, 2009, the Company had total consolidated assets of $541.0 million, net loans of $430.7 million, deposits of $465.0 million, investment securities available-for-sale of $70.7 million and shareholders’ equity of $40.2 million.

Subsidiaries

Other than the Bank, the Company has two trust subsidiaries: MidCarolina I and MidCarolina Trust II. The Bank’s only subsidiary, MidCarolina Investments, Inc, was dormant during 2009. MidCarolina Investments formerly engaged in general securities brokerage and offered insurance and other financial services through a contract arrangement with a third-party provider. The Bank continues to offer these services through a third-party provider.

Employees

At December 31, 2009, the Bank had 82 full-time equivalent employees.

Competition and Market Area

The Bank faces strong competition both in attracting deposits and making real estate and other loans. Its most direct competition for deposits comes from commercial banks, savings institutions and credit unions located in its primary market area, including large financial institutions that have greater financial and marketing resources available to them. At June 30, 2009, there were 16 depository institutions with 50 offices in Alamance County. The Bank had a deposit market share of 17.4% in Alamance County. The Bank also faces additional significant competition for investors’ funds from short-term money market securities and other corporate and government securities. The ability of the Bank to attract and retain savings deposits depends on its ability to generally provide a rate of return, liquidity and risk comparable to that offered by competing investment opportunities.

The Bank’s competition for real estate loans is from savings institutions, credit unions, commercial banks, and mortgage banking companies. It competes for loans primarily through the interest rates and loan fees it charges and the efficiency and quality of services it provides borrowers. Competition is increasing as a result of the reduction of restrictions on the interstate operations of financial institutions.

The Bank’s primary market area is Alamance County. The population of Alamance County is 148,053 and the median household income is $41,922. Alamance County has a diverse economy with no concentration in any one specific industry. Major businesses and industries in the area include LabCorp, a laboratory that provides specialized testing services for the medical industry, Alamance Health Services, Elon University, Honda Power Equipment Manufacturing and GKN Automotive, a manufacturer of automobile drive shafts.

Supervision and Regulation

The Company’s and the Bank’s business and operations are subject to extensive federal and state governmental regulation and supervision. The following is a summary of some of those basic statutes and regulations. However, it is not a complete discussion of all the laws that affect the Company’s business, and it is qualified in its entirety by reference to the particular statutory or regulatory provision or proposal being described.

 

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General. The Company is a bank holding company registered with the Federal Reserve Board (the “FRB”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”). It is subject to supervision and examination by, and the regulations and reporting requirements of, the FRB. Under the BHCA, a bank holding company’s activities are limited to banking, managing or controlling banks, or engaging in other activities the FRB determines are closely related and a proper incident to banking or managing or controlling banks.

The BHCA prohibits a bank holding company from acquiring direct or indirect control of more than 5.0% of the outstanding voting stock, or substantially all of the assets, of any financial institution, or merging or consolidating with another bank holding company or savings bank holding company, without the FRB’s prior approval. Additionally, the BHCA generally prohibits bank holding companies from engaging in a nonbanking activity, or acquiring ownership or control of more than 5.0% of the outstanding voting stock of any company that engages in a nonbanking activity, unless that activity is determined by the FRB to be closely related and a proper incident to banking. In approving an application to engage in a nonbanking activity, the FRB must consider whether that activity can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices.

The law imposes a number of obligations and restrictions on bank holding companies and their insured bank subsidiaries designed to minimize potential losses to depositors and the FDIC insurance funds. For example, if a bank holding company’s insured bank subsidiary becomes “undercapitalized,” the bank holding company is required to guarantee the bank’s compliance (subject to certain limits) with the terms of any capital restoration plan filed with its federal banking agency. A bank holding company is required to serve as a source of financial strength to its bank subsidiaries and to commit resources to support those banks in circumstances in which, absent that policy, it might not do so. Under the BHCA, the FRB may require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary if the FRB determines that the activity or control constitutes a serious risk to the financial soundness and stability of a bank subsidiary of a bank holding company.

The Bank is an insured, North Carolina-chartered bank. Its deposits are insured under the FDIC’s Deposit Insurance Fund, and it is subject to supervision and examination by, and the regulations and reporting requirements of, the FDIC and the Commissioner. The Bank is not a member of the Federal Reserve System.

As an insured bank, the Bank is prohibited from engaging as a principal in an activity that is not permitted for national banks unless (1) the FDIC determines that the activity would pose no significant risk to the deposit insurance fund and (2) the Bank is in compliance with applicable capital standards. Insured banks also are prohibited generally from directly acquiring or retaining any equity investment of a type or in an amount not permitted for national banks.

The Commissioner and the FDIC regulate all areas of the Bank’s business, including its payment of dividends and other aspects of its operations. They conduct regular examinations of the Bank, and the Bank must furnish periodic reports to the Commissioner and the FDIC containing detailed financial and other information about its affairs. The Commissioner and the FDIC have broad powers to enforce laws and regulations that apply to the Bank and to require corrective action of conditions that affect its safety and soundness. These powers include, among others, issuing cease and desist orders, imposing civil penalties, removing officers and directors, and otherwise intervening in the Bank’s operation and management if examinations of the Bank and the reports it files indicate the need to do so.

Under North Carolina banking laws, if a North Carolina bank’s capital stock becomes impaired by losses or other causes, and the bank’s surplus and undivided profits are insufficient to make good the impairment, the Commissioner may require the bank to make the impairment good by an assessment upon the bank’s stockholders. If any stockholder does not pay such assessment, the bank’s board of directors must sell a sufficient amount of the bank’s stock held by that stockholder at public auction to make good the assessment on that stockholder.

The Bank’s business also is influenced by prevailing economic conditions and governmental policies, both foreign and domestic, and, though it is not a member bank of the Federal Reserve System, by the monetary and fiscal policies of the FRB. The FRB’s actions and policy directives determine to a significant degree the cost and availability of funds the Bank obtains from money market sources for lending and investing, and they also influence, directly and indirectly, the rates of interest the Bank pays on its time and savings deposits and the rates it charges on commercial bank loans.

 

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Gramm-Leach-Bliley Act. The federal Gramm-Leach-Bliley Act enacted in 1999 (the “GLB Act”) dramatically changed various federal laws governing the banking, securities and insurance industries.

The GLB Act permitted bank holding companies to become “financial holding companies” and, in general (1) expanded opportunities to affiliate with securities firms and insurance companies; (2) overrode certain state laws that would prohibit certain banking and insurance affiliations; (3) expanded the activities in which banks and bank holding companies may participate; (4) requires that banks and bank holding companies engage in some activities only through affiliates owned or managed in accordance with certain requirements; and (5) reorganized responsibility among various federal regulators for oversight of certain securities activities conducted by banks and bank holding companies.

Payment of Dividends. Under North Carolina law, the Company is authorized to pay dividends as declared by its Board of Directors, provided that no such distribution results in the Company’s insolvency on a going concern or balance sheet basis. However, although the Company is a legal entity separate and distinct from the Bank, its principal source of funds with which it can pay dividends to its shareholders is dividends it receives from the Bank. For that reason, the Company’s ability to pay dividends effectively is subject to the same limitations that apply to the Bank.

In general, the Bank may pay dividends only from its undivided profits. However, if its surplus is less than 50% of its paid-in capital stock, the Bank’s directors may not declare any cash dividend until it has transferred to surplus 25% of its undivided profits or any lesser percentage necessary to raise its surplus to an amount equal to 50% of its paid-in capital stock.

Federal law prohibits the Bank from making any capital distributions, including paying a cash dividend, if it is, or after making the distribution it would become, “undercapitalized” as that term is defined in the Federal Deposit Insurance Act (the “FDIA”). Also, if in the FDIC’s opinion an insured bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice, the FDIC may require, after notice and hearing, that the bank cease and desist from that practice. The FDIC has indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsafe and unsound banking practice. (See “—Prompt Corrective Action” below.) The FDIC has issued policy statements which provide that insured banks generally should pay dividends only out of their current operating earnings. Also, under the FDIA no dividend may be paid by an FDIC-insured bank while it is in default on any assessment due the FDIC. The Bank’s payment of dividends also may be affected or limited by other factors, such as events or circumstances that lead the FDIC to require the Bank to maintain its capital above regulatory guidelines.

In the future, the Company’s ability to declare and pay cash dividends will be subject to its Board of Directors’ evaluation of its operating results, capital levels, financial condition, future growth plans, general business and economic conditions, and other relevant considerations.

Capital Adequacy. The Company and the Bank are required to comply with the FRB’s and FDIC’s capital adequacy standards for bank holding companies and insured banks. The FRB and FDIC have issued risk-based capital and leverage capital guidelines for measuring capital adequacy, and all applicable capital standards must be satisfied for us or the Bank to be considered in compliance with regulatory capital requirements.

Under the risk-based capital guidelines, the minimum ratio (“Total Capital Ratio”) of an entity’s total capital (“Total Capital”) to its risk-weighted assets (including certain off-balance-sheet items, such as standby letters of credit) is 8.0%. At least half of Total Capital must be composed of “Tier 1 Capital.” Tier 1 Capital includes common equity, undivided profits, minority interests in the equity accounts of consolidated subsidiaries, qualifying noncumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock, less goodwill and certain other intangible assets. The remaining Total Capital may consist of “Tier 2 Capital” which includes certain subordinated debt, certain hybrid capital instruments and other qualifying preferred stock, and a limited amount of loan loss reserves. A bank or bank holding company that does not satisfy minimum capital requirements may be required to adopt and implement a plan acceptable to its federal banking regulator to achieve an adequate level of capital.

Under the leverage capital measure, the minimum ratio (the “Leverage Capital Ratio”) of Tier 1 Capital to average assets, less goodwill and various other intangible assets, is 3.0% for entities that meet specified criteria, including having the highest regulatory rating. All other entities generally are required to maintain an additional cushion of 100

 

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to 200 basis points above the stated minimum. The guidelines also provide that banks experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum levels without significant reliance on intangible assets. A bank’s “Tangible Leverage Ratio” (deducting all intangibles) and other indicators of capital strength also will be taken into consideration by banking regulators in evaluating proposals for expansion or new activities.

The FRB and the FDIC also consider interest rate risk (when the interest rate sensitivity of an institution’s assets does not match the sensitivity of its liabilities or its off-balance-sheet position) in evaluating capital adequacy. Banks with excessive interest rate risk exposure must hold additional amounts of capital against their exposure to losses resulting from that risk. The regulators also require banks to incorporate market risk components into their risk-based capital. Under these market risk requirements, capital is allocated to support the amount of market risk related to a bank’s trading activities.

Capital categories of financial institutions are determined only for the purpose of applying the “prompt corrective action” rules described below which have been adopted by the various federal banking regulators, and they do not necessarily constitute an accurate representation of overall financial condition or prospects for other purposes. A failure to meet capital guidelines could subject the the Bank to a variety of enforcement remedies under those rules, including issuance of a capital directive, termination of FDIC deposit insurance, a prohibition on taking brokered deposits, and other restrictions on the Bank’s business. As described below, substantial additional restrictions can be imposed on banks that fail to meet applicable capital requirements.

Prompt Corrective Action. Federal law establishes a system of prompt corrective action to resolve the problems of undercapitalized banks. Under this system, the FDIC has established five capital categories (“well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized”) and it is required to take various supervisory actions, and is authorized to take other discretionary actions, with respect to banks in the three undercapitalized categories. The severity of any actions taken will depend on the capital category in which a bank is placed. Generally, subject to a narrow exception, current federal law requires the FDIC to appoint a receiver or conservator for a bank that is critically undercapitalized.

Under the FDIC’s rules implementing the prompt corrective action provisions, an insured, state-chartered bank that (1) has a Total Capital Ratio of 10.0% or greater, a Tier 1 Capital Ratio of 6.0% or greater, and a Leverage Ratio of 5.0% or greater, and (2) is not subject to any written agreement, order, capital directive, or prompt corrective action directive issued by the FDIC, is considered “well capitalized.” A bank with a Total Capital Ratio of 8.0% or greater, a Tier 1 Capital Ratio of 4.0% or greater, and a Leverage Ratio of 4.0% or greater, is considered “adequately capitalized.” A bank that has a Total Capital Ratio of less than 8.0%, a Tier 1 Capital Ratio of less than 4.0%, or a Leverage Ratio of less than 4.0%, is considered “undercapitalized.” A bank that has a Total Capital Ratio of less than 6.0%, a Tier 1 Capital Ratio of less than 3.0%, or a Leverage Ratio of less than 3.0%, is considered “significantly undercapitalized,” and a bank that has a tangible equity capital to assets ratio equal to or less than 2.0% is considered “critically undercapitalized.” For purposes of these rules, the term “tangible equity” includes core capital elements counted as Tier 1 Capital for purposes of the risk-based capital standards (see “—Capital Adequacy” above), plus the amount of outstanding cumulative perpetual preferred stock (including related surplus), minus all intangible assets (with various exceptions). A bank may be deemed to be in a lower capitalization category than indicated by its actual capital position if it receives an unsatisfactory examination rating.

A bank categorized as “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized” is required to submit an acceptable capital restoration plan to the FDIC. An “undercapitalized” bank also is generally prohibited from increasing its average total assets, making acquisitions, establishing new branches, or engaging in new lines of business, other than in accordance with an accepted capital restoration plan or with the FDIC’s approval. Also, the FDIC may treat an “undercapitalized” bank as being “significantly undercapitalized” if it determines that is necessary to carry out the purpose of the law. On December 31, 2009, the Bank’s capital ratios were at levels to qualify it as “well capitalized.”

Reserve Requirements. Under the FRB’s regulations, all FDIC-insured banks must maintain average daily reserves against their transaction accounts. As of January 1, 2010 no reserves are required on the first $10.7 million of transaction accounts, but a bank must maintain reserves equal to 3.0% on aggregate balances between $10.7 million and $55.2 million, and reserves equal to 10.0% on aggregate balances in excess of $55.2 million. The FRB may adjust these percentages from time to time. Because the Bank’s reserves must be maintained in the form of vault cash or in an account at a Federal Reserve Bank or with a qualified correspondent bank, one effect of the reserve requirement is to reduce the amount of the Bank’s assets that are available for lending and other investment activities.

 

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Federal Deposit Insurance. The Bank’s deposits are insured by the FDIC to the full extent provided in the Federal Deposit Insurance Act, and the Bank pays assessments to the FDIC for that insurance coverage. Under the Act, the FDIC may terminate the Bank’s deposit insurance if it finds that the Bank has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated applicable laws, regulations, rules or orders.

