Attached files
EXHIBIT 13
CORNERSTONE BANCORP AND SUBSIDIARY
Portions of Registrant's
2009 Annual Report to
Shareholders Incorporated
by Reference into 2009 Form 10-K
CAUTIONARY NOTICE WITH RESPECT TO FORWARD LOOKING STATEMENTS
Statements included in this report which are not historical in nature
are intended to be, and are hereby identified as "forward looking statements"
for purposes of the safe harbor provided by Section 21E of the Securities
Exchange Act of 1934, as amended. Words such as "estimate," "project," "intend,"
"expect," "believe," "anticipate," "plan," "may," "will," "should," "could,"
"would," "assume," "indicate," "contemplate," "seek," "target," "potential," and
similar expressions identify forward-looking statements. The Company cautions
readers that forward looking statements including without limitation, those
relating to the Company's new offices, future business prospects, revenues,
working capital, adequacy of the allowance for loan losses, liquidity, capital
needs, interest costs, and income, are subject to certain risks and
uncertainties that could cause actual results to differ from those indicated in
the forward looking statements, due to several important factors identified in
this report, among others, and other risks and factors identified from time to
time in the Company's other reports filed with the Securities and Exchange
Commission.
These forward-looking statements are based on our current expectations,
estimates and projections about our industry, management's beliefs, and
assumptions made by management. Such information includes, without limitation,
discussions as to estimates, expectations, beliefs, plans, strategies, and
objectives concerning the Company's future financial and operating performance.
These statements are not guarantees of future performance and are subject to
risks, uncertainties and assumptions that are difficult to predict, particularly
in light of the fact that the Company is a relatively new company with limited
operating history. Therefore, actual results may differ materially from those
expressed or forecasted in such forward-looking statements. The risks and
uncertainties include, but are not limited to:
o future economic and business conditions;
o the Company's growth and ability to maintain growth;
o governmental monetary and fiscal policies;
o legislative and regulatory changes;
o the effect of interest rate changes on our level, costs and
composition of deposits, loan demand, and the values of our loan
collateral, securities, and interest sensitive assets and
liabilities;
o the effects of competition from a wide variety of local,
regional, national and other providers of financial, investment
and insurance services, as well as competitors that offer banking
products and services by mail, telephone, computer, and/or the
Internet;
o credit risks;
o higher than anticipated levels of defaults on loans;
o perceptions by depositors about the safety of deposits;
o failure of our customers to repay loans;
o failure of assumptions underlying the establishment of the
allowance for loan losses, including the value of collateral
securing loans;
o the risks of opening new offices, including, without limitation,
the related costs and time of building customer relationships and
integrating operations, and the risk of failure to achieve
expected gains, revenue growth and/or expense savings;
o changes in accounting policies, rules, and practices;
o cost and difficulty of implementing changes in technology or
products;
o loss of consumer confidence and economic disruptions resulting
from terrorist activities;
o ability to weather the current economic downturn;
o loss of consumer or investor confidence; and
o other factors and information described in this report and in any
of the other reports we file with the Securities and Exchange
Commission under the Securities Act of 1934.
All forward-looking statements are expressly qualified in their
entirety by this cautionary notice. The Company undertakes no obligation to
publicly update or revise any forward-looking statements, whether as a result of
2
new information, future events or otherwise. In light of these risks,
uncertainties, and assumptions, the forward-looking events discussed in this
report might not occur.
WEBSITE REFERENCES
References to the Bank's website included in, or incorporated by
reference into, this report are for information purposes only, and are not
intended to incorporate the website by reference into this report.
BUSINESS OF THE COMPANY
Cornerstone Bancorp (the "Company") is a bank holding company and has
no operations other than those carried on by its wholly owned subsidiary,
Cornerstone National Bank (the "Bank"). The Bank commenced business in 1999, and
conducts a general banking business from three offices in the Easley area of
Pickens County, in the Berea area of Greenville County, and in the Powdersville
area of Anderson County, South Carolina. In 2004, the Bank established a wholly
owned subsidiary, Crescent Financial Services, Inc. ("Crescent"), which is an
insurance agency that has not yet engaged in any significant operations.
Services of the Bank
Deposits
The Bank offers the full range of deposit services typically available
in most banks and savings and loan associations, including checking accounts,
NOW accounts, retirement accounts (including Individual Retirement Accounts),
and savings and other time deposits of various types, ranging from daily money
market accounts to longer-term certificates of deposit. The transaction accounts
and time certificates are tailored to the principal market area at rates
competitive with those offered in the area. All deposit accounts are insured by
the Federal Deposit Insurance Corporation ("FDIC") up to the maximum amount
permitted by law. The Bank solicits these accounts from individuals, businesses,
associations and organizations, and government authorities.
Lending Activities
The Bank offers a range of lending services, including commercial
loans, consumer loans, and real estate mortgage loans. To address the risks
inherent in making loans, management maintains an allowance for loan losses
based on, among other things, an evaluation of the Bank's loan loss experience,
management's experience at other financial institutions in the market area, peer
data, the amount of and trends in past due and nonperforming loans, current
economic conditions and the values of loan collateral. Based upon such factors,
management makes various assumptions and judgments about the ultimate
collectibility of the loan portfolio and provides an allowance for loan losses
based upon a percentage of the outstanding balances and specific loans. However,
because there are certain risks that cannot be precisely quantified,
management's judgment of the allowance is necessarily approximate and imprecise.
The adequacy and methodology of the allowance for loan losses is also subject to
regulatory examination.
Real Estate Loans
One of the primary components of the Bank's loan portfolio is loans
secured by first or second mortgages on residential and commercial real estate.
These loans generally consist of short to mid-term commercial real estate loans,
construction and development loans and residential real estate loans (including
home equity and second mortgage loans). Interest rates may be fixed or
adjustable and the Bank frequently charges an origination fee. The Bank seeks to
manage credit risk in the commercial real estate portfolio by emphasizing loans
on owner-occupied office and retail buildings where the loan-to-value ratio at
origination, established by independent appraisals, does not exceed 80%. In
addition, the Bank generally requires personal guarantees of the principal
owners of the property. The loan-to-value ratio at origination for first and
second mortgage loans generally does not exceed 80%, and for construction loans,
generally does not exceed 75% of cost. The Bank employs a reappraisal policy to
routinely monitor real estate collateral values on real estate loans where the
repayment is dependent on sale of the collateral. In addition, in an effort to
control interest rate risk, long term residential mortgages are not originated
for the Bank's portfolio.
3
The principal economic risk associated with all loans, including real
estate loans, is the creditworthiness of the borrowers. The ability of a
borrower to repay a real estate loan depends upon a number of economic factors,
including employment levels and fluctuations in the value of real estate. In the
case of a real estate construction loan, there is generally no income from the
underlying property during the construction period, and the developer's personal
obligations under the loan are typically limited. In the case of a real estate
purchase loan that is not fully amortized, the borrower may be unable to repay
the loan at the end of the loan term and thus may be forced to refinance the
loan at a higher interest rate, or, in certain cases, the borrower may default
as a result of its inability to refinance the loan. Each of these factors
increases the risk of nonpayment by the borrower.
In 2007, the Company increased real estate construction loans
approximately 60%. This segment of the Bank's business is managed in specific
ways in order to minimize the risks normally associated with construction
lending. Management requires lending personnel to visit job sites, maintain
frequent contact with borrowers and arrange for third-party inspections of
completed work prior to issuing additional construction loan draws. As a result
of the real estate crisis in the Bank's markets throughout 2009, the Bank
tightened underwriting standards. The Bank's loan policy now contains specific
minimum net worth requirements for borrowers, minimum debt coverage ratios, and
for loans to construct single family residential properties, written contracts
with the end purchaser that contain significant consequences to the purchaser
for terminating the contract.
The Bank faces additional credit risks to the extent that it engages in
making adjustable rate mortgage loans ("ARMs"). In the case of an ARM, as
interest rates increase, the borrower's required payments increase, thus
increasing the potential for default. The marketability of all real estate
loans, including ARMs, is also generally affected by the prevailing level of
interest rates.
Commercial Loans
The Bank makes loans for commercial purposes in various lines of
business. Commercial loans include both secured and unsecured loans for working
capital (including inventory and receivables), loans for business expansion
(including acquisition of real estate and improvements), and loans for purchases
of equipment and machinery. Equipment loans are typically made for a term of
five years or less at either fixed or variable rates, with the loan fully
amortized over the term and secured by the financed equipment. Working capital
loans typically have terms not exceeding one year and are usually secured by
accounts receivable, inventory or personal guarantees of the principals of the
business. Commercial loans vary greatly depending upon the circumstances and
loan terms are structured on a case-by-case basis to better serve customer
needs.
The risks associated with commercial loans vary with many economic
factors, including the economy in the Bank's market areas. The well-established
banks in the Bank's market areas make proportionately more loans to medium- to
large-sized businesses than the Bank makes. Many of the Bank's commercial loans
are made to small- to medium-sized businesses, which typically are not only
smaller, but also have shorter operating histories and less sophisticated record
keeping systems than larger entities. As a result, these smaller entities may be
less able to withstand adverse competitive, economic and financial conditions
than larger borrowers. In addition, because payments on loans secured by
commercial property generally depend to a large degree on the results of
operations and management of the properties, repayment of such loans may be
subject, to a greater extent than other loans, to adverse conditions in the real
estate market or the economy.
Consumer Loans
The Bank makes a variety of loans to individuals for personal and
household purposes, including secured and unsecured installment and term loans,
home equity loans and lines of credit and unsecured revolving lines of credit.
The secured installment and term loans to consumers generally consist of loans
to purchase automobiles, boats, recreational vehicles, mobile homes and
household furnishings, with the collateral for each loan being the purchased
property. The underwriting criteria for home equity loans and lines of credit
are generally the same as applied by the Bank when making a first mortgage loan,
as described above, and home equity lines of credit typically expire 15 years or
less after origination, unless renewed or extended.
Consumer loans generally involve more credit risks than other loans
because of the type and nature of the underlying collateral or because of the
absence of any collateral. Consumer loan repayments are dependent on the
borrower's continuing financial stability and are likely to be adversely
affected by job loss, divorce and illness. Furthermore, the application of
4
various federal and state laws, including federal and state bankruptcy and
insolvency laws, may limit the amount which can be recovered on such loans in
the case of default. In most cases, any repossessed collateral will not provide
an adequate source of repayment of the outstanding loan balance. Although the
underwriting process for consumer loans includes a comparison of the value of
the security, if any, to the proposed loan amount, the Bank cannot predict the
extent to which the borrower's ability to pay, and the value of the security,
will be affected by prevailing economic and other conditions.
Other Services
The Bank participates in a regional network of automated teller
machines that may be used by Bank customers in major cities throughout the
Southeast. The Bank offers both VISA and MasterCard brands of credit and debit
cards together with related lines of credit. The lines of credit may be used for
overdraft protection as well as pre-authorized credit for personal purchases and
expenses. Credit cards are underwritten and funded by a third party provider.
The Bank also provides stored value cards, direct deposit of payroll and social
security checks, and automatic drafts for various accounts, but does not
currently provide international or trust banking services, other than foreign
currency exchange through a correspondent bank. The Bank offers an Internet
banking product accessible via the Bank's custom website at
www.cornerstonenationalbank.com. The interactive banking product includes an
electronic bill payment service that allows customers to make scheduled and/or
recurring bill payments electronically. The Bank also offers remote check
deposit services to commercial and small business customers. The Bank offers
merchant and other business related services to its commercial customers.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following information describes various financial aspects of the
Bank's business. This information should be read in conjunction with the
consolidated financial statements of the Company, which appear elsewhere in this
document, and the Company's Form 10-K, filed with the Securities and Exchange
Commission.
Critical Accounting Policies
The Company has adopted various accounting policies, which govern the
application of accounting principles generally accepted in the United States of
America in the preparation of the Company's financial statements. The
significant accounting policies of the Company are described in the notes to the
consolidated financial statements.
Certain accounting policies involve significant judgments and
assumptions by management, which have a material impact on the carrying value of
certain assets and liabilities. Management considers such accounting policies to
be critical accounting policies. The judgments and assumptions used by
management are based on historical experience and other factors, which are
believed to be reasonable under the circumstances. Because of the nature of the
judgments and assumptions made by management, actual results could differ from
these judgments and estimates, which could have a material impact on the
carrying values of assets and liabilities and the results of operations of the
Company.
The Company believes the allowance for loan losses is a critical
accounting policy that requires the most significant judgments and estimates
used in preparation of its consolidated financial statements. Refer to the
sections "Allowance for Loan Losses," "Potential Problem Loans," "Impaired
Loans" and note 1 to the consolidated financial statements for a detailed
description of the Company's estimation process and methodology related to the
allowance for loan losses.
Management also believes that current economic conditions have added
complexity to the process involved in evaluating other-than temporary-impairment
("OTTI") of the Company's debt securities. The process of determining OTTI is
inherently judgmental, involving the weighing of positive and negative factors
and evidence that may be objective or subjective. In the current environment,
the factors that must be evaluated are numerous, and changing rapidly, making
the evaluation more difficult.
5
Effect of Economic Trends
Problems in the economy over the last eighteen months have adversely
impacted the ability of some borrowers to repay their loans. Although the
Company's market area has not experienced the negative effects of the recession
and declines in real estate markets to the same extent as some other markets in
the country, these factors have had a significant effect on our operations as
evidenced by the increases in our potential problem loans, charge-offs,
nonaccrual loans and real estate owned. The majority of problem loans in 2009
were real estate loans. These loans were often collateralized by newly
constructed homes and were foreclosed on after real estate sales in the
Company's market area decreased significantly in the summer of 2008. Borrowers
were generally builders and developers who did not have the cash flow required
to support the level of inventory financed with area banks. The process of
foreclosure in South Carolina is lengthy and expensive. The impact of foregone
interest on nonaccruing loans in the process of foreclosure combined with
attorney's fees, property taxes, and costs to sell repossessed property
negatively impacted the Company's income in 2009. The Bank had two commercial
relationships that were not collateralized by real estate. The collateral for
these loans was converted back to cash more quickly than the real estate loans,
but non-real estate collateral brought a significantly lower recovery of funds
and resulted in higher charge-off percentages or losses on disposal.
The current outlook for the national economy in the United States
("U.S.") is cautiously optimistic. Late in 2009 the economy began to show some
signs of recovery, although high unemployment levels persist. Real estate prices
in the single family home segment of our local markets appear to have leveled
and sales are occurring again. The number of loans past due has declined in the
fourth quarter of 2009. As of December 31, 2009, the Company owned 37 properties
that were acquired through foreclosure. As of March 30, 2010, twelve properties
had been sold or were under contract.
Governmental Response to the Financial Crisis
During the fourth quarter of 2008 and continuing throughout 2009 the
FDIC, the Federal Reserve, the Department of the Treasury and Congress took a
number of actions designed to alleviate or correct mounting problems in the
financial services industry. A number of these initiatives were directly
applicable to community banks.
Congress enacted the Emergency Economic Stabilization Act of 2008
which, among other things, temporarily increased the maximum amount of FDIC
deposit insurance from $100,000 to $250,000 and created a Troubled Assets Relief
Program ("TARP") administered by Treasury. In October, 2008, Treasury announced
a Capital Purchase Program ("CPP") under TARP to increase the capital of healthy
banks. Under the CPP, Treasury would purchase preferred stock with warrants from
qualified banks and bank holding companies in an amount up to 3% of the seller's
risk-weighted assets as of September 30, 2008. Institutions wishing to
participate in the CPP were required to file an application with their principal
federal regulators. The Company filed such an application and received
preliminary approval to sell preferred stock to the Treasury, but ultimately
elected not to participate in the CPP because of (i) the cost of the preferred
stock, (ii) the open-ended administrative burdens associated with the preferred
stock, including having to agree to allow Treasury to amend unilaterally the
stock purchase agreement to comply with subsequent changes in applicable federal
statutes, (iii) the fact that the Company and the Bank were already well
capitalized under regulatory guidelines and expected to continue to be so, and
(iv) management's belief that other sources of capital were, and would continue
to be, available should additional capital be needed.
The FDIC also implemented in October, 2008 a Temporary Liquidity
Guarantee Program consisting of a deposit insurance component pursuant to which
it undertook to provide deposit insurance in an unlimited amount for
non-interest bearing transaction accounts, and a debt guarantee component
pursuant to which it undertook to fully guarantee senior, unsecured debt issued
by banks or bank holding companies. Coverage of both components was automatic
until December 5, 2008, at which time covered institutions could opt out of one
or both of the components. Institutions not opting out would be charged fees for
their participation in the components. The Bank did not opt out of either
component.
An unfortunate consequence of the difficulties that have beset the
banking industry in the last eighteen months has been a large increase in bank
failures, which has led to substantial claims being made against the FDIC's
Deposit Insurance Fund. In order to increase the amount in the Deposit Insurance
6
Fund to reflect the increased risk of additional bank failures and insurance
claims, the FDIC raised its assessments on banks for 2009, and collected a
special assessment from the Bank totaling $80,894, which was paid in September,
2009 based on deposits at June 30, 2009. The FDIC also required institutions to
pay three years of deposit insurance premiums in advance. On December 30, 2009
the FDIC collected $997,152 from the Company for deposit insurance premiums. Of
that amount, $63,002 related to the regular quarterly assessment, and $934,150
related to the prepayment of premiums for the years 2010, 2011 and 2012. The
amount of the prepayment portion is included in other assets in the accompanying
consolidated balance sheets as of December 31, 2009. In 2010 and the following
two years, on a quarterly basis, the FDIC will continue to calculate the
assessment amount with then current financial information, and will deduct the
quarterly assessment amount from the prepaid balance. The Bank will expense the
current portion as calculated by the FDIC. The Bank does not earn interest on
the prepaid amount.
Additional governmental efforts to ameliorate the problems afflicting
the banking industry have been adopted or proposed, or are being considered by
Congress and various governmental entities. The Company is presently unable to
predict the impact of any such changes, although it appears that they are likely
to increase operating expenses in the near term without creating completely
offsetting benefits.
Earnings Performance
The Company reported a loss of $1,361,274, or $.65 per common share,
for the year ended December 31, 2009. The Company earned $225,316 in 2008, or
$.11 per basic and diluted common share compared to $1.6 million or $.78 per
basic common share and $.76 per diluted common share for the year ended December
31, 2007. The Company's earnings in 2009 were significantly lower than in 2008
and 2007 due to four specific factors. First, the level of nonperforming loans
and other assets in our portfolio during the year was the single largest reason
for the decline in revenues for 2009. Second, our provision for loan losses
increased significantly in comparison to previous years as a result of
increasing pressure on borrowers due to economic conditions. Third, foreclosure
costs associated with repossession of the underlying collateral on nonperforming
loans were significant. Fourth, continued turmoil in the housing markets
decreased our ability to broker mortgage loans for our local customers, which
further decreased noninterest income in 2009. The Company's net interest income
(the difference between interest earned on interest earning assets and interest
paid on interest bearing liabilities) decreased to $4.6 million, down from $5.3
million in 2008 and $5.8 million for 2007. The Company had noninterest income of
$982,000 in 2009 compared to $64,000 in 2008. Noninterest income for 2008
included an other-than-temporary-loss on an investment in FNMA preferred stock.
