Attached files

file filename
EX-31.01 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - Bank of the Carolinas CORPd245102dex3101.htm
EX-10.01 - WRITTEN AGREEMENT - Bank of the Carolinas CORPd245102dex1001.htm
EX-32.01 - CERTIFCATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER - Bank of the Carolinas CORPd245102dex3201.htm
EXCEL - IDEA: XBRL DOCUMENT - Bank of the Carolinas CORPFinancial_Report.xls
EX-31.02 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - Bank of the Carolinas CORPd245102dex3102.htm
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 September 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 November 14, 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

September 30, 2011

INDEX

 

Part I. FINANCIAL INFORMATION

  

Item 1. Financial Statements

  

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

     3   

Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2011 and 2010

     4   

Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2010

     5   

Consolidated Statements of Changes in Stockholders’ Equity for the Nine Months Ended September 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

     23   

Item 3. Quantitative and Qualitative Disclosures about Market Risk

     31   

Item 4. Controls and Procedures

     31   

Part II. OTHER INFORMATION

  

Item 1. Legal Proceedings

     32   

Item 1A. Risk Factors

     32   

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

     34   

Item 3. Defaults Upon Senior Securities

     34   

Item 4. [Removed and Reserved]

     34   

Item 5. Other Information

     34   

Item 6. Exhibits

     34   

SIGNATURES

     35   

EXHIBIT INDEX

     36   

 

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)

 

     September 30,
2011
    December 31
2010*
 
     (Unaudited)        

Assets:

    

Cash and due from banks, noninterest-bearing

   $ 4,922      $ 4,303   

Interest-bearing deposits in banks

     4,431        6,262   
  

 

 

   

 

 

 

Cash and cash equivalents

     9,353        10,565   

Federal funds sold

     22,630        9,330   

Investment securities

     113,768        110,373   

Loans receivable

     324,757        366,153   

Less: Allowance for loan losses

     (8,691     (6,863
  

 

 

   

 

 

 

Total loans, net

     316,066        359,290   

Premises and equipment

     12,448        13,106   

Other real estate owned

     9,825        8,314   

Bank owned life insurance

     10,640        10,371   

Deferred tax assets

     3,509        5,123   

Prepaid FDIC insurance assessment

     2,759        3,670   

Accrued interest receivable

     1,700        1,814   

Other assets

     3,179        3,014   
  

 

 

   

 

 

 

Total assets

   $ 505,877      $ 534,970   
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity:

    

Deposits:

    

Noninterest-bearing demand deposits

   $ 34,446      $ 33,730   

Interest-checking deposits

     38,527        34,004   

Savings and money market deposits

     103,163        114,923   

Time deposits

     241,422        233,512   
  

 

 

   

 

 

 

Total deposits

     417,558        416,169   

Securities sold under agreements to repurchase

     45,412        45,603   

Federal Home Loan Bank advances

     10,000        22,000   

Subordinated debt

     7,855        7,855   

Other liabilities

     2,226        1,639   
  

 

 

   

 

 

 

Total liabilities

     483,051        493,266   
  

 

 

   

 

 

 

Commitments and contingencies (Note 6)

     —          —     

Stockholders’ Equity:

    

Preferred stock, no par value

     13,179        13,179   

Discount on preferred stock

     (787     (991

Common stock, $5 per share par value

     19,486        19,486   

Additional paid-in capital

     12,984        12,988   

Retained deficit

     (23,650     (3,268

Accumulated other comprehensive income

     1,614        310   
  

 

 

   

 

 

 

Total Stockholders’ Equity

     22,826        41,704   
  

 

 

   

 

 

 

Total Liabilities and Stockholders’ Equity

   $ 505,877      $ 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
September 30
    Nine Months Ended
September 30
 
     2011     2010     2011     2010  

Interest income

        

Interest and fees on loans

   $ 4,276      $ 5,102      $ 13,415      $ 15,809   

Interest on securities

     823        822        2,422        2,607   

Other interest income

     16        12        42        45   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     5,115        5,936        15,879        18,461   
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

        

Interest on deposits

     1,075        1,181        3,405        3,839   

Interest on borrowed funds

     571        641        2,075        1,997   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     1,646        1,822        5,480        5,836   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     3,469        4,114        10,399        12,625   

Provision for loan losses

     5,650        858        14,567        2,860   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income (loss) after provision for loan losses

     (2,181     3,256        (4,168     9,765   
  

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest income

        

Customer service fees

     318        316        951        961   

Increase in value of bank owned life insurance

     91        91        269        270   

Gains on investment securities

     —          178        6        368   

Other income

     6        4        16        5   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest income

     415        589        1,242        1,604   
  

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest expense

        

Salaries and benefits

     1,757        1,686        4,947        5,400   

Occupancy and equipment

     502        537        1,571        1,665   

FDIC insurance assessments

     345        155        949        717   

Data processing services

     218        210        654        607   

Valuation provisions and net operating costs associated with foreclosed real estate

     1,053        349        4,050        1,061   

Other

     1,205        857        3,591        2,660   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest expense

