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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2011

Commission File No.: 000-52195

 

 

BANK OF THE CAROLINAS CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

NORTH CAROLINA   20-4989192

(State or other jurisdiction

of incorporation)

 

(IRS Employer

Identification No.)

135 Boxwood Village Drive

Mocksville, North Carolina

  27028
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (336) 751-5755

 

 

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

Indicate by check mark 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 (Section 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  x    No  ¨

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

 

Large accelerated filer

 

¨

  

Accelerated filer

 

¨

Non-accelerated filer

 

¨

  

Smaller reporting company

 

x

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

On August 12, 2011 there were 3,897,174 outstanding shares of the registrant’s common stock.

 

 

 


Table of Contents

BANK OF THE CAROLINAS CORPORATION

FORM 10-Q

June 30, 2011

INDEX

 

Part I. FINANCIAL INFORMATION

     3   

        Item 1.

  

Financial Statements

     3   
  

Consolidated Balance Sheets at June 30, 2011 and December 31, 2010

     3   
  

Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2011 and 2010

     4   
  

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2011 and 2010

     5   
  

Consolidated Statements of Changes in Stockholders’ Equity for the Six Months Ended June 30, 2011 and 2010

     6   
  

Notes to Consolidated Financial Statements

     7   

        Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     22   

        Item 3.

  

Quantitative and Qualitative Disclosures about Market Risk

     29   

        Item 4.

  

Controls and Procedures

     29   

Part II. OTHER INFORMATION

     30   

        Item 1.

  

Legal Proceedings

     30   

        Item 1A.

  

Risk Factors

     30   

        Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     31   

        Item 3.

  

Defaults Upon Senior Securities

     31   

        Item 4.

  

[Removed and Reserved]

     31   

        Item 5.

  

Other Information

     31   

        Item 6.

  

Exhibits

     31   

SIGNATURES

     32   

EXHIBIT INDEX

     33   

 

2


Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Bank of the Carolinas Corporation

Consolidated Balance Sheets

(amounts in thousands, except share and per share data)

 

     June 30,     December 31  
     2011     2010*  
     (Unaudited)        

Assets:

    

Cash and due from banks, noninterest-bearing

   $ 10,172      $ 4,303   

Interest-bearing deposits in banks

     4,256        6,262   
  

 

 

   

 

 

 

Cash and cash equivalents

     14,428        10,565   

Federal funds sold

     8,175        9,330   

Investment securities

     118,534        110,373   

Loans receivable

     345,617        366,153   

Less: Allowance for loan losses

     (6,685     (6,863
  

 

 

   

 

 

 

Total loans, net

     338,932        359,290   

Premises and equipment

     12,681        13,106   

Other real estate owned

     6,066        8,314   

Bank owned life insurance

     10,549        10,371   

Deferred tax assets

     3,941        5,123   

Prepaid FDIC insurance assessment

     3,095        3,670   

Accrued interest receivable

     1,720        1,814   

Other assets

     2,922        3,014   
  

 

 

   

 

 

 

Total assets

   $ 521,043      $ 534,970   
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity:

    

Deposits:

    

Noninterest-bearing demand deposits

   $ 38,176      $ 33,730   

Interest-checking deposits

     37,139        34,004   

Savings and money market deposits

     107,717        114,923   

Time deposits

     243,066        233,512   
  

 

 

   

 

 

 

Total deposits

     426,098        416,169   

Securities sold under agreements to repurchase

     45,710        45,603   

Federal Home Loan Bank advances

     10,000        22,000   

Subordinated debt

     7,855        7,855   

Other liabilities

     2,235        1,639   
  

 

 

   

 

 

 

Total liabilities

     491,898        493,266   
  

 

 

   

 

 

 

Commitments and contingencies (Note 6)

     —          —     

Stockholders’ Equity:

    

Preferred stock, no par value

     13,179        13,179   

Discount on preferred stock

     (856     (991

Common stock, $5 per share par value

     19,486        19,486   

Additional paid-in capital

     12,983        12,988   

Retained deficit

     (16,571     (3,268

Accumulated other comprehensive income

     924        310   
  

 

 

   

 

 

 

Total Stockholders’ Equity

     29,145        41,704   
  

 

 

   

 

 

 

Total Liabilities and Stockholders’ Equity

   $ 521,043      $ 534,970   
  

 

 

   

 

 

 

Preferred shares authorized

     3,000,000        3,000,000   

Preferred shares issued and outstanding

     13,179        13,179   

Common shares authorized

     15,000,000        15,000,000   

Common shares issued and outstanding

     3,897,174        3,897,174   

 

* Derived from audited consolidated financial statements.

The accompanying notes are an integral part of these consolidated financial statements.

 

3


Table of Contents

Bank of the Carolinas Corporation

Consolidated Statements of Operations

(Unaudited)

(dollars in thousands, except per share data)

 

     Three Months Ended     Six Months Ended  
     June 30     June 30  
     2011     2010     2011     2010  

Interest income

        

Interest and fees on loans

   $ 4,489      $ 5,324      $ 9,139      $ 10,707   

Interest on securities

     845        851        1,599        1,785   

Other interest income

     15        16        26        33   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     5,349        6,191        10,764        12,525   
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

        

Interest on deposits

     1,176        1,209        2,330        2,658   

Interest on borrowed funds

     891        684        1,504        1,356   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     2,067        1,893        3,834        4,014   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     3,282        4,298        6,930        8,511   

Provision for loan losses

     6,572        1,086        8,917        2,002   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income (loss) after provision for loan losses

     (3,290     3,212        (1,987     6,509   
  

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest income

        

Customer service fees

     328        330        633        645   

Increase in value of bank owned life insurance

     89        90        178        179   

Gains on investment securities

     6        94        6        190   

Other income (loss)

     2        (2     10        1   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest income

     425        512        827        1,015   
  

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest expense

        

Salaries and benefits

     1,604        1,799        3,190        3,714   

Occupancy and equipment

     527        533        1,069        1,128   

FDIC insurance assessments

     334        263        604        562   

Data processing services

     224        191        436        397   

Valuation provisions and net operating costs associated with foreclosed real estate

     2,747        343        2,997        712   

Other

     1,323        952        2,386        1,803   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest expense

     6,759        4,081        10,682        8,316   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

     (9,624     (357     (11,842     (792

Provision (benefit) for income taxes

     —          (169     996        (369
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

     (9,624     (188     (12,838     (423

Dividends and accretion on preferred stock

     (232     (227     (464     (454
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss available to common stockholders

   $ (9,856   $ (415   $ (13,302   $ (877
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss per common share:

        

Basic

   $ (2.53   $ (0.11   $ (3.41   $ (0.23
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ (2.53   $ (0.11   $ (3.41   $ (0.23
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4


Table of Contents

Bank of the Carolinas Corporation

Consolidated Statements of Cash Flows

(Unaudited)

(dollars in thousands)

 

     Six Months Ended June 30  
     2011     2010  

Cash flows from operating activities:

    

Net loss

   $ (12,838   $ (423

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

    

Provision for loan losses

     8,917        2,002   

Stock based compensation expense (benefit)

     (5     12   

Loss on disposal of premises and equipment

     3        6   

Depreciation and amortization

     504        538   

Change in valuation allowance on other real estate owned

     2,528        474   

Loss on sale of other real estate owned

     176        54   

Gain on sale of securities

     (6     (190

Increase in bank owned life insurance

     (178     (179

Net amortization/accretion of premiums and discounts on investments

     398        131   

Net change in other assets

     1,494        5,191   

Net change in other liabilities

     596        (144
  

 

 

   

 

 

 

Net cash provided by operating activities

     1,589        7,472   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Net change in federal funds sold

     1,155        21,660   

Purchases of premises and equipment

     (82     (31

Purchases of securities

     (21,926     (72,337

Proceeds from sales, calls, maturities and principal repayments of securities available for sale

     14,371        91,694   

Redemption of FHLB stock

     65        —     

Improvements made to other real estate owned

     —          (19

Proceeds from sales of other real estate owned

     1,420        1,147   

Proceeds from sales of premises and equipment

     —          1   

Net decrease in loans

     9,565        16,829   
  

 

 

   

 

 

 

Net cash provided by investing activities

     4,568        58,944   
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Net increase (decrease) in deposits

     9,929        (79,930

Net additions (repayments) of other borrowings

     (12,000     10,000   

Increase (decrease) in repurchase agreements

     107        (927

Cash dividends paid on preferred stock

     (330     (329
  

 

 

   

 

 

 

Net cash used by financing activities

     (2,294     (71,186
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     3,863        (4,770

Cash and cash equivalents at beginning of period

     10,565        12,544   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 14,428      $ 7,774   
  

 

 

   

 

 

 

Supplemental disclosure of cash flow information:

    

Cash paid during the period for interest

   $ 3,425      $ 4,813   
  

 

 

   

 

 

 

Noncash investing and financing activities:

    

Change in fair value of securities available for sale, net of tax

   $ 614      $ 1,210   
  

 

 

   

 

 

 

Transfer from loans to other real estate owned

   $ 1,876      $ 2,604   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

5


Table of Contents

Bank of the Carolinas Corporation

Consolidated Statements of Changes in Stockholders’ Equity

(Unaudited)

(dollars in thousands)

 

                                              Accumulated        
                Discount                 Additional     Retained     Other     Total  
    Preferred Stock     on Preferred     Common Stock     Paid-In     Earnings     Comprehensive     Stockholders’  
    Shares     Amount     Stock     Shares     Amount     Capital     (Deficit)     Income     Equity  