Noninterest income was $1.075 million in 2007. The Company provided $2.955
million, $815,000, and $197,000 to the allowance for loan losses in 2009, 2008,
and 2007, respectively, and had other operating expenses of $4.8 million in
2009, and $4.3 million in 2008 and 2007.
Net Interest Income
Net interest income is the amount of interest earned on interest
earning assets (loans, investment securities, time deposits in other banks and
federal funds sold), less the interest expenses incurred on interest bearing
liabilities (interest bearing deposits and borrowed money), and is the principal
source of the Bank's earnings. Net interest income is affected by the level of
interest rates, volume and mix of interest earning assets and the relative
funding of these assets. Due to the fact that the Bank's and therefore, the
Company's, assets are largely monetary in nature, material changes in interest
rates can have a material impact on the Bank's net interest income. The Company
and the Bank monitor the Bank's assets and liabilities and the interest
sensitivity of these assets and liabilities using various tools, including
models which attempt to calculate the impact on the Bank's net interest margin
as interest rates change. However, these models, as well as the tables included
here, employ assumptions about the Bank's interest sensitive assets and
liabilities which may or may not prove to be accurate. Such assumptions include,
but are not limited to, repayment patterns of borrowers, calls of securities,
and unscheduled redemptions of certificates of deposit. The tables on the
following pages include historical analyses of yields earned and rates paid on
interest sensitive assets and liabilities, the effects of changes in the volume
and relative mix of interest sensitive assets and liabilities, the effect of
changes in interest rates, and the ratio of assets and liabilities repricing
over specific time horizons. While the Company's and the Bank's management
cannot predict the timing and extent of changes in interest rates, they do
attempt to manage the Bank's interest rate sensitivity to enable the Company to
react to protect the Company's earnings stream throughout various interest rate
cycles.
For the years ended December 31, 2009, 2008, and 2007, net interest
income was $4.6 million, $5.3 million, and $5.8 million, respectively. The
decrease in 2009 from 2008 is attributable to higher levels of nonperforming
7
loans and lower interest rates, partially offset by increases in the volume of
loans (see "Rate/Volume Analysis of Net Interest Income" below). In 2009, total
average interest earning assets increased to $171.7 million from $141.2 million
in 2008. The average yield on interest earning assets decreased 177 basis points
to 4.68% in 2009 compared to 6.45% in 2008. The average cost of interest bearing
liabilities decreased 87 basis points to 2.25% from 3.12% in 2008. Rates on
interest earning assets and interest bearing liabilities have adjusted downward
since the third quarter of 2007. The Company's loan portfolio adjusted to rate
movements more quickly than the interest bearing deposit portfolio. However,
nonperforming assets also had an impact on overall yields. The effect of both
trends was narrowed interest margins. The net yield on average interest earning
assets decreased in 2009 to 2.69% from 3.76% in 2008. The interest rate spread
in 2009 was 2.43% compared to 3.33% in 2008.
8
The tables, "Average Balances, Yields and Rates", provide a detailed
analysis of the effective yields and rates on the categories of interest earning
assets and interest bearing liabilities for the Company for the years ended
December 31, 2009, 2008, and 2007.
Average Balances, Yields and Rates
(Dollars in thousands)
Year ended December 31, 2009 Year ended December 31, 2008
---------------------------- ----------------------------
Interest Average Interest Average
Average Income/ Yields/ Average Income/ Yields/
Balances(1) Expense Rates(2) Balances(1) Expense Rates(2)
----------- ------- -------- ----------- ------- --------
Assets
Securities ........................................... $ 23,652 $1,026 4.34% $ 22,607 $1,161 5.14%
Federal Funds Sold ................................... 9,994 16 .16% 3,429 92 2.68%
Loans (3), (4) ....................................... 138,066 6,998 5.07% 115,162 7,849 6.82%
-------- ------ -------- ------
Total interest earning assets ................. 171,712 8,040 4.68% 141,198 9,102 6.45%
Cash and due from banks .............................. 1,187 3,624
Allowance for loan losses ............................ (1,982) (1,394)
Premises and equipment ............................... 5,424 5,687
Cash surrender value of life insurance policies ...... 1,801 1,731
Other real estate owned .............................. 2,402 372
Other assets ......................................... 2,308 1,489
-------- --------
Total assets .................................. $182,852 $152,707
======== ========
Liabilities and shareholders' equity
Interest bearing liabilities:
Interest bearing transaction accounts ........... $ 13,169 75 .57% $ 13,502 125 .92%
Savings and money market ........................ 34,936 657 1.88% 14,994 296 1.98%
Time deposits ................................... 86,435 2,199 2.54% 76,234 2,808 3.68%
-------- ------ -------- ------
Total interest bearing deposits ............... 134,540 2,931 2.18% 104,730 3,229 3.08%
Federal Funds purchased and
customer repurchase agreements ................... 3,842 78 2.04% 5,351 170 3.18%
FHLB advances ........................................ 8,559 238 2.78% 6,955 228 3.28%
Broker repurchase agreements ......................... 5,000 177 3.53% 4,836 171 3.53%
-------- ------ -------- ------
Total interest bearing liabilities ............ 151,941 3,424 2.25% 121,872 3,798 3.12%
-------- ------ -------- ------
Noninterest bearing demand deposits and other
liabilities ...................................... 11,941 11,466
Shareholders' equity ................................. 18,970 19,369
-------- --------
Total liabilities and shareholders' equity .... $182,852 $152,707
======== ========
Interest rate spread (5) ............................. 2.43% 3.33%
----- -----
Net interest income and net yield on earning
assets(6) .......................................... $4,616 2.69% $5,304 3.76%
====== ----- ====== -----
Interest free funds supporting earning assets (7) .... $ 19,771 $ 19,326
(1) Average balances calculated based on a daily basis.
(2) Calculated based on the number of days in the year that each type of asset
or liability was in existence. Yield calculated on a pre-tax basis. The
estimated tax equivalent yield on securities was 4.81% in 2009 and 5.63% in
2008.
(3) Nonaccruing loans are included in the average loan balances and income on
such loans is recognized on a cash basis.
(4) Interest income on loans includes loan fee income as well as interest
income. The amount of loan fees included is $236,777 in 2009 and $401,297 in
2008.
(5) Total yield on interest earning assets less the rate paid on total interest
bearing liabilities.
(6) Net interest income divided by total interest earning assets.
(7) Total interest earning assets less total interest bearing liabilities.
9
Average Balances, Yields and Rates
(Dollars in thousands)
Year ended December 31, 2008 Year ended December 31, 2007
---------------------------- ----------------------------
Interest Average Interest Average
Average Income/ Yields/ Average Income/ Yields/
Balances(1) Expense Rates(2) Balances(1) Expense Rates(2)
----------- ------- -------- ----------- ------- --------
Assets
Securities .......................................... $ 22,607 $1,161 5.14% $ 17,978 $ 944 5.25%
Federal Funds Sold .................................. 3,429 92 2.68% 4,538 228 5.02%
Loans (3), (4) ...................................... 115,162 7,849 6.82% 102,917 8,835 8.58%
-------- ------ -------- -------
Total interest earning assets ................ 141,198 9,102 6.45% 125,433 10,007 7.98%
Cash and due from banks ............................. 3,624 2,468
Allowance for loan losses ........................... (1,394) (1,263)
Premises and equipment .............................. 5,687 5,214
Cash surrender value of life insurance policies ..... 1,731 1,660
Other real estate owned ............................. 372 44
Other assets ........................................ 1,489 1,442
-------- --------
Total assets ................................. $152,707 $134,998
======== ========
Liabilities and shareholders' equity
Interest bearing liabilities:
Interest bearing transaction accounts .......... $ 13,502 125 .92% $ 13,708 157 1.15%
Savings and money market ....................... 14,994 296 1.98% 10,461 222 2.12%
Time deposits .................................. 76,234 2,808 3.68% 71,613 3,444 4.81%
-------- ------ -------- -------
Total interest bearing deposits .............. 104,730 3,229 3.08% 95,782 3,823 3.99%
Federal Funds purchased and
customer repurchase agreements .................. 5,351 170 3.18% 5,335 238 4.47%
FHLB advances ....................................... 6,955 228 3.28% 2,805 116 4.13%
-------- -------
Broker repurchase agreements ........................ 4,836 171 3.53%
-------- ------
Total interest bearing liabilities ........... 121,872 3,798 3.12% 103,922 4,177 4.02%
-------- ------ -------- -------
Noninterest bearing demand deposits and other
liabilities ..................................... 11,466 12,577
Shareholders' equity ................................ 19,369 18,499
-------- --------
Total liabilities and shareholders' equity ... $152,707 $134,998
======== ========
Interest rate spread (5) ............................ 3.33% 3.96%
----- -----
Net interest income and net yield on earning
assets(6) ......................................... $5,304 3.76% $ 5,830 4.65%
====== ----- ======= -----
Interest free funds supporting earning assets (7) ... $ 19,326 $ 21,511
(1) Average balances calculated based on a daily basis.
(2) Calculated based on the number of days in the year that each type of asset
or liability was in existence. Yield calculated on a pre-tax basis. The
estimated tax equivalent yield on securities was 5.63% in 2008 and 5.53% in
2007.
(3) Nonaccruing loans are included in the average loan balances and income on
such loans is recognized on a cash basis.
(4) Interest income on loans includes loan fee income as well as interest
income. The amount of loan fees included is $401,297 and $371,754 in 2008
and 2007, respectively.
(5) Total yield on interest earning assets less the rate paid on total interest
bearing liabilities.
(6) Net interest income divided by total interest earning assets.
(7) Total interest earning assets less total interest bearing liabilities.
10
Rate/Volume Analysis of Net Interest Income
As discussed under the caption "Net Interest Income," the Bank's net
income is largely dependent on net interest income. The table below calculates
the relative impact on net interest income caused by changes in the average
balances (volume) of interest sensitive assets and liabilities and the impact
caused by changes in interest rates earned or paid. Each table compares two
years as indicated below. The effect of a change in average balance has been
determined by applying the average rate in the earlier year to the change in
average balance in the later year, as compared with the earlier year. The effect
of a change in the average rate has been determined by applying the average
balance in the earlier year to the change in the average rate in the later year,
as compared with the earlier year. In 2009 and 2008 changes in interest rates
had the most significant impact on interest income.
Year ended December 31, 2009 compared to 2008
Increase (Decrease) Due to
--------------------------
Rate Volume Rate/Volume(1) Change
---- ------ -------------- ------
Interest earned on: (Dollars in thousands)
Securities (2) ........................................ $ (181) $ 54 $ (9) $ (136)
Federal Funds sold .................................... (86) 176 (165) (75)
Loans ................................................. (2,012) 1,561 (400) (851)
------- ------- ------- -------
Total interest income ............................. (2,279) 1,791 (574) (1,062)
Interest paid on:
Deposits .............................................. (931) 767 (134) (298)
Federal Funds purchased and customer
repurchase agreements ......................... (61) (48) 17 (92)
FHLB advances ......................................... (35) 53 (8) 10
Broker repurchase agreements .......................... - 6 - 6
------- ------- ------- -------
Total interest expense ....................... (1,027) 778 (125) (374)
------- ------- ------- -------
Change in Net Interest Income .............................. $(1,252) $ 1,013 $ (449) $ (688)
======= ======= ======= =======
(1) Rate/ Volume is calculated as the difference between the average balances
for the periods multiplied by the difference between the average rates for
the periods.
(2) Income calculated on a pre-tax basis.
Year ended December 31, 2008 compared to 2007
Increase (Decrease) Due to
--------------------------
Rate Volume Rate/Volume(1) Change
---- ------ -------------- ------
Interest earned on: (Dollars in thousands)
Securities (2) ........................................ $ (20) $ 243 $ (5) $ 218
Federal Funds sold .................................... (107) (56) 26 (137)
Loans ................................................. (1,821) 1,051 (216) (986)
------- ------- ------- -------
Total interest income ............................. (1,948) 1,238 (195) (905)
Interest paid on:
Deposits .............................................. (851) 316 (58) (593)
Federal Funds purchased and customer
repurchase agreements ......................... (69) 1 - (68)
FHLB advances ......................................... (24) 171 (35) 112
Broker repurchase agreements .......................... - - 171 171
------- ------- ------- -------
Total interest expense ....................... (944) 488 78 (378)
------- ------- ------- -------
Change in Net Interest Income .............................. $(1,004) $ 750 $ (273) $ (527)
======= ======= ======= =======
(1) Rate/ Volume is calculated as the difference between the average balances
for the periods multiplied by the difference between the average rates for
the periods.
(2) Income calculated on a pre-tax basis.
11
Interest Rate Sensitivity
Interest rate sensitivity measures the timing and magnitude of the
repricing of assets compared with the repricing of liabilities and is an
important part of asset/liability management. The objective of interest rate
sensitivity management is to generate stable growth in net interest income, and
to control the risks associated with interest rate movements. Management
constantly reviews interest rate risk exposure and the expected interest rate
environment so that adjustments in interest rate sensitivity can be made in a
timely manner.
When interest sensitive liabilities exceed interest sensitive assets
for a specific repricing "horizon," a negative interest sensitivity gap results.
The gap is positive when interest sensitive assets exceed interest sensitive
liabilities. For a bank with a negative gap such as the Bank, falling interest
rates would be expected to have a positive effect on net interest income and
increasing rates would be expected to have the opposite effect. However, if one
or more assumptions prove incorrect, the margin may not be impacted in the
manner expected. On a cumulative basis, rate sensitive liabilities exceeded rate
sensitive assets, resulting in a liability sensitive position at the end of 2009
of $31.8 million, for a cumulative gap ratio of .74 calculated at the one-year
time horizon, assuming that all assets and liabilities would reprice at the
earliest possible time. Interest-bearing liabilities, in particular, may not
reprice in conjunction with or by the same magnitude as movements in market
interest rates.
The following table reflects the balances of interest earning assets
and interest bearing liabilities at the earlier of their repricing or maturity
dates. Amounts of fixed rate loans are reflected at the loans' final maturity
dates. Variable rate loans are reflected at the earlier of their contractual
maturity date or the date at which the loan may be repriced contractually.
Deposits in other banks and debt securities are reflected at the earlier of each
instrument's repricing date for variable rate instruments or the ultimate
maturity date for fixed rate instruments. Overnight federal funds sold are
reflected in the earliest repricing interval due to the immediately available
nature of these funds. Interest bearing liabilities with no contractual
maturity, such as interest bearing transaction accounts and savings deposits are
reflected in the earliest repricing interval due to contractual arrangements
which give management the opportunity to vary the rates paid on these deposits
within a thirty-day or shorter period. However, the Bank is under no obligation
to vary the rates paid on those deposits within any given period. Fixed rate
time deposits, principally certificates of deposit, are reflected at their
contractual maturity dates. Federal funds purchased are presented in the
immediate repricing interval because the interest rate paid adjusts at the
beginning of each month. The table does not reflect repricing that could occur
as a result of prepayment of loans or early withdrawal of time deposits or
movement into or out of non-maturing deposit accounts.
12
Interest Sensitivity Analysis
December 31, 2009
-----------------
1-3 3-12 1-3 3-5 5-15 > 15
Immediate Months Months Years Years Years Years Total
--------- ------ ------ ----- ----- ----- ----- -----
(Dollars in thousands)
Interest earning assets
Securities (1) .................... $ - $ - $ - $ 185 $ 2,302 $ 10,999 $ 16,558 $ 30,044
Federal funds sold ................ 1,670 - - - - - - 1,670
Loans(2) (3) ...................... 72,333 7,200 8,213 15,573 21,406 3,285 9,753 137,763
-------- -------- -------- -------- -------- -------- -------- --------
74,003 7,200 8,213 15,758 23,708 14,284 26,311 169,477
-------- -------- -------- -------- -------- -------- -------- --------
Interest bearing deposits
Interest bearing transaction
accounts .......................... 13,309 - - - - - - 13,309
MMDAs & Savings ................... 48,077 - - - - - - 48,077
Time deposits ..................... 1,233 14,834 37,404 21,925 4,365 - - 79,761
Federal Funds purchased and
Customer repurchase agreements .... 588 150 2,519 - - - - 3,257
FHLB advances ..................... - 1,538 1,613 4,302 231 2,059 - 9,743
Broker repurchase agreements .. ... - - - 2,000 - 3,000 - 5,000
-------- -------- -------- -------- -------- -------- -------- --------
63,207 16,522 41,536 28,227 4,596 5,059 - 159,147
-------- -------- -------- -------- -------- -------- -------- --------
Interest sensitivity gap .............. $ 10,796 $ (9,322) $(33,323) $(12,469) $ 19,112 $ 9,225 $ 26,311 $ 10,330
Cumulative interest sensitivity gap ... $ 10,796 $ 1,474 $(31,849) $(44,318) $(25,206) $(15,981) $ 10,330
Gap ratio ............................. 1.17 .44 .20 .56 5.16 2.82 -
Cumulative gap ratio .................. 1.17 1.02 .74 .72 .84 .90 1.06
December 31, 2008
-----------------
1-3 3-12 1-3 3-5 5-15 > 15
Immediate Months Months Years Years Years Years Total
--------- ------ ------ ----- ----- ----- ----- -----
(Dollars in thousands)
Interest earning assets
Securities (1) .................... $ - $ - $ - $ 1,541 $ 1,617 $ 9,718 $ 7,915 $ 20,791
Federal funds sold ................ 140 - - - - - - 140
Loans (2)(3) ...................... 73,618 2,246 10,128 13,409 27,135 2,105 2,541 131,182
-------- -------- -------- --------- -------- -------- -------- --------
Total interest earning assets .. 75,558 2,468 10,245 15,212 28,752 11,823 8,055 152,113
-------- -------- -------- --------- -------- -------- -------- --------
Interest bearing deposits
Interest bearing transaction
accounts ........................ 13,013 - - - - - - 13,013
MMDAs & Savings ................... 21,135 - - - - - - 21,135
Time deposits ..................... 3,174 22,566 41,584 9,647 1,393 - - 78,364
Federal Funds purchased and
Customer repurchase agreements .... 3,243 150 2,650 350 - - - 6,393
FHLB advances ..................... 3,500 38 113 4,302 301 2,140 - 10,394
Broker repurchase agreements ...... - - - - 2,000 3,000 - 5,000
-------- -------- -------- --------- -------- -------- -------- --------
Total interest bearing
liabilities ................ 44,065 22,754 44,347 14,299 3,694 5,140 - 134,299
-------- -------- -------- --------- -------- -------- -------- --------
Interest sensitivity gap .............. $ 31,493 $(20,286) $(34,102) $ 913 $ 25,058 $ 6,683 $ 8,055 $ 17,814
Cumulative interest sensitivity gap ... $ 31,493 $ 11,207 $(22,895) $ (21,982) $ 3,076 $ 9,759 $ 17,814
Gap ratio ............................. 1.71 .11 .23 1.06 7.78 2.30 -
Cumulative gap ratio .................. 1.71 1.17 .79 .82 1.02 1.07 1.13
(1) Securities with call features have been included in the period in which the
security matures.