     5,080        3,794        15,762        12,110   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     (6,846     51        (18,688     (741

Provision (benefit) for income taxes

     —          (31     996        (400
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

     (6,846     82        (19,684     (341

Dividends and accretion on preferred stock

     (234     (229     (698     (683
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss available to common stockholders

   $ (7,080   $ (147   $ (20,382   $ (1,024
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss per common share:

        

Basic

   $ (1.82   $ (0.04   $ (5.23   $ (0.26
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ (1.82   $ (0.04   $ (5.23   $ (0.26
  

 

 

   

 

 

   

 

 

   

 

 

 

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)

 

     Nine Months Ended
September 30
 
     2011     2010  

Cash flows from operating activities:

    

Net loss

   $ (19,684   $ (341

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

    

Provision for loan losses

     14,567        2,860   

Stock based compensation expense (benefit)

     (4     11   

Loss on disposal of premises and equipment

     3        6   

Depreciation and amortization

     751        804   

Change in valuation allowance on other real estate owned

     3,191        591   

Loss on sale of other real estate owned

     125        107   

Gain on sale of securities

     (6     (368

Increase in bank owned life insurance

     (269     (270

Net amortization/accretion of premiums and discounts on investments

     572        273   

Net change in other assets

     1,361        5,352   

Net change in other liabilities

     93        (432
  

 

 

   

 

 

 

Net cash provided by operating activities

     700        8,593   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Net change in federal funds sold

     (13,300     23,480   

Purchases of premises and equipment

     (96     (171

Purchases of securities

     (31,533     (99,832

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

     29,691        128,039   

Redemption of FHLB stock

     298        —     

Improvements made to other real estate owned

     —          (19

Proceeds from sales of other real estate owned

     2,855        2,581   

Proceeds from sales of premises and equipment

     —          1   

Net decrease in loans

     20,975        15,961   
  

 

 

   

 

 

 

Net cash provided by investing activities

     8,890        70,040   
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Net increase (decrease) in deposits

     1,389        (78,959

Net additions (repayments) of other borrowings

     (12,000     5,000   

Decrease in repurchase agreements

     (191     (812

Cash dividends paid on preferred stock

     —          (494
  

 

 

   

 

 

 

Net cash used by financing activities

     (10,802     (75,265
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     (1,212     3,368   

Cash and cash equivalents at beginning of period

     10,565        12,544   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 9,353      $ 15,912   
  

 

 

   

 

 

 

Supplemental disclosure of cash flow information:

    

Cash paid during the period for interest

   $ 4,900      $ 2,139   
  

 

 

   

 

 

 

Noncash investing and financing activities:

    

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

   $ 1,304      $ 1,129   
  

 

 

   

 

 

 

Transfer from loans to other real estate owned

   $ 7,682      $ 3,598   
  

 

 

   

 

 

 

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

    —          —          —          —          —          —          (341     —          (341

Other comprehensive income

    —          —          —          —          —          —          —          1,129        1,129   
                 

 

 

 

Total comprehensive income

    —          —          —          —          —          —          —          —          788   
                 

 

 

 

Stock based compensation expense

    —          —          —          —          —          11        —          —          11   

Discount accretion on preferred stock

    —          —          189        —          —          —          (189     —          —     

Dividends accrued on preferred stock

    —          —          —          —          —          —          (494     —          (494
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, September 30, 2010

    13,179      $ 13,179      $ (1,056     3,897,174      $ 19,486      $ 12,989      $ (724   $ 1,423      $ 45,297   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 31, 2010

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

Net loss

    —          —          —          —          —          —          (19,684     —          (19,684

Other comprehensive income

    —          —          —          —          —          —          —          1,304        1,304   
                 

 

 

 

Total comprehensive loss

    —          —          —          —          —          —          —          —          (18,380
                 

 

 

 

Stock based compensation benefit

    —          —          —          —          —          (4     —          —          (4

Discount accretion on preferred stock

    —          —          204        —          —          —          (204     —          —     

Dividends accrued on preferred stock

    —          —          —          —          —          —          (494     —          (494
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, September 30, 2011

    13,179      $ 13,179      $ (787     3,897,174      $ 19,486      $ 12,984      $ (23,650   $ 1,614      $ 22,826   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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 September 30, 2011 and December 31, 2010 and for the three- and nine-month periods ended September 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 nine-month periods ended September 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
September 30,
    Nine months ended
September 30,
 
     2011     2010     2011     2010  

Net income (loss) applicable to common stock

   $ (7,080   $ (147   $ (20,382   $ (1,024
  

 

 

   

 

 

   

 

 

   

 

 

 

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        517,245   
  

 

 

   

 

 

   

 

 

   

 

 

 

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):

 

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

Investment securities available for sale:

              

U.S. Government agencies securities

   $ 46,234       $ 1,119       $ 11       $ 47,342       $ 47,342   

State and municipal bonds

     3,436         173         —           3,609         3,609   

Corporate securities

     963         98         —           1,061         1,061   

Mortgage-backed securities

     58,184         1,248         33         59,399         59,399   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities available for sale

     108,817         2,638         44         111,411         111,411   

Investment securities held to maturity:

              

Corporate securities

     2,357         68         239         2,186         2,357   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 111,174       $ 2,706       $   283       $ 113,597       $ 113,768   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2010  
            Gross      Gross                
     Amortized
Cost
     Unrealized
Gains
     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   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Management of the Bank believes all unrealized losses on available-for-sale securities as of September 30, 2011 represent temporary impairments related to market fluctuations. The unrealized losses on our securities are a nominal portion of the total value of the portfolio. The Bank has no intention of selling these securities before their maturity and has the appropriate sources of liquidity to hold these securities until maturity so that no recognized losses will occur.