Balance, December 31, 2009

    13,179      $ 13,179      $ (1,245     3,897,174      $ 19,486      $ 12,978      $ 300      $ 294      $ 44,992   

Net loss

    —          —          —          —          —          —          (423     —          (423

Other comprehensive income

    —          —          —          —          —          —          —          1,210        1,210   
                 

 

 

 

Total comprehensive income

    —          —          —          —          —          —          —          —          787   
                 

 

 

 

Stock based compensation expense

    —          —          —          —          —          12        —          —          12   

Discount accretion on preferred stock

    —          —          124        —          —          —          (124     —          —     

Dividends accrued on preferred stock

    —          —          —          —          —          —          (329     —          (329
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2010

    13,179      $ 13,179      $ (1,121     3,897,174      $ 19,486      $ 12,990      $ (576   $ 1,504      $ 45,462   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 31, 2010

    13,179      $ 13,179      $ (991     3,897,174      $ 19,486      $ 12,988      $ (3,268   $ 310      $ 41,704   

Net loss

    —          —          —          —          —          —          (12,839     —          (12,839

Other comprehensive loss

    —          —          —          —          —          —          —          614        614   
                 

 

 

 

Total comprehensive loss

    —          —          —          —          —          —          —          —          (12,225
                 

 

 

 

Stock based compensation benefit

    —          —          —          —          —          (5     —          —          (5

Discount accretion on preferred stock

    —          —          135        —          —          —          (135     —          —     

Dividends accrued on preferred stock

    —          —          —          —          —          —          (329     —          (329
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2011

    13,179      $ 13,179      $ (856     3,897,174      $ 19,486      $ 12,983      $ (16,571   $ 924      $ 29,145   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

6


Table of Contents

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements

(Unaudited)

NOTE 1. BASIS OF PRESENTATION

In the opinion of management, the financial information included in these unaudited financial statements reflects all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the financial information as of June 30, 2011 and December 31, 2010 and for the three- and six-month periods ended June 30, 2011 and 2010, in conformity with accounting principles generally accepted in the United States of America.

The preparation of financial statements requires management to make estimates and assumptions that affect reported amounts of assets and liabilities at the date of the financial statements, as well as the amounts of income and expense during the reporting period. Actual results could differ from those estimates. Operating results for the three- and six-month periods ended June 30, 2011 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2011.

The results presented here are for Bank of the Carolinas Corporation (“the Company”), the parent company of Bank of the Carolinas (“the Bank”). The organization and business of the Company, accounting policies followed by the Company and other relevant information are contained in the notes to the financial statements filed as part of the Company’s annual report on Form 10-K for the year ended December 31, 2010. This quarterly report should be read in conjunction with the annual report. Because the Company has no separate operations and conducts no business on its own other than owning the Bank, this discussion concerns primarily the business of the Bank. However, because the financial statements are presented on a consolidated basis, the Company and the Bank are collectively referred to as “the Company” unless otherwise noted.

NOTE 2. EARNINGS PER SHARE

Basic earnings (loss) per share represents income (loss) available to common stockholders divided by the weighted average number of common shares outstanding during the period. When applicable, the weighted average shares outstanding for the diluted earnings per share computations are adjusted to reflect the assumed conversion of shares available under stock options using the treasury stock method.

Earnings (loss) per share have been computed based on the following (dollars in thousands):

 

     Three months ended     Six months ended  
     June 30,     June 30,  
     2011     2010     2011     2010  

Net income (loss) applicable to common stock

   $ (9,856   $ (415   $ (13,302   $ (877
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average number of common shares outstanding

     3,897,174        3,897,174        3,897,174        3,897,174   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average number of diluted common shares outstanding

     3,897,174        3,897,174        3,897,174        3,897,174   
  

 

 

   

 

 

   

 

 

   

 

 

 

Common stock options and common stock warrants - anti-dilutive

     502,205        517,245        502,205        42,040   
  

 

 

   

 

 

   

 

 

   

 

 

 

The common stock warrants referred to above were issued to the United States Treasury in connection with the Company’s April 17, 2009 participation in the Capital Purchase Program, which was authorized as a part of the TARP legislation passed by Congress during 2008.

 

7


Table of Contents

NOTE 3. INVESTMENT SECURITIES

The amortized cost, estimated fair values and carrying values of the investment securities portfolios at the indicated dates are summarized as follows (dollars in thousands):

 

     June 30, 2011  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Estimated
Fair Value
     Carrying
Value
 

Investment securities available for sale:

              

U.S. Government agencies securities

   $ 56,526       $ 806       $ 109       $ 57,223       $ 57,223   

State and municipal bonds

     3,439         175         —           3,614         3,614   

Corporate securities

     963         46         —           1,009         1,009   

Mortgage-backed securities

     53,783         664         109         54,338         54,338   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities available for sale

     114,711         1,691         218         116,184         116,184   

Investment securities held to maturity:

              

Corporate securities

     2,350         96         239         2,207         2,350   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 117,061       $ 1,787       $ 457       $ 118,391       $ 118,534   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     December 31, 2010  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Estimated
Fair Value
     Carrying
Value
 

Investment securities available for sale:

              

U.S. Government agencies securities

   $ 53,141       $ 746       $ 369       $ 53,518       $ 53,518   

State and municipal bonds

     3,696         165         2         3,859         3,859   

Corporate securities

     962         —           22         940         940   

Mortgage-backed securities

     48,265         355         397         48,223         48,223   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities available for sale

     106,064         1,266         790         106,540         106,540   

Investment securities held to maturity:

              

Corporate securities

     3,833         131         239         3,725         3,833   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 109,897       $ 1,397       $ 1,029       $ 110,265       $ 110,373   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

NOTE 4. LOANS

The loan portfolio as of the dates indicated is summarized below (dollars in thousands):

 

     June 30,
2011
    December 31,
2010
 

Real estate loans:

    

1-4 family residential

   $ 80,823      $ 78,750   

Commercial real estate

     153,525        161,839   

Construction and development

     30,086        35,310   

Home equity

     30,034        31,465   
  

 

 

   

 

 

 

Total real estate loans

     294,468        307,364   
  

 

 

   

 

 

 

Commercial business and other loans

     43,699        51,581   
  

 

 

   

 

 

 

Consumer loans:

    

Installment

     3,739        4,300   

Other

     3,711        2,908   
  

 

 

   

 

 

 

Total consumer loans

     7,450        7,208   
  

 

 

   

 

 

 

Gross loans receivable

     345,617        366,153   

Allowance for loan losses

     (6,685     (6,863
  

 

 

   

 

 

 

Loans, net

   $ 338,932      $ 359,290   
  

 

 

   

 

 

 

 

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Table of Contents

Impaired loans, segregated by class of loans, are summarized as follows as of the dates indicated (dollars in thousands):

 

     June 30, 2011      December 31, 2010  
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 

With no related allowance:

                             

Commercial - Non Real Estate

   $ 2,843       $ 4,849       $ —         $ 4,860       $ 105       $ 1,888       $ 2,012       $ —         $ 2,083       $ 127   

Commercial Real Estate

                             

Owner occupied

     11,603         13,693         —           13,930         326         6,805         7,755         —           7,778         412   

Income producing

     3,384         3,477         —           3,517         59         1,694         1,694         —           1,740         63   

Multifamily

     1,312         1,344         —           1,363         22         —           —           —           —           —     

Construction & Development

                             

1 - 4 Family

     245         245         —           245         4         98         100         —           99         8   

Other

     1,274         1,670         —           1,678         50         1,141         1,192         —           1,247         56   

Farmland

     —           —           —           —           —           —           —           —           —           —     

Residential

                             

Equity Lines

     —           —           —           —           —           37         80         —           80         6   

1 - 4 Family

     4,243         5,534         —           5,589         144         2,634         2,686         —           2,697         156   

Junior Liens

     —           —           —           —           —           18         20         —           20         2   

Consumer - Non Real Estate

                             

Credit Cards

     —           —           —           —           —           —           —           —           —           —     

Other

     19         21         —           21         1         101         156         —           157         11   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans with no allowance

   $ 24,923       $ 30,833       $ —         $ 31,203       $ 711       $ 14,416       $ 15,695       $ —         $ 15,901       $ 841   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

                             

Commercial - Non Real Estate

   $ 3,315       $ 3,315       $ 1,216       $ 3,368       $ 86       $ 2,633       $ 3,103       $ 513       $ 3,138       $ 149   

Commercial Real Estate

                             

Owner occupied

     1,929         4,559         52         4,575         66         10,430         10,434         951         10,465         430   

Income producing

     3,359         3,359         84         3,373         83         2,899         2,899         72         2,924         123   

Multifamily

     —           —           —           —           —           —           —           —           —           —     

Construction & Development

                             

1 - 4 Family

     748         748         11         780         20         1,138         1,138         44         1,138         69   

Other

     923         926         68         929         25         148         148         —           148         8   

Farmland

     —           —           —           —           —           —           —           —           —           —     

Residential

                             

Equity Lines

     —           —           —           —           —           497         497         447         503         21   

1 - 4 Family

     4,843         4,844         363         4,865         117         3,117         3,134         516         3,141         142   

Junior Liens

     331         331         5         365         10         59         60         25         60         1   

Consumer - Non Real Estate

                             

Credit Cards

     —           —           —           —           —           —           —           —           —           —     

Other

     —           —           —           —           —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans with an allowance

   $ 15,448       $ 18,082       $ 1,799       $ 18,255       $ 407       $ 20,921       $ 21,413       $ 2,568       $ 21,517       $ 943   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total:

                             

Commercial - Non Real Estate

   $ 6,158       $ 8,164       $ 1,216       $ 8,228       $ 191       $ 4,521       $ 5,115       $ 513       $ 5,221       $ 276   

Commercial Real Estate

   $ 21,587       $ 26,432       $ 136       $ 26,758       $ 556       $ 21,828       $ 22,782       $ 1,023       $ 22,907       $ 1,028   

Construction & Development

   $ 3,190       $ 3,589       $ 79       $ 3,632       $ 99       $ 2,525       $ 2,578       $ 44       $ 2,632       $ 141   

Residential

   $ 9,417       $ 10,709       $ 368       $ 10,819       $ 271       $ 6,362       $ 6,477       $ 988       $ 6,501       $ 328   

Consumer - Non Real Estate

   $ 19       $ 21       $ —         $ 21       $ 1       $ 101       $ 156       $ —         $ 157       $ 11   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 40,371       $ 48,915       $ 1,799       $ 49,458       $ 1,118       $ 35,337       $ 37,108       $ 2,568       $ 37,418       $ 1,784   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Troubled debt restructurings (TDR) are a subset of impaired loans and totaled $23.6 million at June 30, 2011 and $22.1 million at December 31, 2010.