(2) There were no unamortized deferred loan fees included in the above tables
in either year.
(3) Nonaccruing loans of $9.7 million are included in the 2009 table. $2.4
million are included in the 2008 table. All nonaccruing loans are included
in the >15 years category.
13
Provision for Loan Losses
The provision for loan losses is charged to earnings based on
management's continuing review and evaluation of the loan portfolio and general
economic conditions. The following table summarizes the activity in the
allowance for loan losses.
Year ended December 31,
2009 2008 2007
---- ---- ----
(Dollars in thousands)
Allowance for loan losses, beginning of year ........................... $ 1,699 $ 1,293 $ 1,200
Provision for loan losses .............................................. 2,955 815 197
Charge-offs ............................................................ (1,959) (685) (104)
Recoveries ............................................................. - 276 -
------- ------- -------
Allowance for loan losses, end of year ................................. $ 2,695 $ 1,699 $ 1,293
======= ======= =======
See "Impaired Loans" and "Allowance for Loan Losses" for a discussion
of the factors management considers in its review of the adequacy of the
allowance and provision for loan losses.
Noninterest Income
Noninterest income, which consists primarily of service charges on
deposit accounts, mortgage loan origination fees, gains and losses on securities
sales, and other fee income, increased by $.9 million to $1.0 million in 2009
from $100,000 in 2008, which was a decrease from $1.1 million in 2007. Service
charges were fairly consistent in 2009 compared to 2008. The Company sold
securities with a fair value of $10.8 million, resulting in a net gain of
$299,063 in 2009. Noninterest income in 2008 included the impact of the Other
Than Temporary Impairment charge in the amount of $918,264 taken on FNMA
Preferred stock in September 2008. Mortgage loan origination fee income
continued a trend of decreases in 2009. Effective November 30, 2009, the Company
closed its mortgage origination department due to the difficulties involved in
brokering mortgage loans to third party investors. When the housing and mortgage
markets stabilize, the Company intends to reevaluate offering conventional 30
and 15-year mortgage loans to its customers.
Noninterest Expenses
Noninterest expenses, which consist primarily of salaries and employee
benefits, occupancy costs, data processing expenses and professional and
regulatory fees, totaled $4.8 million in 2009, and $4.3 million in 2008 and
2007. Salaries and employee benefits decreased slightly in 2009. There was no
accrual of incentive compensation in 2009 due to economic conditions. As of the
end of 2009, the Company employed 36 full-time personnel. Net occupancy and
equipment expenses decreased to $572,025 from $600,426 in 2008, which increased
from $567,222 in 2007. Data processing, supplies, and advertising expenses all
decreased in 2009 compared to 2008. The Company is constantly looking for ways
to become more efficient and to find cost savings without compromising customer
service. Professional and regulatory fees increased 72.3% in 2009 in comparison
to 2008, primarily due to the increased cost of FDIC insurance. The Company
expensed $307,376 for FDIC premiums in 2009 compared to $76,224 in 2008. The
company expensed $322,687 and $117,272 for loan expenses and expenses to
maintain other real estate owned in 2009 compared to $51,706 and $50,889,
respectively, in 2008. The increases are related to foreclosure expenses and
property taxes paid in order to protect the Company's interest in real estate
collateral. The Company's efficiency ratio, which is measured as the ratio of
noninterest expense to the sum of net interest income plus other income
expressed as a percentage, was 86.2% in 2009 compared to 81% in 2008 and 62% in
2007.
14
Income Taxes
For 2009 the Company recorded an income tax benefit of $819,737
compared to a benefit of $17,600 in 2008 and tax expense of $810,232 in 2007.
The primary reasons for the benefit recognized in 2009 are the exclusions of
nontaxable municipal bond income and operating expenses related to nonperforming
assets. The benefit recognized in 2008 primarily resulted from the exclusion of
nontaxable municipal bond income and the tax effect of the other than temporary
impairment charge on the FNMA preferred stock. In the fourth quarter of 2008
legislation was passed by Congress making the OTTI charge includable in ordinary
income for holders of FNMA and Federal Home Loan Mortgage Corporation ("FHLMC")
preferred stocks. The FNMA preferred stock was sold in 2009. The financial
accounting standard under which the Bank accounts for income taxes requires
certain items of income and expense (principally provision for loan losses,
depreciation, and prepaid expenses) to be included in one reporting period for
financial accounting purposes and another for income tax purposes. Refer to the
notes to the Company's consolidated financial statements contained elsewhere
herein for more information.
Investment Securities
Management assigns securities upon purchase into one of the categories
(trading, available-for-sale and held-to-maturity) designated by GAAP based on
intent, taking into consideration other factors including expectations for
changes in market rates of interest, liquidity needs, asset/liability management
strategies, and capital requirements. The Bank has not historically held
securities for trading purposes. As of December 31, 2009, 2008, and 2007, the
Bank's investment portfolio comprised approximately 15.9%, 12.7%, and 13.4%,
respectively, of total assets.
The following table summarizes the carrying amounts of securities held
by the Bank at December 31, 2009 and 2008. Available-for-sale securities are
stated at estimated fair value. The Company had no held-to-maturity securities
in either period. Federal Reserve Bank of Richmond and Federal Home Loan Bank of
Atlanta stocks have no quoted market value, but have historically been redeemed
at par value, and are therefore carried at cost. However, there can be no
assurance that these stocks will be redeemed at par value in the future. There
are no individual issuers, other than government sponsored enterprises, whose
securities represent more than 10% of the Company's consolidated shareholders'
equity at December 31, 2009. Government sponsored enterprises ("GSEs") are
agencies and corporations established by the U. S. Government, including among
others, the Federal Home Loan Banks, Federal National Mortgage Association,
Federal Home Loan Mortgage Corporation and Federal Farm Credit Banks. Until
2008, securities issued by these enterprises were not obligations of the U. S.
Government and were not backed by the full faith and credit of the U. S.
Government or otherwise guaranteed by the U. S. Government, although they were
commonly treated as guaranteed. In 2008, in an attempt to stabilize U.S. and
international financial markets, the U.S. Government explicitly guaranteed
certain debt instruments of the GSEs. These securities have generally been and
will continue to be eligible to be used as security for public deposits of the
U. S. Treasury, government agencies and corporations and states and other
political subdivisions. At December 31, 2009 and 2008, securities with a fair
value of $22.9 million and $18.4 million respectively, were pledged to
collateralize public deposits, sweep accounts, and customer and broker
repurchase agreements. Refer to the notes to the Company's consolidated
financial statements contained elsewhere herein for more information.
Investment Securities Portfolio Composition
December 31,
2009 2008
---- ----
(Dollars in thousands)
Available for sale:
Government sponsored enterprise bonds ........... $10,188 $ 9,293
Mortgage-backed securities ...................... 12,364 4,280
Municipal bonds ................................. 6,350 6,072
FNMA preferred stock ............................ - 32
------- -------
Total available for sale ..................... 28,902 19,677
Federal Reserve Bank of Richmond stock ............. 405 394
Federal Home Loan Bank of Atlanta stock ............ 737 720
------- -------
Total .............................................. $30,044 $20,791
======= =======
15
The following table presents contractual maturities and weighted
average yields of securities at December 31, 2009 and 2008. Securities are
presented at their carrying value (available for sale securities are carried at
fair value and other securities are carried at book value, which is equal to
their amortized cost.)
Investment Securities Portfolio Maturities and Yields
December 31, 2009 December 31, 2008
Amount Yield(1) Amount Yield(1)
------ -------- ------ --------
(Dollars in thousands) (Dollars in thousands)
Available for sale securities:
Government sponsored enterprises
Within one year .................................... $ - -% $ - -%
After one through five years ....................... 2,032 4.34% 2,631 4.44%
After five through ten years ....................... 8,155 3.96% 6,662 5.90%
FNMA and FHLMC Mortgage-backed securities (2)
After one through five years ....................... 185 3.79% 280 3.84%
After five through ten years ....................... - -% - -%
After 10 years ..................................... 12,180 3.97% 4,000 5.75%
Municipal bonds
After one through five years .................... 269 3.62% 247 3.25%
After five through ten years .................... 1,536 3.86% 1,888 3.80%
After 10 years .................................. 4,545 4.09% 3,937 4.09%
Other securities
No stated maturity ................................. 1,142 2.33% 1,146 2.06%
------- -------
Total .............................................. $30,044 3.94% $20,791 4.88%
======= =======
(1) Yields calculated on a pre-tax basis.
(2) These securities mature on an amortizing basis. They are included here in
the period of final maturity.
While seven of the Company's Government sponsored enterprise bonds and
mortgage-backed securities available-for-sale are in an unrealized loss position
as of December 31, 2009, none has been in an unrealized loss position for twelve
months or more. None of these securities is expected to have a loss of principal
at final maturity. The Company has the intent and ability to hold these
securities until such time as the value recovers or the securities mature. All
of the Company's municipal bonds were in an unrealized gain position as of
December 31, 2009. During 2008, the Company recognized other-than
temporary-impairment on the FNMA preferred stock of $606,054, net of tax, based
on analysis under FSP 115-1 and FNMA's being placed into conservatorship by the
U.S. Treasury Department. The Company sold the FNMA preferred stock in 2009 at
an additional loss of $58,788. The Company's investments are obligations of the
United States, its sponsored enterprises, or municipal securities. In the
opinion of Management, there is no concentration of credit risk in the
investment portfolio.
Loan Portfolio
Management believes the loan portfolio is adequately diversified,
although real estate collateral is the predominant collateral in the portfolio.
There are no significant concentrations of loans to any particular individuals,
and there are no foreign loans. The Bank does have loans in certain broad
categories that comprise over 25% of Tier 1 Capital adjusted for the allowance
for loan losses. Those categories are as follows: real estate rental and
leasing, accommodation and food services, construction, retail trade, health
care and social assistance, and other services. The Company believes that the
Bank has appropriate controls in place to monitor risks that may arise due to
concentrations in the loan portfolio.
Loans made outside the loan policy guidelines may present additional
credit risk to the Company. In order to monitor these loans and the total number
and amount of loans made with exceptions to loan policies, the Bank monitors all
16
loans approved with policy exceptions. Monthly, statistics regarding the number
of loans and the amount of loans with policy exceptions are reported to the
Board of Directors. One of the policy exceptions reported is for loans exceeding
the regulatory guidelines on loan to value ratios. The regulatory loan to value
guidelines permit exceptions to the guidelines not to exceed 100% of Total
Regulatory Capital for single family residential mortgage loans ($20.2 million
at December 31, 2009), or 30% of Total Regulatory Capital for real estate loans
other than single family residential loans ($6.0 million as of December 31,
2009). As of December 31, 2009, the Bank had $6.5 million of loans which
exceeded regulatory loan to value guidelines. This amount is within the
allowable maximum of exceptions to the guidelines. Of the total exceptions,
74.4% were not exceptions at the time the loan was made, but became exceptions
upon reappraisal. Reappraisals are routinely ordered when a loan is collateral
dependent and showing signs of weakness. Specifically, the Company's reappraisal
policy states that collateral for single family construction loans will be
reappraised if the home is complete and remains unsold for twelve months, or if
the original loan has been outstanding for eighteen months. For development
loans, if lot absorption varies from the original appraiser's estimates by 25%
or more, the collateral will be reappraised. Collateral will also be reappraised
if there is any indication that the collateral may have decreased significantly
in value. If the value of collateral decreases significantly upon reappraisal,
the Company may take any one or a combination of steps to protect its position.
Possible actions include requesting additional collateral from the borrower,
requiring the borrower to make principal reductions on the loan, or charge-off
of a portion of the loan balance.
The Company currently has concentrations in real estate lending,
including construction and development loans. This segment of the Bank's
business is managed in specific ways in order to minimize the risks normally
associated with construction lending. Management requires lending personnel to
visit job sites, maintain frequent contact with borrowers and perform or
commission inspections of completed work prior to issuing additional
construction loan draws. In addition, management employs additional procedures
for monitoring construction loans such as engaging an independent appraiser to
perform routine inspections of construction work to determine the percentage
complete prior to approval of draws on construction loans. However, even tight
internal controls and management oversight will not prevent some borrowers from
defaulting on these types of loans. Where declining market conditions last for a
long period of time, many participants in the housing and real estate
construction industries cannot continue to perform as specified in their loan
agreements without sales activity. In such cases, the Bank attempts to work with
various borrowers in the real estate and construction industry to minimize the
effect on the Bank and the borrowers. Loans in this situation are placed on
nonaccrual, and included in the Company's impaired loans. See "Impaired Loans"
below.
The banking industry offers products that can increase credit risk
should economic conditions change over the course of a loan's life.
Interest-only loans, adjustable rate loans, and loans with amortization periods
that differ from the maturity date (i.e., balloon payment loans) are examples of
products that could subject the Company to increased credit risk in periods of
changing economic conditions. The Company evaluates each customer's credit
worthiness based on current and expected economic conditions and underwrites and
monitors each such loan for associated risks. Therefore, Management does not
believe that these particular products subject the Company to unusual credit
risk. As of December 31, 2009, the Bank did not have in its portfolio any
residential mortgage loans with negative amortization features, long term
interest only payment features, or loan to value ratios at origination in excess
of 100%.
Until November 2009, the Bank had a mortgage loan brokerage department
that accepted mortgage applications for mortgages with terms greater than 15
years. Mortgage applications were processed and sent to third parties for
underwriting. Approved loans were funded by, and closed in the name of, third
parties and the Bank received an origination fee. However, effective November
2009, the Bank suspended such mortgage originations. When the housing and
mortgage loan markets stabilize, the Bank intends to reevaluate offering this
service to its customers.
17
The amount of loans outstanding at December 31, 2009 and 2008 are shown
in the following table according to type of loan:
Loan Portfolio Composition
December 31,
------------
2009 2008
---- ----
(Dollars in thousands)
%of %of
Amount Loans Amount Loans
------ ----- ------ -----
Commercial and industrial ............................... $ 14,974 10.9% $ 18,597 14.2%
Real Estate - construction .............................. 53,827 39.1 49,670 37.9
Real Estate - mortgage
1-4 family residential ........................... 23,285 16.9 26,429 20.1
Nonfarm, nonresidential .......................... 41,810 30.3 33,214 25.3
Multifamily residential .......................... 2,520 1.8 1,223 .9
Consumer installment .................................... 1,347 1.0 2,049 1.6
-------- ----- -------- -----
Total Loans ...................................... 137,763 100.0% 131,182 100.0%
===== =====
Less allowance for loan losses .................. (2,695) (1,699)
-------- --------
Net Loans .................................... $135,068 $129,483
======== ========
Maturity Distribution of Loans
The Bank's loan portfolio has a large component of adjustable rate
loans. As of December 31, 2009, approximately $82.4 million or 59.8% of the
Bank's loan portfolio was variable rate.
The following table sets forth the maturity distribution of the Bank's
loans, by type, as of December 31, 2009, as well as the type of interest
requirement on loans with maturities greater than one year. For purposes of this
table, variable rate loans are included in the period of their final maturity,
as opposed to their repricing date.
Maturity Distribution on Loans
December 31, 2009
-----------------
(Dollars in thousands)
1 Year 1-5 5 Years
or Less Years or More Total
------- ----- ------- -----
Commercial and industrial ................................. $10,202 $ 4,421 $ 351 $ 14,974
Real Estate-construction .................................. 43,264 10,556 7 53,827
Real Estate-mortgage ...................................... 20,867 35,146 11,602 67,615
Consumer .................................................. 885 348 114 1,347
------- ------- ------- --------
Total ............................................... $75,218 $50,471 $12,074 $137,763
======= ======= ======= ========
Predetermined rate, maturity greater than one year ........ 24,905 1,772 26,677
Variable rate, maturity greater than one year ............. 25,566 10,302 35,868
Impaired Loans
A loan will be considered to be impaired when, in management's judgment
based on current information and events, it is probable that the loan's
principal or interest will not be collectible in accordance with the terms of
the original loan agreement. Impaired loans, when not material, will be carried
on the balance sheet at a value not to exceed their observable market price or
the fair value of the collateral if the repayment of the loan is expected to be
provided solely by the underlying collateral. The carrying values of any
material impaired loans will be measured based on the present value of expected
future cash flows discounted at the loan's effective interest rate, which is the
contractual interest rate adjusted for any deferred loan fees or costs, premium
or discount existing at the inception or acquisition of the loan.
18
Loans which management identifies as impaired generally will be
nonperforming loans. Nonperforming loans include nonaccrual loans or loans which
are 90 days or more delinquent as to principal or interest payments. As of
December 31, 2009, the Bank had nonaccrual loans of $9.7 million. This amount
includes 28 loans, all of which are collateral dependent. These loans are
secured by real estate, and were in the process of foreclosure or other
collection processes as of December 31, 2009. If these loans had been current,
the Company would have recorded additional interest income of $292,243 on these
loans. All previously accrued but uncollected income on these loans has been
eliminated from the accompanying consolidated income statement. Impairment
reserves of $165,771 are included in the allowance for loan losses related to
loans on nonaccrual as of December 31, 2009. The Company has already charged-off
$224,271 related to these loans as of December 31, 2009. The Company's
investment in nonaccruing loans has been increasing throughout 2009 partly
because of the length of time required to foreclose on property in South
Carolina. The loans on nonaccrual at December 31, 2009 had been on nonaccrual
and in the foreclosure process for an average of 134 days. This does not include
the 90-day period prior to placing the loan on non-accrual during which the Bank
did not record interest. The length of time required to obtain title to
foreclosed property is increased if the creditor seeks a deficiency judgment
against a guarantor or if the property is rented. A minimum of thirty days is
added for deficiency judgments and notice requirements of ninety days are
required if the property is rented.
The Company also considers restructured loans to be impaired under the
definition of an impaired loan. As of December 31, 2009 the bank had 24 loans
totaling $4.05 million that are restructured in some manner. Of those 24 loans,
15 loans totaling $1.5 million are newly constructed single family homes. These
loans are current, but paying interest only. The average loan amount is $99,444.