 

8


Table of Contents

NOTE 4. LOANS

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

 

     September 30,     December 31,  
     2011     2010  

Real estate loans:

    

1-4 family residential

   $ 81,220      $ 78,750   

Commercial real estate

     133,201        161,839   

Construction and development

     36,117        35,310   

Home equity

     30,116        31,465   
  

 

 

   

 

 

 

Total real estate loans

     280,654        307,364   
  

 

 

   

 

 

 

Commercial business and other loans

     37,226        51,581   
  

 

 

   

 

 

 

Consumer loans:

    

Installment

     3,738        4,300   

Other

     3,139        2,908   
  

 

 

   

 

 

 

Total consumer loans

     6,877        7,208   
  

 

 

   

 

 

 

Gross loans receivable

     324,757        366,153   

Allowance for loan losses

     (8,691     (6,863
  

 

 

   

 

 

 

Loans, net

   $ 316,066      $ 359,290   
  

 

 

   

 

 

 

 

9


Table of Contents

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

 

    September 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

  $ 1,147      $ 1,797      $ —        $ 1,846      $ 59      $ 1,888      $ 2,012      $ —        $ 2,083      $ 127   

Commercial Real Estate

                   

Owner occupied

    4,491        8,681        —          9,480        244        6,805        7,755        —          7,778        412   

Income producing

    3,515        3,607        —          3,662        77        1,694        1,694        —          1,740        63   

Multifamily

    1,293        1,327        —          1,353        22        —          —          —          —          —     

Construction & Development

                   

1 - 4 Family

    1,324        1,367        —          1,396        61        98        100        —          99        8   

Other

    1,077        1,243        —          1,255        54        1,141        1,192        —          1,247        56   

Farmland

    —          —          —          —          —          —          —          —          —          —     

Residential

                   

Equity Lines

    65        65        —          66        2        37        80        —          80        6   

1 - 4 Family

    6,400        7,910        —          7,969        335        2,634        2,686        —          2,697        156   

Junior Liens

    —          —          —          —          —          18        20        —          20        2   

Consumer - Non Real Estate

                   

Credit Cards

    —          —          —          —          —          —          —          —          —          —     

Other

    19        20        —          21        2        101        156        —          157        11   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans with no allowance

  $ 19,331      $ 26,017      $ —        $ 27,048      $ 856      $ 14,416      $ 15,695      $ —        $ 15,901      $ 841   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

With an allowance recorded:

                   

Commercial - Non Real Estate

  $ 2,478      $ 3,503      $ 1,002      $ 3,568      $ 149      $ 2,633      $ 3,103      $ 513      $ 3,138      $ 149   

Commercial Real Estate

                   

Owner occupied

    1,767        1,818        167        1,824        69        10,430        10,434        951        10,465        430   

Income producing

    3,992        3,992        126        4,023        153        2,899        2,899        72        2,924        123   

Multifamily

    —          —          —          —          —          —          —          —          —          —     

Construction & Development

                   

1 - 4 Family

    380        380        10        401        16        1,138        1,138        44        1,138        69   

Other

    666        666        321        670        26        148        148        —          148        8   

Farmland

    —          —          —          —          —          —          —          —          —          —     

Residential

                   

Equity Lines

    —          —          —          —          —          497        497        447        503        21   

1 - 4 Family

    6,709        6,714        223        6,740        193        3,117        3,134        516        3,141        142   

Junior Liens

    400        400        3        493        19        59        60        25        60        1   

Consumer - Non Real Estate

                   

Credit Cards

    —          —          —          —          —          —          —          —          —          —     

Other

    —          —          —          —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans with an allowance

  $ 16,392      $ 17,473      $ 1,852      $ 17,719      $ 625      $ 20,921      $ 21,413      $ 2,568      $ 21,517      $ 943   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total:

                   

Commercial - Non Real Estate

  $ 3,625      $ 5,300      $ 1,002      $ 5,414      $ 208      $ 4,521      $ 5,115      $ 513      $ 5,221      $ 276   

Commercial Real Estate

  $ 15,058      $ 19,425      $ 293      $ 20,342      $ 565      $ 21,828      $ 22,782      $ 1,023      $ 22,907      $ 1,028   

Construction & Development

  $ 3,447      $ 3,656      $ 331      $ 3,722      $ 157      $ 2,525      $ 2,578      $ 44      $ 2,632      $ 141   