 

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Table of Contents

Non-accrual loans and an age analysis of past due loans, segregated by class of loans, were as follows (dollars in thousands):

 

    30 - 59
Days
Past Due
    60 - 89
Days
Past Due
    90 Days
or More
Past Due
    Total
Past Due
    Current     Total
Loans
    90 Days
Past Due
and Still
Accruing
    Non-accrual
Loans
 

June 30, 2011:

               

Commercial - Non Real Estate

  $ 396      $ 702      $ 616      $ 1,714      $ 41,985      $ 43,699      $ —        $ 2,843   

Commercial Real Estate

               

Owner occupied

    473        2,018        9,932        12,423        84,411        96,834        —          12,318   

Income producing

    —          —          1,248        1,248        48,290        49,538        —          3,384   

Multifamily

    —          —          —          —          6,752        6,752        —          1,312   

Construction & Development

               

1 - 4 Family

    417        —          245        662        3,946        4,608        —          245   

Other

    126        255        1,053        1,434        24,044        25,478        —          1,420   

Farmland

    —          —          —          —          401        401        —          —     

Residential

               

Equity Lines

    7        55        —          62        29,972        30,034        —          —     

1 - 4 Family

    1,537        1,346        2,794        5,677        73,310        78,987        —          5,491   

Junior Liens

    —          —          —          —          1,836        1,836        —          —     

Consumer - Non Real Estate

               

Credit Cards

    —          —          —          —          —          —          —          —     

Other

    29        4        —          33        3,706        3,739        —          19   

Other

    —          —          —          —          3,711        3,711        —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 2,985      $ 4,380      $ 15,888      $ 23,253      $ 322,364      $ 345,617      $ —        $ 27,032   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    30 - 59
Days
Past Due
    60 - 89
Days
Past Due
    90 Days
or More
Past Due
    Total
Past Due
    Current     Total
Loans
    90 Days
Past Due
and Still
Accruing
    Non-accrual
Loans
 

December 31, 2010:

               

Commercial - Non Real Estate

  $ 2,250      $ 148      $ 1,380      $ 3,778      $ 47,803      $ 51,581      $ —        $ 3,068   

Commercial Real Estate

               

Owner occupied

    4,321        —          3,785        8,106        96,100        104,206        —          13,827   

Income producing

    345        —          1,349        1,694        48,518        50,212        —          1,349   

Multifamily

    —          —          —          —          7,003        7,003        —          —     

Construction & Development

               

1 - 4 Family

    1,299        1,233        99        2,631        2,968        5,599        —          1,236   

Other

    286        —          251        537        29,174        29,711        —          1,038   

Farmland

    —          —          —          —          418        418        —          —     

Residential

               

Equity Lines

    503        87        —          590        30,875        31,465        —          432   

1 - 4 Family

    2,026        1,697        1,391        5,114        71,693        76,807        —          3,561   

Junior Liens

    —          —          —          —          1,943        1,943        —          78   

Consumer - Non Real Estate

               

Credit Cards

    —          —          —          —          —          —          —          —     

Other

    74        1        96        171        4,129        4,300        —          101   

Other

    —          —          —          —          2,908        2,908        —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 11,104      $ 3,166      $ 8,351      $ 22,621      $ 343,532      $ 366,153      $ —        $ 24,690   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The Bank categorizes loans and leases into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. This categorization is made on all commercial, commercial real estate, and construction and development loans. The Bank uses the following definitions for risk ratings:

Special Mention - Loans and leases classified as special mention, while still adequately protected by the borrower’s capital adequacy and payment capability, exhibit distinct weakening trends and/or elevated levels of exposure to external conditions. If left unchecked or uncorrected, these potential weaknesses may result in deteriorated prospects of repayment. These exposures require management’s close attention so as to avoid becoming undue or unwarranted credit exposures.

Substandard - Loans and leases classified as substandard are inadequately protected by the borrower’s current financial

 

11


Table of Contents

condition and payment capability or of the collateral pledged, if any. Loans and leases so classified have a well-defined weakness or weaknesses that jeopardize the orderly repayment of debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

Doubtful - Loans and leases classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or orderly repayment in full, on the basis of current existing facts, conditions and values, highly questionable and improbable. Possibility of loss is extremely high, but because of certain important and reasonably specific factors that may work to the advantage and strengthening of the exposure, its classification as an estimated loss is deferred until its more exact status may be determined. The Company’s practice is to charge-off the portion of the loan amount determined to be doubtful in the quarter that the determination is made if the repayment of the loan is collateral dependent.

Loss - Loans and leases classified as loss are considered to be non-collectible and of such little value that their continuance as bankable assets is not warranted. This does not mean the loan has absolutely no recovery value, but rather it is neither practical nor desirable to defer writing off the loan, even though partial recovery may be obtained in the future. Losses are taken in the period in which they surface as uncollectible.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass-rated loans. As of June 30, 2011 and December 31, 2010, and based on the most recent analysis performed, the risk category of loans and leases is as follows (dollars in thousands):

 

     June 30, 2011  
     Pass      Special
Mention
     Substandard      Doubtful      Loss  

Internal Risk Rating Grades

              

Commercial - Non Real Estate

   $ 33,028       $ 3,912       $ 4,887       $ 1,872       $ —     

Commercial Real Estate

              

Owner occupied

     62,137         13,388         21,309         —           —     

Income producing

     34,472         6,672         8,394         —           —     

Multifamily

     3,862         749         2,141         —           —     

Construction & Development

              

1 - 4 Family

     2,160         1,347         1,101         —           —     

Other

     21,276         2,191         2,011         —           —     

Farmland

     401         —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 157,336       $ 28,259       $ 39,843       $ 1,872       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total:

              

Commercial - Non Real Estate

   $ 33,028       $ 3,912       $ 4,887       $ 1,872       $ —     

Commercial Real Estate

   $ 100,471       $ 20,809       $ 31,844       $ —         $ —     

Construction & Development

   $ 23,837       $ 3,538       $ 3,112       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 157,336       $ 28,259       $ 39,843       $ 1,872       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     December 31, 2010  
     Pass      Special
Mention
     Substandard      Doubtful      Loss  

Internal Risk Rating Grades

              

Commercial - Non Real Estate

   $ 36,269       $ 9,381       $ 5,625       $ 306       $ —     

Commercial Real Estate

              

Owner occupied

     65,512         17,632         21,062         —           —     

Income producing

     36,450         9,169         4,593         —           —     

Multifamily

     4,646         1,524         833         —           —     

Construction & Development

              

1 - 4 Family

     2,996         1,125         1,478         —           —     

Other

     25,169         2,939         1,402         201         —     

Farmland

     418         —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 171,460       $ 41,770       $ 34,993       $ 507       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total:

              

Commercial - Non Real Estate

   $ 36,269       $ 9,381       $ 5,625       $ 306       $ —     

Commercial Real Estate

   $ 106,608       $ 28,325       $ 26,488       $ —         $ —     

Construction & Development

   $ 28,583       $ 4,064       $ 2,880       $ 201       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 171,460       $ 41,770       $ 34,993       $ 507       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

12


Table of Contents

All consumer-related loans, including residential real estate and non-real estate, are evaluated and monitored based upon payment activity. Once a consumer-related loan becomes past due on a recurring basis, the Company will pull that loan out of the homogenized pool and evaluate it individually for impairment. At this time, the consumer-related loan may be placed on the Company’s internal watch list and risk rated either special mention or substandard, depending upon the individual circumstances. Consumer-related loans at June 30, 2011 and December 31, 2010, segregated by class of loans, were as follows (dollars in thousands):

 

     June 30, 2011      December 31, 2010  
     Performing      Non-
Performing
     Performing      Non-
Performing
 

Risk Based on Payment Activity

           

Residential

           

Equity Lines

   $ 30,034       $ —         $ 31,069       $ 396   

1 - 4 Family

     76,699         2,288         73,682         3,125   

Junior Liens

     1,836         —           1,866         77   

Consumer - Non Real Estate

           

Credit Cards

     —           —           —           —     

Other

     3,720         19         4,294         6   
  

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 112,289       $ 2,307       $ 110,911       $ 3,604   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total:

           

Residential

   $ 108,569       $ 2,288       $ 106,617       $ 3,598   

Consumer - Non Real Estate

   $ 3,720       $ 19       $ 4,294       $ 6   
  

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 112,289       $ 2,307       $ 110,911       $ 3,604   
  

 

 

    

 

 

    

 

 

    

 

 

 

NOTE 5. ALLOWANCE FOR LOAN LOSSES

The allowance for possible loan losses is a reserve established through a provision for possible loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Company’s allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for loan losses also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans.