Homes priced under $150,000 have generally continued to sell through the
economic crisis in our market area due to first time home buyer programs. Of the
remaining $2.5 million, one loan ($555,000) is collateralized by several rental
properties, one loan ($1.3 million) is collateralized by undeveloped land, and
seven loans are collateralized by various types of property. All of these
additional loans are in compliance with their restructured terms, but deemed to
be impaired due to changes in the original terms or due to the absence of terms
that would be in effect under normal conditions. These loans are considered
impaired primarily because of terms such as interest-only payment requirements
that would not normally be available under current conditions. The Company has
not charged off amounts associated with accruing impaired loans as of December
31, 2009. Refer to the notes to the Company's consolidated financial statements
contained elsewhere herein for more information. The allowance for loan losses
includes management's best estimate of the probable losses on these loans. At
December 31, 2008 the Bank had $2.4 million of nonaccrual loans or loans 90 days
or more past due.
Generally, the accrual of interest will be discontinued on impaired
loans when principal or interest becomes 90 days past due, or when payment in
full is not anticipated, and any previously accrued interest on such loans will
be reversed against current income. Any subsequent interest income will be
recognized on a cash basis when received unless collectibility of a significant
amount of principal is in serious doubt. In such cases, collections are credited
first to the remaining principal balance on a cost recovery basis. An impaired
loan will not be returned to accrual status unless principal and interest are
current and the borrower has demonstrated the ability to continue making
payments as agreed.
Potential Problem Loans
Management identifies and maintains a list of potential problem loans.
A loan is added to the potential problem list when management becomes aware of
information about possible credit problems of borrowers that causes serious
doubts as to the ability of such borrowers to comply with the current loan
repayment terms. These loans are designated as such in order to be monitored
more closely than other credits in the Bank's portfolio. Potential problem loans
include loans such as loans that are not included in nonaccrual status, or loans
that are past due 90 days or more and still accruing interest. Loans in the
amount of $4.0 million had been determined by management to be potential problem
loans at December 31, 2009. The majority of these loans are secured by real
estate. These loans have not been restructured as of December 31, 2009 and are
not on nonaccrual, but they exhibit some weaknesses. Management is currently
assessing the potential impact on the Bank and the Company. Reassessment would
normally be in the form of a new appraisal on the collateral supporting the loan
if the loan is collateral dependent. These loans are monitored closely by
management.
Allowance for Loan Losses
The allowance for loan losses is increased by direct charges to
operating expense. Losses on loans are charged against the allowance in the
19
period in which management determines that it is likely that such loans have
become uncollectible. Recoveries of previously charged off loans will be
credited to the allowance. In reviewing the adequacy of the allowance for loan
losses at each year end, management takes into consideration the historical loan
losses experienced by the bank, current economic conditions affecting the
borrowers' ability to repay, the volume of loans, and the trends in delinquent,
nonaccruing, and any potential problem loans, and the quality of collateral
securing nonperforming and problem loans. Management considers the allowance for
loan losses to be adequate to cover its estimate of loan losses inherent in the
loan portfolio as of December 31, 2009.
In calculating the amount required in the allowance for loan losses,
management applies a consistent methodology that is updated quarterly. The
methodology utilizes a loan risk grading system and detailed loan reviews to
assess credit risks and the overall quality of the loan portfolio. Also, the
calculation provides for management's assessment of trends in national and local
economic conditions that might affect the general quality of the loan portfolio.
At the beginning of 2009 the Company's market area was just beginning
to realize the effects of the economic downturn. Other areas of the United
States were feeling the effects of inflated real estate prices earlier and in
much more significant ways than the Upstate of South Carolina. We had continued
to have reasonable levels of unemployment and some continued economic activity
throughout most of 2008. However, during 2009 it became apparent that the
construction industry in South Carolina had not only overbuilt its inventory of
homes, but the industry was also responsible for a large portion of the
employment base. By November of 2009, unemployment levels in South Carolina had
reached 12.3% and unemployment in the Company's market areas ranged from 10.5%
to 12.7% in the month of November. As a result, the Company's problem loans
continued to increase throughout the year.
The table below summarizes the Company's loan loss experience in 2008
and 2009. The charge-offs on commercial loans were related to three
relationships. These loans experienced the highest charge-off percentages of any
of our loans, by far. By contrast, the real estate loan charge-offs were
comprised of 19 relationships and 32 individual loans.
20
Summary of Loan Loss Experience
Year ended December 31,
-----------------------
2009 2008
---- ----
(Dollars in thousands)
Total loans outstanding at end of period ............................................... $ 137,763 $ 131,182
Average amount of loans outstanding .................................................... $ 138,066 $ 115,162
--------- ---------
Balance of allowance for loan losses-beginning ......................................... $ 1,699 $ 1,293
Loans charged-off
Commercial and industrial ........................................................ 669 186
Commercial real estate ........................................................... 1,289 498
Consumer installment ............................................................. 1 1
--------- ---------
Total charge-offs ............................................................. 1,959 685
Recoveries of loans previously charged-off - commercial loans .......................... - 276
--------- ---------
Net (charge-offs) recoveries ........................................................... (1,959) (409)
Additions to allowance charged to expense .............................................. 2,955 815
--------- ---------
Additions to allowance charged to expense
Balance of allowance for loan losses-ending ............................................ $ 2,695 $ 1,699
========= =========
Ratios
Net (charge-offs) recoveries to average loans outstanding ........................ (1.42%) (.35%)
Net (charge-offs) recoveries to loans at end of period ........................... (1.42%) (.31%)
Allowance for loan losses to average loans ....................................... 1.95% 1.48%
Allowance for loan losses to loans at end of period .............................. 1.96% 1.30%
Net (charge-offs) recoveries to allowance for loan losses ........................ (72.7%) (24.1%)
Net (charge-offs) recoveries to provision for loan losses ........................ (66.3%) (50.3%)
The allowance for loan losses is not restricted to specific categories
of loans and is available to absorb losses in all categories. Each category of
loans is reviewed for characteristics that increase or decrease risk of loss,
such as the availability and marketability of collateral, degree of
susceptibility to changes in economic conditions, etc., for purposes of
estimating the allowance for loan losses. (See "Business of the
Company--Services of the Bank" for a discussion of risk characteristics for each
loan category.) Individual loans are graded using an internal grading system
that considers information specific to the loan. If warranted, a specific
allocation may be associated with that loan for purposes of estimating the
adequacy of the allowance for loan losses.
Real Estate Owned
The Bank had $6.713 million and $575,000 of real estate owned pursuant
to foreclosure or in-substance foreclosure at December 31, 2009 and 2008,
respectively. Real estate owned is initially recorded at its estimated fair
market value less estimated selling costs. The estimated fair value is generally
determined by appraisal at the time of acquisition. The Bank's investment in
real estate owned is comprised of 37 properties at December 31, 2009. The
majority of these properties are single family homes or residential lots. Two of
the properties are commercial properties, and two are commercially zoned
building lots. The Company's plan for liquidating these properties involves
listing the properties with experienced local real estate agents and pricing the
properties appropriately for sale within a six month period. Sales plans for
properties listed but unsold for more than six months will be reevaluated. Since
year end, nine properties have been disposed of. The Company had no investment
in repossessed assets other than real estate. See note 7 to the consolidated
financial statements for further information.
21
Deposits
The amounts and percentage composition of deposits held by the Bank as
of December 31, 2009 and 2008 are summarized below:
Deposit Composition
December 31,
------------
2009 2008
---- ----
(Dollars in thousands)
% of % of
Amount Deposits Amount Deposits
------ -------- ------ --------
Noninterest bearing demand $ 11,235 7.4% $ $10,070 8.2%
Interest bearing transaction accounts 13,308 8.7 13,013 10.6
Savings 37,317 24.5 13,849 11.3
Money market 10,760 7.1 7,286 6.0
Time deposits $100,000 and over 51,245 33.6 41,810 34.1
Other time deposits 28,516 18.7 36,554 29.8
--------- ----- --------- -----
Total deposits $ 152,381 100.0% $ 122,582 100.0%
========= ===== ========= =====
The average amounts of and average rate paid on deposits held by the
Bank for the years ended December 31, 2008 and 2007, are summarized below:
Average Deposits
Year ended December 31,
-----------------------
2009 2008
---- ----
Amount Rate Amount Rate
------ ---- ------ ----
(Dollars in thousands)
Noninterest bearing demand ..................................... $ 11,227 -% $ 10,914 -%
Interest bearing transaction accounts .......................... 13,169 .57% 13,502 .92%
Savings and money market ....................................... 34,936 1.88% 14,994 1.98%
Time deposits .................................................. 86,435 2.54% 76,234 3.68%
--------- ---------
Total average deposits ................................... $ 145,767 $ 115,644
========= =========
As of December 31, 2009, the Bank held $51.2 million of time deposits
with balances of $100,000 or more. Of that amount, $8.0 million mature within
three months, $8.8 million mature over three through six months, $17.5 million
mature over six through twelve months, and $16.9 million mature over twelve
months. $400,000 of time deposits over $100,000 or more are at floating rates of
interest at December 31, 2009.
While many of the large time deposits are acquired from customers with
standing relationships with the Bank, it is a common industry practice not to
consider these types of deposits as core deposits because their retention can be
expected to be heavily influenced by rates offered, and therefore such deposits
may have the characteristics of shorter-term purchased funds. Certain deposits
included in total deposits over $100,000 are brokered deposits. Brokered
deposits are acquired in the wholesale market but are issued to the eventual
customer in increments of less than $100,000. The majority of these deposits are
not redeemable prior to maturity except in the case of death. All time deposits
over $100,000 involve the maintenance of an appropriate matching of maturity
distribution and a diversification of sources to achieve an appropriate level of
liquidity.
Customer Repurchase Agreements
Customer repurchase agreements consist of sweep accounts and retail
repurchase agreements, and totaled $3.3 million and $4.6 million at December 31,
2009 and 2008, respectively. Securities issued by government sponsored
enterprises with an amortized cost of $3.3 million and $5.6 million (fair value
of $3.3 million and $5.9 million) were used as collateral for the sweep accounts
and retail repurchase agreements, at December 31, 2009 and 2008, respectively.
22
All of the sweep accounts pay interest on a floating rate basis. The customer
repurchase agreements pay interest on a fixed rate basis and have maturities of
varying lengths. As of December 31, 2009 all of the Bank's customer repurchase
agreements mature in 2010. During 2009 the average amount of customer repurchase
agreements and sweep accounts totaled $3.8 million. The Bank paid an average
interest rate of 2.04% on these funds in 2009.
Broker Repurchase Agreements
Broker repurchase agreements consist of two separate borrowings
totaling $5.0 million. These borrowings carry fixed rates of interest with call
features. The agreements mature as follows: $3.0 million maturing on January 15,
2015, callable by the broker quarterly after January 15, 2012, and $2.0 million
maturing on January 15, 2013, callable by the broker quarterly, beginning
January 10, 2010. Securities with fair value of $6.0 million and amortized cost
of $5.7 million collateralize the agreements. During 2009, the highest balance
as of any month end for broker repurchase agreements was $5.0 million and the
average balance for 2009 was $5.0 million. The average rate paid on broker
repurchase agreements during 2009 was 3.53%. During 2008 the highest balance as
of any month end for broker repurchase agreements was $5.0 million and the
average balance for 2008 was $4,836,066. The average rate paid on broker
repurchase agreements during 2008 was 3.53%.
Liquidity
Liquidity is the ability to meet current and future obligations through
liquidation or maturity of existing assets or the acquisition of additional
liabilities. Adequate liquidity is necessary to meet the requirements of
customers for loans and deposit withdrawals in the most timely and economical
manner. Some liquidity is ensured by maintaining assets that may be immediately
converted into cash at minimal cost (amounts due from banks and federal funds
sold). However, the most manageable sources of liquidity are composed of
liabilities, with the primary focus on liquidity management being on the ability
to obtain deposits within the Bank's service area. Core deposits (total deposits
less time deposits greater than $100,000) provide a relatively stable funding
base, and were equal to 53.4% of total assets at December 31, 2009.
Asset liquidity is provided from several sources, including amounts due
from banks and federal funds sold, unpledged securities, and funds from maturing
loans. The Company had $6.0 million in cash and cash equivalents at December 31,
2009. The Bank has access to $4.1 million in lines of credit with other banks
and a line of credit with the Federal Home Loan Bank of Atlanta ("FHLB"), all of
which are subject to various conditions and may be terminated at the option of
the lender, as additional sources of liquidity funding. The lines with the other
banks are for short-term use only. Approximately 50% of the lines available from
other banks are unsecured, and 50% would need to be collateralized. There were
no balances outstanding on these lines as of December 31, 2009.
The line with the FHLB is equal to 10% of assets, provided that
adequate collateral is available for pledging. The line may be used for short or
long term funding needs and may be used on a fixed or variable-rate basis. As of
December 31, 2009, the Bank had $9.7 million at a weighted average rate of
interest equal to 2.55%, maturing at various dates through 2018, borrowed from
the FHLB. During 2009, the highest balance as of any month end for borrowings
from the FHLB was $9.8 million. The average rate paid on the advances during
2009 was 2.78%. The average balance of FHLB advances for 2009 was $8.6 million.
During 2008, the highest balance as of any month end for borrowings from the
FHLB was $10.4 million. The average rate paid on advances during 2008 was 3.28%.
The average balance of FHLB advances for 2008 was $7.0 million.
At December 31, 2009, approximately $9.2 million of additional funds
were available under the FHLB line provided that eligible collateral is
available. The Bank primarily uses bonds and mortgage-backed securities issued
by US Government agencies to collateralize advances. As of December 31, 2009
securities with a market value of $5.6 were available to pledge as collateral to
the FHLB should the Company require additional funding. Management believes that
the Bank's overall liquidity sources are adequate to meet its operating needs in
the ordinary course of its business.
Off-Balance Sheet Risk
The Company, through the operations of the Bank, makes contractual
commitments to extend credit in the ordinary course of its business activities.
These commitments are legally binding agreements to lend money to customers of
23
the Bank at predetermined interest rates for a specified period of time. At
December 31, 2009 and 2008, unfunded commitments to extend credit were $17.6
million and $21.9 million, respectively. At December 31, 2009, the unfunded
commitments consisted of $17.3 million at variable rates and $304,600 at fixed
rates with $10.4 million expiring within one year. Past experience indicates
that many of these commitments to extend credit will expire unused and it is
unlikely that a large portion would be used in a short period of time. However,
through its various sources of liquidity discussed above, the Bank believes that
it will have the necessary resources to meet these obligations should the need
arise.
In addition to commitments to extend credit, the Bank also issues
standby letters of credit which are assurances to a third party that it will not
suffer a loss if the Bank's customer fails to meet its contractual obligation to
the third party. Standby letters of credit totaled approximately $660,000 at
December 31, 2009. Past experience indicates that many of these standby letters
of credit will expire unused. However, through its various sources of liquidity
discussed above, the Bank believes that it will have the necessary resources to
meet these obligations should the need arise.
The Bank offers an automatic overdraft protection product.
Approximately $1.2 million of overdraft protection is available under this
product as of December 31, 2009. The Bank expects the majority of this capacity
will not be utilized. During 2009, the average balance of demand deposit
overdrafts was $20,177.
Neither the Company nor the Bank is involved in other off-balance sheet
contractual relationships, unconsolidated related entities that have off-balance
sheet arrangements or transactions that could result in liquidity needs or other
commitments or significantly impact earnings. The Company did not maintain any
obligations under non-cancelable operating lease agreements at December 31,
2009. The Company has less than one year remaining on a five-year contract with
a company which provides data, item and ATM processing services. The monthly
costs are approximately $20,000. The Company expects to replace the existing
contract with a new five-year contract. Refer to notes 12 and 16 to the
Company's consolidated financial statements for additional discussion on these
and other commitments and contingencies and financial instruments with
off-balance sheet risk.
Capital Resources
At December 31, 2009, total shareholders' equity decreased by
approximately $1.1 million from $19.1 million at December 31, 2008 to $18.0
million at December 31, 2009. The decrease was due to a net loss of $1,361,274,
items related to stock based compensation and the stock dividend, including
option exercises, of $150,749 and an unrealized gain on investment securities of
$112,983, net of tax. The Company does not anticipate it will need to raise
additional capital in 2010 if the economy does not deteriorate further. The
Company's current plan is to maintain its asset size in 2010, and return to
modest growth in 2011.
The Company made capital expenditures for furniture and equipment in
2009 totaling approximately $5,000. Capital expenditures for premises and
equipment planned for 2010 consist of replacements of outdated computer
equipment. There are no plans for additional premises in 2010.
The Company and the Bank are subject to regulatory capital adequacy
standards. Under these standards, financial institutions are required to
maintain certain minimum ratios of capital to risk-weighted assets and adjusted
total assets (Tier 1 leverage ratio). Under the provisions of the Federal
Deposit Insurance Corporation Improvements Act of 1991, federal financial
institution regulatory authorities are required to implement prescribed "prompt
corrective action" upon the deterioration of the capital position of a bank. If
the capital position of an affected institution were to fall below certain
levels, increasingly stringent regulatory corrective actions are mandated.
Additionally, the OCC may require higher minimum capital ratios for an
individual bank in view of its circumstances. The Company's and the Bank's
regulatory capital requirements and positions are summarized in note 20 to the
consolidated financial statements.
Because the Bank had a relatively high level of nonperforming assets at
December 31, 2009 and recorded a substantial loss for 2009, the OCC may require
the Bank to maintain capital ratios in excess of those generally required to be
well capitalized and may seek the Bank's agreement to take other specified
actions intended to reduce the risks faced by the Bank. The OCC has the
authority to enforce such an agreement with various regulatory actions.
24
Return on Equity and Assets
The following table shows the return on assets (net income divided by
average total assets), return on equity (net income divided by average equity),
dividend payout ratio (cash dividends declared per share divided by net income
per share), and equity to assets ratio (average equity divided by average total
assets) for the years ended December 31, 2009 and 2008.
December 31,
------------
2009 2008
----- ----
Return on assets ............................ (.75%) .15%
Return on equity ............................ (7.21%) 1.16%
Dividend payout ratio ....................... - 265%
Equity to assets ratio (average) ............ 10.42% 12.68%
In May, 2008 the Company declared its first cash dividend. The amount
of the dividend was determined based on a number of factors, including previous
year's earnings, capital levels, prospects for growth and earnings during the
coming twelve months, and availability of dividends from the Bank to the
Company. There can be no assurance that cash dividends will be declared in the
future.