Residential

  $ 13,574      $ 15,089      $ 226      $ 15,268      $ 549      $ 6,362      $ 6,477      $ 988      $ 6,501      $ 328   

Consumer - Non Real Estate

  $ 19      $ 20      $ —        $ 21      $ 2      $ 101      $ 156      $ —        $ 157      $ 11   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals

  $ 35,723      $ 43,490      $ 1,852      $ 44,767      $ 1,481      $ 35,337      $ 37,108      $ 2,568      $ 37,418      $ 1,784   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

10


Table of Contents

Impaired loans include loans whose contractual terms have been restructured in a manner that grants a concession to a borrower experiencing financial difficulties. Troubled debt restructurings (TDRs) are a subset of impaired loans and totaled $22.9 million at September 30, 2011 and $22.1 million at December 31, 2010.

The following tables illustrate TDR information for the three and nine months ended September 30, 2011:

 

    For the three months ended September 30, 2011     For the nine months ended September 30, 2011  

Troubled Debt Restructuring

  Number of
Contracts
    Pre-Modification
Recorded
Investment
    Post-Modification
Recorded
Investment
    Number of
Contracts
    Pre-Modification
Recorded
Investment
    Post-Modification
Recorded
Investment
 

Commercial - Non Real Estate

    5      $ 315      $ 315        18      $ 2,195      $ 2,195   

Commercial - Real Estate

    4        693        693        12        3,656        3,656   

Construction & Development

    1        902        902        6        2,311        2,311   

Residential

    8        3,891        3,891        25        6,270        6,270   

Consumer - Non Real Estate

    —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals

    18      $ 5,801      $ 5,801        61      $ 14,432      $ 14,432   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

There were no loans restructured in the twelve months prior to September 30, 2011 that went into default during the three- or nine-month period ended September 30, 2011. For the purposes of this report, default is defined as being 90-days past due or on non-accrual status without performance.

Some loan modifications classified as TDRs may not ultimately result in the full collection of principal and interest, as modified, and result in potential incremental losses. These potential incremental losses have been factored into our overall allowance for loan losses estimate. The level of any re-defaults will likely be affected by future economic conditions. Once a loan becomes a TDR, it will continue to be reported as a TDR until it is ultimately repaid in full, reclassified to loans held for sale, or foreclosed and sold. Included in the allowance for loan losses at September 30, 2011 was an impairment reserve for TDRs in the amount of $564,000.

 

11


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
 

September 30, 2011:

                       

Commercial - Non Real Estate

   $     338       $ 140       $ 1,301       $ 1,779       $ 35,447       $ 37,226       $ —         $ 2,008   

Commercial Real Estate

                       

Owner occupied

     992         —           2,769         3,761         77,472         81,233         —           5,045   

Income producing

     1,372         —           1,200         2,572         42,722         45,294         —           3,307   

Multifamily

     —           —           —           —           6,674         6,674         —           1,293   

Construction & Development

                       

1 - 4 Family

     —           —           57         57         4,339         4,396         —           57   

Other

     518         514         478         1,510         28,869         30,379         —           1,378   

Farmland

     —           —           —           —           1,342         1,342         —           —     

Residential

                       

Equity Lines

     65         —           —           65         30,051         30,116         —           65   

1 - 4 Family

     1,488         488         3,342         5,318         74,278         79,596         —           5,944   

Junior Liens

     19         —           —           19         1,605         1,624         —           —     

Consumer - Non Real Estate

                       

Credit Cards

     —           —           —           —           —           —           —           —     

Other

     36         29         —           65         3,673         3,738         —           19   

Other

     —           —           —           —           3,139         3,139         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $   4,828       $ 1,171       $ 9,147       $ 15,146       $ 309,611       $ 324,757       $ —         $ 19,116   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     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 condition and payment capability or of the collateral pledged, if any. Loans and leases so classified have a well-defined

 

12


Table of Contents

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 September 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):

 

     September 30, 2011  
Internal Risk Rating Grades    Pass      Special
Mention
     Substandard      Doubtful      Loss  

Commercial - Non Real Estate

   $   29,578       $ 3,195       $ 3,092       $ 1,361       $ —     

Commercial Real Estate

              

Owner occupied

     56,769         9,078         15,386         —           —     

Income producing

     29,154         7,449         8,691         —           —     

Multifamily

     3,753         801         2,120         —           —     

Construction & Development

              

1 - 4 Family

     2,105         1,489         802         —           —     

Other

     20,532         7,939         1,908         —           —     

Farmland

     980         362         —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 142,871       $ 30,313       $ 31,999       $ 1,361       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total:

              

Commercial - Non Real Estate

   $ 29,578       $ 3,195       $ 3,092       $ 1,361       $ —     

Commercial Real Estate

   $ 89,676       $ 17,328       $ 26,197       $ —         $ —     

Construction & Development

   $ 23,617       $ 9,790       $ 2,710       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 142,871       $ 30,313       $ 31,999       $ 1,361       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2010  
Internal Risk Rating Grades    Pass      Special
Mention
     Substandard      Doubtful      Loss  