The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

The Company’s allowance for loan losses consists of three elements: (i) specific valuation allowances determined in accordance with accounting principles regarding receivables based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with accounting principles regarding contingencies based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general

 

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Table of Contents

valuation allowances determined in accordance with accounting principles regarding contingencies based on general economic conditions and other qualitative risk factors both internal and external to the Company.

Historical valuation allowances are calculated based on the historical loss experience of specific types of loans at the time they were charged-off. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are periodically updated based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and the total dollar amount of the loans in the pool. The Company’s pools of similar loans include commercial and industrial loans, commercial real estate loans, construction and development loans, residential real estate loans, and consumer and other loans. General valuation allowances are based on general economic conditions and other qualitative risk factors both internal and external to the Company. In general, such valuation allowances are determined by evaluating, among other things: (i) levels and trends in delinquencies and impaired loans; (ii) levels of and trends in chargeoffs and recoveries; (iii) levels of non-impaired substandard loans; (iv) trends in volume and terms of loans; (v) effects of changes in risk selection and underwriting practices; (vi) experience, ability, and depth of lending management and staff; (vii) national and local economic trends and conditions; (viii) industry conditions; and (ix) effect of changes in credit concentrations. Management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. Loans identified as losses by management, internal loan review and/or regulatory examiners are charged-off.

 

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Table of Contents

Changes in the allowance for loan losses by segment are as follows:

 

     Beginning
Balance
     Chargeoffs     Recoveries      Provision      Ending
Balance
 

June 30, 2011:

             

Commercial - Non Real Estate

   $ 2,252       $ (2,077   $ 179       $ 2,430       $ 2,784   

Commercial Real Estate

             

Owner occupied

     1,055         (4,570     21         3,958         464   

Income producing

     99         (54     —           91         136   

Multifamily

     —           —          —           —           —     

Construction & Development

             

1 - 4 Family

     181         (168     4         128         145   

Other

     486         (362     97         243         464   

Farmland

     —           —          —           —           —     

Residential

             

Equity Lines

     459         (672     2         325         114   

1 - 4 Family

     1,078         (1,426     6         1,353         1,011   

Consumer - Non Real Estate

     161         (85     10         57         143   

Unallocated

     1,092         —          —           332         1,424   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 6,863       $ (9,414   $ 319       $ 8,917       $ 6,685   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

 

     Individually Evaluated for Impairment  
     June 30, 2011      December 31, 2010  
     Allowance      Total Loans      Allowance      Total Loans  

Commercial - Non Real Estate

   $ 1,216       $ 6,966       $ 513       $ 4,580   

Commercial Real Estate

           

Owner occupied

     52         12,805         951         17,235   

Income producing

     84         6,743         72         4,593   

Multifamily

     5         1,312         —           —     

Construction & Development

           

1 - 4 Family

     11         992         44         1,236   

Other

     68         2,198         25         1,288   

Farmland

     —           —           —           —     

Residential

           

Equity Lines

     —           —           447         534   

1 - 4 Family

     363         9,335         516         5,770   

Consumer - Non Real Estate

     —           20         —           101   

Unallocated

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,799       $ 40,371       $ 2,568       $ 35,337   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Collectively Evaluated for Impairment  
     June 30, 2011      December 31, 2010  
     Allowance      Total Loans      Allowance      Total Loans  

Commercial - Non Real Estate

   $ 1,568       $ 36,733       $ 1,739       $ 47,001   

Commercial Real Estate

           

Owner occupied

     412         84,028         104         86,971   

Income producing

     51         42,795         27         45,619   

Multifamily

     —           5,440         —           7,003   

Construction & Development

           

1 - 4 Family

     134         3,616         137         4,363   

Other

     396         23,280         461         28,422   

Farmland

     —           401         —           418   

Residential

           

Equity Lines

     114         30,034         12         30,931   

1 - 4 Family

     643         71,488         562         72,981   

Consumer - Non Real Estate

     144         3,719         161         4,199   

Unallocated

     1,424         —           1,092         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 4,886       $ 301,534       $ 4,295       $ 327,908   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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NOTE 6. COMMITMENTS AND 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, lines of credit and standby letters of credit. These instruments involve elements of credit risk in excess of amounts recognized in the accompanying financial statements.

The Company’s risk of loss related to unfunded loan commitments and lines of credit or standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments under such instruments as it does for on-balance sheet instruments. The amount of collateral obtained, if any, is based on management’s credit evaluation of the borrower. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The following table presents a summary of outstanding financial instruments whose contract amounts represent credit risk as of June 30, 2011 (dollars in thousands):

 

Unfunded loan commitments

   $ 31,336   

Financial standby letters of credit

     2,477   
  

 

 

 

Total unused commitments

   $ 33,813   
  

 

 

 

Following the termination of his employment on May 12, 2010, the Company’s former Chief Financial Officer, who also served as the Bank’s Executive Vice Chairman and Chief Operating Officer, and as a director of the Company and the Bank, instituted a lawsuit against the Bank and several individuals on May 14, 2010, as described under Part II, Item 1 of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010. Based on the advice of outside counsel, the Company believes that the claims against the Bank will not result in a material loss and the Bank is vigorously defending the lawsuit.

NOTE 7. OTHER COMPREHENSIVE INCOME

Accounting principles generally accepted in the United States of America require that recognized revenue, expenses, gains, and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component in the equity section of the balance sheet. Such items, along with net income, are considered components of comprehensive income. Accounting principles do not require per share amounts of comprehensive income to be disclosed. The components of other comprehensive income and related income tax effects are as follows (dollars in thousands):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2011     2010     2011     2010  

Unrealized holding gains on securities available-for-sale

   $ 1,223      $ 1,564      $ 1,004      $ 2,158   

Reclassification adjustment for gains (losses) realized in net loss

     (6     (94     (6     (190
  

 

 

   

 

 

   

 

 

   

 

 

 

Net unrealized holding gains on securities available-for-sale

     1,217        1,470        998        1,968   

Income tax effect

     (469     (566     (384     (758
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income, net of income tax effect

   $ 748      $ 904      $ 614      $ 1,210   
  

 

 

   

 

 

   

 

 

   

 

 

 

NOTE 8. RECENT ACCOUNTING PRONOUNCEMENTS

In January 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-01, Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. Under the existing effective date in Update 2010-20, public-entity creditors would have provided disclosures about troubled debt restructurings for periods beginning on or after December 15, 2010. The amendments in this Update temporarily defers the effective date for interim and annual periods ending after June 15, 2011, enabling public-entity creditors to provide those disclosures after the Board clarifies the guidance for determining what constitutes a troubled debt restructuring. The deferral in this Update will result in more

 

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consistent disclosures about troubled debt restructurings. This amendment does not defer the effective date of the other disclosure requirements in Update 2010-20. The deferral in this amendment is effective upon issuance and is not expected to have a significant impact on the Company.

In April 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This update provides additional guidance and amendments to Subtopic 310-40, Receivables – Troubled Debt Restructurings by Creditors. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following exist; the restructuring constitutes a concession, and the debtor is experiencing financial difficulties. The amendments clarify the guidance on a creditor’s evaluation of whether it has granted a concession, and on a creditor’s evaluation of whether a debtor is experiencing financial difficulties.

The amendments in this Update are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. As a result of applying these amendments, an entity may identify receivables that are newly considered impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. An entity should disclose the total amount of receivables and the allowance for credit losses as of the end of the period of adoption related to those receivables that are newly considered impaired under Section 310-10-35 for which impairment was previously measured under Subtopic 450-20, Contingencies—Loss Contingencies. An entity should disclose the information required by paragraphs 310-10-50-33 through 50-34, which was deferred by Accounting Standards Update No. 2011-01, Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20, for interim and annual periods beginning on or after June 15, 2011. The amendments are not expected to have a significant impact on the Company.

In April 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-3, Reconsideration of Effective Control for Repurchase Agreements. The amendments in this Update remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. Other criteria applicable to the assessment of effective control are not changed by the amendments in this Update. Those criteria indicate that the transferor is deemed to have maintained effective control over the financial assets transferred (and thus must account for the transaction as a secured borrowing) for agreements that both entitle and obligate the transferor to repurchase or redeem the financial assets before their maturity when all of the listed conditions have been met. The amendments are not expected to have a significant impact on the Company.

In May 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-4, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this Update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the Board does not intend for the amendments in this Update to result in a change in the application of the requirements in Topic 820.

Some of the amendments clarify the Board’s intent about the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. The amendments are not expected to have a significant impact on the Company.

In June 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-5, Presentation of Comprehensive Income. Under the amendments to Topic 220, Comprehensive Income, in this Update, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. In a single continuous statement, the entity is required to present the components of net income and total net income, the components of other comprehensive income and a total for other comprehensive income, along with the total of comprehensive income in that statement. In the two-statement approach, an entity is required to present components of net income and total net income in the statement of net income. The statement of other comprehensive income should immediately follow the statement of net

 

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income and include the components of other comprehensive income and a total for other comprehensive income, along with a total for comprehensive income.