During 2010, the Bank's plan of operation is to continue to attract
new deposit customers, convert our nonperforming assets into interest earning
assets, to increase the ratio of services per customer and increase the account
profitability of the Bank's current customers. The Bank plans to seek deposit
accounts from individuals and businesses in the Easley, Berea, Powdersville and
surrounding markets. The Bank intends to offer competitive rates for such
accounts and may seek new accounts by offering rates slightly above those
prevailing in the market. Management will continue to emphasize personal
service, accessibility, and flexibility as reasons for customers to do business
with the Bank. Personal contacts by management, advertising, and competitive
prices and services will be the Bank's principal marketing tools.
Inflation
Since the assets and liabilities of a bank are primarily monetary in
nature (payable in fixed, determinable amounts), the performance of a bank is
affected more by changes in interest rates than by inflation. Interest rates
generally increase as the rate of inflation increases, but the magnitude of the
change in rates may not be the same.
While the effect of inflation on banks is normally not as significant
as is its influence on those businesses that have large investments in plant and
inventories, it does have an effect. During periods of high inflation, there are
normally corresponding increases in the money supply, and banks will normally
experience above-average growth in assets, loans and deposits. Also general
increases in the prices of goods and services usually result in increased
operating expenses.
Market for Common Equity and Related Stockholder Matters
The following table shows the high and low bid prices of our common
stock reported by the OTC Bulletin Board for the past two years. The prices
reflect inter-dealer prices, without retail mark-up, mark-down, or commission
and may not represent actual transactions. The prices have been adjusted to
reflect a 5% stock dividend declared in April 2009 to shareholders of record as
of May 12, 2009.
Year ended Year ended
December 31, 2009 December 31, 2008
----------------- -----------------
Low High Low High
--- ---- --- ----
First Quarter ........... $4.10 $8.25 $10.71 $14.76
Second Quarter .......... $4.10 $6.00 $13.09 $13.33
Third Quarter ........... $4.00 $6.00 $9.80 $13.23
Fourth Quarter .......... $3.55 $5.90 $9.52 $10.95
Although the common stock of the Company may be traded from time to
time on an individual basis, no active trading market has developed and none may
25
develop in the foreseeable future. The common stock is not listed on any
exchange. The stock is quoted on the OTC Bulletin Board under the symbol
"CTOT.OB."
As of February 10, 2010, there were approximately 590 holders of record
of the Company's common stock, excluding individual participants in security
position listings.
The Company paid cash dividends of $597,471 ($.30 per share) for the
first time in 2008. The dividend policy of the Company is subject to the
discretion of the Board of Directors and depends upon a number of factors,
including earnings, financial conditions, cash needs and general business
conditions, as well as applicable regulatory considerations. Because the Company
has no operations other than those of the Bank and only has limited income of
its own, the Company would rely on dividends from the Bank as its principal
source of cash to pay cash dividends.
Each national banking association is required by federal law to obtain
the prior approval of the Office of the Comptroller of the Currency (the "OCC"),
the primary Federal regulator of national banks, for the payment of dividends if
the total of all dividends declared by the board of directors of such bank in
any year will exceed the total of (i) such bank's net profits (as defined and
interpreted by regulation) for that year plus (ii) the retained net profits (as
defined and interpreted by regulation) for the preceding two years, less any
required transfers to surplus. In addition, national banks can only pay
dividends to the extent that retained net profits (including the portion
transferred to surplus) exceed bad debts (as defined by regulation).
The payment of dividends by the Company and the Bank may also be
affected or limited by other factors, such as the requirements to maintain
adequate capital above regulatory guidelines. In addition, if, in the opinion of
the applicable regulatory authority, a bank under its jurisdiction is engaged in
or is about to engage in an unsafe or unsound practice (which, depending on the
financial condition of the Bank, could include the payment of dividends), such
authority may require, after notice and hearing, that such bank cease and desist
from such practice. The OCC has indicated that paying dividends that deplete a
national bank's capital base to an inadequate level would be an unsafe and
unsound banking practice. The Federal Reserve, the OCC and the FDIC have issued
policy statements, which provide that bank holding companies and insured banks
should generally only pay cash dividends out of current operating earnings.
Management's Annual Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate
internal control over financial reporting, as such term is defined in Exchange
Act Rule 13a-15(f). A system of internal control over financial reporting is a
process designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles.
Under the supervision and with the participation of management,
including the principal executive officer and the principal financial officer,
the Company's management has evaluated the effectiveness of its internal control
over financial reporting as of December 31, 2009 based on the criteria
established in a report entitled "Internal Control - Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission" and the
interpretive guidance issued by the Securities and Exchange Commission in
Release No. 34-55929. Based on this evaluation, the Company's management has
evaluated and concluded that the Company's internal control over financial
reporting was effective as of December 31, 2009.
This annual report does not include an attestation report of the
Company's independent registered public accounting firm regarding internal
control over financial reporting because management's report was not subject to
attestation by the Company's registered public accounting firm pursuant to
temporary rules of the Securities and Exchange Commission that permit the
Company to provide only management's report in this annual report.
26
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors
Cornerstone Bancorp and Subsidiary
Easley, South Carolina
We have audited the accompanying consolidated balance sheets of Cornerstone
Bancorp and Subsidiary (the "Company") as of December 31, 2009 and 2008, and the
related consolidated statements of income (loss), shareholders' equity and
comprehensive income (loss) and cash flows for each of the three years in the
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 financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes 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 Cornerstone Bancorp
and Subsidiary as of December 31, 2009 and 2008, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2009, in conformity with United States generally accepted
accounting principles.
We were not engaged to examine management's assessment of the effectiveness of
Cornerstone Bancorp and Subsidiary's internal control over financial reporting
as of December 31, 2009, included in the accompanying Management's Annual Report
on Internal Controls Over Financial Reporting, and, accordingly, we do not
express an opinion thereon.
/s/ Elliott Davis, LLC
Greenville, South Carolina
March 30, 2010
27
CORNERSTONE BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31,
------------
2009 2008
---- ----
Assets
Cash and due from banks ................................................................... $ 4,369,596 $ 3,820,227
Federal funds sold ........................................................................ 1,670,000 140,000
------------- -------------
Cash and cash equivalents .......................................................... 6,039,596 3,960,227
Investment securities
Available-for-sale ................................................................... 28,902,143 19,676,604
Other investments .................................................................... 1,142,050 1,114,150
Loans, net ................................................................................ 135,067,914 129,483,130
Property and equipment, net ............................................................... 5,291,203 5,551,275
Cash surrender value of life insurance policies ........................................... 1,838,663 1,768,520
Other real estate owned ................................................................... 6,712,948 575,000
Other assets .............................................................................. 3,975,813 1,722,161
------------- -------------
Total assets ................................................................ $ 188,970,330 $ 163,851,067
============= =============
Liabilities And Shareholders' Equity
Liabilities
Deposits
Noninterest bearing .............................................................. $ 11,234,486 $ 10,069,125
Interest bearing ................................................................. 141,146,788 112,512,449
------------- -------------
Total deposits ................................................................... 152,381,274 122,581,574
Federal funds purchased .............................................................. - 1,810,000
Customer repurchase agreements ....................................................... 3,257,002 4,582,619
Borrowings from Federal Home Loan Bank of Atlanta .................................... 9,743,172 10,394,005
Broker repurchase agreements ......................................................... 5,000,000 5,000,000
Other liabilities .................................................................... 549,477 345,922
------------- -------------
Total liabilities ................................................................ 170,930,925 144,714,120
Commitments and contingencies - Notes 11 and 15
Shareholders' equity
Preferred stock, 10,000,000 shares authorized, no shares issued ...................... - -
Common stock, no par value, 20,000,000 shares authorized, 2,105,738 and
1,991,565 shares issued at December 31, 2009 and 2008, respectively ................ 18,799,728 18,323,333
Retained earnings (deficit) .......................................................... (921,014) 765,906
Accumulated other comprehensive income ............................................. 160,691 47,708
------------- -------------
Total shareholders' equity ....................................................... 18,039,405 19,136,947
------------- -------------
Total liabilities and shareholders' equity ....................................... $ 188,970,330 $ 163,851,067
============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
28
CORNERSTONE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
Year ended December 31,
-----------------------
2009 2008 2007
---- ---- ----
Interest Income
Loans and fees on loans .............................................. $ 6,997,466 $ 7,848,630 $ 8,834,764
Investment securities ................................................ 1,025,983 1,161,545 944,003
Federal funds sold and other ......................................... 16,378 91,870 228,687
------------ ------------ ------------
Total interest income ........................................... 8,039,827 9,102,045 10,007,454
Interest Expense
Deposits ............................................................. 2,930,929 3,229,237 3,822,618
Federal funds sold and customer repurchase agreements ................ 78,438 170,090 238,562
Federal Home Loan Bank advances ...................................... 237,870 228,129 115,810
Broker repurchase agreements ......................................... 176,619 170,756 -
------------ ------------ ------------
Total interest expense .......................................... 3,423,856 3,798,212 4,176,990
------------ ------------ ------------
Net interest income ............................................. 4,615,971 5,303,833 5,830,464
Provision for loan losses ............................................ 2,955,000 815,000 196,636
------------ ------------ ------------
Net interest income after provision for loan losses ............. 1,660,971 4,488,833 5,633,828
Noninterest Income (Expense)
Mortgage loan origination fees ....................................... 154,905 275,721 437,157
Service fees on deposit accounts ..................................... 572,973 579,298 542,937
Gain on sale of available-for-sale investments ....................... 299,063 - -
Other-than-temporary-impairment of FNMA preferred stock .............. - (918,264) -
Gain (loss) on sale of repossessed assets ............................ (228,547) 3,464 (9,672)
Other ................................................................ 183,225 123,747 104,392
------------ ------------ ------------
Total noninterest income ........................................ 981,619 63,966 1,074,814
------------ ------------ ------------
Noninterest Expenses
Salaries and benefits ................................................ 2,392,717 2,415,115 2,443,315
Occupancy and equipment .............................................. 572,025 600,426 567,222
Data processing ...................................................... 218,110 231,958 234,671
Advertising .......................................................... 30,258 69,859 76,530
Supplies ............................................................. 69,383 85,895 111,918
Professional and regulatory fees ..................................... 551,330 320,027 314,516
Directors fees ....................................................... 138,475 130,450 127,700
Loan expenses ........................................................ 322,687 51,706 24,766
Other real estate owned .............................................. 117,272 50,889 8,216
Deposit charge-offs .................................................. 20,912 26,461 39,387
Other operating ...................................................... 390,432 362,297 337,416
------------ ------------ ------------
Total noninterest expenses ...................................... 4,823,601 4,345,083 4,285,657
------------ ------------ ------------
Income (loss) before income taxes ............................... (2,181,011) 207,716 2,422,985
Income tax provision (benefit) ....................................... (819,737) (17,600) 810,232
------------ ------------ ------------
Net income (loss) ............................................... $ (1,361,274) $ 225,316 $ 1,612,753
============ ============ ============
Earnings (Loss) Per Common Share
Basic ................................................................ $ (.65) $ .11 $ .78
Diluted .............................................................. $ (.65) $ .11 $ .76
Weighted Average Common Shares Outstanding
Basic ................................................................ 2,103,039 2,089,384 2,063,917
Diluted .............................................................. 2,103,039 2,143,953 2,117,693
The accompanying notes are an integral part of these consolidated financial
statements.
29
CORNERSTONE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (LOSS)
Accumulated
Common stock Retained other Total
------------ earnings comprehensive shareholders'
Shares Amount (deficit) income (loss) equity
------ ------ --------- ------------- ------
Balance, December 31, 2006 ..................... 1,777,313 $ 15,972,666 $ 1,499,803 $ 66,258 $ 17,538,727
------------
Net income ..................................... - - 1,612,753 - 1,612,753
Other comprehensive income, net of
income taxes:
Unrealized gain on investment
securities .............................. - - - 151,794 151,794
------------
Comprehensive income ........................ 1,764,547
Stock based compensation ....................... - 40,797 - - 40,797
Stock option exercises, including
Tax benefit of $54,550 ................... 27,306 238,990 - - 238,990
Stock dividend (10%), net of
cash in lieu of fractional shares ....... 178,550 1,932,875 (1,935,106) - (2,231)
------------ ------------ ------------ ------------ ------------
Balance, December 31, 2007 ..................... 1,983,169 18,185,328 1,177,450 218,052 19,580,830
------------
Net income ..................................... - - 225,316 - 225,316
Other comprehensive income, net of
income taxes:
Unrealized loss on investment
securities .............................. - - - (170,344) (170,344)
------------
Comprehensive income ........................ 54,972
Cumulative effect of accounting change ......... - - (39,389) - (39,389)
Stock based compensation ....................... - 56,172 - - 56,172
Stock option exercises ......................... 8,396 81,833 - - 81,833
Cash dividend paid ............................. - - (597,471) - (597,471)
------------ ------------ ------------ ------------ ------------
Balance, December 31, 2008 ..................... 1,991,565 18,323,333 765,906 47,708 19,136,947
------------
Net loss ....................................... - - (1,361,274) - (1,361,274)
Other comprehensive income, net of
income taxes:
Unrealized gain on investment
securities .............................. - - - 112,983 112,983
------------
Comprehensive loss .......................... (1,248,291)
Stock based compensation ....................... - 72,464 - - 72,464
Stock option exercises ......................... 14,172 80,000 - - 80,000
Stock dividend (5%), net of cash in
lieu of fractional shares ................. 100,001 323,931 (325,646) - (1,715)
------------ ------------ ------------ ------------ ------------
Balance, December 31, 2009 ..................... 2,105,738 $ 18,799,728 $ (921,014) $ 160,691 $ 18,039,405
============ ============ ============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements
30
CORNERSTONE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31,
------------------------
2009 2008 2007
---- ---- ----
Operating Activities
Net income (loss) ....................................................... $ (1,361,274) $ 225,316 $ 1,612,753
Adjustments to reconcile net income to net cash provided
by operating activities
Depreciation and net amortization ................................. 351,303 292,585 285,241
Deferred income tax (benefit) expense ............................. (286,803) (315,107) 4,508
Provision for loan losses ......................................... 2,955,000 815,000 196,636
Other than temporary impairment of FNMA Preferred ................. - 918,264 -
Gain on sale of available-for-sale investments .................... (299,063) - -
(Gain) loss on sale of repossessed collateral ..................... 202,296 (3,464) 9,672
Gain on sale of fixed assets ...................................... (625) (481) -
Non-cash option expense ........................................... 72,464 56,172 40,797
Increase in other assets .......................................... (2,184,323) (9,958) (216,723)
Increase (decrease) in other liabilities .......................... 145,474 (240,717) (104,341)
------------ ------------ ------------
Net cash provided by (used for) operating activities ............ (405,551) 1,737,610 1,828,543
------------ ------------ ------------
activities
Investing Activities
Proceeds from maturities and principal paydowns of
investment securities .................................................. 16,654,053 4,276,949 4,358,412
Proceeds from sale of OREO .............................................. 2,498,705 399,208 96,528
Purchase of investment securities ....................................... (25,495,248) (7,085,514) (5,005,942)
Purchase of FHLB and Federal Reserve stock, net ......................... (27,900) (297,650) (2,900)
Increase in loans, net .................................................. (17,167,459) (23,849,672) (11,365,651)
Proceeds from sale of property and equipment ............................ 625 7,495 -
Capitalization of improvements to OREO .................................. (63,943) - -
Purchase of property and equipment ...................................... (5,448) (32,295) (1,679,829)
------------ ------------ ------------
Net cash used for investing activities .......................... (23,606,615) (26,581,479) (13,599,382)
------------ ------------ ------------
Financing Activities
Net increase in deposits ................................................ 29,799,700 11,647,106 9,268,272
Net increase (decrease) in customer repurchase agreements ............... (1,325,617) (1,220,316) 738,795
Net increase (decrease) Federal funds purchased ......................... (1,810,000) 1,810,000 -
Borrowings from Federal Home Loan Bank of Atlanta ....................... 4,500,000 11,800,000 1,000,000
Repayments to Federal Home Loan Bank of Atlanta ......................... (5,150,833) (4,950,833) (150,833)
Proceeds from broker repurchase agreements .............................. - 5,000,000 -
Proceeds from exercise of stock options ................................. 80,000 81,833 238,990
Cash dividends paid ..................................................... - (597,471) -
Cash paid in lieu of fractional shares .................................. (1,715) - (2,231)
------------ ------------ ------------
Net cash provided by financing activities ....................... 26,091,535 23,570,319 11,092,993
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents ....... 2,079,369 (1,273,550) (677,846)
Cash and cash equivalents, beginning of year ................................... 3,960,227 5,233,777 5,911,623
------------ ------------ ------------
Cash and cash equivalents, end of year ......................................... $ 6,039,596 $ 3,960,227 $ 5,233,777
============ ============ ============
Cash paid for:
Interest ................................................................ $ 3,457,004 $ 3,803,188 $ 4,145,118
============ ============ ============
Income taxes ............................................................ $ 54,946 $ 438,048 $ 932,075
============ ============ ============
Non-cash Supplemental information:
Loans transferred to other real estate owned ............................ $ 8,922,517 $ 931,761 $ 69,000
============ ============ ============
Loans charged-off, net .................................................. $ 1,958,726 $ 409,567 $ 103,505
============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements
31
CORNERSTONE BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES
Cornerstone Bancorp, (the "Company") was incorporated under the laws of
the State of South Carolina for the purpose of operating as a bank holding
company for Cornerstone National Bank (the "Bank"). The Company obtained
regulatory approval to acquire the Bank and opened the Bank for business in 1999
with a total capitalization of $6.0 million. To increase capital available for
growth, the Company offered 445,000 shares of its common stock pursuant to a
prospectus dated October 4, 2005. Upon completion in January 2006, the offering
added approximately $6.0 million to the Company's total capitalization.
The Bank provides full commercial banking services to customers and is
subject to regulation by the Office of the Comptroller of the Currency ("OCC")
and the Federal Deposit Insurance Corporation. The Company is subject to
regulation by Federal Reserve and to limited regulation by the South Carolina
State Board of Financial Institutions. The Bank maintains branch locations in
the Berea area of Greenville County and the Powdersville area of Anderson
County, South Carolina in addition to its headquarters in Easley in Pickens
County, South Carolina. In 2004, the Bank established a wholly owned subsidiary,
Crescent Financial Services, Inc. ("Crescent"), which is an insurance agency. In
2009, 2008 and 2007, Crescent's transactions were immaterial to the consolidated
financial statements.
Basis of presentation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiary, the Bank. The Company operates as one
business segment. All significant intercompany balances and transactions
have been eliminated. The accounting and reporting policies conform to
accounting principles generally accepted in the United States of America
and to general practices in the banking industry. The Company uses the
accrual basis of accounting.
Estimates
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
("GAAP") requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities as of the date of the financial statements and the
reported amount of income and expenses during the reporting periods. Actual
results could differ from those estimates. The Company's most significant
estimates relate to the allowance for loan losses and income taxes.