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       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

13


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 September 30, 2011 and December 31, 2010, segregated by class of loans, were as follows (dollars in thousands):

 

     September 30, 2011      December 31, 2010  
Risk Based on Payment Activity    Performing      Non-
Performing
     Performing      Non-
Performing
 

Residential

           

Equity Lines

   $ 30,051       $ 65       $ 31,069       $ 396   

1 - 4 Family

     78,084         1,512         73,682         3,125   

Junior Liens

     1,624         —           1,866         77   

Consumer - Non Real Estate

           

Credit Cards

     —           —           —           —     

Other

     3,719         19         4,294         6   
  

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 113,478       $ 1,596       $ 110,911       $ 3,604   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total:

           

Residential

   $ 109,759       $ 1,577       $ 106,617       $ 3,598   

Consumer - Non Real Estate

   $ 3,719       $ 19       $ 4,294       $ 6   
  

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 113,478       $ 1,596       $ 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

 

14


Table of Contents

conditions; and (iii) general 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.

 

15


Table of Contents

Changes in the allowance for loan losses by segment are as follows (dollars in thousands):

 

     Beginning
Balance
     Chargeoffs     Recoveries      Provision      Ending
Balance
 

September 30, 2011:

             

Commercial - Non Real Estate

   $ 2,252       $ (4,085   $ 427       $ 4,280       $ 2,874   

Commercial Real Estate

             

Owner occupied

     1,055         (5,731     21         6,290         1,635   

Income producing

     99         (101     —           190         188   

Multifamily

     —           —          —           —           —     

Construction & Development

             

1 - 4 Family

     181         (212     4         168         141   

Other

     486         (492     99         785         878   

Farmland

     —           —          —           —           —     

Residential

             

Equity Lines

     459         (692     2         483         252   

1 - 4 Family

     1,078         (1,922     43         1,902         1,101   

Consumer - Non Real Estate

     161         (115     15         93         154   

Unallocated

     1,092         —          —           376         1,468   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 6,863       $ (13,350   $ 611       $ 14,567       $ 8,691   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

 

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

Commercial - Non Real Estate

   $ 1,002       $ 4,422       $ 513       $ 4,580   

Commercial Real Estate

           

Owner occupied

     167         5,541         951         17,235   

Income producing

     126         6,852         72         4,593   

Multifamily

     —           1,293         —           —     

Construction & Development

           

1 - 4 Family

     10         802         44         1,236   

Other

     321         3,054         25         1,288   

Farmland

     —           —           —           —     

Residential

           

Equity Lines

     —           65         447         534   

1 - 4 Family

     223         13,675         516         5,770   

Consumer - Non Real Estate

     3         19         —           101   

Unallocated

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,852       $   35,723       $ 2,568       $   35,337   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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

Commercial - Non Real Estate

   $ 1,872       $ 32,804       $ 1,739       $ 47,001   

Commercial Real Estate

           

Owner occupied

     1,468         75,692         104         86,971   

Income producing

     62         38,442         27         45,619   

Multifamily

     —           5,381         —           7,003   

Construction & Development

           

1 - 4 Family

     131         3,595         137         4,363   

Other

     557         27,324         461         28,422   

Farmland

     —           1,342         —           418   

Residential

           

Equity Lines

     252         30,051         12         30,931   

1 - 4 Family

     878         67,545         562         72,981   

Consumer - Non Real Estate

     151         3,719         161         4,199   

Unallocated

     1,468         —           1,092         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 6,839       $ 285,895       $ 4,295       $ 327,908   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

16


Table of Contents

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 September 30, 2011 (dollars in thousands):

 

Unfunded loan commitments

   $ 30,538   

Financial standby letters of credit

     2,477   
  

 

 

 

Total unused commitments

   $ 33,015   
  

 

 

 

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
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011     2010  

Unrealized holding gains on securities available-for-sale

   $ 1,121      $ 46      $ 2,125      $ 2,204   

Reclassification adjustment for gains realized in net loss

     —          (178     (6     (368
  

 

 

   

 

 

   

 

 

   

 

 

 

Net unrealized holding gains (losses) on securities available-for-sale

     1,121        (132     2,119        1,836   

Income tax effect

     (431     51        (815     (707
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss), net of income tax effect

   $ 690      $ (81   $ 1,304      $ 1,129   
  

 

 

   

 

 

   

 

 

   

 

 

 

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 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.

 

17


Table of Contents

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 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

 

18


Table of Contents

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.