The Federal Deposit Insurance Reform Act of 2005 (“FDIRA”) changed the Federal deposit insurance system by, among other things:

 

   

merging the Bank Insurance Fund and Savings Association Insurance Fund into a new Deposit Insurance Fund (the “DIF”);

 

   

raising the level of Federal deposit insurance coverage for retirement accounts to $250,000;

 

   

establishing a range of 1.15% to 1.50% within which the FDIC must set and maintain the required reserve ratio for the DIF;

 

   

requiring that, if the DIF reserve ratio falls, or within six months is expected to fall, below the statutorily required minimum of 1.15%, the FDIC must adopt a restoration plan that provides for the DIF to be restored; and

 

   

eliminating restrictions on premium rates based on the DIF reserve ratio, and giving the FDIC discretion to price deposit insurance according to the risk posed to the DIF by each insured institution, regardless of the DIF reserve ratio.

During October 2008, the Emergency Economic Stabilization Act of 2008 temporarily raised the basic limit on federal deposit insurance coverage for all accounts from $100,000 to $250,000 per depositor until December 31, 2009. During May 2009, that increased coverage was extended until December 31, 2013, at which time it will return to $100,000 for all accounts other than retirement accounts for which FDIRA permanently increased the basic coverage to $250,000.

FDIC Temporary Liquidity Guarantee Program. During 2008, the FDIC implemented its Temporary Liquidity Guarantee Program (TLGP), which applies to, among others, all U.S. depository institutions insured by the FDIC and all U.S. bank holding companies, unless they have opted out of the TLGP or the FDIC has terminated their participation. The Bank chose to participate in the TLGP. Under the original terms of the transaction account guarantee component of the TLGP, all noninterest-bearing transaction accounts would be insured in full by the FDIC until December 31, 2009, regardless of the standard maximum deposit insurance amount. During August 2009, the FDIC extended the transaction account guarantee component of the TLGP through June 30, 2010.

FDIC Insurance Assessments. Under FDIRA, the FDIC uses a risk-based assessment system to determine the amount of the Bank’s deposit insurance assessment based on an evaluation of the probability that the Bank will cause a loss to the DIF. That evaluation takes into consideration risks attributable to different categories and concentrations of the Bank’s assets and liabilities and any other factors the FDIC considers relevant, including information obtained from the Commissioner. A higher assessment rate results in an increase in the deposit insurance assessments paid by the Bank.

The FDIC is responsible for maintaining the adequacy of the DIF, and the amount the Bank pays for deposit insurance is influenced not only by the assessment of the risk it poses to the DIF, but also by the adequacy of the insurance fund at any time to cover the risk posed by all insured institutions. FDIC insurance assessments could be increased substantially in the future if the FDIC finds such an increase to be necessary in order to adequately maintain the insurance fund.

During 2008, and because the DIF reserve ratio had fallen below the minimum of 1.15% mandated by FDIRA, the Board of Directors of the FDIC adopted a restoration plan to return the reserve ratio to that minimum level required by FDIRA within five years. During February 2009, the Board amended its restoration plan to provide for the minimum DIF reserve ratio to be restored within seven years and voted to impose a special assessment on insured institutions of 20 basis points, and to increase regular assessment rates for 2009. However, during May 2009, the special assessment was reduced to 5 basis points on each insured institution’s assets minus its Tier 1 capital as of

 

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June 30, 2009, but not more than 10 basis points of the institution’s assessment base for the second quarter of 2009. The special assessment was payable on September 30, 2009.

During October 2009, the FDIC again amended its restoration plan to provide for the minimum DIF reserve ratio to be restored within eight years, and adopted a uniform 3 basis point increase in regular assessment rates effective January 1, 2011. During November 2009, the FDIC amended its regulations to require that insured institutions prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012 on December 30, 2009.

Restrictions on Transactions with Affiliates. The Bank is subject to the provisions of Section 23A of the Federal Reserve Act which, among other things, limits the amount of:

 

   

a bank’s loans or extensions of credit to, or investment in, its affiliates;

 

   

assets a bank may purchase from affiliates, except for real and personal property exempted by the FRB;

 

   

the amount of a bank’s loans or extensions of credit to third parties collateralized by securities or obligations of the bank’s affiliates; and

 

   

a bank’s issuance of a guarantee, acceptance or letter of credit for its affiliates.

The total amount of these transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. The Bank also must comply with other provisions under Section 23A designed to prevent the Bank’s taking of low-quality assets from an affiliate.

The Bank also is subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibit a bank or its subsidiaries generally from engaging in transactions with its affiliates unless those transactions are on terms substantially the same, or at least as favorable to the bank or its subsidiaries, as would apply in comparable transactions with nonaffiliated companies.

Federal law also restricts the Bank’s ability to extend credit to its and the Company’s executive officers, directors, principal shareholders and their related interests. These credit extensions (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated third parties, and (2) must not involve more than the normal risk of repayment or present other unfavorable features.

Interstate Banking and Branching. The Bank Holding Company Act, as amended by the interstate banking provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Interstate Banking Law”), permits adequately capitalized and managed bank holding companies to acquire control of the assets of banks in any state. Acquisitions are subject to provisions that cap at 10.0% the portion of the total deposits of insured depository institutions in the United States that a single bank holding company may control, and generally cap at 30.0% the portion of the total deposits of insured depository institutions in a state that a single bank holding company may control. Under certain circumstances, states have the authority to increase or decrease the 30.0% cap, and states may set minimum age requirements of up to five years on target banks within their borders.

Subject to certain conditions, the Interstate Banking Law also permits interstate branching by allowing a bank in one state to merge with a bank located in a different state. Each state was allowed to prohibit interstate branching in that state by merger by enacting legislation to that effect. The Interstate Banking Law also permits banks to establish branches in other states by opening new branches or acquiring existing branches of other banks, provided the laws of those other states specifically permit that form of interstate branching. North Carolina has adopted statutes which, subject to conditions, authorize out-of-state bank holding companies and banks to acquire or merge with North Carolina banks and to establish or acquire branches in North Carolina.

Community Reinvestment. Under the Community Reinvestment Act (the “CRA”), an insured bank has a continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific

 

9


lending requirements or programs for banks, nor does it limit a bank’s discretion to develop, consistent with the CRA, the types of products and services it believes are best suited to its particular community. The CRA requires the federal banking regulators, in their examinations of insured banks, to assess the banks’ records of meeting the credit needs of their communities, using the ratings of “outstanding,” “satisfactory,” “needs to improve,” or “substantial noncompliance,” and to take that record into account in its evaluation of various applications by those banks. All banks are required to make public disclosure of their CRA performance ratings. The Bank received a “satisfactory” rating in its last CRA examination during 2007.

USA Patriot Act of 2001. The USA Patriot Act of 2001 was enacted in response to the terrorist attacks that occurred in the United States on September 11, 2001. The Act strengthened the ability of U.S. law enforcement and the intelligence community to work cohesively to combat terrorism on a variety of fronts. The Act’s impact on all financial institutions is significant and wide ranging. The Act contains sweeping anti-money laundering and financial transparency requirements and imposes various other regulatory requirements, including standards for verifying customer identification at account opening, and rules promoting cooperation among financial institutions, regulators and law enforcement agencies in identifying parties that may be involved in terrorism or money laundering.

Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 became effective on July 30, 2002. It addressed accounting, corporate governance and disclosure issues and imposed significant requirements on all public companies. Some provisions of the Act became effective immediately while others are still being implemented.

In general, the Sarbanes-Oxley Act mandated important corporate governance and financial reporting requirements intended to enhance the accuracy and transparency of public companies’ reported financial results. It established specific responsibilities for corporate chief executive officers, chief financial officers and audit committees in the financial reporting process, and it created a regulatory body to oversee auditors of public companies. It enhanced SEC enforcement tools, criminal penalties for federal mail, wire and securities fraud, and criminal penalties for document and record destruction in connection with federal investigations. It also lengthened the statute of limitations for securities fraud claims and provided new corporate whistleblower protection.

The economic and operational effects of the Sarbanes-Oxley Act on public companies, including the company, have been and will continue to be significant in terms of the time, resources and costs associated with compliance. Because the Act, for the most part, applies equally to larger and smaller public companies, the Company will continue to be presented with additional challenges as a smaller, community-oriented financial institution seeking to compete with larger financial institutions in its markets.

Available Information

The Company makes its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports available free of charge on its internet website www.midcarolinabank.com, as soon as reasonably practicable after the reports are electronically filed with the SEC. Any materials that the Company files with the SEC may be read and/or copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington DC 20549. Information on the operation of the Public Reference room may be obtained by calling the SEC at 1-800-SEC-0330. These filings are also accessible on the SEC’s website at www.sec.gov.

 

ITEM 2. DESCRIPTION OF PROPERTY

The Bank owns its main office, which is located at 3101 South Church Street in Burlington, as well as its full-service branch offices located at 5509-A West Friendly Avenue, Suite 102, Greensboro, North Carolina and 842 South Main Street, Graham, North Carolina. The Bank leases its full-service offices located at Cum-Park Plaza, 2214 North Church Street, Burlington; 703 Suite 101,Green Valley Road, Greensboro; and 1107 South Fifth Street, Mebane, North Carolina. The Bank occupies space in the Alamance Regional Medical Center in Burlington from which it operates a limited-service office as well as a limited-service office located in the Village of Brookwood Retirement Center located in Burlington.

The total net book value of the Bank’s furniture, fixtures, leasehold improvements, land, buildings and equipment at December 31, 2009 was approximately $7.1 million. All properties are considered by the Bank’s management to be

 

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in good condition and adequately covered by insurance. Additional information about this property is set forth in Note (F) to the Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K, which note is incorporated herein by reference.

 

ITEM 3. LEGAL PROCEEDINGS

As previously disclosed in our 2008 Annual Report on Form 10-K, on July 22, 2008, the Company and the Bank filed a civil action in the Superior Court of Alamance County, North Carolina, against their former President and Chief Executive Officer whose employment was terminated for cause during 2007. The Company’s lawsuit alleged claims (which involved amounts that were not material to the Company’s financial condition or results of operations). On July 24, 2008, the former officer filed a claim for arbitration pursuant to his employment agreement with the Bank, disputing that there was cause for the termination of his employment and seeking to be paid additional salary and benefits under the agreement and other compensatory agreements between him and the Bank.

On December 31, 2009, the former officer voluntarily dismissed the arbitration proceeding, with prejudice. On January 19, 2010, the Bank voluntarily dismissed its civil action. Those dismissals resolved all matters between the parties that were the subject of those proceedings. No payments were made by either party to the other in connection with the dismissals.

PART II

 

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES

There currently is a limited trading market for the Company’s common stock, and there can be no assurance that a more active market will develop. The Company’s common stock is traded in the over-the-counter markets, with prices for the stock being published on the OTC Bulletin Board under the symbol “MCFI.” There were 1,671 stockholders of record as of January 29, 2010, not including the persons or entities whose stock is held in nominee or “street” name and by various banks and brokerage firms.

The table below presents the high and low closing prices for the Company’s common stock as published on the OTC Bulletin Board for each quarter in the years ended December 31, 2009 and 2008. The prices in the table have been adjusted to reflect declared stock splits in the form of stock dividends in 2007.

 

     High    Low

2009

     

First quarter

   $ 7.50    $ 4.05

Second quarter

   $ 7.00    $ 4.50

Third quarter

   $ 7.10    $ 5.25

Fourth quarter

   $ 6.35    $ 4.00

2008

     

First quarter

   $ 11.55    $ 10.00

Second quarter

   $ 11.20    $ 8.57

Third quarter

   $ 10.10    $ 8.00

Fourth quarter

   $ 9.60    $ 7.00

 

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Since it was organized in 2002, the Company has retained its earnings as additional capital to support growth in its earning assets, and it has not paid any cash dividends on its common stock. Information regarding regulatory restrictions on the Company’s and the Bank’s abilities to pay cash dividends is contain in this report under the captions “ITEM 1. DESCRIPTION OF BUSINESS — Supervision and Regulation” above, and in NOTE P to the Company’s financial statements included in this Report under Item 8. Although the Company is a legal entity separate and distinct from the Bank, the Company’s principal source of funds with which it could pay cash dividends would be the dividends the Company receives from the Bank. For that reason, the Company’s ability to pay dividends effectively is subject to the same limitations that apply to the Bank. In the future, in addition to the regulatory considerations referenced above, the Company’s ability to declare and pay cash dividends will be subject to the Board of Directors’ evaluation of the Company’s and the Bank’s operating results, capital levels, financial condition, future growth plans, general business and economic conditions, and other relevant considerations, as well as to changes in applicable statutes, regulations or regulatory policies that could have a material effect on the Company’s and the Bank’s business.

Recent Repurchase of Company’s Securities

The Company did not repurchase any of its securities in the last quarter of the fiscal year ending December 31, 2009.

 

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ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth certain summary consolidated financial data, performance ratios and other data at, or for the periods indicated. As this information is only a summary, you should read it in conjunction with the historical financial statements (and related notes) of the Company and “Item 7. —Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

MidCarolina Financial Corporation

Table 1

Selected Consolidated Financial Information and Other Data

($ in thousands, except per share and nonfinancial data)

 

     At or for the Year Ended December 31,
     2009    2008    2007    2006    2005

Operating Data:

              

Total interest income

   $ 27,583    $ 29,616    $ 31,053    $ 27,061    $ 19,208

Total interest expense

     10,440      15,294      17,721      14,241      8,327
                                  

Net interest income

     17,143      14,322      13,332      12,820      10,881

Provision for loan losses

     4,455      1,665      425      394      1,373
                                  

Net interest income after provision

     12,688      12,657      12,907      12,426      9,508

Noninterest income

     2,787      2,220      2,627      2,304      2,683

Noninterest expense

     12,281      9,462      8,305      9,077      8,546
                                  

Income before income taxes

     3,194      5,415      7,229      5,653      3,645

Provision for income taxes

     818      1,741      2,342      1,757      1,277
                                  

Net income

     2,376      3,674      4,887      3,896      2,368

Dividends on preferred stock

     417      417      417      417      104
                                  

Net income available to common shareholders

   $ 1,959    $ 3,257    $ 4,470    $ 3,479    $ 2,264
                                  

Per Share Data (1):

              

Earnings per common share - basic

   $ 0.40    $ 0.66    $ 0.98    $ 0.80    $ 0.53

Earnings per common share - diluted

     0.40      0.66      0.92      0.73      0.48

Market price

              

High

     7.50      11.55      19.60      18.18      12.37

Low

     4.00      7.00      9.00      10.51      8.44

Close

     4.62      7.50      9.50      15.80      10.36

Book value - common shares

     7.23      6.57      6.13      5.20      4.25

Weighted average common shares outstanding

              

Basic

     4,927,828      4,915,350      4,548,565      4,348,128      4,299,522

Diluted

     4,930,310      4,916,876      4,851,738      4,775,853      4,669,601

Selected Year-End Balance Sheet Data:

              

Total assets

   $ 541,004    $ 540,847    $ 467,186    $ 420,850    $ 370,440

Loans, held to maturity

     438,087      434,662      371,714      313,572      279,962

Allowance for loan losses

     7,307      5,632      4,462      4,222      4,090

Deposits

     465,020      467,948      373,897      339,275      300,262

Short-term borrowings

     520      —        19,000      25,000      10,000

Long-term debt

     33,764      33,764      38,764      26,764      34,764

Shareholders’ equity

     40,185      37,143      33,150      28,259      23,093

Selected Average Balances:

              

Total assets

   $ 550,607    $ 506,581    $ 447,442    $ 397,514    $ 329,395

Loans, net

     441,704      405,119      344,620      301,405      252,914

Total interest-earning assets

     523,692      486,979      427,142      379,168      309,935

Deposits

     475,012      425,790      370,128      329,724      264,730

Total interest-bearing liabilities

     467,372      432,436      380,288      338,283      280,412

Shareholders’ equity

     38,614      35,830      29,901      24,550      19,743

Shareholders’ equity less average preferred equity

     33,795      31,011      25,082      19,731      17,910

 

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MidCarolina Financial Corporation

Table 1

Selected Consolidated Financial Information and Other Data

($ in thousands, except per share and nonfinancial data)

 

     At or for the Year Ended December 31,  
     2009     2008     2007     2006     2005  

Selected Performance Ratios:

          

Return on average assets

   0.43   0.73   1.09   0.98   0.72

Return on average equity excluding preferred equity

   5.80   10.50   17.82   17.63   12.64

Net interest spread

   3.03   2.54   2.61   2.93   3.23

Net interest margin

   3.27   2.94   3.12   3.38   3.51

Noninterest income to total net revenue

   13.98   16.14   16.46   15.23   19.78

Noninterest income to average assets

   0.51   0.54   0.59   0.58   0.81

Noninterest expense to average assets

   2.23   1.97   1.86   2.28   2.59

Asset Quality Ratios:

          

Nonperforming loans to period-end loans

   1.68   0.72   0.19   0.25   0.08

Allowance for loan losses to period-end loans

   1.67   1.30   1.20   1.35   1.46

Allowance for loan losses to nonperforming loans

   99.50   180.34   637.43   531.74   1725.74

Nonperforming assets to total assets

   1.89   0.88   0.21   0.74   0.83

Net loan charge-offs to average loans

   0.63   0.12   0.05   0.05   0.09

Capital Ratios:

          

Total risk-based capital

   11.93   11.19   11.48   11.28   11.34

Tier 1 risk-based capital

   10.67   9.97   10.37   10.12   9.90

Leverage ratio

   8.79   8.68   8.95   8.73   8.64

Equity to assets ratio

   7.43   6.87   7.10   6.71   6.23

Other Data:

          

Number of banking offices

   8      8      8      8      6   

Number of full time equivalent employees

   82      79      77      71      69   

 

(1) All per share data has been restated to reflect the effects of a stock split effected in the form of a 25% stock dividend in 2005, a stock split effected in the form of a 10% stock dividend in 2006 and a 25% split effected dividend in January 2007.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The discussion and analysis that follows is intended to assist readers in the understanding and evaluation of the financial condition and results of operations of the Company. It should be read in conjunction with the audited consolidated financial statements and accompanying notes included in this Annual Report on Form 10-K and the supplemental financial data appearing throughout this discussion and analysis. Because the Company’s primary asset is the Bank, the discussion that follows focuses on the Bank’s business and operations.

EXECUTIVE OVERVIEW

Significant accomplishments

In the opinion of its management, the Company’s most significant accomplishments during 2009, which are discussed in more detail in this Item 7, were as follows:

 

   

Reduced concentration of wholesale funding by $24.1 million or 11.6%

 

   

Reduced concentration of construction loan portfolio by 26.4% or $24.3 million

 

   

Average non-interest bearing deposits increased 18.2%

 

   

Improved interest margin to 3.27% from 2.94%

Challenges.

The Bank has achieved significant growth without the advent of acquisitions or mergers since first opening its doors in 1997. The financial industry in general is faced with many uncertainties and challenges. As management plans its strategic goals and objectives, future expectations of economic activity, and how these uncertainties could impact the Company’s performance, must be taken into consideration. The challenges that we believe are most likely to have an impact on the operations of the Company in the foreseeable future are presented below:

 

   

Sustaining profitable growth

 

   

Managing margins in an abnormally low interest rate environment

 

   

Competition from bank and non-bank entities, including fierce price competition

 

   

Uncertainty of real estate values

 

   

Obtaining adequate funding of asset growth

 

   

Maintaining liquidity during an uncertain economic environment

 

   

Managing equity in an unpredictable capital market

 

   

Managing asset quality during a period of economic uncertainty

SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA

Selected Consolidated Financial Information and Other Data are presented in Table 1 of Item 6. The information in this table is derived in part from the audited consolidated financial statements and notes thereto of the Company. The information in this table does not purport to be complete and should be read in conjunction with the Company’s consolidated financial statements that are included in this Annual Report on Form 10-K.

FINANCIAL CONDITION

DECEMBER 31, 2009 AND 2008

The Company’s total assets totaled $541.0 million at year-end 2009 a modest increase of $157,000, or .03%, when compared to year-end 2008. Loans, excluding those held for sale, increased by $3.4 million, or 0.78%, from $434.7 million at the beginning of the year to $438.1 million at year end. The change in loans was composed principally of increases of $18.6 million in commercial mortgage loans, $7.8 million in residential mortgage loans (including income producing properties) and $934,000 in commercial and industrial loans, offset by decreases of $24.4 million in construction loans and $923,000 in loans to individuals, all of which are segments of lending the Company targets and intends to continue targeting in the future. Investment securities decreased by $405,000, or 0.57%, from $71.1 million to $70.7 million. Liquid assets, consisting of cash and demand balances due from banks, interest-earning deposits in other banks and investment securities, were 14.82% of total assets, at December 31, 2009 and 16.05% at December 31, 2008. The Bank, as a member of the FHLB of Atlanta, has an investment of $2.3 million in FHLB stock. The Bank’s investment in life insurance used to offset the cost of employee benefit plans, increased by $286

 

15


thousand during 2009 to $8.3 million. The increase was due to an increase in the cash surrender value of the policies. Other assets increased $4.6 million over 2008. The components of other assets that incurred significant change include other real estate owned which increased $1.3 million or 78.0% over 2008 year-end, reflecting the distressed economy affecting the industry; prepaid expense increased $3.0 million from 2008 year-end, resulting from a 3-year prepayment of FDIC insurance premiums paid December 2009.

Deposits decreased a modest $2.9 million during 2009. However, the mix of deposits showed significant improvement as total transactional accounts comprised of noninterest-bearing demand accounts and interest-bearing demand accounts increased $65.1 million or 53.60%, from $121.4 million at December 31, 2008 to $186.5 million at December 31, 2009. Individually, noninterest-bearing demand accounts decreased $1.4 million, or 3.34%, interest bearing demand accounts increased 66.5 million, or 84.94%, savings accounts increased $2.5 million or 42.91%, and time deposits decreased $70.5 million or 20.69% over the amount of these deposits at December 31, 2008. The Bank also used wholesale brokered certificates of deposit and advances from the FHLB of Atlanta, Georgia as funding sources during 2009 to serve as a secondary source of funding asset growth. Borrowings from the FHLB remained unchanged at $25.0 million at December 31, 2009. Wholesale brokered certificates of deposit decreased $21.0 million or 17.03% and comprised approximately 22.02% of total deposit balances. Typically brokered certificates of deposit have similar terms to retail certificates of deposit issued in the Bank’s local markets, with rates marginally lower than local market certificates of deposit rates.

Total shareholders’ equity increased by $3.0 million, or 8.04%, during 2009. All capital ratios continue to place the Company and the Bank in excess of the minimum required to be a well-capitalized institution by regulatory measures. The Company issued $4.8 million in Non-Cumulative Perpetual Preferred Stock on August 15, 2005 and $8.5 million in Trust Preferred Securities during prior years, so as to remain “well capitalized” under regulatory capital guidelines without diluting existing shareholders’ ownership. The Trust Preferred Securities and Preferred Stock should provide sufficient capital to retain a “well-capitalized” designation as defined by regulatory capital guidelines for the foreseeable future. The Trust Preferred Securities qualify as Tier 1 regulatory capital and are reported in Federal Reserve regulatory reports as a qualifying security in a consolidated subsidiary. The junior subordinated debentures issued to guarantee the Trust Preferred Securities do not qualify as Tier 1 regulatory capital. On July 2, 2003, the Federal Reserve issued a letter, SR 03-13, stating that notwithstanding any potential implications FASB Accounting Standards Codification™ (ASC) Topic 810 may have on reporting trust preferred securities on financial statements, trust preferred securities will continue to be included in Tier 1 capital until notice is given to the contrary. There can be no assurance that the Federal Reserve will continue to allow institutions to include trust-preferred securities in Tier I capital for regulatory capital purposes. In the event of a disallowance, there would be a reduction in the Company’s consolidated capital ratios. However, the Company believes that the Bank would remain “well capitalized” under FDIC guidelines.

NET INTEREST INCOME

Similar to most financial institutions, the primary component of earnings for the Bank is net interest income. Net interest income is the difference between interest income, principally from the loan and investment securities portfolios, and interest expense, principally on deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, “volume” refers to the average dollar level of interest-earning assets and interest-bearing liabilities, “spread” refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities and “margin” refers to net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as levels of non-interest-bearing liabilities. During the years ended December 31, 2009, 2008 and 2007, average interest-earning assets were $523.7 million, $487.0 million and $427.1 million, respectively. During these same years, the Bank’s net yields on average interest-earning assets were 3.27%, 2.94% and 3.12%, respectively. The increase in net yields from 2008 to 2009 is a reflection of the dramatic decrease in interest rates over the year. An overall increase in spread which is the difference between yields earned on interest bearing assets less the interest paid on interest bearing liabilities was strongly influenced by the Bank’s concerted effort to increase lower cost transactional accounts during 2009. The Bank’s balance sheet is well positioned for changes in interest rates. When interest rates change, the Bank’s earnings and net yields remain stable as the Bank’s ratio of interest-earning assets to interest-bearing liabilities is well matched under all interest rate environments and time periods measured by the Bank.

Table 2, following this discussion, “Average Balances and Net Interest Income”, presents an analysis of the Bank’s net interest income for 2009, 2008 and 2007.

 

16


Table 3, following this discussion, “Volume and Rate Variance Analysis”, shows the amounts of changes in net interest income due to changes in volume and rates and illustrates that the change in the average rate of loans was offset by the decrease in average deposit rates. These two variables were the predominant factors in the higher amount of net interest income realized by the Bank in 2009, when compared to 2008.

RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2009 AND 2008

Overview. The Company reported net income available to common shareholders of $2.0 million, or $0.40 per diluted common share, for the year ended December 31, 2009, compared with net income available to shareholders of $3.3 million, or $0.66 per diluted common share, for 2008, a decrease of $1.3 million or $0.26 per diluted share.

Net Interest Income. Net interest income increased to $17.1 million for the year ended December 31, 2009, a $2.8 million or 19.70% increase from the $14.3 million earned in 2008. Total interest income benefited from moderate growth in the level of average earning assets offset by significantly lower liability yields caused by historically low interest rates during the year. The rates earned on a significant portion of the Bank’s loans adjust immediately when indexes like the prime rate change. Conversely, a large portion of interest-bearing liabilities, including certificates of deposit and Bank borrowings, have rates fixed until maturity. As a result, interest rate reductions will generally result in an immediate drop in the Bank’s interest income on loans, with a more delayed impact on interest expense because reductions in interest costs will only occur upon renewals of certificates of deposit or borrowings. Interest rate increases will generally result in an immediate increase in the Bank’s interest income on loans, with a more delayed impact on interest expense because increases in interest costs will only occur upon renewals of certificates of deposit or borrowings. Average total interest-earning assets increased $36.7 million, or 7.53%, during 2009 compared to 2008, while the average yield decreased by 81 basis points from 6.08% to 5.27%. As interest rates remained very low during 2009, the average rate on loans repriced and decreased year over year. The average rate on investment securities decreased in 2009 compared to 2008 reflecting the lower reinvestment yields available for securities purchased or reinvested during the year. Average total interest-bearing liabilities increased by $34.9 million, or 8.07%, a slightly higher growth rate than average interest-earning asset balances. The average cost of interest-bearing liabilities decreased by 131 basis points from 3.54% to 2.23%. With the cost on interest bearing liabilities decreasing more significantly than the yield on earning assets, the Bank’s net interest margin increased by 33 basis points. For the year ended December 31, 2009, the net interest margin was 3.27%, while for the year ended December 31, 2008, the net interest margin was 2.94%. Table 3 reflects the volume and rate variances from 2009 vs. 2008.

Provision for Loan Losses. The Bank recorded $4.5 million in the provision for loan losses in 2009, an increase of $2.8 million from the $1.7 million provision made in 2008. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. In evaluating the allowance for loan losses, management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. For 2009, large provisions were made each quarter in response to the weakened economy and real estate market. Specifically, builder/construction loans experienced a significant deterioration in their collateral values and many developers experienced decreased rates of building lot inventory turn-over. Although the bank reduced its total exposure to construction loans by $24.3 million or 26.4% from $91.9 million at December 31, 2008 to $67.6 million at December 31, 2009, significant risk to property value depreciation continues to persist in the Company’s construction loan portfolio. Real estate developers’ ability to service debt for extended time periods remains tentative as cash flows have deteriorated. Total loans outstanding, net of loans held for sale, increased by $3.4 million in 2009 and by $62.9 million in 2008. At December 31, 2009, the allowance for loan losses was $7.3 million, an increase of $1.7 million, or 29.74%, from the $5.6 million at the end of 2008. The allowance represented 1.66% and 1.30%, respectively, of loans outstanding at the end of 2009 and 2008, net of loans held for sale. The increase in the allowance is reflective of the on going economic and real estate market deterioration experienced locally as well as nationally and internationally. At December 31, 2009, the Bank had $7.3 million in non-accrual loans. In 2008, the Bank had $3.1 million in non-accrual loans. For a more detailed discussion of the provision of loan losses and the established reserve, see the section entitled “Analysis of Allowance for Loan Losses.”