Concentrations of credit risk
The Company makes loans to individuals and businesses in and around Upstate
South Carolina for various personal and commercial purposes. The Bank has a
diversified loan portfolio and the borrowers' ability to repay their loans
is not dependent upon any specific economic sector. The Bank monitors
concentrations in its customer base using the North American Industry Codes
("NAIC") and using certain regulatory definitions. As of December 31, 2009,
the Bank has concentrations of credit in real estate rental and leasing,
accommodation and food services, construction, retail trade, health care
and social assistance, and other services, which by NAIC category comprise
over 25% of Tier 1 Capital adjusted for the allowance for loan losses. The
Bank also has a concentration in loans collateralized by real estate.
Although a majority of the Bank's loans are collateralized by real estate,
the Bank believes that it has proper internal controls to identify and
mitigate risks associated with this concentration in real estate
collateral.
Investment securities
The Company accounts for investment securities in accordance with financial
accounting standards which require that investments in equity and debt
securities to be classified into three categories:
(Continued)
32
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued
1. Available-for-sale securities: These are securities that are not
classified as either held to maturity or as trading securities. These
securities are reported at fair market value. Unrealized gains and
losses are reported, net of income taxes, as separate components of
shareholders' equity (accumulated other comprehensive income).
2. Held-to-maturity securities: These are investment securities that the
Company has the ability and intent to hold until maturity. These
securities are stated at cost, adjusted for amortization of premiums and
the accretion of discounts.
3. Trading securities: These are securities that are bought and held
principally for the purpose of selling in the near future. Trading
securities are reported at fair market value, and related unrealized
gains and losses are recognized in the income statement. The Company has
no trading securities.
The Company reviews all investments with unrealized losses as of the balance
sheet date for possible impairment. Our review consists of an examination of
each security with regard to its issuer, credit rating, time to maturity and
likelihood of sale prior to maturity. Any losses determined to be other than
temporary are recognized through the income statement.
The financial accounting standard followed by the Company defines fair
value, establishes a framework for measuring fair value under generally
accepted accounting principles, and expands disclosures about fair value
measurements. Available for sale securities owned by the Company include
government sponsored enterprise bonds, mortgage-backed securities issued by
government sponsored enterprises, and municipal bonds. The fair values of
the Company's available for sale investments, other than municipal bonds,
are measured on a recurring basis using quoted market prices in active
markets for identical assets and liabilities ("Level 1 inputs" under the
standard). Due to the lower level of trading activity in municipal bonds,
the fair market values of these investments are measured based on other
inputs such as inputs that are observable or can be corroborated by
observable market data for similar assets with substantially the same terms
("Level 2 inputs" under the standard.)
Other investments include the Bank's stock investments in the Federal
Reserve Bank of Richmond ("Reserve Bank") and the Federal Home Loan Bank of
Atlanta ("FHLB"). The Bank, as a member institution, is required to own
certain stock investments in the Reserve Bank and FHLB. The stock is
generally pledged against any borrowings from the Reserve Bank and FHLB. No
ready market exists for the stock and it has no quoted market value.
Redemption of these stock investments has historically been at par value.
However, there can be no assurance that future redemptions will be at par
value. Other investments are carried at cost.
Gains or losses on dispositions of investment securities are based on the
differences between the net proceeds and the adjusted carrying amount of
the securities sold, using the specific identification method.
Loans, interest and fee income on loans
Loans are stated at the principal balance outstanding. Unearned discount
and the allowance for possible loan losses are deducted from total loans in
the balance sheet. Interest income is recognized over the term of the loan
based on the principal amount outstanding.
Generally, the accrual of interest will be discontinued on impaired loans
when principal or interest becomes 90 days past due, or when payment in
full is not anticipated, and any previously accrued interest on such loans
will be reversed against current income. Any subsequent interest income
will be recognized on a cash basis when received unless collectibility of a
significant amount of principal is in serious doubt. In such cases,
collections are credited first to the remaining principal balance on a cost
recovery basis. An impaired loan will not be returned to accrual status
unless principal and interest are current and the borrower has demonstrated
the ability to continue making payments as agreed. Non-performing assets
include real estate acquired through foreclosure or deed taken in lieu of
foreclosure, and loans on non-accrual status. Fee income on loans is
recognized as income at the time loans are originated. Due to the
short-term nature of the majority of the Bank's loans and the immateriality
of the net deferred amount, this method approximates the income that would
be earned if the Company deferred loan fees and costs.
(Continued)
33
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued
Allowance for loan losses
The Company provides for loan losses using the allowance method. Loans that
are determined to be uncollectible are charged against the allowance.
Provisions for loan losses and recoveries on loans previously charged off
are added to the allowance. The provision for loan losses charged to
operating expenses reflects the amount deemed appropriate by management to
establish an adequate reserve to meet the probable loan losses incurred in
the current loan portfolio. Management's judgment is based on periodic and
regular evaluation of individual loans, the overall risk characteristics of
the various portfolio segments, past experience with losses, delinquency
trends, and prevailing economic conditions. While management uses the best
information available to make evaluations, future adjustments to the
allowance may be necessary if economic conditions differ substantially from
the assumptions used in making the evaluations. The allowance for loan
losses is also subject to periodic evaluation by various regulatory
authorities and may be subject to adjustment upon their examination.
The Bank accounts for impaired loans in accordance with a financial
accounting standard that requires all lenders to value a loan at the loan's
fair value if it is probable that the lender will be unable to collect all
amounts due according to the 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. Loans that experience insignificant payment
delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment
shortfalls on a case-by-case basis taking into consideration all the
circumstances of the loan and the borrower, including the length of the
delay, reasons for the delay, the borrower's payment record and the amount
of the shortfall in relation to the principal and interest owed. Impairment
is determined on a case-by-case basis. The fair value of an impaired loan
may be determined based upon the present value of expected cash flows,
market price of the loan, if available, or value of the underlying
collateral. Expected cash flows are required to be discounted at the loan's
effective interest rate.
When the ultimate collectibility of an impaired loan's principal is in
doubt, wholly or partially, all cash receipts are applied to principal.
Once the reported principal balance has been reduced to zero, future cash
receipts are applied to interest income, to the extent that any interest
has been foregone. Further cash receipts are recorded as recoveries of any
amounts previously charged off.
A loan is also considered impaired if its terms are modified in a troubled
debt restructuring. For these accruing impaired loans, cash receipts are
typically applied to principal and interest receivable in accordance with
the terms of the restructured loan agreement. Interest income is recognized
on these loans using the accrual method of accounting.
Other real estate owned
Other real estate owned is carried at fair value (market value less
estimated selling cost), determined using an independent appraisal.
Property and equipment
Property and equipment are stated at cost, net of accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful lives of the related assets. Maintenance and repairs are charged to
operations, while major improvements are capitalized. Upon retirement, sale
or other disposition of property and equipment, the cost and accumulated
depreciation are eliminated from the accounts, and gain or loss is included
in income from operations.
Income taxes
The Company accounts for income taxes in accordance with a financial
accounting standard that requires that deferred tax assets and liabilities
be recognized for the expected future tax consequences of events that have
been recognized in the consolidated financial statements or tax returns.
Deferred tax assets and liabilities are measured using the enacted tax
rates expected to apply to taxable income in the years in which those
temporary differences are expected to be realized or settled.
(Continued)
34
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued
The Company has analyzed its filing positions in the federal and state
jurisdictions where it is required to file income tax returns, as well as
all open tax years in these jurisdictions. The Company believes that income
tax filing positions taken or expected to be taken in its tax returns will
more likely than not be sustained upon audit by the taxing authorities and
does not anticipate any adjustments that will result in a material adverse
impact on the Company's financial condition, results of operations, or cash
flows. Therefore, no reserves for uncertain income tax positions have been
recorded.
Advertising and public relations expense
Advertising, promotional and other business development costs are generally
expensed as incurred. External costs incurred in producing media
advertising are expensed the first time the advertising takes place.
External costs relating to direct mailing costs are expensed in the period
in which the direct mailings are sent.
Earnings per common share
Basic earnings per common share is computed on the basis of the weighted
average number of common shares outstanding. The treasury stock method is
used to compute the effect of stock options on the weighted average number
of common shares outstanding for diluted earnings per common share. As of
December 31, 2009, there were no common stock equivalents included in the
Company's loss per share calculation. Options to purchase 106,255 shares of
common stock were antidilutive as of December 31, 2009 and were excluded
from the diluted share calculation. The Company declared a five percent
stock dividend to shareholders of record on May 12, 2009 and 10 percent
stock dividends to shareholders of record as of May 8, 2007, May 9, 2006,
May 10, 2005, May 11, 2004, March 17, 2003 and April 30, 2002. 2008 and
2007 share and per share amounts on the Consolidated Statements of income
(loss) have been restated to reflect the applicable transactions.
Cash surrender value of life insurance policies
Cash surrender value of life insurance policies represents the cash value
of policies on certain officers of the Bank.
Statement of cash flows
For purposes of reporting cash flows, cash and cash equivalents are those
amounts which have an original maturity of three months or less.
Fair values of financial instruments
The Company discloses fair value information for financial instruments,
whether or not recognized in the balance sheet, when it is practicable to
estimate the fair value. Under GAAP, a financial instrument is defined as
cash, evidence of an ownership interest in an entity or contractual
obligations that require the exchange of cash or other financial
instruments. Certain items are specifically excluded from the disclosure
requirements, including the Company's common stock. In addition, other
nonfinancial instruments such as premises and equipment and other assets
and liabilities are not subject to the disclosure requirements.
The following methods and assumptions were used by the Company in
estimating fair values of financial instruments as disclosed herein:
Cash and due from banks - The carrying amounts of cash and due from
banks approximate their fair value.
Federal funds sold - The carrying amounts of federal funds sold
approximate their fair value.
Investment securities - Fair values for investment securities are
based on quoted market prices. The carrying amounts of Reserve Bank
and FHLB stocks approximate their fair values.
Cash surrender value of life insurance policies - The cash surrender
value of life insurance policies held by the Bank approximates fair
values of the policies.
(Continued)
35
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued
Loans - For variable rate loans that reprice frequently and for loans
that mature within one year, fair values are based on carrying values.
Fair values for all other loans are estimated using discounted cash
flow analyses, with interest rates currently being offered for loans
with similar terms to borrowers of similar credit quality. Fair values
for impaired loans are estimated using discounted cash flow analyses or
underlying collateral values, where applicable.
Deposits - Fair values for deposits are estimated using a discounted
cash flow calculation that applies interest rates currently being
offered on similar accounts to a schedule of aggregated expected
monthly maturities. Repricing time frames for non-maturing deposits are
estimated using FDICIA 305 guidelines.
Customer repurchase agreements - Fair values of repurchase agreements
are estimated using a discounted cash flow analysis that applies
interest rates currently being offered on similar accounts to a
schedule of aggregated expected monthly maturities.
Borrowings from Federal Home Loan Bank of Atlanta - Borrowings from the
FHLB which have variable rates of interest are deemed to be carried at
fair value. Fair values of fixed rate advances are estimated using a
discounted cash flow calculation that applies interest rates currently
being offered on advances to a schedule of aggregated expected
maturities.
Broker repurchase agreements - Fair values of broker repurchase
agreements are estimated using a discounted cash flow analysis that
applies interest rates currently being offered on similar accounts to a
schedule of aggregated expected monthly maturities.
Stock Based Compensation
The Company has issued stock options to certain directors who were
organizers of the Company and the Bank, and also has a stock-based director
and employee compensation plan (the "2003 Plan") as further described in
Note 18. Under the 2003 Plan, 18,000 options were granted during each of
the years 2004, 2005, 2006 and 2007. 19,200 options were granted in 2008.
Options to purchase 15,600 shares of common stock were granted in 2009.
Stock dividends were declared subsequent to the grant dates of the
Organizers' options and some of the employees' options. Pursuant to the
terms of the 2003 Plan and the Organizers' option agreements, the number of
options outstanding was increased and the exercise price was decreased to
give effect to these stock dividends.
The Company accounts for stock based compensation in accordance with GAAP.
Fair value of an option grant is estimated on the date of grant using the
Black-Scholes option pricing model. The risk free interest rates used for
the 2009, 2008, and 2007 grants were 2.34%, 3.91%, and 4.68%, respectively,
which was the 10 Year Constant Maturity Rate on U.S. Treasury Securities
during the months in which the options were granted. The assumed dividend
rate was zero and the expected option life was 10 years for 2009, 2008, and
2007 grants. Volatility is difficult to measure accurately due to the low
volume of trading of the Company's stock. The common stock is not listed on
any exchange and has no active trading market. Since 2006, the stock has
been quoted on the OTC Bulletin Board. Based on information available at
the date of the grant, the volatility assumption used for 2009 option
grants was 38.71%, for 2008 option grants was 28%, and for 2007 option
grants was 12%.
Recently issued accounting standards
The following is a summary of recent authoritative pronouncements that
affect accounting, reporting, and disclosure of financial information by
the Company:
In June 2009, the FASB issued "The FASB Accounting Standards Codification
TM and the Hierarchy of Generally Accepted Accounting Principles - a
replacement of FASB Statement No. 162." This standard establishes the FASB
Accounting Standards Codification TM ("ASC") as the source of authoritative
generally accepted accounting principles for nongovernmental entities.
The standard was effective for interim and annual periods ending after
September 15, 2009. It did not have any impact on the Company's financial
position. In conjunction with the issuance of the ASC, the FASB also issued
its first Accounting Standards Update, "Topic 105 -Generally Accepted
Accounting Principles."
(Continued)
36
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued
The update was effective for interim and annual periods ending after
September 15, 2009 and did not have an impact on the Company's financial
position or results of operations. It did change the referencing system for
accounting standards.
"Amendments to the Impairment Guidance of EITF Issue No. 99-20," was issued
in January 2009. Prior to the Staff Position, other-than-temporary
impairment was determined by using either "Recognition of Interest Income
and Impairment on Purchased Beneficial Interests and Beneficial Interests
that Continue to be Held by a Transferor in Securitized Financial Assets,"
("EITF 99-20") or "Accounting for Certain Investments in Debt and Equity
Securities," depending on the type of security. EITF 99-20 required the use
of market participant assumptions regarding future cash flows regarding the
probability of collecting all cash flows previously projected. Other
standards determined impairment to be other than temporary if it was
probable that the holder would be unable to collect all amounts due
according to the contractual terms. To achieve a more consistent
determination of other-than-temporary impairment, the Staff Position amends
EITF 99-20 to determine any other-than-temporary impairment based on the
guidance in SFAS No. 115, allowing management to use more judgment in
determining any other-than-temporary impairment. The Staff Position was
effective for the Company as of December 31, 2008. Management has reviewed
and evaluated the Company's security portfolio for any other-than-temporary
impairments.
The SEC's Office of the Chief Accountant and the staff of the FASB issued
press release 2008-234 on September 30, 2008 ("Press Release") to provide
clarifications on fair value accounting. The Press Release included
guidance on the use of management's internal assumptions and the use of
"market" quotes. It also reiterated the factors in SEC Staff Accounting
Bulletin ("SAB") Topic 5M that should be considered when determining
other-than-temporary impairment: the length of time and extent to which the
market value has been less than cost; financial condition and near-term
prospects of the issuer; and the intent and ability of the holder to retain
its investment for a period of time sufficient to allow for any anticipated
recovery in market value.
On October 10, 2008, the FASB issued a staff position ("FSP"), "Determining
the Fair Value of a Financial Asset When the Market for That Asset Is Not
Active." This FSP clarified the application of previously issued standards
in a market that is not active, and provided an example to illustrate key
considerations in determining the fair value of a financial asset when the
market for that asset is not active. The FSP was effective upon issuance,
including prior periods for which financial statements have not been
issued. For the Company, this FSP was effective for the quarter ended
September 30, 2008. The Company considered the guidance in the Press
Release and in FSP SFAS 157-3 when conducting its review for
other-than-temporary impairment as of the balance sheet date.
On April 9, 2009, the FASB issued three staff positions related to fair
value which are discussed below.
"Recognition and Presentation of Other-Than-Temporary Impairments"
categorizes losses on debt securities available-for-sale or
held-to-maturity determined by management to be other-than-temporarily
impaired into losses due to credit issues and losses related to all other
factors. Other-than-temporary impairment (OTTI) exists when it is more
likely than not that the security will mature or be sold before its
amortized cost basis can be recovered. An OTTI related to credit losses
should be recognized through earnings. An OTTI related to other factors
should be recognized in other comprehensive income. The FSP does not amend
existing recognition and measurement guidance related to
other-than-temporary impairments of equity securities.
"Determining Fair Value When the Volume and Level of Activity for the Asset
or Liability Have Significantly Decreased and Identifying Transactions That
are Not Orderly" recognizes that quoted prices may not be determinative of
fair value when the volume and level of trading activity have significantly
decreased. The evaluation of certain factors may necessitate that fair
value be determined using a different valuation technique. Fair value
should be the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction, not a forced liquidation or
distressed sale. If a transaction is considered to not be orderly, little,
if any, weight should be placed on the transaction price. If there is not
sufficient information to conclude as to whether or not the transaction is
orderly, the transaction price should be considered when estimating fair
value. An entity's intention to hold an asset or liability is not relevant
in determining fair value.
(Continued)
37
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued
Quoted prices provided by pricing services may still be used when
estimating fair value in accordance with financial accounting standards;
however, the entity should evaluate whether the quoted prices are based on
current information and orderly transactions. Inputs and valuation
techniques are required to be disclosed in addition to any changes in
valuation techniques.
"Interim Disclosures about Fair Value of Financial Instruments" requires
disclosures about the fair value of financial instruments for interim
reporting periods of publicly traded companies as well as in annual
financial statements and also requires those disclosures in summarized
financial information at interim reporting periods A publicly traded
company includes any company whose securities trade in a public market on
either a stock exchange or in the over-the-counter market, or any company
that is a conduit bond obligor. Additionally, when a company makes a filing
with a regulatory agency in preparation for sale of its securities in a
public market it is considered a publicly traded company for this purpose.
The three staff positions were effective for periods ending after June 15,
2009, with early adoption permitted for periods ending after March 15,
2009, in which case all three must be adopted. The Company adopted the
staff positions for its second quarter quarterly report on Form 10-Q. The
staff positions did not have a material impact on the consolidated
financial statements.
Also on April 1, 2009, the FASB issued an FSP, "Accounting for Assets
Acquired and Liabilities Assumed in a Business Combination That Arise from
Contingencies." This FSP requires that assets acquired and liabilities
assumed in a business combination that arise from a contingency be
recognized at fair value. If fair value cannot be determined during the
measurement period, the asset or liability can still be recognized if it
can be determined that it is probable that the asset existed or the
liability had been incurred as of the measurement date and if the amount of
the asset or liability can be reasonably estimated. If it is not determined
to be probable that the asset/liability existed/was incurred or no
reasonable amount can be determined, no asset or liability is recognized.