 

19


Table of Contents

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

 

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

Assets valued on a recurring basis

           

Investment securities:

           

U.S. government and agency

   $ 47,342       $ —         $ 47,342       $ —     

State and municipals

     3,609         —           3,609         —     

Corporate

     1,061         —           1,061         —     

Mortgage-backed

     59,399         —           59,399         —     

Assets valued on a non-recurring basis

           

Impaired loans

     35,723         —           35,723         —     

Other real estate owned

     9,825         —           9,825         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 156,959       $ —         $ 156,959       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     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):

 

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

Securities sold under overnight repurchase agreements

   $ 412         0.10   $ 603         0.13

Securities sold under term repurchase agreements

     45,000         4.38        45,000         4.38   

Federal Home Loan Bank advances

     10,000         0.19        22,000         1.13   

Trust preferred securities

     5,155         3.29        5,155         3.25   

Subordinated debt

     2,700         4.00        2,700         4.00   
  

 

 

      

 

 

    

Total borrowed funds

   $ 63,267         3.58   $ 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.

 

20


Table of Contents

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 September 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       $ 8,790   

Agreement dated 8/20/2008

     20,000         3.78        8/20/2015         8/20/2011         3,363   
  

 

 

            

 

 

 

Total

   $ 45,000         4.38         $ 12,153   
  

 

 

            

 

 

 

The Bank utilizes borrowings from the Federal Home Loan Bank (“FHLB”) as a source of liquidity. At September 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 September 30, 2011 (dollars in thousands):

 

     Outstanding
Principal
Balance
     Annual
Effective
Interest Rate
    Final
Maturity
Date
 

Advance dated 2/16/2010

   $ 10,000         0.19     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. Furthermore, the Company is now party to a written agreement with the Federal Reserve, which restricts the Company’s ability to make interest payments on subordinated debt, as described below.

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. This debt can be repaid in full at any time with no penalty.

Under the terms of a written agreement between the Company and the Federal Reserve Bank of Richmond, the Company and the Bank may not make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation of the Federal Reserve Board of Governors.

 

21


Table of Contents

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 September 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. In addition, the Company has entered into a written agreement with the Federal Reserve Bank of Richmond, which prohibits the Company’s payment of any dividends without the prior approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation of the Federal Reserve Board of Governors.

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 September 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.

NOTE 12. INCOME TAXES

The Company utilizes the liability method of computing income taxes. Under the liability method, deferred tax liabilities and assets are established for future tax return effects of the temporary differences between the stated value of assets and liabilities for financial reporting purposes and their tax bases. The focus is on accruing the appropriate balance sheet deferred tax amount, with the statement of income effect being the result of the changes in the balance sheet amounts from period to period. The current portion of income tax expense is provided based upon the actual tax liability incurred for tax return purposes.

An evaluation of the probability of being able to realize the future benefits of deferred tax assets is made. A valuation allowance is provided for the deferred tax asset when it is more likely than not that some portion or all of the deferred tax asset will not be realized. At September 30, 2011, a valuation allowance of $7.4 million was established against our deferred tax asset. This valuation along with a current year income tax benefit of $6.4 million resulted in a $996,000 income tax expense for the nine months ending September 30, 2011 compared to an income tax benefit of $400,000 for the first nine months of 2010.

 

22


Table of Contents
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.

Written Agreement with Federal Reserve

The Company entered into a written agreement (the “Agreement”) with the Federal Reserve Bank of Richmond on August 26, 2011. The description of the Agreement set forth below is qualified in its entirety by reference to the Agreement, a copy of which is included as Exhibit 10.01 to this Quarterly Report on Form 10-Q, and incorporated herein by reference.

Source of Strength. The Agreement requires that the Company take appropriate steps to fully utilize its financial and managerial resources to serve as a source of strength to the Bank and ensure that the Bank complies with the requirements of the consent order entered into between the North Carolina Commissioner of Banks, the FDIC, and the Bank.

Dividends, Distributions, and other Payments. The Agreement prohibits the Company’s payment of any dividends without the prior approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation. It also prohibits the Company from directly or indirectly taking any dividends or any other form of payment representing a reduction in capital from the Bank without the prior written approval of the Federal Reserve Bank of Richmond.

Under the terms of the Agreement, the Company and the Bank may not make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation of the Federal Reserve Board of Governors.

Debt and Stock Redemption. The Agreement requires that the Company and any non-bank subsidiary of the Company not, directly or indirectly, incur, increase or guarantee any debt without the prior written approval of the Federal Reserve Bank. The Agreement also requires that the Company not, directly or indirectly, purchase or redeem any shares of its capital stock without the prior written approval of the Federal Reserve Bank of Richmond.

Capital Plan, Cash Flow Projections and Progress Reports. The Agreement requires that the Company file an acceptable capital plan and certain cash flow projections with the Federal Reserve Bank of Richmond. It also requires that the Company file a written progress report within 30 days after the end of each calendar quarter while the Agreement remains in effect.

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

 

23


Table of Contents

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 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

 

24


Table of Contents
   

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.

 

25


Table of Contents

CHANGES IN FINANCIAL CONDITION

Total Assets

At September 30, 2011, total assets were $505.9 million, a decrease of 5.4% 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 $12.7 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 $113.8 million at September 30, 2011, compared to $110.4 million at December 31, 2010. The increase was a result of the reduction in the loan portfolio referred to above. A summary of the Company’s investment securities holdings by major category at September 30, 2011 and December 31, 2010 is included in Note 3 of “Notes to Consolidated Financial Statements”.

