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EX-21 - T Bancshares, Inc.v216852_ex21.htm
EX-23 - T Bancshares, Inc.v216852_ex23.htm
EX-32.1 - T Bancshares, Inc.v216852_ex32-1.htm
EX-31.2 - T Bancshares, Inc.v216852_ex31-2.htm
EX-31.1 - T Bancshares, Inc.v216852_ex31-1.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10−K
 
x  ANNUAL REPORT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2010
 
o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ___________to ___________.
 
Commission File Number: 000-51297
 
T Bancshares, Inc.
(Exact name of registrant as specified in its charter)
 
Texas
 
71-0919962
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer  Identification Number)
     
16000 Dallas Parkway, Suite 125, Dallas, Texas 75248
 
(972) 720-9000
(Address of principal executive offices) (ZIP Code)
 
Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $0.01

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

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

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

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

Indicate by check mark if no disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to Form 10-K.   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.
 
Large accelerated filer ¨
 Accelerated filer ¨
 Non-accelerated filer ¨
 Smaller reporting company x

As of June 30, 2010, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of voting and non-voting common stock held by non-affiliates was $5.2 million.

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

The number of common shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: 1,941,305 shares of the Company’s Common Stock ($0.01 par value per share) were outstanding as of March 31, 2011

Specified portions of the registrant’s definitive Proxy Statement relating to the registrant’s 2011 Annual Meeting of Shareholders, which is to be filed pursuant to Regulation 14A within 120 days after the end of the registrant’s fiscal year ended December 31, 2010, are incorporated by reference in Part III of this Annual Report on Form 10-K.
 
 
 

 
 
TABLE OF CONTENTS

PART I
        3  
   
Item 1. Business
    3  
   
Item 1A. Risk Factors
    18  
   
Item 2. Properties
    24  
   
Item 3. Legal Proceedings
    24  
   
Item 4. (Removed and Reserved)
    24  
             
PART II
        24  
   
Item 5. Market for Registrant’s Common Equity and Related Shareholder Matters and Issuer Purchases of Equity Securities
    24  
   
Item 6. Select Financial Data
    25  
   
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
    25  
   
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
    39  
   
Item 8. Financial Statements and Supplementary Data
    40  
   
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
    64  
   
Item 9A. Controls and Procedures
    64  
   
Item 9B. Other Information
    64  
             
PART III
        65  
   
Item 10. Directors, Executive Officers, and Corporate Governance
    65  
   
Item 11. Executive Compensation
    65  
   
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
    65  
   
Item 13. Certain Relationships and Related Transactions and Director Independence
    65  
   
Item 14. Principal Accountant Fees and Services
    65  
             
PART IV
        66  
   
Item 15. Exhibits and Financial Statement Schedules
    66  
 
 
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PART I

FORWARD-LOOKING STATEMENTS

This annual report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934, that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause the results of T Bancshares, Inc. to differ materially from those expressed or implied by such forward-looking statements. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including any projections of financing needs, revenue, expenses, earnings or losses from operations, or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements of expectation or belief; and any statements of assumptions underlying any of the foregoing. In addition, forward looking statements may contain the words “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will be,” will continue,” “will result,” “seek,” “could,” “may,” “might,” or any variations of such words or other words with similar meanings.
 
The risks, uncertainties and assumptions referred to above include risks that are described in “Business—Risk Factors” and elsewhere in this annual report and that are otherwise described from time to time in our Securities and Exchange Commission reports filed after this report.
 
The forward-looking statements included in this annual report represent our estimates as of the date of this annual report. We specifically disclaim any obligation to update these forward-looking statements in the future. These forward-looking statements should not be relied upon as representing our estimates or views as of any date subsequent to the date of this annual report.
 
Item 1. 
Business.
 
General
 
T Bancshares, Inc. (the “Company,” “we,” “us,” or “our,” hereafter) was incorporated under the laws of the State of Texas on December 23, 2002 to serve as the bank holding company for T Bank, N.A., a national bank (the “Bank”), which opened on November 2, 2004. The Bank operates through a main office located at 16000 Dallas Parkway, Dallas, Texas, and another full-service banking office at 8100 North Dallas Parkway, Plano, Texas. We also have a loan production office located at 850 E. State Highway 114, Suite 200, Southlake, Texas.  Other than its ownership of the Bank, the Company conducts no material business.
 
The Bank is a full-service commercial bank offering a broad range of commercial and consumer banking services to small- to medium-sized businesses, independent single-family residential and commercial contractors and consumers. Lending services include consumer loans and commercial loans to small to medium-sized businesses and professional concerns. The Bank offers a wide range of deposit services including demand deposits, regular savings accounts, money market accounts, individual retirement accounts, and certificates of deposit with fixed rates and a range of maturity options. These services are provided through a variety of delivery systems including automated teller machines, private banking, telephone banking and Internet banking.

As of December 31, 2010, the Bank had approximately $115 million in assets, $94 million in total loans and $96 million in deposits.
 
Market Area
 
Our primary service areas include North Dallas, Addison, Plano, Frisco, Southlake, Grapevine and the neighboring Texas communities. We serve these markets from three locations, one of which is a loan production office. Our main office is located at 16000 Dallas Parkway, Dallas, Texas, and we also have a full-service branch office at 8100 North Dallas Parkway, Plano, Texas. The branch office enables us to more effectively serve the Plano/Frisco sector of our primary banking market. We have a loan production office located at 850 E State Highway 114, Southlake, Texas. Our primary service area represents a diverse market with a growing population and economy. According to data obtained from the United States Census and ESRI Business Information Systems, between 2000 and 2007, the population of the North Dallas/Addison area grew almost 7%, the population of the Frisco/Plano area grew more than 32% and the population of Northeast Tarrant County grew more that 22%. This population growth has attracted many businesses to the area and led to growth in the local service economy, and, while they cannot be certain, we expect this trend to continue.

The market for financial services is rapidly changing and intensely competitive and is likely to become more competitive as the number and types of market entrants increases. The Bank competes in both lending and attracting funds with other commercial banks, savings and loan associations, credit unions, consumer finance companies, pension trusts, mutual funds, insurance companies, mortgage bankers and brokers, brokerage and investment banking firms, asset-based nonbank lenders, government agencies and certain other non-financial institutions, including retail stores, which may offer more favorable financing alternatives than the Bank.
 
 
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Most of the deposits held in financial institutions in our primary banking market are attributable to branch offices of out-of-state banks. We believe that banks headquartered outside of our primary service area often lack the consistency of local leadership necessary to provide efficient service to individuals and small- to medium-sized business customers. Through our local ownership and management, we believe we are uniquely situated to efficiently provide these customers with loan, deposit and other financial products tailored to fit their specific needs. We believe that the Bank can compete effectively with larger and more established banks through an active business development plan and by offering local access, competitive products and services and more responsive customer service.
 
Lending Services
 
Lending Policy
 
We offer a full range of lending products, including commercial loans to small- to medium-sized businesses and professional concerns and consumer loans to individuals. We compete for these loans with competitors who are well established in our primary market area and have greater resources and lending limits. As a result, we currently have to offer more flexible pricing and terms to attract borrowers.
 
The Bank’s delegations of authority, which is approved by the Board of Directors, provide for various levels of officer lending authority. The Bank has an independent review that evaluates the quality of loans on a quarterly basis and determines if loans are originated in accordance with the guidelines established by the board of directors. Additionally, our board of directors has formed a Directors’ Loan Committee with members determined by board resolution to provide the following oversight:

 
·
ensure compliance with loan policy, procedures and guidelines as well as appropriate regulatory requirements;
 
·
approve secured loans above an aggregate amount of $750,000 and unsecured loans above an aggregate amount of $250,000 to any entity and/or related interest;
 
·
monitor delinquent and non-accrual loans;
 
·
monitor overall loan quality through review of information relative to all new loans;
 
·
monitor our loan review systems; and
 
·
review the adequacy of the loan loss reserve.
 
We follow a conservative lending policy, but one which permits prudent risks to assist businesses and consumers in our lending market. Interest rates vary depending on our cost of funds, the loan maturity, the degree of risk and other loan terms. The Bank does not make any loans to any of its directors or executive officers.
 
Lending Limits
 
The Bank’s lending activities are subject to a variety of lending limits. Differing limits apply based on the type of loan or the nature of the borrower, including the borrower’s relationship to the Bank. In general, however, the Bank is able to loan any one borrower a maximum amount equal to either:
 
 
·
15% of the Bank’s capital and surplus and allowance for loan losses; or
 
·
25% of its capital and surplus and allowance for loan losses if the amount that exceeds 15% is secured by cash or readily marketable collateral, as determined by reliable and continuously available price quotations; or
 
·
any amount when the loan is fully secured by a segregated deposit at the Bank and the Bank has perfected its security interest in the deposit.
 
These legal limits will increase or decrease as the Bank’s capital increases or decreases as a result of its earnings or losses, among other reasons. 

Credit Risks

The principal economic risk associated with each category of loans that the Bank makes is the creditworthiness of the borrower. Borrower creditworthiness is affected by general economic conditions and the strength of the relevant business market segment. General economic factors affecting a borrower’s ability to repay include interest, inflation and employment rates, as well as other factors affecting a borrower’s customers, suppliers and employees. The well-established financial institutions in our primary service area currently make proportionately more loans to medium- to large-sized businesses than the Bank makes. Many of the Bank’s anticipated commercial loans will likely be made to small- to medium-sized businesses that may be less able to withstand competitive, economic and financial pressures than larger borrowers.
 
 
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Real Estate Loans

The Bank makes commercial real estate loans, construction and development loans, small business loans and residential real estate loans. These loans include commercial loans where the Bank takes a security interest in real estate as a prudent practice and measure and not as the principal collateral for the loan.

 
·
Construction and development loans. We make construction and development loans on a pre-sold and speculative basis. If the borrower has entered into an agreement to sell the property prior to beginning construction, then the loan is considered to be on a pre-sold basis. If the borrower has not entered into an agreement to sell the property prior to beginning construction, then the loan is considered to be on a speculative basis. Construction and development loans are generally made with a term of six to 12 months and interest is paid monthly. The ratio of the loan principal to the value of the collateral as established by independent appraisal typically will not exceed industry standards and applicable regulations. Speculative loans are based on the borrower’s financial strength and cash flow position. Loan proceeds will be disbursed based on the percentage of completion and only after the project has been inspected by an experienced construction lender or third-party inspector. Risks associated with construction loans include, without limitation, fluctuations in the value of real estate, the financial condition of the buyer on a presold basis and of the builder on a speculative basis, and new job creation trends.

 
·
Commercial real estate. Commercial real estate loan terms generally are limited to ten years or less, although payments may be structured on a longer amortization basis. Interest rates may be fixed or adjustable, although rates typically are not fixed for a period exceeding 60 months. The Bank generally charges an origination fee for its services. The Bank generally requires personal guarantees from the principal owners of the property supported by a review by the Bank’s management of the principal owners’ personal financial statements. The Bank also makes commercial real estate loans to owner occupants of the real estate held as collateral. Risks associated with commercial real estate loans include fluctuations in the value of real estate, new job creation trends, tenant vacancy rates and the quality of the borrower’s management. The Bank limits its risk by analyzing borrowers’ cash flow and collateral value on an ongoing basis. In addition, at least two of our directors are experienced in the acquisition, development and management of commercial real estate and use their experience to assist in the evaluation of potential commercial real estate loans.

 
·
Residential real estate. The Bank’s residential real estate loans consist of loans to acquire and renovate existing homes for subsequent re-sale, residential new construction loans and, on a very limited basis, second mortgage loans and traditional mortgage lending for one-to-four family residences. The Bank offers primarily adjustable rate mortgages. All loans are made in accordance with the Bank’s appraisal and loan policy with the ratio of the loan principal to the value of collateral as established by independent appraisal generally not exceeding 80%, unless the borrower has private mortgage insurance. We believe these loan-to-value ratios are sufficient to compensate for fluctuations in real estate market value and to minimize losses that could result from a downturn in the residential real estate market.

Commercial and Industrial Loans
 
Loans for commercial purposes in various lines of businesses are a major component of the Bank’s loan portfolio. The targets in the commercial loan markets are retail establishments, professional service providers, in particular dentists, and small-to medium-sized businesses. The terms of these loans vary by purpose and by type of underlying collateral, if any. The commercial loans primarily are underwritten on the basis of the borrower’s ability to service the loan from income and their creditworthiness. The Bank will typically make equipment loans for a term of ten years or less at fixed or variable rates, with the loan fully amortized over the term. Loans to support working capital will typically have terms not exceeding one year and will usually be secured by accounts receivable, inventory or personal guarantees of the principals of the business. For loans secured by accounts receivable or inventory, principal will typically be repaid as the assets securing the loan are converted into cash, and for loans secured with other types of collateral, principal will typically be repaid over the term of the loan or due at maturity.

Commercial lending generally involves greater credit risk than residential mortgage or consumer lending, and involves risks that are different from those associated with commercial real estate lending. Although commercial loans may be collateralized by equipment or other business assets, the liquidation of collateral in the event of a borrower default may represent an insufficient source of repayment because equipment and other business assets may, among other things, be obsolete or of limited use. Accordingly, the repayment of a commercial loan depends primarily on the creditworthiness and projected cash flow of the borrower (and any guarantors), while liquidation of collateral is considered a secondary source of repayment. 
 
 
5

 
 
Consumer Installment Loans
 
The Bank makes a variety of loans to individuals for personal, family and household purposes, including secured and unsecured installment and term loans, second mortgages, home equity loans and home equity lines of credit. The amortization of second mortgages generally does not exceed 15 years and the rates generally are not fixed for longer than 12 months. Repayment of consumer loans depends upon the borrower’s financial stability and is more likely to be adversely affected by divorce, job loss, illness and personal hardships than repayment of other loans. Because many consumer loans are secured by depreciable assets such as boats, cars and trailers, the loan should be amortized over the useful life of the asset. The loan officer will review the borrower’s past credit history, past income level, debt history and, when applicable, cash flow and determine the impact of all these factors on the ability of the borrower to make future payments as agreed. The principal competitors for consumer loans are the established banks and finance companies in our market.
 
PortfolioComposition
 
The following table sets forth the composition of the Bank’s loan portfolio at December 31, 2010. Loan balances do not include undisbursed loan proceeds, unearned income, and allowance for loan losses.
 
   
Portfolio Percentage
at
December 31, 2010
 
Commercial and industrial
    67 %
Real Estate – mortgage
    23 %
Real Estate – construction
    9 %
Consumer installment
    1 %
         
      100 %
 
Investments
 
The Bank invests a portion of its assets in U.S. Treasuries, government agency mortgage backed securities, direct obligations of quasi government agencies including Fannie Mae, Freddie Mac, and the Federal Home Loan Bank, and federal funds sold. No investment in any of those instruments exceeds any applicable limitation imposed by law or regulation. The Bank’s investments are managed in relation to loan demand and deposit growth, and are generally used to provide for the investment of excess funds at minimal risks while providing liquidity to fund increases in loan demand or to offset deposit fluctuations. The Bank’s Asset-Liability Committee reviews the investment portfolio on an ongoing basis in order to ensure that the investments conform to the Bank’s policy as set by the Board of Directors.
 
Deposit Services
 
Deposits are the major source of the Bank’s funds for lending and other investment activities. Additionally, we also generate funds from loan principal repayments and prepayments. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are influenced significantly by general interest rates and market conditions. The Bank considers the majority of its regular savings, demand, NOW, and money market deposit accounts to be core deposits. These accounts comprised approximately 43% of the Bank’s total deposits at December 31, 2010. The Bank’s remaining deposits were composed of time deposits less than $100,000, which comprised 13% of total deposits, and time deposits of  $100,000 and greater, which comprised approximately 44% of total deposits at December 31, 2010. The Bank believes it is very competitive in the types of accounts and interest rates we offer on deposit accounts, in particular money market accounts and time deposits. We actively solicit these deposits through personal solicitation by its officers and directors, advertisements published in the local media, and through our Internet banking strategy.

Trust Services
 
Since August 2006, the Bank has offered traditional fiduciary services, such as serving as executor, trustee, agent, administrator or custodian for individuals, nonprofit organizations, employee benefit plans and organizations. The Bank’s trust department works with our customers and their financial advisors to define objectives, goals and strategies for their investment portfolios and tailor their investment portfolios accordingly. As of December 31, 2010, the Bank had approximately $853 million in trust assets under management.
 
 
6

 
 
Other Banking Services

Other banking services currently offered or anticipated include cashier’s checks, travelers’ checks, direct deposit of payroll and Social Security payments, bank-by-mail, remote check deposits, automated teller machine cards and debit cards. The Bank offers its customers free usage of any automated teller machine in the world.
 
Employees
 
The success of the Bank depends, in significant part, on its ability to attract, retain and motivate highly qualified management and other personnel, for whom competition is intense. The Bank currently has 25 full-time equivalent employees. None of the Bank’s employees are represented by a collective bargaining agreement. The Bank believes that its relations with its employees are good.
 
Employees are covered by a comprehensive employee benefit program which provides for, among other benefits, hospitalization and major medical insurance, disability insurance, and life insurance. Such employee benefits are considered by management to be generally competitive with employee benefits provided by other similar employers in the Bank's geographic market area.
 
Other Available Information
 
We file or furnish with the Securities and Exchange Commission (the “SEC”) annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and other reports required by Section 13(a) or 15(d) of the Securities Exchange Act of 1934. You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site at www.sec.gov that contains our reports, proxy statements, and other information that we file electronically with the SEC.
 
In addition, our annual reports on Form 10-K and quarterly reports on Form 10-Q are available through our Internet website,   www.tbank.com, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our Internet website and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K.
 
SUPERVISION AND REGULATION
 
Banking is a complex, highly regulated industry. Consequently, our growth and earnings performance and those of the Bank can be affected not only by management decisions and general and local economic conditions, but also by the statutes administered by, and the regulations and policies of, various governmental regulatory authorities. These authorities include, but are not limited to, the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the SEC, the Federal Deposit Insurance Corporation (the “FDIC”), the Office of the Comptroller of the Currency (“Comptroller”), the Internal Revenue Service, and state taxing authorities. The effect of these statutes, regulations, and policies and any changes to any of them can be significant and cannot be predicted.
 
The primary goals of the bank regulatory scheme are to maintain a safe and sound banking system and to facilitate the conduct of sound monetary policy. In furtherance of these goals, Congress has created several largely autonomous regulatory agencies and enacted numerous laws that govern banks, bank holding companies, and the banking industry. The system of supervision and regulation applicable to us and our banking subsidiary establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC’s deposit insurance funds, the Bank’s depositors, and the public, rather than our shareholders and creditors. The following is an attempt to summarize some of the relevant laws, rules, and regulations governing banks and bank holding companies, but does not purport to be a complete summary of all applicable laws, rules, and regulations governing banks and bank holding companies. The descriptions are qualified in their entirety by reference to the specific statutes and regulations discussed.
 
T Bancshares, Inc.
 
We are a bank holding company registered with, and subject to regulation by, the Federal Reserve under the Bank Holding Company Act of 1956, as amended. The Bank Holding Company Act and other federal laws subject bank holding companies to particular restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations.

In accordance with Federal Reserve policy, we are expected to act as a source of financial strength to the Bank and commit resources to support the Bank. This support may be required under circumstances when we might not be inclined to do so absent this Federal Reserve policy. As discussed below, we could be required to guarantee the capital plan of the Bank if it becomes undercapitalized for purposes of banking regulations.
 
 
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Certain acquisitions
 
The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before (1) acquiring more than 5% of the voting stock of any bank or other bank holding company, (2) acquiring all or substantially all of the assets of any bank or bank holding company, or (3) merging or consolidating with any other bank holding company.
 
Additionally, the Bank Holding Company Act provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly or substantially lessen competition or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve’s consideration of financial resources generally focuses on capital adequacy, which is discussed below. As a result of the USA PATRIOT Act, which is discussed below, the Federal Reserve is also required to consider the record of a bank holding company and its subsidiary bank(s) in combating money laundering activities in its evaluation of bank holding company merger or acquisition transactions.
 
Under the Bank Holding Company Act, any bank holding company located in Texas, if adequately capitalized and adequately managed, may purchase a bank located outside of Texas. Conversely, an adequately capitalized and adequately managed bank holding company located outside of Texas may purchase a bank located inside Texas. In each case, however, restrictions currently exist on the acquisition of a bank that has only been in existence for a limited amount of time or will result in specified concentrations of deposits.
 
Change in bank control
 
Subject to various exceptions, the Bank Holding Company Act and the Change in Bank Control Act of 1978, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. With respect to our Company, control is rebuttably presumed to exist if a person or company acquires 10% or more, but less than 25%, of any class of voting securities.
 
Permitted activities
 
Generally, bank holding companies are prohibited under the Bank Holding Company Act from engaging in or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in any activity other than (1) banking or managing or controlling banks or (2) an activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.
 
Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:
 
 
·
factoring accounts receivable;
 
·
making, acquiring, brokering, or servicing loans and usual related activities;
 
·
leasing personal or real property;
 
·
operating a non-bank depository institution, such as a savings association;
 
·
trust company functions;
 
·
financial and investment advisory activities;
 
·
conducting discount securities brokerage activities;
 
·
underwriting and dealing in government obligations and money market instruments;
 
·
providing specified management consulting and counseling activities;
 
·
performing selected data processing services and support services;
 
·
acting as agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and
 
·
performing selected insurance underwriting activities.
 
 
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Despite prior approval, the Federal Reserve has the authority to require a bank holding company to terminate an activity or terminate control of or liquidate or divest certain subsidiaries or affiliates when the Federal Reserve believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness, or stability of any of its banking subsidiaries. A bank holding company that qualifies and elects to become a financial holding company is permitted to engage in additional activities that are financial in nature or incidental or complementary to financial activity. The Bank Holding Company Act expressly lists the following activities as financial in nature:
 
 
·
lending, exchanging, transferring, investing for others, or safeguarding money or securities;
 
·
insuring, guaranteeing, or indemnifying against loss or harm, or providing and issuing annuities, and acting as principal, agent, or broker for these purposes, in any state;
 
·
providing financial, investment, or advisory services;
 
·
issuing or selling instruments representing interests in pools of assets permissible for a bank to hold directly;
 
·
underwriting, dealing in, or making a market in securities;
 
·
other activities that the Federal Reserve may determine to be so closely related to banking or managing or controlling banks as to be a proper incident to managing or controlling banks;
 
·
foreign activities permitted outside of the United States if the Federal Reserve has determined them to be usual in connection with banking operations abroad;
 
·
merchant banking through securities or insurance affiliates; and
 
·
insurance company portfolio investments.
 
To qualify to become a financial holding company, the Bank and any other depository institution subsidiary that we may own at the time must be “well capitalized” and “well managed” and must have a Community Reinvestment Act rating of at least “satisfactory.” Additionally, we would need to file an election with the Federal Reserve to become a financial holding company and must provide the Federal Reserve with 30 days’ written notice prior to engaging in a permitted financial activity. A bank holding company that falls out of compliance with these requirements may be required to cease engaging in some of its activities. The Federal Reserve serves as the primary “umbrella” regulator of financial holding companies, with supervisory authority over each parent company and limited authority over its subsidiaries. Expanded financial activities of financial holding companies generally will be regulated according to the type of such financial activity: banking activities by banking regulators, securities activities by securities regulators, and insurance activities by insurance regulators. We have not elected to become a financial holding company.
 