The entity should determine a rational basis for subsequently measuring the
acquired assets and assumed liabilities. Contingent consideration
agreements should be recognized initially at fair value and subsequently
reevaluated. The FSP was effective for business combinations with an
acquisition date on or after the beginning of the Company's first annual
reporting period beginning on or after December 15, 2008. The Company will
assess the impact of the FSP if and when a future acquisition occurs.
The Securities and Exchange Commission ("SEC") issued Staff Accounting
Bulletin ("SAB") No. 111 on April 9, 2009 to amend Topic 5.M. (ASC
320-10-S99), "Other Than Temporary Impairment of Certain Investments in
Debt and Equity Securities" and to supplement FSP SFAS 115-2 and SFAS
124-2. SAB 111 maintains the staff's previous views related to equity
securities; however debt securities are excluded from its scope. The SAB
provides that "other-than-temporary" impairment is not necessarily the same
as "permanent" impairment and unless evidence exists to support a value
equal to or greater than the carrying value of the equity security
investment, a write-down to fair value should be recorded and accounted for
as a realized loss. The SAB was effective upon issuance and had no impact
on the Company's financial position.
The FASB issued a standard, "Subsequent Events," in May 2009 which provides
guidance on when a subsequent event should be recognized in the financial
statements. Subsequent events that provide additional evidence about
conditions that existed at the date of the balance sheet should be
recognized at the balance sheet date. Subsequent events that provide
evidence about conditions that arose after the balance sheet date but
before financial statements are issued, or are available to be issued, are
not required to be recognized. The date through which subsequent events
have been evaluated must be disclosed as well as whether it is the date the
financial statements were issued or the date the financial statements were
available to be issued. For non-recognized subsequent events which should
be disclosed to keep the financial statements from being misleading, the
nature of the event and an estimate of its financial effect, or a statement
that such an estimate cannot be made, should be disclosed. The standard is
effective for interim or annual periods ending after June 15, 2009. See
Note 23 for Management's evaluation of subsequent events.
The FASB issued ASU 2009-05, "Fair Value Measurements and Disclosures
(Topic 820) - Measuring Liabilities at Fair Value" in August, 2009 to
provide guidance when estimating the fair value of a liability. When a
quoted price in an active market for the identical liability is not
available, fair value should be measured using (a) the quoted price of an
identical liability when traded as an asset; (b) quoted prices for similar
liabilities
(Continued)
38
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES, Continued
or similar liabilities when traded as assets; or (c) another valuation
technique consistent with the principles of Topic 820 such as an income
approach or a market approach. If a restriction exists that prevents the
transfer of the liability, a separate adjustment related to the restriction
is not required when estimating fair value. The ASU was effective October
1, 2009 for the Company and had no impact on financial position or
operations.
Accounting standards that have been issued or proposed by the FASB that do
not require adoption until a future date are not expected to have a
material impact on the consolidated financial statements upon adoption.
Risks and Uncertainties
In the normal course of its business the Company encounters two significant
types of risks: economic and regulatory. There are three main components of
economic risk: interest rate risk, credit risk and market risk. The Company
is subject to interest rate risk to the degree that its interest-bearing
liabilities mature or reprice at different times, or on different bases,
than its interest-earning assets. Credit risk is the risk of default on the
Company's loan and investment portfolios that results from borrowers'
inability or unwillingness to make contractually required payments. Market
risk reflects changes in the value of collateral underlying loans
receivable and the valuation of real estate held by the Company.
The Company is subject to the regulations of various governmental agencies.
These regulations can and do change significantly from period to period.
The Company also undergoes periodic examinations by the regulatory
agencies, which may subject it to further changes with respect to asset
valuations, amounts of required loss allowances and operating restrictions
as a result of the regulators' judgments based on information available to
them at the time of their examination.
Reclassification
Certain amounts in prior year's financial statements have been reclassified
to conform to current year presentation. No changes have been made that
affect the reported results of operations, financial condition or cash
flows.
NOTE 2 - RESTRICTIONS ON CASH AND DUE FROM BANKS
The Bank is required to maintain average reserve balances, computed by
applying prescribed percentages to its various types of deposits, either at the
Bank or on deposit with the Reserve Bank. At December 31, 2009 and 2008 these
required reserves were met by vault cash.
NOTE 3 - FEDERAL FUNDS SOLD
When the Bank's cash reserves (Note 2) are in excess of the required
amount, it may lend any excess to other banks on a daily basis. As of December
31, 2009 and 2008 federal funds sold amounted to $1,670,000 and $140,000,
respectively.
39
NOTE 4 - INVESTMENT SECURITIES
The amortized cost and fair value of investment securities
available-for-sale are as follows:
December 31, 2009
-----------------
Amortized Gross unrealized Fair
Cost Gains Losses value
---- ----- ------ -----
Government sponsored enterprise bonds ...................... $10,339,754 $ 38,979 $ 191,026 $10,187,707
Mortgage-backed securities ................................. 12,232,754 189,480 57,812 12,364,422
Municipal bonds ............................................ 6,086,285 263,729 - 6,350,014
----------- ----------- ----------- -----------
Total investment securities available-
for-sale ........................................... $28,658,793 $ 492,188 $ 248,838 $28,902,143
=========== =========== =========== ===========
December 31, 2008
-----------------
Amortized Gross unrealized Fair
cost Gains Losses value
---- ----- ------ -----
Government sponsored enterprise bonds ...................... $ 8,859,181 $ 433,569 $ - $ 9,292,750
FNMA preferred stock ....................................... 87,200 - 54,800 32,400
Mortgage-backed securities ................................. 4,173,881 113,419 7,611 4,279,689
Municipal bonds ............................................ 6,484,056 46,120 458,411 6,071,765
----------- ----------- ----------- -----------
Total investment securities available-for-sale ..... $19,604,318 $ 593,108 $ 520,822 $19,676,604
=========== =========== =========== ===========
While seven of the Company's Government sponsored enterprise bonds and
mortgage-backed securities available-for-sale are in an unrealized loss position
as of December 31, 2009, none have been in an unrealized loss position for
twelve months or more. None of these securities are expected to have a loss of
principal at final maturity. The Company believes it is more likely than not it
will hold these securities until such time as the value recovers or the
securities mature. All of the Company's municipal bonds were in an unrealized
gain position as of December 31, 2009. During 2008, the Company recognized
other-than-temporary-impairment on the FNMA preferred stock of $606,054, net of
tax, based on analysis under FSP 115-1 and FNMA's being placed into
conservatorship by the U.S. Treasury Department. The Company sold the FNMA
preferred stock in 2009 at an additional loss of $58,788. The table below
summarizes, by investment category, the length of time that individual
securities have been in a continuous loss position as of December 31, 2009.
Total Unrealized
Less than Twelve Months Over Twelve Months Losses
----------------------- ------------------ ------
Gross Gross
Unrealized Unrealized
Losses Fair Value Losses Fair Value
------ ---------- ------ ----------
Government sponsored
enterprise bonds ........................ $ 191,026 $ 5,898,728 $ - $ - $ 191,026
Mortgage-backed securities ................... 57,812 7,727,556 - - 57,812
Municipal bonds .............................. - - - - -
----------- ----------- ---- ---- -----------
Total ............................. $ 248,838 $13,626,284 $ - $ - $ 248,838
=========== =========== ==== ==== ===========
At December 31, 2009 and 2008, securities with a fair value of
$22,889,893 and $18,440,430, respectively, were pledged to collateralize public
deposits, sweep accounts, advances from the FHLB, and repurchase agreements.
During 2009, the Company sold securities with a fair value of $10,752,749 and
recognized a net gain on the sale of those securities of $299,063. There were no
sales of securities for the years ended December 31, 2008 or 2007.
(Continued)
40
NOTE 4 - INVESTMENT SECURITIES, Continued
The amortized cost and fair value of securities at December 31, 2009,
by contractual maturity, are shown in the following chart. Expected maturities
may differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.
December 31, 2009
-----------------
Amortized Fair
Cost Value
---- -----
Due after one through five years ........... $ 2,430,513 $ 2,486,061
Due after five through ten years ........... 9,785,027 9,691,469
After ten years or no maturity ............. 16,443,253 16,724,613
----------- -----------
Total investment securities ............ $28,658,793 $28,902,143
=========== ===========
The Bank, as a member institution, is required to own stock in the
Reserve Bank and the FHLB. These stocks are included at cost in the accompanying
Consolidated Balance Sheets under the caption "Other investments." No ready
market exists for these stock investments and they have no quoted market value.
However, redemption of these stocks has historically been at par value. Stock
held in the FHLB is pledged as collateral against advances from the FHLB.
NOTE 5 - LOANS
The composition of net loans by major loan category is presented below.
December 31,
------------
2009 2008
---- ----
Commercial ............................. $ 14,974,286 $ 18,596,972
Real estate - construction ............. 53,827,245 49,669,669
Real estate - mortgage ................. 67,614,913 60,866,234
Consumer ............................... 1,346,807 2,048,818
------------- -------------
Loans, gross ........................... 137,763,251 131,181,693
Less allowance for loan losses ......... (2,695,337) (1,698,563)
------------- -------------
Loans, net ............................. $ 135,067,914 $ 129,483,130
============= =============
As of December 31, 2009, approximately $82.4 million or 59.8% of total
gross loans were variable rate loans.
The FHLB has a blanket lien on certain types of the Company's loans as
collateral for FHLB advance borrowings. See Note 10. The Reserve Bank has a lien
on certain other loan types should the Bank borrow from the Discount Window. As
of December 31, 2009 there were no borrowings from the Discount Window of the
Reserve Bank.
At December 31, 2009 the Bank had non-accrual loans of $9.7 million,
which are considered to be impaired. This amount includes 27 loans and one line
of credit, all of which are collateral dependent. These loans are secured by
real estate, and were in the process of foreclosure or other collection
processes as of December 31, 2009. If these loans had been current, the Company
would have recorded additional interest income of $292,943 in 2009. All
previously accrued but uncollected income on these loans has been eliminated
from the accompanying consolidated statements of income (loss). Included in the
allowance for loan losses are special reserves of $165,771 related to these
loans. The Company charged-off $224,271 related to impaired loans in 2009.
As of December 31, 2009, the Bank has restructured another $4.05
million of loans that are performing in accordance with their restructured
terms, but are deemed to be impaired due to the changes in their terms. Average
impaired loans in 2009 (average loans on nonaccrual or loans 90 days or more
delinquent as to principal or interest payments) were $7.3 million. At December
31, 2008 the Company held nonaccrual loans in the amount of $2.4 million.
(Continued)
41
NOTE 5 - LOANS, Continued
Activity in the allowance for loan losses for the years ended December
31, 2009, 2008, and 2007 is summarized in the table below.
Year ended December 31,
-----------------------
2009 2008 2007
---- ---- ----
Allowance for loan losses, beginning of year ..................... $ 1,698,563 $ 1,293,130 $ 1,199,999
Provision for loan losses ........................................ 2,955,000 815,000 196,636
Charge-offs ...................................................... (1,958,726) (685,166) (103,505)
Recoveries ....................................................... 500 275,599 -
----------- ----------- -----------
Allowance for loan losses, end of year ........................... $ 2,695,337 $ 1,698,563 $ 1,293,130
=========== =========== ===========
NOTE 6 - PROPERTY AND EQUIPMENT
Components of property and equipment included in the balance sheet are
as follows:
December 31,
------------
2009 2008
---- ----
Land and improvements ...................... $ 1,468,480 $ 1,468,480
Bank premises .............................. 4,271,773 4,271,773
Furniture, equipment and software .......... 1,531,250 1,527,107
Vehicles ................................... 58,005 58,005
----------- -----------
Property and equipment ............. 7,329,508 7,325,365
Accumulated depreciation ................... (2,038,305) (1,774,090)
----------- -----------
Property and equipment, net ............ $ 5,291,203 $ 5,551,275
=========== ===========
Depreciation expense for the years ended December 31, 2009, 2008, and
2007, amounted to $265,520, $282,574, and $286,257, respectively. Depreciation
is charged to operations over the estimated useful lives of the assets. The
estimated useful lives and methods of depreciation for the principal items
follow:
Type of Asset Life in Years Depreciation Method
------------------------------------- ------------------------------------ ----------------------------
Furniture, equipment and software 3 to 7 Straight-line
Improvements 5 to 40 Straight-line
Vehicles 5 Straight-line
NOTE 7- OTHER REAL ESTATE OWNED AND REPOSSESSED ASSETS
The Company has acquired a significant number of real estate properties
in settlement of loans via the foreclosure process. A summary of the activity in
other real estate owned follows:
December 31,
------------
2009 2008
---- ----
Beginning balance ............................ $ 575,000 $ 69,000
Additions from foreclosures .................. 8,691,617 951,761
Write downs of value ......................... - (30,017)
Sales ........................................ (2,553,669) (415,744)
----------- -----------
Ending other real estate owned ....... $ 6,712,948 $ 575,000
=========== ===========
The Company recognized a net loss of $228,547 on all types of
repossessed collateral for the year ended December 31, 2009. In 2008, the
Company recognized a gain on the sale of repossessed collateral of $3,464. In
2007, the Company recognized a loss of $9,672 on repossessed collateral.
42
NOTE 8 - DEPOSITS
The following is a detail of the deposit accounts as of:
December 31,
------------
2009 2008
---- ----
Noninterest bearing ...................... $ 11,234,486 $ 10,069,125
Interest bearing:
NOW accounts ........................ 13,308,457 13,013,071
Money market accounts ............... 10,760,323 7,286,130
Savings ............................. 37,317,247 13,848,956
Time, less than $100,000 ............ 28,516,218 36,554,096
Time, $100,000 and over ............. 51,244,543 41,810,196
------------ ------------
Total deposits ................... $152,381,274 $122,581,574
============ ============
Interest expense on time deposits greater than $100,000 was
approximately $1.3 million in 2009, $1.3 million in 2008, and $1.2 million in
2007. Securities issued by government sponsored enterprises with an amortized
cost of $1.7 million and $2.0 million (fair value of $1.7 million and $2.1
million) in 2009 and 2008, respectively, were pledged as collateral for public
funds.
At December 31, 2009 the scheduled maturities of time deposits are as
follows:
2010 $ 53,300,355
2011 15,810,966
2012 3,402,484
2013 2,781,458
2014 and thereafter 4,465,498
------------
$ 79,760,761
============
NOTE 9 - CUSTOMER REPURCHASE AGREEMENTS
Customer repurchase agreements consist of the following:
December 31,
------------
2009 2008
---- ----
Sweep accounts ............................. $ 587,802 $1,432,619
Retail repurchase agreements ............... 2,669,200 3,150,000
---------- ----------
$3,257,002 $4,582,619
========== ==========
The Bank enters into sweep and retail repurchase agreements with its
customers. The sweep agreements generally mature overnight. At December 31,
2009, the Bank had six retail repurchase agreements that mature in 2010.
Securities issued by government sponsored enterprises with an amortized cost of
$3,262,097 and $5,644,221 (fair value of $3,276,795 and $5,905,715) were pledged
as collateral for the sweep accounts and repurchase agreements, at December 31,
2009 and 2008, respectively.
43
NOTE 10 - BORROWINGS FROM FEDERAL HOME LOAN BANK OF ATLANTA
At December 31, 2009 and 2008, the Bank had a line of credit to borrow
funds from the FHLB in the amount of 10% of the Bank's assets. Funds borrowed
from the FHLB are collateralized by a lien on certain of the Bank's available
for sale securities and loans. At December 31, the Bank had advances outstanding
as follows:
December 31,
------------
2009 2008 Interest Rate Maturity Date Terms
---- ---- ------------- ------------- -----
$3,000,000 $ - 1.07% 1/10/2011 Fixed rate
- 3,500,000 .46 1/14/2009 Variable rate credit
1,500,000 1,500,000 2.73 3/16/2010 Fixed rate
1,500,000 1,500,000 2.84 9/16/2010 Fixed rate
1,000,000 1,000,000 2.72 1/25/2011 Fixed rate
177,778 222,222 4.49 12/01/2013 Fixed rate, amortizing
168,519 207,408 4.89 4/14/2014 Fixed rate, amortizing
396,875 464,375 4.78 7/27/2015 Fixed rate, amortizing
2,000,000 2,000,000 3.52 1/16/2018 Fixed rate, convertible
---------- -----------
$9,743,172 $10,394,005
========== ===========
The Company's convertible advance from the FHLB is convertible to a
variable rate instrument at the option of the FHLB on January 16, 2013. During
2009 the highest balance as of any month end for borrowings from the FHLB was
$9.8 million. The average rate paid on advances during 2009 was 2.78%. The
average balance of FHLB advances for 2009 was $8.6 million. During 2008, the
highest balance as of any month end for borrowings from the FHLB was $10.4
million. The average rate paid on advances during 2008 was 3.28%. The average
balance of FHLB advances for 2008 was $7.0 million.
NOTE 11 - BROKER REPURCHASE AGREEMENTS
Broker repurchase agreements consist of two separate borrowings
totaling $5.0 million. These borrowings carry fixed rates of interest with call
features. The agreements mature as follows: $3.0 million maturing on January 15,
2015, callable by the broker quarterly after January 15, 2012, and $2.0 million
maturing on January 15, 2013, callable by the broker quarterly, beginning
January 10, 2010. Securities with fair value of $6.0 million and amortized cost
of $5.7 million collateralize the agreements. During 2009 the highest balance as
of any month end for broker repurchase agreements was $5.0 million and the
average balance for 2009 was $5.0 million. The average rate paid on broker
repurchase agreements during 2009 was 3.53%. During 2008 the highest balance as
of any month end for broker repurchase agreements was $5.0 million and the
average balance for 2008 was $4,836,066. The average rate paid on broker
repurchase agreements during 2008 was 3.53%.
NOTE 12 - COMMITMENTS AND CONTINGENCIES
The Bank may become party to litigation and claims arising in the
normal course of business. As of December 31, 2009, there was no litigation
pending other than foreclosure actions initiated by the Bank.
The Company expects to enter into a five-year contract with a data,
item, and ATM processing service. Minimum monthly costs for these services are
currently approximately $20,000. Minimum monthly costs are not expected to
increase substantially under the new contract. Volume-related costs may increase
as volume increases.
The Company has signed change of control agreements with three of its
executive officers. These agreements provide for various payments to the
executives in the event of a change in control of the Company.
From time to time the Bank may guarantee merchant credit card accounts
on behalf of certain customers. At December 31, 2009 the total amount guaranteed
by the Bank related to merchant credit card accounts was immaterial.
Refer to Note 16 concerning financial instruments with off balance
sheet risk.