Regardless of whether an entity chooses to present comprehensive income in a single continuous statement or in two separate but consecutive statements, the entity is required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented.

The amendments in this Update do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments do not change the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, with one amount shown for the aggregate income tax expense or benefit related to the total of other comprehensive income items. In both cases, the tax effect for each component must be disclosed in the notes to the financial statements or presented in the statement in which other comprehensive income is presented. The amendments do not affect how earnings per share is calculated or presented. The amendments are not expected to have a significant impact on the Company.

From time to time the FASB issues Proposed Accounting Standards Updates. Such proposed updates are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as Accounting Standards Updates. Management considers the effect of the proposed updates on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective dates of proposed updates.

NOTE 9. FAIR VALUE

Accounting principles generally accepted in the United States of America require that companies measure and record certain assets and liabilities at fair value and record any adjustments to the fair value of those assets. Securities are recorded at fair value on a recurring basis while other assets, such as impaired loans, are recorded at fair value on a non-recurring basis.

The Company uses three levels of measurement to group those assets measured at fair value. These groupings are made based on the markets the assets are traded in and the reliability of the assumptions used to determine fair value. The groupings include:

 

   

Level 1 pricing for an asset or liability is derived from the most likely actively traded markets and considered very reliable. Quoted prices on actively traded equities, for example, fall into this category.

 

   

Level 2 pricing is derived from observable data including market spreads, current and projected rates, prepayment data and credit quality. Our bond price adjustments fall into this category as well as impaired loans and other real estate owned that use appraisals or brokered price opinions to determine fair value.

 

   

Level 3 pricing is derived without observable data. In such cases, mark-to-market strategies are typically employed. These types of instruments often have no active market, possess unique characteristics and are thinly traded.

The Company’s investment securities are measured on a recurring basis through a model used by our bond agent. All of our bond price adjustments meet Level 2 criteria. Prices are derived from a model which uses actively quoted rates, prepayment models and other underlying credit and collateral data.

 

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The following table summarizes the Company’s assets measured at fair value at the dates indicated (dollars in thousands):

 

     At June 30, 2011  
     Total      Level 1      Level 2      Level 3  

Assets valued on a recurring basis

           

Investment securities:

           

U.S. government and agency

   $ 57,223       $ —         $ 57,223       $ —     

State and municipals

     3,614         —           3,614         —     

Corporate

     1,009         —           1,009         —     

Mortgage-backed

     54,338         —           54,338         —     

Assets valued on a non-recurring basis

           

Impaired loans

     40,371         —           40,371         —     

Other real estate owned

     6,066         —           6,066         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 162,621       $ —         $ 162,621       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 
     At December 31, 2010  
     Total      Level 1      Level 2      Level 3  

Assets valued on a recurring basis

           

Investment securities:

           

U.S. government and agency

   $ 53,518       $ —         $ 53,518       $ —     

State and municipals

     3,859         —           3,859         —     

Corporate

     940         —           940         —     

Mortgage-backed

     48,223         —           48,223         —     

Assets valued on a non-recurring basis

           

Impaired loans

     35,337         —           35,337         —     

Other real estate owned

     8,314         —           8,314         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 150,191       $ —         $ 150,191       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

NOTE 10. BORROWED FUNDS

A summary of the Company’s outstanding borrowings and the annual rate of interest currently payable on each category is presented in the following table at the dates indicated (dollars in thousands):

 

     June 30, 2011     December 31, 2010  
     Outstanding
Balance
     Annual
Interest Rate
    Outstanding
Balance
     Annual
Interest Rate
 

Securities sold under overnight repurchase agreements

   $ 710         0.12   $ 603         0.13

Securities sold under term repurchase agreements

     45,000         4.38        45,000         4.38   

Federal Home Loan Bank advances

     10,000         0.16        22,000         1.13   

Trust preferred securities

     5,155         3.19        5,155         3.25   

Subordinated debt

     2,700         4.00        2,700         4.00   
  

 

 

      

 

 

    

Total borrowed funds

   $ 63,565         3.55   $ 75,458         3.31
  

 

 

      

 

 

    

The Bank engages from time-to-time in federal funds purchases from upstream correspondent institutions to meet temporary funding needs. There were none of these transactions outstanding at the close of either period presented in the above table.

 

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The Bank had a total of $45.0 million of borrowings in the form of securities sold under term repurchase agreements that were entered into during 2008. These borrowings are secured by marketable investment securities equal to approximately 109.5% of the principal balances outstanding plus accrued interest and the value of an imbedded interest rate cap. The following table contains certain pertinent information with respect to these agreements at June 30, 2011 (dollars in thousands):

 

     Outstanding
Principal
Balance
     Annual
Effective
Interest Rate
    Final
Maturity
Date
     Beginning
Quarterly
Call Dates
     Collateral
Requirement
 

Agreement dated 7/8/2008

   $ 25,000         4.85     7/8/2018         7/8/2013       $ 7,441   

Agreement dated 8/20/2008

     20,000         3.78        8/20/2015         8/20/2011         2,298   
  

 

 

            

 

 

 

Total

   $ 45,000         4.38         $ 9,739   
  

 

 

            

 

 

 

The Bank utilizes borrowings from the Federal Home Loan Bank (“FHLB”) as a source of liquidity. At June 30, 2011, the FHLB had advances totaling $10.0 million outstanding to the Bank. All of the FHLB advances are secured by the Bank’s qualifying real estate loans. The following table contains a summary of the more significant terms of these borrowings at June 30, 2011 (dollars in thousands):

 

     Outstanding
Principal
Balance
     Annual
Effective
Interest Rate
    Final
Maturity
Date
 

Advance dated 2/16/2010

   $ 10,000         0.16     02/16/12   

During 2008, the Company issued $5.2 million of junior subordinated debentures to its wholly owned capital trust, Bank of the Carolinas Trust I (the “Trust”), which, in turn, issued $5.0 million in trust preferred securities having a like liquidation amount and $155,000 in common securities (all common securities are owned by the Company). The Company has fully and unconditionally guaranteed the Trust’s obligations related to the trust preferred securities. The Trust has the right to redeem the trust preferred securities in whole or in part, on or after March 26, 2013 at a redemption price equal to 100% of the principal amount plus accrued and unpaid interest.

In addition, the Trust may redeem the trust preferred securities in whole (but not in part) at any time within 90 days following the occurrence of a tax event, an investment company event, or a capital treatment event at a special redemption price (as defined in the debenture). Interest is payable quarterly on the trust preferred securities at the annual rate of 90-day LIBOR plus 300 basis points. In February 2011, the Company announced its election to defer its regularly scheduled interest payments on the junior subordinated debentures related to the trust preferred securities.

The Company also has issued $2.7 million of subordinated debt in a private transaction with another financial institution. This subordinated note has a floating interest rate equal to 75 basis points over the Prime Rate published by Wall Street Journal and a maturity date of August 13, 2018. The Company makes monthly interest payments on the outstanding debt to the holder of the note. This debt can be repaid in full at any time with no penalty.

 

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NOTE 11. STOCKHOLDERS’ EQUITY

Preferred Stock:

The Company has 3.0 million shares of preferred stock authorized. There were 13,179 shares of preferred stock issued and outstanding with a $1,000 per share liquidation preference on June 30, 2011 and December 31, 2010. All of the shares were issued on April 17, 2009 in connection with the U.S. Treasury’s TARP Capital Purchase Program.

In February 2011, the Company notified the Treasury of its intent to defer the payment of its regular quarterly cash dividend on its Series A Preferred Stock sold to the Treasury.

Common Stock:

The Company has 15.0 million shares of $5 par value common stock authorized. There were 3,897,174 shares of common stock issued and outstanding at June 30, 2011 and December 31, 2010.

Warrants:

In connection with the issuance of the preferred shares under the U.S. Treasury’s TARP Capital Purchase Plan, the Company issued the U.S. Treasury a warrant to purchase 475,204 shares of its common stock for $4.16 per share. The warrant expires April 17, 2019.

 

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

Introduction

Bank of the Carolinas Corporation (“the Company”) is the parent holding company of Bank of the Carolinas (“the Bank”). Because the Company has no separate operations and conducts no business on its own other than owning the Bank, the discussion contained in this Management’s Discussion and Analysis concerns primarily the business of the Bank. However, because the financial statements are presented on a consolidated basis, the Company and the Bank are collectively referred to herein as the Company unless otherwise noted.

The Bank began operations in December 1998 as a state chartered bank and currently has ten offices in the Piedmont region of North Carolina. The Bank competes for loans and deposits throughout the markets it serves. The Bank, like most community banks, derives most of its revenue from net interest income which is the difference between the income it earns from loans and securities and the interest expense it incurs on deposits and borrowings.

Consent Order with Regulators

The Bank entered into a Stipulation to the Issuance of a Consent Order (the “Stipulation”) with the Federal Deposit Insurance Corporation (the “FDIC”) and the North Carolina Office of the Commissioner of Banks (the “Commissioner”) and the FDIC and the Commissioner issued the related Consent Order (the “Order”), effective April 27, 2011. The description of the Stipulation and the Order set forth below is qualified in its entirety by reference to the Stipulation and the Order, copies of which are included as exhibits 10.1 and 10.2, respectively, to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on May 3, 2011, and incorporated herein by reference.