Sound banking practice
 
Bank holding companies are not permitted to engage in unsound banking practices. For example, the Federal Reserve’s Regulation Y requires a holding company to give the Federal Reserve prior notice of any redemption or repurchase of its own equity securities, if the consideration to be paid, together with the consideration paid for any repurchases in the preceding year, is equal to 10% or more of the company’s consolidated net worth. The Federal Reserve may oppose the transaction if it believes that the transaction would constitute an unsafe or unsound practice or would violate any law or regulation. As another example, a holding company could not impair its subsidiary bank’s soundness by causing it to make funds available to non-banking subsidiaries or their customers if the Federal Reserve believed it not prudent to do so.

The Financial Institutions Reform, Recovery and Enforcement Act of 1989 expanded the Federal Reserve’s authority to prohibit activities of bank holding companies and their non-banking subsidiaries which represent unsafe and unsound banking practices or which constitute violations of laws or regulations. The Financial Institutions Reform, Recovery and Enforcement Act increased the amount of civil money penalties which the Federal Reserve can assess for activities conducted on a knowing and reckless basis, if those activities caused a substantial loss to a depository institution. The penalties can be as high as $1,000,000 for each day the activity continues. The Financial Institutions Reform, Recovery and Enforcement Act also expanded the scope of individuals and entities against which such penalties may be assessed.
 
Further, the Federal Reserve issued Supervisory Letter SR 09-4 on February 24, 2009 and revised March 27, 2009, which provides guidance on the declaration and payment of dividends, capital redemptions, and capital repurchases by bank holding company.  Supervisory Letter SR 09-4 provides that, as a general matter, a bank holding company should eliminate, defer, or significantly reduce its dividends if:  (1) the bank holding company’s net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends, (2) the bank holding company’s prospective rate of earnings retention is not consistent with the bank holding company’s capital needs and overall current and prospective financial condition, or (3) the bank holding company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios.  Failure to do so could result in a supervisory finding that the bank holding company is operating in an unsafe and unsound manner.
 
 
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Anti-tying restrictions
 
Bank holding companies and affiliates are prohibited from tying the provision of services, such as extensions of credit, to other services offered by a holding company or its affiliates.

Dividends

Consistent with its policy that bank holding companies should serve as a source of financial strength for their subsidiary banks, the Federal Reserve has stated that, as a matter of prudent banking, a bank holding company generally should not maintain a rate of distributions to shareholders unless its available net income has been sufficient to fully fund the distributions, and the prospective rate of earnings retention appears consistent with the bank holding company’s capital needs, asset quality, and overall financial condition. In addition, we are subject to certain restrictions on the making of distributions as a result of the requirement that the Bank maintain an adequate level of capital as described below. As a Texas corporation, we are restricted under the Texas Business Organizations Code from paying dividends under certain conditions. Under Texas law, we cannot pay dividends to shareholders if the dividends exceed our surplus or if after giving effect to the dividends, we would be insolvent.
 
Sarbanes-Oxley Act of 2002
 
The Sarbanes-Oxley Act of 2002 (the “SOX Act”) represents a comprehensive revision of laws affecting corporate governance, accounting obligations and corporate reporting. Among other requirements, the SOX Act established: (i) new requirements for audit committees of public companies, including independence, expertise, and responsibilities; (ii) additional responsibilities regarding financial statements for the chief executive officers and chief financial officers of reporting companies; (iii) new standards for auditors and regulation of audits; (iv) increased disclosure and reporting obligations for reporting companies regarding various matters relating to corporate governance; and (v) new and increased civil and criminal penalties for violation of the securities laws. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, smaller companies like us are permanently exempt from having an independent auditor test and report on the effectiveness of their internal controls over financial reporting.
 
The Dodd-Frank Act
 
On July 21, 2010, President Obama signed the Dodd-Frank Act into law. The Dodd-Frank Act will have a broad impact on the financial services industry, imposing significant regulatory and compliance changes, including the designation of certain financial companies as systemically significant, the imposition of increased capital, leverage, and liquidity requirements, and numerous other provisions designed to improve supervision and oversight of, and strengthen safety and soundness within, the financial services sector. Additionally, the Dodd-Frank Act establishes a new framework of authority to conduct systemic risk oversight within the financial system to be distributed among new and existing federal regulatory agencies, including the Financial Stability Oversight Council, or Council, the Federal Reserve, the OCC, and the FDIC.
 
The following items provide a brief description of certain provisions of the Dodd-Frank Act that may have an affect on us.
 
 
The Dodd-Frank Act significantly reduces the ability of national banks to rely upon federal preemption of state consumer financial laws. Although the OCC, as the primary regulator of national banks, will have the ability to make preemption determinations where certain conditions are met, the broad rollback of federal preemption has the potential to create a patchwork of federal and state compliance obligations. This could, in turn, result in significant new regulatory requirements applicable to us and certain of our lending activities, with potentially significant changes in our operations and increases in our compliance costs. It could also result in uncertainty concerning compliance, with attendant regulatory and litigation risks.

 
The Dodd-Frank Act makes permanent the general $250,000 deposit insurance limit for insured deposits. The Dodd-Frank Act also extends until January 1, 2013, federal deposit coverage for the full net amount held by depositors in non-interest bearing transaction accounts. Amendments to the FDIC Act also revise the assessment base against which an insured depository institution’s deposit insurance premiums paid to DIF will be calculated. Under the amendments, the assessment base will no longer be the institution’s deposit base, but rather its average consolidated total assets less its average tangible equity. Additionally, the Dodd-Frank Act makes changes to the minimum designated reserve ratio of the DIF, increasing the minimum from 1.15 percent to 1.35 percent of the estimated amount of total insured deposits, and eliminating the requirement that the FDIC pay dividends to depository institutions when the reserve ratio exceeds certain thresholds. Several of these provisions could increase the FDIC deposit insurance premiums paid by us.
 
 
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The Dodd-Frank Act generally enhances the restrictions on transactions with affiliates under Section 23A and 23B of the Federal Reserve Act, including an expansion of the definition of “covered transactions” and an increase in the amount of time for which collateral requirements regarding covered credit transactions must be satisfied. Insider transaction limitations are expanded through the strengthening of loan restrictions to insiders and the expansion of the types of transactions subject to the various limits, including derivatives transactions, repurchase agreements, reverse repurchase agreements and securities lending or borrowing transactions. Restrictions are also placed on certain asset sales to and from an insider to an institution, including requirements that such sales be on market terms and, in certain circumstances, approved by the institution’s board of directors.

The Dodd-Frank Act strengthens the existing limits on a depository institution’s credit exposure to one borrower. Federal banking law currently limits a federal thrift’s ability to extend credit to one person (or group of related persons) in an amount exceeding certain thresholds. The Dodd-Frank Act expands the scope of these restrictions to include credit exposure arising from derivative transactions, repurchase agreements, and securities lending and borrowing transactions.

The Dodd-Frank Act authorizes the establishment of the Consumer Financial Protection Bureau (“the CFPB”), which has the power to issue rules governing all financial institutions that offer financial services and products to consumers. The CFPB has the authority to monitor markets for consumer financial products to ensure that consumers are protected from abusive practices. Financial institutions will be subject to increased compliance and enforcement costs associated with regulations established by the CFPB.

The Dodd-Frank Act may create risks of “secondary actor liability” for lenders that provide financing to entities offering financial products to consumers. We may incur compliance and other costs in connection with administration of credit extended to entities engaged in activities covered by Dodd-Frank.

The Dodd-Frank Act addresses many investor protection, corporate governance and executive compensation matters that will affect most U.S. publicly traded companies, including ours. The Dodd-Frank Act (1) grants stockholders of U.S. publicly traded companies an advisory vote on executive compensation; (2) enhances independence requirements for compensation committee members; (3) requires companies listed on national securities exchanges to adopt incentive-based compensation clawback policies for executive officers; (4) provides the SEC with authority to adopt proxy access rules that would allow stockholders of publicly traded companies to nominate candidates for election as a director and have those nominees included in a company’s proxy materials; (5) prohibits uninstructed broker votes on election of directors, executive compensation matters (including say on pay advisory votes), and other significant matters, and (6) requires disclosure on board leadership structure
 
Many of the requirements of the Dodd-Frank Act will be implemented over time and most will be subject to regulations implemented over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on our operations is unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make any changes necessary to comply with new statutory and regulatory requirements. Failure to comply with the new requirements may negatively impact our results of operations and financial condition. While we cannot predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on us, these changes could be materially adverse to our investors.

The Bank
 
The Bank is subject to the supervision, examination and reporting requirements of the National Bank Act and the regulations of the Comptroller. The Comptroller will regularly examine the Bank’s operations and has the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions. The Comptroller also has the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law. The Bank is also subject to numerous state and federal statutes and regulations that affect its business, activities and operations. The Bank’s deposits are insured by the FDIC to the maximum extent provided by law.
 
 
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Branching
 
National banks are required by the National Bank Act to adhere to branching laws applicable to state banks in the states in which they are located. Under current Texas law, banks are permitted to establish branch offices throughout Texas with prior regulatory approval. In addition, with prior regulatory approval, banks are permitted to acquire branches of existing banks located in Texas. Finally, banks generally may branch across state lines by merging with banks in other states if allowed by the applicable states’ laws. Texas law, with limited exceptions, currently permits branching across state lines through interstate mergers. Under the Federal Deposit Insurance Act, states may “opt-in” and allow out-of-state banks to branch into their state by establishing a new start-up branch in the state. Texas law currently permits de novo branching into the state of Texas on a reciprocal basis, meaning that an out-of-state bank may establish a new start-up branch in Texas only if its home state has also elected to permit de novo branching into that state.

Deposit insurance assessments

Substantially all of the deposits of the Bank are insured up to applicable limits by the Deposit Insurance Fund (the “DIF”), as administered by the FDIC, and are subject to deposit insurance assessments to maintain the DIF.  Until October 2008, the insurance protection generally did not exceed $100,000 per depositor. Beginning in October 2008, the amount of protection was increased to $250,000, under the Temporary Liquidity Guarantee Program (TLGP) of the Emergency Economic Stabilization Act of 2008. This increased protection to $250,000 was initially available only through December 31, 2009 but in 2010, the FDIC made this $250,000 protection permanent. The new regulations were also expanded whereby the protection for non-interest bearing deposits was unlimited at institutions participating in the TLGP. This unlimited coverage for these non-interest bearing accounts was also initially only available through December 31, 2009 but was extended until December 31, 2012. Non-interest bearing deposits initially also included, by definition, certain Interest on Lawyers Trust Accounts (IOLTA) and Negotiable Order of Withdrawal accounts (NOW Accounts) with a maximum capped interest rate. Effective January 1, 2011 through December 31, 2012, the definition of non-interest bearing was changed to no longer include NOW accounts. The FDIC uses a risk-based assessment system that imposes insurance premiums based upon a risk matrix.  Each insured depository institution is assigned to one of four risk categories that are based on both capital and supervisory evaluations.  

In the second quarter of 2009, the FDIC made a special assessment equal to 0.05 percent of total assets minus Tier 1 capital. The assessment totaled $62,000 and was paid on September 30, 2009.  The FDIC also announced in 2009 the requirement of member banks to prepay on December 30, 2009, their estimated quarterly assessments for 2010, 2011 and 2012, including a three basis point increase in premium rates for 2011 and 2012. The Company’s prepayment amount totaled $921,000 in the aggregate and is being expensed over a three year period based on future quarterly assessment calculations. As of December 31, 2010, $712,000 in pre-paid deposit insurance assessments is included in other assets in the accompanying consolidated balance sheet.

In October 2010, the FDIC adopted a new Restoration Plan for the DIF to ensure that the fund reserve ratio reaches 1.35% by September 30, 2020, as required by the Dodd-Frank Act. Under the Restoration Plan, the FDIC did not institute the uniform three-basis point increase in assessment rates scheduled to take place on January 1, 2011 and maintained the current schedule of assessment rates for all depository institutions. At least semi-annually, the FDIC will update its loss and income projections for the DIF and, if needed, will increase or decrease assessment rates, following notice-and-comment rulemaking, if required. 

As required by the Dodd-Frank Act, the FDIC also revised the deposit insurance assessment system, effective April 1, 2011, to base assessments on the average total consolidated assets of insured depository institutions during the assessment period, less the average tangible equity of the institution during the assessment period. Currently, only deposits are included in determining the premium paid by an institution. This base assessment change necessitated that the FDIC adjust the assessment rates to ensure that the revenue collected under the new assessment system, will approximately equal that under the existing assessment system.
 
Under the FDIA, the FDIC may terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.

Expanded financial activities
 
Similar to bank holding companies, the Gramm-Leach-Bliley Financial Services Modernization Act of 1999 expanded the types of activities in which a bank may engage. Generally, a bank may engage in activities that are financial in nature through a “financial subsidiary” if the bank and each of its depository institution affiliates are “well capitalized,” “well managed” and have at least a “satisfactory” rating under the Community Reinvestment Act. However, applicable law and regulation provide that the amounts of investment in these activities generally are limited to 45% of the total assets of the Bank, and these investments are deducted when determining compliance with capital adequacy guidelines. Further, the transactions between the Bank and this type of subsidiary are subject to a number of limitations.
 
Expanded financial activities of national banks generally will be regulated according to the type of such financial activity: banking activities by banking regulators, securities activities by securities regulators and insurance activities by insurance regulators. The Bank currently has no plans to conduct any activities through financial subsidiaries.
 
 
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Community Reinvestment Act

The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the Federal Reserve, the FDIC, or the Comptroller, shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank. Because our aggregate assets are currently less than $250 million, under the Gramm-Leach-Bliley Act, we are subject to a Community Reinvestment Act examination only once every 60 months if we receive an outstanding rating, once every 48 months if we receive a satisfactory rating and as needed if our rating is less than satisfactory. Additionally, we must publicly disclose the terms of various Community Reinvestment Act-related agreements.

Dividends
 
The Bank is required by federal law to obtain prior approval of the Comptroller for payments of dividends if the total of all dividends declared by its board of directors in any year will exceed its net profits earned during the current year combined with its retained net profits of the immediately preceding two years, less any required transfers to surplus. In addition, the Bank will be unable to pay dividends unless and until it has positive retained earnings. As of December 31, 2010, the Bank had an accumulated deficit of approximately $7.5 million. Accordingly, we will be unable to pay dividends until the accumulated deficit is eliminated.
 
In addition, under the Federal Deposit Insurance Corporation Improvement Act, the Bank may not pay any dividend if the payment of the dividend would cause the Bank to become undercapitalized or in the event the Bank is “undercapitalized.” The Comptroller may further restrict the payment of dividends by requiring that a financial institution maintain a higher level of capital than would otherwise be required to be “adequately capitalized” for regulatory purposes. Moreover, if, in the opinion of the Comptroller, the Bank is engaged in an unsound practice (which could include the payment of dividends), the Comptroller may require, generally after notice and hearing, that the Bank cease such practice. The Comptroller has indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe banking practice. Moreover, the Comptroller has also issued policy statements providing that insured depository institutions generally should pay dividends only out of current operating earnings.

Capital adequacy
 
The Federal Reserve monitors the capital adequacy of bank holding companies, such as the Company, and the Comptroller monitors the capital adequacy of the Bank. The federal bank regulators use a combination of risk-based guidelines and leverage ratios to evaluate capital adequacy and consider these capital levels when taking action on various types of applications and when conducting supervisory activities related to the safety and soundness of the Company and the Bank. The risk-based guidelines apply on a consolidated basis to bank holding companies with consolidated assets of $500 million or more and, generally, on a bank-only basis for bank holding companies with less than $500 million in consolidated assets. Each insured depository subsidiary of a bank holding company with less than $500 million in consolidated assets is expected to be “well-capitalized.”

The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items, such as letters of credit and unfunded loan commitments, are assigned to broad risk categories, each with appropriate risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.
 
An institution is considered "well capitalized" if it has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, and a leverage ratio of 5% or greater, and it is not subject to an order, written agreement, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure.
 
An institution is considered "adequately capitalized" if it has a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of at least 4% and leverage capital ratio of 4% or greater (or a leverage ratio of 3% or greater if the institution is rated composite 1 in its most recent report of examination, subject to appropriate Federal bank regulatory agency guidelines), and the institution does not meet the definition of an undercapitalized institution.

An institution is considered "undercapitalized" if it has a total risk-based capital ratio that is less than 8%, a Tier 1 risk-based capital ratio that is less than 4%, or a leverage ratio that is less than 4% (or a leverage ratio that is less than 3% if the institution is rated composite 1 in its most recent report of examination, subject to appropriate Federal Banking agency guidelines).
 
 
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The Federal Deposit Insurance Corporation Improvement Act of 1991 established a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories (“well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized”), and all institutions are assigned one such category. Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is “critically undercapitalized.” The federal banking agencies have specified by regulation the relevant capital level for each category. An institution that is categorized as “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized” is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. A bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to various limitations. The controlling holding company’s obligation to fund a capital restoration plan is limited to the lesser of 5% of an “undercapitalized” subsidiary’s assets at the time it became “undercapitalized” or the amount required to meet regulatory capital requirements. An “undercapitalized” institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval. The regulations also establish procedures for downgrading an institution to a lower capital category based on supervisory factors other than capital.

Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and other restrictions on its business. As described above, significant additional restrictions can be imposed on FDIC-insured depository institutions that fail to meet applicable capital requirements.
 
Restrictions on Transactions with Affiliates and Loans to Insiders    
 
The Company and the Bank are subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on the amount of:
 
 
·
a bank’s loans or extensions of credit to affiliates;
 
·
a bank’s investment in affiliates;
 
·
assets a bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve;
 
·
the amount of loans or extensions of credit to third parties collateralized by the securities or obligations of affiliates; and
 
·
a bank’s guarantee, acceptance or letter of credit issued on behalf of an affiliate.
 
The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. The Bank must also comply with other provisions designed to avoid the taking of low-quality assets.
 
The Company and the Bank are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibits an institution from engaging in the transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.
 
The Bank is also subject to restrictions on extensions of credit to its executive officers, directors, principal shareholders and their related interests. These extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties and (2) must not involve more than the normal risk of repayment or present other unfavorable features.

Privacy
 
Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing personal financial information with nonaffiliated third parties except for third parties that market the institutions’ own products and services. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing through electronic mail to consumers.
 
 
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Anti-terrorism legislation
 
In the wake of the tragic events of September 11th, on October 26, 2001, the President signed into law the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001. Also known as the “Patriot Act,” the law enhances the powers of the federal government and law enforcement organizations to combat terrorism, organized crime and money laundering. The Patriot Act significantly amends and expands the application of the Bank Secrecy Act, including enhanced measures regarding customer identity, new suspicious activity reporting rules and enhanced anti-money laundering programs.
 
Under the Patriot Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as enhanced due diligence and “know your customer” standards in their dealings with foreign financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures and controls generally require financial institutions to take reasonable steps:
 
 
·
to conduct enhanced scrutiny of account relationships to guard against money laundering and report any suspicious transaction;

 
·
to ascertain the identity of the nominal and beneficial owners of, and the source of funds deposited into, each account as needed to guard against money laundering and report any suspicious transactions;

 
·
to ascertain for any foreign bank, the shares of which are not publicly traded, the identity of the owners of the foreign bank and the nature and extent of the ownership interest of each such owner; and

 
·
to ascertain whether any foreign bank provides correspondent accounts to other foreign banks and, if so, the identity of those foreign banks and related due diligence information.
 
Under the Patriot Act, financial institutions must also establish anti-money laundering programs. The Act sets forth minimum standards for these programs, including: (i) the development of internal policies, procedures and controls; (ii) the designation of a compliance officer; (iii) an ongoing employee training program; and (iv) an independent audit function to test the programs.
 
In addition, the Patriot Act requires the bank regulatory agencies to consider the record of a bank or bank holding company in combating money laundering activities in their evaluation of bank and bank holding company merger or acquisition transactions. Regulations proposed by the U.S. Department of the Treasury to effectuate certain provisions of the Patriot Act provide that all transaction or other correspondent accounts held by a U.S. financial institution on behalf of any foreign bank must be closed within 90 days after the final regulations are issued, unless the foreign bank has provided the U.S. financial institution with a means of verification that the institution is not a “shell bank.” Proposed regulations interpreting other provisions of the Patriot Act are continuing to be issued.
 
Under the authority of the Patriot Act, the Secretary of the Treasury adopted rules on September 26, 2002 increasing the cooperation and information sharing between financial institutions, regulators and law enforcement authorities regarding individuals, entities and organizations engaged in, or reasonably suspected based on credible evidence of engaging in, terrorist acts or money laundering activities. Under these rules, a financial institution is required to:

 
·
expeditiously search its records to determine whether it maintains or has maintained accounts, or engaged in transactions with individuals or entities, listed in a request submitted by the Financial Crimes Enforcement Network (“FinCEN”);

 
·
notify FinCEN if an account or transaction is identified;

 
·
designate a contact person to receive information requests;

 
·
limit use of information provided by FinCEN to: (1) reporting to FinCEN, (2) determining whether to establish or maintain an account or engage in a transaction and (3) assisting the financial institution in complying with the Bank Secrecy Act; and

 
·
maintain adequate procedures to protect the security and confidentiality of FinCEN requests.
 
 
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Under the new rules, a financial institution may also share information regarding individuals, entities, organizations and countries for purposes of identifying and, where appropriate, reporting activities that it suspects may involve possible terrorist activity or money laundering. Such information-sharing is protected under a safe harbor if the financial institution: (1) notifies FinCEN of its intention to share information, even when sharing with an affiliated financial institution; (2) takes reasonable steps to verify that, prior to sharing, the financial institution or association of financial institutions with which it intends to share information has submitted a notice to FinCEN; (3) limits the use of shared information to identifying and reporting on money laundering or terrorist activities, determining whether to establish or maintain an account or engage in a transaction, or assisting it in complying with the Bank Security Act; and (4) maintains adequate procedures to protect the security and confidentiality of the information. Any financial institution complying with these rules will not be deemed to have violated the privacy requirements discussed above.
 
The Secretary of the Treasury also adopted a rule on September 26, 2002 intended to prevent money laundering and terrorist financing through correspondent accounts maintained by U.S. financial institutions on behalf of foreign banks. Under the rule, financial institutions: (1) are prohibited from providing correspondent accounts to foreign shell banks; (2) are required to obtain a certification from foreign banks for which they maintain a correspondent account stating the foreign bank is not a shell bank and that it will not permit a foreign shell bank to have access to the U.S. account; (3) must maintain records identifying the owner of the foreign bank for which they may maintain a correspondent account and its agent in the Unites States designated to accept services of legal process; (4) must terminate correspondent accounts of foreign banks that fail to comply with or fail to contest a lawful request of the Secretary of the Treasury or the Attorney General of the United States, after being notified by the Secretary or Attorney General.
 