Non-Interest Income. Non-interest income increased to $2.8 million for the year ended December 31, 2009 compared to $2.2 million for the year ended December 31, 2008, an increase of $567,000 or 25.54%. A significant factor in the increase in total non-interest income was the reduction in Other Than Temporary Impairment (OTTI) of private label collateralized mortgage obligation securities. OTTI recognized in 2009 was $148,000, which is a decrease of $342,000, a 69.79% improvement compared to the 2008 OTTI write down of $490,000. The decrease in

 

17


the determination of OTTI was influenced by the adoption of ASC Topic 320-10-65-1 (formerly referred to as FSP FAS 115-2) effective January 1, 2009. Prior to January 1, 2009, if an investment was determined to be other than temporarily impaired, then the difference between the book value and market value was recognized as an OTTI loss in earnings. Beginning January 1, 2009, if an investment in a debt security was deemed to be other than temporarily impaired, then the difference between the book value and market value was further evaluated to identify the portion that related to credit deterioration. Only the portion related to credit deterioration is recognized through earnings. The cumulative effect of the change in accounting principle was an opening adjustment of $211,000, net of tax, to increase retained earnings. During 2009 the portion of OTTI that was determined to be credit-related and thus recognized in earnings was $148,000. Mortgage operations income increased to $800 thousand in 2009, from $571 thousand in 2008, reflecting the impact of government initiated first time home buyer incentives and attractive refinancing rates available in the mortgage origination market. Service charges on deposit accounts in 2009 were $910,000, a decrease of $242,000, or 21.01%, compared to $1.2 million in 2008 reflecting the competitive market for attracting and retaining demand deposit accounts. Other non-interest income increased $272,000 in 2009 reflecting a receipt of a one time insurance claim for $252,000. Table 4, following this discussion, is a comparative analysis of the components of non-interest income for 2009, 2008 and 2007.

Non-Interest Expenses. Non-interest expenses totaled $12.3 million for the year ended December 31, 2009, an increase of $2.8 million over the $9.5 million reported for 2008. Noninterest expense of $12.3 million, excluding the effect of the $349,000 loss on sale of other real estate increased $1.9 million for 2009, compared to noninterest expense of $9.5 million, excluding the effect of the $536,000 gain on sale of other real estate in 2008. Salaries and employee benefits increased $239,000 primarily resulting from increases in fair value expenses of Stock Options issued in 2009. Professional and other services increased $184,000 or 33.45% primarily due to expenses incurred to increases in audit and legal fees and proceedings. Deposit and other insurance expense increased $848,000 or 196.30% because of increased FDIC premiums and the special assessment imposed during 2009. Occupancy and equipment expense increased by $449,000 due to increases in maintenance costs and additional lease expense incurred with the relocation of our Green Valley Office located in Greensboro and new software licensure expenses. Data processing and other outside services increased $144,000, or 18.30%, due primarily to costs associated with the reconfiguration and relocation of the Bank’s data processing servers as well as the implementation of a significantly enhanced business and disaster recovery plan. Advertising expense decreased $49,000 reflecting new marketing strategies and programs during 2009. Table 5, following this discussion, presents a comparative analysis of the components of non-interest expenses for 2009, 2008 and 2007.

Income Taxes. The provision for income tax was $818,000 in 2009 and $1.7 million in 2008. The effective tax rates were 25.6% and 32.2%, respectively, on income before income taxes. The decrease in the effective tax rate for 2009 reflects an increase in the proportion of tax-exempt income to total income for 2009 over 2008.

RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2008 AND 2007

Overview. The Company reported net income available to common shareholders of $3.3 million, or $0.66 per diluted common share, for the year ended December 31, 2008, compared with net income available to shareholders of $4.5 million, or $0.92 per diluted common share, for 2007, a decrease of $1.2 million or $0.26 per diluted share. Results for the 12 months ended December 31, 2008 included a one-time after tax adjustment of $248,000 related to Other Than Temporary Impairment of Mortgage Backed Securities. Results for the 12 months ended December 31, 2007 included a one-time after-tax adjustment of $579,000 related to the reversal of accrued benefits for a former executive officer. Excluding the effect of these adjustments, our diluted earnings per common share for 2008 would have been $0.71, compared to $0.80 for 2007.

Net Interest Income. Net interest income increased to $14.3 million for the year ended December 31, 2008, a $990,000 or 7.4% increase from the $13.3 million earned in 2007. Total interest income benefited from strong growth in the level of average earning assets offset by lower asset yields caused by the decrease in interest rates during the year. The rates earned on a significant portion of the Bank’s loans adjust immediately when indexes like the prime rate change. Conversely, a large portion of interest-bearing liabilities, including certificates of deposit and Bank borrowings, have rates fixed until maturity. As a result, interest rate reductions will generally result in an immediate drop in the Bank’s interest income on loans, with a more delayed impact on interest expense because reductions in interest costs will only occur upon renewals of certificates of deposit or borrowings. Interest rate increases will generally result in an immediate increase in the Bank’s interest income on loans, with a more delayed impact on interest expense because increases in interest costs will only occur upon renewals of certificates of deposit or borrowings. Average total interest-earning assets increased $59.8 million, or 14.0%, during 2008 compared to

 

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2007, while the average yield decreased by 119 basis points from 7.27% to 6.08%. As interest rates decreased during 2008, the average rate on loans decreased year over year. The average rate on investment securities increased in 2008 compared to 2007, reflecting management’s decision to purchase higher yielding securities during 2008 taking advantage of the unusual extremes in mortgaged backed securities prices in 2008. Average total interest-bearing liabilities increased by $52.1 million, or 13.7%, consistent with the increase in interest-earning assets. The average cost of interest-bearing liabilities decreased by 113 basis points from 4.66% to 3.53%. With the yield on earning assets decreasing more significantly than the cost of interest bearing liabilities, the Bank’s net interest margin decreased by 18 basis points. For the year ended December 31, 2008, the net interest margin was 2.94%, while for the year ended December 31, 2007, the net interest margin was 3.12%. Table 3 reflects the volume and rate variances from 2008 vs. 2007.

Provision for Loan Losses. The Bank recorded $1.7 million in the provision for loan losses in 2008, an increase of $1.2 million from the $425,000 provision made in 2007. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. In evaluating the allowance for loan losses, management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. For 2008 the provision to loan losses was made in response to the weakened economy and real estate market experienced during 2008, large provisions were made each quarter during the year, total loans outstanding, net of loans held for sale, increased by $62.9 million in 2008 and by $58.1 million in 2007. At December 31, 2008, the allowance for loan losses was $5.6 million, an increase of $1.2 million, or 26.22%, from the $4.5 million at the end of 2007. The allowance represented 1.30% and 1.20%, respectively, of loans outstanding at the end of 2008 and 2007, net of loans held for sale. At December 31, 2008, the Bank had $3.1 million in non-accrual loans. In 2007, the Bank had $700,000 in non-accrual loans. It is management’s opinion that reserve levels are adequate.

Non-Interest Income. Non-interest income decreased to $2.2 million for the year ended December 31, 2008 compared to $2.6 million for the year ended December 31, 2007, a decrease of $407,000 or 15.49%. An Other Than Temporary Impairment of private label collateralized mortgage obligation securities in the amount of $490,000, was recognized in 2008. Excluding the Other Than temporary Impairment, non-interest income increased $83,000 or 3.2% for 2008. Mortgage operations income decreased to $571 thousand in 2008, from $600 thousand in 2007, reflecting a softening in the overall mortgage origination market. Service charges on deposit accounts in 2008 were $1.2 million, an increase of $94,000, or 8.9%, compared to $1.1 million in 2007 reflecting the positive results of a focused marketing effort to increase demand deposit accounts. Table 4, following this discussion, is a comparative analysis of the components of non-interest income for 2008, 2007 and 2006.

Non-Interest Expense. Non-interest expense totaled $9.5 million for the year ended December 31, 2008, an increase of $1.2 million over the $8.3 million reported for 2007. Adjusting non-interest expense for a one-time adjustment of $905,000 related to the reversal of accrued benefits for a former executive officer, non-interest expense for 2007 would have totaled $9.2 million, reflecting an increase of $252,000 or 2.73% for 2008. Substantially all of this increase resulted from the Bank’s growth and development during 2008 and 2007. Personnel costs after the one-time adjustment of $905 thousand related to the reversal of accrued benefits for a former executive officer increased by $3,000 in 2008. Professional and other services increased $74,000 or 15.6% primarily due to expenses incurred related to the preparation of anticipated regulatory changes and increases in legal fees and proceedings. Deposit and other insurance expense increased $80,000 or 22.7% because of increased FDIC premiums. Occupancy and equipment expense increased by $51,000 due to increases in maintenance costs and additional lease expense incurred with the relocation of our Green Valley Office located in Greensboro, NC. Data processing and other outside services decreased $19,000, or 1.7%, due to the renegotiation of our bank platform operating system contract. Advertising expense increased $131,000 reflecting new marketing strategies and programs during 2008. A gain on sale of other real estate was recognized in the amount of $536 and $481 respectively for 2008 and 2007. Table 5, following this discussion, presents a comparative analysis of the components of non-interest expenses for 2009, 2008 and 2007.

Income Taxes. The provision for income tax was $1.7 million in 2008 and $2.3 million in 2007. The effective tax rates were 32.2% and 32.4%, respectively, on income before income taxes.

LIQUIDITY

The Bank’s sources of liquidity are customer deposits, cash and demand balances due from other banks, interest-earning deposits in other banks and investment securities available for sale. These funds, together with loan and securities repayments, are used to fund loans and continuing operations. At December 31, 2009, the Bank had credit

 

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availability with the Federal Reserve Bank of $74.6 million and the FHLB of $167.2 million, with $25.0 million outstanding.

Total deposits were $465.0 million and $467.9 million at December 31, 2009 and 2008, respectively. The Bank’s deposits decreased 0.63% in 2009. Because the Bank’s organic deposit growth was sufficient in amount to meet the total funding needs of the Bank’s asset growth, the Bank reduced its exposure to alternative funding sources during 2009. The Bank reduced its total wholesale funding sources in 2009 by $24.0 million or 11.60%. Total wholesale funding was $183.0 million at December 31, 2009 compared to $207.1 million at December 31, 2008. The Bank will continue to evaluate all funding sources for cost, accessibility, dependability and efficiency. Brokered certificates of deposits decreased $21.0 million during 2009, from $123.4 million in 2008 to $102.4 million in 2009, a decrease of 17.03%. Brokered deposits as a percent of assets decreased from 22.82% in 2008 to 18.92% in 2009.

At December 31, 2009 and 2008, time deposits represented 58.11% and 63.0%, respectively, of the Bank’s total deposits. Certificates of deposit of $100,000 or more represented 48.8% and 59.9%, respectively, of the Bank’s total deposits at December 31, 2009 and 2008. At December 31, 2009, the Bank had $20.8 million in public deposits and $102.4 million in brokered time deposits. These sources of funds are generally considered to be less stable than deposits from the Bank’s local markets. However, management believes that other non-traditional funding time deposits are relationship oriented. While the Bank appreciates the need to pay competitive rates to retain these deposits, other subjective factors also influence deposit retention. Based upon prior experience, the Bank anticipates that a substantial portion of outstanding certificates of deposit will renew upon maturity. The Bank’s aggregate wholesale funding comprised of brokered CD’s, wholesale NOW accounts, FHLB advances, FRB discount window borrowings and CDARS accounts (Certificate of Deposit Account Registry Service) as a percentage of total assets decreased to 33.9% in 2009 from 38.3% in 2008. The wholesale funding aggregate decrease is due primarily to an increase in traditional deposits resulting from our customer base’s recognition of MidCarolina’s consistent performance during a difficult economic period.

Management anticipates that the Bank will continue to utilize non-local market funding sources such as wholesale NOW accounts, CDARS, FHLB advances, FRB advances and brokered certificates of deposits as a less costly diversified funding source to complement the Bank’s local market deposits. Deposits, loan repayments, mortgage-backed securities prepayments, bond maturities, FHLB advances, FRB discount window borrowings and current earnings will be employed to provide liquidity, generate loans, purchase securities, procure fixed assets and meet other operating needs incurred in normal banking activities.

In the normal course of business there are various outstanding contractual obligations of the Bank that will require future cash outflows. In addition, there are commitments and contingent liabilities, such as commitments to extend credit that may or may not require future cash outflows. Table 6, following this discussion, “Contractual Obligations and Commitments”, summarizes the Bank’s contractual obligations and commitments as of December 31, 2008.

CAPITAL RESOURCES

At December 31, 2009 and 2008, shareholders’ equity of the Company totaled $40.2 million and $37.2 million, respectively. The Company’s equity to asset ratio on those dates was 7.42% and 6.9%, respectively, reflecting the Company’s moderate growth during 2009. The Company and the Bank are subject to minimum capital requirements. See “PART 1, ITEM 1 - DESCRIPTION OF BUSINESS — SUPERVISION AND REGULATION.” Because the Company’s only significant asset is its investment in the Bank, information concerning capital ratios is essentially the same for the Company and the Bank.

All capital ratios place the Bank in excess of minimum requirements to be classified as “well capitalized’ by regulatory measures. The Bank’s Tier-1leverage ratio was 8.67% at December 31, 2009.

Note P to the accompanying consolidated financial statements presents an analysis of the Bank’s regulatory capital position as of December 31, 2009 and 2008. Management anticipates that the Bank will remain “well-capitalized” for regulatory purposes throughout 2009.

ASSET/LIABILITY MANAGEMENT

The Bank’s results of operations depend substantially on its net interest income. Like most financial institutions, the Bank’s interest income and cost of funds are affected by general economic conditions and by competition in the market place. The purpose of asset/liability management is to provide stable net interest income growth by protecting

 

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the Bank’s earnings from undue interest rate risk, which arises from volatile interest rates and changes in the balance sheet mix, and by managing the risk/return relationships between liquidity, interest rate risk, market risk and capital adequacy. The Bank maintains, and has complied with, an asset/liability management policy approved by the Board of Directors of the Company and the Bank that provides guidelines for controlling exposure to interest rate risk by utilizing the following ratios and trend analysis: liquidity, equity, volatile liability dependence, portfolio maturities, maturing assets and maturing liabilities. The Bank’s policy is to control the exposure of its earnings to changing interest rates by generally endeavoring to maintain a position within a range around an “earnings neutral position,” which is defined as the mix of assets and liabilities that generate a net interest margin that is least affected by interest rate changes.

When suitable lending opportunities are not sufficient to utilize available funds, the Bank has generally invested such funds in securities, primarily securities issued by U.S. governmental agencies, mortgage-backed securities and securities issued by local governmental municipalities. The securities portfolio contributes to the Bank’s profits and plays an important part in the overall interest rate management. However, management of the securities portfolio alone cannot balance overall interest rate risk. The securities portfolio must be used in combination with other asset/liability techniques to actively manage the balance sheet. The primary objectives in the overall management of the securities portfolio are safety, liquidity, yield, asset/liability management (interest rate risk) and investing in securities that can be pledged for public deposits or as collateral for FHLB advances.

In reviewing the needs of the Bank with regard to proper management of its asset/liability program, the Bank’s management estimates its future needs, taking into consideration historical periods of high loan demand and low deposit balances, estimated loan and deposit increases (due to increased demand through marketing) and forecasted interest rate changes. A number of measures are used to monitor and manage interest rate risk, including income simulations and interest sensitivity (gap) analyses. An income simulation model is the primary tool used to assess the direction and magnitude of changes in net interest income resulting from changes in interest rates. Key assumptions in the model include prepayments on loan and loan-backed assets, cash flows and maturities of other investment securities, loan and deposit volumes and pricing. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies, among other factors.