Loans and Allowance for Loan Losses

At September 30, 2011, the loan portfolio totaled $324.8 million and represented 64.2% of total assets compared to $366.2 million or 68.4% of total assets at December 31, 2010. Total loans at September 30, 2011 decreased $41.4 million or 11.3% from December 31, 2010. The decrease in loans outstanding in the nine-month period is the result of net chargeoffs of $12.7 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 September 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 September 30, 2011, amounted to $8.7 million, an increase of $1.8 million, or 26.6% from December 31, 2010. The allowance consists of specific reserves of $1.9 million and a general allowance $6.8 million. The Bank’s provisions for loan losses amounted to $14.6 million at September 30, 2011 compared to $2.9 million at September 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.

The following table summarizes information regarding our nonaccrual loans, other real estate owned, and 90-day and over past

 

26


Table of Contents

due loans as of September 30, 2011 and December 31, 2010 (dollars in thousands):

 

    September 30,
2011
    December 31,
2010
 

Loans accounted for on a nonaccrual basis:

   

Real estate loans:

   

1-4 family residential

  $ 6,009      $ 4,071   

Commercial real estate

    9,645        15,176   

Construction and development

    1,435        2,274   
 

 

 

   

 

 

 

Total real estate loans

    17,089        21,521   

Commercial business and other loans

    2,008        3,068   

Consumer loans

    19        101   
 

 

 

   

 

 

 

Total nonaccrual loans

    19,116        24,690   

Accruing loans which are contractually past due 90 days or more

    0        0   
 

 

 

   

 

 

 

Total nonperforming loans

    19,116        24,690   

Other real estate owned

    9,825        8,314   
 

 

 

   

 

 

 

Total nonperforming assets

  $ 28,941      $ 33,004   
 

 

 

   

 

 

 

Total nonperforming loans as a percentage of loans

    5.89     6.74

Allowance for loan losses as a percentage of total nonperforming loans

    45.46     27.80

Allowance for loan losses as a percentage of total loans

    2.68     1.87

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

    8.65     8.81

Total nonperforming assets as a percentage of total assets

    5.72     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 September 30, 2011, total deposits were $417.6 million compared to $416.2 million at December 31, 2010. The September 30, 2011 amount represents an increase of 0.3% from December 31, 2010, which is mainly recognized in customer time deposits. At September 30, 2011, the deposit mix was comparable to December 31, 2010.

 

27


Table of Contents

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

 

    September 30,
2011
    December 31,
2010
 

Noninterest bearing demand deposits

  $ 34,446      $ 33,730   

Interest checking deposits

    38,527        34,004   

Savings deposits

    11,603        11,787   

Money market deposits

    91,560        103,136   

Customer time deposits

    198,725        160,514   

Brokered certificates of deposit

    42,697        72,998   
 

 

 

   

 

 

 

Total deposits

  $ 417,558      $ 416,169   
 

 

 

   

 

 

 

Time deposits $100,000 or more:

   

Brokered certificates of deposit

  $ 42,697      $ 72,998   

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

    109,310        74,381   
 

 

 

   

 

 

 

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

  $ 152,007      $ 147,379   
 

 

 

   

 

 

 

As a percent of total deposits:

   

Noninterest bearing demand deposits

    8.25     8.10

Interest checking deposits

    9.23        8.17   

Savings deposits

    2.78        2.83   

Money market deposits

    21.93        24.78   

Customer time deposits

    47.59        38.57   

Brokered certificates of deposit

    10.23        17.54   

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

    36.40        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 September 30, 2011 our balance sheet liquidity ratio (net liquid assets as a percent of unsecured liabilities) amounted to 18.9% and our total liquidity ratio (balance sheet plus off-balance sheet liquidity) was 21.5%.

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 $14.0 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 September 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 September 30, 2011 is adequate to meet its operating needs.

 

28


Table of Contents

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 September 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 September 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.

At September 30, 2011, the Company’s leverage and Tier 1 risk-weighted Capital Ratios were 4.43% and 5.95%, respectively, which are above the minimum level required by regulatory guidelines. At September 30, 2011, the Company’s Total risk-weighted Capital Ratio was 7.92%, which is below the minimum level required by regulatory guidelines. At September 30, 2011, the Bank’s leverage and Tier 1 risk-weighted Capital Ratios were 4.97% and 6.68%, respectively, which are above the minimum levels required by regulatory guidelines. At September 30, 2011, the Bank’s Total risk-weighted Capital Ratio was 7.94%, which is below the minimum level required by regulatory guidelines. At September 30, 2011, the Bank’s leverage and Total risk-weighted Capital Ratios were 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 “under-capitalized” due to total capital ratio of less than 8.0% as of September 30, 2011.

RESULTS OF OPERATIONS

Three Months Ended September 30, 2011 and 2010

Overview. For the three months ended September 30, 2011, the Company incurred a net loss available to common shareholders of $7.1 million, or $1.82 per common share. This compares to a net loss of $147,000, or $0.04 per common share, for the three months ended September 30, 2010. The third quarter of 2011 has an increased level of provision for loan losses and costs related to foreclosed real estate that are still above the levels we experienced prior to 2008.