Bank Secrecy Act

In 2007, the FDIC and the other federal financial regulatory agencies issued an interagency policy on the application of section 8(s) of the Federal Deposit Insurance Act. This provision generally requires each federal banking agency to issue an order to cease and desist when a bank is in violation of the requirement to establish and maintain a Bank Secrecy Act/anti-money laundering (BSA/AML) compliance program, or, in the alternative, the bank fails to correct a deficiency that has been previously cited by the federal banking agency with respect to the bank's BSA/AML compliance program. The policy statement provides that, in addition to the circumstances where the agencies will issue a cease and desist order in compliance with section 8(s), they may take other actions as appropriate for other types of BSA/AML program concerns or for violations of other BSA requirements. The policy statement also does not address the independent authority of the U.S. Department of the Treasury's Financial Crimes Enforcement Network to take enforcement action for violations of the BSA.

Other regulations
 
The Bank’s operations are also subject to various federal and state laws such as:
 
 
·
the federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
 
·
the Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
 
·
the Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
 
·
the Fair Credit Reporting Act of 1978 and its amendment, the Fair and Accurate Credit Transactions Act of 2003, governing the use and provision of information to credit reporting agencies;
 
·
the Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
 
·
the rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.
 
·
the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and
 
·
the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve to implement that act, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.

Collectively, these regulations add to the cost of operations to ensure the Bank is operating in a compliant fashion.

 Regulatory Reform and Legislation

The U. S. and global economies have experienced and are experiencing significant stress and disruptions in the financial sector. Dramatic slowdowns in the housing industry with falling home prices and increasing foreclosures and unemployment have created strains on financial institutions, including government-sponsored entities and investment banks. As a result, many financial institutions sought and continue to seek additional capital, merge or seek mergers with larger and stronger institutions and, in some cases, failed.
 
 
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In response to the financial crisis affecting the banking and financial markets, in October 2008, the Emergency Economic Stabilization Act of 2008 (the “EESA”) was signed into law. Pursuant to the EESA, the U.S. Treasury (the “Treasury”) was authorized to purchase equity stakes in U. S. financial institutions. Under this program, known as the Troubled Asset Relief Program Capital Purchase Program (the “TARP Capital Purchase Program”), the Treasury made $250 billion of capital available to U.S. financial institutions through the purchase of preferred stock or subordinated debentures by the Treasury. In conjunction with the purchase of preferred stock from publicly-held financial institutions, the Treasury received warrants to purchase common stock with an aggregate market price equal to 15% of the total amount of the preferred investment. Participating financial institutions were required to adopt the Treasury’s standards for executive compensation and corporate governance for the period during which the Treasury holds equity issued under the TARP Capital Purchase Program and were restricted from increasing dividends to common shareholders or repurchasing common stock for three years without the consent of the Treasury.

Congress and the regulators for financial institutions have proposed and passed significant changes to the laws, rules and regulations governing financial institutions. Most recently, the House of Representatives and Senate passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) which the President has signed. Prior to the Dodd-Frank Act, Congress and the financial institution regulators made other significant changes affecting many aspects of banking. These recent actions address many issues including capital, interchange fees, compliance and risk management, debit card interchange fees, overdraft fees, the establishment of a new consumer regulator, healthcare, incentive compensation, expanded disclosures and corporate governance. While many of the new regulations are for financial institutions with assets greater than $10 billion, we expect the new regulations to reduce our revenues and increase our expenses in the future. We are closely monitoring those actions to determine the appropriate response to comply and at the same time minimize the adverse effect on our bank.

On September 12, 2010, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee, announced agreement on the calibration and phase — in arrangements for a strengthened set of capital requirements, known as Basel III. Basel III increases the minimum Tier 1 common equity ratio to 4.5%, net of regulatory deductions, and introduces a capital conservation buffer of an additional 2.5% of common equity to risk — weighted assets, raising the target minimum common equity ratio to 7%. This capital conservation buffer also increases the minimum Tier 1 capital ratio from 6% to 8.5% and the minimum total capital ratio from 8% to 10.5%. In addition, Basel III introduces a countercyclical capital buffer of up to 2.5% of common equity or other fully loss absorbing capital for periods of excess credit growth. Basel III also introduces a non-risk adjusted Tier 1 leverage ratio of 3%, based on a measure of total exposure rather than total assets, and new liquidity standards. The Basel III capital and liquidity standards will be phased in over a multi-year period. The final package of Basel III reforms was submitted to the Seoul G20 Leaders Summit in November 2010 for endorsement by G20 leaders, and then will be subject to individual adoption by member nations, including the United States. The Federal Reserve will likely implement changes to the capital adequacy standards applicable to the Company and our subsidiary bank in light of Basel III.

Effect of governmental monetary policies
 
The commercial banking business is affected not only by general economic conditions but also by the fiscal and monetary policies of the Federal Reserve Board. Some of the instruments of fiscal and monetary policy available to the Federal Reserve include changes in the discount rate on member bank borrowings, the fluctuating availability of borrowings at the “discount window,” open market operations, the imposition of and changes in reserve requirements against member banks’ deposits and assets of foreign branches, the imposition of and changes in reserve requirements against certain borrowings by banks and their affiliates, and the placing of limits on interest rates that member banks may pay on time and savings deposits. Such policies influence to a significant extent the overall growth of bank loans, investments, and deposits and the interest rates charged on loans or paid on time and savings deposits. We cannot predict the nature of future fiscal and monetary policies and the effect of such policies on the future business and our earnings.
 
All of the above laws and regulations add significantly to the cost of operating the Bank and thus have a negative impact on our profitability. It should also be noted that there has been a tremendous expansion experienced in recent years by certain financial service providers that are not subject to the same rules and regulations as the Company or the Bank. These institutions, because they are not so highly regulated, have a competitive advantage over us and may continue to draw large amounts of funds away from traditional banking institutions, with a continuing adverse effect on the banking industry in general.
 
 
17

 
 
Item 1A. 
Risk Factors.

An investment in our common stock involves certain risks.  Our business, financial condition, operating results and cash flows can be impacted by a number of factors. These important factors could cause actual results to differ materially from those expressed or implied by these forward-looking statements, including our plans, objectives, expectations and intentions and other factors discussed in the risk factors, described below. You should carefully consider the following risk factors and all other information contained in this Report. The risks and uncertainties described below may not be the only ones we face. Additional risks and uncertainties not presently known to us or that we currently believe are immaterial also may impair our business. If any of the events described in the following risk factors occur, our business, results of operations and financial condition could be materially adversely affected. The value or market price of our common stock could decline due to any of these identified or other risks, and you could lose all or part of your investment.

We are operating under a formal Agreement with the Comptroller.

In 2010, the Bank was informed by the Comptroller that the Comptroller intended to institute an enforcement action for alleged violations of the Federal Trade Commission Act in connection with certain merchants and a payment processor that were Bank customers between September 1, 2006 and August 27, 2007.   The Comptroller proposed that the Bank enter into a formal agreement with the Comptroller (the “Agreement”).

The Bank terminated all business relationships with the merchants and the payment processor on August 27, 2007. The Comptroller alleged that the merchants and the payment processor defrauded consumers and is seeking restitution of such consumers from the Bank, asserting that by accepting consumer payments for deposit from the merchants and introducing those payments into the payment clearing system, the Bank allegedly materially aided the merchants and the payment processor in the alleged fraudulent activity.

Because the cost of defending a regulatory enforcement action would have been significant, would likely have taken a protracted timeframe, and we could not be certain of a favorable outcome to the Bank, we determined that negotiating a settlement with the Comptroller was in the best interest of the Bank.  Accordingly, on April 15, 2010, the Bank executed an Agreement, neither admitting nor denying the Comptroller’s findings, containing the following general terms:

 
·
deposit $5.1 million for consumer restitution charged by the merchants to eligible consumers into a segregated account at the Bank;
 
·
require the Bank to retain an independent claims administrator to locate and arrange for the issuance of individual consumer checks to the identified eligible consumers;
 
·
require the Bank to establish a capital plan which, among other provisions, details the Bank’s plan to achieve tier 1 capital ratio of 9% and total risk based capital ratio of 11.5%;
 
·
require the Bank to develop a written program designed to reduce the level of criticized assets;
 
·
require the Bank to develop and implement an asset liquidity enhancement plan designed to increase the amount of asset liquidity maintained by the Bank, including a loan to deposit ratio of 85%; and
 
·
require the Bank to develop a written profit plan to improve and sustain the earnings of the Bank.

We do not know at this time the precise amounts that will ultimately be payable by us under the terms of the Agreement. In August and September, 2010, the Bank issued settlement offers and checks covering twelve of the thirteen merchants totaling approximately $3.8 million. The settlement offer and checks were valid for ninety days. As of December 31, 2010, approximately $2.0 million of settlement checks had been accepted and cashed by consumers, or 52% of the total.  Under the terms of the restitution plan, the Bank has no further obligation on the $1.802 million of settlement checks which were not accepted and cashed by consumers.

In September, 2010, the Federal Trade Commission (“FTC”) reached a settlement with the thirteenth merchant, Low Pay, Inc. (“Low Pay”). Under the terms of the Bank’s Agreement with the Comptroller, the Bank will receive a refund from the FTC if the FTC is successful collecting its settlement against Low Pay.  We expect that any such refund will be no more than $70 thousand.  With the FTC settlement with Low Pay completed, the Bank was able to move forward with issuing restitution checks totaling approximately $1.6 million, which it did on February 25, 2011, to the Low Pay Consumers. The Bank recorded an additional $560 thousand expense accrual as of September, 2010, for the Low Pay restitution payments.  This was added to the existing $2.4 million previously recorded as of December 31, 2009.  As of December 31, 2010, the Bank had not used, nor had any further obligation to pay, $429 thousand of the previously recorded restitution reserve accrual. The additional expense accrual related to Low Pay resulted in a total restitution reserve accrual as of December 31, 2010, of $989 thousand, or 62% of the total of the Low Pay restitution checks issued.
 
 
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The Bank submitted required capital, liquidity enhancement, and  profit plans, as well as a written program to reduce criticized assets to the Comptroller in accordance with the requirements of the Agreement. Although the Comptroller believed the plans were reasonable and did not object to the plans and program as submitted, there is no assurance that the Bank will be able to comply with all of the remaining requirements of the Agreement, including meeting the stated capital requirements or loan to deposit ratio contained therein.
 
If as a result of its review or examination of the Bank, the Comptroller should determine that the financial condition, capital resources, asset quality, liquidity, earnings ability, or other aspects of its operations have worsened or that it or its management is violating or has violated the Agreement, or failed to comply with any provision of the Agreement, or any law or regulation, various additional remedies are available to the Comptroller. Such remedies include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict our growth, to assess civil monetary penalties, to remove officers and directors, and ultimately to terminate our deposit insurance, which would result in the seizure of the Bank by its regulators.
 
We have made estimates with respect to the amount of restitution that the Bank will ultimately be responsible to pay to consumers in connection with the Agreement with the Comptroller.

In determining the amount of funds that the Bank needs to reserve to make restitution payments to consumers under the Agreement, management has made certain assumptions regarding the number of consumers who elect to accept restitution checks and the ability of the Bank and its claim processor to locate consumers.  

As of December 31, 2010, $2.0 million of settlement checks had been accepted and cashed by consumers, or 52% of the total $3.8 million issued in connection with twelve of the thirteen merchants.  Under the terms of the restitution plan, the Bank has no further obligation on the $1.8 million of settlement checks which were not accepted and cashed by consumers. Amounts previously estimated but not actually paid have been left in the accrued reserve, bringing the total to 62%, or $989 thousand of the $1.6 million of the total potential obligation related to Low Pay.  If management’s estimates prove to be too low and the actual rate that checks are accepted and cashed exceeds 62%, the Bank will be required to recognize additional payments on restitution checks.  As a result, our financial condition and results of operation may be materially adversely affected.

The Agreement with the Comptroller prevents us from being well capitalized under the system of prompt corrective action established by the Federal Deposit Insurance Corporation Improvement Act of 1991 which may inhibit our ability to retain and attract deposits.

The Bank’s capital ratios as of December 31, 2010 were 9.41% tier 1 leverage ratio and 12.20% total risk based capital ratio. Although the Bank’s capital ratios met the definition of well capitalized   under the system of prompt corrective action, the Agreement prevents us from being considered well capitalized regardless of our capital ratios. Because of FDIC restrictions which took affect on January 1, 2010 for all insured banks which are considered not well capitalized, the Bank is restricted from offering rates in excess of .75% over the national average rate for various deposit terms as published weekly by the FDIC.  This may adversely and materially affect the Bank’s ability to attract and retain deposits which could have a negative impact on the Bank’s liquidity and impair its ability to comply with the Order.

Since we commenced operations in 2004, we have had a short and intermittent history of experiencing profits.

Our profitability will depend on the Bank’s profitability and, while we were profitable in 2006 and 2007, we experienced significant and material losses in 2008, 2009 and 2010. We may incur continued difficulties or set backs reaching profitability in the future. We have incurred substantial start-up expenses associated with our organization and our public offering and sustained losses or achieved minimal profitability during our initial years of operations. At December 31, 2010, we had an accumulated deficit account of approximately $7.5 million, principally resulting from the organizational and pre-opening expenses that we incurred in connection with the opening of the Bank, losses on loans, and accrued reserves in connection with the Agreement with the Comptroller. In addition, due to the extensive regulatory oversight to which we are subject, we expect to incur significant administrative costs. Our success will depend, in large part, on our ability to attract and retain deposits and customers for our services. If we are ultimately unsuccessful, you may lose part or all of the value of your investment.
 
 
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Our results of operation and financial condition would be adversely affected if our allowance for loan losses is not sufficient to absorb actual losses.

Experience in the banking industry indicates that a portion of our loans in all categories of our lending business will become delinquent, and some may only be partially repaid or may never be repaid at all. Our methodology for establishing the adequacy of the allowance for loan losses depends on subjective application of risk grades as indicators of borrowers’ ability to repay. Deterioration in general economic conditions and unforeseen risks affecting customers may have an adverse effect on borrowers’ capacity to repay timely their obligations before risk grades could reflect those changing conditions. In times of improving credit quality, with growth in our loan portfolio, the allowance for loan losses may decrease as a percent of total loans. Changes in economic and market conditions may increase the risk that the allowance would become inadequate if borrowers experience economic and other conditions adverse to their businesses. Maintaining the adequacy of our allowance for loan losses may require that we make significant and unanticipated increases in our provisions for loan losses, which would materially affect our results of operations and capital adequacy. Recognizing that many of our loans individually represent a significant percentage of our total allowance for loan losses, adverse collection experience in a relatively small number of loans could require an increase in our allowance. Federal regulators, as an integral part of their respective supervisory functions, periodically review our allowance for loan losses. The regulatory agencies may require us to change classifications or grades on loans, increase the allowance for loan losses with large provisions for loan losses and to recognize further loan charge-offs based upon their judgments, which may be different from ours. Any increase in the allowance for loan losses required by these regulatory agencies could have a negative effect on our results of operations and financial condition.

Failure to implement our business strategies may adversely affect our financial performance.

We have developed a business plan that details the strategies we intend to implement in our efforts to achieve profitable operations. If we cannot implement our business strategies, we will be hampered in our ability to develop business and serve our customers, which, in turn, could have an adverse effect on our financial performance. Even if our business strategies are successfully implemented, we cannot assure you that our strategies will have the favorable impact that we anticipate. Furthermore, while we believe that our business plan is reasonable and that our strategies will enable us to execute our business plan, we have no control over the future occurrence of certain events upon which our business plan and strategies are based, particularly general and local economic conditions that may affect the Bank’s loan-to-deposit ratio, total deposits, the rate of deposit growth, cost of funding, the level of earning assets and interest-related revenues and expenses.
 
We may elect or be compelled to seek additional capital, but that capital may not be available or it may be dilutive.

We are required by the Agreement with the Comptroller to achieve and maintain a Tier 1 leverage capital ratio of 9% and a total risk-based capital ratio of 11.5% by a date determined by the Agreement which is the earlier of 90 days after the Comptroller determines the restitution process has been completed or the Comptroller notifies us of such requirement.  As of December 31, 2010, we exceeded these requirements. However, the restitution process is not completed and, if the rate that currently issued checks are cashed exceeds the amount we have estimated, the Bank may be required to recognize additional payments on restitution checks.  As a result, our financial condition, capital ratios and results of operation may be materially adversely affected.
The Company currently does not have any capital available to invest in the Bank. We will look to raise additional capital through multiple avenues, including focused expense reductions, optimizing our balance sheet for loans and deposits and increasing net interest income and ultimately improving the overall earnings of the Company. A number of financial institutions have recently raised considerable amounts of capital as a result of deterioration in their results of operations and financial condition arising from the negative impact of the mortgage loan market, non-agency mortgage-backed security market, and deteriorating economic conditions, which may diminish our ability to raise additional capital.

Our ability to raise capital will depend on conditions in the capital markets, which are outside our control, and on our financial performance. Accordingly, we cannot be assured of our ability to raise capital when needed, on favorable terms or at all. If we cannot raise additional capital when needed, we will be subject to increased regulatory supervision and the imposition of restrictions on our growth and business. These outcomes could negatively impact our ability to operate or further expand our operations through acquisitions or the establishment of additional branches and may result in increases in operating expenses and reductions in revenues that could have a material adverse effect on our financial condition and results of operations. In addition, in order to raise additional capital, we may need to issue shares of our common stock that would dilute the book value of our common stock and reduce our shareholders’ percentage ownership interest to the extent they do not participate in future offerings. Also, if we are unable to raise additional capital, we may be required to take alterative actions which may include the sale of income-producing assets to meet our capital requirements, which could have an adverse impact on our operations and ability to generate income.
 
 
20

 
 
The success of our trust services is dependent upon market fluctuations and a non-diversified source for its growth.

Since August 2006, we have offered traditional fiduciary services such as serving as executor, trustee, agent, administrator or custodian for individuals, non profit organizations, employee benefit plans and organizations. The Bank received regulatory approval from the Comptroller to establish trust powers in February 2006. As of December 31, 2010, the Bank had approximately $853 million in trust assets under management. To date, virtually all of the growth in our assets under management relates to a registered investment advisor who has advised its clients of the existence of our trust services. We have not compensated the registered investment advisor in any way for making its clients aware of our trust services and cannot assure you that the investment advisor will continue to notify its clients of our trust services or that those clients will open trust accounts at the Bank. Furthermore, the level of assets under management is significantly impacted by the market value of the assets which has increased in 2009 and 2010 after the sharp decline during 2008. In addition, we are subject to regulatory supervision with respect to these trust services that may restrain our growth and profitability.

Certain of our investment advisory and wealth management contracts are subject to termination on short notice, and termination of a significant number of investment advisory contracts could have a material adverse impact on our revenue.

Certain of our investment advisory and wealth management clients can terminate their relationships with us, reduce their aggregate assets under management, or shift their funds to other types of accounts with different rate structures for any number of reasons, including investment performance, changes in prevailing interest rates, inflation, changes in investment preferences of clients, changes in our reputation in the marketplace, change in management or control of clients, loss of key investment management personnel and financial market performance. We cannot be certain that our trust operations will be able to retain all of its clients. If its clients terminate their investment advisory and wealth management contracts, our trust operations, and consequently we, could lose a substantial portion of our revenues and liquidity.

We have a loan concentration related to the acquisition and financing of dental practices.

Loan concentrations are considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At December 31, 2010, our commercial loan portfolio included $66.4 million of loans, approximately 57.6% of our total funded loans, to the dental industry, including practice acquisition loans, dental equipment loans, and dental facility loans. We believe that these loans are well secured to credit worthy borrowers and are diversified geographically. However, to the extent that there is a decline in the dental practice in general, we may incur significant losses in our loan portfolio as a result of this concentration.
 
Our operations are significantly affected by interest rate levels.

Our profitability is dependent to a large extent on our net interest income, which is the difference between interest income we earn as a result of interest paid to us on loans and investments and interest we pay to third parties such as our depositors and those from whom we borrow funds. Like most financial institutions, we are affected by changes in general interest rate levels, which are currently at record low levels, and by other economic factors beyond our control. Prolonged periods of unusually low interest rates may have an adverse effect on earnings by reducing the value of demand deposits, stockholders’ equity and fixed rate liabilities with rates higher than available earning assets. Interest rate risk can result from mismatches between the dollar amount of repricing or maturing assets and liabilities and from mismatches in the timing and rate at which our assets and liabilities reprice. Although we have implemented strategies which we believe reduce the potential effects of changes in interest rates on our results of operations, these strategies will not always be successful. In addition, any substantial and prolonged increase in market interest rates could reduce our customers’ desire to borrow money from us or adversely affect their ability to repay their outstanding loans by increasing their costs since most of our loans have adjustable interest rates that reset periodically. If our borrowers’ ability to repay is affected, our level of non-performing assets would increase and the amount of interest earned on loans will decrease, thereby having an adverse effect on operating results. Any of these events could adversely affect our results of operations or financial condition.

We face intense competition from a variety of competitors.

We face competition for deposits, loans, and other financial services from other community banks, regional banks, out-of-state and in-state national banks, savings banks, thrifts, credit unions and other financial institutions as well as other entities which provide financial services, including consumer finance companies, securities brokerage firms, insurance companies, mutual funds, and other lending sources and alternative investment providers. Some of these financial institutions and financial services organizations are not subject to the same degree of regulation as we are. We face increased competition due to the Gramm-Leach-Bliley Act, which allows insurance firms, securities firms, and other non-traditional financial companies to provide traditional banking services. The banking business in our target banking market and the surrounding areas has become increasingly competitive over the past several years, and we expect the level of competition to continue to increase. Many of these competitors have been in business for many years, have established customers, are larger, have substantially higher lending limits than we do, and are able to offer certain services that we do not provide. In addition, many of these entities have greater capital resources than we have, which among other things may allow them to price their services at levels more favorable to the customer or to provide larger credit facilities.
 
 
21

 
 
We believe that the Bank will be a successful competitor in the area’s financial services market. An inability to compete effectively with other financial institutions serving our target banking market could have a material adverse effect on the Bank’s growth and profitability.

We compete in an industry that continually experiences technological change, and we may not be able to compete effectively with other banking institutions with greater resources.

The banking industry continues to undergo rapid technological changes with frequent introduction of new technology-driven products and services. In addition to providing better service to customers, the effective use of technology increases efficiency and enables us to reduce costs. Our future success depends in part upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional operating efficiencies. Many of our competitors have substantially greater resources to invest in technological improvements. Such technology may permit competitors to perform certain functions at a lower cost than we can. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these to our customers. Our inability to do so could have a material adverse effect on our ability to compete effectively in our market and also on our business, financial condition, and results of operations.

Our legal lending limits may impair our ability to attract borrowers and ability to compete with larger financial institutions.

Our per customer lending limit at December 31, 2010 was approximately $1.9 million, subject to further reduction based on regulatory criteria. Accordingly, the size of loans which we can offer to potential customers is less than the size which many of our competitors with larger lending limits are able to offer. This limit has affected and will continue to affect our ability to seek relationships with larger businesses in our market area. We accommodate loans in excess of our lending limit through the sale of portions of such loans to other banks. However, we may not be successful in attracting or maintaining customers seeking larger loans or in selling portions of such larger loans on terms that are favorable to us.