Management. The Order requires that the Bank have and retain qualified management, including a chief executive officer, senior lending officer, and chief operating officer with qualifications and experience commensurate with their assigned duties and responsibilities within 60 days from the effective date of the Order. Within 30 days of the effective date of the Order, the board of directors must retain a bank consultant to develop a written analysis and assessment of the Bank’s management needs. Within 60 days from receipt of the consultant’s management report, the Bank must formulate a written management plan that incorporates the findings of the management report, a plan of action in response to each recommendation contained in the management report, and a time frame for completing each action.

Capital Requirements. While the Order is in effect, the Bank must maintain a leverage ratio (the ratio of Tier 1 capital to total assets) of at least 8% and a total risk-based capital ratio (the ratio of qualifying total capital to risk-weighted assets) of at least 10%. If the Bank’s capital ratios are below these levels as of the date of any call report or regulatory examination, the Bank must, within 30 days from receipt of a written notice of capital deficiency from its regulators, present a plan to increase capital to meet the requirements of the Order.

Allowance for Loan and Lease Losses and Call Report. Upon issuance of the Order, the Bank must make a provision to replenish the allowance for loan and lease losses (“ALLL”). Within 30 days of the effective date of the Order, the Bank must review its call reports filed with its regulators on or after December 31, 2010, and must amend those reports if necessary to accurately reflect the financial condition of the Bank. Within 60 days of the effective date of the Order, the Bank must submit a comprehensive policy for determining the adequacy of the ALLL.

Concentrations of Credit. Within 60 days of the issuance of the Order, the Bank must perform a risk segmentation analysis with respect to its concentrations of credit and must develop a written plan for systematically reducing and monitoring the Bank’s commercial real estate and acquisition, construction, and development loans to an amount commensurate with the Bank’s business strategy, management expertise, size, and location.

Charge-Offs, Credits. The Order requires that the Bank eliminate from its books, by charge-off or collection, all assets or portions of assets classified “loss” and 50% of those assets classified “doubtful.” If an asset is classified “doubtful,” the Bank may alternatively charge off the amount that is considered uncollectible in accordance with the Bank’s written analysis of loan or lease impairment. The Order also prevents the Bank from extending, directly or indirectly, any additional credit to, or for the benefit of, any borrower who has a loan or other extension of credit from the Bank that has been charged off or classified, on

 

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whole or in part, “loss” or “doubtful” and is uncollected. The Bank may not extend, directly or indirectly, any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been classified “substandard.” These limitations do not apply if the Bank’s failure to extend further credit to a particular borrower would be detrimental to the best interests of the Bank.

Asset Growth. While the Order is in effect, the Bank must notify its regulators at least 60 days prior to undertaking asset growth that exceeds 10% or more per year or initiating material changes in asset or liability composition. The Bank’s asset growth cannot result in noncompliance with the capital maintenance provisions of the Order unless the Bank receives prior written approval from its regulators.

Restriction on Dividends and Other Payments. While the Order is in effect, the Bank cannot declare or pay dividends, pay bonuses, or pay any form of payment outside the ordinary course of business resulting in a reduction of capital without the prior written approval of its regulators. In addition, the Bank cannot make any distributions of interest, principal, or other sums on subordinated debentures without prior regulatory approval.

Brokered Deposits. The Order provides that the Bank may not accept, renew, or roll over any brokered deposits unless it is in compliance with the requirements of the FDIC regulations governing brokered deposits. These regulations prohibit undercapitalized institutions from accepting, renewing, or rolling over any brokered deposits and also prohibit undercapitalized institutions from soliciting deposits by offering an effective yield that exceeds by more than 75 basis points the prevailing effective yields on insured deposits of comparable maturity in the institution’s market area. An “adequately capitalized” institution may not accept, renew, or roll over brokered deposits unless it has applied for and been granted a waiver by the FDIC.

Written Plans and Other Material Terms. Under the terms of the Order, the Bank is required to prepare and submit the following written plans or reports to the FDIC and the Commissioner:

 

   

Plan to improve liquidity, contingency funding, interest rate risk, and asset liability management

 

   

Plan to reduce assets of $500,000 or greater classified “doubtful” and “substandard”

 

   

Revised lending and collection policy to provide effective guidance and control over the Bank’s lending and credit administration functions

 

   

Effective internal loan review and grading system

 

   

Policy for managing the Bank’s other real estate

 

   

Business/strategic plan covering the overall operation of the Bank

 

   

Plan and comprehensive budget for all categories of income and expense for the year 2011

 

   

Policy and procedures for managing interest rate risk

 

   

Assessment of the Bank’s information technology function

Under the Order, the Bank’s board of directors has agreed to increase its participation in the affairs of the Bank, including assuming full responsibility for the approval of policies and objectives for the supervision of all of the Bank’s activities. The Bank must also establish a board committee to monitor and coordinate compliance with the Order.

The Order will remain in effect until modified or terminated by the FDIC and the Commissioner.

 

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CHANGES IN FINANCIAL CONDITION

Total Assets

At June 30, 2011, total assets were $521.0 million, a decrease of 2.6% compared to $535.0 million at December 31, 2010. The asset decrease was primarily the result of reductions in the loan portfolio, including net chargeoffs of $9.1 million. The Bank continues to raise deposits, mainly customer time deposits, which has resulted in increased liquidity and offset reductions in long-term debt.

Investment Securities

Investment securities totaled $118.5 million at June 30, 2011, compared to $110.4 million at December 31, 2010. The increase was a result of increased customer time deposits referred to above. A summary of the Company’s investment securities holdings by major category at June 30, 2011 and December 31, 2010 is included in Note 3 of “Notes to Consolidated Financial Statements”.

Loans and Allowance for Loan Losses

At June 30, 2011, the loan portfolio totaled $345.6 million and represented 66.3% of total assets compared to $366.2 million or 68.4% of total assets at December 31, 2010. Total loans at June 30, 2011 decreased $20.6 million or 5.6% from December 31, 2010. The decrease in loans outstanding in the six-month period is the result of net chargeoffs of $9.1 million and principal repayments in excess of new loans originated due to slower loan demand under the current economic conditions. Real estate loans, including commercial real estate, constituted approximately 85% of the loan portfolio, and commercial business and other loans comprised approximately 15% of the total loan portfolio at both June 30, 2011 and December 31, 2010.

The allowance for loan losses is created by direct charges to income. Losses on loans are charged against the allowance in the period in which such loans, in management’s opinion, become uncollectible. Recoveries during the period are credited to this allowance. The factors that influence management’s judgment in determining the amount charged to operating expense include past loan experience, composition of the loan portfolio, current economic conditions and probable losses.

The appropriateness of the allowance for loan losses is measured on a quarterly basis using an allocation model that assigns reserves to various components of the loan portfolio in order to provide for probable inherent losses. It must be emphasized, however, that the determination of the reserve using the Company’s procedures and methods rests upon various judgments and assumptions about current economic conditions and other factors affecting loans. No assurance can be given that the Company will not in any particular period sustain loan losses that are sizable in relation to amounts reserved or that subsequent evaluations of the loan portfolio, in light of conditions and factors then prevailing, will not require significant changes in the allowance for loan losses or future charges to earnings. In addition, bank regulatory agencies, as an integral part of their routine examination process, periodically review the Company’s allowance. Those agencies may require the Company to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examinations. The Company believes the allowance is appropriate based on management’s current analysis.

The allowance for loan losses at June 30, 2011, amounted to $6.7 million, a decrease of $178,000, or 2.6% from December 31, 2010. The allowance consists of specific reserves of $1.8 million and a general allowance $4.9 million. The Bank’s provisions for loan losses amounted to $8.9 million at June 30, 2011 compared to $2.0 million at June 30, 2010. While the Company has not participated in “subprime” lending activities, we have been affected by the economic downturn in our markets. We continue to work with our customers with troubled credit relationships to the extent that it is reasonably possible.

Certain credit risks are inherent in making loans, particularly commercial and consumer loans. Management prudently assesses these risks and attempts to manage them effectively. The Company also attempts to reduce default risks by adhering to internal credit underwriting policies and procedures. These policies and procedures include officer and customer limits, periodic loan documentation review and follow up on exceptions to credit policies. A loan is placed in nonaccrual status when, in management’s judgment, the collection of interest appears doubtful.

 

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The following table summarizes information regarding our nonaccrual loans, other real estate owned, and 90-day and over past due loans as of June 30, 2011 and December 31, 2010 (dollars in thousands):

 

     June 30,
2011
    December 31,
2010
 

Loans accounted for on a nonaccrual basis:

    

Real estate loans:

    

1-4 family residential

   $ 5,491      $ 4,071   

Commercial real estate

     17,014        15,176   

Construction and development

     1,665        2,274   
  

 

 

   

 

 

 

Total real estate loans

     24,170        21,521   

Commercial business and other loans

     2,843        3,068   

Consumer loans

     19        101   
  

 

 

   

 

 

 

Total nonaccrual loans

     27,032        24,690   

Accruing loans which are contractually past due 90 days or more

     —          —     
  

 

 

   

 

 

 

Total nonperforming loans

     27,032        24,690   

Other real estate owned

     6,066        8,314   
  

 

 

   

 

 

 

Total nonperforming assets

   $ 33,098      $ 33,004   
  

 

 

   

 

 

 

Total nonperforming loans as a percentage of loans

     7.82     6.74

Allowance for loan losses as a percentage of total nonperforming loans

     24.73     27.80

Allowance for loan losses as a percentage of total loans

     1.93     1.87

Total nonperforming assets as a percentage of loans and other real estate owned

     9.41     8.81

Total nonperforming assets as a percentage of total assets

     6.35     6.17

Deposits

The Company’s deposit services include business and individual checking accounts, interest bearing checking accounts, savings accounts, money market accounts, IRA deposits and certificates of deposit. At June 30, 2011, total deposits were $426.1 million compared to $416.2 million at December 31, 2010. The June 30, 2011 amount represents an increase of 2.4% from December 31, 2010, which is mainly recognized in customer time deposits. At June 30, 2011, the deposit mix was comparable to December 31, 2010.