Based on the results of the income simulation model, as of December 31, 2009, due to the extremely low interest rate environment, the Bank would expect a decrease in net interest income of $376,000 if interest rates increase from current rates by an instantaneous 100 basis points and an increase in net interest income of $547,000 thousand if interest rates decrease from current rates by an instantaneous 100 basis points.

The analysis of an institution’s interest rate gap (the difference between the repricing of interest-earning assets and interest-bearing liabilities during a given period of time) is another standard tool for the measurement of the exposure to interest rate risk. Management believes that because interest rate gap analysis does not address all factors that can affect earnings performance, it should be used in conjunction with other methods of evaluating interest rate risk.

Table 7, following this discussion, “Interest Rate Sensitivity Analysis”, sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 2009, which are projected to reprice or mature in each of the future time periods shown. Except as stated below, the amounts of assets and liabilities shown which reprice or mature within a particular period were determined in accordance with the contractual terms of the assets or liabilities. Loans with adjustable rates are shown as being due at the end of the next upcoming adjustment period. Money market deposit accounts are considered rate sensitive and are placed in the shortest period. Negotiable order of withdrawal or other transaction accounts are also assumed to be rate sensitive and are placed in the shortest period. In making the gap computations, none of the assumptions sometimes made regarding prepayment rates and deposit decay rates are used for any interest-earning assets or interest-bearing liabilities. In addition, the table does not reflect scheduled principal payments that will be received throughout the lives of the loans. The interest rate sensitivity of the Bank’s assets and liabilities illustrated in the table would vary substantially if different assumptions were used or if actual experience differs from that indicated by such assumptions.

Table 7 illustrates that if assets and liabilities reprice in the time intervals indicated in the table, the Bank is asset sensitive within three months, liability sensitive over three months to twelve months, asset sensitive within twelve months and asset sensitive thereafter. As stated above, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates

 

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on other types may lag behind changes in market interest rates. For instance, while the table is based on the assumption that money market accounts are immediately sensitive to movements in rates, the Bank expects that in a changing rate environment the amount of the adjustment in interest rates for such accounts would be less than the adjustment in categories of assets that are considered to be immediately sensitive. The same is true for all other interest-bearing transaction accounts. Additionally, certain assets have features that restrict changes in the interest rates of such assets both on a short-term basis and over the lives of such assets. Further, in the event of a change in market interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the tables. Finally, the ability of many borrowers to service their adjustable-rate debt may decrease in the event of an increase in market interest rates. Due to these shortcomings, the Bank places primary emphasis on its income simulation model when managing its exposure to changes in interest rates. The Bank does not normally make interest rate predictions, or take undue risk on potential changes in interest rate direction. The Bank is currently neutral in its rate sensitivity. Should interest rates increase or decrease, the Bank’s earnings, margins and spreads would be positively impacted.

LENDING ACTIVITIES

General. The Bank provides to its customers a full range of short- to medium-term commercial, mortgage, construction and personal loans, both secured and unsecured. The Bank also makes real estate mortgage and construction loans.

The Bank’s loan policies and procedures establish the basic guidelines governing its lending operations. Generally, the guidelines address the types of loans that the Bank seeks, target markets, underwriting and collateral requirements, terms, interest rate and yield considerations and compliance with laws and regulations. All loans or credit lines are subject to approval procedures and amount limitations. These limitations apply to the borrower’s total outstanding indebtedness to the Bank, including the indebtedness of any guarantor. The policies are reviewed and approved at least annually by the Board of Directors of the Bank. The Bank supplements its own supervision of the loan underwriting and approval process with periodic loan audits by internal loan examiners and outside professionals experienced in loan review work. The Bank has focused its portfolio lending activities on typically higher yielding commercial, construction and consumer loans. The Bank also originates 1-4 family mortgages that are typically sold into the secondary market, servicing released.

Table 8, “Loan Portfolio Composition”, following this discussion, provides an analysis of the Bank’s loan portfolio composition by type of loan as of the end of each of the last five years.

Table 9, “Loan Maturities”, following this discussion, presents, at December 31, 2009, (i) the aggregate maturities or re-pricings of commercial, industrial and commercial mortgage loans and of real estate constructions loans and (ii) the aggregate amounts of such loans by variable and fixed rates.

Commercial and Industrial Loans. At December 31, 2009, the Bank’s commercial and industrial loan portfolio equaled $64.2 million, or 14.6% of total loans, as compared with $63.2 million, or 14.6% of total loans, at December 31, 2008. Commercial and industrial loans include both secured and unsecured loans for working capital, expansion and other business purposes. Short-term working capital loans generally are secured by accounts receivable, inventory and/or equipment. The Bank also makes term commercial loans secured by equipment and real estate. Lending decisions are based on an evaluation of the financial strength, management and credit history of the borrower, and the quality of the collateral securing the loan. With few exceptions, the Bank requires personal guarantees and secondary sources of repayment.

Commercial and industrial loans generally provide greater yields and reprice more frequently than other types of loans, such as real estate loans, as most commercial loan yields are tied to the prime rate index. Therefore, yields on most commercial loans adjust with changes in the prime rate.

Real Estate Loans. Real estate loans are originated for the purpose of purchasing, constructing or refinancing one to four family, five or more family and commercial properties. The Bank offers fixed and adjustable rate options. The Bank provides customers access to long-term conventional real estate loans through its mortgage loan department which makes Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Company (“FHLMC”) and Government National Mortgage Association (“GNMA”)— conforming loans that are originated with a commitment from a correspondent bank to purchase the loan within 30-45 days of closing.

Residential 1- 4 family loans are classified into two categories: conforming loans, that are originated under the underwriting guidelines established by FNMA, FHLMC or GNMA and held for sale and nonconforming loans that

 

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are originated and retained in the Bank’s loan portfolio. The terms “conforming” and “nonconforming” do not refer to credit quality, but rather to whether the loan is underwritten so that it can be sold in the secondary market. At December 31, 2009, the Bank had $228,000 loans held for sale while nonconforming loans held in the Bank’s permanent portfolio amounted to $442,000. The Bank’s permanent residential mortgage loans are generally secured by properties located within the Bank’s market area. Most of the one to four family residential mortgage loans that the Bank makes are conforming loans and are sold within 30 days of closing to a correspondent bank. The Bank originated 288 loans in the amount of $51.5 million for sale in the secondary market during 2009. The Bank receives a fee for each loan originated, with fees aggregating $800,000 for the year ended December 31, 2009 and $571,000 for the year ended December 31, 2008. The Bank anticipates that it will continue to be an active originator of residential loans. Nonconforming residential mortgage loans that are retained in the Bank’s loan portfolio generally have rate terms of five years or less, with amortizations up to 20 years.

The Bank has made, and anticipates continuing to make, commercial real estate loans. Commercial real estate loans amounted to $174.9 million at December 31, 2009. These loans are secured principally by commercial buildings for office, storage and warehouse space, and by agricultural properties. Generally in underwriting commercial real estate loans, the Bank requires the personal guarantee of borrowers and a demonstrated cash flow capability sufficient to service the debt. Loans secured by commercial real estate usually involve a greater degree of risk than 1-4 family residential mortgage loans. Payments on such loans are often dependent on successful operation or management of the properties.

The Bank originates 1- 4 family residential construction loans for the construction of custom homes (where the home buyer is the borrower) and provides financing to builders and consumers for the construction of pre-sold homes. The Bank generally receives a pre-arranged permanent financing commitment from an outside entity prior to financing the construction of pre-sold homes. The Bank lends to builders who have demonstrated a favorable record of performance and profitable operations and who are building in markets that management believes it understands and in which it is comfortable with the economic conditions. The Bank also makes commercial real estate construction loans, generally for owner-occupied properties. The Bank further endeavors to limit its construction lending risk through adherence to established underwriting procedures. The Bank generally requires documentation for all draw requests and utilizes loan officers to inspect the project prior to honoring draw requests from the builder. With few exceptions, the Bank requires personal guarantees and secondary sources of repayment on construction loans.

Consumer Loans and Home Equity Lines of Credits. Loans to individuals include automobile loans, boat and recreational vehicle financing, home equity and home improvement loans and miscellaneous secured and unsecured personal loans. Consumer loans generally can carry significantly greater risks than other loans, even if secured, if the collateral consists of rapidly depreciating assets such as automobiles and equipment. Repossessed collateral securing a defaulted consumer loan may not provide an adequate source of repayment of the loan. Consumer loan collections are sensitive to job loss, illness and other personal factors. The Bank attempts to manage the risks inherent in consumer lending by following established credit guidelines and underwriting practices designed to minimize risk of loss.

Loan Approvals. The Bank’s loan policies and procedures establish the basic guidelines governing its lending operations. Generally, the guidelines address the type of loans that the Bank seeks, target markets, underwriting and collateral requirements, terms, interest rate and yield considerations and compliance with laws and regulations. All loans or credit lines are subject to approval procedures and amount limitations. These limitations apply to the borrower’s total outstanding indebtedness to the Bank, including the indebtedness of any guarantor. The policies are reviewed and approved at least annually by the Board of Directors of the Bank. The Bank supplements its own supervision of the loan underwriting and approval process with periodic loan audits by independent, outside professionals experienced in loan review analysis.

Responsibility for loan production rests with the Senior Commercial Lending Officer in each market. The responsibility for loan underwriting, loan processing and approval is with the Chief Credit Officer. The Board of Directors of the Bank reviews the President’s lending authority annually. The Board, in turn delegates loan authority to the Chief Credit Officer and other loan officers of the Bank. Delegated authorities may include loans, letters of credit, overdrafts, uncollected funds and such other authority as determined by the Board of Directors or the President.

The President and the Chief Credit Officer each have the authority to approve loans up to $400 thousand. The President in conjunction with the Chief Credit Officer have the combined authority to approve loans up to $2 million which is the maximum staff, in-house lending limit set by the Board of Directors. The Board’s Loan Committee approves all loans in excess of the staff’s in-house lending limit. The Committee consists of the President, the

 

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Chairman and Vice Chairman of the Bank’s Board and six outside directors as appointed by the Board of the Bank

Additionally, all loans of $50 thousand or greater and all loans with relationship exposure of $200,000 or above are reviewed by the Management Loan Committee comprised of the President, Chief Credit Officer, and the Senior Commercial Loan Officers for Alamance County and Guilford County. The Bank’s Loan Committee reviews all loans with total exposure of $1.0 million or greater and approves all loans with total exposure of $2.0 million or greater. The Bank’s legal lending limit was $13.9 million at December 31, 2009. The Bank seldom makes loans approaching its legal lending limit.

COMMITMENTS TO EXTEND CREDIT

In the ordinary course of business, the Bank enters into various types of transactions that include commitments to extend credit that are not included in loans receivable, net, presented on the Company’s consolidated balance sheets. The Bank applies the same credit standards to these commitments as it uses in all its lending activities and has included these commitments in its lending risk evaluations. The Bank’s exposure to credit loss under commitments to extend credit is represented by the amount of these commitments. See Note O to the accompanying consolidated financial statements and Table 6.

ASSET QUALITY

The Bank considers asset quality to be of primary importance, and employs a formal internal loan review process to ensure adherence to the lending policy as approved by the Bank’s Board of Directors. It is the responsibility of each loan officer to assign an appropriate risk grade to loans when originated. Credit Administration, through the loan review process, validates the accuracy of the initial risk grade assessment. In addition, as a given loan’s credit quality changes, it is the responsibility of Credit Administration to change the borrower’s risk grade accordingly. The process of determining the allowance for loan losses is fundamentally driven by the risk grade system. In determining the allowance for loan losses and any resulting provision to be charged against earnings, particular emphasis is placed on the results of the loan review process. Consideration is also given to historical loan loss experience, the value and adequacy of collateral, economic conditions in the Bank’s market area and other factors. For loans determined to be impaired, the allowance is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. This evaluation is inherently subjective, as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. At December 31, 2009 the Bank had 24 loans on the Loan Watch List totaling $8.3 million comprised of 8 Builder/construction loans totaling $4.1 Million, 8 commercial and industrial loans for $3.7 million and 8 residential mortgage loans for $551,000. The allowance for loan losses represents management’s estimate of the appropriate level of reserve to provide for probable losses inherent in the loan portfolio.

The Bank’s policy regarding past due loans normally requires a prompt charge-off to the allowance for loan losses following timely collection efforts and a thorough review. Further efforts are then pursued through various means available. Loans carried in a non-accrual status are generally collateralized and are considered in the determination of the allowance for loan losses.

NONPERFORMING ASSETS

The Company’s total nonperforming assets increased $5.4 million to $10.2 million at December 31, 2009, from $4.8 million at December 31, 2008, reflecting the distressed economy mentioned previously. Non accrual loans, a subset of nonperforming assets comprised 71.9% of total nonperforming assets or $7.3 million. Other real estate owned comprised the remaining significant component of nonperforming assets in the amount of $2.9 million or 28.0% of total nonperforming assets. Restructured loans at December 31, 2009, which were not included in total nonperforming assets, consisted of two construction loans.

Table 10, “Nonperforming Assets”, following this discussion, sets forth, for the last five years, information with respect to the Bank’s nonperforming assets.

The Company’s consolidated financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on loans, unless a loan is placed on non-accrual basis. Loans are accounted for on a non-accrual basis when management has serious concerns about the collectibility of principal or interest. Generally, the Bank’s policy is to place a loan on non-accrual status when the loan becomes 90 days past due. Loans are also

 

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placed on non-accrual status in cases where management is uncertain whether the borrower can satisfy the contractual terms of the loan agreement. Payments received on non-accrual loans generally are applied to principal first, and then to interest after all principal payments have been satisfied. Restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal, have been granted due to the borrower’s weakened financial condition. The Bank accrues interest on restructured loans at the restructured rate when management anticipates that no loss of original principal will occur. Potential problem loans are defined as loans currently performing that are not included in non-accrual or restructured loans, but are loans that management has concerns as to the borrower’s ability to comply with present repayment terms. These loans could deteriorate to non-accrual, past due or restructured loans status. Therefore, management quantifies the risk associated with problem loans in assessing the adequacy of the allowance for loan losses. At December 31, 2008, the Bank identified $7.8 million in non-accrual loans. At December 31, 2008, the Bank identified $3.1 million in non-accrual loans.

Other real estate owned consists of foreclosed, repossessed and idled properties. At December 31, 2009, there were $2.9 million assets classified as real estate owned. At December 31, 2008, there were $1.6 million assets classified as real estate owned.

ANALYSIS OF ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged-off against the allowance when management believes that the collectibility of principal is unlikely. Recoveries of amounts previously charged-off are credited to the allowance.

The allowance for loan losses relating to loans that are determined to be impaired under SFAS No. 114 is based on discounted cash flows using the loan’s initial effective interest rate or the estimated fair value of the collateral, less costs to sell, for certain collateral dependent loans. Large groups of smaller balance homogeneous loans that are collectively evaluated for impairment (such as residential mortgage and consumer installment loans) are excluded from impairment evaluation, and their allowance for loan losses is calculated in accordance with the allowance for loan losses policy described below.