An economic downturn, especially one affecting our primary service area, could diminish the quality of our loan portfolio, reduce our deposit base, and negatively affect our financial performance.

Adverse economic developments can impact the collectability of loans and the sustainability of our core deposits and may negatively impact our earnings and financial condition. In addition, the banking industry in general is affected by economic conditions such as inflation, recession, unemployment, and other factors beyond our control. A prolonged economic recession or other economic dislocation could cause increases in nonperforming assets and impair the values of real estate collateral, thereby causing operating losses, decreasing liquidity, and eroding capital. Factors that adversely affect the economy in our local banking market could reduce our deposit base and the demand for our products and services, which may decrease our earnings capability.
 
Monetary policy and other economic factors could adversely affect the Bank’s profitability.

Our results of operations may be materially and adversely affected by changes in prevailing economic conditions, including declines in real estate market values, rapid changes in interest rates, and the monetary and fiscal policies of the federal government. Our profitability is partly a function of the spread between the interest rates earned on investments and loans and those paid on deposits. As with most banking institutions, our net interest spread is affected by general economic conditions and other factors that influence market interest rates and our ability to respond to changes in such rates. At any given time, our assets and liabilities may be affected differently by a given change in interest rates. As a result, an increase or decrease in rates could have a material adverse effect on our net income, capital and liquidity. While we take measures to reduce interest-rate risk, these measures may not adequately minimize exposure to interest-rate risk.

We are subject to extensive regulatory oversight, which could constrain our growth and profitability.

Banking organizations such as the Company and the Bank are subject to extensive federal and state regulation and supervision. Laws and regulations affecting financial institutions are undergoing continuous change, and we cannot predict the ultimate effect of these changes. We cannot assure you that any change in the regulatory structure or the applicable statutes and regulations will not materially and adversely affect the business, condition or operations of the Company or the Bank or benefit competing entities that are not subject to the same regulations and supervision.

Bank regulators have imposed various conditions, among other things, that: (1) the Company would not assume additional debt without prior approval by the Federal Reserve Board; (2) the Company and the Bank will remain well-capitalized at all times; (3) we will make appropriate filings with the regulatory agencies; and (4) the Bank will meet all regulatory requirements as set forth. The regulatory capital requirements imposed on the Bank could have the effect of constraining growth.

We are subject to extensive state and federal government supervision and regulations that impose substantial limitations with respect to loans, purchase of securities, payments of dividends, and many other aspects of the banking business. Regulators include the Comptroller, the Federal Reserve, and the FDIC. Applicable laws, regulations, interpretations, assessments and enforcement policies have been subject to significant and sometimes retroactively applied changes and may be subject to significant future changes.
 
 
22

 
 
The Dodd-Frank Act, enacted in July 2010, instituted major changes to the banking and financial institutions regulatory regimes in light of the recent performance of and government intervention in the financial services sector. Other changes to statues, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect the Company in substantial and unpredictable ways. Such changes could subject the Company to reduced revenues, additional costs, limit the types of financial services and products the Company may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on the Company’s business, financial condition and results of operations.

Regulatory agencies are funded, in part, by assessments imposed upon banks. Additional assessments could occur in the future which could impact our financial condition. Many of these regulations are intended to protect depositors, the public, and the FDIC, not shareholders. Future legislation or government policy could adversely affect the banking industry, our operations, or shareholders. The burden imposed by federal and state regulations may place banks, in general, and us, specifically, at a competitive disadvantage compared to less regulated competitors. Federal economic and monetary policy may affect our ability to attract deposits, make loans, and achieve satisfactory operating results.

Current adverse market conditions have resulted in a lack of liquidity and reduced business activity.

Dramatic declines in the housing market, with falling home prices and increasing foreclosures and unemployment have resulted in significant write-downs of asset values by financial institutions.  These write-downs have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail.  To the extent a weak institution in our market merges with or is acquired by a stronger institution, the competition within the market may increase.  Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced, and in some cases, ceased to provide funding to borrowers including other financial institutions.  The willingness of other banks to lend to the Bank may be further reduced by the fact the Bank is new and has no established banking relationships.  Loans from other banks will be essential for the Bank to maintain liquidity and grow its loan portfolio.  The Bank anticipates having sufficient liquidity to fund its immediate growth and operations following its initial capitalization; however, a prolonged lack of available credit with resulting reduced business activity could materially adversely affect our business, financial condition and results of operations.

RISKS RELATED TO OUR COMMON STOCK

Our common stock is thinly traded and, therefore, you may have difficulty selling shares.

The Company’s common stock is traded on the Over-the-Counter Bulletin Board (“OTCBB”); however, we have no ability to ensure that an active market will exist in the future or that shares can be liquidated without delay. The average daily trading volume in our stock was 284 in 2010.

We do not anticipate paying dividends for the foreseeable future.

We do not anticipate dividends will be paid on our common stock for the foreseeable future. The Company is largely dependent upon dividends paid by the Bank to provide funds to pay cash dividends if and when the board of directors may declare such dividends. No assurance can be given that future earnings will be sufficient to satisfy regulatory requirements and permit the legal payment of dividends to shareholders at any time in the future. Even if we could legally declare dividends, the amount and timing of such dividends would be at the discretion of our board of directors. The board may in its sole discretion decide not to declare dividends.
 
The market price of our common stock may be volatile.

The market price of our common stock is subject to fluctuations as a result of a variety of factors, including the following:

 
·
quarterly variations in our operating results or those of other banking institutions;

 
·
changes in national and regional economic conditions, financial markets or the banking industry; and

 
·
other developments affecting us or other financial institutions.

The trading volume of our common stock is limited, which may increase the volatility of the market price for our stock. In addition, the stock market has experienced significant price and volume fluctuations in recent years. This volatility has had a significant effect on the market prices of securities issued by many companies for reasons not necessarily related to the operating performance of these companies.
 
 
23

 
 
Item 2. 
Properties.

Our main office is located at 16000 Dallas Parkway, Dallas, Texas 75248. We occupy 4,357 square feet of the main lobby-accessed ground floor of a multi-story office building at that address. The lease for our main office began on January 1, 2004 and is for a term of 125 months.  We subsequently leased an additional 3,493 square feet on the second floor of the same building to house our trust and operations areas. The lease began on June 1, 2006, and is for a term of 64 months. The leases also call for the Bank to pay for a pro rata share of operating, tax and electric costs above a certain base amount. We also operate a branch office located at 8100 North Dallas Parkway, Plano, Texas, which is approximately 10 miles north of the main office. The branch office occupies 1,750 square feet in a two story, commercial building in a developed commercial center. The lease for our branch office began on December 1, 2003 and is for a term of 120 months. The lease rate increased on month 60. The lease also calls for the Bank to pay for a pro rata share of operating and tax costs above a certain base amount. We also operate a loan production office located at 850 E Highway 114, Southlake, Texas, which is approximately 15 miles northwest of the main office. The loan production office occupies 2,245 square feet on the second floor of a two story, commercial building in a developed commercial center. The lease for our office began on February 1, 2007 and is for a term of 120 months. The lease rate is scheduled to increase on February 1, 2012. The lease also calls for the Bank to pay for a pro rata share of operating and tax costs above a certain base amount. Management believes that the principal terms of the leases are consistent with prevailing market terms and conditions and that these facilities are in good condition and adequate to meet our current needs.

Item 3. 
Legal Proceedings.

The Bank is involved, from time to time, as plaintiff or defendant in various legal actions arising in the normal course of its business. Based on the information presently available, management believes that the ultimate outcome in such proceedings, in the aggregate, will not have a material adverse effect on the business’s financial condition or results of operations of the Company on a consolidated basis.  On April 15, 2010, the Bank settled a threatened enforcement action by the Comptroller.  See “Item 1A – Risk Factors”

Item 4. 
[Removed and Reserved]

PART II

Item 5. 
Market for Registrant’s Common Equity and Related Shareholder Matters and Issuer Purchases of Equity Securities.

Market Information

Our common stock has been quoted on the OTCBB under the symbol “TBNC.OB” since June 2007 and “FMPX.OB” from November 2004 to June 2007. The table below gives the high and low bid information for the last two fiscal years. The bid information in the table was obtained from the OTCBB and reflects inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions. There may have been other transactions in our common stock of which we are not aware.

   
High
   
Low
 
2010
           
Fourth Quarter
 
$
2.50
   
$
1.60
 
Third Quarter
 
$
3.50
   
$
1.50
 
Second Quarter
 
$
3.75
   
$
0.75
 
First Quarter
 
$
5.76
   
$
3.00
 
                 
2009
               
Fourth Quarter
 
$
5.38
   
$
4.55
 
Third Quarter
 
$
5.80
   
$
3.75
 
Second Quarter
 
$
6.00
   
$
3.00
 
First Quarter
 
$
7.25
   
$
3.50
 

On March 22, 2011 we had 354 holders of record of our common stock.
 
 
24

 
 
Dividends

It is the policy of our Board of Directors to reinvest earnings for such period of time as is necessary to ensure our successful operations. There are no current plans to initiate payment of cash dividends, and future dividends will depend on our earnings, capital and regulatory requirements, financial condition, and other factors considered relevant by our Board of Directors. In addition, we are subject to regulatory restrictions on our payment of dividends. For more information regarding the Company’s ability to pay dividends, please refer to the “Supervision and Regulation” section under Item 1.

Securities Authorized for Issuance Under Equity Compensation Plans

Equity Compensation Plan Information

Plan Category
 
Number of securities
to be issued upon
exercise of
outstanding options,
warrants, and rights
(a)
   
Weighted average
exercise price of
outstanding options,
warrants, and rights
(b)
   
Number of securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected in (a))
 
                   
Equity compensation plans approved by security holders
   
260,000
   
$
9.14
     
36,500
 

Item 6. 
Select Financial Data.

Because the registrant is a small business issuer, disclosure under this item is not required.

Item 7. 
Management’s Discussion and Analysis of Financial Condition and Results of Operation.

This management’s discussion and analysis of financial condition and results of operations contains forward-looking statements that involve risks and uncertainties. Please see “Item 1—Business—Forward-Looking Statements” for a discussion of the uncertainties, risks and assumptions associated with these statements. You should read the following discussion in conjunction with our audited consolidated financial statements and the notes to our audited consolidated financial statements included elsewhere in this report. Our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those listed under “Item 1A—Risk Factors” and included in other portions of this report.

General

We are a bank holding company headquartered in Dallas, Texas, offering a broad array of banking services through our wholly owned banking subsidiary, T Bank, N.A.

We were incorporated under the laws of the State of Texas on December 23, 2002 to organize and serve as the holding company for the Bank. The Bank opened for business on November 2, 2004.

Business Strategy

The Bank operates as a full-service community bank emphasizing prompt, personalized customer service to further our strategy of attracting deposits from the general public and using such deposits and other sources of funds to originate commercial business loans, commercial real estate loans, and a variety of consumer loans. We believe our philosophy, encompassing the service aspects of community banking, distinguish the Bank from its larger and non-locally owned competitors and allows us to capitalize on an opportunity as a locally-owned and locally-managed community bank to acquire significant market share.

The Bank’s goal is to sustain profitability, maintain controlled growth by focusing on increasing our loan and deposit market share by developing and offering new financial products, services and delivery channels; closely managing yields on earning assets and rates on interest-bearing liabilities; focusing on noninterest income opportunities, controlling noninterest expenses and maintaining strong asset quality.
 
 
25

 
 
2010 Executive Overview

Financial Highlights

The following were significant factors related to 2010 results as compared to 2009.

Total assets were lower at December 31, 2010 as compared to December 31, 2009 at $115.1 million and $139.4 million, respectively. All of this decline was due to decline in net loans by $27.2 million from December 31, 2009. Management allowed loan runoff throughout the year and minimized new loan production in order to strengthen the Bank’s capital ratios.

Cash and equivalents at December 31, 2010 increased by $2.9 million to $10.2 million as compared to December 31, 2009;

Total liabilities were down $23.8 million to $104.0 million at December 31, 2010 compared to December 31, 2009, which included a decline in deposits of $12.4 million and borrowings of $10.0 million. These declines corresponded with the intended decrease in total assets.

Although net loans declined, net interest income remained unchanged for the year ending 2010 at $5.2 million compared to $5.2 million for the year ending 2009. This is primarily due to improvement in the Bank’s net interest margin increasing from 3.4% at December 31, 2009 to 4.3% at December 31, 2010, despite the reduction in the amount of earning assets.

Trust income was up $889,000 and was partially offset by an increase in trust expenses, resulting in a net increase of $101,000 in net trust income for 2010 compared to 2009. This increase is primarily due to the financial equities markets averaging higher in 2010 compared to the prior year, and both trust income and expenses correlate closely to the market value of assets in custody which are largely invested in the markets.

The Company recorded a provision for loan losses of approximately $851,000 for the year ended December 31, 2010, a decrease of $519,000, from the $1.4 million provision for loan losses in 2009. The allowance for loan loss to total loans percentage increased from 1.39% at December 31, 2009 to 1.83% at December 31, 2010. Loan charge-offs of $1.06 million occurring prior to March 31, 2010, were followed by net loan recoveries of $250,000 in the following three quarters, resulting in net loan charge-offs of $810,000 for the year ended December 31, 2010 compared to $1.3 million in the prior year.  

Nonperforming assets decreased 24%, from $5.4 million as of December 31, 2009 to $4.1 million as of December 31, 2010. Ratios of nonperforming assets as a percentage of total assets also decreased from 3.88% at December 31, 2009 to 3.58% at December 31, 2010.

Net loss for 2010 was $470,000, compared to net loss of $3.8 million in 2009. The $851,000 provision for loan losses as well as a $560,000 provision for restitution payments related the Low Pay merchant covered by the Agreement with the Comptroller created the net loss, which was offset significantly by ordinary operating profits. The net loss for 2009 was primarily the result of $1.3 million in net loan charge-offs, the initial charge of $2.4 million to establish a reserve for consumer restitution for the twelve merchants other than Low Pay in connection with the Agreement with the Comptroller, and a reserve of $185,000 representing the estimated cost to administer the Restitution. (see Item 1A “ Risk Factors ”)

 Recent Developments

In September, 2010, the FTC reached a settlement with one of the merchants, Low Pay. Under the terms of the Bank’s Agreement with the Comptroller, the Bank will receive a refund from the FTC if the FTC is successful collecting its settlement against Low Pay.  We expect that any such refund will be no more than $70 thousand.  With the FTC settlement with Low Pay completed, the Bank was able to move forward with issuing restitution checks totaling approximately $1.6 million, which it did on February 25, 2011. The Bank recorded an additional $560 thousand expense accrual as of September, 2010, for the Low Pay restitution payments.  This was added to the existing $2.4 million previously recorded as of December 31, 2009.  As of December 31, 2010, the Bank had not used, nor had any further obligation to pay, $429 thousand of the previously recorded restitution reserve accrual. The additional expense accrual related to Low Pay resulted in a total restitution reserve accrual as of December 31, 2010, of $989 thousand, or 62% of the total of the Low Pay restitution checks issued.  
 
 
26

 
 
Critical Accounting Policies

The Company’s financial condition and results of operations are sensitive to accounting measurements and estimates of matters that are inherently uncertain. When applying accounting policies in areas that are subjective in nature, the Company must use its best judgment to arrive at that carrying value of certain assets. The following accounting policies are identified by management as being critical to the results of operations:

Allowance for Credit Losses

The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. Management estimates the allowance balance required by considering the collectability of loans based on historical experience and the borrower’s ability to repay, the nature and volume of the portfolio, information about specific borrower situations and the estimated value of any underlying collateral, economic conditions and other factors. The allowance consists of general and specific reserves. The specific component relates to loans that are individually evaluated and determined to be impaired. This evaluation is often based on significant estimates and assumptions due to the level of subjectivity and judgment necessary to account for highly uncertain matters of the susceptibility of such matters to change. The general component relates to the entire group of loans that are evaluated in the aggregate based primarily on industry historical loss experience adjusted for current economic factors. To the extent actual loan losses differ materially from management’s estimate of these subjective factors, loan growth/run-off accelerates, or the mix of loan types changes, the level of the provision for loan loss, and related allowance can, and will, fluctuate. As of December 31, 2010, the allowance for loan loss was $1.8 million which represented approximately 1.83% of total loans.

Securities available for sale

Securities available for sale are evaluated periodically to determine whether a decline in their value is other than temporary. The term "other than temporary" is not intended to indicate a permanent decline in value. Rather, it means that the prospects for near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of the security.

The initial indication of OTTI for both debt and equity securities is a decline in the market value below the amount recorded for an investment, and the severity and duration of the decline. In determining whether an impairment is other than temporary, we consider the length of time and the extent to which the market value has been below cost, recent events specific to the issuer, including investment downgrades by rating agencies and economic conditions of its industry, our intent to sell the investment, and if it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. For marketable equity securities, we also consider the issuer's financial condition, capital strength, and near−term prospects. For debt securities and for perpetual preferred securities that are treated as debt securities for the purpose of OTTI analysis, we also consider the cause of the price decline (general level of interest rates and industry− and issuer−specific factors), the issuer's financial condition, near−term prospects and current ability to make future payments in a timely manner, the issuer's ability to service debt, and any change in agencies' ratings at evaluation date from acquisition date and any likely imminent action. Once a decline in value is determined to be other than temporary, the security is segmented into credit− and noncredit−related components. Any impairment adjustment due to identified credit−related components is recorded as an adjustment to current period earnings, while noncredit−related fair value adjustments are recorded through other comprehensive income. In situations where we intend to sell or it is more likely than not that we will be required to sell the security, the entire OTTI loss must be recognized in earnings.

Income Taxes

Deferred tax assets and liabilities are the expected future tax amounts for the temporary difference between carrying amounts and tax basis of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. Positions taken by the Company in preparing the consolidated federal tax return are subject to the review of the Internal Revenue Service or to reinterpretation based on management’s ongoing assessment of facts and evolving case law, and as such positions taken by management could result in a material adjustment to the financial statements.

Periodically and in the ordinary course of business, we are involved in inquiries and reviews by tax authorities that normally require management to provide supplemental information to support certain tax positions we take in our tax returns. Uncertain tax positions are initially recognized in the financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions are initially and subsequently measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and all relevant facts. Management believes it has taken appropriate positions on its tax returns, although the ultimate outcome of any tax review cannot be predicted with certainty. Still, no assurance can be given that the final outcome of these matters will not be different than what is reflected in the current and historical financial statements.
 
 
27

 
 
Loan income recognition

Interest income on loans is accrued at the contractual rate based on the principal outstanding. Loan origination fees and certain direct loan origination costs are deferred and amortized as a yield adjustment over the contractual loan terms. Accrual of interest is discontinued when its receipt is in doubt, which typically occurs when a loan becomes impaired. Any interest accrued to income in the year when interest accruals are discontinued is generally reversed. Management may elect to continue the accrual of interest when a loan is in the process of collection and the estimated fair value of the collateral is sufficient to satisfy the principal balance and accrued interest. Loans are returned to accrual status once the doubt concerning collectability has been removed and the borrower has demonstrated the ability to pay and remain current. Payments on nonaccrual loans are generally applied to principal.

Real estate acquired through foreclosure

We record foreclosed real estate assets at the lower of cost or estimated fair value on the acquisition date and at the lower of such initial amount or estimated fair value less estimated selling costs thereafter. Estimated fair value is based upon many subjective factors, including location and condition of the property and current economic conditions, among other things. Because the calculation of fair value relies on estimates and judgments relating to inherently uncertain events, results may differ from our estimates.

Write−downs at time of transfer are made through the allowance for loan losses. Write−downs subsequent to transfer are included in our noninterest expenses, along with operating income, net of related expenses of such properties and gains or losses realized upon disposition.

Stock Based Compensation

We adopted FASB ASC Topic 718 using the modified-prospective-transition method. Accordingly, no compensation expense was recognized in our financial statements for years ended prior to January 1, 2006. For the years ended December 31, 2010 and 2009, we recorded expense of $43,000 and $103,000, respectively, for option grants.

We calculated the compensation expense of the options using the Modified Black-Scholes-Merton option pricing model to determine the fair value of the options granted. In calculating the fair value of the options, management makes assumptions regarding the risk-free rate of return, the expected volatility of our common stock and the expected life of the options.

Recent Accounting Pronouncements

Please refer to Note 1 of the accompanying Consolidated Financial Statements for information related to the adoption of new accounting standards and the effect of newly issued but not yet effective accounting standards.

Financial Condition

Investment Securities

Securities held to maturity represent those securities which the Bank has the positive intent and ability to hold to maturity. The primary purpose of the Bank’s investment portfolio is to provide a source of earnings for liquidity management purposes, to provide collateral to pledge against public deposits, and to control interest rate risk. In managing the portfolio, the Bank seeks to attain the objectives of safety of principal, liquidity, diversification, and maximized return on investment.

At December 31, 2010, securities available for sale consisted of mortgage-backed securities guaranteed by U.S. government agencies. Securities held to maturity consisted of a GNMA mortgage backed security having an amortized cost of $641,000 and a fair value of $682,000. Restricted securities consisted of Federal Reserve Bank Stock, having an amortized cost and fair value of $420,000, Federal Home Loan Bank stock, having an amortized cost and fair value of $760,600. The weighted average yield for the securities was 2.73% at December 31, 2010.

At December 31, 2009, securities available for sale consisted of mortgage-backed securities guaranteed by U.S. government agencies. Securities held to maturity consisted of a GNMA mortgage backed security having an amortized cost of $801,000 and a fair value of $830,000. Restricted securities consisted of Federal Reserve Bank Stock, having an amortized cost and fair value of $420,000, Federal Home Loan Bank stock, having an amortized cost and fair value of $861,000. The weighted average yield for the securities was 2.37% at December 31, 2009.
 
 
28

 
 
The following presents the amortized cost and fair values of the securities portfolio at December 31, 2010 and 2009:

   
As of December 31,
 
   
2010
   
2009
 
(000's)
 
Amortized
Cost
   
Estimated
Fair Value
   
Amortized
Cost
   
Estimated
Fair Value
 
Securities Available for Sale:
                       
U.S. Government Agencies
 
$
4,077
   
$
4,067
   
$
3,988
   
$
4,005
 
Securities Held to Maturity:
                               
U.S. Government Agencies
   
641
     
682
     
801
     
830
 
Securities, restricted:
                               
Other
   
1,181
     
1,181
     
1,281
     
1,281
 
Total
 
$
5,899
   
$
5,930
   
$
6,070
   
$
6,116
 

The following tables summarize the maturity distribution schedule with corresponding weighted-average yields of securities held to maturity and securities available for sale as of December 31, 2010. Yields are calculated based on amortized cost. Mortgage-backed securities are included in maturity categories based on their stated maturity date. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Other securities classified as restricted include stock in the Federal Reserve Bank and the Federal Home Loan Bank, which have no maturity date. These securities have been included in the total column only.