 

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The following table presents a breakdown of our deposit base at June 30, 2011 and December 31, 2010 (dollars in thousands):

 

     June 30,
2011
    December 31,
2010
 

Noninterest bearing demand deposits

   $ 38,176      $ 33,730   

Interest checking deposits

     37,139        34,004   

Savings deposits

     11,895        11,787   

Money market deposits

     95,822        103,136   

Customer time deposits

     176,534        160,514   

Brokered certificates of deposit

     66,532        72,998   
  

 

 

   

 

 

 

Total deposits

   $ 426,098      $ 416,169   
  

 

 

   

 

 

 

Time deposits $100,000 or more:

    

Brokered certificates of deposit

   $ 66,532      $ 72,998   

Customer time deposits issued in denominations of $100,000 or more

     85,284        74,381   
  

 

 

   

 

 

 

Total time deposits issued in denominations of $100,000 or more

   $ 151,816      $ 147,379   
  

 

 

   

 

 

 

As a percent of total deposits:

    

Noninterest bearing demand deposits

     8.96     8.10

Interest checking deposits

     8.72        8.17   

Savings deposits

     2.79        2.83   

Money market deposits

     22.49        24.78   

Customer time deposits

     41.43        38.57   

Brokered certificates of deposit

     15.61        17.54   

Total time deposits issued in denominations of $100,000 or more

     35.63        35.41   

Liquidity

Liquidity management is the process of managing assets and liabilities, as well as their maturities, to ensure adequate funding for loan and deposit activities, as well as continued growth of the Company. Sources of liquidity come from both balance sheet and off-balance sheet sources. We define balance sheet liquidity as the relationship that net liquid assets have to unsecured liabilities. Net liquid assets are the sum of cash and cash items, less required reserves on demand and interest checking deposits, plus demand deposits due from banks, plus temporary investments, including federal funds sold, plus the fair value of investment securities, less collateral requirements related to public funds on deposit and repurchase agreements. Unsecured liabilities are equal to total liabilities less required cash reserves on noninterest-bearing demand deposits and interest checking deposits less the outstanding balances of all secured liabilities, whether secured by liquid assets or not. We consider off-balance sheet liquidity to include unsecured federal funds lines from other banks and loan collateral which may be used for additional advances from the Federal Home Loan Bank. As of June 30, 2011 our balance sheet liquidity ratio (net liquid assets as a percent of unsecured liabilities) amounted to 18.2% and our total liquidity ratio (balance sheet plus off-balance sheet liquidity) was 21.6%.

In addition, we have the ability to borrow $10.0 million from the discount window of the Federal Reserve, as well as lines of credit from correspondent banks of $19.0 million subject to our pledge of marketable securities, which could be used for temporary funding needs. We also have the ability to borrow from the Federal Home Loan Bank on similar terms. While we consider these arrangements sources of back-up funding, we do not consider them as liquidity sources because they require our pledge of liquid assets as collateral. We regularly borrow from the Federal Home Loan Bank as a normal part of our business. These advances, which totaled $10.0 million at June 30, 2011, are secured by various types of real estate-secured loans. The Company closely monitors and evaluates its overall liquidity position. The Company believes its liquidity position at June 30, 2011 is adequate to meet its operating needs.

 

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Interest Rate Sensitivity

Fluctuating interest rates, increased competition, and changes in the regulatory environment continue to significantly affect the importance of interest rate sensitivity management. Rate sensitivity arises when interest rates on assets change in a different period of time or in a different proportion to interest rates on liabilities. The primary objective of interest rate sensitivity management is to prudently structure the balance sheet so that movements of interest rates on assets and liabilities are highly correlated and produce a reasonable net interest margin even in periods of volatile interest rates. The Company uses an asset/liability simulation model to project potential changes to the Company’s net interest margin, net income, and economic value of equity based on simulated changes to market interest rates, namely the prime rate. Our goal is to maintain an interest rate sensitivity position as close to neutral as practicable whereby little or no change in interest income would occur as interest rates change. On June 30, 2011, we were cumulatively asset sensitive for the next twelve months, which means that our interest bearing assets would reprice more quickly than our interest bearing liabilities. Theoretically, our net interest margin will increase if market interest rates rise or decrease if market interest rates fall. However, the repricing characteristic of assets is different from the repricing characteristics of funding sources. Therefore, net interest income can be impacted by changes in interest rates even if the repricing opportunities of assets and liabilities are perfectly matched.

Capital Adequacy

Regulatory guidelines require banks to hold minimum levels of capital based upon the risk weighting of certain categories of assets as well as any off-balance sheet contingencies. Federal regulators have adopted risk-based capital and leverage capital guidelines for measuring the capital adequacy of banks and bank holding companies. All applicable capital standards must be satisfied for the Company and the Bank to be considered in compliance with regulatory requirements.

As described above, the Company and the Bank’s Boards of Directors entered into a regulatory consent order with their respective banking regulators during the second quarter which, among other things, requires that the Bank maintain capital levels in excess of normal regulatory minimums, including a Leverage Capital Ratio of at least 8.0% and a Total Risk-Based Capital Ratio of at least 10.0%, and that the Company and the Bank seek the approval of their respective regulators prior to the payment of any cash dividend. At June 30, 2011, the Bank was not in compliance with the minimum capital requirements. As a result, the Bank will be required to present its federal and state regulators with a plan to increase its capital ratios to the required percentages. The Bank has hired a consultant to help formulate this plan and assist in the exploration of other strategic alternatives.

On June 30, 2011, the Company’s Tier 1 and Total risk-weighted Capital Ratios were 7.29% and 9.22%, respectively, which were well above the minimum levels required by regulatory guidelines. At June 30, 2011, the Company’s Leverage Capital Ratio was 5.48%, which was also well above the minimum level required by the regulatory guidelines. On June 30, 2011, the Bank’s Tier 1 risk-weighted Capital Ratio was 7.92%, well above the minimum level required by regulatory guidelines. On June 30, 2011, the Bank’s leverage and Total risk-weighted Capital Ratios were 5.95% and 9.17%, respectively, both non-compliant with the levels specified in the above referenced consent order with bank regulators. Banks are placed into one of four capital categories based on the above three separate capital ratios. The four categories are “well-capitalized,” “adequately capitalized,” “under-capitalized” and “critically under-capitalized.” The Bank was considered “adequately capitalized” as of June 30, 2011. As of June 30, 2011, the Company’s capital ratios were above the minimum levels required by regulatory guidelines for bank holding companies.

RESULTS OF OPERATIONS

Three Months Ended June 30, 2011 and 2010

Overview. For the three months ended June 30, 2011, the Company incurred a net loss available to common shareholders of $9.9 million, or $2.53 per common share. This compares to a net loss of $415,000, or $0.11 per common share, for the three months ended June 30, 2010. The second quarter of 2011 has an increased level of provision for loan losses that is still above the levels we experienced prior to 2008.

Net Interest Income. The Company’s net interest income for the three months ended June 30, 2011 totaled $3.3 million compared to $4.3 million at June 30, 2010. Net interest income decreased due to the loss of $7.2 million in interest earning assets and an increase of $12.3 million of non-performing assets compared to June 30, 2010. The net interest margin decreased 70 basis points from 3.39% in the second quarter of 2010 to 2.69% in the second quarter of 2011. Also affecting the margin was a prepayment

 

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penalty of $273,000 paid to the FHLB on a $10.0 million note. The prepayment will assist the Bank with its capital ratios, earnings, and net interest margin on a prospective basis.

Provision for Loan Losses. The loan loss provision amounted to $6.6 million for the quarter ended June 30, 2011, an increase of $5.5 million, or 505.2%, from the $1.1 million provision recorded in the comparable quarter of 2010. Net charge-offs totaled $8.2 million in the second quarter of 2011 compared to $957,000 in the second quarter of 2010.

Noninterest Income. Noninterest income totaled $425,000 for the three months ended June 30, 2011 compared to $512,000 (including $6,000 for 2011 and $94,000 in 2010 in gains on sale of investment securities) for the comparable three-month period of 2010. Noninterest income includes customer service charges on deposit accounts, bank owned life insurance, and gains on investment securities. Excluding gains on sale of investment securities, noninterest income remained relatively flat for the three months ended June 30, 2011 and 2010.

Noninterest Expenses. Noninterest expenses totaled $6.8 million and $4.1 million for the three months ended June 30, 2011 and 2010, respectively. Excluding the increase of other real estate expenses of $2.4 million, noninterest expenses for the three months would have only increased by $274,000. The increase in other real estate expense is primarily due to valuations performed on foreclosed assets. Other noninterest expenses affecting overhead cost were: (1) FDIC insurance assessment, which increased $71,000 due to increased rates; (2) credit review expense, which has increased $102,000 due to capital raising efforts; and (3) consultant fees, which have increased $111,000 due to additional needs regarding the consent order. An offset to the above-mentioned expenses has been a decrease of $195,000 in salaries and benefits as a result of management reorganization.