The provision for loan losses charged to operating expense is based on factors which, in management’s judgment, deserve current recognition in estimating probable loan losses. Such factors considered by management include growth and composition of the loan portfolio, the relationship of the allowance for loan losses to outstanding loans and economic conditions. While management uses the best information available to make evaluations, this evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change.

In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.

Growth in loans outstanding has, throughout the Bank’s history, been the primary reason for increases in the Bank’s allowance for loan losses and the resultant provisions for loan losses necessary to provide for those increases. This growth has been spread among the Bank’s major loan categories, with the concentrations of major loan categories being relatively consistent. Between December 31, 2008 and December 31, 2009, the range of each major category of loans as a percentage of total loans outstanding is as follows: residential mortgage loans – 16.9% to 18.7%; commercial mortgage loans – 36.0% to 39.9%; construction loans – 21.1% to 15.4%; commercial and industrial loans – 14.6% to 14.6%; loans to individuals – 1.4% to 1.2%; and home equity lines of credit – 10.0% to 10.2%. For the past five fiscal years through 2009, the Bank’s loan loss experience has been similar to that of other peer banks in North Carolina, with net loan charge-offs in each year of ranging from 0.05% to 0.63% of average loans outstanding. Charge offs are typically recognized when it is the opinion of management that all or a portion of an outstanding loan becomes uncollectible. Loan repayment may be realized through a contractual agreement, or through liquidation of assets pledged as collateral. Net charge-offs totaled $495,000 or 0.12% of outstanding loans for 2008 and $2.8 million or 0.63% of outstanding loans for 2009. The Bank’s allowance for loan losses at December 31, 2008 of $5.6 million represents 1.30% of total loans outstanding, net of loans held for sale. The Bank’s allowance for loan losses at December 31, 2009 was $7.3 million or 1.67% of outstanding loans, net of loans held for sale. The allowance for loan losses as a percentage of loans outstanding increased in 2009 compared to 2008 due to an increase in loans outstanding as well as increases in non performing loans reflecting the decline in the local, national and international

 

25


economic environment. Non performing loans increased $4.2 million during 2009 to $7.3 million compared to $3.1 million at December 31, 2008. $6.9 million of the non performing loans at December 31, 2009, or 93.6%, were concentrated in commercial real estate.

Table 11, “Allocation for the Allowance of Loan Losses”, following this discussion, presents the allocation of the allowance for loan losses at the end of each of the last five years. The allocation is based on an evaluation of defined loan problems, historical ratios of loan losses and other factors that may affect future loan losses in the categories of loans shown.

Table 12, “Loan Loss and Recovery Experience”, following this discussion, sets forth for each of the last five years information regarding changes in the Bank’s allowance for loan losses.

INVESTMENT ACTIVITIES

The Bank’s portfolio of investment securities, all of which are available for sale, consists primarily of U.S. government agency securities, mortgage-backed securities, private label collateralized mortgage obligations and securities issued by local governments. Securities to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale and carried at fair value, with any unrealized gains or losses reflected as an adjustment to stockholders’ equity. Securities held for indefinite periods of time include securities that management intends to use as part of its asset/liability management strategy and that may be sold in response to changes in interest rates and/or significant prepayment risks. It is the Bank’s policy to classify its investment securities as available for sale. Table 13, “Securities Portfolio Composition”, following this discussion, summarizes investment securities by type at December 31, 2009, 2008 and 2007.

Table 14, “Securities Portfolio Composition”, following this discussion, summarizes the amortized costs, fair values and weighted average yields of the Bank’s investment securities at December 31, 2009, by contractual maturity groups.

The Bank does not engage in, nor does it presently intend to engage in, securities trading activities and therefore does not maintain a trading account. At December 31, 2009, there were no securities of any issuer (other than governmental agencies) held in the Bank’s portfolio that exceeded 10% of the Company’s shareholders’ equity.

SOURCES OF FUNDS

Deposit Activities. The Bank provides a range of deposit services, including non-interest-bearing checking accounts, interest-bearing checking and savings accounts, money market accounts and certificates of deposit. These accounts generally earn interest at rates established by management based on competitive market factors and management’s desire to increase or decrease certain types or maturities of deposits. As described in “-Liquidity” above, the Bank uses wholesale deposits as a funding source. However, the Bank strives to establish customer relations to attract core deposits in non-interest-bearing transactional accounts and thus to reduce the Bank’s costs of funds.

Table 15, “Average Deposits”, following this discussion, sets forth for the for the years ended December 31, 2009, 2008 and 2007 the average balances outstanding and average interest rates for each major category of deposits.

Table 16, “Maturities of Time Deposits of $100,000 or More”, which follows this discussion, presents maturities of certificates of deposit with balances of $100,000 or more at December 31, 2009.

Borrowings. As additional sources of funding, the Bank uses advances from the FHLB under a line of credit equal to 30% of the Bank’s total assets, subject to qualifying collateral. The available aggregate line of credit was $167.2 million at December 31, 2009. Outstanding advances at December 31, 2009 totaled $25.0 million, $10.0 million maturing in 2010, bearing interest at a weighted average rate of 4.70%, $5 million maturing in 2011 at 2.37% and $10 million maturing in 2018 at 2.98%.The Bank had no daily rate credit advances outstanding at December 31, 2009. Pursuant to collateral agreements with the FHLB, at December 31, 2009, advances are secured by loans with a carrying amount of $110.8 million, which approximates market value. Advances outstanding at December 31, 2008 totaled $25.0 million.

The Bank also has a line of credit with the FRB through their discount window in the amount of $74.6 million. No borrowings were outstanding at December 31, 2009. The line of credit is secured by loans with a carrying amount of $95.4 million, which approximates market value.

 

26


In addition to FHLB advances, the Company issued $8.8 million of junior subordinated debentures to its wholly owned capital trusts, MidCarolina I and MidCarolina Trust II, to fully and unconditionally guarantee the preferred securities issued by the Trusts. These long term obligations, which currently qualify as Tier I capital for the Company, constitute a full and unconditional guarantee by the Company of the Trusts’ obligations under the Capital Trust Securities.

CRITICAL ACCOUNTING POLICIES

We have established various accounting policies that govern the application of accounting principles generally accepted in the United States of America in the preparation of our financial statements. Significant accounting policies are described in Note B to the audited consolidated financial statements. These policies may involve significant judgments and estimates that have a material impact on the carrying value of certain assets and liabilities. Different assumptions made in the application of these policies could result in material changes in our financial position and results of operations.

Allowance for Loan Losses. The Company’s most significant critical accounting policy is the determination of the Bank’s allowance for loan losses. A critical accounting policy is one that is both very important to the portrayal of the Company’s financial condition and results, and requires management’s most difficult, subjective or complex judgments. What makes these judgments difficult, subjective and/or complex is the need to make estimates about the effects of matters that are inherently uncertain. If the mix and amount of future write-offs differ significantly from those assumptions used in making a determination, the allowance for loan losses and provision for loan losses on the income statement could be materially affected. For further discussion of the allowance for loan losses and a detailed description of the methodology used in determining the adequacy of the allowance, see the sections of this discussion titled “Asset Quality,” “Analysis of Allowance for Loan Losses” and Note B to the consolidated financial statements contained in this Annual Report.

Other Than Temporary Impairment. We evaluate securities for other-than-temporary impairment at least on a monthly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) the anticipated outlook for changes in the general level of interest rates, (4) whether, for debt securities, it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis, and (5) whether, for equity securities, our intent and ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

Off-Balance Sheet Arrangements. The Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect of the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

RISKS ASSOCIATED WITH THE BANK AND THE COMPANY

Concentration of Operations. The Bank’s operations are concentrated in the Piedmont region of North Carolina. As a result of this geographic concentration, the Bank’s results may correlate to the economic conditions in this area. A deterioration in economic conditions in this market area, particularly in the industries on which these geographic areas depend, may adversely affect the quality of the Bank’s loan portfolio and the demand for the Bank’s products and services, and accordingly, its results of operations.

Risks Associated with Loans. A significant source of risk for the Bank arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans. The Bank has underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for loan losses, that management believes are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying the Bank’s loan portfolio. Such policies and procedures, however, may not prevent unexpected losses that could adversely affect results of operations. A dramatic fluctuation in real estate prices may affect loan collateral values as well as credit extension decisions related to homebuilding and construction segments of the Bank’s real estate loan portfolio.

Competition with Larger Financial Institutions. The banking and financial services business in the Bank’s market area continues to be a competitive field and is becoming more competitive as a result of:

 

27


 

changes in regulations;

 

 

changes in technology and product delivery systems; and

 

 

the accelerating pace of consolidation among financial services providers.

It may be difficult to compete effectively in the Bank’s market, and results of operations could be adversely affected by the nature or pace of change in competition. The Bank competes for loans, deposits and customers with various bank and non-bank financial services providers, many of which are much larger in total assets and capitalization, have greater access to capital markets and offer a broader array of financial services.

Trading Volume. The Company’s trading volume is relatively low when compared with more seasoned companies listed on the Nasdaq Capital Market, the Nasdaq Global & Global Select Market System, the New York Stock Exchange or other consolidated reporting systems or stock exchanges. The market in the Company’s common stock may be limited in scope relative to other companies. The Company cannot guarantee that a more active and liquid trading market for the Company’s common stock will develop in the future.

Technological Advances. The banking industry is undergoing technological changes with frequent introductions of new technology-driven products and services. In addition to improving customer services, the effective use of technology increases efficiency and enables financial institutions to reduce costs. The Bank’s future success will depend, in part, on its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in the Bank’s operations. Many of our competitors have substantially greater resources than the Company and the Bank to invest in technological improvements.

Government Regulations. Current and future legislation and the policies established by federal and state regulatory authorities will affect the Company’s and the Bank’s operations. The Bank is subject to supervision and periodic examination by the FDIC and the Commissioner. The Company is subject to the supervision and regulation of the Federal Reserve and the Commissioner. Banking regulations, designed primarily for the protection of depositors, may limit the Company’s and the Bank’s growth and the return to our shareholders by restricting certain of the Company’s and the Bank’s activities, such as:

 

 

the payment of dividends to the Company’s shareholders;

 

 

possible mergers with or acquisitions of or by other institutions;

 

 

investment policies;

 

 

loans and interest rates on loans;

 

 

interest rates paid on deposits;

 

 

expansion of branch offices; and/or

 

 

the possibility to provide or expand securities or trust services.

The Company cannot predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that any changes may have on future business and earnings prospects. The cost of compliance with regulatory requirements may adversely affect the Company’s and the Bank’s ability to operate profitably.

 

28


MidCarolina Financial Corporation

Table 2

Average Balances and Net Interest Income (1)

($ in thousands)

 

     Year Ended December 31, 2009     Year Ended December 31, 2008     Year Ended December 31, 2007  
     Average
Balance
    Interest    Average
Rate
    Average
Balance
    Interest    Average
Rate
    Average
Balance
    Interest    Average
Rate
 

Interest-earning assets:

                     

Loans, net

   $ 441,704      $ 24,160    5.47   $ 405,119      $ 25,763    6.36   $ 344,620      $ 27,037    7.85

Investment securities

     70,289        3,378    4.81     69,728        3,561    5.11     72,013        3,581    4.97

Interest-earning cash deposits

     9,387        21    0.22     9,678        131    1.35     8,080        264    3.27

Other

     2,312        24    1.04     2,454        161    6.56     2,429        171    7.04
                                                   

Total interest-earning assets

     523,692        27,583    5.27     486,979        29,616    6.08     427,142        31,053    7.27
                                             

Other assets

     26,915             19,602             20,300        
                                       

Total assets

   $ 550,607           $ 506,581           $ 447,442        
                                       

Interest-bearing liabilities:

                     

Deposits:

                     

Demand deposits

     112,438        1,510    1.34     74,531        1,275    1.71     80,529        2,796    3.47

Savings deposits

     6,663        20    0.30     5,772        29    0.50     6,024        60    1.00

Fixed maturity deposits

     312,282        7,648    2.45     308,562        12,192    3.95     249,096        12,501    5.02

Short term borrowed funds

     2,225        15    0.67     9,807        288    2.94     16,636        1,094    6.58

Long term borrowed funds

     33,764        1,247    3.69     33,764        1,510    4.47     28,003        1,270    4.54
                                                   

Total interest-bearing liabilities

     467,372        10,440    2.23     432,436        15,294    3.54     380,288        17,721    4.66
                                             

Noninterest-bearing deposits

     43,629             36,925             34,479        

Other liabilities

     992             1,390             2,774        

Stockholders’ equity

     38,614             35,830             29,901        
                                       

Total liabilities and stockholders’ equity

   $ 550,607           $ 506,581           $ 447,442        
                                       

Net interest income and interest rate spread

     $ 17,143    3.03     $ 14,322    2.54     $ 13,332    2.61
                                             

Net yield on average interest-earning assets

        3.27        2.94        3.12
                                 

Ratio of average interest-earning assets to average interest-bearing liabilities

     112.05          112.61          112.32     
                                       

 

(1) includes nonaccrual and nonperforming loans, the impact of which is not significant. Tax exempt income is not computed on a tax equivalent basis.