  
  
Maturing
  
  
  
  
  
  
  
  
  
  
  
After One Year
  
  
After Five Years
  
  
 
  
  
 
  
  
  
One Year
  
  
Through
  
  
Through
  
  
After
  
  
 
  
  
  
or Less
  
  
Five Years
  
  
Ten Years
  
  
Ten Years
  
  
Total
  
(000's), except percentages
  
Amount
  
  
Yield
  
  
Amount
  
  
Yield
  
  
Amount
  
  
Yield
  
  
Amount
  
  
Yield
  
  
Amount
  
  
Yield
  
Securities Available for Sale:
                                                                               
U.S. Government Agencies
 
$
-
     
-
%
 
$
672
     
2.17
%
 
$
-
     
-
%
 
$
3,405
     
3.09
%
 
$
4,077
     
2.94
%
Securities Held to Maturity:
                                                                               
U.S. Government Agencies
   
-
     
-
     
-
     
-
     
-
     
-
     
641
     
5.15
     
641
     
5.15
 
Securities, restricted:
                                                                               
Other
   
-
       
-
   
-
       
-
   
-
     
-
     
-
     
-
     
1,181
     
-
 
Total
 
$
-
     
-
%
 
$
672
     
2.17
%
 
$
-
     
-
%
 
$
4,046
     
3.41
%
 
$
5,899
     
3.24
%

Loan Portfolio Composition

Commercial and industrial loans comprise the largest group of loans in our portfolio amounting to $64.4 million, or 67.0% of the total loan portfolio, at December 31, 2010, which is down from $88.9 million, or 72.1% of the total loan portfolio, at December 31, 2009. Commercial real estate loans comprise the second largest group of loans in the portfolio.  At December 31, 2010, commercial real estate loans totaled $30.7 million, or 32.0% of the total loan portfolio, compared to $32.5 million, or 26.4%, at year end in prior year. The following table sets forth the composition of our loan portfolio:

   
As of December 31,
 
(000's)
 
2010
   
2009
 
Commercial and industrial
 
$
64,381
     
67.0
%
 
$
88,920
     
72.1
%
Consumer installment
   
1,002
     
1.0
%
   
1,852
     
1.5
%
Real estate — mortgage
   
22,377
     
23.3
%
   
25,464
     
20.7
%
Real estate — construction and land
   
8,309
     
8.7
%
   
7,045
     
5.7
%
Other
   
6
     
0.0
%
   
2
     
0.0
%
   
$
96,075
     
100.0
%
 
$
123,283
     
100.0
%
                                 
Less allowance for loan losses
   
1,754
             
1,713
         
Less deferred loan fees
   
136
             
151
         
                                 
   
$
94,185
           
$
121,419
         
 
 
29

 
 
Loan concentrations are considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At December 31, 2010, our commercial loan portfolio included $66.4 million of loans, approximately 57.6% of our total funded loans, to the dental industry, as compared to $77.0 million, or 62.6% of total funded loans, at December 31, 2009. We believe that these loans are to credit worthy borrowers and are diversified geographically. As new loans are generated to replace loans which have paid off or reduced balances as a result of payments, the percentage of the total loan portfolio creating the foregoing concentration may remain constant thereby continuing the risk associated with industry concentration.

As of December 31, 2010, 20.7% of the loan portfolio consisting of commercial, consumer and real estate loans, or $19.9 million, matures or re-prices within one year or less. The following table presents the contractual maturity ranges for commercial, consumer and real estate loans outstanding at December 31, 2010 and 2009, and also presents for each maturity range the portion of loans that have fixed interest rates or variable interest rates over the life of the loan in accordance with changes in the interest rate environment as represented by the base rate:

   
As of December 31, 2010
 
       
Over 1 Year through 5 Years
 
Over 5 Years
     
(000's)
 
One Year or
Less
 
Fixed Rate
 
Floating or
Adjustable
Rate
 
Fixed Rate
 
Floating or
Adjustable
Rate
 
Total
 
                           
Commercial and industrial
 
$
6,708
   
$
6,558
   
$
28,038
   
$
22,422
   
$
655
   
$
64,381
 
Consumer installment
   
567
     
435
     
-
     
-
     
-
     
1,002
 
Real estate — mortgage
   
6,998
     
6,292
     
3,977
     
1,889
     
3,221
     
22,377
 
Real estate — construction and land
   
5,604
     
2,060
     
-
     
-
     
645
     
8,309
 
Other
   
6
     
-
     
-
     
-
     
-
     
6
 
                                                 
Total
 
$
19,883
   
$
15,345
   
$
32,015
   
$
24,311
   
$
4,521
   
$
96,075
 

   
As of December 31, 2009
 
       
Over 1 Year through 5 Years
 
Over 5 Years
     
(000's)
 
One Year or
Less
 
Fixed Rate
 
Floating or
Adjustable
Rate
 
Fixed Rate
 
Floating or
Adjustable
Rate
 
Total
 
                           
Commercial and industrial
 
$
19,132
   
$
5,950
   
$
1,798
   
$
30,948
   
$
31,092
   
$
88,920
 
Consumer installment
   
669
     
1,183
     
-
     
-
     
-
     
1,852
 
Real estate — mortgage
   
4,741
     
7,447
     
1,810
     
1,368
     
10,098
     
25,464
 
Real estate — construction and land
   
4,474
     
2,082
     
361
     
128
     
-
     
7,045
 
Other
   
2
     
-
     
-
     
-
     
-
     
2
 
                                                 
Total
 
$
29,018
   
$
16,662
   
$
3,969
   
$
32,444
   
$
41,190
   
$
123,283
 

Scheduled contractual principal repayments of loans do not reflect the actual life of such assets. The average life of loans is less than their average contractual terms due to prepayments.
 
 
30

 
 
Nonperforming Assets

Our primary business is making commercial, real estate, and consumer loans. That activity entails potential loan losses, the magnitude of which depends on a variety of economic factors affecting borrowers which are beyond our control. While we have instituted underwriting guidelines and policies and credit review procedures to protect us from avoidable credit losses, some losses will inevitably occur.

Non-performing assets include non-accrual loans and other repossessed assets. Non-performing assets decreased $1.3 million to $4.1 million at December 31, 2010, as compared to $5.4 million at December 31, 2009. Nonperforming loans decreased $2.0 million to $1.8 million at December 31, 2010, as compared to $3.8 million at December 31, 2009. Other real estate owned at December 31, 2010, increased $675,000 to $2.3 million, as compared to $1.6 million at December 31, 2009. 

Loans are placed on nonaccrual status when management has concerns relating to the ability to collect the loan principal and interest and generally when such loans are 90 days or more past due. A loan is considered impaired when it is probable that not all principal and interest amounts will be collected according to the loan contract.

Foreclosed assets represent property acquired as the result of borrower defaults on loans. Foreclosed assets are recorded at estimated fair value, less estimated selling costs, at the time of foreclosure. Write-downs occurring at foreclosure are charged against the allowance for possible loan losses. On an ongoing basis, properties are appraised as required by market indications and applicable regulations. Write-downs are provided for subsequent declines in value and are included in other non-interest expense along with other expenses related to maintaining the properties.

The following table sets forth certain information regarding nonaccrual loans by type, including ratio of such loans to total assets as of the dates indicated:

   
As of December 31,
 
(000's)
 
2010
   
2009
 
Allocated:
 
Amount
   
Loan
Category to
Total Assets
   
Amount
   
Loan
Category to
Total Assets
 
                         
Commercial and industrial
 
$
367
     
0.32
%
 
$
2,155
     
1.55
%
Real estate — mortgage
   
1,462
     
1.27
 
   
-
     
-
 
Real estate — construction
   
-
     
-
 
   
1,633
     
1.17
 
Consumer and other
   
-
     
-
 
   
-
     
-
 
Total nonaccrual loans
   
1,829
     
1.59
 
   
3,788
     
2.72
 
Other real estate owned
   
2,291
     
1.99
 
   
1,616
     
1.16
%
Total non-performing assets
 
$
4,120
     
3.58
%
 
$
5,404
     
3.88
%
Restructured loans
 
2,395
     
2.08
%
 
1,345
     
0.96
%
Loans past due 90 days and accruing
 
-
     
-
%
 
$
-
     
-
%

We record interest payments received on impaired loans as interest income unless collections of the remaining recorded investment are placed on nonaccrual, at which time we record payments received as reductions of principal. We recognized interest income on impaired loans of approximately $215,000 and $121,000 during the years ended December 31, 2010 and 2009, respectively. If interest on impaired loans had been recognized on a full accrual basis during the years ended December 31, 2010 and 2009, respectively, income would have increased by approximately $81,000 and $74,000.

Restructured loans are loans on which, due to the borrower’s financial difficulties, we have granted a concession that we would not otherwise consider. This may include a transfer of real estate or other assets from the borrower, a modification of loan terms, or a combination of the two. Modifications of terms that could potentially qualify as a restructuring include reduction of contractual interest rate, extension of the maturity date at a contractual interest rate lower than the current rate for new debt with similar risk, or a reduction of the face amount of debt, either forgiveness of principal or accrued interest. As of December 31, 2010 we have $2.4 million in loans considered restructured that are not already on nonaccrual. Of the nonaccrual loans at December 31, 2010, $367,000 met the criteria for restructured. A loan continues to qualify as restructured until a consistent payment history has been evidenced, generally no less than twelve months.

We had no loans past due 90 days and still accruing interest at December 31, 2010 and 2009.
 
 
31

 
 
Potential problem loans consist of loans that are performing in accordance with contractual terms, but for which we have concerns about the borrower’s ability to comply with repayment terms because of the borrower’s potential financial difficulties. We monitor these loans closely and review their performance on a regular basis. At December 31, 2010  we had $682,000 in loans of this type, which were not included in non-accrual or restructured loans.

Credit Risk Management

Credit risk is the risk of loss arising from the inability of a borrower to meet its obligations. We manage credit risk by evaluating the risk profile of the borrower, repayment sources, the nature of the underlying collateral, and other support given current events, conditions, and expectations. We attempt to manage the risk characteristics of our loan portfolio through various control processes, such as credit evaluation of borrowers, establishment of lending limits, and application of lending procedures, including the holding of adequate collateral and the maintenance of compensating balances. However, we seek to rely primarily on the cash flow of our borrowers as the principal source of repayment. Although credit policies and evaluation processes are designed to minimize our risk, management recognizes that loan losses will occur and the amount of these losses will fluctuate depending on the risk characteristics of our loan portfolio, as well as general and regional economic conditions.

We provide for loan losses through the establishment of an allowance for loan losses by provisions charged against earnings. Our allowance represents an estimated reserve for existing losses in the loan portfolio. We deploy a systematic methodology for determining our allowance that includes a quarterly review process, risk rating, and adjustment to our allowance. We classify our portfolios as either consumer or commercial and monitor credit risk separately as discussed below. We evaluate the adequacy of our allowance continually based on a review of all significant loans, with a particular emphasis on nonaccruing, past due, and other loans that we believe require special attention.

The allowance consists of two elements: (1) specific reserves and valuation allowances for individual credits; (2) general reserves for types or portfolios of loans based on historical loan loss experience, judgmentally adjusted for current conditions and credit risk concentrations. All outstanding loans are considered in evaluating the adequacy of the allowance.

Allowance for Loan Losses

The allowance for loan losses is a valuation allowance for credit losses in the loan portfolio. Management has adopted a methodology to properly analyze and determine an adequate loan loss allowance. The analysis is based on sound, reliable and well documented information and is designed to support an allowance that is adequate to absorb all estimated incurred losses in our loan portfolio.

In estimating the specific and general exposure to loss on impaired loans, we have considered a number of factors, including the borrower’s character, overall financial condition, resources and payment record, the prospects for support from any financially responsible guarantors, and the realizable value of any collateral.

We also consider other internal and external factors when determining the allowance for loan losses, which include, but are not limited to, changes in national and local economic conditions, loan portfolio concentrations, and trends in the loan portfolio.

Senior management and the Directors Loan Committee review this calculation and the underlying assumptions on a routine basis not less frequently than quarterly.

The allowance for loan losses amounted to $1.8 million at December 31, 2010 and $1.7 million at December 31, 2009. During the year ended December 31, 2010, the Bank had charge-offs of $1.4 million compared to $1.3 million for the year ended December 31, 2009. The Bank did not experience any charge-offs prior to 2008.  The total reserve percentage increased to 1.83% at year-end 2009 from 1.39% of loans at December 31, 2009 as a result of the effects of economic conditions on borrowers and values of assets pledged as collateral. Based on an analysis performed by management at December 31, 2010, the allowance for loan losses is considered to be adequate to cover estimated loan losses in the portfolio as of that date. However, management’s judgment is based upon a number of assumptions about future events, which are believed to be reasonable, but which may or may not prove valid. Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for loan losses or that significant additional increases in the allowance for loan losses will not be required.
 
 
32

 
 
The table below presents a summary of our loan loss experience for the past five years:

(000's), except percentages
  
2010
  
  
2009
  
  
2008
  
  
2007
  
  
2006
  
Balance at January 1,
 
$
1,713
   
$
1,638
   
$
1,600
   
$
1,000
   
$
400
 
                                         
Charge-offs:
                                       
Commercial and industrial
   
1,224
     
933
     
451
     
-
     
-
 
Consumer installment
   
4
     
88
     
-
     
-
     
-
 
Real estate – construction and land
   
129
     
282
     
-
     
-
     
-
 
Total charge-offs
   
1,357
     
1,303
     
451
     
-
     
-
 
                                         
Recoveries:
                                       
Commercial and industrial
   
547
     
9
     
72
     
-
     
-
 
Consumer installment
   
-
     
-
     
-
     
-
     
-
 
Real estate – construction and land
   
-
     
-
     
-
     
-
     
-
 
Total recoveries
   
547
     
9
     
72
     
-
     
-
 
                               
                                         
Net charge-offs
   
810
     
1,294
     
379
     
-
     
-
 
                                         
Provision for loan losses
   
851
     
1,369
     
417
     
600
     
600
 
Balance at December 31,
 
$
1,754
   
$
1,713
   
$
1,638
   
$
1,600
   
$
1,000
 
                               
                                         
Loans at year-end
 
$
96,075
   
$
123,283
   
$
125,177
   
$
121,726
   
$
89,323
 
Average loans
   
111,556
     
122,814
     
132,524
     
104,943
     
50,125
 
                                         
Net charge-offs/average loans
   
0.73
%
   
1.05
%
   
0.29
%
   
-
%
   
-
%
Allowance for loan losses/year-end loans
   
1.83
     
1.39
     
1.31
     
1.31
     
1.12
 
Total provision for loan losses/average loans
   
0.76
%
   
1.11
%
   
0.31
%
   
0.06
%
   
1.20
%

The following table sets forth the specific allocation of the allowance for years ended December 31, 2010 and 2009 and the percentage of allocated possible loan losses in each category to total gross loans:

   
As of December 31,
 
(000's), except percentages
 
2010
   
2009
 
Allocated:
 
Amount
   
Loan
Category to
Gross Loans
   
Amount
   
Loan
Category to
Gross Loans
 
                         
Commercial and industrial
 
$
1,175
     
67.0
%
 
$
1,285
     
75.0
%
Consumer installment
   
18
     
1.0
 
   
23
     
1.3
 
Real estate — mortgage
   
409
     
23.3
 
   
318
     
18.6
 
Real estate — construction and land
   
152
     
8.6
 
   
87
     
5.1
 
Total allowance for loan losses
 
$
1,754
     
100.0
%
 
$
1,713
     
100.0
%
Note: An allocation for a loan classification is only for internal analysis of the adequacy of the allowance and is not an indication of expected or anticipated losses.

Sources of Funds

General

Deposits, loan and investment security repayments and prepayments, proceeds from the sale of securities, and cash flows generated from operations are the primary sources of our funds for lending, investing, and other general purposes. Loan repayments are generally a relatively stable source of funds, while deposit inflows and outflows tend to fluctuate with prevailing interests rates, markets and economic conditions, and competition.
 
 
33

 
 
Deposits

Deposits are attracted principally from our primary geographic market area with the exception of time deposits, which, due to the Bank’s attractive rates, are attracted from across the nation. The Bank offers a broad selection of deposit products, including demand deposit accounts, NOW accounts, money market accounts, regular savings accounts, term certificates of deposit and retirement savings plans (such as IRAs). Deposit account terms vary, with the primary differences being the minimum balance required, the time period the funds must remain on deposit, and the associated interest rates. Management sets the deposit interest rates weekly based on a review of deposit flows for the previous week, and a survey of rates among competitors and other financial institutions. The Bank relies primarily on customer service and long-standing relationships with customers to attract and retain deposits; however, market interest rates and rates offered by competing financial institutions significantly affect the Bank’s ability to attract and retain deposits. The Bank cannot be considered well capitalized, regardless of its capital ratios. Because of FDIC restrictions which took affect on January 1, 2010 for all insured banks which are not well capitalized, the Bank is restricted from offering rates in excess of .75% over the national average rate for various deposit terms as published weekly by the FDIC.  This further affects the Bank’s ability to attract and retain deposits. (See Item 1A “Risk Factors” for additional discussion regarding our ability to attract and retain deposits).
 
The following table sets forth our average deposit account balances, the percentage of each type of deposit to total deposits, and average cost of funds for each category of deposits:

   
As of December 31,
 
(000's), except percentages
 
2010
   
2009
 
   
Average
Balance
   
Percent of
Deposits
   
Average
Rate
   
Average
Balance
   
Percent of
Deposits
   
Average
Rate
 
Noninterest bearing deposits
  $ 10,499       10.0 %     0.00 %   $ 9,931       8.4 %     0.00 %
NOW accounts  
    1,983       1.9       0.68       1,876       1.6       0.74  
Money market accounts  
    35,869       34.2       0.88       48,249       40.8       1.40  
Savings accounts  
    183       0.2       0.89       197       0.2       1.07  
Certificates of deposit less than $100,000  
    13,794       13.1       3.75       18,607       15.7       4.34  
Certificates of deposit $100,000 or more  
    42,642       40.6       4.05       39,298       33.3       4.57  
   
                                               
Total average deposits  
  $ 104,970       100.0 %     2.72 %   $ 118,158       100.00 %     3.04 %

The following table presents maturity of our domestic certificates of deposits and other time deposits of $100,000 or more at December 31, 2010 and 2009:

   
As of December 31,
 
(000's)
 
2010
   
2009
 
             
Three months or less
 
$
1,467
   
$
8,869
 
Over three months through six months
   
9,184
     
6,695
 
Over six months through twelve months
   
18,420
     
3,620
 
Over twelve months
   
13,368
     
26,850
 
                 
Total
 
$
42,439
   
$
46,034
 

Liquidity

Our liquidity relates to our ability to maintain a steady flow of funds to support our ongoing operating, investing and financing activities. Our Board establishes policies and analyzes and manages liquidity to ensure that adequate funds are available to meet normal operating requirements in addition to unexpected customer demands for funds, such as high levels of deposit withdrawals or loan demand, in a timely and cost-effective manner. The most important factor in the preservation of liquidity is maintaining public confidence that facilitates the retention and growth of a large, stable supply of core deposits and funds. Ultimately, public confidence is generated through profitable operations, sound credit quality and a strong capital position. Liquidity management is viewed from a long-term and a short-term perspective as well as from an asset and liability perspective. We monitor liquidity through a regular review of loan and deposit maturities and forecasts, incorporating this information into a detailed projected cash flow model.
 
 
34

 
 
The Bank’s primary sources of funds will be retail and commercial deposits, loan repayments, maturity of investment securities, other short-term borrowings, and other funds provided by operations. While scheduled loan repayments and maturing investments are relatively predictable, deposit flows and loan prepayments are more influenced by interest rates, general economic conditions, and competition. The Bank will maintain investments in liquid assets based upon management’s assessment of (1) the need for funds, (2) expected deposit flows, (3) yields available on short-term liquid assets, and (4) objectives of the asset/liability management program.

The Bank had cash and cash equivalents of $10.2 million, or 8.8% of total assets at December 31, 2010. In addition to the on balance sheet liquidity available, the Bank has lines of credit with the Federal Home Loan Bank (“FHLB”) and the Federal Reserve Bank of Dallas (“FRB”), which provides the Bank with a source of off-balance sheet liquidity. As of December 31, 2010, the Bank’s established credit line with the FHLB was $17.9 million, or 15.5% of assets, of which $6.0 million was utilized or outstanding. The established credit line with the FRB was $25.3 million, or 22.0% of assets, of which none was utilized at December 31, 2010. The Bank’s trust operations serve in a fiduciary capacity for approximately $853 million in total market value of assets as of December 31, 2010. Some of these custody assets are invested in cash. This cash is maintained either in a third party money market mutual fund (invested predominately in U.S. Treasury securities and other high grade investments) or in a Bank money market account. Only cash which is fully insured by the FDIC is maintained at the Bank. This cash can be moved readily between the Bank and the third party money market mutual fund.  As of December 31, 2010, there was $31.5 million of cash at the third party money market mutual fund available to transfer to the Bank which would be fully FDIC insured for the trust customers of the Bank.

Net Interest Income

The following table presents the changes in net interest income and identifies the changes due to differences in the average volume of earning assets and interest–bearing liabilities and the changes due to changes in the average interest rate on those assets and liabilities.  The changes in net interest income due to changes in both average volume and average interest rate have been allocated to the average volume change or the average interest rate change in proportion to the absolute amounts of the change in each.

   
2010 vs 2009
   
2009 vs 2008
 
(000's)
 
Increase (Decrease) Due to
Change in
         
Increase (Decrease) Due
to Change in
       
   
Rate
   
Volume
   
Total
   
Rate
   
Volume
   
Total
 
                                     
Federal Funds Sold
 
$
(79
)
 
$
(33
 
$
(112
)
 
$
(197
)
 
$
26
   
$
(171
)
Securities and interest bearing deposits
   
(11
)
   
19
     
8
     
(29
)
   
115
     
86
 
Loans, net of reserve
   
149
     
(790)
     
(641
)
   
(593
)
   
(670)
     
(1,263
)
Total earning assets
   
59
     
(804)
     
(745
)
   
(819
)
   
(529)
     
(1,348
)
                                                 
NOW
   
(1
)
   
1
     
-
     
(6
)
   
1
     
(5
)
Money Market
   
(251
)
   
(108
   
(359
)
   
(573
)
   
21
     
(552
)
Savings
   
(1
)
   
-
     
(1)
     
(1
)
   
-
     
(1
)
Certificates of deposit $100,000 or less
   
(109
)
   
(181
)
   
(290
)
   
(171
)
   
(391
)
   
(562
)
Certificates of deposit $100,000 or more
   
(203
)
   
135
     
(68
)
   
(213
)
   
(302
)
   
(515
)
Other Borrowings
   
22
     
(44
   
(22
)
   
(2
)
   
48
     
46
 
Total Interest-bearing liabilities
   
(543
)
   
(197
)
   
(740
)
   
(966
)
   
(623
)
   
(1,589
)
                                                 
Changes in net interest income
 
$
602
   
$
(607)
   
$
(5
)
 
$
147
   
$
94
   
$
241
 

Net interest income for 2010 decreased $5,000, or 0.1%, compared to 2009.  The moderate decrease was the result of a decrease in the average volume of loans, offset primarily by a decrease in the average interest yield for interest-bearing liabilities. The average volume in earning assets decreased $27.3 million to $119.9 million for 2010, compared to $147.2 million for 2009. The average yield on interest-bearing liabilities decreased to 2.56% for 2010, compared to 2.64% for 2009.
 