Income Taxes. The Company performed an analysis of its tax position after three years of tax losses. From this analysis, a valuation allowance has been determined and there was no income tax benefit or expense during the three months ending June 30, 2011 compared to an income tax benefit of $169,000 for the second quarter of 2010.

Six Months Ended June 30, 2011 and 2010

Overview. For the six months ended June 30, 2011, the Company incurred a net loss available to common shareholders of $13.3 million, or $3.41 per common share. This compares to a net loss of $877,000, or $0.23 per common share, for the six months ended June 30, 2010. The first six months of 2011 has an increased level of provision for loan losses that is still above the levels we experienced prior to 2008.

Net Interest Income. The Company’s net interest income for the six months ended June 30, 2011 totaled $6.9 million compared to $8.5 million at June 30, 2010. Net interest income decreased due to the loss of $7.2 million in interest earning assets and an increase of $12.3 million of non-performing assets compared to June 30, 2010. Net interest margin decreased 42 basis points from 3.28% in the six-month period of 2010 to 2.86% in the six-month period of 2011. Also affecting the margin was a prepayment penalty of $273,000 paid to the FHLB on a $10.0 million note. The prepayment will assist the Bank with its capital ratios, earnings, and net interest margin on a prospective basis.

Provision for Loan Losses. The loan loss provision amounted to $8.9 million for the six months ended June 30, 2011, an increase of $6.9 million, or 345.4%, from the $2.0 million provision recorded in the comparable period of 2010. Net charge-offs totaled $9.1 million in the six-month period of 2011 compared to $3.0 million in the six-month period of 2010.

Noninterest Income. Noninterest income totaled $827,000 for the six months ended June 30, 2011 compared to $1.0 million (including $6,000 for 2011 and $190,000 in 2010 in gains on sale of investment securities) for the comparable six-month period of 2010. Noninterest income includes customer service charges on deposit accounts, bank owned life insurance, and gains on investment securities. Excluding gains on sale of investment securities, noninterest income remained relatively flat for the six months ended June 30, 2011 and 2010.

Noninterest Expenses. Noninterest expenses totaled $10.7 million and $8.3 million for the six months ended June 30, 2011 and 2010, respectively. Excluding the increase in other real estate expenses of $2.3 million, noninterest expenses for the six months would have increased by only $81,000. The increase in other real estate expense is primarily due to valuations performed on foreclosed assets. Other noninterest expenses affecting overhead cost were: (1) FDIC insurance assessment, which increased $42,000 due to increased rates; (2) credit review expense, which has increased $153,000 due to capital raising efforts; and (3) legal services, which have increased $217,000 due to ongoing litigation. An offset to the above-mentioned expenses has been a decrease of $524,000 in salaries and benefits as a result of management reorganization.

 

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Income Taxes. The Company performed an analysis of its tax position after three years of tax losses. From this analysis, a valuation allowance of $4.9 million was established against our deferred tax asset. This valuation along with a current year income tax benefit of $3.9 million resulted in a $996,000 income tax expense for the six months ending June 30, 2011 compared to an income tax benefit of $369,000 for the first six months of 2010.

DISCLOSURES ABOUT FORWARD LOOKING STATEMENTS

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

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Smaller reporting companies such as the Company are not required to provide the information required by this item.

Item 4. CONTROLS AND PROCEDURES

The Company’s management, under the supervision and with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures in accordance with Rule 13a-15 of the Securities Exchange Act of 1934 (the “Exchange Act”). Based on their evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective to provide reasonable assurance that it is able to record, process, summarize and report in a timely manner the information required to be disclosed in reports it files under the Exchange Act.

In connection with the above evaluation of the effectiveness of the Company’s disclosure controls and procedures, no change in the Company’s internal control over financial reporting was identified that occurred during the most recent quarterly period that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings

Reference is made to Part II, Item 1, of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010, for a discussion of certain pending litigation.

 

Item 1A. Risk Factors

In addition to the risk factors that were disclosed in response to Item 1A of Part I of Form 10-K for the year ended December 31, 2010, the following risk factors could impact our operations and financial results:

Risks Relating to Our Business

The Bank is subject to a consent order issued by the Federal Deposit Insurance Corporation and the North Carolina Office of the Commissioner of Banks. We will be required to devote significant resources to complying with the order. The order may have a material adverse effect on our operations and the value of our securities.

The Bank is subject to a consent order issued by the Federal Deposit Insurance Corporation and the North Carolina Office of the Commissioner of Banks. The order became effective on April 27, 2011. Among other things, the order restricts our ability to grow our assets and pay dividends.

In addition, the order requires us to improve our risk management, compliance systems, oversight functions, financial management, and capital. While subject to the order, we expect that our management and board of directors will be required to focus considerable time and attention on taking corrective actions to comply with its terms. We are also required to hire third-party consultants and advisers to assist us in complying with the order, which could increase our noninterest expense and reduce our earnings, which could affect the value of our securities.

There can be no assurance that we will be able to successfully address our regulators’ concerns or that we will be able to comply with the terms of the order. If we do not comply with the order, we could be subject to the assessment of civil money penalties, further regulatory sanctions, or other regulatory enforcement actions. The order will remain in effect until modified or terminated by the Federal Deposit Insurance Corporation and the North Carolina Office of the Commissioner of Banks.

The Company relies on dividends from the Bank for substantially all of its revenue. The Bank is currently prohibited from paying dividends without prior regulatory approval.

The Company receives substantially all of its revenue as dividends from the Bank. Under the terms of the consent order with the Bank’s federal and state regulators, the Bank cannot declare or pay dividends without the prior written approval of its regulators. As a result of this dividend restriction, the Company may not be able to service its debt, pay its other obligations, or pay dividends on its common stock and on the preferred stock issued to the U.S. Department of the Treasury under the TARP Capital Purchase Program. Earlier this year, the Company notified the U.S. Department of the Treasury of its intent to defer the payment of its regular quarterly cash dividends on the preferred stock issued to the Treasury. The Company also elected to defer its regularly scheduled interest payment on its junior subordinated debentures related to the outstanding trust preferred securities of Bank of the Carolinas Trust I. These events could have a material adverse effect on the Company’s business, financial condition, results of operations, and the value of the Company’s securities.

Risks Relating to Our Common Stock

The Company’s ability to pay dividends is limited by the Bank’s ability to pay future dividends. The Bank is currently prohibited from paying dividends without prior regulatory approval.

Virtually all of the Company’s operations are conducted through the Bank. As a result, the Company’s ability to pay dividends in the future is limited by the Bank’s ability to pay dividends to the Company. Under the terms of the consent order with the Bank’s federal and state regulators, the Bank cannot declare or pay dividends without the prior written approval of its regulators. If the Bank is not permitted to pay dividends, then the Company’s ability to pay dividends on its common stock will be adversely impacted. This could have a material adverse effect on the value of the Company’s common stock.

 

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

None

 

Item 3. Defaults Upon Senior Securities.

As disclosed on its Current Report on Form 8-K, filed with the Securities and Exchange Commission on February 18, 2011, the Company has notified the United States Department of the Treasury of its intent to defer the payment of its regular quarterly cash dividends on its fixed rate cumulative perpetual preferred stock, series A, issued to the Treasury in connection with the Company’s participation in the Treasury’s TARP Capital Purchase Program. Therefore, the Company is currently in arrears with the dividend payments on the series A preferred stock. As of June 30, 2011, the amount of the arrearage on the dividend payments for the series A preferred stock was $417,335.

 

Item 4. [Removed and Reserved]

 

Item 5. Other Information

None

 

Item 6. Exhibits

The following exhibits are filed with this report.

 

  31.01    Certification of our Chief Executive Officer pursuant to Rule 13a-14(a)
  31.02    Certification of our Chief Financial Officer pursuant to Rule 13a-14(a)
  32.01    Certification of our Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350
101    Interactive data files providing financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2011, in XBRL (eXtensible Business Reporting Language)*

 

*

Pursuant to Regulation 406T of Regulation S-T, these interactive data files are furnished and not filed or part of a registration statement or prospectus for purposes of section 11 or 12 of the Securities Act of 1933, as amended, or section 18 of the Securities Exchange Act of 1934, as amended, and are otherwise not subject to liability.

 

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SIGNATURES

Pursuant to the requirements 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.

BANK OF THE CAROLINAS CORPORATION

 

Date: August 12, 2011

   

By:

 

    /s/ Stephen R. Talbert

   

Stephen R. Talbert

   

President and Chief Executive Officer

Date: August 12, 2011

   

By:

 

    /s/ Eric E. Rhodes

   

Eric E. Rhodes

   

Executive Vice President and Chief Financial Officer

 

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EXHIBIT INDEX

 

Exhibit
Number

  

Description

  31.01    Certification of our Chief Executive Officer pursuant to Rule 13a-14(a)
  31.02    Certification of our Chief Financial Officer pursuant to Rule 13a-14(a)
  32.01    Certification of our Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350
101    Interactive data files providing financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2011, in XBRL (eXtensible Business Reporting Language)*

 

*

Pursuant to Regulation 406T of Regulation S-T, these interactive data files are furnished and not filed or part of a registration statement or prospectus for purposes of section 11 or 12 of the Securities Act of 1933, as amended, or section 18 of the Securities Exchange Act of 1934, as amended, and are otherwise not subject to liability.

 

33