 

29


MidCarolina Financial Corporation

Table 3

Volume and Rate Variance Analysis

(In Thousands)

 

     Year Ended December 31, 2009 vs. 2008     Year Ended December 31, 2008 vs. 2007  
     Increase (Decrease) Due to     Increase (Decrease) Due to  
     Volume     Rate     Total     Volume     Rate     Total  

Interest income:

            

Loans, net

   $ 2,164      $ (3,767   $ (1,603   $ 4,297      $ (5,571   $ (1,274

Investment securities

     28        (211     (183     (115     95        (20

Interest-earning cash deposits

     (2     (108     (110     37        (170     (133

Other

     (5     (132     (137     2        (12     (10
                                                

Total interest income

     2,185        (4,218     (2,033     4,221        (5,658     (1,437
                                                

Interest expense:

            

Deposits

            

Demand deposits

     579        (344     235        (155     (1,366     (1,521

Savings deposits

     4        (13     (9     (2     (29     (31

Fixed maturity deposits

     119        (4,663     (4,544     2,667        (2,976     (309

Short term borrowed funds

     (137     (136     (273     (325     (481     (806

Long term borrowed funds

     —          (263     (263     259        (19     240   
                                                

Total interest expense

     565        (5,419     (4,854     2,444        (4,871     (2,427
                                                

Net interest income increase (decrease)

   $ 1,620      $ 1,201      $ 2,821      $ 1,777      $ (787   $ 990   
                                                

 

30


MidCarolina Financial Corporation

Table 4

Noninterest Income

(In thousands)

 

     Year Ended December 31,
     2009     2008     2007

Service charges on deposit accounts

   $ 910      $ 1,152      $ 1,058

Mortgage operations

     800        571        600

Investment brokerage fees

     245        300        288

Increase in cash surrender value of life insurance

     286        299        290
                      

Core noninterest income

     2,241        2,322        2,236

Securities gains (losses), net

     63        29        8

Impairment on investment securities

     (148     (490     —  

Other noninterest income

     631        359        383
                      

Total noninterest income

   $ 2,787      $ 2,220      $ 2,627
                      

 

31


MidCarolina Financial Corporation

Table 5

Noninterest Expenses

(In thousands)

 

     Year Ended December 31,  
     2009    2008     2007  

Salaries

   $ 4,564    $ 4,338      $ 4,085   

Employee benefits

     1,062      1,049        1,299   

Reversal of accrued employee benefits

     —        —          (905
                       

Total salaries and benefits

     5,626      5,387        4,479   

Occupancy expense

     979      699        428   

Equipment expense

     603      434        425   

Other outside services

     374      307        357   

Data processing

     931      787        774   

Office supplies and postage

     341      350        317   

Deposit and other insurance

     1,280      432        352   

Professional and other services

     734      550        476   

Advertising

     338      387        256   

(Gain) loss on sale of Other real estate

     349      (536     (481

Other

     726      665        922   
                       

Total noninterest expenses

   $ 12,281    $ 9,462      $ 8,305   
                       

 

32


MidCarolina Financial Corporation

Table 6

Contractual Obligations and Commitments

($ in thousands)

 

     Payments Due by Period

Contractual Obligations

   Total    On Demand
or Within

1 Year
   After 1 year
through

3 Years
   After 3 years
through

5 Years
   After
5 Years

Short-term borrowings

   $ 520    $ 520    $ —      $ —      $ —  

Long-term debt

     33,764      10,000      5,000      10,000      8,764

Operating leases

     3,050      388      688      658      1,316
                                  

Total contractual cash obligations excluding deposits

     37,334      10,908      5,688      10,658      10,080

Time deposits

     340,751      326,322      14,429      —        —  
                                  

Total contractual cash obligations

   $ 378,085    $ 337,230    $ 20,117    $ 10,658    $ 10,080
                                  
     Amount of Commitment Expiration Per Period

Commercial Commitments

   Total
Amounts
Committed
   On Demand
or Within 1
Year
   After 1 year
through 3
Years
   After 3 years
through 5
Years
   After 5
Years

Lines of credit and loan commitments (1)

   $ 67,649    $ 30,394    $ 3,614    $ —        33,641
                                  

 

(1) includes financial standby letters of credit, net

 

33


MidCarolina Financial Corporation

Table 7

Interest Rate Sensitivity Analysis

($ in thousands)

 

     At December 31, 2009  
      3 Months
or Less
    Over 3 Months
to 12 Months
    Total Within
12 Months
    Over 12
Months
    Total  

Interest-earning assets:

          

Loans and loans held for sale

   $ 254,171      $ 65,466      $ 319,637      $ 118,678      $ 438,315   

Securities available for sale

     1,407        7,892        9,299        61,420        70,719   

Other earning assets

     10,170        —          10,170        —          10,170   
                                        

Total interest-earning assets

   $ 265,748      $ 73,358      $ 339,106      $ 180,098      $ 519,204   
                                        

Interest-bearing liabilities

          

Fixed maturity deposits

   $ 10,560      $ 112,440      $ 123,000      $ 147,260      $ 270,260   

All other deposits

     153,094        —          153,094        —          153,094   

Borrowings

     28,020        —          28,020        6,264        34,284   
                                        
   $ 191,674      $ 112,440      $ 304,114      $ 153,524      $ 457,638   
                                        

Interest sensitivity gap

   $ 74,074      $ (39,082   $ 34,992      $ 26,574      $ 61,566   

Cumulative interest sensitivity gap

     74,074        34,992        34,992        61,566        61,566   

Cumulative interest sensitivity gap as a percent of total interest-earning assets

     14.27     6.74     6.74     11.86     11.86

Cumulative ratio of interest-sensitive assets to interest-sensitive liabilities

     138.65     111.51     111.51     113.45     113.45

 

34


MidCarolina Financial Corporation

Table 8

Loan Portfolio Composition

($ in thousands)

 

     At December 31,  
     2009     2008     2007     2006     2005  
     Amount     % of
Total
Loans
    Amount     % of
Total
Loans
    Amount     % of
Total
Loans
    Amount     % of
Total
Loans
    Amount    % of
Total
Loans
 

Real Estate:

                     

Construction loans

   $ 67,635      15.43   $ 91,933      21.15   $ 80,051      21.49   $ 71,348      22.61   $ 67,170    23.92

Commercial mortgage loans

     174,926      39.92     156,333      35.97     140,198      37.63     124,385      39.41     100,292    35.71

Home equity lines of credit

     44,627      10.18     43,290      9.96     41,479      11.13     33,090      10.49     30,072    10.71

Residential mortgage loans

     81,377      18.56     73,595      16.93     57,342      15.39     37,163      11.78     38,656    13.76

Residential mortgage loans held for sale

     228      0.05     —        0.00     823      0.22     2,016      0.63     893    0.32
                                                                     

Total real estate loans

     368,793      84.14     365,151      84.01     319,893      85.86     268,002      84.92     237,083    84.42

Commercial and industrial loans

     64,173      14.64     63,239      14.55     46,893      12.59     38,965      12.35     38,929    13.86

Loans to individuals for household, family and other personal expenditures

     5,383      1.22     6,306      1.44     5,796      1.55     8,625      2.73     4,836    1.72
                                                                     

Loans, gross

     438,349      100.00     434,696      100.00     372,582      100.00     315,592      100.00     280,848    100.00
                                         

Less unamortized net deferred loan origination (fees) costs

     (34       (34       (45       (4       7   
                                                 

Total loans

   $ 438,315        $ 434,662        $ 372,537        $ 315,588        $ 280,855   
                                                 

 

35


MidCarolina Financial Corporation

Table 9

Loan Maturities

($ In thousands)

 

     At December 31, 2009  
     Due within
one year
    Due after one
year but within five
    Due after
five years
    Total  
     Amount    Yield     Amount    Yield     Amount    Yield     Amount    Yield  

By loan type:

                    

Construction

   $ 60,118    4.76   $ 6,870    5.71   $ 647    4.56   $ 67,635    4.86

Commercial mortgage

     54,960    4.62     107,790    6.33     12,176    6.62     174,926    5.81

Commercial and industrial

     40,983    4.45     20,563    5.88     2,627    5.75     64,173    4.96
                                    

Total

   $ 156,061    4.63   $ 135,223    6.23   $ 15,450    4.56   $ 306,734    5.42
                                    

By interest rate type:

                    

Fixed rate loans

   $ 99,195      $ 134,421      $ 15,450      $ 249,066   

Variable rate loans

     56,866        802        —          57,668   
                                    
   $ 156,061      $ 135,223      $ 15,450      $ 306,734   
                                    

The above table is based on contractual scheduled maturities. Early repayment of loans or renewals at maturity are not considered in this table.

 

36


MidCarolina Financial Corporation

Table 10

Nonperforming Assets

($ in thousands)

 

     At December 31,  
     2009     2008     2007     2006     2005  

Nonperforming loans

          

Contruction

   $ 4,301      $ 188      $ 700      $ 794      $ 237   

Commercial mortgage

     2,557        2,547        —          —          —     

Residential mortgage

     486        362        —          —          —     

Commercial and industrial

     —          26        —          —          —     

Loans to individuals

     —          —          —          —          —     
                                        

Total nonperforming loans

     7,344        3,123        700        794        237   

Repossessed Assets

     14        47        —          —          19   

Other real estate owned

     2,862        1,608        264        2,337        2,803   
                                        

Total nonperforming assets

   $ 10,220      $ 4,778      $ 964      $ 3,131      $ 3,059   
                                        

Accruing loans past due 90 days or more

   $ —        $ —        $ —        $ —        $ —     

Allowance for loan losses

     7,307        5,632        4,462        4,222        4,090   

Nonperforming loans to year end loans

     1.68     0.72     0.19     0.25     0.80

Allowance for loan losses to year end loans

     1.67     1.30     1.20     1.35     1.46

Nonperforming assets to loans and other real estate owned

     2.32     1.11     0.27     0.99     1.08

Nonperforming assets to total assets

     1.89     0.88     0.21     0.74     0.83

Allowance for loan losses to nonperforming loans

     99.50     180.34     637.43     531.74     1725.74

Restructured loans in accrual status, not included above

   $ 2,619      $ —        $ —        $ —        $ —     

 

37


MidCarolina Financial Corporation

Table 11

Allocation of the Allowance for Loan Losses

($ In thousands)

 

     2009     2008     2007     2006     2005  
     Amount    % of Total
Loans (1)
    Amount    % of Total
Loans (1)
    Amount    % of Total
Loans (1)
    Amount    % of Total
Loans (1)
    Amount    % of Total
Loans (1)
 

Real estate loans:

                         

Construction loans

   $ 1,127    15.43   $ 1,191    21.15   $ 959    21.49   $ 954    22.61   $ 978    23.92

Commercial mortgage loans

     2,918    39.93     2,026    35.97     1,679    37.63     1,664    39.41     1,461    35.71

Home equity lines of credit

     744    10.18     561    9.96     497    11.13     443    10.49     438    10.71

Residential mortgage loans

     1,358    18.56     954    16.93     670    15.02     487    11.78     563    13.76

Residential mortgage loans held for sale

     —      0.00     —      0.00     —      0.00     —      0.00     —      0.00
                                                             

Total real estate loans

     6,147    84.14     4,732    84.01     3,805    85.86     3,548    84.92     3,440    84.42

Commercial and industrial loans

     1,071    14.64     819    14.55     575    12.59     619    12.35     665    13.86

Loans to individuals

     89    1.22     81    1.44     69    1.55     115    2.73     70    1.72
                                                             
   $ 7,307    100.00   $ 5,632    100.00   $ 4,462    100.00   $ 4,222    100.00   $ 4,090    100.00
                                                                 

 

(1) Represents total of all outstanding loans in each category as a percent of total loans outstanding

 

38


MidCarolina Financial Corporation

Table 12

Loan Loss and Recovery Experience

($ in thousands)

 

     At or for the Year Ended December 31,  
     2009     2008     2007     2006     2005  

Loans held to maturity, outstanding at the end of the year

   $ 438,087      $ 434,662      $ 371,714      $ 313,572      $ 279,962   
                                        

Average loans outstanding during the year

   $ 441,704      $ 405,119      $ 344,620      $ 301,405      $ 252,914   
                                        

Allowance for loan losses at beginning of year

   $ 5,632      $ 4,462      $ 4,222      $ 4,090      $ 2,865   

Provision for loan losses

     4,455        1,665        425        394        1,373   
                                        
     10,087        6,127        4,647        4,484        4,238   
                                        

Loans charged off:

          

Real estate loans

     (1,502     (411     (268     (214     —     

Commercial and industrial loans

     (1,396     (106     —          (87     (137

Loans to individuals

     (127     (16     (28     (17     (44
                                        

Total charge-offs

     (3,025     (533     (296     (318     (181
                                        

Recoveries of loans previously charged off:

          

Real estate loans

     32        11        66        2        —     

Commercial and industrial loans

     208        26        38        46        26   

Loans to individuals

     5        1        7        8        7   
                                        

Total recoveries

     245        38        111        56        33   
                                        

Net charge-offs

     (2,780     (495     (185     (262     (148
                                        

Allowance for loan losses at end of year

   $ 7,307      $ 5,632      $ 4,462      $ 4,222      $ 4,090   
                                        

Ratios:

          

Net charge-offs as a percent of average loans

     0.63     0.12     0.05     0.09     0.06

Allowance for loan losses as a percent of loans at end of year

     1.67     1.30     1.20     1.35     1.46

 

39


MidCarolina Financial Corporation

Table 13

Securities Portfolio Composition

(In thousands)

 

     At December 31
     2009    2008    2007

Securities available for sale:

        

U. S. Government agencies

   $ 12,057    $ 2,533    $ 19,372

Mortgage-backed securities

     24,917      50,431      31,986

State and municipal governments

     28,449      17,607      19,275

Private label CMO’s

     4,976      —        —  

Subordinated debentures

     320      553      168
                    

Total securities available for sale

   $ 70,719    $ 71,124    $ 70,801
                    

 

40


MidCarolina Financial Corporation

Table 14

Securities Portfolio Composition

($ in thousands)

 

     At December 31, 2009  
     Amortized
Cost
   Fair
Value
   Book
Yield
 

Securities available for sale:

        

U. S. Government agencies

        

Due within one year

   $ 1,013    $ 1,012    1.26

Due after one but within five years

     11,100      11,045    2.70
                
     12,113      12,057    2.58
                

State and municipal securities

        

Due within one year

     —        —      —     

Due after one but within five years

     5,083      4,949    5.45

Due after five but within ten years

     10,892      10,675    5.71

Due after ten years

     13,404      12,825    5.92
                
     29,379      28,449    5.76
                

Other

        

Due after ten years

     500      320    3.75
                
     500      320    3.75
                

Total securities available for sale

        

Due within one year

     1,013      1,012    1.26

Due after one but within five years

     16,183      15,994    3.55

Due after five but within ten years

     10,892      10,675    5.71

Due after ten years

     13,904      13,145    5.87

Private label collateralized mortgage obligations

     5,683      4,975    5.71

Mortgage-backed securities

     23,690      24,918    5.14
                    
   $ 71,365    $ 70,719    4.99
                    

Yields on tax exempt securities are stated on a federal tax equivalent basis.

 

41


MidCarolina Financial Corporation

Table 15

Average Deposits

($ in thousands)

 

     For the Year Ended December 31,  
     2009     2008     2007  
     Average
Amount
   Average
Rate
    Average
Amount
   Average
Rate
    Average
Amount
   Average
Rate
 

Demand deposits

   $ 112,438    1.34   $ 74,531    1.71   $ 80,529    3.47

Savings deposits

     6,663    0.30     5,772    0.50     6,024    1.00

Fixed maturity deposits

     312,282    2.45     308,562    3.95     249,096    5.02
                           

Total interest-bearing deposits

     431,383    2.13     388,865    3.47     335,649    4.58

Noninterest-bearing deposits

     43,629    —          36,925    —          34,479    —     
                           

Total deposits

   $ 475,012    1.93   $ 425,790    3.17   $ 370,128    4.15
                           

 

42


MidCarolina Financial Corporation

Table 16

Maturities of Time Deposits of $100,000 or More

(In thousands)

 

     At December 31, 2009
     3 Months
or Less
   Over 3 Months
to 6 Months
   Over 6 Months
to 12 Months
   Over 12
Months
   Total

Time Deposits of $100,000 or more

   $ 39,540    $ 40,674    $ 39,213    $ 107,706    $ 227,133
                                  

 

43


Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods. Our market risk arises primarily from interest rate risk inherent in our lending and deposit-taking activities. The structure of our loan and deposit portfolios is such that a significant change in interest rates may adversely impact net market values and net interest income. We do not maintain a trading account nor are we subject to currency exchange risk or commodity price risk. Interest rate risk is monitored as part of the Bank’s Asset/Liability Management function.