 
35

 
 
Net interest income for 2009 increased $241,000, or 4.9%, compared to 2008.  The increase primarily resulted from a decrease in the average interest yield for interest-bearing liabilities and was partly offset by the average yield of earning assets.  The average yield on interest-bearing liabilities decreased to 2.64% for 2009, compared to 4.02% for 2008.

Capital Resources and Regulatory Capital Requirements

Shareholders’ equity decreased $454,000 during 2010 to $11.1 million at December 31, 2010 from $11.6 million at December 31, 2009. The decrease was primarily due to a net loss for 2010 of $470,000. The net loss for 2010 was primarily the result of $810,000 in net loan charge-offs and a charge of $560,000 to increase the reserve for consumer restitution in connection with the Agreement with the Comptroller.

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 possibly additional discretionary actions by regulators that, if undertaken could have a direct material effect on the Bank's and, accordingly, the Company’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 regulations 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 (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined).

To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table.

(000's)
 
Actual
   
For Capital
Adequacy Purposes
   
To Be Well Capitalized
Under Prompt
Corrective Action
Provisions
 
   
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
                                     
As of December 31, 2010
                                   
Total Capital (to Risk Weighted Assets)
 
$
12,156
     
12.20
%
 
$
7,973
>
   
8.00
%
 
$
9,966
>
   
10.00
%
                                                 
Tier 1 Capital (to Risk Weighted Assets)
   
10,904
     
10.94
%
   
3,986
>
   
4.00
%
   
5,979
>
   
6.00
%
                                                 
Tier 1 Capital (to Average Assets)
   
10,904
     
9.41
%
   
4,635
>
   
4.00
%
   
5,793
>
   
5.00
%
                                                 
As of December 31, 2009
                                               
Total Capital (to Risk Weighted Assets)
 
$
12,640
     
11.33
%
 
$
8,925
>
   
8.00
%
 
$
11,156
>
   
10.00
%
                                                 
Tier 1 Capital (to Risk Weighted Assets)
   
11,242
     
10.08
%
   
4,462
>
   
4.00
%
   
6,694
>
   
6.00
%
                                                 
Tier 1 Capital (to Average Assets)
   
11,242
     
7.51
%
   
5,988
>
   
4.00
%
   
7,485
>
   
5.00
%

On April 15, 2010 the Bank entered into a formal Agreement with the Comptroller in which the Bank has agreed to maintain specific capital ratios, among other provisions. (See “Item 1A Risk Factors”). Regardless of the Bank’s capital position, the requirement in the Agreement to meet and maintain a specific capital level means that the Bank may not be deemed to be well capitalized under regulatory requirements, irrespective of the Bank’s actual capital ratios. The capital ratios required by the Order are 11.5% total capital to risk weighted assets and 9.00% tier 1 capital to average assets.
 
 
36

 

Off-Balance Sheet Arrangements and Contractual Obligations

We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the accompanying balance sheets. Our exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do 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 condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of credit extended is based on management’s credit evaluation of the customer and, if deemed necessary, may require collateral.

Standby letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. At December 31, 2010, we had commitments to extend credit and standby letters of credit of approximately $3.4 million and $15,000, respectively.

The following is a summary of the our contractual obligations, including certain on-balance-sheet obligations, at December 31, 2010:

   
As of December 31, 2010
 
(000's)
 
Less than
One Year
   
One to
Three Years
   
Over Three to
Five Years
   
Over Five
Years
 
Unused lines of credit
 
$
2,930
   
$
-
   
$
-
   
$
423
 
Standby letters of credit
   
15
     
-
     
-
     
-
 
Operating Leases
   
272
     
430
     
184
     
75
 
Certificates of Deposit
   
36,940
     
17,262
     
674
     
-
 
Total
 
$
40,157
   
$
17,692
   
$
858
   
$
498
 

Results of Operations

Our operating results depend primarily on our net interest income. Net interest income is the difference between interest income, principally from loan, lease and investment securities portfolios, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume and spread and are reflected in the net interest margin. Volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities. Spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. Margin refers to net interest income divided by average interest-earning assets, and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities.

While interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate. Interest rates are highly sensitive to many factors that are beyond the control of the Company, including changes in the expected rate of inflation, the influence of general and local economic conditions and the monetary and fiscal policies of the United States government, its agencies and various other governmental regulatory authorities.

Net interest income was unchanged for the years ended December 31, 2010 and 2009, at $5.2 million. Net interest margin was 4.3% and 3.4% for the years ended December 31, 2010 and 2009, respectively. The increase in net interest margin was offset by reduction of average earning assets to $119.9 million in 2010 compared to $147.2 million in 2009, resulting in no change in the net interest income.

Total interest income was $7.8 million and $8.5 million for the years ended December 31, 2010 and 2009, respectively. The decrease in interest income was primarily a result of lower average loan balances of $10.4 million. Total average loans and average yield for the year ended December 31, 2010 was $109.6 million and 6.9% compared with $121.0 million and 6.7% for the year ended December 31, 2009.

Total interest expense was $2.6 million and $3.3 million for the year ended December 31, 2010 and 2009, respectively. The decrease in interest expense was a result of a decrease in deposit interest rates and interest bearing deposits. The average interest rate for interest-bearing liabilities was 2.6% for the year ended December 31, 2010, essentially unchanged compared to same period in 2009.
 
 
37

 
 
The following table sets forth our average balances of assets, liabilities and shareholders’ equity, in addition to the major components of net interest income and our net interest margin for the years ended December 31, 2010 and 2009.
 
   
Twelve Months Ended December 31,
 
(000'S)
 
2010
   
2009
 
   
Average
Balance
   
Interest
   
Average
Yield
   
Average
Balance
   
Interest
   
Average
Yield
 
Interest-earning assets
                                   
                                     
Loans, net of reserve(1)
 
$
109,588
   
$
7,598
     
6.93
%
 
$
120,991
   
$
8,239
     
6.72
%
Federal funds sold
   
799
     
2
     
0.19
 
   
17,930
     
114
     
0.63
 
Securities and other
   
9,532
     
153
     
1.60
 
   
8,322
     
145
     
1.71
 
Total earning assets
   
119,919
     
7,753
     
6.46
 
   
147,243
     
8,498
     
5.69
 
Cash and other assets
   
6,509
                     
4,385
                 
Total assets
 
$
126,428
                   
$
151,628
                 
                                                 
Interest-bearing liabilities
                                               
NOW accounts
 
$
1,983
   
 
13
     
0.68
 
 
$
1,875
   
 
14
     
0.74
 
Money market accounts
   
35,869
     
314
     
0.88
 
   
48,249
     
673
     
1.40
 
Savings accounts
   
183
     
2
     
0.89
 
   
197
     
2
     
1.07
 
Certificates of deposit less than $100,000
   
13,794
     
517
     
3.75
 
   
18,608
     
807
     
4.34
 
Certificates of deposit $100,000 or greater
   
42,642
     
1,727
     
4.05
 
   
39,299
     
1,795
     
4.57
 
Total interest bearing deposits
   
94,471
     
2,573
     
2.72
 
   
108,228
     
3,291
     
3.04
 
Borrowed funds
   
6,933
     
27
     
0.39
 
   
18,379
     
49
     
0.27
 
Total interest bearing liabilities
   
101,404
     
2,600
     
2.56
 
   
126,607
     
3,340
     
2.64
 
Noninterest bearing deposits
   
10,499
                     
9,931
                 
Other liabilities
   
3,965
                     
637
                 
Stockholders equity
   
10,560
                     
14,453
                 
Total liabilities and stockholders' equity
 
$
126,428
                   
$
151,628
                 
                                                 
Net interest income
          $
5,153
                    $
5,158
         
Net interest spread
                   
3.90
%
                   
3.05
%
Net interest margin
                   
4.30
%
                   
3.45
%
(1) Includes nonaccrual loans 

Provision for Loan Losses

We established a provision for loan losses, which are charged to operations, at a level required to reflect probable incurred credit losses in the loan portfolio. For additional information concerning this determination, see the section of this discussion and analysis captioned “Allowance for Loan and Lease Losses.”

The provision for loan losses for the years ended December 31, 2010 and 2009 were $851,000 and $1.4 million respectively.

 
38

 

Noninterest Income

The components of non-interest income for the years ended December 31, 2010 and 2009 were as follows:

   
Year ended December 31,
 
   
2010
   
2009
 
Service charges and fees
  $ 159     $ 116  
Trust services
    7,735       6,846  
                 
    $ 7,894     $ 6,962  

Non-interest income for the year-ended December 31, 2010 increased $932,000 or 13.4%, as compared to 2009. The increase is due primarily to trust income attributable to the general improvement in the market values of assets in trust accounts on which the fees are based.

Noninterest Expenses

For the fiscal year ended December 31, 2010, our noninterest expenses totaled $12.7 million, compared to $14.6 million for 2009.

Salaries and employee benefits decreased $350,000 to $2.7 million for the year ended December 31, 2010, as compared to $3.1 million for 2009.  We had 25 full-time equivalent employees as of December 31, 2010, and 28 full-time employees as of December 31, 2009.

Occupancy and equipment expenses totaled $1.0 million for the year ended December 31, 2010, as compared to $1.3 million for 2009. Expense in both periods is attributable primarily to lease expense and depreciation and amortization of leasehold improvements and furniture, fixtures and equipment.

Expenses related to trust consulting services were $6.6 million for the year ended December 31, 2010, compared to $5.8 million for 2009. Advisory fees are based on total assets held in custody and are paid to a fund advisor to manage the assets in the trust. Similar to trust income, the increase in trust expense is directly attributable to the general improvement in the market values in trust accounts.

Professional fees were $694,000 for the year ended December 31, 2010, compared to $640,000 for 2009.

Data processing fees were $256,000 for the year ended December 31, 2010, compared to $268,000 for 2009.

Other expenses decreased $2.1 million to $1.4 million for the year ended December 31, 2010, as compared to $3.5 million for 2009.  In 2009, $2.5 million expense was recorded for the reserve for consumer restitution in connection with the Agreement with the Comptroller and related accrued expenses.

Income Taxes

No federal tax expense has been recorded for the fiscal years ended December 31, 2010 and 2009 based upon prior net operating losses and the Company’s carry-forward of those losses. The Company has fully reserved the federal tax benefit of these losses. Cumulative net operating loss available to carry forward for tax purposes amounted to approximately $3.8 million as of December 31, 2010. This is lower than the losses per the financial statements as all organizational costs are capitalized for income tax purposes.
 
Item 7A.       Quantitative and Qualitative Disclosures about Market Risk.

Because the registrant is a smaller reporting company, disclosure under this item is not required.

 
39

 
 
Item 8.          Financial Statements and Supplementary Data
 
INDEX TO FINANCIAL STATEMENTS
 
 
Page
   
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
41
   
FINANCIAL STATEMENTS
 
   
Consolidated Balance Sheets
42
   
Consolidated Statements of Operations
43
   
Consolidated Statements of Changes in Stockholders’ Equity
44
   
Consolidated Statements of Cash Flows
45
   
Notes to Consolidated Financial Statements
46

 
40

 
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and
Shareholders

We have audited the accompanying consolidated balance sheets of T Bancshares, Inc. (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of T Bancshares, Inc. as of December 31, 2010 and 2009, and the consolidated results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
 
/s/ WEAVER AND TIDWELL, L.L.P.
Dallas, Texas
March 31, 2011

 
41

 
 
T BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2010 and 2009

(000's), except share amounts
 
2010
   
2009
 
             
ASSETS
           
             
Cash and due from banks
 
$
2,142
   
$
1,216
 
Interest-bearing deposits
   
4,695
     
5,526
 
Federal funds sold
   
3,352
     
550
 
Total cash and cash equivalents
   
10,189
     
7,292
 
                 
Securities available for sale at estimated fair value
   
4,067
     
4,005
 
Securities held to maturity at amortized cost
   
641
     
801
 
Securities, restricted at cost
   
1,181
     
1,281
 
Loans, net of allowance for loan losses of $1,754 and $1,713, respectively
   
94,185
     
121,419
 
Bank premises and equipment, net
   
539
     
793
 
Other real estate owned
   
2,291
     
1,616
 
Other assets
   
2,055
     
2,204
 
Total assets
 
$
115,148
   
$
139,411
 
                 
LIABILITIES
               
                 
Demand deposits:
               
Noninterest-bearing
 
$
11,919
   
$
9,428
 
Interest-bearing
   
28,975
     
36,157
 
Time deposits $100,000 and over
   
42,439
     
46,034
 
Other time deposits
   
12,437
     
16,506
 
Total deposits
   
95,770
     
108,125
 
                 
Borrowed funds
   
6,000
     
16,000
 
Other liabilities
   
2,241
     
3,695
 
Total liabilities
   
104,011
     
127,820
 
                 
SHAREHOLDERS’ EQUITY
               
                 
Common Stock, $ .01 par value; 10,000,000 shares authorized; 1,941,305 shares issued and outstanding
   
19
     
19
 
Additional paid-in capital
   
18,580
     
18,537
 
Retained deficit
   
(7,452
)
   
(6,982
)
Accumulated other comprehensive income
   
(10
)
   
17
 
Total shareholders' equity
   
11,137
     
11,591
 
Total liabilities and shareholders' equity
 
$
115,148
   
$
139,411
 

See accompanying notes to consolidated financial statements

 
42

 
 
T BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2010 and 2009

(000's), except per share amounts
 
2010
   
2009
 
             
Interest Income
           
             
Loan, including fees
 
$
7,598
   
$
8,239
 
Securities
   
138
     
139
 
Federal funds sold
   
2
     
114
 
Interest-bearing deposits
   
15
     
6
 
Total interest income
   
7,753
     
8,498
 
                 
Interest Expense
               
                 
Deposits
   
2,573
     
3,291
 
Borrowed funds
   
27
     
49
 
Total interest expense
   
2,600
     
3,340
 
                 
Net interest income
   
5,153
     
5,158
 
Provision for loan losses
   
851
     
1,370
 
Net interest income after provision for loan losses
   
4,302
     
3,788
 
                 
Noninterest Income
               
                 
Trust income
   
7,735
     
6,846
 
Service fees
   
159
     
116
 
Total noninterest income
   
7,894
     
6,962
 
                 
Noninterest Expense
               
                 
Salaries and employee benefits
   
2,727
     
3,077
 
Occupancy and equipment
   
1,016
     
1,285
 
Trust expenses
   
6,597
     
5,809
 
Professional fees
   
694
     
640
 
Data processing
   
256
     
268
 
Other
   
1,376
     
3,515
 
Total noninterest expense
   
12,666
     
14,594
 
                 
Net Loss
 
$
(470
)
 
$
(3,844
)
                 
Loss per common share:
               
                 
Basic
   
(0.24
)
   
(1.99
Diluted
   
(0.24
)
   
(1.99
                 
Weighted average common shares outstanding
   
1,941,305
     
1,936,099
 
Weighted average diluted shares outstanding
   
1,941,305
     
1,936,099
 

See accompanying notes to consolidated financial statements

 
43

 
 
T BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2010 and 2009

(000's)
 
Common
Stock
   
Additional
Paid-in
Capital
   
Retained
Deficit
   
Accumulated
Other
Comprehensive
Income
   
Total
 
                               
BALANCE, December 31, 2008
 
$
17
   
$
16,915
   
$
(3,138
)
 
$
-
   
$
13,794
 
                                         
Comprehensive loss:
                                       
Net loss
                   
(3,844
           
(3,844
Change in accumulated gain on securities available for sale
                           
17
     
17
 
Total comprehensive loss
                                   
(3,827
                                         
Net proceeds from rights offering
   
2
     
1,519
                     
1,521
 
Stock based compensation
           
 103
                     
103
 
BALANCE, December 31, 2009
 
$
19
   
$
18,537
   
$
(6,982
)
 
$
17
   
$
11,591
 
                                         
Comprehensive loss:
                                       
Net loss
                   
(470
)
           
(470
)
Change in accumulated gain on securities available for sale
                           
(27
)
   
  (27
)
Total comprehensive loss
                                   
(497
)
Stock based compensation
           
 43
                     
 43
 
BALANCE, December 31, 2010
 
$
19
   
$
18,580
   
$
(7,452
)
 
$
(10
 
$
11,137
 

See accompanying notes to consolidated financial statements

 
44

 
 
T BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2010 and 2009

(000's)
 
2010
   
2009
 
             
Cash Flows from Operating Activities
           
Net loss
 
$
(470
)
 
$
(3,844
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
               
                 
Provision for loan losses
   
851
     
1,370
 
Depreciation and amortization
   
285
     
458
 
Securities premium amortization (discount accretion), net
   
53
     
57
 
Loss on sale of securities
   
1
     
-
 
(Gain)loss on sale of real estate
   
12
     
(1
)
Stock based compensation
   
43
     
103
 
Change in operating assets and liabilities:
               
Other assets
   
149
     
(676
Other liabilities
   
(1,454
   
2,835
 
Net cash provided by (used in) operating activities
   
(530
   
302
 
                 
Cash Flows from Investing Activities
               
Principal payments and maturities of securities held to maturity
   
161
     
180
 
Purchase of securities available for sale
   
(54,056
)
   
(56,685
)
Principal payments, calls and maturities of securities available for sale
   
3,913
     
2,640
 
Proceeds from sale of securities available for sale
   
49,999
     
50,000
 
Purchase of securities, restricted
   
(629
)
   
(984
)
Proceeds from sale of securities, restricted
   
729
     
425
 
Net change in loans
   
24,988
     
(1,388
)
Proceeds from sale of other real estate
   
708
     
377
 
Purchases of premises and equipment
   
(31
)
   
(82
)
Net cash provided by (used in) investing activities
   
25,782
     
(5,517
)
                 
Cash Flows from Financing Activities
               
Net change in demand deposits
   
(4,691
)
   
(6,899
)
Net change in time deposits
   
(7,664
   
3,928
 
Proceeds from borrowed funds
   
83,400
     
236,517
 
Repayment of borrowed funds
   
(93,400
)
   
(231,017
)
Net proceeds from rights offering
   
-
     
1,521
 
Net cash provided  by (used in) financing activities
   
(22,355
   
4,050
 
                 
Net change in cash and cash equivalents
   
2,897
     
(1,165
)
Cash and cash equivalents at beginning of period
   
7,292
     
8,457
 
                 
Cash and cash equivalents at end of period
 
$
10,189
   
$
7,292
 
                 
Supplemental disclosures of cash flow information
               
Cash paid during the period for
               
Interest
 
$
2,624
   
$
3,316
 
Income taxes
 
$
-
   
$
-
 
Non-cash transactions:
               
Transfers from loans to other real estate owned
 
$
1,395
   
$
1,992
 

See accompanying notes to consolidated financial statements
 
 
45

 
 
NOTE 1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Organization and Nature of Operations
 
T Bancshares, Inc. (the “Company”) is a bank holding company headquartered in Dallas, Texas. The consolidated financial statements include the accounts of T Bancshares, Inc. and its wholly owned subsidiary, T Bank, N.A. (the “Bank”). The Company’s financial condition and operating results principally reflect those of the Bank. All intercompany transactions and balances are eliminated in consolidation.
 
The Bank provides a full range of banking services to individuals and corporate customers with two banking facilities serving North Dallas, Addison, Plano, Frisco and surrounding area communities. Additionally, the Bank maintains a loan production office in Southlake. The Bank’s primary business segment is community banking and consists of attracting deposits from the general public and using such deposits and other sources of funds to originate commercial business loans, commercial real estate loans, and a variety of consumer loans. At December 31, 2010, the Bank’s loan portfolio consisted of approximately $66.4 million, or 57.6% of the loan portfolio, in loans to dentists and dental practices. Substantially all loans are secured by specific collateral, including business assets, consumer assets, and commercial real estate.
 
The Bank also offers traditional fiduciary services primarily to clients of Cain Watters & Associates P.C. The Bank, Cain Watters & Associates P.C., and III:I Financial Management Research, L.P. have entered into an advisory services agreement related to the trust operations.
 
Use of Estimates
 
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets, liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period, as well as the disclosures provided. Changes in assumptions or in market conditions could significantly affect the estimates. The determination of the allowance for loan losses, the fair value of stock options, the fair values of financial instruments and other real estate owned, and the status of contingencies are particularly susceptible to significant change in recorded amounts.
 
Cash and Cash Equivalents
 
The Company maintains its cash in bank deposit accounts, which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts and does not believe it is exposed to significant credit risk on cash and cash equivalents.
 
For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash on hand, deposits with other financial institutions, and federal funds sold. Net cash flows are reported for customer loan and deposit transactions.
 
Trust Assets
 
Property held for customers in a fiduciary capacity, other than trust cash on deposit at the Bank, is not included in the accompanying consolidated financial statements since such items are not assets of the Company.
 
Securities
 
Debt securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them until maturity. Securities to be held for indefinite periods of time are classified as available for sale and carried at fair value, with the unrealized holding gains and losses reported as a component of other comprehensive income, net of tax. Securities held for resale in anticipation of short-term market movements are classified as trading and are carried at fair value, with changes in unrealized holding gains and losses included in income. Management determines the appropriate classification of securities at the time of purchase. Securities with limited marketability, such as stock in the Federal Reserve Bank and the Federal Home Loan Bank, are carried at cost. The Bank has investments in stock of the Federal Reserve System and the Federal Home Loan Bank as is required for participation in the services offered. These investments are classified as restricted and are recorded at cost.
 
Interest income includes amortization of purchase premiums and accretion of purchase discounts. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments. Gains and losses are recorded on the trade date and determined using the specific identification method. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
 
 
46

 
 
Loans
 
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned interest, deferred loan fees, and allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees are deferred and recognized in interest income using the level-yield method without anticipating prepayments.
 
Interest income on commercial business and commercial real estate loans is discontinued when the loan becomes 90 days delinquent unless the credit is well secured and in process of collection. Unsecured consumer loans are generally charged off when the loan becomes 90 days past due. Consumer loans secured by collateral other than real estate are charged off after a review of all factors affecting the ability to collect on the loan, including the borrower’s history, overall financial condition, resources, guarantor support, and the realizable value of any collateral. However, any consumer loan past 180 days is charged off. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not received for loans placed on nonaccrual are reversed against interest income. Interest received on such loans is accounted for on a cash-basis or cost-recovery method, until qualifying for return to accrual basis. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
 
Allowance for Loan Losses
 
The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. Management estimates the allowance balance required by considering the collectability of loans based on historical experience and the borrower’s ability to repay, the nature and volume of the portfolio, information about specific borrower situations and the estimated value of any underlying collateral, economic conditions and other factors.
 
The allowance consists of general and specific reserves. The specific component relates to loans that are individually evaluated and determined to be impaired. This evaluation is often based on significant estimates and assumptions due to the level of subjectivity and judgment necessary to account for highly uncertain matters of the susceptibility of such matters to change. The general component relates to the entire group of loans that are evaluated in the aggregate based primarily on industry historical loss experience adjusted for current economic factors. To the extent actual loan losses differ materially from management’s estimate of these subjective factors, loan growth/run-off accelerates, or the mix of loan types changes, the level of the provision for loan loss, and related allowance can, and will, fluctuate.
 