44
NOTE 13 - LINES OF CREDIT
At December 31, 2009, the Bank had lines of credit to purchase federal
funds totaling $4,100,000 from unrelated banks. One line is a collateralized
line and the other is an uncollateralized line. The interest rate varies daily.
These lines of credit are available on a short-term basis for general corporate
purposes of the Bank. The lenders have reserved the right to withdraw the lines
at their option. There were no balances outstanding under these lines as of
December 31, 2009. $1.8 million was outstanding on a line of credit at December
31, 2008.
NOTE 14 - INCOME TAXES
The provision for income taxes is reconciled to the amount of income
tax computed at the federal statutory rate on income before income taxes as
follows:
Year ended December 31,
-----------------------
2009 2008 2007
----- ---- ----
Tax expense (benefit) at statutory rate ........... $(741,544) (34)% $ 70,623 34% $ 823,815 34%
Increase (decrease) in taxes resulting from:
State income taxes, net of federal benefit ... - - 7,789 4 48,471 2
Tax-exempt investments ....................... (78,845) (5) (75,249) (36) (31,835) (1)
Increase in cash value of life insurance ..... (23,849) (2) (24,171) (12) (23,277) (1)
Other ........................................ 24,501 2 3,408 2 (6,942) (1)
--------- --- --------- --- --------- ---
Income tax provision .............................. $(819,737) (39)% $ (17,600) (8)% $ 810,232 33%
========= === ========= === ========= ===
The income tax effects of cumulative temporary differences at December
31, 2009 and 2008 are as follows:
2009 2008
---- ----
Deferred tax assets:
Allowance for loan losses ........................................................ $704,559 $513,045
Other than temporary impairment .................................................. - 312,210
Stock based compensation ......................................................... 37,036 22,627
Other ............................................................................ 148,957 25,921
-------- --------
890,552 873,803
-------- --------
Deferred tax liabilities:
Unrealized net gain on securities available for sale ............................. 82,739 24,577
Depreciation ..................................................................... 68,414 82,658
Prepaid expenses ................................................................. 25,531 32,401
-------- --------
176,684 139,636
-------- --------
Net deferred tax asset .................................................... $713,868 $734,167
======== ========
The net deferred taxes are included in other assets in the consolidated
balance sheets. Deferred tax assets represent the future tax benefit of
deductible differences and, if it is more likely than not that a tax asset will
not be realized, a valuation allowance is required to reduce the recorded
deferred tax assets to net realizable value. As of December 31, 2009 and 2008,
no valuation allowance was deemed necessary.
The following summary of the provision for income taxes includes tax
deferrals that arise from temporary differences in the recognition of certain
items of revenue and expense for tax and financial reporting purposes:
Year ended December 31,
-----------------------
2009 2008 2007
---- ---- ----
Income taxes currently payable (receivable) ....................... $(781,874) $ 436,176 $ 805,724
Deferred income tax provision (benefit) ........................... (37,863) (453,776) 4,508
--------- --------- ---------
Income tax provision (benefit) ............................ $(819,737) $ (17,600) $ 810,232
========= ========= =========
The Company has analyzed the tax positions taken or expected to be
taken in its tax returns and concluded it has no liability related to uncertain
tax positions in accordance with FIN 48.
45
NOTE 15 - RELATED PARTY TRANSACTIONS
Certain directors, executive officers and companies with which they are
affiliated, are customers of and have loan transactions with the Bank in the
ordinary course of business. These loans were made on substantially the same
terms, including interest rates and collateral, as those prevailing at the time
for comparable arms-length transactions.
A summary of loan transactions with directors, including their
affiliates, and executive officers is as follows:
Year ended December 31,
-----------------------
2009 2008 2007
---- ---- ----
Balance, beginning of year ................................. $ 5,958,663 $ 6,443,949 $ 5,835,997
New loans or lines of credit ............................... 2,588,627 1,272,822 4,470,962
Payments on loans or lines of credit ....................... (908,891) (1,758,108) (3,863,010)
----------- ----------- -----------
Balance, end of year ....................................... $ 7,638,399 $ 5,958,663 $ 6,443,949
=========== =========== ===========
Deposits by directors, executive officers, and their related interests,
at December 31, 2009 and 2008 were $2,306,089 and $2,911,291, respectively.
NOTE 16 - FINANCIAL INSTRUMENTS WITH OFF BALANCE SHEET RISK
In the ordinary course of business, and to meet the financing needs of
its customers, the Bank is a party to various financial instruments with off
balance sheet risk. These financial instruments, which include commitments to
extend credit and standby letters of credit, involve, to varying degrees,
elements of credit and interest rate risk in excess of the amounts recognized in
the balance sheet. The contract amounts of those instruments reflect the extent
of involvement the Bank has in particular classes of financial instruments.
The Bank's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual amounts of those
instruments. The Bank uses the same credit policies in making commitments and
conditional obligations as it does for on balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any material condition established in the
contract. Commitments generally have fixed expiration dates or other termination
clauses and may require the payment of a fee. At December 31, 2009 and 2008,
unfunded commitments to extend credit were $17.6 million and $21.9 million,
respectively, and outstanding letters of credit were approximately $660,000 and
$1.1 million, respectively. At December 31, 2009, the unfunded commitments
consisted of $17.3 million at variable rates and $304,600 at fixed rates with
$10.4 million expiring within one year. The Bank evaluates each customer's
credit worthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Bank upon extension of credit, is based on management's
credit evaluation of the borrower. Collateral varies but may include accounts
receivable, inventory, property, plant and equipment, and commercial and
residential real estate.
Fair values of off balance sheet lending commitments are based on fees
currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the counterparties' credit standing, and
were immaterial in 2009 and 2008.
The Bank offers an automatic overdraft protection product.
Approximately $1.2 million of overdraft protection is available under this
product as of December 31, 2009. The Bank expects that much of this capacity
will not be utilized. During 2009 the average balance of total demand deposit
overdrafts was $20,177.
NOTE 17 - EMPLOYEE BENEFIT PLAN
The Company sponsors a Simple IRA Plan for the benefit of all eligible
employees. The Bank contributes up to three percent of the employee's
compensation. Employer contributions made to the Plan in 2009, 2008, and 2007
amounted to $53,458, $54,828, and $47,934, respectively.
46
NOTE 18 - STOCK OPTION PLANS
In 1999, the Board of Directors awarded options (the "Organizers'
Options") to purchase 4,000 shares of the Company's common stock to each of the
organizing directors of the Company and the Bank (an aggregate of 40,000
shares). These options had an exercise price of $10.00 per share and became
exercisable in one-third increments each year beginning on December 14, 2000.
The Organizers' Options were set to expire ten years from the date of grant,
unless they terminated sooner as a result of the holder's ceasing to be a
director. Pursuant to the option agreements as further discussed below, the
total number of such options outstanding and the exercise price was adjusted as
a result of the stock dividends discussed in Note 19 below. During 2009 options
to purchase 14,172 shares of the Company's common stock were exercised at an
exercise price of $5.84 per share. As of December 14, 2009, the remaining
unexercised Organizers' Options expired.
In 2003, the Company's shareholders approved the Cornerstone Bancorp
2003 Stock Option Plan (the "2003 Plan"), which reserved 125,000 shares of the
Company's common stock for issuance upon exercise of options. Pursuant to the
2003 Plan as further discussed below, the number of shares reserved for issuance
has been increased to 192,162 shares as a result of the 10% stock dividends
declared from 2004 to 2007 and a 5% stock dividend in 2009 as discussed in Note
19 below. Employees and Directors are eligible to participate in the 2003 Plan,
which has a term of 10 years. Awards under the 2003 Plan must be made by the
Board of Directors or by a Committee of Directors designated by the Board at an
exercise price equal to the fair market value of the Company's common stock on
the date of grant. During 2009, 15,600 options to purchase common shares were
granted and none were exercised. During 2009, 3,866 options that fully vested in
2008 were forfeited. As of December 31, 2009, 106,255 options to purchase common
shares remain outstanding under the 2003 Plan. See Note 1 for more information.
A summary of the activity in the plans is presented below:
Weighted Average Aggregate
Shares Exercise Price(1) Intrinsic Value(2)
------ ----------------- ------------------
Outstanding at December 31, 2006 ....................... 123,516 $8.19
-------
Granted (3) ............................................ 32,383 8.98
Exercised .............................................. (27,306) 6.43
Forfeited or expired ................................... (1,320) 10.62
-------
Outstanding at December 31, 2007 ....................... 127,273 8.74
Granted ................................................ 19,200 11.90
Exercised .............................................. (8,396) 9.29
Forfeited or expired ................................... (6,265) 12.20
-------
Outstanding at December 31, 2008 ....................... 131,812 9.46
Granted (3) ............................................ 22,241 9.45
Exercised .............................................. (14,172) 5.64
Forfeited or expired ................................... (33,626) 6.39
-------
Outstanding at December 31, 2009 ....................... 106,255 10.49
=======
Options exercisable at end of year ..................... 59,254 9.82 $ -
Shares available for grant ............................. 59,487
(1) The weighted average exercise price has been adjusted to reflect 10%
stock dividends declared by the Company's Board of Directors annually
from 2002 through 2007 and a 5% stock dividend declared by the Company's
Board of Directors in 2009.
(2) The aggregate intrinsic value of a stock option in the table above
represents the total pre-tax intrinsic value (the amount by which the
current market value of the underlying stock exceeds the exercise price
of the option). At December 31, 2009 the amount represents the value that
would have been received by the option holders had all option holders
exercised their options on that date. This amount changes based on
changes in the market value of the Company's common stock. At December
31, 2009 the OTCBB quoted price was $4.10. Therefore, none of the
Company's options had intrinsic value as of that date.
(3) Granted options include new grants as well as adjustments of previous
grants as a result of 10% stock dividends declared by the Company's Board
of Directors annually from 2002 through 2007 and a 5% stock dividend in
2009.
Options granted after 2005 vest over a five-year period, according to
the option agreements. All options granted prior to 2006 have fully vested. The
weighted average life of options outstanding was 6.39 years and 5.03 years at
December 31, 2009 and 2008, respectively. Expense related to stock based
47
compensation recorded in the accompanying consolidated statements of income
(loss) was $72,464, $56,172, and $40,797 for the years ended 2009, 2008, and
2007, respectively. There were 38,911 non-vested options outstanding (estimated
fair value of $234,926) at the beginning of 2009. During 2009, 9,746 options
vested (estimated fair value of $59,787), and 15,600 options were granted
(estimated fair value of $81,432). After giving effect to the five percent stock
dividend declared in 2009, at December 31, 2009, 47,001 non-vested options
(estimated fair value of $265,606) were outstanding.
NOTE 19 - DIVIDENDS
The Company paid a 5% stock dividend in 2009 to shareholders of record
on May 12, 2009. The Company paid cash dividends of $597,471 in May 2008. No
other cash dividends have been paid. The Company's payment of cash dividends is
within the discretion of its Board of Directors, and is dependent on the
Company's receiving cash dividends from the Bank. Federal banking regulations
restrict the amount of dividends that the Bank can pay to the Company. Future
dividend policy will depend on the Company's earnings, capital requirements,
financial condition and other factors considered relevant by the Company's Board
of Directors. The Company's Board of Directors declared 10 percent stock
dividends to shareholders of record on May 8, 2007, May 9, 2006, May 10, 2005,
May 11, 2004, March 17, 2003 and on April 30, 2002.
NOTE 20 - REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory, and possible additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities, and certain off-balance-sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set forth in
the table below) of total and Tier 1 capital to risk-weighted assets, and of
Tier 1 capital to adjusted total assets ("Tier 1 leverage ratio"). Management
believes, as of December 31, 2009, that the Bank meets all capital adequacy
requirements to which it is subject.
As of December 31, 2009, the most recent notification of the banking
regulators categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action. The Bank's actual capital amounts and
ratios and minimum regulatory amounts and ratios are presented as follows:
To be well capitalized
For capital under prompt corrective
adequacy purposes action provisions
Actual Minimum Minimum
------ ------- -------
(Dollars in thousands)
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of December 31, 2009
Total Capital (to risk weighted assets) ............... $19,730 12.8% $12,366 8.0% $15,458 10.0%
Tier 1 Capital (to risk weighted assets) .............. 17,788 11.5 6,183 4.0 9,274 6.0
Tier 1 leverage ratio ................................. 17,788 9.2 7,702 4.0 9,627 5.0
As of December 31, 2008
Total Capital (to risk weighted assets) ............... $20,366 14.4% $11,314 8.0% $14,144 10.0%
Tier 1 Capital (to risk weighted assets) .............. 18,667 13.2 5,657 4.0 8,486 6.0
Tier 1 leverage ratio ................................. 18,667 12.1 6,161 4.0 7,702 5.0
The Company is also subject to capital adequacy guidelines established
by the Reserve Bank, which establish the minimum ratios for capital adequacy as
they apply to the Bank. For 2009 and 2008, the Company's capital amounts and
ratios were at least as great as shown above for the Bank.
Because the Bank had a relatively high level of nonperforming assets at
December 31, 2009 and recorded a substantial loss for 2009, the OCC may require
the Bank to maintain capital ratios in excess of those shown to be well
capitalized in the table above. The OCC may also seek the Bank's agreement to
take other specified actions intended to reduce the risks faced by the Bank. The
OCC has the authority to enforce such an agreement with various regulatory
actions.
48
NOTE 21 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments were
as follows:
December 31,
------------
2009 2008
---- ----
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
Financial Assets
Cash and due from banks .............................. $ 4,369,596 $ 4,369,596 $ 3,820,227 $ 3,820,227
Federal funds sold ................................... 1,670,000 1,670,000 140,000 140,000
Investment securities ................................ 30,044,193 30,044,193 20,790,754 20,790,754
Loans, gross ......................................... 137,763,251 139,365,487 131,181,693 132,967,973
Cash surrender value of life insurance policies ...... 1,838,663 1,838,663 1,768,520 1,768,520
Financial Liabilities
Deposits ............................................. 152,381,274 150,540,716 122,581,574 122,334,482
Fed Funds purchased and customer sweeps .............. 587,802 587,802 3,242,619 3,242,619
Customer repurchase agreements ....................... 2,669,200 2,766,397 3,150,000 3,235,288
Borrowings from FHLB ................................. 9,743,172 9,925,595 10,394,005 10,581,424
Broker repurchase agreements ......................... 5,000,000 5,182,105 5,000,000 5,135,404
The Company adopted a new accounting standard on January 1, 2008 which
requires disclosure of the levels of inputs used in determining fair value of
the Company's assets measured at fair value, including available for sale
securities and other real estate owned. The table below presents the balances of
assets measured at fair value on a recurring or nonrecurring basis by level
within the hierarchy of inputs that may be used to measure fair value.
December 31,2009
----------------
Total Level 1 Level 2 Level 3
----- ------- ------- -------
Investment securities, recurring .................... $30,044,193 $22,552,129 $6,350,014 $ 1,142,050
=========== =========== ========== ===========
Other real estate owned, nonrecurring ............... $ 6,712,945 $ - $ - $ 6,712,948
=========== =========== ========== ===========
Impaired loans, nonrecurring ........................ $13,793,781 $ - $ - $13,793,781
=========== =========== ========== ===========
December 31, 2008
-----------------
Investment securities, recurring .................... $20,790,754 $13,604,839 $6,071,765 $ 1,114,150
=========== =========== ========== ===========
Other real estate owned, nonrecurring ............... $ 575,000 $ - $ - $ 575,000
=========== =========== ========== ===========
Impaired loans, nonrecurring ........................ $ 2,357,610 $ - $ - $ 2,357,610
=========== =========== ========== ===========
NOTE 22 - PARENT COMPANY INFORMATION
Following is condensed financial information of Cornerstone Bancorp
(parent company only):
Condensed Balance Sheets
December 31,
------------
2009 2008
---- ----
Assets
Cash and interest bearing deposits ........... $ 94,502 $ 371,668
Investment in subsidiary ..................... 17,949,044 18,770,624
Other assets ................................. 9,720 9,005
----------- -----------
Total Assets ............................... $18,053,266 $19,151,297
=========== ===========
Liabilities And Shareholders' Equity
Accrued expenses ............................. $ 13,861 $ 14,350
Shareholders' equity ......................... 18,039,405 19,136,947
----------- -----------
Total Liabilities and Shareholders' Equity . $18,053,266 $19,151,297
=========== ===========
(Continued)
49
NOTE 22 - PARENT COMPANY INFORMATION, Continued
Condensed Statements Of Income
Year ended December 31,
-----------------------
2009 2008 2007
---- ---- ----
Income
Interest ....................................................... $ 4,645 $ 19,117 $ 35,893
Expenses
Sundry ......................................................... 58,893 56,063 55,164
----------- ----------- -----------
Loss before equity in undistributed net
income (loss) of bank subsidiary ..................... (54,248) (36,946) (19,271)
Equity in undistributed net income (loss) of
subsidiary ........................................... (1,307,026) 262,262 1,632,024
----------- ----------- -----------
Net income (loss) ............................................ $(1,361,274) $ 225,316 $ 1,612,753
=========== =========== ===========
Condensed Statements Of Cash Flows
Year ended December 31,
-----------------------
2009 2008 2007
---- ---- ----
Operating Activities
Net income (loss) .................................................. $(1,361,274) $ 225,316 $ 1,612,753
Adjustments to reconcile net income to net cash
provided by (used for) operating activities
Equity in undistributed net (income) loss of
subsidiary ................................................ 1,307,026 (262,262) (1,632,024)
Decrease (increase) in other assets ........................... (715) 2 62,476
Increase (decrease) in accrued expenses ....................... (489) 343 (7,697)
----------- ----------- -----------
Net cash used for operating activities .............. (55,452) (36,601) 35,508
----------- ----------- -----------
Investing Activities
Investment in bank subsidiary ...................................... (299,999) - (70,000)
----------- ----------- -----------
Financing Activities
Cash dividend paid .............................................. - (597,471) -
Cash paid in lieu of fractional shares .......................... (1,715) - (2,231)
Exercise of stock options, net of tax ........................... 80,000 81,833 184,439
----------- ----------- -----------
Net cash provided (used) by financing
activities ....................................... 78,285 (515,638) 182,208
----------- ----------- -----------
Net increase (decrease) in cash ............................. (277,166) (552,239) 147,716
Cash, beginning of year ................................................ 371,668 923,907 776,191
----------- ----------- -----------
Cash, end of year ...................................................... $ 94,502 $ 371,668 $ 923,907
=========== =========== ===========
NOTE 23 - EVALUATION OF SUBSEQUENT EVENTS
In accordance with FASB ASC 855, "Subsequent Events," issued in May
2009 and effective for periods ending after June 15, 2009, management performed
an evaluation to determine whether or not there have been any subsequent events
since the balance sheet date.
5