Net Interest Income. The Company’s net interest income for the three months ended September 30, 2011 totaled $3.5 million compared to $4.1 million at September 30, 2010. Net interest income decreased due to the loss of $25.1 million in interest earning assets and an increase of $8.7 million of non-performing assets compared to September 30, 2010. The net interest margin decreased 42 basis points from 3.35% in the third quarter of 2010 to 2.93% in the third quarter of 2011.

 

29


Table of Contents

Provision for Loan Losses. The loan loss provision amounted to $5.7 million for the quarter ended September 30, 2011, an increase of $4.8 million, or 558.5%, from the $858,000 provision recorded in the comparable quarter of 2010. Net charge-offs totaled $3.6 million in the third quarter of 2011 compared to $1.7 million in the third quarter of 2010.

Noninterest Income. Noninterest income totaled $415,000 for the three months ended September 30, 2011 compared to $589,000 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 of $178,000 in 2010, noninterest income remained relatively flat for the three months ended September 30, 2011 and 2010.

Noninterest Expenses. Noninterest expenses totaled $5.1 million and $3.8 million for the three months ended September 30, 2011 and 2010, respectively. Excluding the increase of other real estate expenses of $704,000, noninterest expenses for the three months would have only increased by $582,000. 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 $190,000 due to increased rates; (2) director and shareholder expenses, which has increased $114,000 due to increased premiums for director and officer liability insurance; and (3) consultant fees, which have increased $175,000 due to additional needs regarding the consent order.

Income Taxes. The Company performed an analysis of its tax position after three years of tax losses. From this analysis, a valuation allowance was established against our deferred tax asset and there was no income tax benefit or expense during the three months ending September 30, 2011 compared to an income tax benefit of $31,000 for the third quarter of 2010.

Nine Months Ended September 30, 2011 and 2010

Overview. For the nine months ended September 30, 2011, the Company incurred a net loss available to common shareholders of $20.4 million, or $5.23 per common share. This compares to a net loss of $1.0 million, or $0.26 per common share, for the nine months ended September 30, 2010. The first nine 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 nine months ended September 30, 2011 totaled $10.4 million compared to $12.6 million at September 30, 2010. Net interest income decreased due to the loss of $25.1 million in interest earning assets and an increase of $8.7 million of non-performing assets compared to September 30, 2010. Net interest margin decreased 42 basis points from 3.30% in the nine-month period of 2010 to 2.88% in the nine-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 during the second quarter. 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 $14.6 million for the nine months ended September 30, 2011, an increase of $11.7 million, or 409.3%, from the $2.9 million provision recorded in the comparable period of 2010. Net charge-offs totaled $12.7 million in the nine-month period of 2011 compared to $4.7 million in the nine-month period of 2010.

Noninterest Income. Noninterest income totaled $1.2 million for the nine months ended September 30, 2011 compared to $1.6 million for the comparable nine-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 of $6,000 for 2011 and $368,000 in 2010, noninterest income remained relatively flat for the nine months ended September 30, 2011 and 2010.

Noninterest Expenses. Noninterest expenses totaled $15.8 million and $12.1 million for the nine months ended September 30, 2011 and 2010, respectively. Excluding the increase in other real estate expenses of $3.0 million, noninterest expenses for the nine months would have increased by only $663,000. 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 $231,000 due to increased rates; (2) credit review expense, which has increased $153,000 due to capital raising efforts; (3) consulting expense, which increased $180,000 due to additional needs regarding the consent order; (4) director and shareholder expenses, which has increased $189,000 due to increased premiums for director and officer liability insurance; and (5) legal services, which have increased $172,000 due to ongoing litigation. An offset to the above-mentioned expenses has been a decrease of $453,000 in salaries and benefits as a result of management reorganization.

 

30


Table of Contents

Income Taxes. The Company performed an analysis of its tax position after three years of tax losses. From this analysis, a valuation allowance of $7.4 million was established against our deferred tax asset. This valuation along with a current year income tax benefit of $6.4 million resulted in a $996,000 income tax expense for the nine months ending September 30, 2011 compared to an income tax benefit of $400,000 for the first nine 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.

 

31


Table of Contents

PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings

As disclosed in the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on September 7, 2011, the parties to the civil action Michael D. Larrowe v. Bank of the Carolinas, et al., (No. 1:10-CV-378), brought in the United States District Court for the Middle District of North Carolina, filed a stipulation of dismissal in which the parties agreed to dismiss their claims against one another. The dismissal is “with prejudice,” meaning that the parties may not file suit against each other again on the same claims. All parties agreed to bear their own costs and legal fees. No funds were exchanged in order to effect the dismissal.

Mr. Larrowe was formerly the chief financial officer and a director of the Company and the Bank. He also served as the Bank’s executive vice chairman and chief operating officer. On May 14, 2010, Mr. Larrowe instituted the above-referenced lawsuit against the Bank and certain of its directors and employees.