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.

Bank Premises and Equipment
 
Bank premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 5 to 40 years. Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 10 years. Leasehold improvements are depreciated over the lease term or estimated life, whichever is shorter. Repair and maintenance costs are expensed as incurred.

Foreclosed Assets

Assets acquired through or instead of loan foreclosure are held for sale and are initially recorded at fair value less estimated selling costs when acquired, establishing a new cost basis. Costs after acquisition generally expensed. If the fair value of the asset declines, a write-down is recorded through expense.  The valuation of foreclosed assets is subjective in nature and may be adjusted in the future because of changes in economic conditions. Foreclosed assets are included in the accompanying balance sheets and totaled $2.3 million and $1.6 million at December 31, 2010 and 2009.
 
Stock Based Compensation

The Company adopted Financial Accounting Standards Board Accounting Standards Codification(FASB ASC) Topic 718 using the modified-prospective-transition method. Under this method, prior periods are not restated. Also, under this transition method, stock compensation cost recognized beginning January 1, 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant-date estimated fair value, and (b) compensation cost for all share-based payments granted on or subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of FASB ASC Topic 718.

 
47

 
 
Income Taxes
 
The Company accounts for income taxes utilizing the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. 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 recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
 
The Company has provided a 100% valuation allowance for its net deferred tax asset due to the Company’s net operating loss carry-forward of approximately $3.8 million as of December 31, 2010. 

The Company accounts for uncertainties in income taxes in accordance with current accounting guidance which prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  Benefits from tax positions should be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of cumulative benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. No uncertain tax positions have been recognized.

The Company files income tax returns in the U.S. federal jurisdiction and the Texas state jurisdiction. The Company is no longer subject to U.S. federal income tax examinations by tax authorities for years before 2006.

LossPer Share
 
Basic loss per share are computed by dividing net loss applicable to common shareholders by the weighted average number of common shares outstanding. Diluted earnings per share are computed by dividing net loss by the weighted average number of shares of common stock and common stock equivalents. Common stock equivalents consist of stock options and warrants and are computed using the treasury stock method.
 
The Company reported a net loss for the year ended December 31, 2010. The dilutive effect of 212,500 outstanding options and 96,750 outstanding warrants for the year ended December 31, 2010, is not considered in the per share calculations for these periods as the impact would have been anti-dilutive.
 
Comprehensive Income
 
Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes net unrealized gains and losses on available for sale securities, which are recognized as a separate component of equity.  Accumulated comprehensive income (loss), net for the year ended December 31, 2010 and 2009 is reported in the accompanying consolidated statements of changes in stockholders’ equity.

Transfer of Financial Asssets

Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (i) the assets have been isolated from the Corporation, (ii) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (iii) the Corporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
 
Loss Contingencies
 
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated.
 
Fair Value of Financial Instruments
 
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

 
48

 
 
Recent Accounting Pronouncements

Accounting Standards Update (“ASU”) No. 2010-06, Fair Value Measurements and Disclosures (Topic 820) - Improving Disclosures About Fair Value Measurements. -  In 2010, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance expanding disclosures related to fair value measurements including (i) the amounts of significant transfers of assets or liabilities between Levels 1 and 2 of the fair value hierarchy and the reasons for the transfers, (ii) the reasons for transfers of assets or liabilities in or out of Level 3 of the fair value hierarchy, with significant transfers disclosed separately, (iii) the policy for determining when transfers between levels of the fair value hierarchy are recognized, and (iv) for recurring fair value measurements of assets and liabilities in Level 3 of the fair value hierarchy, a gross presentation of information about purchases, sales, issuances and settlements. The new guidance further clarifies that (i) fair value measurement disclosures should be provided for each class of assets and liabilities (rather than major category), which would generally be a subset of assets or liabilities within a line item in the statement of financial position and (ii) disclosures should be provided about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements for each class of assets and liabilities included in Levels 2 and 3 of the fair value hierarchy. The disclosures related to the gross presentation of purchases, sales, issuances and settlements of assets and liabilities included in Level 3 of the fair value hierarchy will be required beginning January 1, 2011. The remaining disclosure requirements and clarifications made by the new guidance became effective on January 1, 2010. Adoption of this authoritative guidance did not have a significant effect on the financial condition and results of operations.

ASC 310 Receivables (“ASC 310”) was amended to enhance disclosures about credit quality of financing receivables and the allowance for credit losses. The amendments require an entity to disclose credit quality information, such as internal risk gradings, more detailed nonaccrual and past due information, and modifications of its financing receivables. The disclosures under ASC 310, as amended, will be effective for interim and annual reporting periods ending on or after December 15, 2010. The FASB has elected to defer the disclosures related to troubled debt restructurings (“TDRs”) included within ASU No. 2010-20. The disclosures related to TDRs are expected to be effective for the second quarter 2011.  Disclosures required by this standard did not have a significant impact on our financial condition and results of operations, but it has significantly expanded the disclosures that we are required to provide.

NOTE 2.SECURITIES
 
Year-end securities consisted of the following:
   
December 31, 2010
 
(000's)
 
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Estimated
Fair Value
 
Securities Available for Sale:
                       
U.S. Government Agencies
 
$
4,077
   
$
40
   
$
50
   
$
4,067
 
                                 
Securities Held to Maturity:
                               
U.S. Government Agencies
 
$
641
   
$
41
   
$
-
   
$
682
 
                                 
Securities, restricted
                               
Other
 
$
1,181
   
$
-
   
$
-
   
$
1,181
 
  
   
December 31, 2009
 
(000's)
 
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Estimated
Fair Value
 
Securities Available for Sale:
                       
U.S. Government Agencies
 
$
3,988
   
$
20
   
$
3
   
$
4,005
 
                                 
Securities Held to Maturity:
                               
U.S. Government Agencies
 
$
801
   
$
29
   
$
-
   
$
830
 
                                 
Securities, restricted
                               
Other
 
$
1,281
   
$
-
   
$
-
   
$
1,281
 
 
 
49

 
 
Securities, restricted consists of Federal Reserve Bank stock and Federal Home Loan Bank stock which are carried at cost.

Management has the ability and intent to hold the securities classified as held to maturity in the table above until they mature, at which time the Company will receive full value for the securities. Furthermore, as of December 31, 2010, management does not have the intent to sell any of the securities classified as available for sale in the table above and believes that it is more likely than not that the Company will not have to sell any such securities before a recovery of cost. Management does not believe any of the securities are impaired due to reasons of credit quality.

Securities with a carrying value of $641,000 and $601,000 at December 31, 2010 and 2009 were pledged to the Company’s trust department.  Securities with a carrying value of $4.1 million and $4.2 million at December 31, 2010 and 2009 were pledged to secure borrowings at the Federal Home Loan Bank in Dallas. 

The amortized cost and estimated fair value of securities, excluding trading securities, at December 31, 2010 are presented below by contractual maturity. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Residential mortgage backed securities are shown separately since they are not due at a single maturity date.

   
Held to Maturity
   
Available for Sale
 
(000's)
 
Amortized
Cost
   
Estimated
Fair Value
   
Amortized
Cost
   
Estimated
Fair Value
 
                         
Due in one year or less
 
$
   
$
   
$
   
$
 
Due after one year through five years:
   
     
     
     
 
Due after five years through ten years
   
     
     
     
 
Due after ten years
   
     
     
     
 
Mortgage-backed securities
   
641
     
682
     
4,077
     
4,067
 
                                 
Total
 
$
641
   
$
682
   
$
4,077
   
$
4,067
 

NOTE 3.LOANS AND ALLOWANCE FOR LOAN LOSSES
 
Major classifications of loans are as follows:
(000's)
 
December 31,
2010
   
December 31,
2009
 
             
Commercial and industrial
 
$
64,381
   
$
88,920
 
Consumer installment
   
1,002
     
1,852
 
Real estate — mortgage
   
22,377
     
25,464
 
Real estate — construction and land
   
8,309
     
7,045
 
Other
   
6
     
2
 
                 
     
96,075
     
123,283
 
                 
Less allowance for loan losses
   
1,754
     
1,713
 
Less deferred loan fees
   
136
     
151
 
                 
Net loans
 
$
94,185
   
$
121,419
 
 
 
50

 
 
The allowance for loan losses as of December 31, 2010 and 2009, and the change for the years then ended is presented below. Management has evaluated the adequacy of the allowance for loan losses by estimating the losses in various categories of the loan portfolio.

(000's)
 
2010
   
2009
 
Balance at January 1,
  $ 1,713     $ 1,638  
                 
Charge-offs:
               
Commercial and industrial
    1,224       933  
Consumer installment
    4       88  
Real estate – construction and land
    129       282  
Total charge-offs
    1,357       1,303  
                 
Recoveries:
               
Commercial and industrial
    547       9  
Consumer installment
    -       -  
Real estate – construction and land
    -       -  
Total recoveries
    547       9  
                 
Net charge-offs
    810       1,294  
                 
Provision for loan losses
    851       1,369  
Balance at December 31,
  $ 1,754     $ 1,713  
 
   
December 31,
   
December 31,
 
(000's)
 
2010
   
2009
 
             
Impaired loans were as follows:
           
Year end loans with allowance allocated
  $ 1,517     $ 1,426  
Year end loans with no allowance allocated
    2,600       3,637  
Impaired loans
  $ 4,117     $ 5,063  
                 
Amount of allowance allocated
  $ 255     $ 180  
                 
Average of impaired loans during the year
  $ 4,824     $ 4,392  
                 
Interest income recognized during impairment
  $ 215     $ 121  
                 
Loans past due 90 days still on accrual
  $ -     $ -  
                 
Non-accrual  loans:
               
Commercial and industrial
  $ 367     $ 2,155  
Real estate – mortgage
    1,462       -  
Real estate – construction and land
    -       1,633  
Total
  $ 1,829     $ 3,788  

 
51

 

Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.
 
The Company’s impaired loans and related allowance as of December 31, 2010 is summarized in the following table:

   
Unpaid
   
Recorded
   
Recorded
                     
   
Contractual
   
Investment
   
Investment
   
Total
           
Average
 
   
Principal
   
With No
   
With
   
Recorded
   
Related
   
Recorded
 
(000's)
 
Balance
   
Allowance
   
Allowance
   
Investment
   
Allowance
   
Investment
 
                                                 
Commercial and industrial
 
$
2,672
   
$
1,139
   
$
1,517
   
$
2,656
   
$
255
   
$
2,529
 
Consumer installment
   
-
     
-
     
-
     
-
     
-
     
-
 
Real estate – mortgage
   
1,534
     
1,461
     
-
     
1,461
     
-
     
1,521
 
Real estate – construction and land
   
-
     
-
     
-
     
-
     
-
     
774
 
Other
   
-
     
-
     
-
     
-
     
-
     
-
 
Total
 
$
4,206
   
$
2,600
   
$
1,517
   
$
4,117
   
$
255
   
$
4,824
 

As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including internal credit risk based on past experiences as well as external statistics and factors.   Loans are classified in one of four categories: (i) pass, (ii) special mention, (iii) substandard or (iv) doubtful. Loans classified as loss are charged-off.

The classifications of loans reflect a judgment about the risks of default and loss associated with the loan. The Company reviews the ratings on credits quarterly. Ratings are adjusted to reflect the degree of risk and loss that is felt to be inherent in each credit. Our methodology is structured so that specific allocations are increased in accordance with deterioration in credit quality (and a corresponding increase in risk and loss) or decreased in accordance with improvement in credit quality (and a corresponding decrease in risk and loss).

Credits rated special mention show clear signs of financial weaknesses or deterioration in credit worthiness, however, such concerns are not so pronounced that the Company generally expects to experience significant loss within the short-term. Such credits typically maintain the ability to perform within standard credit terms and credit exposure is not as prominent as credits rated more harshly.

Credit rated substandard are those in which the normal repayment of principal and interest may be, or has been, jeopardized by reason of adverse trends or developments of a financial, managerial, economic or political nature, or important weaknesses exist in collateral. A protracted workout on these credits is a distinct possibility. Prompt corrective action is therefore required to strengthen the Company’s position, and/or to reduce exposure and to assure that adequate remedial measures are taken by the borrower. Credit exposure becomes more likely in such credits and a serious evaluation of the secondary support to the credit is performed.

Credits rated doubtful are those in which full collection of principal appears highly questionable, and which some degree of loss is anticipated, even though the ultimate amount of loss may not yet be certain and/or other factors exist which could affect collection of debt. Based upon available information, positive action by the Company is required to avert or minimize loss.

At December 31, 2010, the following summarizes the Company’s internal ratings of its loans:
 
           
Special
                   
(000's)
 
Pass
   
Mention
   
Substandard
   
Doubtful
   
Total
 
                                         
Commercial and industrial
 
$
61,273
   
$
1,261
   
$
1,847
   
$
-
   
$
64,381
 
Consumer installment
   
1,002
     
-
     
-
     
-
     
1,002
 
Real estate - mortgage
   
17,706
     
958
     
3,713
     
-
     
22,377
 
Real estate – construction and land
   
6,900
     
1,048
     
361
     
-
     
8,309
 
Other
   
6
     
-
     
-
     
-
     
6
 
Total
 
$
86,887
   
$
3,267
   
$
5,921
   
$
-
   
$
96,075
 

 
52

 
 
At December 31, 2010, the Company’s past due loans are as follows:

                                 
Total 90
 
   
30-89 Days
   
Greater Than
   
Total
   
Total
   
Total
   
Days Past Due
 
(000's)
 
Past Due
   
90 Days
   
Past Due
   
Current
   
Loans
   
Still Accruing
 
                                     
Commercial and industrial
  $ -     $ -     $ -     $ 64,381     $ 64,381     $ -  
Consumer installment
    -       -       -       1,002       1,002       -  
Real estate – mortgage
    -       1,461       1,461       20,916       22,377       -  
Real estate – construction and  land
    -       -       -       8,309       8,309       -  
Other
    -       -       -       6       6       -  
Total
  $ -     $ 1,461     $ 1,461     $ 94,614     $ 96,075     $ -  

NOTE 4.BANK PREMISES AND EQUIPMENT
 
Year-end premises and equipment were as follows:
 
(000's)
 
December 31,
2010
   
December 31,
2009
 
             
Leasehold improvements
 
$
929
   
$
929
 
Furniture and equipment
   
1,907
     
1,876
 
     
2,836
     
2,805
 
                 
Less: accumulated depreciation
   
2,297
     
2,012
 
Balance at end of period
 
$
539
   
$
793
 
 
Depreciation expense, including amortization of leasehold improvements, was $285,000 and $458,000 for the years ended December 31, 2010 and 2009, respectively.

NOTE 5.OTHER ASSETS
 
Other assets as of December 31, 2010 and 2009, were as follows:
 
(000's)
 
December 31,
2010
   
December 31,
2009
 
             
Prepaid assets
   
1,015
     
1,136
 
Accounts receivable – trust fees
   
680
     
640
 
Accrued interest receivable
   
330
     
397
 
Other
   
30
     
31
 
Total
 
$
2,055
   
$
2,204
 

 
53

 
 
NOTE 6.DEPOSITS
 
Deposits at December 31, 2010 and 2009 are summarized as follows:

(000's)
 
December 31, 2010
   
December 31, 2009
 
                         
Noninterest bearing demand
 
$
11,919
     
13
%
 
$
9,428
     
9
%
Interest bearing demand (NOW)
   
2,130
     
2
 
   
         1,960
     
2
 
Money market accounts
   
26,671
     
28
 
   
34,006
     
31
 
Savings accounts
   
174
     
0
 
   
191
     
0
 
Certificates of deposit, less than $100,000
   
12,437
     
13
 
   
16,506
     
15
 
Certificates of deposit, greater than $100,000
   
42,439
     
44
 
   
46,034
     
43
 
Total
 
$
95,770
     
100
%
 
$
108,125
     
100
%

At December 31, 2010, the scheduled maturities of certificates of deposit were as follows:

2011
   
36,940
 
2012
   
14,804
 
2013
   
2,458
 
2014
   
316
 
2015
   
358
 
Total
 
$
54,876
 

NOTE 7. BORROWED FUNDS
 
Borrowed funds as of December 31, 2010 and December 31, 2009, were as follows:

(000's)
 
December 31,
2010
   
December 31,
2009
 
             
Federal Home Loan Bank
 
$
6,000
   
$
16,000
 
 
At December 31, 2010, borrowed funds consisted of two $3.0 million advances from the Federal Home Loan Bank of Dallas. The loans have a term of 1 year and 3 months and mature on April 13, 2011 and January 28, 2011, respectively. The interest rates for the loans are fixed at 0.54% and 0.10%. The Company has a $25.3 million credit line with the Federal Reserve Bank of Dallas, secured by $40.4 million in pledged commercial and industrial loans, and an $17.9 million credit line with the Federal Home Loan Bank of Dallas, secured by $13.9 million in pledged real estate loans and $4.0 million in pledged securities.

NOTE 8. OTHER LIABILITIES
 
Other liabilities as of December 31, 2010 and December 31, 2009, were as follows:
 
(000's)
 
December 31,
2010
   
December 31,
2009
 
             
Reserve for consumer restitution
 
$
963
   
$
2,685
 
Trust Advisor Fees Payable
   
576
     
522
 
Audit Fees
   
121
     
38
 
Incentive Compensation
   
107
     
51
 
Franchise & Property Taxes
   
100
     
37
 
Interest Payable
   
77
     
101
 
Legal
   
10
     
28
 
Other Accruals
   
287
     
233
 
   
$
2,241
   
$
3,695
 
 
 
54

 
 
NOTE 9.BENEFIT PLANS
 
The Company funds certain costs for medical benefits in amounts determined at the discretion of management. The Company offers a 401K plan, which provides for contributions by employees. As of December 31, 2010, the Company had no plans to match employee contributions.
 
NOTE 10.INCOME TAXES
 
The provision (benefit) for income taxes consists of the following:
 
(000s)
 
2010
   
2009
 
             
Income tax expense (benefit) was as follows:
           
Current federal taxable income
 
$
-
   
$
-
 
NOL utilized
   
-
     
-
 
Total current taxes due
   
-
     
-
 
                 
Deferred federal tax provision (benefit)
   
160
     
1,296
 
Valuation allowance
   
(142
   
(1,296
Other
   
(18
   
-
 
   
$
-
   
$
-
 
 
The effective tax rate differs from the U. S. statutory tax rate due to the following for 2010 and 2009:
 
U.S. statutory rate
   
34.0
%
Valuation Allowance
   
-30.0
%
Other
   
-4.0
%
Effective tax rate
   
0.0
%
 
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of December 31 are as follows:
 
(000s)
 
2010
   
2009
 
             
Deferred tax assets:
           
Stock-based compensation
   
129
     
114
 
Allowance for loan losses
   
597
     
583
 
FAS91 fees
   
46
     
51
 
Accrued liabilities
   
327
     
913
 
Net operating loss carryforward
   
1,276
     
599
 
Total deferred tax asset
   
2,375
     
2,260
 
Deferred tax liabilities:
               
Depreciation and amortization
   
(43
)
   
(70
)
     
2,332
     
2,190
 
Less valuation allowance for net deferred tax asset
   
(2,332
)
   
(2,190
)
   
$
-
   
$
-
 
 
Management has provided a 100% valuation allowance for its net deferred tax asset. For year ended December 31, 2010, the Company had a taxable loss of $2.0 million, which increased the net tax operating loss carry-forward to $3.8 million.  The net operating loss carry-forward will fully expire in 2030 if not used. For year ended December 31, 2009, the Company produced a taxable loss of $980,000.

Projections for continued levels of profitability will be reviewed quarterly and any necessary adjustments to the deferred tax assets will be recognized in the provision or benefit for income taxes. In assessing the realization rate of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. At December 31, 2010, management believes it is more likely than not that the Company will not realize the benefits of those deductible differences.
 
 
55

 

NOTE 11.STOCK OPTIONS AND WARRANTS
 
The shareholders of the Company approved the 2005 Stock Incentive Plan (“Plan”) at the annual shareholder meeting held on June 2, 2005. The Plan authorizes the granting of options to purchase up to 260,000 shares of common stock of the Company to employees of the Company and its subsidiaries. The Plan is designed to provide the Company with the flexibility to grant incentive stock options and non-qualified stock options to its executive and other officers. The purpose of the Plan is to provide increased incentive for key employees to render services and to exert maximum effort for the success of the Company.

The Plan is administered by the Board of Directors and has a term of 10 years. Any award that expires or is forfeited is returned to the Plan.  Stock options are granted under the Plan with an exercise price equal to or greater than the stock fair market value at the date of grant. All stock options granted have ten-year lives with vesting terms of five years.

The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model. Expected volatilities are based on historical volatility of the Company’s stock. The risk-free rate for the period within the contractual life of the stock option is based upon the five year Treasury rate at the date of grant.

As of December 31, 2010 and December 31, 2009, options to purchase a total of 212,500 and 195,500 had been issued with an average exercise price of $9.14 and $10.03, respectively. These options vest through May 2015.
 
The Company recorded $43,000 and $103,000 in compensation expense for the years ended December 31, 2010 and December 31, 2009, respectively, in connection with the Stock Incentive Plan. This amount is not reduced by related deferred tax assets since all deferred tax assets are impaired as of December 31, 2010 (see Note 10). As of December 31, 2010 there was $80,000 of total unrecognized compensation cost related to non-vested equity-based compensation awards expected to vest, with an average vesting period of 3.2 years.

The following is a summary of activity in the  Plan for 2010 and 2009:
 
   
2010
   
2009
 
   
Number of
Shares
Underlying
Options
   
Weighted
Average
Exercise
Prices
   
Number of
Shares
Underlying
Options
   
Weighted
Average
Exercise
Prices
 
Outstanding at beginning of the year
   
195,500
   
$
10.03
     
205,500
   
$
9.87
 
Granted
   
27,000
     
1.79
     
-
     
-
 
Exercised
   
-
     
-
     
-
     
-
 
Expired / forfeited
   
10,000
     
6.75
     
10,000
     
6.75
 
                                 
Outstanding at end of period
   
212,500
   
$
9.14
     
195,500
   
$
10.03
 
Exercisable at end of period
   
164,800
   
$
10.21
     
155,900
   
$
10.13
 
Available for grant at end of period
   
36,500
             
53,500
         

   
2010
   
2009
 
   
Shares
   
Weighted
Average
Grant Date
Fair Value
   
Shares
   
Weighted
Average
Grant Date
Fair Value
 
                         
Nonvested at January 1
   
39,600
   
$
3.24
     
88,700
   
$
2.78
 
Granted
   
27,000
     
0.98
     
-
     
-
 
Vested
   
10,900
     
3.55
     
39,100
     
2.37
 
Forfeited
   
8,000
     
2.01
     
10,000
     
2.01
 
                                 
Nonvested at December 31
   
47,700
   
$
2.10
     
39,600
   
$
3.24
 
 
 
56

 
 
The fair value of options granted was determined using the following weighted-average assumptions as of grant date:
 
   
2010
   
2009
 
             
Risk-free interest rate
    2 %     n/a  
Dividend yield
    0 %     n/a  
Expected stock price volatility
    42 %     n/a  
Expected term
 
10.0 years
      n/a  
Forfeiture rate
    0 %     n/a  

All options carry exercise prices ranging from $1.01 to $13.00. At December 31, 2010, there were 164,800 exercisable options with no intrinsic value as the exercise price exceeded the stock price.