See the section entitled Asset/Liability Management for a more detailed discussion of market risk.

 

44


Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

LOGO

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders

MidCarolina Financial Corporation and Subsidiary

Burlington, North Carolina

We have audited the accompanying consolidated statements of financial condition of MidCarolina Financial Corporation and Subsidiary (hereinafter referred to as the “Company”) as of December 31, 2009 and 2008, and the related consolidated statements of operations, comprehensive income, changes in shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2009. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MidCarolina Financial Corporation and Subsidiary as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2009, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note C to the consolidated financial statements, effective January 1, 2009 the Company changed its method of accounting for other-than-temporary impairment of debt securities as a result of adopting new accounting guidance.

LOGO

Raleigh, North Carolina

February 25, 2010

 

45


CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

December 31, 2009 and 2008

 

     2009     2008  
     (Amounts in thousands,
except share data)
 

Assets

    

Cash and due from banks

   $ 1,581      $ 1,694   

Federal funds sold and interest-earning deposits

     7,848        14,040   

Investment securities:

    

Available for sale

     70,719        71,124   

Loans held for sale

     228        —     

Loans

     438,087        434,662   

Allowance for loan losses

     (7,307     (5,632
                

Net loans

     430,780        429,030   

Investment in stock of Federal Home Loan Bank of Atlanta

     2,322        1,969   

Investment in life insurance

     8,179        7,893   

Premises and equipment, net

     7,063        7,455   

Other assets

     12,284        7,642   
                

Total assets

   $ 541,004      $ 540,847   
                

Liabilities and Shareholders’ Equity

    

Deposits:

    

Noninterest-bearing demand deposits

   $ 41,655      $ 43,104   

Interest-bearing demand deposits

     144,839        78,309   

Savings

     8,266        5,784   

Time

     270,260        340,751   
                

Total deposits

     465,020        467,948   

Short-term borrowings

     520        —     

Long-term debt

     33,764        33,764   

Accrued expenses and other liabilities

     1,515        1,939   
                

Total liabilities

     500,819        503,651   
                

Shareholders’ equity:

    

Noncumulative, perpetual preferred stock, no par value, 20,000,000 shares authorized; 5,000 shares issued and outstanding at December 31, 2009 and 2008

     4,819        4,819   

Common stock, no par value; 80,000,000 shares authorized; 4,927,828 shares issued and outstanding at December 31, 2009 and 2008, respectively

     14,958        14,626   

Retained earnings

     20,805        18,635   

Accumulated other comprehensive loss

     (397     (884
                

Total shareholders’ equity

     40,185        37,196   
                

Total liabilities and shareholders’ equity

   $ 541,004      $ 540,847   
                

See accompanying notes to consolidated financial statements.

 

46


CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended December 31, 2009, 2008 and 2007

 

     2009     2008     2007  
     (Amounts in thousands, except
per share data)
 

Interest Income

      

Loans

   $ 24,160      $ 25,763      $ 27,037   

Investment securities:

      

Taxable

     2,248        2,725        2,556   

Tax-exempt

     1,130        836        1,025   

Federal funds sold and interest-earning deposits

     21        131        264   

Other

     24        161        171   
                        

Total interest income

     27,583        29,616        31,053   
                        

Interest Expense

      

Demand deposits

     1,510        1,275        2,796   

Savings deposits

     20        29        60   

Time deposits

     7,648        12,192        12,501   

Short-term borrowings

     15        288        1,094   

Long-term debt

     1,247        1,510        1,270   
                        

Total interest expense

     10,440        15,294        17,721   
                        

Net Interest Income

     17,143        14,322        13,332   

Provision for loan losses

     4,455        1,665        425   
                        

Net interest income after provision for loan losses

     12,688        12,657        12,907   
                        

Noninterest Income

      

Service charges on deposit accounts

     910        1,152        1,058   

Mortgage operations

     800        571        600   

Investment services

     245        300        288   

Increase in cash surrender value of life insurance

     286        299        290   

Gain on sale of available for sale investments

     189        29        8   

Impairment on nonmarketable investments

     (126     —          —     

Total other-than-temporary impairment loss

     (456     (490     —     

Portion of loss recognized in other comprehensive income

     308        —          —     
                        

Net impairment loss recognized in earnings

     (148     (490     —     

Other

     631        359        383   
                        

Total noninterest income

     2,787        2,220        2,627   
                        

Noninterest Expense

      

Salaries and employee benefits

     5,626        5,387        5,384   

Reversal of accrued employee benefits

     —          —          (905

Occupancy and equipment

     1,582        1,133        853   

Other outside services

     374        307        357   

Data processing

     931        787        774   

Office supplies and postage

     341        350        317   

Deposit and other insurance

     1,280        432        352   

Professional and other services

     734        550        476   

Advertising

     338        387        256   

(Gain) loss on sale of other real estate owned

     349        (536     (481

Other

     726        972        922   
                        

Total noninterest expense

     12,281        9,462        8,305   
                        

Income before income taxes

     3,194        5,415        7,229   

Provision for income taxes

     818        1,741        2,342   
                        

Net income

     2,376        3,674        4,887   

Dividends on preferred stock

     (417     (417     (417
                        

Net income available to common shareholders

   $ 1,959      $ 3,257      $ 4,470   
                        

Net Income Per Common Share:

      

Basic

   $ .40      $ .66      $ .98   
                        

Diluted

   $ .40      $ .66      $ .92   
                        

See accompanying notes to consolidated financial statements.

 

47


CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Years Ended December 31, 2009, 2008 and 2007

 

     2009     2008     2007  
     (Amounts in thousands)  

Net income

   $ 2,376      $ 3,674      $ 4,887   
                        

Other comprehensive income (loss):

      

Securities available for sale:

      

Change in unrealized holding gains (losses) on available for sale securities, net of actual gains

     1,485        (1,350     232   

Tax effect

     (573     521        (89

Reclassification of impairment on private label collateralized mortgage obligations

     148        490        —     

Tax effect

     (57     (189     —     

Reclassification of gains recognized in net income

     (189     (29     (8

Tax effect

     73        10        3   

Portion of other-than-temporary impairment loss recognized in other comprehensive income

     (308     —          —     

Tax effect

     119        —          —     
                        

Total other comprehensive income (loss)

     698        (547     138   
                        

Comprehensive income

   $ 3,074      $ 3,127      $ 5,025   
                        

See accompanying notes to consolidated financial statements.

 

48


CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Years Ended December 31, 2009, 2008 and 2007

 

                          Retained
earnings
    Accumulated
other com-
prehensive
loss
    Total
shareholders’
equity
 
     Preferred stock    Common stock        
     Shares    Amount    Shares    Amount        
     (Amounts in thousands, except share data)  

Balance at December 31, 2006

   5,000    $ 4,819    3,619,786    $ 13,007      $ 10,908      $ (475   $ 28,259   

Net income

   —        —      —        —          4,887        —          4,887   

Other comprehensive income

   —        —      —        —          —          138        138   

Effect of 5-for-4 stock split

   —        —      904,481      (10     —          —          (10

Preferred dividends paid

   —        —      —        —          (417     —          (417

Stock options exercised

   —        —      94,137      279        —          —          279   

Expense recognized in connection with stock awards and stock options

   —        —      124      14        —          —          14   
                                                 

Balance at December 31, 2007

   5,000      4,819    4,618,528      13,290        15,378        (337     33,150   

Net income

   —        —      —        —          3,674        —          3,674   

Other comprehensive loss

   —        —      —        —          —          (547     (547

Preferred dividends paid

   —        —      —        —          (417     —          (417

Stock options exercised

   —        —      309,300      792        —          —          792   

Current income tax benefit

   —        —      —        498        —          —          498   

Expense recognized in connection with stock awards and stock options

   —        —      —        46        —          —          46   
                                                 

Balance at December 31, 2008

   5,000      4,819    4,927,828      14,626        18,635        (884     37,196   

Cumulative effect of accounting method change

   —        —      —        —          211        (211     —     

Net income

   —        —      —        —          2,376        —          2,376   

Other comprehensive income

   —        —      —        —          —          698        698   

Preferred dividends paid

   —        —      —        —          (417     —          (417

Expense recognized in connection with stock awards and stock options

   —        —      —        332        —          —          332   
                                                 

Balance at December 31, 2009

   5,000    $ 4,819    4,927,828    $ 14,958      $ 20,805      $ (397   $ 40,185   
                                                 

See accompanying notes to consolidated financial statements.

 

49


CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31, 2009, 2008 and 2007

 

     2009     2008     2007  
     (Amounts in thousands)  

Operating Activities

      

Net income

   $ 2,376      $ 3,674      $ 4,887   

Depreciation and amortization

     567        481        458   

Provision for loan losses

     4,455        1,665        425   

Stock option expense

     332        46        14   

Deferred income tax (liability) benefit

     (1,114     (573     138   

Impairment of nonmarketable investments

     126        —          —     

Gain on sale of investment securities available for sale

     (189     (29     (8

Impairment of investment securities available for sale

     148        490        —     

(Gain) loss on sale of other real estate owned

     349        (536     (481

Gain on sale of loans

     (800     (571     (598

Origination of loans held for sale

     (42,750     (21,489     (27,280

Proceeds from sales of loans held for sale

     43,322        22,883        29,071   

Increase in cash surrender value life insurance

     (286     (299     (290

Changes in assets and liabilities:

      

Prepayment of FDIC insurance assessment

     (3,134     —          —     

(Increase) decrease in other assets

     604        572        (1,877

Increase (decrease) in accrued expenses and other liabilities

     (731     (93     729   
                        

Net cash provided by operating activities

     3,275        6,221        5,188   
                        

Investing Activities

      

Purchases of investment securities available for sale

     (44,174     (51,091     (33,316

Maturities and calls of investment securities available for sale

     8,855        25        1,447   

Principal paydowns on investment securities available for sale

     750        4,793        3,398   

Sales of investment securities available for sale

     36,162        44,570        31,677   

Net increase in loans from originations and principal repayments

     (10,187     (65,347     (58,591

(Purchase) redemption of FHLB stock

     (353     997        (290

Purchases of premises and equipment

     (185     (1,065     (632

Improvement costs on other real estate owned

     (134     (16     —     

Proceeds from sale of other real estate owned

     2,511        1,112        2,818   
                        

Net cash provided (used) by investing activities

     6,755        (66,022     (53,489
                        

Financing Activities

      

Net increase (decrease) in deposits

     (2,928     94,051        34,622   

Net increase (decrease) in short-term borrowings

     520        (19,000     (6,000

Proceeds from (repayment of) long-term debt

     —          (5,000     12,000   

Non-cumulative perpetual preferred stock dividends paid

     (417     (417     (417

Purchase of fractional shares

     —          —          (10

Proceeds from stock options exercised

     —          792        279   

Tax benefit from exercise of stock options

     —          498        —     
                        

Net cash provided (used) by financing activities

     (2,825     70,924        40,474   
                        

Net increase (decrease) in cash and cash equivalents

     (6,305     11,123        (7,827

Cash and cash equivalents, beginning of year

     15,734        4,611        12,438   
                        

Cash and cash equivalents, end of year

   $ 9,429      $ 15,734      $ 4,611   
                        

Supplemental Cash Flow Disclosure

      

Interest paid on deposits and borrowed funds

   $ 10,697      $ 15,305      $ 17,614   

Income taxes paid

     1,621        2,349        1,573   

Summary of Noncash Investing and Financing Activities

      

Unrealized gain (loss) on investment securities available for sale, net of tax effect

   $ 698      $ (547   $ 138   

Transfer of loans to other real estate owned

     3,982        1,904        264   

See accompanying notes to consolidated financial statements.

 

50


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2009, 2008 and 2007

Note A - Organization and Operations

In April 2002, the shareholders of MidCarolina Bank (the “Bank”) approved an Agreement and Plan of Reorganization pursuant to which the Bank became a wholly owned banking subsidiary of MidCarolina Financial Corporation (the “Company”), a North Carolina corporation formed as a holding company for the Bank. At the closing of the holding company reorganization, one share of the Company’s no par value common stock was exchanged for each of the outstanding shares of the Bank’s common stock.

The Bank was incorporated and began operations on August 14, 1997. The Bank is engaged in general commercial banking primarily in Alamance and Guilford Counties, North Carolina, and operates under the banking laws of North Carolina and the Rules and Regulations of the Federal Deposit Insurance Corporation. The Bank undergoes periodic examinations by those regulatory authorities.

Note B - Summary of Significant Accounting Policies

Basis of Consolidation

The consolidated financial statements include the accounts and transactions of the Company, the Bank, and the Bank’s wholly owned subsidiary, MidCarolina Investments, Inc. The Company wholly owns the capital trusts used to issue trust preferred securities. The trusts are not consolidated as a part of these financial statements. All intercompany transactions and balances have been eliminated in consolidation.

Use of Estimates

Preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses.

Cash and Cash Equivalents

For the purpose of presentation in the consolidated statements of cash flows, cash and cash equivalents include cash and due from banks, federal funds sold and interest-earning deposits. Federal regulations require institutions to set aside specified amounts of cash as reserves against transactions and time deposits. As of December 31, 2009, the daily average gross reserve requirement was $3.3 million. Due from bank balances are maintained in other financial institutions. Federal funds sold are generally purchased and sold for one-day periods, but may from time to time have longer terms.

Investment Securities

Investment securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity and reported at amortized cost. Investment securities held for current resale are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings. The Company currently has no such securities. Investment securities not classified either as securities held to maturity or trading securities are classified as available for sale and reported at fair value, with net unrealized gains and losses net of related taxes excluded from earnings and reported as accumulated other comprehensive income in shareholders’ equity. The classification of investment securities as held to maturity, trading or available for sale is determined at the date of purchase. Realized gains and losses from sales of investment securities are determined based upon the specific identification method on a trade-date basis. Premiums and discounts are recognized in interest income using the interest method over the terms of the securities.

Loans and Interest Income

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their unpaid principal balances, less unearned income and net of any deferred loan fees and costs. Interest income is recorded as earned on an accrual basis. The Company discontinues the recognition of

 

51


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2009, 2008 and 2007

 

interest income when, in the opinion of management, collection of such interest is doubtful. It is the general policy of the Company to discontinue the accrual of interest on loans, including loans impaired when principal or interest payments are contractually delinquent 90 days or more. Any unpaid amounts previously accrued on these loans are reversed from income, and thereafter interest is recognized only to the extent payments are received.

A loan is considered impaired when, in management’s judgment, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Management determines when loans become impaired through its normal loan administration and review functions. Loans identified as troubled debt restructurings (TDRs) are considered impaired. Loans identified as substandard or doubtful as a result of the loan review process are potentially impaired loans. Loans that experie