The Company’s organizers advanced funds for organizational and other preopening expenses. As consideration for the advances the organizers received warrants to purchase one share of common stock for every $20 advanced up to a limit of $100,000. A total of 96,750 warrants were issued and remain outstanding at December 31, 2010. These warrants are exercisable at a price of $10.00 per share at any time until November 2, 2014.
 
NOTE 12.LOAN COMMITMENTS AND OTHER CONTINGENCIES
 
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the accompanying balance sheets. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. At December 31, 2010, the Company had commitments to extend credit and standby letters of credit of approximately $3.4 million and $15,000, respectively. At December 31, 2009, the Company had commitments to extend credit and standby letters of credit of approximately $6.8 million and $15,000, respectively.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

The Company has four lease agreements, which expire on or before 2017. In addition to the leases for office space, the Company also leases various pieces of office equipment under short-term agreements. The following table summarizes loan commitments and minimum rental commitments for office space leases as of December 31, 2010:
 
   
As of December 31, 2010
 
(000's)
 
Less than
One Year
   
One to
Three Years
   
Over Three to
Five Years
   
Over Five
Years
 
Unused lines of credit
 
$
2,930
   
$
-
   
$
-
   
$
423
 
Standby letters of credit
   
15
     
-
     
-
     
-
 
Operating Leases
   
272
     
430
     
184
     
75
 
Total
 
$
3,217
   
$
430
   
$
184
   
$
498
 
 
Lease expense for the years ended December 31, 2010 and 2009 was $292,000 and $286,000, respectively.
 
The Company is involved in various regulatory inspections, inquiries, investigations and proceedings, and litigation matters that arise from time to time in the ordinary course of business. The process of resolving matters through litigation or other means is inherently uncertain, and it is possible that an unfavorable resolution of these matters, will adversely affect the Company, its results of operations, financial condition and cash flows. The Company’s regular practice is to expense legal fees as services are rendered in connection with legal matters, and to accrue for liabilities when payment is probable.
 
 
57

 
 
Employment Agreements
 
The Company has entered into employment agreements with two officers of the Bank, Steve Jones and Patrick Howard. The agreements are for an initial one-year term and are automatically renewable for an additional one-year term unless either party elects not to renew.
 
NOTE 13.RELATED PARTIES
 
The Company purchased corporate insurance through an insurance agency in which one of its principals is also a director and organizer of the Company. Premiums paid totaled $188,000 and $91,000 for the years ended December 31, 2010 and 2009, respectfully.
 
The Company purchased employee benefit insurance through an insurance agency in which one of its principals is also a director and organizer of the Company. During the years ended December 31, 2010 and 2009 those premiums totaled $250,000 and $212,000 respectively.
 
Certain Directors and Officers of the Bank have depository accounts with the Bank. None of those deposit accounts have terms more favorable than those available to any other depositor.

NOTE 14.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 possibly additional discretionary actions by regulators that, if undertaken could have a direct material effect on the Bank's and, accordingly, the Company’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 regulations 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 (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table.

In 2010, the Bank was informed by the Comptroller that the Comptroller intended to institute an enforcement action for alleged violations of the Federal Trade Commission Act in connection with certain merchants and a payment processor that were Bank customers between September 1, 2006 and August 27, 2007.   The Comptroller proposed that the Bank enter into a formal agreement with the Comptroller (the “Agreement”).

The Bank terminated all business relationships with the merchants and the payment processor on August 27, 2007. The Comptroller alleged that the merchants and the payment processor defrauded consumers and is seeking restitution of such consumers from the Bank, asserting that by accepting consumer payments for deposit from the merchants and introducing those payments into the payment clearing system, the Bank allegedly materially aided the merchants and the payment processor in the alleged fraudulent activity.

Because the cost of defending a regulatory enforcement action would have been significant, would likely have taken a protracted timeframe, and we could not be certain of a favorable outcome to the Bank, we determined (and currently still believe) that negotiating a settlement with the Comptroller was in the best interest of the Bank.  Accordingly, on April 15, 2010, the Bank executed an Agreement, neither admitting nor denying the Comptroller’s findings containing the general terms outlined as follows:

 
·
deposit $5.1 million for consumer restitution charged by the merchants to eligible consumers into a segregated account at the Bank;
 
·
require the Bank to retain an independent claims administrator to locate and arrange for the issuance of individual consumer checks to the identified eligible consumers;
 
·
require the Bank to establish a capital plan which, among other provisions, details the Bank’s plan to achieve tier 1 capital ratio of 9% and total risk based capital ratio of 11.5%;
 
·
require the Bank to develop a written program designed to reduce the level of criticized assets;
 
·
require the Bank to develop and implement an asset liquidity enhancement plan designed to increase the amount of asset liquidity maintained by the Bank, including a loan to deposit ratio of 85%; and
 
·
require the Bank to develop a written profit plan to improve and sustain the earnings of the Bank.

 
58

 

We do not know at this time the precise amounts that will ultimately be payable by us under the terms of  the Agreement. In August and September, 2010, the Bank issued settlement offers and checks covering twelve of the thirteen merchants totaling approximately $3.8 million. The settlement offer and checks were valid for ninety days. As of December 31, 2010, approximately $2.0 million of settlement checks had been accepted and cashed by consumers, or 52% of the total.  Under the terms of the restitution plan, the Bank has no further obligation on the approximately $1.8 million of settlement checks which were not accepted and cashed by consumers.

In September, 2010, the Federal Trade Commission (“FTC”) reached a settlement with the thirteenth merchant, Low Pay. Under the terms of the Bank’s Agreement with the Comptroller, the Bank will receive a refund from the FTC if the FTC is successful collecting its settlement against Low Pay.  We expect that any such refund will be no more than $70 thousand.  With the FTC settlement with Low Pay completed, the Bank was able to move forward with issuing restitution checks totaling approximately $1.6 million, which it did on February 25, 2011 to the Low Pay customers. The Bank recorded an additional $560 thousand expense accrual as of September, 2010, for the Low Pay restitution payments.  This was added to the existing $2.4 million previously recorded as of December 31, 2009.  As of December 31, 2010, the Bank had not used, nor had any further obligation to pay, $429 thousand of the previously recorded restitution reserve accrual. The additional expense accrual related to Low Pay resulted in a total restitution reserve accrual as of December 31, 2010, of $989 thousand, or 62% of the total of the Low Pay restitution checks issued.

The Bank submitted required capital, liquidity enhancement, and  profit plans, as well as a written program to reduce criticized assets to the Comptroller in accordance with the requirements of the Agreement. Although the Comptroller believed the plans were reasonable and did not object to the plans and program as submitted, there is no assurance that the Bank will be able to comply with all of the remaining requirements of the Agreement, including meeting the stated capital requirements or loan to deposit ratio contained therein.  

If as a result of its review or examination of the Bank, the Comptroller should determine that the financial condition, capital resources, asset quality, liquidity, earnings ability, or other aspects of its operations have worsened or that it or its management is violating or has violated the Agreement, or failed to comply with any provision of the Agreement, or any law or regulation, various additional remedies are available to the Comptroller. Such remedies include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict our growth, to assess civil monetary penalties, to remove officers and directors, and ultimately to terminate our deposit insurance, which would result in the seizure of the Bank by its regulators.

To be categorized as well capitalized under prompt corrective action provisions, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. However, regardless of the Bank’s capital position, the requirement in the Agreement to meet and maintain a specific capital level means that the Bank may not be deemed to be well capitalized under regulatory requirements as of December 31, 2010. The capital ratios required by the Agreement are 11.5% Total Capital to Risk Weighted Assets and 9.00% Tier 1 Capital to Average Assets. As of December 31, 2010, the Bank’s Total Capital to Risk Weighted Assets ratio and Tier 1 Capital to Average Assets ratio of 12.20% and 9.41%, respectively, were above the requirements set forth in the Agreement. Under the terms of the Agreement, the Bank has until the earlier of 90 days after the Bank receives notice from the Assistant Deputy Comptroller that the restitution process has been completed or written notice from the Comptroller that the Bank’s capital is materially deficient to achieve the capital ratios stated in the Agreement. As of December 31, 2010, the Bank has not received either communication from the Comptroller, and therefore does not consider itself in breach of this provision of the Agreement.
 
 
59

 

(000's)
 
Actual
   
For Capital
Adequacy Purposes
   
To Be Well Capitalized
Under Prompt
Corrective Action
Provisions
 
   
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
                                     
As of December 31, 2010
                                   
Total Capital (to Risk Weighted Assets)
 
$
12,156
     
12.20
%
 
$
7,973
>
   
8.00
%
 
$
9,966
>
   
10.00
%
                                                 
Tier 1 Capital (to Risk Weighted Assets)
   
10,904
     
10.94
%
   
3,986
>
   
4.00
%
   
5,979
>
   
6.00
%
                                                 
Tier 1 Capital (to Average Assets)
   
10,904
     
9.41
%
   
4,635
>
   
4.00
%
   
5,793
>
   
5.00
%
                                                 
As of December 31, 2009
                                               
Total Capital (to Risk Weighted Assets)
 
$
12,640
     
11.33
%
 
$
8,925
>
   
8.00
%
 
$
11,156
>
   
10.00
%
                                                 
Tier 1 Capital (to Risk Weighted Assets)
   
11,242
     
10.08
%
   
4,462
>
   
4.00
%
   
6,694
>
   
6.00
%
                                                 
Tier 1 Capital (to Average Assets)
   
11,242
     
7.51
%
   
5,988
>
   
4.00
%
   
7,485
>
   
5.00
%
 
NOTE 15.FAIR VALUE OF FINANCIAL INSTRUMENTS

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. FASB ASC Topic 820 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 
·
Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

 
·
Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.
 
 
·
Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.
 
 
60

 
 
In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein.

Securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.
 
The following table summarizes financial and nonfinancial assets measured at fair value as of December 31, 2010 and 2009, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
 
(000's)
 
Level 1
Inputs
   
Level 2
Inputs
   
Level 3
Inputs
   
Total
Fair Value
 
As of December 31, 2010
                       
Securities available for sale:
                       
U.S. government agencies
 
$
   
$
4,067
   
$
   
$
4,067
 
Other Assets:
                               
OREO
   
     
2,291
     
     
2,291
 
                                 
As of December 31, 2009
                               
Securities available for sale:
                               
U.S. government agencies and corporations
 
$
   
$
4,005
   
$
   
$
4,005
 
Other Assets:
                               
OREO
   
     
1,616
     
     
1,616
 

Non-financial assets measured at fair value on a non-recurring basis are comprised of OREO. Certain OREO assets, upon initial recognition, were remeasured and reported at fair value through a charge-off to the allowance for possible loan losses based upon the fair value of the OREO asset. The fair value of an OREO asset, upon initial recognition, is estimated using Level 2 inputs based on a market approach using observable market data, such as comparable sales in the area.  In connection with the measurement and initial recognition of the OREO assets, the Company recognized charge-offs of the allowance for loan losses totaling $1.4 million, which has been recorded on the consolidated statement of income through the provision for loan losses.
 
Carrying amount and estimated fair values of financial instruments were as follows at year end:
 
   
2010
   
2009
 
   
Carrying
Amount
   
Estimated
Fair Value
   
Carrying
Amount
   
Estimated
Fair Value
 
Financial assets
                       
Cash and cash equivalents
 
$
10,189
   
$
10,189
   
$
7,292
   
$
7,292
 
Securities available for sale
   
4,067
     
4,067
     
4,005
     
4,005
 
Loans, net
   
94,185
     
94,305
     
121,419
     
120,702
 
Accrued interest receivable
   
330
     
330
     
397
     
397
 
                                 
Financial liabilities
                               
Deposits
   
95,770
     
97,717
     
108,125
     
108,685
 
Accrued interest payable
   
77
     
77
     
101
     
101
 
 
The methods and assumptions used to estimate fair value are described as follows:
 
Carrying amount is the estimated fair value for cash and cash equivalents, restricted securities, accrued interest receivable and payable, and demand and savings deposits and variable rate loans or deposits that re-price frequently and fully. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent re-pricing, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. The estimated fair value of other financial instruments and off-balance-sheet loan commitments approximate cost and are not considered significant to this presentation.
 
 
61

 
 
NOTE 16.PARENT COMPANY CONDENSED FINANCIAL STATEMENTS
 
T BANCSHARES, INC.
CONDENSED BALANCE SHEET

(000's)
 
December 31,
2010
   
December 31,
2009
 
             
ASSETS
           
             
Cash and due from banks
 
$
256
   
$
367
 
Investment in subsidiary
   
10,894
     
11,259
 
                 
Total assets
 
$
11,150
   
$
11,626
 
                 
LIABILITIES AND CAPITAL
               
                 
Accounts payable
   
13
     
35
 
Capital
   
11,137
     
11,591
 
                 
Total liabilities and capital
 
$
11,150
   
$
11,626
 
 
T BANCSHARES, INC.
CONDENSED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,

(000's)
 
2010
   
2009
 
             
Equity in loss from subsidiary
 
$
(338
)
 
$
(3,663
                 
Noninterest expense:
               
Professional and administrative
   
89
     
78
 
Stock options
   
43
     
103
 
Total noninterest expenses
   
132
     
181
 
                 
Net loss
 
$
(470
)
 
$
(3,844
)

 
62

 

NOTE 17.PARENT COMPANY CONDENSED FINANCIAL STATEMENTS cont’d

T BANCSHARES, INC.
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,

(000's)
 
2010
   
2009
 
             
Cash Flows from Operating Activities
           
             
Net Loss
 
$
(470
)
 
$
(3,844
)
Adjustments to reconcile net income to net cash provided by(used in) operating activities:
               
                 
Equity in loss of Subsidiary
   
338
     
3,663
 
Stock based compensation
   
43
     
103
 
Net change in other assets
   
-
     
333
 
Net change in other liabilities
   
(22
   
16
 
Net cash provided by (used in) operating activities
   
(111
   
271
 
                 
Cash Flows from Investing Activities
               
                 
Proceeds from sale of premises and equipment
   
-
     
-
 
Net cash provided by investing activities
   
-
     
-
 
                 
Cash Flows from Financing Activities
               
                 
Proceeds from rights offering
   
-
     
1,763
 
Contribution to bank
   
-
     
(2,000
 
Payment of capitalized rights offering costs
   
-
     
-
 
Net cash used in financing activities
   
-
     
(237
)
                 
Net change in cash and cash equivalents
   
(111)
     
34
 
Cash and cash equivalents at beginning of period
   
367
     
333
 
                 
Cash and cash equivalents at end of period
 
$
256
   
$
367
 
                 
Supplemental disclosures of cash flow information
               
Cash paid during the period for
               
Interest
 
$
-
   
$
-
 
Income taxes
 
$
-
   
$
-
 
 
 
63

 
 
Item 9.          Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.
 
None.
 
Item 9A.       Controls and Procedures.
 
As of the end of the period covered by this Annual Report on Form 10-K, our principal executive officer and principal financial officer have evaluated the effectiveness of our “disclosure controls and procedures” (“Disclosure Controls”).  Disclosure Controls, as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act, such as this Annual Report, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.  Disclosure Controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.  
 
Our management, including the principal executive officer and principal financial officer, does not expect that our Disclosure Controls will prevent all error and all fraud.  A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.  Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected.  These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake.  The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
 
Based upon their controls evaluation, our chief executive officer and principal financial officer have concluded that our Disclosure Controls are effective at a reasonable assurance level.
 
Management’s Report on Internal Control over Financial Reporting
 
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) of the Securities and Exchange Act of 1934. The Company’s internal control over financial reporting system is designed to provide reasonable assurance to management and the Board of Directors regarding the reliability of the Company’s financial reporting and the preparation of published financial statements in accordance with generally accepted accounting principles.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to the financial statement preparation’s and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
The Company’s management assessed the effectiveness of the Company’s internal controls over financial reporting as of December 31, 2010, utilizing the framework established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management believes that as of December 31, 2010, the Company’s internal controls over financial reporting are effective.
 
Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that accurately and fairly reflect, in reasonable detail, transactions and dispositions of assets; and provide reasonable assurances that: (1) transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States; (2) receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and (3) unauthorized acquisitions, use, or disposition of the Company’s assets that could have a material affect on the Company’s financial statements are prevented or timely detected.
 
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal controls over financial reporting. 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.
 
Item 9B.       Other Information.
 
None.

 
64

 
 
PART III
 
Item 10.        Directors, Executive Officers, and Corporate Governance
 
Information concerning the Company’s directors and executive officers will appear in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders, to be filed pursuant to Regulation 14A on or before April 30, 2011, under the caption “Election of Directors” and “Executive Officers.” Such information is incorporated herein by reference.
 
Information concerning compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, will appear in the Company’s Proxy Statement for the 2011 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2011, under the caption “Section 16(a) Beneficial Ownership Reporting Compliance.” Such information is incorporated herein by reference.
 
We have adopted a Code of Conduct and Ethics, which is applicable to all directors, officers and employees of the Company and the Bank. The Code of Conduct and Ethics will appear in the Company’s Proxy Statement for the 2011 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2011, under the caption “Code of Ethics.” Such information is incorporated herein by reference.
 
Item 11.        Executive Compensation.
 
Information in response to this item will appear in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders, to be filed pursuant to Regulation 14A on or before April 30, 2011, under the captions “Executive Compensation,” “Director Compensation,” and “Compensation Committee.” Such information is incorporated herein by reference.
 
Item 12.        Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters.
 
Information concerning security ownership of certain beneficial owners and management will appear in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders, to be filed pursuant to Regulation 14A on or before April 30, 2011, under the caption “Security Ownership of Certain Beneficial Owners and Management.” Such information is incorporated herein by reference.
 
Item 13.        Certain Relationships and Related Transactions and Director Independence.
 
Information concerning certain relationships and related transactions will appear in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders, to be filed pursuant to Regulation 14A on or before April 30, 2011, under the caption “Certain Relationships and Related Transactions.” Such information is incorporated herein by reference.
 
Item 14.        Principal Accountant Fees and Services.
 
Information concerning principal accounting fees and services will appear in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders, to be filed pursuant to Regulation 14A on or before April 30, 2011, under the caption “Independent Public Accountants.” Such information is incorporated herein by reference.

 
65

 
PART IV
 
Item 15.        Exhibits and Financial Statement Schedules.
 
Exhibit
No.
 
Description of Exhibit
     
3.1
 
Articles of Incorporation (1)
3.2
 
Bylaws of Registrant (2)
10.1
 
T Bancshares, Inc. (f/k/a First Metroplex Capital, Inc.) 2005 Incentive Plan (3)(4)
10.2
 
Form of Incentive Stock Option Agreement (3)(4)
10.3
 
Form of Non-Qualified Stock Option Agreement (3)(4)
10.4
 
T Bancshares, Inc. (f/k/a First Metroplex Capital, Inc.) Organizers' Warrant Agreement dated November 2, 2004  (5)
10.5
 
T Bancshares, Inc. (f/k/a First Metroplex Capital, Inc.) Shareholders' Warrant Agreement dated November 2, 2004  (5)
10.6
 
Extension of term of initial Shareholder Warrants (5)
10.7
 
Form of Employment Agreement by and between T Bancshares, Inc. and Patrick Howard (4)(6)
10.8
 
Form of Employment Agreement by and between T Bancshares, Inc. and Steve Jones (4)(7)
10.9
 
Agreement between T Bank, N.A. and the Office of the Comptroller of the Currency, dated April 15, 2010(8)
10.10
 
Consent Order for Civil Money Penalty of T Bank, N.A., dated April 15, 2010(8)
21
 
Subsidiaries of T Bancshares, Inc.  *
23
 
Consent of Weaver and Tidwell L.L.P.*
31.1
 
Rule 13a-14(a) Certification of Chief Executive Officer*
31.2
 
Rule 13a-14(a) Certification of Chief Financial Officer*
32
 
Certification Pursuant to Rule 14d-14(b) of the Securities Exchange Act*
 
(1)
 
Incorporated by reference from the Quarterly Report on Form 10-QSB filed by Registrant with the SEC on August 14, 2007.
(2)
 
Incorporated by reference from the Current Report on Form 8-K filed by Registrant with the SEC on April 30, 2008.
(3)
 
Incorporated by reference from the Registration Statement on Form S-8 filed by the Registrant with the SEC on September 20, 2005 (file no. 333-128456).
(4)
 
Indicates a compensatory plan or contract.
(5)
 
Incorporated by reference from the Registration Statement on Form SB-2 filed by the Registrant with the SEC on December 15, 2003 and as amended on June 11, 2007 (file no. 333-111153)..
(6)
 
Incorporated by reference from the Current Report on Form 8-K filed by Registrant with the SEC on September 5, 2007.
(7)
 
Incorporated by reference from the Annual Report on Form 10-KSB filed by Registrant with the SEC on March 5, 2005 and, as amended on April 20, 2005.
(8)
 
Incorporated by reference from the Annual Report on Form 10-K filed by Registrant with the SEC on April 15, 2010.
*
 
Filed Herewith

 
66

 
SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
   
T BANCSHARES, INC.
     
Dated: 
March 31, 2011
By:
/s/ Patrick Howard
   
Patrick Howard
     
   
President & Chief Executive Officer
(Principal Executive Officer)
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
 
SIGNATURE
 
TITLE
 
DATE
         
/s/ Patrick Howard 
 
Director and Principal Executive
 
March 31, 2011
Patrick Howard
 
 Officer
   
         
/s/ Ken Bramlage 
 
Principal Financial Officer and
 
March 31, 2011
Ken Bramlage
 
Principal Accounting Officer
   
         
/s/ Stanley E. Allred
 
Director
 
March 31, 2011
Stanley E. Allred
       
         
/s/ Dan Basso 
 
Director
 
March 31, 2011
Dan Basso
       
         
/s/ Frankie Basso 
 
Director
 
March 31, 2011
Frankie Basso
       
         
/s/ David Carstens 
 
Director
 
March 31, 2011
David Carstens
       
         
/s/ Ron Denheyer 
 
Director
 
March 31, 2011
Ron Denheyer
       
         
/s/ Eric Langford 
 
Director
 
March 31, 2011
Eric Langford
       
         
/s/ Steven M. Lugar 
 
Director
 
March 31, 2011
Steven M. Lugar, CFP
       
 
 
67

 
 
SIGNATURE
 
TITLE
 
DATE
         
/s/ Charles M. Mapes, III 
 
Director
 
March 31, 2011
Charles M. Mapes, III
       
         
/s/ Thomas McDougal
 
Director
 
March 31, 2011
Thomas McDougal, DDS
       
         
/s/ Anthony Pusateri 
 
Director
 
March 31, 2011
Anthony Pusateri
       
         
/s/ Gordon R. Youngblood
 
Director
 
March 31, 2011
Gordon R. Youngblood
       
         
/s/ Cyvia Noble 
 
Director
 
March 31, 2011
Cyvia Noble
       
         
/s/ Steven Jones 
 
Director
 
March 31, 2011
Steven Jones
       

 
68